Zebra Technologies Corp Q4 FY2020 Earnings Call

Good day, and welcome to the Zebra Technologies Fourth Quarter and Full Year 2020 Earnings Results Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead.

Good morning, and welcome to Zebra's fourth quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least 1 year. Slide 2 conveys that the forward-looking statements we make today are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year, on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Anders will begin with our fourth quarter results. Then Nathan will provide additional detail on the financials and discuss our 2021 outlook. Anders will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Senior Vice President of Global Sales, will join us as we take your questions. Now let's flip to Slide 4 as I turn the call over to Anders.

Thank you, Mike. Good morning, everyone, and thank you for joining us. I am proud of our employees' resiliency and focus on serving our customers' critical needs during the pandemic. Through their efforts, we were able to deliver exceptional results to close out a challenging 2020. For the quarter, we realized adjusted net sales growth of more than 10%, or more than 8% on an organic basis; an adjusted EBITDA margin of 23.5%, a 210 basis point year-over-year improvement; non-GAAP diluted earnings per share of $4.46, a 25% increase from the prior year; and strong free cash flow. Each of these measures significantly exceeded our outlook. We generated more business in Q4 than any other quarter in our history. Our teams executed well to satisfy a faster-than-expected recovery in demand from smaller customers through our distribution channel, particularly for our printing solutions. Demand from our large customers also continued to be strong due to their need to digitize and automate workflows in an increasingly on-demand economy. We also drove improved profitability and cash flow while investing in research and development projects to drive sustainable, profitable growth. Our record Q4 results capped a challenging full year 2020, in which we realized slight declines in sales and earnings per share. However, we did achieve record free cash flow of $895 million for the year. With that, I will now turn the call over to Nathan to review our Q4 financial results in more detail and discuss our 2021 outlook.

Thank you, Anders. Let's start with the P&L on Slide 6. In Q4, we returned to profitable growth after a particularly challenging first 9 months of the year. Net sales increased 8.3% before the impact of currency and acquisitions. Our sales mix of large and small orders normalized to pre-pandemic levels, driven by a recovery of our run-rate business, which was driven in part by pent-up demand. Our Asset Intelligence & Tracking segment, including printing and supplies, significantly benefited from the recovery in smaller business demand, with segment sales increasing 14% from the prior year. Our Enterprise Visibility & Mobility segment sales increased 5.6%, driven by solid growth in enterprise mobile computing solutions. We also realized strong growth in services and software, driven by our managed and support services and Zebra retail solutions. From a regional perspective, we realized solid year-over-year growth in North America and significant growth in EMEA, while Asia Pac and Latin America were slower to recover. In North America, sales increased 6%. Printing, supplies, data capture, and services were bright spots. In EMEA, sales increased 20%. Printing, supplies, mobile computing, and services grew double-digits as we saw strong demand through our partner distribution channel. APAC sales were down 4% year-over-year, yet increased sequentially. Printing and mobile computing were bright spots, and we saw modest growth in China. Latin America sales declined 15%, with all major product and service categories declining in a challenging macro environment. Adjusted gross margin expanded 200 basis points to 47.8%, driven primarily by a $12 million recovery of China import tariffs paid in prior periods and improved services and software margin. Business mix had a negligible impact on year-on-year margin comparisons. Additionally, this quarter's results were impacted by $10 million of premium freight costs. Adjusted operating expenses increased $28 million from the prior year period and improved 20 basis points as a percentage of sales. We continue to diligently manage costs while accelerating high-return investments in the business. Fourth-quarter adjusted EBITDA margin was 23.5%, a 210 basis point increase from the prior year period, primarily driven by higher gross margin. We drove non-GAAP earnings per diluted share of $4.46, a $0.90 or 25.3% year-over-year increase. Turning now to the balance sheet and cash flow highlights on Slide 7. We generated $895 million of free cash flow in full year 2020. This was $271 million higher than the prior year. Free cash flow conversion of 130% was significantly higher than our target of 100%, primarily due to timing of customer collections and vendor payments. Lower 2020 payments of incentive compensation, taxes, and interest also contributed to the improvement. Our balance sheet remains strong. From a debt leverage perspective, we ended 2020 at 1.2x net debt-to-adjusted EBITDA leverage ratio, which is comfortably below our target maximum of 2.5x. Let's now turn to our outlook. We entered the new year with a strong order backlog and healthy channel inventory levels. We are encouraged by the pickup in demand, primarily from our smaller customers, which includes pent-up demand from those who had paused spending during the peak of the pandemic. This momentum, along with our sales pipeline, positions us well for double-digit sales growth for the first quarter and full year 2021. In Q1, we expect adjusted net sales to increase between 25% and 29%. This outlook assumes a 300 to 350 basis point additive impact from the acquisition of Reflexis and foreign currency changes. We anticipate Q1 adjusted EBITDA margin of slightly higher than 23%, which assumes gross margin expansion and operating expense leverage. Non-GAAP diluted EPS is expected to be in the range of $4.30 to $4.50. For the full year 2021, we anticipate adjusted net sales growth between 10% and 14%, with growth moderating through the year as we cycle more challenging comparisons and navigate a continued uncertain global economic recovery. This outlook assumes approximately 3 percentage points additive impact from the acquisition of Reflexis and foreign currency changes. We anticipate full year 2021 adjusted EBITDA margin between 21% and 22%, which assumes gross margin expansion from the prior year. We expect free cash flow to be at least $700 million for the year. We do not expect to repeat the exceptionally high level of free cash flow conversion that we achieved in 2020. Please reference additional modeling assumptions shown on Slide 8. With that, I will turn the call back to Anders to discuss how we're advancing our Enterprise Asset Intelligence vision in our end markets.

Thank you, Nathan. Our team has done a fantastic job executing in a challenging environment. We have strong momentum entering 2021, supported by our order backlog and pipeline of business. We continue to build on our industry-leading offerings by investing in our people, operations, and innovation to drive sustainable growth. In 2020, we acquired Reflexis and launched a record number of new products and solutions to ensure that we continue to advance our industry leadership position. Slide 10 highlights how we are building on our foundational capabilities to elevate our value proposition. We are uniquely positioned to solve our customers' complex operational challenges. Our unmatched access to frontline operational data from our vast installed base of products and solutions can be harnessed to gain real-time actionable insights. The result is a more intelligent enterprise with optimized workflows. Through the pandemic, there has been a dramatic increase in the adoption of omnichannel and online shopping. Retailers need proven solutions to overcome the significant fulfillment challenges posed by this profound behavioral shift. If goods are not delivered or made available for pickup as promised, the retailer risks losing its shopper to a competitor. To address this issue, retailers have been prioritizing their capital spend in our broad portfolio of solutions with a sense of urgency. We are enabling retailers to generate an unprecedented amount of valuable data captured through mobile computers, point-of-sale systems, RFID, and other intelligent automation solutions, all of which are critical to digitizing their operations. Key benefits to the retailer include better operational visibility and insights; increased employee collaboration and labor productivity; improved inventory accuracy; well-equipped associates with real-time actionable information; and more satisfied customers. Last month, we participated in the National Retail Federation's virtual sessions, where we showcased how Zebra's solutions help retailers deliver a superior omnichannel shopping experience. At one of the sessions, AutoZone explained how our Reflexis workforce and task management solution equipped their associates with highly flexible mobile technology that enables enhanced customer responsiveness and provides insightful data for analytics and reporting. We are proud to enable AutoZone to go the extra mile to delight its shoppers. Now turning to Slide 12. We continue to be excited about our opportunity to help our customers meet their mission-critical needs in an increasingly on-demand economy. As a trusted strategic partner, we orchestrate end-to-end workflows for customers in a variety of end markets. As I mentioned, retailers continue to prioritize investment in our products and solutions to address their omnichannel fulfillment strategies and related warehouse automation needs. In Q4, we secured multi-million dollar orders from a range of e-tailers, mass merchants, grocers, department stores, and auto parts retailers. In transportation and logistics, strong e-commerce growth continues to drive parcel volumes, while last-mile on-demand fulfillment has become increasingly important. The Italian Post recently selected our printing and scanning solutions for their 13,000 post offices. Separately, the deployment of our TC7 Series mobile computers to United States Postal Service carriers is on track to resume as expected in late Q1, with a goal of completion in Q3. In health care, the need for increased real-time visibility into the entire patient journey as well as the demand for innovative solutions to provide safe and efficient care continue to make health care our highest-growth end market opportunity. In Q4, we grew our relationship with one of America's leading health care providers. New acute care applications have made it increasingly important for this customer to equip more of their clinicians with mobile computers. The most recent use case we addressed was COVID drive-through testing with our health care-purposed TC5 Series mobile computers, which seamlessly interface with their electronic medical record system. Although the manufacturing sector has been hardest hit in 2020, we are optimistic regarding our prospects of returning to growth soon. We see a vibrant opportunity to increase automation in workflows, and we are viewed as a visionary in this market. In Q4, we also secured notable wins beyond our traditional end markets. This included a competitive takeaway win with a leading waste hauler in North America. This customer initiated a multiyear rollout of our ET5 Series tablets, accessories, and related services for its dispatch application, which is improving training and productivity among its drivers, dispatchers, and supervisors. Another important win was with one of the largest metropolitan police departments in the United States. Using our TC7 Series mobile computers, along with ZQ5 Series mobile printers, they implemented an automated parking citation application that generated enough revenue to cover their technology investment in a matter of months. In closing, we continue to find substantial opportunities in our primary end markets, and we are excited about the emerging prospects we see in newer markets. We are well-positioned for ongoing success as the need to digitize and automate workflows continues to accelerate. Now I'll hand the call back over to Mike.

Thank you, Anders. We will now begin the question and answer session.

The first question comes from Andrew Buscaglia from Berenberg.

Your guidance shows strong projections for Q1, but it seems more conservative for the full year. Can you discuss what you're anticipating for the latter half of the year? Your guidance suggests that EVM may see low single-digit growth, while AIT might trend negatively in Q4. What factors are contributing to that outlook for the second half? Any insights would be appreciated.

First, our industry leadership and our steadfast investments in our broad solutions is what's enabling us to rebound stronger and, I think, faster than our competitors. So we do expect double-digit growth for Q1, but also for the full year 2021. And obviously, this is a strong rebound from a more challenging 2020. We do feel as confident as ever about our business. We do expect growth across all our regions, verticals, and business lines as we look at 2021. But we are a bit more cautious about the assumptions we put into our second-half forecast, given the global macro uncertainty that we're facing. And we're also starting to cycle tougher comparisons in Q4. We should also mention that we're not assuming any growth in large deals or large accounts in the second half of 2021.

Okay. And how much of USPS is in the Q1 guide? Because that's such a big guide. And then maybe any other color you can give us on USPS into Q2 and Q3, maybe the percentage that's accounted for per quarter or something?

Yes. The rollout with USPS is moving forward as we anticipated. The teams remain very engaged. As mentioned, we have paused the rollout of our EMC, which includes 300,000 TC77s, since October due to the election and holiday season, but we plan to resume this in late Q1. We expect it to have a modest effect on our Q1 guidance. For the entire year, we estimate that USPS will contribute around one percentage point to our sales growth, mainly in the first half of the year.

Okay. So regarding the Q1 guidance, it's all purely organic with very little related to USPS. It's mainly driven by end market demand. Is this primarily in EVM, or is there a significant order in AIT, or possibly both?

Yes. So that's correct on USPS, and I'd say broad-based across both segments in Q1.

Yes, it's been nice to see the business perform very nicely in Q4 and the outlook for Q1 across all our products and verticals.

The next question is from Tommy Moll of Stephens.

Anders, I wanted to start with a follow-up on your retail and e-commerce end markets. And in the second half of last year, maybe most of last year, once the pandemic took hold, it sounded like within those end markets, it was larger customers who were leaning in quicker into some of the omnichannel capabilities that you offer. Then in today's commentary, you indicated that some small customer activity has resumed and looking positive. Maybe some of that's on the printer side, but I'm curious what you could give us on the mid- or smaller-sized customers within those retail and e-commerce end markets? Anything changing for the better there? Or any context would be helpful.

Yes. First, I'd say that across all the verticals that we play in, we are uniquely positioned to empower front-line workers to perform their duties better and more effectively and with higher customer service, particularly where COVID-19 has helped accelerate some of those secular trends around digitization and automation. So each of our 4 primary verticals had a positive growth trajectory as we entered into 2021, and we're making good progress also in some newer expansion verticals that we talked about in our prepared remarks. Now specifically for retail and e-commerce, I said we saw a step change in consumer adoptions of omnichannel and e-commerce as part of the early phase of COVID. If you look at in-the-store, buy-online, pick-up-at-store and other delivery use-cases, we're growing very rapidly. And in the warehouse, a lot of investments in technology to help automate them are also necessary for retailers to transform their business models. And we're starting to see pilots for our Enterprise Asset Intelligence solutions starting to resume. Another trend that we see in retail is around equipping all associates with a device. That's also very synergistic with our Reflexis workforce and task management solutions, where they work very much hand-in-hand. The strength we saw around more small and medium-sized businesses was broad-based. It includes retail. Also, e-commerce is probably a little less of smaller companies; there's more large businesses. But the small and medium-sized business strength that we saw especially expand across the 4 verticals that we work in.

Perhaps I can add that during the height of the pandemic, specifically in the second and third quarters, we observed that large retail and e-commerce customers were able to continue investing and actively pursued transforming their businesses. In contrast, small and medium-sized customers slowed their spending and were cautious. We particularly noticed this trend outside the U.S. However, we discovered that our solutions, especially in printing and scanning, are vital for these customers. They ultimately need to come back and refresh their purchases, which is contributing significantly to the pent-up demand we experienced in the fourth quarter as they returned to make those essential buys.

That's very helpful. And Anders, you referenced something I wanted to ask as a follow-up, relating to the proof-of-concept-type pilots that you have with some retailers, where, potentially, all associates in the store have some kind of device. What additional color could you give us there just in terms of what inning we're in, in terms of those pilots, when there might be an opportunity for some larger scale commercialization of that concept? And then I noted, let's see, last month, end of January, you introduced a new mobile computer series at EC5x, and the description there sounded like it might be tied to this pilot concept. So I wonder if you could comment on that product innovation as well to the extent it's related.

Yes. For our customers to introduce a device for every worker, that's a great opportunity for Zebra and great expansion for us. Our estimate is, today, that in retail, about 1/3 of all store associates are equipped with a device. And I'd say, today, it varies greatly between retailers how deeply they are penetrated into their associate base with devices. Some are much further along than others. We have worked to basically expand our portfolio of mobile computing devices to ensure that we have kind of appropriate form factors and price points to enable our customers to take this more deeply into their associate base, and we expect that this will be a continued trend. I'm not sure I expect it to be kind of big step-function changes in behaviors but more looking to continually add devices to the store associate base to be able to ensure that they are all connected and able to take advantage of all the other digital tools and solutions that the retailers offer.

Yes, I wanted to just point out 2 other things that I think address this question. One, you're right about the release of the EC5, it's EC50 and EC55, which are devices that combine a consumer-like form factor with all of the advantages that we bring to the enterprise Android ecosystem. And so we expect that, that device, in particular, will play a role in this trend of a device for all. But I also wanted to point out another synergistic part of our strategy, which is the acquisition of Reflexis. Well, Reflexis, as you know, does task and workforce management and, therefore, needs to reach every worker within the enterprise, in particular, of course, retail, which is their dominant vertical. And so, therefore, having a device in the hand of every worker now all of a sudden becomes essential again, and now we're in a great position to meet that demand.

The next question is from Jim Ricchiuti of Needham & Company.

Anders, I wanted to follow up on your comment about the second half and the assumptions concerning large deals. You mentioned that you're not assuming large deals. How does that compare with previous years, considering that typically some of that large deal activity tends to materialize as the year progresses?

That's correct. I'd say this is more a matter of limited visibility into the second half than it is, that there's a certainty that there won't be growth in larger deals. I think this is similar to how we generally forecast our years. So yes.

Okay. I have a follow-up question regarding component constraints. We're hearing about tightness in semiconductor components throughout the supply chain. I'm curious about how significantly that is impacting your supply chain.

Yes. We've definitely seen the lead times extending. But our team is working diligently, and I think we are on top of it. We have incorporated whatever visibility we have to extended lead times for our semiconductors and other components into our outlook also, particularly for the second half.

The next question is from Meta Marshall with Morgan Stanley.

Great. I guess I just wanted to dig into how you guys are thinking about gross margins into Q1 and into 2021. Clearly, you guys saw a pickup in kind of your smaller customers, which would have helped gross margins in Q4. You clearly have some large deals and still some kind of overhang from freight as you head through 2021. So just how we should be thinking of the progression of gross margins through 2021? And then maybe just as a second question, just given the kind of very healthy cash flow that you guys saw in 2020 and kind of the continuation of that into 2021, how do you guys kind of think about balance sheet prioritization currently?

Yes. So if you look at our full year guide, EBITDA of 21% to 22%. We expect gross margin to improve year-on-year, primarily due to the order size mix normalizing, which we saw in Q4 and implied in our Q1 guide. We do expect premium freight costs to persist around $30 million to $40 million, yet declining in the second half as air travel returns. And within the full-year guide, we do expect OpEx to increase as a percent of sales once you include a full year of Reflexis as well as the majority of our spend returning post-COVID, including incentive compensation and travel, particularly in the second half. I also think it's worth noting when you look at the full-year EBITDA guide, Reflexis, as we stated, is going to be a dollar-neutral year, yet slightly dilutive given the investments in go-to-market and the platform. Then we do expect that to scale over time. In response to your second question, our free cash flow for the year was $895 million, marking a strong conclusion to the year, largely driven by improved core working capital performance, particularly in accounts receivable. We experienced robust collection efforts and some early timing benefits at year-end, along with front-loaded sales in Q4 that contributed positively. Additionally, small incremental accounts receivable factoring, reduced taxes, lower interest expenses, and incentive compensation also helped exceed year-on-year expectations. Looking ahead to 2021, we anticipate a decline, mainly due to the outstanding performance in 2020, as we return to a more typical free cash flow conversion rate over the two-year horizon.

The next question is from Paul Coster of JPMorgan.

I'm just wondering if we are at the sort of inflection point for the company in terms of the sort of mix shift and margin outlook. As the AIT business sort of comes back a bit, will be a bit driven by the smaller accounts here, obviously has higher margins. But you've also got the software and services business growing faster. As far as I can figure it out here, you're probably seeing in excess of 50% growth for the Reflexis business, which has, what, 20 percentage points higher gross margins than the rest of the business. So it sort of feels to me like we're heading towards a new margin structure over the next 3 or 4 years. Can you comment on that?

The margin structure or more on the business inflection, generally?

Well, yes, the margin is related, obviously, Anders. But will gross margins continue to expand from this point? And will the business mix be permanently changing?

Yes. Okay. I think Nate is best positioned to answer that.

Yes, Paul. So if we look at margin and margin expansion over time, we do believe we can go higher, and we have many levers to achieve that. I think, as you mentioned, scaling some of the newer markets with richer gross margin, Reflexis being one of those proof points. We always continue to focus on driving higher gross margin and productivity through all of our operational efficiencies across the business. And we've had a track record of doing that and driving profitable growth. And we do expect EBITDA margins to get back to the pre-pandemic levels in '21, and we really don't see any reason that, that should be constrained as we move forward in terms of continued expansion.

I'm trying to understand if there will be a shift towards AIT and service and software, and whether that will lead to a structural increase in margins over the long term, going beyond just returning to pre-pandemic levels to levels similar to before the MSI acquisition.

Yes. First, consider the business surrounding our core near adjacencies and the Enterprise Asset Intelligence or Intelligent Edge Solutions, which are newer offerings. I believe our core business in AIT printing and scanning, including services, is in very good shape and will continue to grow at a solid pace over the long term. I don't expect printing to significantly outperform other areas since it has fluctuated over the last year. There is likely some pent-up demand for printing solutions compared to other offerings. However, looking at our Enterprise Asset Intelligence vision and Intelligent Edge Solutions, I anticipate our software assets and more intelligent automation solutions will grow faster than the company average in terms of gross margin, and scaling will support this growth. As we invest in these new solutions, we will enter an investment phase initially, but we expect margins to improve significantly once revenue begins to rise. Does that address your question?

Yes, it does. Regarding Reflexis, is it correct that it's currently experiencing more than 50% compound growth? Could you also share some insights on the growth rate for Temptime?

So we aren't commenting on the specific growth rates that they have. But Reflexis has been growing at nice double-digit growth rates for the last several years, and we have high expectations that will continue to do that and that it will also help accelerate some of our other growth of some of our other software assets that will be benefiting from being associated with and incorporated into the Reflexis platform. And Temptime has had nice growth over the last few years. And we do see this year the opportunity to accelerate growth as we support COVID-19 vaccine rollouts and distribution. So we do expect a double-digit growth for our Temptime business as well.

The next question is from Joe Aiken of William Blair.

This is Joe filling in for Brian today. I want to begin by discussing some of the successes you've had outside of your typical markets. You mentioned a waste hauler in your prepared remarks, and I’m curious if you could elaborate on that. What factors contributed to that success? Also, what opportunities do you see in various nontraditional markets, and how significant might they be moving forward?

Sure, I can begin. We've been focusing on enhancing our products to meet the needs of emerging verticals such as government and utilities. Additionally, we've made significant investments in our go-to-market strategy, starting with our acquisition of Xplore. We've also adjusted our other products to better address these new use cases. This has been a key area of focus and investment for us over the past few years to position ourselves effectively. Now, we have a range of solutions and partners that will enable us to seize these opportunities successfully. Joe?

Yes. I would only add that the end markets that have shown some particular promise are government, both federal and state and local as well as the broader service industry, where the waste hauling example fits in. The Xplore acquisition, where Xplore has a strong market, the rugged tablets are a strong product offering into those markets, has been instrumental in leading us there. But it also has been something we've been pursuing for some time, but it does take some time to build up the channel infrastructure as well as fine-tune the product offering and hire the appropriate type of dedicated and expert sales reps who can operate in those verticals. And we feel we now have that in place, and it's beginning to pay off.

Great. That's really helpful. And I know, on some past calls, you've talked about the transition to Android on the mobile devices in the past and the benefit you're seeing from that. Is that transition largely over at this point? And maybe just to put a finer point on that, what percentage of devices do you estimate that you're shipping today are running Microsoft operating system?

Yes. First, regarding our mobile computing platform, we experienced solid growth in Q4, benefiting from a recovery in the small and medium-sized business segment. There are three key trends worth highlighting. The first is the emergence of new use cases. We previously discussed the second trend, which involves equipping every worker with a device. The most significant driver has been the omnichannel approach in retail. Health care is a newer area that presents numerous new use cases. The third trend pertains to the transition to Android. We maintain strong momentum in this transition and see substantial opportunities ahead. Our market share in Android remains around 60%, yet Android now constitutes about 80% of our mobile computing sales. While we've often talked about moving older legacy Windows devices to Android, we now believe the opportunity to refresh existing older Android devices is even greater. We estimate there are low double-digit millions of Android devices in circulation, which tend to have a shorter refresh cycle compared to the older Windows devices, which we estimate are in the high single-digit millions. Thus, we have a more balanced view and really aim to address both areas. Android has indeed been a significant catalyst for our growth.

Next question is from Richard Eastman of Robert W. Baird.

Just a quick question. Could you tell us if the China tariff rebate impacted gross profit margin and whether that had an effect on the EVM margin? Was the impact limited to EVM?

Thank you for the question. Out of the $12 million, $8 million was related to EVM, and $4 million was for AIT in the fourth quarter.

Okay, okay. Yes, in Q4? Okay. And then just a question around maybe the balance that you saw in your go-to-market. So for all of '20, can you just kind of tell us how the direct business did relative to the channel? I'm just thinking sales growth or decline?

Yes. I can start, and then Joe can provide some additional color also. Our direct business obviously did very well because we had strong large deal activity, but also a lot of the larger customers that we worked with, we have been supporting through channel partners. So our channel centricity, so that's how much of our revenues go through channel partners, was actually, I think, at an all-time high in Q3 or Q4. So we have maintained a high degree of channel centricity in the business. Joe?

Yes, exactly. Our strategy has been and will continue to be a focus on a channel-first go-to-market approach. This has proven to be very effective for us during the pandemic, as our strong relationships with partners have played a crucial role in our faster recovery, which is reflected in our run rate. Additionally, a significant contribution from large deals in the second half stands out, highlighting that the percentage of our business flowing through the channel has increased as part of our overall strategy.

When you speak to some of the smaller and medium customers, is that visibility coming through from the VARs? I mean, again, we speak about the channel, but we obviously put distribution in there versus the VARs. And I guess my question is, what's the visibility on the VARs in the smaller and medium-sized customers rebounding in '21? Do you have that visibility either in orders? Or is it kind of frontlog and conversation with VARs or...

Well, so we rarely have visibility to the specific individualized orders on small and medium businesses, right? We have the distribution and channel in between. But what we know is that our distributors have a very strong outlook for the upcoming quarters, at least, and are ordering strongly with us. As we indicated, our order volumes have been strong. And that's, I think, a reflection of that optimism that our distributors are feeling, in particular, also from SMB customers.

I understand. In 2021, the gross profit margin assumption is notably higher. I'm curious if the mix of end-customers varies from small to medium, especially given that you've mentioned large orders in the latter half of the year. Are you cautious about that aspect? Additionally, does this customer mix support the expected increase in gross margin for 2021?

We anticipate a more conventional business mix in 2021 compared to 2020, especially in the second and third quarters, where large deals were somewhat overrepresented. As Joe mentioned, we don’t have strong visibility around individual smaller deals, but our channel account managers regularly collaborate with our channel partners to discuss forecasts, specific deals, and the support they require from us. Therefore, we have some degree of visibility, although it obviously diminishes the further out we look.

Yes, I understand. And just to focus on gross margin for a moment longer, what is the pricing assumption for 2021? Are we able to capture enough price increases to offset some of the COGS inflation that we are experiencing in the business? It seems likely, but do you anticipate any net price increase, or will it mainly be a matter of net pricing?

So maybe first, I think when you talk about COGS increase, is that the freight charges you're referring to? Or...

Yes, so there's freight charges and just any other cost inflation in the supply chain, in your supply chain.

Yes. I think we don't modify our pricing based on what we believe to be a temporary cost inflation for freight. But we do have a lot of analytics and thoughts around our overall price points and where the market is. And we do always strive to get a premium for our brand. So pricing and margin is obviously a very strong focus that we have across the company. But we haven't necessarily gone and changed our price list because of this. Joe, if you want to add anything to that?

Looking back at 2020, our business was primarily focused on larger clients. There was a temporary pause in purchasing from smaller clients that resumed toward the end of the year. However, in the long term, small client contributions were below the average. In 2021, we anticipate that this mix will shift back to normal, which should lead to a normalization of average price points as well.

The next question is from Keith Housum of Northcoast Research.

Congratulations on a good quarter and good guidance. Just trying to unpack the printer growth a little bit more. Can you help me understand that, in terms of that growth, is a substantial part of that growth being driven by not only the SMBs, but also growth in the supplies business as well?

Yes, we experienced significant growth in both printing and supplies, with both segments showing double-digit increases this quarter. Our printing business grew across the entire portfolio, benefiting from pent-up demand, especially in EMEA, which faced a more severe impact earlier in the pandemic. Additionally, we took several steps in early 2020 to enhance our go-to-market strategy and our channel ecosystem in printing, and those efforts are now yielding positive results. This has made us more competitive and is contributing to our increasing market share in printing. Furthermore, our small and mid-sized business segment recovered more swiftly than anticipated. In Q4, the manufacturing vertical has been relatively weak, though printing remains strong overall and is improving. Notably, RFID had an excellent quarter for printing, likely reaching record levels. Supplies also performed well, particularly in North America, and Temptime posted strong results in the fourth quarter. Overall, we have a robust lineup of smart and connected printers with exceptional manageability through our Link-OS operating system, which is a significant market differentiator.

Thank you for the information. I would like to follow up on a comment made earlier during the Q&A. It was mentioned that the U.S. Postal Service is expected to contribute approximately 1% growth for the year, mostly in the first half. However, you also noted that the contribution would be very modest in the first quarter. If I am calculating correctly, this could suggest a $400 million contribution from the U.S. Postal Service in the second quarter. Is that accurate, and does that figure include both ancillary projects and the main fulfillment of 300,000 devices?

Yes. If you consider the USPS for the year and the size of the rollout, looking at the 300,000 printers we plan to deliver in 2021, you can deduce that we're selling around 2 million mobile computers each year. This information can give you an idea of the average price range. The figure you have for Q2 seems a bit higher than what we would expect for the overall annual guidance.

Yes. Remember, we've talked about earlier, the total volume of mobile computers for USPS, this contract is about 300,000 over 2 years.

Understood. Understood. Yes. Just doing the math there, I guess, that $400 million, roughly, I understand it might be a little bit high. It seems a little bit more than a lot of us were assuming for the entire value of the contract. And we realize you guys fulfilled some last year as well as what you'll fulfill this year. So it seems, again, perhaps higher than what a lot of us were assuming.

Yes. As I said, I think the best way for you to think about USPS this year is that 1% of our growth in 2021 is coming from growth of our USPS business. And I wouldn't say Q2 is the only quarter, but Q1 will start ramping up towards the end of Q1, but Q2 and Q3 will certainly be part of it.

The next question is from Blake Gendron of Wolfe Research.

I want to follow-up there with some of the growth commentary. So the dollar impact from what you would consider pent-up demand to be greater or less than 4Q? And do you expect some pent-up demand follow-through into the second quarter? And I guess, longer term, I mean, are we going to see this pent-up demand idiosyncrasy show up in subsequent years just based on the replacement cycle? Or is it going to normalize fairly quickly as we recover here on the pandemic?

Well, yes, the pent-up demand concept is a little hard to quantify. But I'd say that starting with our products and solutions, are now mission-critical for our enterprise customers, and they need that to compete effectively in their on-demand economy. The sales to our larger companies, larger customers that we talked about in an earlier question, remained strong. And they have prioritized spending with us to better position themselves to address the newer automation and digitization trends like omnichannel, as an example. And I'd say our larger customers who are better positioned to pivot their businesses early in the pandemic, to align with how consumers wanted to behave how the economy was working at that point, while smaller customers had to kind of pause spending or certainly cut back on it. But I think, now, we see the smaller companies coming back and other customers are also realizing that they need to invest in order to compete. Competing in the same way they did prior to COVID is not necessarily going to be a successful formula. And I think that part of this is also that we have been able to execute very well during the pandemic, and we've been able to gain share. Our supply chain has shown great agility to be able to respond to customers that quickly want to ramp up their order volumes, and I think we were able to do that well and seize some opportunities that way. So we have been realizing some good demand from this pent-up demand, you can say, which helped us in Q4, and I expect it to help us in Q1 here also. But more broadly though, as we look forward, we are very excited about the business overall and the growth prospects that we have not just in Q4, Q1, but the longer term, based on our ability to help our customers digitize and automate their businesses.

Yes. This is Nathan. As Anders mentioned, it's certainly challenging to quantify. In our Q1 guidance, we believe that pent-up demand is likely driving low double-digit growth on top of mid-teen growth from our normal growth rates, along with the effects of acquisitions, foreign exchange, and comparisons to last year, where we began to feel the impacts of COVID late in Q1.

Yes, that's helpful. I understand it's tough to quantify and disaggregate everything. But the longer-term growth outlook is kind of what I was getting at, and that's constructive. My follow-up is on EVM. I'm just wondering, over the last call it, 12 months or through the pandemic, what the growth of existing customers is with EVM versus new customer wins? How you see that evolving, I guess, here over 2021 and beyond? And is there any major margin difference between one or the other? Or should we think about EVM kind of along the same lines and delineate large versus small customers in terms of margin difference?

Yes. I’d like to start by mentioning that when it comes to new customers, it's uncommon for us to find completely new clients who haven't engaged with us in some capacity before, as most companies already conduct some level of business with us. Instead, we often see new awards or new use cases emerging from our existing customers. Our insights are generally limited to our larger clients. We've certainly gained a solid number of new customers and I anticipate that we will keep introducing new use cases and applications. Our portfolio of solutions reflects substantial investment aimed at broadening the range of use cases to tackle our customers' most urgent issues. We are confident in our competitive position and our ability to capture these new opportunities. While they may not be entirely new customers, they do represent new use cases.

Yes. I mean, to your point about is there a big margin difference between the 2, I would say, not noticeably. The new customers that we are able to acquire, so ones that were previously competitor customers, there have been meaningful ones, of course, right? I mean, USPS is one example of those that was in the last 12 months. But they do range from the small to the large and, therefore, I would expect, without having done the analysis, that there isn't a meaningful margin difference between the 2.

That's very helpful. One more, if I can sneak it in here. Your balance sheet is in great shape. I wonder if you could just level set the capital allocation thoughts here, and maybe update us on the M&A pipeline?

Certainly. I'll begin. We finished the year with a net debt-to-adjusted EBITDA ratio of 1.2x, which is lower than our maximum target of 2.5x. Our main focus remains on both organic and inorganic investments in the business, and we are enthusiastic about the opportunities available in those areas. We also have our share repurchase program, which we view as a flexible method for returning capital. We plan to continue being opportunistic with this strategy, as demonstrated by our $200 million in repurchases in 2020, and we will carry this approach into this year.

We are very enthusiastic about the prospects for our business and view mergers and acquisitions as a key growth avenue. We see M&A as a means to accelerate our efforts on our Enterprise Asset Intelligence vision. It is not merely a standalone growth driver, but rather a strategy to enhance the execution of our vision. We are focusing on select bolt-on acquisitions as well as those with higher growth potential that will help advance our Enterprise Asset Intelligence goals. There are promising opportunities in the digitization and automation of supply chains and various workflows. Additionally, as mentioned by Nate, we maintain a strong balance sheet that supports these initiatives.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Gustafsson for closing remarks.

Yes. To wrap up, I would like to thank our employees and partners for our exceptional Q4 results and a strong start to 2021. And as we continue to navigate the pandemic, our top priority continues to be protecting the health and well-being of our employees, partners, and customers. So stay safe, everyone.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.