Zebra Technologies Corporation (ZBRA) Q3 2021 Earnings Call Transcript

Image source: The Motley Fool.

Zebra Technologies Corporation (ZBRA -1.52%)
Q3 2021 Earnings Call
Nov 2, 2021, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

[Operator Instructions] Good day, and welcome to the Third Quarter 2021 Zebra Technologies Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead.

Micheal Steele -- Vice President of Investor Relations

Good morning, and welcome to Zebra's third quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Our forward-looking statements 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 this 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 third quarter results, then Nathan will provide additional detail on the financials and discuss our fourth quarter outlook. Anders will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer, will join us as we take your questions.

Now let's turn to Slide four as I hand it over to Anders.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team delivered exceptional third quarter results that exceeded our outlook, supported by robust broad-based demand for our solutions. For the quarter, we realized adjusted net sales growth of 27% or 23% on an organic basis, an adjusted EBITDA margin of 21.7% and a 140 basis point year-over-year improvement. Non-GAAP diluted earnings per share of $4.55, a 39% increase from the prior year. And strong free cash flow. Our customers are prioritizing investment in our solutions to digitize and automate their workflows in an increasingly on-demand global economy.

We realized double-digit sales growth across all four regions, with particularly strong growth in EMEA. Favorable business mix and higher service and software margins enabled us to expand our gross profit margin despite escalating freight costs. Our teams have been diligently leveraging alternative modalities of transport and expediting shipments to mitigate the impact of continued industrywide supply chain challenges. We also scaled operating expenses while continuing to invest in initiatives to drive sustainable, profitable growth.

With that, I will now turn the call over to Nathan to review our Q3 financial results in more detail and discuss our Q4 outlook.

Nathan Winters -- Chief Financial Officer

Thank you, Anders. Let's start with the P&L on Slide six. In Q3, adjusted net sales increased 26.6%, including the impact of currency and acquisitions, and 23.2% on an organic basis reflecting broad-based demand for our solutions from customers of all sizes. Our Asset Intelligence and Tracking segment, including printing and supplies, grew 12.1%, while Enterprise Visibility & Mobility segment sales increased 27.9%, driven by exceptional growth in mobile computing.

Note that we also realized double-digit growth across services and software. All four regions grew double digits. North America sales increased 14%, with particular strength in mobile computing, supplies and services. EMEA sales increased 39% and with strong growth across all major solutions offerings, particularly mobile computing. APAC sales grew 17%, with strength across most geographies, including China. And in Latin America, sales increased 41%, continuing with strong recovery with double-digit growth in all major offerings. Adjusted gross margin expanded 130 basis points to 45.1%, primarily driven by favorable business mix and higher service and software margins.

These benefits were partially offset by significant premium freight charges, which we will discuss further in a moment. Adjusted operating expenses as a percentage of sales improved 30 basis points as we continue to prioritize high-return investments in the business. Third-quarter adjusted EBITDA margin was 21.7%, a 140 basis point increase from the prior year period, reflecting higher gross margin and operating expense leverage. We drove non-GAAP earnings per diluted share of $4.55, $1.28 or 39% year-over-year increase which benefited from lower interest expense and a favorable tax rate.

Turning now to the balance sheet and cash flow highlights on Slide seven. We generated $798 million of free cash flow through the first nine months of 2021. This was $316 million higher than the prior year, primarily due to increased profitable growth. Our balance sheet remains strong. From a debt leverage perspective, we ended Q3 at a modest 0.5 times net debt to adjusted EBITDA leverage ratio, which provides us ample flexibility. In the first nine months of 2021, we invested more than $300 million to acquire Fetch Robotics and Adaptive Vision to advance our intelligent automation solutions in manufacturing and the warehouse. We made $24 million of venture investments in four portfolio companies. In addition, we made $38 million of capital expenditures and $25 million of share repurchases.

On Slide eight, we show the multiyear impact of transitory costs primarily related to expedited freight due to supply chain bottlenecks caused by the pandemic, as well as tariffs on China imports. Our supply chain team continues to take extraordinary measures to satisfy customer demand in an exceptionally challenging environment. Global freight costs are elevated for all modalities of delivery across our supply chain. This includes higher shipping cost per kilo, a significant shift from ocean to airfreight as well as increased cost to expedite component parts to our Tier one manufacturers to meet customer commitments. In Q3 compared to pre-pandemic rates, we incurred incremental premium freight costs of $44 million, which was $36 million higher than the prior year.

For Q4, we now expect approximately $55 million of premium freight costs based on the higher spot rates we are seeing in the market, which translates to a four percentage point negative gross margin impact. We expect premium freight costs to abate as component supply and freight capacity improves. Let's now turn to our outlook. Our robust sales pipeline and strong order backlog is supported by broad-based demand for our solutions as enterprises look to automate their operations to satisfy increasing consumer expectations. Despite extended lead times and uneven inventory availability, we expect fourth-quarter adjusted net sales to increase between 8% and 12% year-over-year. This outlook assumes a two percentage point additive impact from acquisitions and foreign currency changes. We anticipate Q4 adjusted EBITDA margin to be slightly higher than 21%, which assumes gross margin contraction from the prior year due to significantly higher premium freight expense, which I discussed earlier. We are also experiencing product component inflation, which we expect to largely offset with price increases that became effective in September. Non-GAAP diluted EPS is expected to be in the range of $4.20 to $4.50. We have increased our free cash flow outlook to be at least $950 million for the year due to higher-than-expected profitability.

Please reference additional modeling assumptions shown on Slide nine. With that, I will turn the call back to Anders to discuss how we're advancing our Enterprise Asset Intelligence vision in new and existing markets with spotlights on our acquisition of Antuit and our healthcare vertical.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Thank you, Nathan. I am encouraged by the strengthening demand across our business and the bold actions our teams are taking to navigate supply chain challenges. Slide 11 illustrates how we digitize and automate the front line of business by leveraging our industry-leading portfolio of products, solutions, software and services. By transforming workflows Zebra's customers can address complex operational challenges to achieve higher levels of performance. By closely collaborating with our partners and customers, we help businesses across a variety of end markets to implement solutions that maximize their return on investment.

Human labor is a scarce resource. Our innovative solutions empower their workforce to do their jobs more effectively by navigating constant change in near real time, utilizing insights driven by advanced software capabilities such as machine vision, prescriptive analytics and artificial intelligence. In October, we acquired Antuit for approximately $145 million to further advance our Enterprise Asset Intelligence vision. This high-margin Software as a Service business generated sales of approximately $27 million in 2020, nearly doubling over a three-year period.

Slide 12 illustrates how the AI-powered demand forecasting solution ensures that its retail and consumer product customers have the right inventory at the right time at the optimal price, whether it's fulfilled through online ordering or in-store shopping. Antuit's cutting-edge offering complements our suite of workflow software solutions, including Reflexis, Zebra Prescriptive Analytics, Workforce Connect and SmartCount, which works together to increase the performance of labor and inventory across the integrated supply chain. Our growing software suite will help our customers break down silos between planning and execution, giving them a competitive advantage that can increase revenue and margins as they navigate the increased demands of omnichannel fulfillment.

Now turning to Slide 13. Businesses partner with Zebra to optimize their end-to-end workflows. I would like to highlight a few recent key wins across our end markets that demonstrate how Zebra solutions are improving productivity and service levels. In retail, Zebra is enabling improved execution of omnichannel fulfillment as more consumers shop online. We recently secured our largest win to date in India, providing TC21 mobile computers and printers to help a local retailer compete more effectively against its larger omnichannel and e-commerce global competitors. We are also enabling a Japanese supermarket chain to provide an improved customer experience with our EC55 personal shopping mobile computing solution.

Over the next several quarters, a leading home improvement retailer will be deploying 90,000 TC52 mobile computers to a broader number of associates in their stores. Key use cases include item locationing, best-in-class long-range imaging, mobile point-of-sale and e-commerce functionality. Competitive differentiators for this win included our seamless network connectivity, best-in-class noise cancellation and enterprise leading durability. Our mobile computers will also have full desktop functionality when inserted into workstation cradles.

This retailer is also deploying our Workforce Connect Software-as-a-Service solution, which enables associate-to-associate instant collaboration as well as associated-to-group and's store-to-store communication. A leading North American transportation and logistics company is deploying 9,000 TC77 mobile computers to their truck drivers for loading and delivery use cases. This solution will increase productivity, improve inventory accuracy, log driving times and track regulatory compliance. Turning to

Slide 14, we highlight how healthcare providers are using Zebra solutions to digitize and automate the patient journey and address labor challenges. Our recently published Vision study highlights that 95% of decision-makers expect to increase spending in healthcare IT and clinical mobility in the next year. We have some exciting recent strategic wins that demonstrate our value proposition. We recently secured a takeaway win of a leading U.S. healthcare provider with more than 150 hospitals and approximately 2,000 sites of care.

This customer selected Zebra to provide a multiyear rollout of 85,000 scanners for a wide range of use cases, including bedside nursing, surgery, pharmacy and inventory management. They also recognized our unique software tools that enable real-time event tracking to prioritize patient care. A large Eastern European public hospital system recently placed in order to provide 19,000 TC25 mobile computers to nurses across 100 hospitals. Hospitals are facing labor shortages made worse by the pandemic, which puts patient safety at risk. Zebra's solutions, including printers and wrist bands, reduces the administrative burden on the nursing staff and allows for more efficient patient care. Our value proposition to this customer also includes real-time tracking of costs of supplies, equipment and medicine.

Additionally, Zebra is growing our long-standing relationship with GE Healthcare, whose solution, Encompass, utilizes Zebra's Bluetooth beacon technology for medical equipment asset management. This solution improves asset utilization and prevents unnecessary equipment replacement purchases. Caregivers also benefit by reduced time searching for medical equipments, which can increase time dedicated to patient care. In closing, the pandemic has accelerated trends that have been driving Zebra's business, including omnichannel shopping adoption, the desire for track and trace across the supply chain and the need for a more digital healthcare experience. Our core markets are vibrant and our prospects to scale newer expansion markets are bright. We are steadily navigating through significant transitory industrywide supply chain challenges. That said, we continue to be as excited as ever about our long-term profitable growth prospects.

Now I'll hand the call back over to Mike.

Micheal Steele -- Vice President of Investor Relations

Thanks, Anders. We'll now open the call to Q&A. [Operator Instructions]

Questions and Answers:

Operator

[Operator Instructions]. The first question today comes from Tommy Moll with Stephens. Please go ahead.

Tommy Moll -- Stephens -- Analyst

Good morning, and thanks for taking my questions.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Good morning.

Tommy Moll -- Stephens -- Analyst

Anders, I wanted to start on your Antuit acquisition. Wondered if you could highlight a couple of ways in which it might be synergistic with your portfolio. And I really -- I had two buckets in mind. First just in terms of scale, you've got more robust go-to-market capabilities, more robust R&D dollars you can put against it. So what would you highlight for us there? But also just in terms of the portfolio and fit, so if I'm a customer, what augmented capabilities will you be able to deliver with the software platform given you've got other software adjacencies and hardware opportunities to deliver a solution versus what the portfolio -- or rather what Antuit would have done as a pure stand-alone business?

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Yes. I'll try to go through and give you some insights to each of those points. But the first, this helps us in our -- to augment our solutions around improving retail store execution for our customers as well as for consumer products companies. It is very synergistic with our Enterprise Asset Intelligence vision. And we talked about our sense, analyze, act framework here, and this is very much around the analyze and act part of this, enabling our customers to sense what's happening in the real world, analyze this information and act on it in real time.

The solution that Antuit offers is a demand-sensing solution, it's called, that's -- but that they take in lots of different data feeds, anything from in-store sales to weather, social media and use that to determine basically what demand trends will be. And they can be very quick and do this much better than, say, traditional models. If you take an example, like when COVID happened, Antuit's algorithms were able to better and quicker adjust to this new environment. And it's very, say, synergistic with our other offerings, particularly, say, on the software side, where say -- take Reflexis, where Antuit's insights will generate actions for our Reflexis task management solution, so they can be to go and replenish something, move inventory from the back of store to the front of store or other parts of the supply chain.

So it is very much kind of works synergistically with our broader software solution as well as with our devices. So our mobile computers will generate insights that Antuit can analyze and put into its AI algorithms to drive better insights from. And with this broader set of solutions, we position Zebra to be more of a strategic solutions partner to our customers. And we have access to more executives or -- more customers and more executive level people at our customers than Antuit would have individually. So therefore, we think that this fits very well with our broader strategy.

Tommy Moll -- Stephens -- Analyst

Thank you.

Joachim Heel -- Chief Revenue Officer

One other addition, this is Joe Heel. If you think about the customer set, you mentioned go-to-market, that Antuit targets, it is primarily merchandising executives in retail and in packaged goods. Of course, that retail is a very strong segment for us, so that should give us the ability to leverage our scale to the benefit of Antuit's offering. And conversely, we have a position in packaged goods, but Antuit will give us a stronger offering to further expand our offerings in general, not just Antuit, but in the way Anders described, into packaged goods.

Tommy Moll -- Stephens -- Analyst

Thank you, both. That's very helpful. I wanted to pivot for my follow-up to the margin. And again, we appreciate the transparency you've offered around the premium freight headwinds and the trajectory there. So we're looking at $55 million for Q4. And my question really is the following. If you think about how the fourth quarter is progressing, both in terms of the realization of some of the pricing actions you've taken, then also you've got on the cost side, it's dynamic and presumably changing on a day-to-day or week-to-week basis. So if you think about where you likely end the quarter, once all that rolls through versus the full quarter outlook you gave, I think it was above 21% for the quarter. Does it feel like the exit rate is probably a little better than that average? Or how do you see things shaping up here in real-time?

Nathan Winters -- Chief Financial Officer

Tommy, maybe just to start with the fourth quarter. As you mentioned, you are slightly above 21%. That is down from the prior year, a little over two points. So four points, that's the premium freight, but offset by favorable business mix as well as improved service margin as well as improvement just in the underlying product margin. And as you mentioned, we have raised prices to offset the component pricing, so the unit price. I think -- so that's something we're continuing to monitor and assess is how the transitory impacts play out. I would say from a logistics and freight perspective, we do expect that to moderate through the first half of 2022. But I'd say it's something we're managing day to day, week to week. And we'll see how the quarters play out in terms of when we start to see a meaningful benefit from where we're at today.

Tommy Moll -- Stephens -- Analyst

Nathan, just to make sure I'm tracking you here. It sounds like the pricing actions are really more targeting the product aspect of inflation rather than the freight. Am I hearing you correctly?

Nathan Winters -- Chief Financial Officer

That's correct.

Tommy Moll -- Stephens -- Analyst

Okay.

Nathan Winters -- Chief Financial Officer

That's correct. We have not raised prices to offset the transitory premium freight expenses, but that's something we'll continue to assess as this plays out.

Tommy Moll -- Stephens -- Analyst

Great. I appreciate the insight. I will turn it back.

Operator

Our next question comes from Andrew Buscaglia with Berenberg. Please go ahead.

Andrew Buscaglia -- Berenberg -- Analyst

Hi, guys. Just on that question around margins. How are you able to manage sort of the supply constraint issue in securing parts for your products? And it seems broadly across most of industrial customers and the customer companies in general, but these constraints will continue into next year. So I guess, what are you doing on that side of things to manage? You talked about the freight cost, but just wondering in terms of securitization of parts.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Yes. So I'll start kind of at the higher level here. And so if you look at the broader backdrop, demand has ramped very fast over the past year, and we have now prioritized meeting our customer needs and commitments. And while we are not always able to meet our traditional lead times due to these industrywide supply chain challenges, we have been working with our partners and customers to make sure that we can deliver very strong double-digit year-over-year growth. And I'd say based on feedback from our customers and partners, we've been managing this better than our competition.

Specifically for how to secure parts, looking at the semiconductor industry shortages that has impacted the availability and pricing of some parts more than others, or some of our devices than more than others, this is a highly dynamic environment. And we get -- so we sort out and get good news on some parts. Next day, we get some more challenging news on other parts. So it is kind of very much of a dynamic environment for us. But I'd say our teams have been working very well. Done an exceptional job of working all angles to figure out how to mitigate these issues. Starting with -- we've been built more resiliency in our supply chain by putting in new assembly plants across Southeast Asia, so we're less dependent on any particular plant.

And in Q3, for instance, we had to move volume between plants based on COVID outbreaks. So that was a great way for us to leverage that. We've also worked really hard to engage with our semiconductor suppliers to make sure that we get our fair share, so we get proper allocations of parts. And we're having a large part of our engineering team working on redesigning our devices to qualify new alternative components that are not as exposed to or limited with supply. So we're doing all of these things to ensure that we can meet our customer needs as well as possible here. But as I said, it's a dynamic environment. It's difficult to predict how exactly it's going to play out. But based on our conversations with our suppliers, I'd say, we expect a gradual improvement by mid-2022 on the component side.

Andrew Buscaglia -- Berenberg -- Analyst

Okay. Yes, that's helpful. You do stand out as someone who's managed these constraints very well and you raise the line of fire of that issue. So I thought it does sound like you have the capabilities in place to keep that going. And I think -- on the demand side, I thought that your AIT sales would be a little bit higher. How much of that is related to that supply constraint issue? Or are you seeing any sort of moderating in demand?

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

First, I'd say, we continue to drive innovation across the entire portfolio of products and solutions. And we're helping our customers to digitize and automate their operations. And the core business is very vibrant. And we're very excited about the adjacent expansion opportunities that we have. Now specifically for printing, we had a very solid -- we delivered a very solid growth across the regions in printing. Printing was up across most of its portfolio. We have particular strength in manufacturing, which tends to deploy mostly tabletop printers. We also saw strong run rate or smaller business through our channel.

But it's fair to say that printing was disproportionately impacted by supply chain challenges. And that was -- that includes both component issues, but also that our main assembly plant in Southeast Asia had to almost shut down based on COVID, and we had to shift a lot of the volume from Vietnam to China. So that took some capacity out of the quarter. But it still was a very good quarter for printing. We could have done probably a little bit better, but we still believe that we continue to gain share. Certainly, year-to-date, we gained a lot of share in printing. And also in the AIT segment here, we had very strong growth in supplies across all regions, and that includes our Temptime portfolio. And we -- in Q2, we launched our new SOHO printer, very excited about that. That's off to a good start.

Andrew Buscaglia -- Berenberg -- Analyst

Got it. Thanks, Anders.

Operator

Our next question comes from Jim Ricchiuti with Needham & Co. Please go ahead.

Jim Ricchiuti -- Needham & Co. -- Analyst

Hi. Good morning. I'm wondering if you could -- how you would characterize your large projects business, Anders, you highlighted a few nice wins. And I'm also wondering to what extent that business is being impacted by the component constraints, the logistics challenges, whether customers are themselves being impacted by bottlenecks elsewhere in their supply chain, that's affecting the time lines for when these projects are going to go forward.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Yes. I'll start with our large customers, our larger projects are continuing to do well. We saw growth in that year-over-year. But the mix between kind of our run rate business and large customers has moderated, gone back to a little bit more what we would see as historically normal rates versus what we saw a year ago. I don't think we can say we've seen any impact on our customers' rollout schedules based on supply chain issues. And we clearly work really hard with our large customers as well as our channel partners to make sure that we understand what is true demand, what our customers truly need to have in order to run their business versus what they might want to have or think of as more risk buys. So we can satisfy all our customers, but particularly our larger customers here. But demand from them continues to be strong and as -- in line with what we've seen previously. And maybe Joe Heel, do you have any additional color here?

Joachim Heel -- Chief Revenue Officer

Yes. I would echo what you said, we have not seen any delay in large businesses due to bottlenecks on our customers' parts elsewhere, and we have had some extraordinary wins even in this past quarter. As you know, the large projects are somewhat lumpy here and there, but we had double-digit growth nearly in the large projects business as well. including some extremely nice wins in multiple geographies. So we're very pleased with it.

Jim Ricchiuti -- Needham & Co. -- Analyst

Got it. And a follow-up, just I appreciate the color on your expectations looking out to the first half of next year as it relates to components and some of the unusual freight costs you're incurring, I'm wondering how we should be thinking about your operating expense levels over the next several quarters only because things are beginning to normalize. We have presumably trade shows starting to occur again and I'm just wondering if we need to be mindful of some temporary cost savings you might have benefited from this year being layered back in over the next several quarters?

Nathan Winters -- Chief Financial Officer

Jim, I think it's fair to say that as we go into next year, we do expect some of the discretionary spend, particularly around travel and trade shows to pick up. But I'd say it's no different than any other variable we manage within the year in the pluses and minuses, and still expect to grow despite some of those incremental costs that we'll incur. And as usual, we'll find offsets and efficiencies to mitigate that impact as we go into next year.

Jim Ricchiuti -- Needham & Co. -- Analyst

Got it. Thank you. I will jump back into the queue.

Operator

The next question comes from Meta Marshall with Morgan Stanley. Please go ahead.

Meta Marshall -- Morgan Stanley -- Analyst

Great. I wanted to maybe first ask a question just on kind of seasonality. I know a lot of your retail customers don't tend to be as active in Q4. But we're also kind of dealing with the labor shortage, so just any kind of perceptions of what you're seeing as far as seasonality into Q4.

And then maybe a second question, clearly, you're highlighting success within healthcare and this has been a continued area of success for you guys. Are you able to use kind of your traditional go-to-market or the partnerships that you think you could explore that would kind of further accelerate that opportunity? Thanks.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Yes. Thank you, Meta. I'll start and then I'll ask Joe Heel to provide some extra color here also. But first on seasonality. I think seasonality this year has been similar to what we would normally have seen, but we had slight increases quarter-over-quarter in Q3 and into Q4. So not a huge difference from that perspective. Obviously, demand has been strong and very broad-based. So that certainly helps on the overall demand profile. But I don't think that the -- seasonality has meaningfully changed and Joe can comment on that in a second. On the other part, on healthcare.

Health care has been our fastest-growing vertical if you look over the last several years and we would expect it to continue to be our fastest-growing vertical, not necessarily every quarter but over a longer period of time. And we have built up a -- we said, first, we're leveraging our traditional sales team, but we have a dedicated healthcare sales team within our sales organization and we have largely dedicated healthcare partners. If you take somebody who's an expert in manufacturing and send them to a hospital, the language is different, the solutions are different. So it really warrants to have more specialized partners, and we have a large number of specialized both regular resellers, but also ISVs and other partners to help us make sure that we have a robust go-to-market organization and capability as we can. Joe? All right.

Joachim Heel -- Chief Revenue Officer

This is Joe Heel. I would add to each of those points, respectively, the following. On the seasonality, the one additional thing we have seen is that retailers have been ordering further in advance, right? They're seeing, of course, the shortages that are -- that exist in the supply chain and are working with us to anticipate those. So that means that we can plan our supply to them further in advance. And so our reflection of their seasonality to sort of pull forward in that regard. In terms of healthcare and the go-to-market that we use there, as Anders said, yes, we have specialized partners in those areas that we have been building out over the last few years.

Two other things I think characterize our go-to-market and routes to market, in particular, one is we have a higher-than-average investment of our own resources. We have learned and determined that being present in those hospitals, which is, of course, a more fragmented customer seat -- customer set is important. And therefore, we have made more investments in our own resources in those areas, and we're more present together with our partners, of course.

And then the second is that we've also learned that we need to expand our partner set to more, let's say, nontraditional partners, which would include, in particular, ISVs. They're very important ISVs for electronic health records that we need to form partnerships with. And OEMs, there are important OEMs that participate in this -- in the healthcare segment and we have formed some very strong alliances with those as well. And that's helped us with our growth in healthcare.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Just one --

Meta Marshall -- Morgan Stanley -- Analyst

Great.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

-- more points on this. We have -- as we work with our customers now, particularly Joe mentioned retailers, we have greater visibility. The supply chain constraints have enabled us to get greater visibility into their requirements. And our pipeline is more robust and we entered the quarters with a greater backlog than we normally would, but it's not like they have been pulling forward demand. But as you look into the future, the more robust pipeline and backlog gives us better visibility as we look into next year.

Meta Marshall -- Morgan Stanley -- Analyst

Great. Thank you.

Operator

Our next question comes from Paul Chung with JPMorgan. Please go ahead.

Paul Chung -- JPMorgan -- Analyst

Hi. Thanks for taking my questions. So just a follow-up on margins. If we think about EBITDA margins kind of ex freight costs, maybe you are kind of in that mid-20s percent range. You mentioned maybe some temporary costs come back, but is this kind of the more normalized margin profile we should expect maybe in, I don't know, second half of '22 when some of these costs fade a bit? And as your software product mix continues to accelerate, can we see further expansion there? And then I have a follow-up.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Yes, Paul. So I think if you look back, our track record of driving -- we have a track record of driving profitable growth. I mean we'll exit the year around 23%, and that's a 150 basis-point improvement from where we exited 2019 despite the transitory cost increase. We do believe EBITDA margin can go higher. We have many levers to achieve that. You mentioned one, scaling new markets that have traditionally richer gross margin, whether that be software or the fixed industrial machine vision markets we're entering. Along with the team, continuing to driving higher margin and productivity through the operational efficiencies across the business, which we've always done. So again, we do expect margins -- EBITDA margins to improve beyond this year, particularly as the transitory freight abates.

Paul Chung -- JPMorgan -- Analyst

Thanks. And then your free cash flow in the quarter pretty much paid for Fetch. So your flexibility to continue, kind of, inorganic expansion is really quite good. Debt level is in a good place. Where are you looking to kind of expand the portfolio and what leverage levels are you comfortable with? Reflexis, Antuit, those driving higher-margin software mix, should we continue to expect priority on software kind of moving forward as well? And then you mentioned Adaptive Vision as well, if you could provide an update on how that business is going. Thank you.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Yes. So I'll -- yes, I'll start on the kind of the M&A side of this. M&A continues to be a priority for us. We are certainly very excited about the outlook for the business, and we do see M&A as a vector for growth. We're quite pleased with the recent acquisitions of Fetch, Antuit and Adaptive Vision as well. We look at M&A as a way for us to accelerate our strategy to advance our Enterprise Asset Intelligence vision. And we're targeting select bolt-on acquisitions as well as some high-growth acquisitions that would truly advance our EAI vision. We see opportunities in digitizing and automating supply chains and workflows more broadly.

And as you said, we have a strong balance sheet that can support our M&A opportunities. Then on Adaptive Vision, that's part of our machine vision fixed industrial scanning solution set. We acquired them back in Q2, and they provide software solutions that help our customers to design in machine vision or fix industrial scanning solutions in their workflows, and to be able to more easily extract useful information from there digital images that they take. And so it's an integral part of our machine vision solution and helps to make sure that it is -- our solutions are easier to implement than our competitors. So it's one of our value propositions. And so far, we're very excited about the overall entry into that market.

Paul Chung -- JPMorgan -- Analyst

Thank you.

Operator

Our next question comes from Brian Drab with William Blair. Please go ahead.

Brian Drab -- William Blair -- Analyst

Hey, good morning. Such great momentum in a number of end markets. I'm wondering, Anders, are there any end markets where the impact of COVID-related sales and sales stimulated by the pandemic has been delayed? And end markets where it's not going to be really a headwind for like a tough comp in 2022 where maybe it's the rental car market or healthcare market that just kind of took a while to get going, do you see any end markets that just have yet to really drive growth as it relates to the pandemic where we'll see incremental growth in '22?

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

The pandemic has really accelerated a number of secular trends that's supporting our business and helping to drive enterprises to implement our type of solutions. The themes around how to digitize and automate our customers' businesses is a, let's say, a high priority across all our vertical markets, across all the end markets and geographies, how to improve frontline worker efficiency and to reduce frictions from those workflows. So I don't think there's any -- I can't think of any meaningful markets that would be hampered by this environment or kind of really lagging from this. This is a pretty broad-based picture. We did see early on during COVID, would say that healthcare was hit hard because they the traditional acute care business was, for healthcare provider, largely shut down. And if it wasn't truly acute, they wouldn't admit patients, and it became only taking care of COVID. But that has rebounded and we're now surpassing 2019 levels.

Brian Drab -- William Blair -- Analyst

I understand, Joe. Can I interject and just say -- I don't think I asked the question clearly as I wanted to. But do you see any end markets where you look at the end market right now and say, OK, that's starting to kick in where it hasn't to date, where you're excited about incremental growth going forward.

Joachim Heel -- Chief Revenue Officer

Anders, would you like me to say something?

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Yes, I'll take just a couple of comments on this and see --

Brian Drab -- William Blair -- Analyst

Yes. Thanks.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

-- there are certainly areas that -- and then Joe Heel, you can provide some extra color. I'll just highlight one market, I think that we can see that is starting to kick in, and that will be hospitality. Hospitality was largely shut down for most part of COVID and that's coming back. And we do see a number of pipeline for opportunities within the hospitality segment is recovering nicely. And then Joe, you have some other ideas.

Joachim Heel -- Chief Revenue Officer

Yes, I was going to mention three, one perhaps that you might not expect. Hospitality is one. Another one that has sort of a longer curve where we expect benefits to continue is manufacturing, which has been recovering really nicely. You saw that already this quarter, but we expect that to continue. There's much to be recovered there. And a third one that you might not think of would be Japan. Japan has been a market that has been on the sidelines for a bit, in particular, during the pandemic. But many of the Japanese customers have not yet migrated to Android. And now that they are seeing the recovery from the pandemic, they're doing that. So there's a market opportunity there that is extending strongly, we believe, into the next year.

Brian Drab -- William Blair -- Analyst

And what percentage of revenues in Japan roughly today?

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

It's a small part of our revenue stream today, but it's a nice upside opportunity for us.

Joachim Heel -- Chief Revenue Officer

Right.

Brian Drab -- William Blair -- Analyst

Okay. And then just the last question on software. Are you able to give us an update since there's been so many acquisitions and growth in software and you're making the comments that the margins are being aided by higher -- the overall margin being aided by higher margin than software. Where are you in terms of the size of that software business? I know you don't kind of shy away from same percentage of total revenue historically from software. But just curious if you could give any comment on that. Or like what -- when do you envision software being 5% or 10% of sales down the road? Any quantification or clarity on that would be helpful.

Nathan Winters -- Chief Financial Officer

Yes. So if you look at our software -- the SaaS portfolio of the business, it's still small, mid-single digit as a percent of the company. And we haven't stated a target or an aspiration in terms of what's the right mix. Obviously, it's an area of the business we expect to grow organically faster than the core business over time. And it's a priority from an M&A perspective. But in terms of -- we haven't -- we don't have a set date in terms of what percentage of sales we want to get to by a particular year, except for, again, to continue to build out the suite of offerings we have and turn it into a driver of organic growth.

Brian Drab -- William Blair -- Analyst

Thanks for taking my question.

Operator

Our next question comes from Keith Housum with Northcoast Research. Please go ahead.

Keith Housum -- Northcoast Research -- Analyst

Good morning, guy. And, congratulations on the quarter. Just want to revisit the supply chain challenges once again. Is there a feeling that the supply chain challenges are kind of peaking now and perhaps are going to slow way to recovery? Or we're not quite sure if they've peaked quite yet and we still have to work through it.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

There are different parts of supply chain challenges here now. I talked a little bit about the semiconductor issues. We also have more logistics issues around ocean freight and airfreight. I would think that on the freight side, I would expect a quicker recovery and I would expect that to moderate as we get into the first half of 2022. So I think we're probably at peak rates and capacity constraints, but not that there will be a kind of binary improvement in this area that it goes from whatever it is today to what it was prior to COVID. It will be a gradual improvement, I think. On the component side, I think we're -- we wouldn't expect it to get any worse. But I think again, we -- as I mentioned earlier, we would expect kind of a gradual improvement by mid-2022. Does that help?

Keith Housum -- Northcoast Research -- Analyst

It does. And on the component side, is it primarily with chips? Or does it seem that the issues are popping up and is [Indecipherable] and you got one issue here that you may resolve it, you go to a different issue?

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

I think it's largely on the semiconductor side, but it does move around. So we secure -- so backing up one step. So even before COVID, even before this, every quarter when we started, we would have certain parts that were on allocation or that we needed to find more. But so that's a normal part. But the number of parts today is much higher. And we work on solving for one part, the next week some other part pops up. So the frequency and the number of parts are much -- that are on allocation or longer lead times is greater. But we try to make sure that we work very closely with our semiconductor suppliers to let them know what our true requirements are. And we've signed long-term supply agreements, price agreements and so forth to make sure that we get proper consideration when they do allocate parts. And -- but it's a complex process, but I think we've been managing it very well so far. Great. I appreciate it. And then moving over to the software. You've got Reflexis now probably for at least a part -- better part of the year. In terms of the approach to the sales, is it still direct -- primarily as a direct deal? And is it the same as your regular sales force? Or do you have a different software sales force? And then how does Antuit go to market and how do you envision signing these things together going forward?

Keith Housum -- Northcoast Research -- Analyst

Great. I appreciate it. And then moving over to the software. You've got Reflexis now probably for at least a part -- better part of the year. In terms of the approach to the sales, is it still direct -- primarily as a direct deal? And is it the same as your regular sales force? Or do you have a different software sales force? And then how does Antuit go to market and how do you envision signing these things together going forward?

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

So I'll start and then Joe Heel can provide some extra insights here also. But for Reflexis or our broader software portfolio, we have set up a dedicated software sales teams within our broader go-to-market organization. So you can think of our traditional account management teams would be able to start the conversation, qualify an account to some degree and then bring in our software experts to do a lot of the more technical part of the selling activities. So we -- but with that is in a more dedicated part of the organization to make sure we have the right level of or depth of knowledge and insights.

We are doing this largely direct today, but we are also working with expanding our portfolio -- our partner portfolio here. And there's a number of other type of resellers and system integrators who are interested in working with us to be able to represent us and participate in doing implementation services. And Antuit, we specifically -- with Antuit here now, we are initially keeping the Antuit sales team somewhat separate because we want to make sure we keep the focus and dedication to that. But leveraging again the account teams access to accounts as well as the broader expertise we have in our software go-to-market side. Joe?

Joachim Heel -- Chief Revenue Officer

I think you said it well, I have nothing to add.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Okay. Very good.

Keith Housum -- Northcoast Research -- Analyst

Great. Thanks, guys. I appreciate it.

Operator

Our next question comes from Damian Karas with UBS. Please go ahead.

Damian Karas -- UBS -- Analyst

Hey. Good morning, guys.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Good morning.

Damian Karas -- UBS -- Analyst

I think you've covered a lot of ground. You did highlight particular strength in mobile computing, I think most notably in Europe. Maybe you could just elaborate on what you're seeing that's driving that. To some extent, is it a matter of Europe just catching up? Or are there any particular end markets, customers or outsized projects that are driving that mobile computing strength in Europe?

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Yes, I'll start again and Joe can also add some extra colors on Europe. But first, I'd say we're very pleased with Q3 overall. We've seen great demand and we've -- that has been able to drive our revenues to exceed the high end of our guidance range. And our customers are aggressively pursuing digital enterprise transformation strategies, which is causing us to basically exceed our expectations as far as revenue growth this year. We talked about the supply chain issues as being a moderator on this, but we've still been able to deliver double-digit growth across all the regions in each of our product segments. And we continue to see strong growth from both our smaller customers as well as our large strategic accounts.

And based on our performance, I clearly expect that we are continuing to take share in the industry. And we entered Q4 with a strong backlog and we have a healthy pipeline, which I think provides good visibility into 2022. Specifically for Europe, I think we saw -- Europe obviously had a fantastic quarter. So strength in nearly all the subregions of EMEA, and growth was across all our verticals with particular strength in transportation logistics, and that was driven by some very attractive large postal services' wins. And retail was also a very strong vertical for us. From a product perspective, mobile computing and services were particularly strong, while our printing business is more impacted by supply chains. Joe, any further comments?

Joachim Heel -- Chief Revenue Officer

Yes, I would say that the strength in Europe was perhaps a little bit of an artifact of us trying to get the optimal mix of supply that's available to the customers that we have. If you look over more than one quarter, you'll see that the strength in North America and Europe is pretty much exactly on par. So we're seeing equal strength in both over two or three quarters here. This is more of a one quarter artifact, I would say.

Damian Karas -- UBS -- Analyst

Understood. That's really helpful. And I guess we've all seen the headlines since last quarter on Honeywell's actions taken against Zebra investors. Do you have some questions on this? Anders, maybe you could just kind of give us an update on the ITC case and that pending litigation? How would you expect these matters to play out?

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

First, we have a policy of not commenting on ongoing litigation. So it's hard for me to provide a lot of color, as much color as I'd like here. But clearly, we have -- we plan to vigorously defend our positions here. And I'd like to remind everybody that we have the broadest and deepest intellectual property portfolio of the industry. And we will remain laser focused on extending our lead and taking share in the market and to beat our competitions in the marketplace.

Damian Karas -- UBS -- Analyst

Okay. Great. I appreciate it. Best of luck, guys.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Thank you.

Operator

Our next question comes from -- or our last question comes from Rob Mason with Baird. Please go ahead.

Rob Mason -- Baird -- Analyst

Yes. Good morning. And nice job on the quarter as well. A lot of ground has been covered. I was just -- I was curious, though, if you could delineate your growth by channel during the quarter. It sounds like both sides, both run rate business and large deal business were both strong, but I was curious how each one might have weighted out. And then maybe if you could comment as well just on how the backlog -- strong backlog that you mentioned as well, how that might be weighted between those channels?

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Yes. I'll -- Joe, do you want to take the lead on this? Joe?

Joachim Heel -- Chief Revenue Officer

Yes, sure. I can take the lead if you like. So in the past quarter, our direct channel mix was slightly higher than in the past. So we had a little bit more in our direct business than -- rather than our channel business. But our channel centricity, so the percentage of our business that goes to channel, remains extremely high, as is our strategy sort of in the over 80% range. And our backlog continues to be very strong. As we entered into the current quarter, we've had a very strong backlog again, and we're already building backlog for future quarters as you might not be surprised to hear.

Rob Mason -- Baird -- Analyst

Does the backlog favor large deal versus the channel? Distinction on the -- draw a distinction.

Joachim Heel -- Chief Revenue Officer

Generally, yes. Generally more for large deals. Yes.

Rob Mason -- Baird -- Analyst

Okay. Okay. And then a number of nice wins that you commented on during the quarter, one in particular, the U.S. home improvement. When -- I'm just curious, was that -- were you the incumbent in that account? Or was that a competitive takeaway?

Joachim Heel -- Chief Revenue Officer

In this case, we're the incumbent.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Yes. We were the incumbent and there was a refresh of an earlier Android implementation.

Rob Mason -- Baird -- Analyst

Yes. Yes. Maybe is where I was headed with the question because I recall that was one of your maybe larger -- or I think you had a large early win in Android with home improvement retailer in the U.S. And I'm just curious, are you starting then now to see refreshes more broadly on your Android installs? And if so, I'm just curious if you can make a stronger determination around how the life -- I guess the lifespan of those devices is faring versus legacy devices.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Yes. So we are definitely seeing a number of our customers that were early adopters of Android now upgrading or refreshing to second-generation Android. And the refresh cycle for Android devices is a bit little faster than it was with Microsoft. The level of innovation on the platform is higher. So you can think of the number of new Android versions coming out is quite frequent and they tend to require more memory, faster processor speed to run properly. And that, combined with our customers putting more and more applications on the devices. So that also drives more memory as an example. So there's a number of things that are causing our customers to want to upgrade and refresh the portfolio at a faster pace than what they -- what we saw with older Microsoft platforms.

Rob Mason -- Baird -- Analyst

And you mentioned as well that's going to a broader set of users at that customer. I'm just curious if you could -- is there an order of magnitude that you could speak to?

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Yes. So definitely a much deeper penetration of devices into our customers' operations. The value of having every worker be digitally connected and aware is a priority, I would say, for virtually all our vertical end markets, but particularly in retail and healthcare. And we talked about how, today, roughly -- our estimate is that 1/3 of retail store associates have access to a mobile device. And when we talk to our retail customers, they certainly have an aspiration to get that to be much, much higher. And similarly, in healthcare, we did a vision study. I think it's a couple of years back now where the expectation there was to bring it from about 60% up to 95% over the next few years.

Rob Mason -- Baird -- Analyst

Great. Great. Thanks for taking the questions.

Operator

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Gustafsson for any closing remarks.

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

To wrap up, I would just like to thank our employees and partners for their extraordinary efforts to drive -- or to serve unprecedented customer demand in a supply constrained environment. And while we are focused on maximizing profitable growth in the business, our top priority continues to be the health and safety of our employees, partners, and customers as we recover from the pandemic. We would also like to wish a warm welcome to the Antuit team. Thank you, and have a great day, everyone.

Operator

[Operator Closing Remarks]

Duration: 64 minutes

Call participants:

Micheal Steele -- Vice President of Investor Relations

Anders Gustafsson -- Anders Gustafsson-Zebra Technologies Corporation-Chief Executive Officer & Director

Nathan Winters -- Chief Financial Officer

Joachim Heel -- Chief Revenue Officer

Tommy Moll -- Stephens -- Analyst

Andrew Buscaglia -- Berenberg -- Analyst

Jim Ricchiuti -- Needham & Co. -- Analyst

Meta Marshall -- Morgan Stanley -- Analyst

Paul Chung -- JPMorgan -- Analyst

Brian Drab -- William Blair -- Analyst

Keith Housum -- Northcoast Research -- Analyst

Damian Karas -- UBS -- Analyst

Rob Mason -- Baird -- Analyst

More ZBRA analysis

All earnings call transcripts