Good day and welcome to the Second Quarter 2019 Zebra Technologies Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. 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.
Good morning and thank you for joining us today. Before we begin, I need to inform you that certain statements made on this call are forward-looking and subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These 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 filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe our business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of this slide presentation. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer, and Olivier Leonetti, our Chief Financial Officer. Anders will start with our second quarter highlights.
Olivier will then provide more detail on the financials and discuss our third quarter and full-y ear outlook. Anders will conclude with progress made on Zebra's 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. Throughout this presentation, unless otherwise indicated, our references to sales growth are year-over-year on a constant currency basis and exclude results from the recently acquired Xplore Technologies, Temptime, and Profitect businesses. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Now I'll turn the call over to Anders.
Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team executed well and drove strong, profitable growth in the second quarter. As you can see on slide four, we reported net sales growth of more than 8% or 7% on an organic basis, an adjusted EBITDA margin of 21.2%, a 150 basis point year-over-year improvement, and non-GAAP diluted EPS of $3.02, a 22% increase from the prior year. We continue to outpace the competition through our innovation, unmatched scale, and deep relationships with customers and partners. Our mobile computing, data capture and printing portfolios have never been stronger. This has been accomplished through focused R&D investment to build upon our best-in-class offerings. We saw broad-based global growth in Q2 with solid performance both direct and through the channel.
Operational discipline and cost efficiencies enabled us to accelerate profit growth without compromising our investments in our employees and growth initiatives. Enterprise mobile computing was a bright spot, growing double digits as we continue to extend our lead in the industry through the broadest selection of Android-powered solutions. Enterprise workers are utilizing our mobile computers for a variety of new use cases. We are also benefiting from the multiyear transition to Android from the Windows operating system. Organic investments in initiatives to diversify growth are paying off. For example, RFID solutions and our Workforce Connect software application were additional bright spots in the second quarter. We also continue to see acquisitions as a vector of profitable growth for the company and a way to penetrate attractive adjacent market opportunities. In the second quarter, we announced and closed on the Profitect acquisition.
Profitect is the leading provider of prescriptive analytics, which is an attractive growth opportunity for us, and advances our position as a solutions provider, as well as our enterprise asset intelligence vision. Overall, our solid first half performance and leadership position in the market provides us confidence in our outlook for the year. With that, I will now turn the call over to Olivier to review our financial results, discuss our outlook, and our new $1 billion share repurchase authorization. Our strong balance sheet and cash flow generation afford us the ability to return capital to shareholders while continuing to invest in our business.
Thank you, Anders. Let us start with the P&L. As you can see on slide six, net sales grew 8.4% in the second quarter, which translated to 7% on an organic basis before the impacts of currencies and acquisitions. We saw diversified growth in each of our reporting segments and most regions. Enterprise Visibility & Mobility segment sales increased 9.2%, led by particularly strong demand in mobile computing and support services. Asset Intelligence & Tracking segment sales increased 2.9%, with growth in printing, supplies, services, and retail solutions. Turning to our regions, in North America, sales grew 7%, primarily driven by strength in mobile computing, services, and RFID. We saw particular strength in retail and healthcare and had some major competitive wins. EMEA sales increased 9% with relative strength in mobile computing and services.
We saw growth across most countries. Retail and transportation and logistics were particularly strong, with continued traction in RFID. Sales in our Asia Pacific region were up 7% with relative strength in our mobile computing and printing categories. We realized strong growth in Australia, Southeast Asia, and China. Latin America sales were flat, primarily due to lower sales in Mexico due to continued geopolitical weakness. Adjusted gross margin expanded 100 basis points from the prior period, primarily driven by go-to-market discipline as well as increased productivity and cost efficiencies, particularly in support services. Consistent with one of our key operating principles, adjusted operating expenses as a percentage of net sales improved 100 basis points from the prior period. We have a balanced approach of driving operating leverage while continuing to make prudent investments in growth initiatives.
Second quarter 2019 adjusted EBITDA margin was 21.2%, a 150 basis point increase from the prior period. We drove non-GAAP earnings per diluted share of $3.02, a 22% year-over-year increase. Turning now to the balance sheet and cash flow highlights on slide seven. We generated $165 million of free cash flow in the first half of 2019. This was $68 million lower than the prior period, entirely due to the increased working capital usage in the first quarter, which we previously discussed. Free cash flow generation in the second quarter was higher than the prior year period and we expect a strong second-half performance. Our 1.8x net debt to adjusted EBITDA ratio is below the midpoint of our targeted range of 1.5x to 2.5x .
As Anders mentioned, today we announced that our board has authorized a $1 billion share repurchase program. Our strong balance sheet and cash flow profile enable us the flexibility to maintain our debt leverage target range while investing in our business, including acquisitions and repurchasing up to approximately 2% of our shares outstanding annually. Let us turn to our outlook on slide eight. We're currently cycling our prior year third quarter exceptional performance. With that said, net sales growth in Q3 2019 is expected to be between 3% and 5%, which assumes an approximately two percentage point positive impact from recent acquisitions and an approximately one percentage point negative impact from foreign currency changes. We believe Q3 2019 adjusted EBITDA margin will be approximately 22%, which assumes higher gross margin and operating expense leverage from the prior year.
Non-GAAP diluted EPS is expected to be in the range of $3.15 to $3.35. We're maintaining our full- year 2019 net sales growth to be between 5% and 8%, which assumes approximately 2 percentage point positive impact from recent acquisitions and approximately 1 percentage point negative impact from foreign currency rate changes. Given that we are assuming about 50 basis points additional adverse impact in FX from our prior guide, we have effectively increased our organic growth guide by approximately 50 basis points. Full- year 2019 adjusted EBITDA margin is now expected to be approximately 22%, an improvement from 2018 and our prior guide. Our team has been driving gross margin improvement and operating leverage at the high end of our expectations. We continue to expect that full- year 2019 free cash flow will exceed $625 million.
Unlike 2018, we assume that working capital will be a use of cash in 2019. You can see other full- year 2019 modeling assumptions on slide eight. With that, I will turn the call back to Anders to discuss the progress we are making on our enterprise asset intelligence vision.
Thank you, Olivier. We are very pleased with our Q2 results and the momentum we see in our business. Now turning to slide 10, w e are advancing our enterprise asset intelligence vision to enable every frontline asset and worker to be visible, connected, and optimally utilized. Zebra enables this vision by providing a digital view of the entire enterprise. Our products and solutions sense data from assets, products, and processes. This information, including status and location, is analyzed in real time to determine the best possible operational action to improve productivity and provide greater insight into business operations. An integral part of our solutions ecosystem is Savanna, our cloud enablement platform that connects our devices and powers our intelligent edge solutions. Savanna benefits our partners and customers by providing visibility of workflows at the frontline of business.
In June, we launched Savanna Data Services, which delivers sensor information, data analytics, and event triggers through application programming interfaces, or APIs, to enable workflow optimization. Savanna supports developers through a self-service web portal with monetizable API-based data services, which empowers our partner community and end customers to build secure, scalable digital services with ease and speed. It is a clear step forward in elevating our reputation as a solutions provider, enabling customers to enhance the analytics layer of the sense, analyze, act framework. As a proof point, Doddle, a London-based e-commerce service provider, has been an early user of Savanna Data Services. They have been leveraging print from cloud APIs to reduce the deployment time of its ship-from-store proposition.
Longer term, they expect to use the blockchain ledger of Savanna to distribute data across the supply chain to reduce return handling costs and get items back into inventory more quickly. We've also been advancing our enterprise asset intelligence vision through acquisitions, the most recent being Profitect in Q2. Profitect complements our growing suite of other Zebra software applications, including Workforce Connect, MotionWorks, and our visibility services offering. The addition of Profitect's offerings, its technology, and talented team expands our relevancy deeper and wider in global retail operations. The solution identifies areas for improving inventory and pricing accuracy, out-of-stocks, unsellable merchandise, and assortment discrepancies. Over time, we expect to leverage Profitect's artificial intelligence and machine learning capabilities to address all of the vertical markets we serve.
We also intend to incorporate Profitect's functionality into Savanna to further build out the analyze and act layers of the platform, benefiting both Zebra and our partners. The acquisitions we have made over the past year enable us to scale attractive existing categories where we are underpenetrated and enter high growth new markets outside the core that advance us as a solutions provider. In addition to Profitect, Temptime has enabled us to expand our smart supplies offering into time temperature monitoring, and Xplore has augmented our enterprise tablet portfolio with best-in-class ultra-rugged form factors. We have made solid progress on our enterprise asset intelligence vision as we help businesses across many industries digitize their operations and gain a performance edge.
We are doing this by leveraging our deep knowledge of workflows and capitalizing on key technology mega trends, including mobility, automation, cloud computing, and the proliferation of smart devices and sensors, all of which create opportunities for Zebra. Slide 11 highlights the range of vertical markets we serve, including healthcare, retail and e-commerce, transportation and logistics, and manufacturing, as well as other attractive markets that broaden and diversify our growth opportunities. In healthcare, our fastest-growing vertical, our solutions translate into more efficient operations and increased patient safety. We recently implemented a clinical mobility solution with Nemours Children's Health System that empowers its staff to improve operations at its two hospitals, including remote patient monitoring. This customer replaced its smartphone consumer devices used by nurses with our healthcare purposed TC51 mobile computers to improve connectivity, durability, and collaboration.
We helped provide a seamless bridge between medical devices and electronic health records for a 360-degree real-time view of patient health and status for optimal care. Our improved capabilities as a solutions provider are moving us up the stack with healthcare providers like Nemours. In retail and e-commerce, we are a trusted strategic partner with the leaders in this space. We have found that most retailers see significant opportunity for improvement with their omni-channel fulfillment capabilities as they stretch to meet consumers' heightened expectations. Our customers are deploying a wide range of increasingly complex solutions that can include RFID, professional services, and software applications such as Workforce Connect. We are also seeing an increasing number of our customers equipping their associates and shoppers with our mobile computers that empower them with the real-time information they need to successfully execute omni-channel fulfillment and elevate the overall in-store experience.
This increased level of tech investment delivers a high ROI to the customer and is necessary to compete effectively. A prominent department store chain recently chose to upgrade its mobile computers in their stores with our latest Android-powered TC52 model to enable their new omni-channel strategy. As this retailer rolls out our solution, we are providing professional and support services to ensure a smooth transition. We have seen many competitive takeaways like this one with prominent retail and e-commerce players who require a best-in-class enterprise-grade solution. In transportation and logistics, most customers cite capacity utilization, labor shortages, and expedited delivery requirements as top challenges they face over the coming years. By helping to drive increased productivity and efficiencies, Zebra can help bring their operations to a higher level with their current workforce and resources.
The results of our recent warehouse vision study show that more than three-quarters of respondents say that augmenting workers with technology is the best way to introduce automation in the warehouse. As a thought leader and trusted advisor, we are demonstrating a number of proven ways to meet this need. For example, Zebra will be rolling out a solution with a global Transportation and Logistics customer over the next year. We will be enhancing the effectiveness of parcel delivery in Europe with a solution featuring TC57 mobile computers, various professional and support services, and the monitoring of the load density of the customer's air cargo containers. In manufacturing, our customers are looking for trusted partners who can increase their operational visibility and efficiency.
A notable example can be found with a major Asian contract manufacturer who's rolling out our RFID solutions on its plant floor to increase accuracy and reduce costs. Beyond our traditional verticals, we are excited about our opportunity in adjacent markets. For example, we are well-positioned to make new inroads into the federal public safety market. Our TC57 and TC77 enterprise-class mobile computers, as well as our L10 and XSLATE R12 rugged tablets, are now certified for use on the FirstNet network. Our offering is ideal for a wide variety of mission-critical applications inside and outside the four walls. In summary, we are excited about the innovative solutions we are implementing with a diverse set of customers worldwide to address their increasingly complex business priorities. The success we are realizing in the marketplace demonstrates the progress we are making with our enterprise asset intelligence vision.
We continue to focus our investments in solutions that extend our lead in the industry and drive shareholder value. Now, I'll hand the call over to Mike.
Thanks, Anders. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to as many of you as possible.
Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question today comes from Andrew Buscaglia with Berenberg. Please go ahead.
Hey, guys, t hanks for taking my question. Can you talk about, just digging into your guidance, it implies a fairly large ramp into Q4, and Q3 looks a bit more muted. Can you talk about what's reflected in your guide? I get the sense your margins are strong, but I get the sense you're holding back a little bit on the top line there. How did you come up with that guide?
Good morning, Andrew. We are guiding at this stage for nominal growth of about 3% to 5%. That would translate into a 2% to 4% on an organic basis. If you remember last year in Q3, we had a very strong growth, about 15%. You have to take this guide in the context of a tough compare. To answer a bit more specifically to your question, at this stage, we are planning to have growth across our portfolio, either from a product standpoint or regional standpoints. We feel good about the guide we are presenting to you today based upon our ability today to cover key trends in the market. From a profitability standpoint, our guide includes leverage on the EBITDA line at about 22%.
That would be about 100 basis point improvement in term of profitability, and a s you have seen now for a few quarters, we believe we have OpEx or gross margin leverage in the P&L d ue to the operational discipline we have in the company, and that is also reflected in our guide.
Got it. I think there's a little bit of confusion, you know, with regards to one of your bigger competitors having substantially weaker results. I guess, can you comment on what you're seeing? Do you guys think you're gaining share generally? What are you seeing in the channel? Yeah, if you could talk a little bit more about inventories at distributors.
Yeah. I won't be able to comment on other competitors' results or anything like that. We feel good about where we are. We have a strong and compelling vision for the company that we have been executing diligently on over the last several years. Specifically here in Q2, I think we executed very well and drove strong profitable growth across the company. We had solid performance in Asia Pac, EMEA, and North America, both direct and through our channel. We saw from a product perspective, particular strength in our mobile computing portfolio and services. From the vertical perspective, retail and e-commerce as well as transportation logistics were strong performers. All our verticals were up for the first half. Today we have a strong competitive position basically on the base of the strength of our product portfolio.
I think also our value propositions are resonating very well with our customers. Specifically on the inventory position, I'd say we manage channel inventory very carefully, every quarter, all the time. We continue to have the channel inventory comfortably be within the band of what we consider to be normal. There's nothing unusual for us in that area.
Okay.
Maybe sales, so we compensate our salespeople on the sales out, so there's no incentive to drive, say, overstocking of the channel.
Okay, got it. Thanks, guys.
The next question comes from Jim Ricchiuti with Needham & Company. Please go ahead.
Thank you. Good morning. I'm wondering, as we look out at the second half guidance, what is that assumed for larger deals? I wonder, can you characterize your larger deal pipeline? You've clearly had, sounds like some competitive wins thus far this year.
We are not planning an abnormal amount of large deals. They are not totally contemplated in the guide we are putting forward, Jim, and maybe Joe can complement.
Yeah. Large deals have become an important part of our portfolio. In the second half, we expect a number of large deals. As Olivier says, not unusual for that part of the year. In particular, Q4 is usually a large deal quarter, and we don't expect an unusual number of large deals in this year relative to previous years.
Thank you and j ust my follow-up question, just as it relates to the macro environment, seems like you're seeing pretty good strength in your core markets, but where are you, if at all, seeing signs of potential caution from the customer base? Are you seeing it in the smaller markets like manufacturing, which is very fragmented, but still a reasonably sizable part of your business?
Well, I'd start by saying that our solutions have become much more foundational to our customers' strategies. Our customers are much more dependent on our type of technology to be able to execute on their top priorities, you know, t hings like we help them increase workflow efficiencies, particularly important in tight labor markets. We provide real-time guidance to the front line of their employees and enhance the customer patient experience. We do all this through our partner ecosystems. Our business, we've worked hard on making sure that we have diversified our business as much as we can across geographies, products, and verticals, and I think that is helping us. Every quarter, we'll see some countries or some verticals have some ups and downs. This is no different. Last year was maybe a little unusual in that it was very broad-based.
We mentioned last quarter, and it still holds true, that Mexico would be a little soft based on geopolitical environment. Generally, we saw strong performance across most of our sub-regions across the world.
Thank you.
The next question today comes from Paul Coster with J.P. Morgan. Please go ahead.
Yes, thanks for taking my question. Anders, I know many investors are concerned that the so-called Android upgrade cycle might be peaking. Can you give us your latest thoughts on where we stand in the replacement of Windows CE and Windows Mobile, and why you believe that the growth might persist beyond this year?
First I'd say from a broader perspective, I'd say that we are seeing our broad and innovative portfolio of products and solution more broad, across the entire portfolio, driving solid growth across the business. Android and mobile computing is one aspect, but this is something that's much broader for us than one product line. Again, I go back to s ome of the things that, I think, differentiates us in the market of, you know, some things like our deep understanding of workflows, and giving our customers the ability to leverage data at the edge to take more, you know, good real-time decisions to help to optimize and drive their businesses. We're very excited about the opportunities in all our product lines, and there are several mega trends that support the growth, like the on-demand economy.
Now, s pecifically, to mobile computing, you know, we have seen great growth over several years now, and we're certainly very excited about the progress we've made and the outlook we have for that business. There are several drivers for the growth we've seen. There's things like a number of new use cases that are being deployed. That's, you know, underpinned by the strong portfolio of software capabilities that we have developed for our mobile computing portfolio. These new use cases, I think of as being long-term growth drivers. You know, a couple of examples, a lot of our customers are looking to consolidate multiple devices or multiple applications onto our mobile computers.
One example will be many verticals, many customers are using or have historically used dedicated PBX, or wireless PBX phones for people. Now with our Workforce Connect application, you know, we can consolidate that device and that use case onto our mobile computers. Another trend we're seeing is that our customers are looking to put more and more technology in the hands of all their people, pushing technology further into the organization. The trend of having a device for everybody is gaining a lot of traction. I'd say also our big screen portfolio of mobile computers, so tablets and vehicle-mounted computers, are seeing a lot of new use cases and interest also.
Specifically to the Android transition, it clearly has been a catalyst for growth for us. We still have over 60% market share in Android, and the overall mobile computing market is now more than 50% made up of Android devices. We still think that there's lots of potential in this market. We anticipate or we forecast that there are still about approximately 10 million legacy Windows devices in the market. These devices are not all going to be converted to Android by 2020 when Microsoft stops supporting their older mobile operating systems. This conversion cycle will take longer but w e see good drivers, o ur software continues to be a great driver, and new devices. We've released some new devices specifically to capitalize on the warehouse transition that's ramping up now. Our MC33 and MC93 products.
Android is clearly a great driver, but it's only one of several long-term drivers for our mobile computing business.
Quick follow-up. You're obviously investing a lot in software. You're acquiring your way into software data services, cloud applications, APIs, and so on. How is this expressed in your business model? I know some folks are looking in vain for the software line, and it's not there. Does it just translate into margin improvement on the hardware side?
Well, first, I'll give you a couple of thoughts around our software business and the strategy for it. We've gone from having kind of made, historically, say, dumber devices to smarter devices and now a more smart infrastructure. Very much focused on driving a performance edge for our customers. It's an entire portfolio. Software has become a great differentiator for us. Our software DNA layer makes it a lot easier for our customers to integrate, manage, and adapt their suites of Zebra products, s pecifically, we launched the Savanna Data Services. That's a great new capability for us that enables Zebra and our partners and our customers to more easily access data, as well as enable Zebra to monetize that data. It also helps demonstrate thought leadership for us and moves us up the stack as a solutions provider.
It will help pull through our broader solutions as well. Software is still a modest part of our overall business, but software, as a differentiator, is something that's embedded into all our devices also. We do expect it to continue to be a bigger and bigger part of our business.
To complement Paul on the business model impact, clearly the strong gross margin performance of the company, which we have posted now for several quarters, is also due to the strength of the software offering. You don't see that necessarily in the software line in the P&L, but it's reflected also in the strong gross margin we have for hardware, as Anders said, and t his software offering allows us to sell based upon a return on investment basis rather than just speed and feeds. We are, as a result, perceived as a thought leader in the industry, and that is reflected in the way we price.
Thank you.
The next question today comes from Brian Drab with William Blair. Please go ahead.
Hi, good morning. I was wondering if we could just maybe drill into slide six a little further and just curious on the 3% growth in AIT. Can you talk about maybe just specifically within that segment, first in terms of end markets, retail, manufacturing, T&L, which were above or below 3%? Then it would be great too if you could mention in terms of geographies for AIT, which were above or below 3%? Thanks.
Yeah. I'll start here, so f irst, AIT grew in Q2. We did see fewer large deals in Q2 2019 versus last year, we were not able to replicate all of the large deals that we saw last year, they were mostly in retail, also some other ones. Within our printing portfolio, I'd call out RFID printers as a particularly strong growing segment of our portfolio. Overall, our printed portfolio and our overall AIT portfolio is positioned very well, we like the growth prospects we see in the market here. We do have a strong and fresh portfolio of smart connected printers, which has really an unrivaled manageability through our Link-OS, that's a great differentiator. From a regional portfolio, we saw good growth from printing in Asia-Pac, we saw it in Europe particularly.
I think I would call out those two as the strongest areas for us. Even China had good growth for us, which is a good printing market. We were up high single digits in China as well. We are offsetting some of the discrete electronics manufacturing by penetrating other manufacturing sectors in China, like automotive and other heavier manufacturing. Does that answer your question?
Yeah. I was hoping. Yes, that's all helpful, obviously, but I was hoping maybe more specifically. I guess you're saying retail was below 3% and manufacturing and T&L were above. I still feel like I'm guessing at the specific answer to my question and trying to read between the lines.
Yeah.
I guess 3% and the other regions were below. Some were above and below. I'm just trying to reconcile this with what we're seeing from some of the CapEx trends in these end markets.
The way we model our printing business is actually we are not seeing today any key outliers. As Anders and Joe mentioned earlier, you could have a vertical or a particular country being an outlier in a particular quarter. We would characterize printing as being strong across the majority of the portfolio. That was the case in Q2, and that's also our assumption in the rest of the year. No particular outliers, really, Brian.
Okay, thanks, t hen just a follow-up on a different topic. The Android business is doing very well, and these products are relatively new in your portfolio, and whenever there's a new product, obviously there's opportunity to take some of the manufacturing costs, you know, out over time. I'm wondering, is that a key lever that you might be able to pull over time as kind of optimizing the cost to manufacture these Android products?
We always look at doing value engineering routinely as part of our product roadmaps and look at bringing out costs, and based on volume, we renegotiate pricing with our suppliers. I would say, though, here that we have been actively doing this for some time, and the margin position now on our Android products are very much in line with the margin position on our legacy Windows devices. This is not something that we haven't done. This is something we've been doing actively for some time.
Right. Okay, thanks. That's helpful. Thank you.
The next question comes from Keith Housum with Northcoast Research. Please go ahead.
Good morning, guys, a q uestion for you, Olivier. When you're talking through the geographical growth, it sounds like retail and healthcare continues to be a significant driver of that growth. Quite honestly, it's been several years for seeing that, and we're expecting to perhaps see T&L and warehousing and manufacturing perhaps contribute more to that growth here this year and perhaps into next year. Can you provide a little bit more color on the growth you're seeing in those segments, and are they jumping onto the Android train, or is there still a little bit of time before you see it happening?
I'll take that for you here. First, you asked basically about T&L and manufacturing and any other kind of vertical for us. Transportation logistics was up very strongly in Q2, up double digits in Q2. It tends to have a very solid growth profile. If you look at the last 18 months, T&L has done very well. There's some strong secular trends that supports that. You see T&L providers are facing expedited delivery times, labor shortages, a number of new, you could say, economics that comes with delivering one box to every household versus a number of boxes to corporations. All of those things are being good backdrop for us to talk about how we can help introduce automation and technology to help address those issues.
I think we are uniquely positioned in many ways to help the customer drive those, or capitalize on those issues. In transportation logistics, the Android is having particular play now in the warehouse transition. The warehouse is now starting to really ramp, moving from Microsoft to Android. We see our intelligent SmartPack location solutions, RFID, and so forth, to also be particularly well-suited for the retail space and the warehouse, and giving us a thought leadership position also. If we move to manufacturing. Manufacturing was not quite as robust in Q2, but it has performed very well over the last 18 months also. Our portfolio is increasingly enabling Industry 4.0.
We see manufacturing as a sizable market opportunity for us. Manufacturers are looking for increased visibility into their supply chain, the Android transition is, I would say, accelerating within manufacturing. Location Solutions has manufacturing as its primary vertical market.
I'd like to add one more thing. This is Joe Heel. We spoke before about the fact that of the legacy Windows device, about 10 million, we think, remain to be replaced in the market. If you look in more detail into that remaining installed base, we believe the majority of that is in the warehousing and manufacturing space. For a variety of reasons, those customers have been slower to adopt those technologies. We do expect that that adoption will now pick up. You see this reflected in the fact that we've released, just in the past quarter, the MC93, and before that, the MC33, which are the flagship devices that serve that warehouse and manufacturing market. We're seeing good adoption in that space as evidence of the Android transition now focusing heavily on warehouse and manufacturing going forward.
Great, v ery helpful, you know I get this question often, I know it's a very imprecise science here, but the nine to 10 million mobile computers that we think still are installed with Windows, you know, that number really hasn't moved probably over the past year, maybe even 18 months that we've been talking about it. Is there any more precision that you guys are getting on that number to say that that number still remains at roughly that same range? Is it still just, this is our best guess based on incomplete data that's out there?
It is incomplete data, I guess, in that we can't go and identify each and every one of those 10 million devices. It has come down, and the numbers we've used on our calls over the last 18 months has come down. I'd say the reason it hasn't come down maybe faster is that it was only last year that the market, you know, switched to be more, over 50% Android from Microsoft. There's still a substantial amount of legacy Windows devices being sold into the market. While we are, say, eating into the install base on one end, we are adding to it, or the industry is adding to it on the other end with new legacy devices.
Yeah.
Good point.
I think the one dynamic that has perhaps surprised us a bit as well, is that in those segments that still have very high penetration of Windows mobile computers, our customers have continued to buy mobile computers at relatively high rates. There are some markets around the world where more than 50% of the mobile computing revenues are still in the Windows category. That's prolonged the Windows existence, and will also prolong the transition cycle to Android going forward.
We've had a couple of questions that kind of talks about Android having peaked or being close to peaking. We certainly don't see that. We expect the Android transition to continue for some time, and when you then couple that with the proliferation of new use cases and deeper penetration of devices into corporations, you know, we believe mobile computing is going to be a good growth business for some time.
Yeah, sure, g ood point, and i f I could just squeak one more in here in terms of the share repurchase, did I hear you guys say that you guys are going to cap the share repurchases at 2% of the shares outstanding annually? Then are you guys willing to take on additional debt to be opportunistic with the share repurchases?
Keith, you summarized it well in terms of what we're planning to do. Let me give a bit of background on why the buyback. One, we have achieved now the bottom of our leverage range of about one and a half. We'll achieve that in the third quarter, start of the fourth quarter. That's why we believe that buyback should be on the table. We believe that the strength of the cash flow of the company will allow us to invest in the business, invest in M&A, and still do a buyback. To your point, we plan to buy back within a 12 months periods, about 2% of the shares outstanding. Would we go higher opportunistically? We would see.
Great and a re you willing to take on additional debt in order to fund those share repurchases?
We don't think we need to do that. The strength of the cash flow will allow us to finance buyback with the cash of the company.
Great. Thanks, guys. I appreciate it.
The next question comes from Richard Eastman with Baird. Please go ahead.
Yes, good morning. Olivier or Anders, could you just speak to pricing and price capture in the quarter and what actions were taken, if any, on pricing in both the channel and, quite frankly, I know on the larger projects, you know, it is a bid process, but has pricing inched up on the large bid opportunities as well?
We work in a competitive environment. We have strong competitors, and it's always been a competitive market. We've been able to focus very much our attention on making sure that we have a very compelling portfolio of solutions that are attractive to our customers, and we are, certainly, you know, looking to see us getting a premium in the market. I think we have been able to achieve that for a long time. Obviously, we have to compete on occasion for deals, but we've so far been able to do that well, and offsetting any price pressure with additional cost reductions to maintain or even now increase our gross margins. I wouldn't characterize that the price pressure or the competitiveness of the market is particularly different today than it was three months ago or six months ago, and m aybe, Joe, you have any further comments.
Our margin picture always has two parts. We already talked about the large deals. Anders described that very well. The other part is what happens in our run rate, which is the pricing of the transactions that goes primarily in smaller quantities through distribution. We've developed, I think, a very good level of expertise to work closely with our distributors and partners to understand exactly where the market price is and to price that in a competitive way so that we can continue to grow. We've been pleased with our ability to realize good pricing in that segment while continuing to gain share.
Just to put some clarity on that, when I look at the adjusted gross margin year over year, I think it's up 100 basis points, 100 basis points. Is there a price capture piece of that? Did price year over year on a consolidated basis with the channel, with the products, did it add, you know, 20 basis points to that gross margin improvement, or is there a number, Olivier, that you could just slice out of that and say, look, on a consolidated basis, both through the channel, through direct, that we're capturing so many basis points of that 100 as price?
It's difficult to answer with precision. The strength of the margin is due to multiple drivers. The way we price, the value of what we offer, and also the supply chain efficiencies that I mentioned earlier. I wouldn't point to one in particular, and it's very difficult to parse all the pieces, Richard.
Okay. Sorry.
As I said, you know, we mentioned earlier, software becoming a bigger part of our portfolio. That's helpful. I should also mention services has been able to improve margins quite nicely in Q2. We expect that to continue to be a strong margin contributor.
Okay, and then c ould I ask you again, just against that consolidated 7% core growth for the quarter, did the channel grow at or above that in the direct business? I think you alluded to some of the retail wins, maybe not as great this quarter, but just a growth rate on large direct wins versus the channel. How did it look relative to the 7% core?
One, it does change quarter to quarter. In Q2, our direct sales were stronger than the growth in the channel. In Q1, we saw it the other way. There, the channel was stronger than the direct sales of the large deals.
Okay, okay, and j ust my last question, I'm looking at maybe Xplore revenue was a little bit below where I thought it might come in. Now, arguably, we just straight lined the acquired revenue, you know, per quarter. But I'm curious if you could maybe just speak a little bit to the Xplore acquisition and maybe how you're maybe repositioning or investing in their product portfolio to, you know, whether you're expanding their adjacent markets, or what's the investment strategy at Xplore, and what's the hope for benefit there going forward?
Yes. As a reminder, first, we bought Xplore to really help strengthen our broader big screen mobile computing portfolio, right? That includes Xplore, our ET5 portfolio of tablets, and our vehicle-mounted computers, and t his portfolio as a whole has been growing very nicely. That includes Q2. We had very good growth across the portfolio in Q2. Since we acquired Xplore, it has really helped us cement us as the clear number two in the rugged tablet space. We continue to think of that as a very attractive market. Our new Xplore products have been very well received, and we have our first, Android powered Xplore tablets now available in the market. The integration is going well, and we're now working on really optimizing the go-to-market to help drive scale and efficiencies.
Xplore is now available for all our partners to resell, and we're looking to see how do we, you know, capitalize also on some of the near adjacencies where Xplore has some strength that hasn't been historical strengths of Zebra, and J oe can help.
Perhaps you asked about where are we investing in, as you said, repositioning, and I would specifically identify two things. The first Anders just identified, which is the tablet market has additional vertical depth that outside of the core verticals that we've been talking about at Zebra for many quarters now. Things like government, public safety, and utility segments would be examples of such areas, and we are repositioning and investing in penetrating those segments, number one. Number two would be the announcement that we just made to launch the L10 Android version. I think it's a very important additional investment. Why is that? It enables us to leverage that strength that we talked about earlier, our software capabilities, our Mobility DNA capabilities. In Android, w e can now leverage that in the tablet space, and we think that will differentiate us. Those are two areas of investment we've made.
Okay, v ery good. Thank you.
The next question comes from James Fawcett with Morgan Stanley. Please go ahead.
Hi, everyone. This is Eric on for James. Thanks for taking the question. You mentioned a global customer rollout in Transportation and Logistics, including load density monitoring. I just wanted to ask, is this including your SmartPack solution? Maybe on that, if you can talk about how trials have been progressing, if you have more color on just timing to prove out ROI there.
Yeah, so t hat specific reference was to SmartPack. Our broader portfolio of what we call intelligent edge solutions, SmartPack, SmartLens, RFID location solutions and so forth, is progressing nicely. We have a growing pipeline of pilots, and we're certainly working hard to make sure we can convert all of those pilots into proper commercial rollouts over time. We feel we're making good progress, and it's also truly helping us position Zebra as a thought leader, and it pulls through a lot of our other products as well. Joe will have some more comments.
Yeah. Two more sort of flavors of color here. You can think about the expansion first in the way that Anders mentioned, going from smaller trials where we're really trying to prove the technology, and also prove the ROI of the solution to the customer, to rollouts that include 100s or 1,000s of dock doors where we now monitor the loading. We now have multiple customers where we are rolled out in that sense, and we see that continue to expand. The other direction of expansion is there are multiple use cases within this solution. You can monitor not only the loading of trailers, but you can also monitor the loading of air cargo containers, for example. There are other examples of how this technology and this solution can be expanded. We are doing so in both of these directions.
That's great. That's really helpful. Thank you, and then m aybe just if you could help us get a sense of how you're thinking about your capital allocation strategy, given the newly announced share repurchase program, and if that potentially impacts any plans for M&A in your strategy there.
The priority for us is to invest in our business, either organically and inorganically. We believe that M&A will be a strong vector of growth for the company, and we believe that based upon the strong cash flow of Zebra, that we can invest in the business and still return excess cash through a buyback. No big change at this stage, Eric. As we have reached now the bottom of our targeted leverage range, we believe we can do the three investments I have mentioned, organic, inorganic, and buyback.
That's great. Thank you.
Our last question today comes from Jeffrey Kessler with Imperial. Please go ahead.
Thank you, and thank you for getting me on the call. You alluded a little bit to the institutional market before. I want to know if you could update us a little bit on penetration into not just what we'll call safe cities, government civil projects, but also the education market, K through 12 and college, which seems to be, you know, in other areas of security and tracking and AIDC, we're seeing a lot of growth in that specific market simply because it's been gestating for so long.
Yeah, I'll start and then Joe will provide some extra color, but f irst, on the public safety market, we talked about that on the call today. We think that is an attractive market opportunity for us in the range of several $100 millions , and I think it's a market that's poised to grow materially as rugged computers becomes a valid choice and enables new use cases there.
Historically, the public safety market has been made up of either traditional dedicated first responder devices that you're all familiar with. Also, there's been a lot of consumer devices in that space. We think that there's room for our mobile computers as well as a good way of augmenting that market, and providing growth for Zebra, and m aybe some other thoughts from Joe here.
Yeah. If you look at the public sector opportunities, including education, I think we would say we see the majority of the opportunity in the public safety first and in government second. I think that would be sort of our order of opportunity priority at the moment.
Okay. Secondly, I'm wondering, have you taken into account with regard to your Forex guidance, the possibility that Forex could be better or worse than expected in particular places like the U.K., if things don't get organized there? Is that in the guidance already?
It is, and b y the way, FX at the moment is a headwind. As we have said before, we have multiple levers to manage the P&L of the company, and we believe that we can manage FX as well.
All right. Excellent.
Thank you.
Go on. I'm sorry.
That was it, Jeffrey.
Okay, okay, t hank you very much.
You take care.
This concludes our question and answer session. I would like to turn the call back over to Mr. Gustafsson, please, for any closing remarks.
Thank you. Yeah. As we wrap up, I want to thank the Zebra team and our partners for another quarter of excellent execution and for delivering strong financial results. I also want to welcome the Profitect team to Zebra. Have a great day, everyone.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.