Zebra Technologies Corporation (ZBRA) Earnings Call Transcript & Summary

All right. I am Meta Marshall. I cover the networking space here at Morgan Stanley. We are pleased to have Zebra here today. We've got Anders, CEO of Zebra. I'm going to read a disclosure, and then we'll kind of jump into questions. Please note that all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures appear on the Morgan Stanley public website at morganstanley.com/researchdisclosures or at the registration desk.

Well, maybe kind of just start with the same question we've kicked off most of the sessions of just any coronavirus impact or just how it's impacting kind of your business today?

Obviously, the coronavirus makes a very fluid situation. Lots of news coming out every day and lots of reactions. So we did talk about it at our earnings call presentation back, I guess, 3 weeks ago now or so. I'll start by saying, our first priority is making sure that our employee, partners and customers are safe. And this is a human story more than anything, I think. For us, it has been predominantly a supply chain impact. In our call 3 weeks back, we did highlight some softness in China from tariffs and from the coronavirus, demand issues. But since our supply chain is largely China based, that was the bigger issue. We have dedicated teams that are working very closely with all our Tier 1, Tier 2, Tier 3 suppliers to make sure that we are in contact several times a day to make sure we have up-to-date information that we can help if there's issues and stuff. The supply chain is definitely coming back to life in China. They're definitely ramping up. Depending on the supply -- the contract manufacturer or the region they're in, they're slightly different ramps. If they source more people from Wuhan, they might be a little slower to getting back into gear, but today it's definitely either people are almost at capacity or they're getting at towards capacity. So from what we've seen so far, it seems to be kind of developing in a reasonable fashion.

Okay. Got it. That's helpful. And now kind of turning to the core business. You've seen a tremendous benefit over the past couple of years from digital transformation efforts and just kind of gaining leverage as you integrated the Motorola business. As you look forward to the next couple of years, what are the drivers of the growth? Is it still digital transformation? Or are there additional technologies we should be mindful of?

Digital transformation is obviously a big, big concept, right? It's been very, very helpful to us across all the verticals we work with. So we see it as a big secular tailwind for us. I would say, from a digital transformation perspective, it started mostly in, say, in people making investments in their core network. So the core of their business, more ERP systems and data centers and so forth. But over the last few years, there's been a great trend of investing more at the edge to make sure you start getting access to more data at the edge, leveraging that data for real-time decision-making and that plays right into our stronghold. So we've seen industries like retail going from brick-and-mortar retail -- e-commerce and brick-and-mortar retail both investing a lot in new capabilities like omnichannel, which is very much a digitization strategy. But also say health care, where we help nurses and caregivers, free them up from sitting in front of a PC screen, entering data or retrieving data, to be able to spend time in front of patients, and have access to all that data. So I expect that they will continue to be a big driver. And it's also a kind of a continuum of solution. So we expect that our core business is going to continue to do well for a long time, but we also have a lot of new types of solutions that we can talk about that are driving -- we expect to drive growth for the longer term.

Got it. And another big kind of driver of the business has been the transition from Windows to Android, kind of on the mobile computers. Now that mix has kind of switched to more Android and Windows, how do you think about that transition progressing further? And is there still additional tailwinds from that transition?

There's definitely some substantial tailwinds that will continue for several years, I'd say. I think it was in 2015, we first started talking about this at the time, if my memory serves me right, we said it was about 15 million Windows devices in the market. And we now believe it's approximately 10 million devices left. So it's been a tailwind for the last few years, but there's still 2/3 of the volume that we saw 5 years back are still here, and that's despite Windows devices now being out of support. So I expect that we will continue to see that installed base dwindle down to nothing. Now when Windows devices are out of support, you might ask why is anybody buying an out of support device? And I think it's a fair question. I think by far the biggest reason is that the software applications that these devices, these Microsoft devices run on were written a long time ago. The people who wrote them have left. The languages they were written in are no longer something that young engineers necessarily know. So the lift of porting that software or rewriting those applications is big. And if you're, say, a warehouse manager and you have a tight budget, you might feel it's a reasonable trade-off to run on an unsupported platform while you port that software. I suspect if the Board of Directors were aware, they would feel that, that's probably not an appropriate trade-off. But over time, it's hard to say that this would not dwindle down. And one of the reason I would say is that Microsoft devices now are no longer part of the kind of the cost curve that Android devices are on. Components are going obsolete. So they will not get cheaper.

Got it. Okay. Maybe on the transportation sector, you've seemed to benefit on both ends as you enable retailers to compete, but you also enable better shipping and logistics there. Do you see more growth coming from larger retailers where you can cross-sell across the businesses or from typical shipping customers?

The retail versus T&L?

Yes. So basically, kind of retail, directly shipping versus kind of traditional T&L.

Yes, we see both as having been great customers and the investment in the last mile delivery is -- has been a great driver. We talked about the USPS win that we had in the fall. We have -- we mentioned on our call that we had gotten, I think, we'll -- at least one new large win in each continent, and that we have the largest postal service provider in each of our 4 continents as customers. So on the one hand, you have people who are doing -- e-commerce providers that are delivering themselves, and they need the same kind of capabilities, the same technology. And if you're a T&L provider, the business model has changed as much as it has in retail. They've gone from delivering many boxes to a few number of corporations to one box to every household. So they need technology to help them drive better service levels at greater efficiency. So we are very pleased to be able to have solutions that addresses both.

Got it. And so looking at the -- maybe the USPS deal specifically, what were kind of the distinguishing reasons why you think that you were able to win or what helps you differentiate so that you kind of won these latest 4 deals in all the postal service geographies that you mentioned?

Yes. USPS had a framework for how they evaluated each of the different suppliers. The device at hand was one of them, how well does it meet their requirements, price was a piece of it also. But a big part was around kind of the vision of the company, the relationship with the company, the integrity and trustworthiness of the company. So I think we scored well across all of those. And we -- for us, the sales cycle is for these types of deals tend to be very long we've engaged in years, but we also make sure that we position ourselves as broader than the device at hand.

Got it. And so how should we think about the revenue trajectory of the deal considering, I think, it's maybe a little bit different than investors were maybe thinking upfront?

So for us, this is a fairly normal how a large deal kind of rolls out. Yes. It tends to be that our customers give us an award and that award comes a little bit ahead of deployment. It's not like they're sitting there waiting, saying, I have my softwares ready, everything is ready, I just need the order so I can start rolling out. So we get the award and we start lining up with all the other pieces that has to happen. So for us, this is a normal situation. And we told -- on the call, we said that they will start ramping up in Q2, and we're continuing to ramp through the year, but 2021 is expected to be the bigger year. And this is based on the schedule that basically USPS has shared with us so far. We're not trying to second-guess what they're going to do. But I'd say also, though, USPS is a large organization. They have many opportunities. And with this new win, we have -- our position within the organization is strengthened. So we also feel that we are now better positioned to compete for other business within the USPS.

Okay. And then just reiterating on the kind of $570 million deal size. The vast majority of that is hardware, but there is an element of software and services that would extend for a longer period of time.

Yes. So the -- that is the broad framework that USPS had laid out. And what we are providing is the TC7 device, we have custom software. We have our mobility DNA and cyber software also as well as both professional and managed services.

Okay. Got it. And then SmartPack in transportation is an area where you guys have talked about for growth. And so how should we think about the SmartPack opportunity?

Yes, it goes back to the conversation earlier about the T&L company, what are they doing to kind of position themselves to thrive in an e-commerce world. Transportation and logistics companies generally have been very forward-looking in trying to figure out how can they leverage technology to both drive a greater degree of high-level of service, but also drive greater efficiencies. And as more and more shipments or trucks are filled with loose parcels or e-commerce packages versus pallets or containers, something like our SmartPack solution becomes much more important. The average truck in the U.S. is filled with 70% revenue-generating freight and 30% air. So if we can improve the efficiency by how they pack a truck by 5%, which doesn't sound to be that hard, you reduce the number of trucks you need by 5%, fuel by 5%. So lots of good stuff comes out of that. So it's a great driver for efficiencies. It's also, if you think about what we can do with this over time, we can as sort of saying -- use analytics and say, this is a box that's going to be offloaded at the first stop, so put it close to the door or this is a particularly heavy box, put it at the bottom, don't put it on top of other things because it could damage other boxes. So we can use analytics to help automate or improve the whole loading process.

And where are you on seeing customer adoption of that?

It's been great. T&L companies view it as a very innovative solution. They are -- we have a number of pilots going on. It requires fairly substantial changes to transportation logistic companies processes, which tends to be their bigger lift in getting it to be kind of go to commercial rollout. But it is in commercial rollout. It is in many, many thousand of dock doors.

Okay. Got it. I think people understand retail and kind of increased digitization and all of the increased amount of trucks we see kind of for transportation and logistics. Health care is another kind of rapidly growing opportunity for you. Is there a particular kind of technological pain point that you guys have been seeing as your greatest opportunity? Or where have you been best suited to kind of displace competitive products?

Yes, health care has been the fastest-growing vertical for us for the last several years. The catalyst for health care to become a big market for us was the introduction of the medical health records. So now you had a kind of an ERP system where you had digital data. Before that doctors will come walk around with a Manila folder with hand scribbled notes. Now you can pen data, you can extract data from health records. So the first application tended to be around bedside care. Caregiver would come in and read the barcode on the patient, read the barcode on the medication and his or her ID label to make sure the right patient got the right medication, the right dose at the right time by an authorized caregiver. That's been a great application that improves efficiency, but certainly improves quality of care. But now we see also how that's starting to be backwards integrated. So when you scan the medication, you can then debit the inventory of that medication and eventually, you say it is time now to reorder automatically medication from distribution channels. But we also see great value in being able to free up caregiver's time. So it's not sitting behind a PC to enter data or retrieve data before or after seeing patients. If you -- say, 5 years ago, you might remember, nurses or caregivers tended to have a computer on wheels. They were big honkers with a battery and PCs and printers and all sorts of things. Today, that is largely a mobile computer and a mobile printer. As I said, one of the more recent drivers for efficiency has been around voice, where we have a great workforce connect. There is a great voice solution that can enable somebody in an ER department to just push-to-talk, be able to reach anybody who has say a certain skill set or certain locations. So this has been a great driver, and I expect that to continue to be great driver as it becomes more and more global.

Okay. And I mean, does that involve partnering with more kind of established health care leaders? Do you guys feel like there's better ways to kind of get your products into that market?

So we partner with, I would say, all the larger health care providers, solutions providers now. But we also have a number of smaller providers that we work with who have either relationship more locally or more uniquely, but -- so we have a similar kind of go-to-market model as we have otherwise. But we -- it's a partner-centric model, but we look at who are all the partners that have -- can add value to what we do and try to partner with them.

Got it. And then in manufacturing, that maybe an end market that you think of or the market may think of as more mature. Where are you more optimistic on growth in this segment? And where is the pain point you still see being able to offer innovative solutions?

In manufacturing, we had -- it's been one of our main verticals since the beginning. And the drivers are very much the same as, I'd say, other verticals. It's the digitization, being able to drive greater visibility into the supply chain. And we have a number of solutions that help our customers kind of move towards an industry 4.0 type environment. So I'll give you 2 examples. I think locationing. So our MotionWorks solutions are -- is a great new capability for manufacturers that are trying to track more and more assets. Again, we work in inventory, chassis of cars or expensive tools and so forth, anything that they need to track and trace as they go through the supply chain process. But also, we launched FulfillmentEdge at the, I think, at NRF this year. That's more of a warehouse type solution where we take information and we can put it onto a heads up display, and we can enable people to walk down an aisle, say turn left here, stop at this bin, pick up 2 of those, and we can automate how that's done versus the traditional kind of more green screen that people talk about. But what it also does is that it enables us to more dynamically allocate tasks. So in picking solutions, historically, there has been, you get -- in the morning, you get a long list of things. Here are the 15 things you're going to go do today. And when you're done with this, you're done for the day and you can go home. We take the information much more dynamically that you get an order with a short delivery time coming at 11 a.m. that becomes now the highest priority. And you assign somebody to do that versus having a long printed out static list of things to do; or that you have one person in isle 3, that person can do 3 different things versus sending 3 different people there to do that. So you can drive a brand-new set of efficiencies and better service level and better cost position for that.

Got it. Maybe turning to kind of inventory or location technologies in retail. I think for -- RFID has kind of been a technology you guys invested heavily in, there's kind of thoughts around machine vision and those type of technologies. And just how do you see kind of the interplay between those 2 and your opportunity in both ways of kind of how retail is kind of looking at inventory management?

Yes. So first, I said, we invest in solutions that serve our customers today that serve our customers tomorrow and can serve our customers 5 years from now. So we want to make sure that we can be there and have the right solutions for what they need to do at that point in time. And we -- most of our customers they are looking for, I would say, evolutionary change. So having a portfolio of solution that can bring them from today all the way into the future is very valuable. People like to see that we can then be a partner that can solve today's problem, which is why they give us an award, but they also see us as a trusted partner who can work with them to solve problems for tomorrow. RFID certainly been the technology that's been around for a long time, but in the last 6 to 8 quarters, let's say, it's become a much higher growth solution, driven by obviously many more use cases around inventory accuracy, but it's not just retail, it's in health care, it's in manufacturing. But machine vision is another solution that augments, computer vision augments other solutions, another way for us to sense. So barcode can sense something, RFID tags can provide information, computer vision can do it also. So we see that we want to make sure that we can sense as much useful information, extract as much useful information from the physical world and analyze that and provide real-time feedback or reactions to our customers, and we try to have a broad portfolio of solutions to help.

Got it. You've been able to drive a lot of operating leverage out of the business over the past couple of years, yet you guys continue to highlight that you think there's more leverage to get. So where could we potentially see that operating leverage come from over the next couple of years?

Yes. So over the last many years, certainly the last 5 years since we did the acquisition, we've driven great leverage in the P&L. I think we have opportunities across all line items in the P&L. We certainly want to continue to drive attractive growth rates. We have improved our gross margins by several points. And I think we still have opportunity to do that, better, more thoughtful about pricing, but certainly, driving cost efficiencies from scale and design and more innovative solutions. And our OpEx is -- we have a meaningful line there. And we think that there's leverage to be had on OpEx line too. So we do believe that we have opportunities to drive attractive EBITDA margin expansion and EPS growth.

Okay. And maybe circling in on that transactional pricing initiatives you kind of implemented with channel partners, just how to think about how that gets implemented? Or is there any elasticity of demand that, that causes?

So we are implementing and piloting now a solution where we are using machine learning type technologies to be smarter about our pricing globally. And we think that, that has opportunity to drive attractive returns for us. That will be rolled out for this -- in this year. Yes.

Got it. And you've done a number of acquisitions over the last 2 to 3 years as the leverage has come down to basically a much more manageable level. Do you feel like you have the portfolio you need now? Or where would be areas you'd like to invest?

We have, I think, a very strong portfolio in our core business. If you look at our mobile computing, printing and scanning portfolio, I don't see any particular gaps in our portfolio. But we're obviously still very interested in expanding our solutions portfolio in newer things. If you look at what we've done over the last 2 years, we've made 4 acquisitions, 2 were in kind of near adjacencies where we had a little less market share than we felt were appropriate, and where we have felt we had a strong right to play. So Xplore was the first one. That's a ruggedized tablet. We felt that we had tablet business before ourselves, but we were a smaller player. But it felt like that was a, in our view, kind of a different form factor of mobile computer so that was an easy bolt-on acquisition that we integrated that team into our mobile computing team. Then we did Temptime, which was part of our supplies business. There was kind of EAI, enabling our supplies business. So there we have chemically treated supplies that change color with temperature. So you can now digitize the supply chain there also. And if you have vaccines in Africa, say, where the -- you can't quality control the supply chain very easily, you can still verify that the efficiency or efficacy of that vaccine is right. And then the last 2 ones was Profitect, which is a software as a service, prescriptive analytics tool and Cortexica, machine vision, computer vision technologies. Those are more looking at expanding our new Intelligent Edge Solutions and helping to drive some of those automations, intelligent automation solutions. So much more focused on building new capabilities also.

Okay. Got it. Are there any questions from the audience. James?

Thanks for being here today. I wanted to ask quickly, how you think about the kind of growth prospects. Historically, you kind of thought it was GDP plus. It's been faster than that over the last few years. Growth has come down a little bit or is it expected to. Just wondering like what the puts and takes are and how relationship with the like of USPS could impact that? And if that -- how much of a driver, one way or another, that could be, et cetera?

Yes, we feel good about our growth prospects. If you look at our core portfolio of solutions that's what we have talked about as driving the 4% to 5% growth through a cycle, as we talked about, right, over the last 5 years, we've delivered over 6% growth. So certainly done meaningfully higher than that. We see that a lot of the newer solutions around our Intelligent Edge applications, intelligent automation as having a materially higher potential than that, but we don't want to get ahead of ourselves. Also we want to make sure they started from a small base, and they're going to grow faster. And if you look at those solutions within our overall portfolio, they're growing very nicely, but they're starting from a smaller base. But over a longer period of time, over several years, you would expect that, that will become a much more meaningful base and drive growth.

Got it. You've started offering more offerings kind of on a subscription basis, SmartSight being kind of one of those. What has been kind of the reception of the subscription products? And how has that kind of changed how you thought about pricing in some of your portfolio?

Yes. So we have some software-as-a-service solutions, and we have also more applications or use cases as a service. I said if it is pure hardware device as a service, it's less attractive because then it becomes more of a leasing solution. So for us, when we look at as a service type offerings, it is making sure we can bundle a number of capabilities. And like with SmartSight, there's a robot that's part of the delivery vehicle, but the robot is only kind of incidental to what it does. It is what -- it's the outcomes that is really the service that we sell. And I think our customers have been quite receptive to that, and we're thinking hard about how we can be more creative in coming up with other ways of bundling solutions to offer them as a service.

Got it. Well, we are basically out of time. So thank you, and I appreciate you guys being -- oh, sorry, we have one last question.

Great. Reverting back to a couple of questions ago about the M&A activity you guys have had, you seem pretty acquisitive the last few years and successful in doing so. Are you content with the current portfolio? Or do you expect to continue to be aggressive moving forward?

We feel that we have a very strong portfolio in our core, but we do see great opportunity to expand in some of our newer areas around Intelligent Edge Solutions or intelligent automation. So we would expect that there are other solutions, other companies that could be quite attractive add-ons to our portfolio to help us become a broader solutions provider to our customers. But the M&A is a way for us to accelerate our strategy. It is not a strategy in and of itself. It is to help us make sure that we can realize the vision that we have quicker.

Got it. All right. Well, I appreciate you guys being here. And thank you, and see everybody offline exactly at this moment.

Thank you.