Zebra Technologies Corporation (ZBRA) Earnings Call Transcript & Summary

And we are live. Good morning, everyone. Welcome to the 48th J.P. Morgan TMC Conference, the first virtual one as far as I'm aware anyway. My name is Paul Coster. I cover alternative energy and IT hardware at JPMorgan. And it is my pleasure to welcome Olivier Leonetti, the CFO of Zebra, to our first session. Good morning, Olivier. Can you hear me?

Good morning, Paul. Good morning again. Nice to see you, and nice to see virtually all our participants. This is also a first for me, so yes.

All right. And I'm aiming for the worst self-administered haircut of the TMC season. So before we start, I just wanted to make sure that everyone knows how to participate here. If you have a question, there is a little box up in your Zoom somewhere. You just tap on it, enter the question, and I will do my best to read the questions. I'll probably fail. Let's give it a shot.

Let me start though, Olivier, by asking you to talk about the recent past for Zebra Technologies. It's been a really fabulous couple of years, up until a few weeks anyway, and that wasn't your fault. Talk to us a little bit about the last 2 years, something of a golden period, I think, for Zebra.

Yes. So we have set up, following the acquisition of some of the Motorola assets, we have set up a pure-play, asset-intelligent company, solving important problems for our customers. And we are serving today strong secular trends. If you look at, for example, on-demand economy, automation, the need to increase productivity, the need to increase collaboration, we have created a company able to solve those needs. We have also created a strong go-to-market. I'm sure, Paul, we'll go through that a bit later during this Q&A. And also, I would characterize the company as a company with a strong operational discipline. When it comes to executing, cost management, pricing, margin management, we have been doing well. And we look at this current pandemic actually as an opportunity for us to win shares. We know that this crisis will end. We want to exit strong. And we believe that this crisis is actually accelerating some of the trends I mentioned earlier. So we feel as good as we could be about the future for our company.

Let me address something which comes so often to my desk anyway, and I'm sure indirectly to you, and that is, oh, it's just a product company. It just makes hardware solutions. This is easily commoditized. I think I've been answering this question for many years, not very well apparently because I still get it. Perhaps you can sort of address this question. And in doing so, perhaps differentiate between the EVM and the AIT segments, what are they?

So we have 2 sets of hardware. One is, as you said, AIT, Asset Intelligence & Tracking. It's the Zebra legacy company, including printing supply and Zebra retail solutions. And then you have the EVM segment, Enterprise Visibility & Mobility segment, which includes mobile computing and data capture. So you have those 2 sets of assets totally integrated, wrapped around a set of solutions, which is enabled through Savanna, which is our cloud platform. All those devices I described are connected through a cloud solution. We are also using this cloud solution to track how our assets are performing, but also to track the data that those assets are identifying. And then we propose an outcome to our customers: workflow optimization, improvement in collaboration, preventive maintenance, you name it. And we believe that today, we are one of the very few companies able to provide the services we do, these 360 asset-tracking and then data-mining solutions.

And the EVM segment, what is -- I mean perhaps you can just explain what that segment is and how that ties to that?

So EVM will be the mobile computing and data capture. So mobile computing, we are today a leader in this market. We have more than 50% market share. Our market share is actually expanding. And data capture would be a scanning device.

So the -- what this leads to is people looking for this big service revenues, and they don't see it, right? What they see is that you're still, in largest part, a hardware company. So how is this value proposition that you've just described expressed in your business model?

The way I talk about it, because most of us use it, not all of us, but most of us, is the way I would describe Amazon Prime. Amazon Prime as a revenue stream for Amazon is not a big part of their revenue stream, but it's a key enabler and a key part of the competitive advantage of Amazon. For us, the solution set around Savanna is actually what is the differentiator. We are mainly, today, a software company. Most of our engineers in R&D are software engineers, and that's why we have been able to actually expand. A good indicator is the way we have been able to increase EBITDA pre-crisis by about, over the last 3 years, close to 4 points because of the value proposition we are providing to our customers.

So in the last couple of years, you've sort of been tied to the whole IoT, cloud, data, AI theme. You've also sort of seen some strong end markets. And of course, you've seen the benefits of the Motorola acquisition flow through. As I said, a golden period, and then March came. So you just reported your first quarter. It wasn't so bad. Actually, revenues were only down 1%, and EBITDA margins were down a couple of hundred basis points from expediting freight and so on. First of all, talk to us about what you've seen so far by geography and vertical, and then perhaps why did you withdraw guidance. It didn't sound that awful. In fact, stock responded very well.

So of course, I'm not going to update our guidance today. But just going back to what we said during our last earnings call, what we have seen is an impact to the company only due to C-19. We believe -- we know very soon, for sure, but we believe we actually gained shares during the quarter. And if you look at the EBITDA margin decline of 2 points, 1 point is transitory. It's due to tariff, and it's due also to expedite costs due to C-19. And about 1 point is due to [ oil hike ] mix. The channel is ordering -- has been ordering less, basically, because the channel has been resetting the level of inventory. So that's what happened in the quarter. If you look at regions and vertical from a regional standpoint, the regions -- the key regions, Europe and the U.S., did actually pretty well, considering the circumstances. Most of the decline from a regional standpoint came out of China for reasons that all of us would imagine, not only the impact of C-19, but also before the impact of tariff. And from a vertical standpoint, we are a very diversified company. And the picture actually depend not by vertical, but by subverticals. So if you take, for example, retail, some part of retail have done very well and are doing very well. Everything associated with grocery, with e-commerce, this is a segment which, relatively speaking, is performing well. Buy Online Pick Up In Store is doing well. Now if you are in the apparel business, if you are in the department store business, obviously, that has been impacted. In health care, health care has been doing well overall; as a segment, it generally depends. Transportation for grocery is doing well. Transportation for e-commerce is doing well. Transportation for pharma is doing well. But if you transport parts of automobiles or if you transport cars, doing less well. And manufacturing, the same picture. Some doing well if you sell food and pharma, but if you do discrete manufacturing, aviation, cars, that is doing less well. So the picture by vertical is mixed. And you see the value proposition of Zebra, Paul, we are very diversified. So if a part of a subvertical is not doing well, another one can, relatively speaking, take over some.

So crystal ball time. Can you talk a little bit about how you -- well, first, what is Zebra -- what is your basic assumption around what happens next in terms of how you're managing your business? Are you looking for a deep, long recession, for instance? And what -- how do you think the recovery plays out for you?

So we don't -- I mean I don't pretend I know about what is going to happen. I'm not sure many people can pretend they know. But there are certain things we know. We know that the secular trends we are serving are accelerating: automation, on-demand economy, the requirement to improve your collaboration, the productivity of your team members. That trend is sound. This trend is accelerating, and we are uniquely positioned to serve the trend. So in other words, our strategy is sound. There was nothing wrong with our business. This crisis is not going to last. And what we do today is we navigate, improve the P&L, manage the cash flow while investing in the business, whilst doing while doing no harm. Actually, some of the products and solutions we're working on, we're trying to accelerate them. We're actually working on a solution to trace and track, very relevant in the current context. So that's the way we're navigating through this period. And if you study prior crisis, this one is -- has no equivalent. You see that, usually, our industry has been bouncing back fast from crisis and Zebra faster than the industry. So we are as optimistic as we can be today, Paul.

All right. I mean the playbook last time around, I think it predates you, of course, but that CFO of Zebra was -- that Zebra made pretty significant investments in '08, '09 and came out with huge market share gains at that time. That was awesome. Hopefully, you can do the same. With which, can you talk about your long-term expectations around business model growth and margins? And have they changed at all?

They haven't. We said, post crisis, we believe it's still true past that we can grow this business on an organic basis at a rate of 4% to 5%, and M&A -- and we will do more tuck-in M&A going forward. We'll be on top of this. We don't think it's an aspiration. We have been able to achieve those goals if you look over the last 3 years as a CAGR. And from a margin standpoint, we have been able in the past to improve margin, I mentioned that earlier, Paul, by about 4 points over the last 3 years. And we believe we have the ability to keep doing that going forward, either through pricing power, through COGS, management and OpEx scaling. Again, we're not selling a commodity. We are something -- we're selling something which is providing a high ROI for our customers. And this trend we see expanding going forward. Of course, we have to execute, but that's the way we see the future today. If you look at automation, workflow management, compliance, productivity, those trends are exciting. And we are uniquely positioned today, we believe, as a company to serve those, Paul.

Okay. Much has been made of the Android upgrade cycle. It's almost become a bit of a joke actually because everyone says, oh, well, it's a $10 million opportunity, and it's been a $10 million opportunity for about 2 years now. And we're all starting to kind of wonder whether we just went kind of down a garden path with no end to it. What is happening there? I know that -- I mean what is your market share of the overall market? What is your share of the Android market? Is this upgrade cycle from Microsoft to Android even relevant anymore? Talk to us about this, please.

Yes. So we have more than a 50% market share of the mobile computer market. It's an important market we serve. In Android, we have been the leader for a period of time. We have more than 60% market share. And if you look at our market share in mobile computing, it's actually growing and accelerating. If you look at the last quarter, the last year, it's an increased level of market share gain. What is happening today, you have 2 things. One is, and that's a modest trend, this first trend, is a refresh cycle where you have Windows getting end of life. Some actually of the releases are actually already end of life. So you have this phenomenon going on and then our customers moving to Android, where we are a leader. So that's one trend, refresh cycle. And on this trend, the tail is actually a very sizable tail. The $10 million you mentioned is still, we believe, what is the addressable part of the market. Because Microsoft, despite the end of life, is still being used for run rate orders because it costs to transform your activities to Android. So people are, some, today keep buying in small orders Windows. So we believe that this replacement will last for a number of years, maybe another 2 years. But then you have an important trend going on, Paul, which is new use cases. If you and I know that we do that nowadays, too much, but you go to a pharmacy, you go to a store, you go to -- when you have online deliveries at your place, you see all those workers equipped with a mobile computer. Those are new use cases we didn't have 3, 4 years ago. And this trend where more and more -- every worker now has a tendency to be equipped with a device is a trend we are benefiting from. And we see this trend accelerating. I mean, today, we're developing, we are starting to market what we call a proximity monitoring and tracking, contact tracking solution using our devices. So with this, we see mobile computing actually being a strong vector of growth going forward through use cases, new use cases and the Windows replacement.

Yes. In addition to new cases, new use cases, the CEO has often talked about near adjacencies where you have, and I quote him, "the right to play." I feel like I'm almost a Zebra employee at this time. I've heard that so many times. Can you talk to us about what these opportunities are?

So we believe we can go, as I indicated, 4% to 5% organic plus M&A. Why do we believe we can do this? I mean, again, we have to execute. That's always true. And we don't -- I mean I hesitate to say this because it's obviously a competitive market. But if you look at the markets we serve, we have many avenues to achieve our long-term goals. If you look at our core market: printer, mobile computing, scanning supply, that's about a $10 billion market growing at about 3% to 4%. So we have been gaining shares in this market. So that's an avenue of growth. Another avenue of growth is to cover adjacent markets: tablets, supplies, bioptics, RFID, smart solutions, computer vision, intelligent automation. This other market I've described is more than $15 billion. I mean if you include automation, it's actually much, much larger than this and growing at a multiple of our core market. And you have a lot of synergies between core and adjacent, that's why they are called adjacent. And you have a lot of synergies between automation and what we do. So we see today that we have many avenues to achieve our goals and many fields where we have the right to play as well, Paul.

I'd like to go into a couple of those momentarily. In the meantime, though, can you talk a little bit about the go to -- one of the reasons why you're differentiated, I think, is you've got this very mature channel and you got a lot of product to come through that channel, and your competitors seem to have a fairly patchy response across each of the segments. Do you -- I mean I'm sure you agree with all of that, but can you elaborate?

So we touch the sales in the vast majority of the cases in one way or another, either directly through our sales force, our system engineers or indirectly through micro-targeting, our marketing engine. But in 80% of the cases, 80% of the revenue, we use the channel to fulfill our solutions. And the channel, which is an important part of the value proposition of Zebra, which is obviously global, is now more and more specialized to do the final step of customization. So we have channel now specialized in health care, channel specialized in RFID and soon, more level of specialization of the channel by subverticals by actually even solutions. So we go to the market together, and we believe it's a formidable, actually part of the value proposition of the company, having this spread, this ability to tailor to the customer need.

It may be surprising to people who are new to the story, but you're spending over $400 million a year in R&D. Where is that going? And can you wrap that into the whole kind of sustainable competitive advantage sort of thesis here that you think you have? And it feels like there's a lot of things.

Yes. So if you look at today, R&D as a proportion of revenue were about 10%. You mentioned this, and it's about twice on our #1 competitor, right? So 10%, about twice. And we are about twice the size now, maybe 2.5x the size of our #1 competitor. So you can see, I mean, we are overinvesting -- not over, but we're investing much more than our #1 competitor by a high margin. And we today invest -- and the investment has changed over time. Today, we invest a portion on products and solutions, which will be launched in 2 years. But actually, about 1/3 of the investment in solutions we're going to launch in 2 years plus. So we're investing in automation. We're investing in machine learning. We're investing today in computer vision. That's part of the investments. So -- and we have today a track record for innovation. And we, today, because of this investment, we are perceived as a thought leader by our customers. And [indiscernible] not always, but more now the selling [indiscernible] Paul, would be ROI-based. We have access to the top management of the key customers we serve, and the conversation will look like this, Zebra, how could you solve these problems or come up with a solution? And that's now how some of the conversations are going because of the R&D investment and the power of the solutions we have been able to launch.

What do you think the company will look like in 5 years from now? Is it going to be the same, just bigger?

It's an evolution. We could be the same and be a very appealing company. Or we could be Zebra 3.0, 4.0 because we have been in business for now half a century. And the 4.0, 5.0 would look like a company serving the automation at another level, being able to manage workflow at another level, being able to give productive analytics at another level. All of that, we have been working, you know the company well, Paul, for a number of years. We have been working on that since those themes for 4 full years, and we're accelerating. We're investing today organically. We have made acquisitions to support those trends. And if we execute, and it's hard to do, it could be a very exciting future for our customers, Zebra, our employees and investors as well.

I mean the acquisitions maybe give a clue here. Let's start with maybe the least immediately impactful is Cortexica, which puts you into the machine vision space. And obviously, you have AI and machine learning capabilities already. Does this sort of signal your move into sort of key and Cognex-type arena?

You have a lot of white space in the -- and I mentioned computer vision more than machine vision. But we are going to serve today white spaces, so we don't think, at this stage, things would change at some stage. We're going to compete, so we want to address different use cases today, Paul.

Okay. But nonetheless, it's not necessarily mobile worker-attached technology, right?

Not necessarily, no. It could be object recognition as well. It could be the supply-chain management. It could be logistics. It could be many various work flows with good machineries and people as well.

So Temptime is interesting because it allows you to monitor the temperature and the -- and how a product move through the channel through the T&L infrastructure. And that seems very topical given debate around vaccines. Can you talk about that a little bit?

So Temptime is an acquisition we made about a year ago, working very well. They monitor the temperature over time for an object. Today, it's used with vaccines. It is good to be used for vaccine going forward. We believe it could be used also in pharma overall and in the food supply chain. And we are also today, of course, in contact with the various health care providers to be helping the launch of a new vaccine when that comes for C-19 indeed. So that's part of, not the only one, part of the value proposition of the company, again, smart asset tracking people but also vaccines.

All right. And the other acquisition, which I think was interesting, was Xplore. Xplore got you into the ruggedized laptop space. I think there's some use in warehouses, but also police vehicles. So it moved you into the first responder market, competing with a neighbor, actually, I suppose, [indiscernible]. So talk to us about that acquisition. Is that beginning of more to come in that space?

So if you look at today what we do, Paul, we track assets, we analyze the result of the tracking and then we propose an action, right? So we track today through an RFID. We're going to use computer vision. We mentioned that we're developing capabilities, analytical capabilities, and then we propose an action either to a human or to a robot tomorrow. So mobile -- the tablet is a device to propose an action to a human. And this acquisition gave us a key position. We were a bit -- we didn't have the same power in ruggedized tablets as we had in other parts of the market. This acquisition gave us the credibility in the market to address, it's a relatively large market, to address also verticals, government, first responders, that we didn't address before. And the reception we got as Zebra has been very positive. Actually, the ask originally, Paul, was from our customers. They said, we like what you do. We want you to help us in the larger form factor part of the business. That's why we made that acquisition as well.

So we'll see 100 basis points of growth through acquisitions, moving you into these adjacencies, something of that nature. It doesn't sound like we're going to see another big transformative deal, though, the kind you did with most of our Enterprise Solutions business, which was twice the size of your company, of course, correct?

That's true. We don't think we need to do that. There is, of course, a lot of risk. But tuck-in acquisitions, consolidating our reading capabilities, consolidating our software, analytical capabilities and on the act, again, investing in, for example, tablets but also in robots, is where we want to invest through M&A. And all of that will be mainly tuck-in. .

Well, I think you did such a great job with the big acquisition. I think you have the right to do something sizable moving forward personally. The balance sheet looks pretty good now. I mean when you bought Motorola, I seem to recall the leverage went up to 5x net debt-to-EBITDA or thereabouts. You're now under 2x, if I remember correctly. You also got a $750 million undrawn revolver. So it just feels like you're well set up for whatever is about to happen.

We think so, and we worked hard for this. The liquidity, the solvability of the company is very strong. So we have today a leverage ratio of 1.5. Our target trend is 1.5 to 2.5. We have also a revolver capability of about $1 billion. We have a bit less available under it, about $700 million, but we'll increase this as we generate free cash flow. So we feel strong about the solvability and the liquidity of the company to a point where today, we want to use the strength of the balance sheet to gain shares. Today, pricing power matters, but less than before, but helping on credit could be the enabler to increase shares. And we are today looking at using our balance sheet to be stronger in the market.

How does that work? I mean it's not the channel you're extending credit to, is it?

It could be on some cases. It could be the channel. It could be our -- some of our end users. Yes.

Okay. We've got only a few minutes to go. So a couple of wrap-up questions here. Section 301 tariffs were imposed a couple of years ago now, and you've responded by changing your supply chain. Where do we stand? And when does the associated expense, both the tariff expense and the investment in the new supply chain, go away so we see the margin accretion in the normal environment?

So we have been looking at diversifying our supply chain now for about a bit more than a year, and we will be done this quarter. So we have duplicated our manufacturing footprint that we don't own, by the way, to our partners in Asia and actually in Mexico. So today, you have full redundancy for every product line. So mobile computer is built in 2 to 3 places. We have done that to mitigate tariff, but also to build, and it's going to be a theme going forward for many companies to build resiliency in our supply chain.

And the margin impact should be beneficial when?

All the excess costs due to tariff would go away at the end of this quarter. Will COGS be lower excluding tariff? Over time, but not immediately, but we expect the cost to be at parity with what we had in China.

Okay. And then my last question is there's this big USPS contract out there. We think it's about $500 million of value over -- revenue over 2 years or something of that nature. First of all, am I correct? And secondly, is it still going to happen given some of the rhetoric we've heard from the politicians?

So the contract award was for $570 million, but the bid we won is below that value. So we have the ability to reach that level, but the bid value was below this. And since then, we won -- we mentioned that on our last earnings call, we were awarded in Q1 an additional contract, 30,000 units under this large umbrella. I mean of course, we are listening to the news. But if you look at the interface between our 2 organizations, USPS and Zebra, the level of engagement is very high. We're still staging. We are still -- we received the orders. And we believe that this order is still totally in play. The USPS is providing a key service to us, U.S. citizens, and we don't see that going away anytime soon. As a big reminder, also, you know that, Paul, but for the audience, most of the order is expected to be delivered next year, particularly first part of next year. And the reason for this is that 3G, which is going to be decommissioned, so all the devices used by USPS will have to be changed.

Got it. Got it. We have to wrap at this point, but that was a good point at which to end anyway. Olivier, thanks so much for participating today. I appreciate it.

You take care. Appreciate the time, everybody. Take care. Bye-bye.

Okay. Bye-bye.