Zebra Technologies Corporation (ZBRA) Earnings Call Transcript & Summary

Okay. Welcome to another presentation at William Blair's 40th Annual Growth Stock Conference. I'm Brian Drab, analyst covering Zebra Corporation and also industrial technology broadly for William Blair. Before we get started, I have to tell you that you can find a full list of disclosures on our website, williamblair.com. And today, we're very happy to have with us Anders Gustafsson, who's the Chief Executive Officer of Zebra. Also in the background, we have Mike Steele and Shawn Alcaraz from Investor Relations. And with that, Anders, thank you very much for being here, and maybe I'll just turn it over to you for some opening comments.

Thank you, Brian. It's nice to be here, even if it's only virtually. Yes, so a few comments on Zebra. Not quite sure who's in the audience today here, but I'll give a bit of an overview of who we are. We've been in business for 51 years now, so a little bit more than 50 years. And we continue to be very well positioned for both, I believe, the short and the long term. Our solutions are more critical today than ever before as we give frontline workers an edge by empowering them with the technology to help them do their jobs most effectively. Now industry-leading companies, they trust Zebra to equip their workers and facilities with the type of solutions that bring their mission-critical operations to the next level. We are uniquely positioned, let's say, to address customers' key challenges. We have a deep understanding of workflows and an unmatched access to frontline operational data from the vast -- our vast installed base of devices and other solutions. We can address big global problems, such as ensuring food safety across the supply chain or a broad range or more localized issues, like increasing bed turns in hospitals, modernizing distribution centers to satisfy e-commerce demands or ensuring that retail associates and store inventory are optimized to maintain product availability. Methods for sensing and analyze, and acting on operational data from the frontline of businesses, have undergone a massive transformation in the past years as the on-demand economy has taken hold. Inefficient manual processes have evolved into workflows that are augmented and enriched by purpose-built technologies, including hardware, software and Intelligent Edge Solutions that bring it all together. Businesses are now demanding information about what's happening at the edge of their operations so they can run their entire operations smoother, safer and smarter. They generate large volumes of data, and they are uncertain about how to take all those disparate points of information and effectively collator in near real-time. So we have invested in software solutions and services that help our customers leverage real-time data to better orchestrate their workflows and gain a performance edge. Investments in advancing our capabilities in this area is a top priority. And I got to say, we are as excited as ever about our opportunities.

Great. Thanks, Anders. Was getting a little feedback there. But can you hear me okay, Anders?

Yes.

It might just be on my end.

So I think a lot of these conversations at the conference are, of course, starting with how COVID is impacting your business. And now you had a slight decline in the first quarter in revenue. The guidance is for down 11% to 17% in the second quarter. Of course, no surprise that there's a near-term impact. But can you just talk about how the pandemic has affected the different industry verticals that you've -- that you planned, maybe retail, manufacturing, transportation and logistics, et cetera? And then the near term, how is it impacting you? And then longer term, are there actually some opportunities that are arising out of these different business models that have come to be?

Yes. I think for us, COVID-19 started out as a supply challenge. There was a -- our supply chain has largely been domiciled in China. And so in middle or when the Chinese economy kind of shut down around the Chinese New Year, it had an impact on our supply chain. And that had -- that was really what caused the impact on our Q1 numbers. And that took us longer to get our devices over to the U.S. and Europe. We had to charter airplanes to fly them around and so forth. As we get into Q2, it became much more of a demand issue. Now I think for us, we have some customers who are doing very busy, very engaged and others who are -- had to shut down much more of their operations. We are -- many of our customers, they requested us to be deemed as an essential business as we were enabling them to perform their essential work. So if you're -- say if you look at our 4 verticals that we focus mostly on, we have different -- we had kind of the good trends and the more challenging trends in each of those. You can start with retail, which is our largest vertical. We saw retailers that had grocery, general merchandise or e-commerce or were associated with those. They did particularly well. You -- I think quite been -- it's been quite a lot in the press around how grocery volumes have gone up. So 60%, 70%, 80% increase in just grocery volumes. But the e-commerce part or the omnichannel part of grocery has gone up several hundred percent for most large grocers. So customers have kind of learned a new mode of shopping. So they do buy online, pick up in store, and our equipment is essential to making that, enable retailers to scale those operations. But in other retailers, like people who have more apparel or who are more exposed to department stores, they may have had to shut down all of their operations. So obviously, not quite as much activity from those customers. Then if you look at manufacturing, we saw manufacturing customers that were more process industry oriented, so pharmaceuticals and food. They continue to do very well, while more discrete manufacturers, automotive, aerospace, they were often shut down or have started to come back but more slowly. And in transportation logistics, I'd say there, we see anybody who had great exposure to more delivered to home, so e-commerce delivery, the courier-type services, they were doing very, very well. But transportation logistics customers, they were more focused on B2B supply chains. They had much less volume to deal with here now. And lastly, in health care. There, we've seen acute care solutions be very -- in great demand. So we were helping to stand up pop-up hospitals and drive-through test facilities and just ramping or scaling existing health care facilities to be able to deal with the expected increased flow of COVID-19 patients. But on the other hand, health care providers, they make most of their money on elective care procedures. And they -- most of them had to shut that down. So obviously, that was offset to a good stuff. You're muted, Brian.

Yes. I muted it because everyone is going to discover, I stopped mowing my own lawn here, the guys right outside my window. But what I was saying, yes, thank you for going through that. It was great detail. And I wanted to just talk a little bit more about longer-term growth. And first, looking at the historical growth, your Asset Intelligence Tracking segment or AIT accounts for about 1/3 of sales. That's grown at 3% to 4% on average over the last few years organically, and it's in line with the expectations that you set for that business, I think, originally at the time of the merger with Motorola. And the major product line there is barcode printers, many different models of printers. But on the EVM segment, on that side of the business, enterprise visibility and mobility, it's 2/3 of the revenue that's been growing at a high single-digit rate. It's about double the initial expectation that you had, I think, for that business when it was acquired. And can you talk about what's driven that outperformance? And of course, we'll get into talking about Android here. And then can you talk about the long-term growth expectations for that segment? And does COVID impact that positively or negatively?

Yes. The -- on the EVM side, it's -- our mobile computing business has been particularly strong over the last 5 years. We were -- at the time when we combined with Motorola's Enterprise business, we had a vision that Android would enable us to compete much more with consumer devices that were making some inroads into our type of customers, not for our traditional use cases, but they were competing for the same CapEx dollars. And I think we were more successful than we had expected, I'd say. And -- but it's not just that it's Android. It is the use cases that they enable. So we've initially talked quite a bit about -- there was -- I think when we -- in 2015, we were mentioning there was like, our estimate, 15 million Microsoft devices in the market that needed to be upgraded. And we had expected that most of that will be done by 2020, by now as those Microsoft operating systems were going to be -- going out of support at that point. So we didn't expect customers to maintain them after that. So what we've seen, though, is that there's still about 10 million or so Microsoft devices in the market. We've obviously -- we've sold more than 5 million Android devices, and certainly, the industry has. But the -- as we've kind of been eaten into some of that installed base, customers still continue to buy Microsoft devices also. So there will be more Microsoft devices to upgrade over time, but it's not going to be the same step function maybe as people had expected.

Anders, can I ask one question on that point? I get often from investors is, what is the plan for an operation that has Microsoft devices that is going beyond the support from Microsoft? And how long can they go without that support?

Yes. I think it probably varies by companies. I would say, my -- Mike's high-level thought would be that if you're talking to warehouse manager, as an example, who has Microsoft devices, he or she may have a budget for how much they can spend on IT and the -- upgrading the existing software that they had from recording the existing software from Microsoft devices to Android is both a complicated and somewhat costly task. The people who wrote that software is probably no longer there. So it's going to be kind of a heavy lift from that perspective. So that person at times make a trade-off and says that I'm going to -- I may have very limited access to the outside Internet and therefore, feel that I'm safer and can maintain those Microsoft devices. But if you were to talk to, say, the Board of Directors, and would they be comfortable with having unsupported IT devices on their network. I suspect that they will be much more uncomfortable with that and make a different trade-off. But they generally don't have the visibility, I think, into what's going on in individual warehouses or locations like that.

Okay. And I cut you off there, but I -- go ahead.

Yes. No, so the -- I think the bigger driver for us -- driver for Android has been the new use cases it has enabled. So in -- historic, 5 years back, we would have had, say, 6, 7, 8 Microsoft devices in a large retail facility. Today, they were routinely around 70, 80 devices. And we've gone from those devices having maybe 2, 3 applications to now having 60, 70 applications. So the touch screen has -- enables people to put much more easily, have other use cases and make them much more customer facing. So there's been a much greater penetration. And now we have a lot of our customers, who talk about they want to be able to equip every worker in their facility with a device. They want everybody to be connected and have the ability to interact with the systems, get data, upload data and get tasks and communicate also with their colleagues. So the penetration of devices is getting to be much, much greater. And that is, I would say, a much bigger driver than the upgrade cycle from Microsoft.

Okay. Okay. Great. So if you look at these 2 segments, again, the AIT segment, barcoding has been growing at this 3% to 4% rate, EVM and the mobile computer is at faster rate. Do you think that, that continues -- that discrepancy continues going forward? And then also, can you talk about how that affects gross margin, given that the faster-growing segment, the EVM has recently had about -- gross margin about 400 basis points lower than the AIT segment. Does that kind of put a cap on gross margin to any extent?

We have -- first, I think that the growth of our business overall, we see as being attractive, and we drive to maximize growth in all our product segments that would -- as much as we can. From a margin perspective, we have some delta between different products, but it's been moderating over time. So if you go back 5 years, the delta between our printing and mobile computing business or the gross margins for those product categories was much greater, with the mobile computing gross margins have improved quite substantially over the last several years. And we continue to drive the margin improvement across the portfolio. And you've seen other areas like in services, we've been able to improve margins quite attractively over the past couple of years, too. So we don't see that there is a upper limit, per se, on our gross margins as we introduce new SmartDEX solutions or our Intelligent Edge Solutions, more software solutions. We also see opportunities to continue to drive that. But we are -- gross margin, I'd say, is the line item on the P&L apart from revenue growth, that is the most -- that has the most focus within the organization. So everybody is very focused on making sure that we drive gross margin hard. But we're trying to make sure, obviously, that we maximize the long-term value of the enterprise. So we're trying to make sure we get the best growth and margin profile and get leverage throughout the P&L.

What's the main reason for that difference between those segments? And can you raise the EVM segment gross margin, do you think to get closer to AIT longer term?

Yes. There's a number of reasons for it. But one is competitive dynamics, certainly. But if you look at the EVM gross margin profile since 2015 to now, I think it's probably up, maybe 300 basis points or something in that ballpark, maybe a little bit more. So we have been able to improve margins quite a bit by doing a number of things. Starting with -- on the product side, we have platformed a lot of our devices. So we have the same kind of hardware architecture for them. That also means from a software perspective that we can reuse probably 90% of the software that we have. So we get a lot of scale benefits in our development for that. We also spend a lot of effort on analytics around pricing to make sure that we are very thoughtful about how we price to make sure we don't let our competitors come in, but also that we are trying to make sure we get fair price for our solutions.

Okay. Great. And back on Android for a minute, since you've had so much success there. In the mobile computing market, my impression was that historically, that business had maybe 40% or 50% share of that market. I don't -- so maybe you could comment on whether I'm right or wrong on that. And then also on Android, I think you've said that in some periods, your share was well above 60%. And can you talk about whether those figures are in the ballpark? And what you expect for your share in that market, how it's trended lately? And are you still by far the clear leader there? Any more competition popping up in Android?

Yes. So for enterprise mobile computing solutions, when we acquired the enterprise business, we had a memory search, we cracked 37% market share. Now it's overall, but that was largely Microsoft at that point. And today, we have a little bit over 50%. But if you peel back the onion here, you will see that in Android, we still have over 60% market share. So we have a very strong position. And I think in Android, the #2 is less than 10% market share. So we have a great scale benefit compared to our competitors. And our goal is clearly to continue to make sure that we drive market share gains. We've been able to do that consistently across our 3 main product categories. Printing, for the last 13 years, I think we've gained roughly 1% of share per year. And in mobile computing, we've certainly done more than that over the past 5 years.

Great. And then just going back to margins in general for a second. Most of the margin expansion that you have seen and you've had very significant margin expansion over the last few years, it's come from leverage on your operating expenses and, I think, benefits from implementing the ERP system and all these efficiencies that you drove postmerger. What is the opportunity to continue to leverage those operating expenses going forward? And is there further opportunity for expansion there?

Yes. I think we always have opportunities to drive margin improvement across the P&L, gross margin and other margins, too. But the -- we have -- we tend -- over the last few years, we've had some bigger initiatives like around services, where we in-sourced our repair facilities in North America, we changed our service provider outside of North America that has had a great impact. The cost of goods sold, we've been able to impact by the platforming of products and scale in software and also, of course, negotiating with our contract manufacturing partners. But I -- so for the most part, this is more like a daily grind that is deeply ingrained in our culture. It's not like we have one or two big things that we work on and then we have to find some new big things. It's every day, we know, there's smaller opportunities, but they all add up to a meaningful advantage or improvement in margins. So for us, it's more of a cultural part of how we operate the business. We put a lot of effort behind identifying that setting, beginning of the year, setting targets for what we want to do on the cost side and on negotiations around our COGS and other areas and then making sure we go and drive that hard, including the redesigning products to get greater margins, so taking cost out of products, value engineering and so forth.

Right. So the OpEx has gone from 31% to 27% of sales over the last few years. So maybe you don't have the opportunity for such significant gains. I guess, it's not going to be 100 basis points a year, but you'll still grind that lower?

Yes. That's the expectation.

Okay. Got it. And then all of a sudden, we have 7 minutes left. I want to make sure that we hit on some of these important topics, but maybe in a second, I'll ask you just what you want to say that's most important. But I wanted to touch on software, too. I get a lot of questions on your software business. Can you talk about -- and RFID, what -- how significant are these businesses right now within Zebra? Software is still just a few percentage points of revenue, I believe, and probably the same with RFID, and what's the expectation there?

Yes. So first, I'd say, the investors tend to want to kind of categorize companies into software companies or hardware companies. And I think that, that is a false distinction when it comes to Zebra. I think of ourselves is that we are a solutions company. The reason we have such high gross margin on our devices is that we leverage a lot of software to differentiate and offer value in those, right? So for us, we develop hardware devices and software together that solve unique customer problems. So I think that's the kind of the secret sauce for us. Our software revenues that we break out as part of our software services piece, are, fair to say, more modest today, but the value that we offer through software in our devices is much greater. And why are we not breaking out those or charging our customers more for here's the hardware cost, here's the software costs is that we believe that we actually get more negotiations power by keeping them together. In many parts of the world, they see software as being a variable cost, and they don't want to pay for it. So if we put it into the hardware line, it makes it easier for us to charge a fair value for it. But -- so that's one part of it. But the other part would be, we do offer now many more or more pure software solutions. So if you look at our 2 latest acquisitions, Profitect or Zebra Prescriptive Analytics, as we call it now, and Cortexica, those are 2 pure software businesses. And they -- but they do leverage our customer relationships and other solutions. So over time, I do expect that software become a more and more prominent part. But I just encourage people to try to think a little bit more deeply about the solutions part, which requires both hardware and software. It's not like a commodity part of -- piece of hardware where you can run anybody's software on it. It is slightly different.

Right. Okay. And then you want to elaborate on RFID at all?

Yes. RFID has been a great -- growing very attractive -- at very attractive rates over the last several years. So it's been around for quite a while. But I think now with in -- for us, retail has been the main driver, and it's been a lot of focus by retailers than on inventory accuracy, in-store merchandise accuracy as they want to do more omnichannel or e-commerce type of transactions. And at that point, it is that much more important to have an accurate view of your inventory. If you've taken an order online and say you'll come by in 2 hours and pick it up and it turns out, you don't actually have the merchandise. That's a very bad experience, and those customers are unlikely to come back. So -- and retailers are not terribly good at having inventory accuracy. So that's the main -- has been the main driver, but it's also been around than reducing labor and other efficiencies. So -- and part of the why it's growing here also now is that the -- there's many more software applications that customers have written around this or other software providers have done. So the applications -- the suite of applications is also greater.

Great. So we just have a couple of minutes left. And just the last question, then I'll let you make whatever closing comments you'd like to. But 4% to 5% was the growth rate that you've talked about for the longer-term potential for the business. Is there anything that has changed, given the pandemic and opportunities that have arisen or other opportunities that have arisen that would make you feel like maybe the longer-term potential is greater than that 4% to 5% at this point? And then just any other closing comments that you'd like to make, we just have about a minute.

Yes. So first, I'd say, we feel very good about how we're positioned. And the 4% to 5% growth that we -- that number came from looking at independent market research estimates for growth of our core markets and then adding a little bit for us taking share. But we certainly don't view that as a ceiling. We're trying to maximize our growth as much as we can. And we have entered a lot of new spaces. We talk about the new software acquisitions we made, as an example, and other type of Intelligent Edge Solutions that's like SmartSight and SmartLens and so forth. So I see good opportunities for us to continue to grow. As part of now the COVID-19 crisis, what has changed for us. First, I do expect that the world will get back to business. And my sense from talking to customers and partners here in this period where we all kind of work from home is that people are eager to get back to working more normally. They want to get back to competing, to investing, to running their businesses. And I think the -- lot of the trends that we had been talked about earlier of how to digitize businesses, omnichannel, e-commerce, those are all -- those trends, I believe, are all being accelerated and accentuated by the trend here now. These trends are helping people, the social distancing, both from a consumer and from a work employee perspective. So we feel good about our acquisition and how we can move forward.

Great. Well, thank you very much, Anders, for being with us. Unfortunately, we're out of time. These 30-minute windows do fly by.

Thank you so much.

And thanks Mike and the team getting us ready, and thanks, everyone, for tuning in.

Thank you.