Zebra Technologies Corporation (ZBRA) Earnings Call Transcript & Summary

Welcome, everybody. I'm Meta Marshall. I head up networking coverage here at Morgan Stanley. We're delighted today to have Zebra with us. We have Anders Gustafsson, CEO; Nathan Winters, CFO; and Mike Steele from IR, who are available for questions today. I'm going to start with a brief disclosure. For important disclosures, please see Morgan Stanley's research disclosures website at morganstanley.com/researchdisclosures. If you have any questions, reach out to your Morgan Stanley sales rep. And just for anybody in the audience, we do have the portal up here, so if you e-mail me any questions through the portal during the session, I'll relay them to the team.

So Anders, thank you so much for being here today. I'd like to just kick off our discussion with a bit of an overview of some of the trends that really -- that you saw that accelerated through the COVID pandemic. Can you just start us off with an overview of some of the puts and takes you saw in demand for your products over the last year for what's been a pretty phenomenal year for you guys?

Yes. I'd start by saying that all things kind of digitization and automation across pretty much all verticals have accelerated substantially over the last year. We feel that our customers' sense -- have a greater sense of urgency of automating and digitizing their processes. And for us, also, we -- I guess, just from a trend perspective, in Q2 when COVID kind of hit the hardest, we saw our largest, say, most sophisticated customers, to some degree, were the best positioned to kind of pivot and adapt to a COVID world, while smaller customers or nonessential customers were shut down or had to pause. But in Q4, we definitely saw the companies that had paused a bit more in the middle of the year to come back. So we did see strong recovery in Q4 across all our customer sets.

Got it. You just kind of mentioned, some of your larger customers being the best positioned, how much of the incremental kind of deal activity you saw during the year was those large customer scaling solutions versus kind of trying out new technologies altogether or just net new customers coming to you and saying, we have this need, can you help us address it?

Yes. First, I think all the things you talked about were drivers for the business. The needs across verticals around digitization and automation were -- there's a lot of commonality. I'd say, during COVID, there was a premium on just being able to scale existing solutions to a large degree. It was harder to implement brand-new technologies because customers would generally not want to be on-site to have people from outside of their companies on-site to do pilots and proof-of-concept and so forth. So it was more deploying, more proven technology to help them scale new use cases. For us, we could see that number of new use cases that had gone from being very nichey in kind of prior to COVID to becoming mainstream. And I would say, buy online, pick up at store would be one of those, right? E-commerce and omnichannel was a large driver for our customers to be able to adopt and scale those. But buy online, pick up at store was something that was a relatively modest used application before, but very quickly became a kind of centerpiece for our grocery, general merchandise retailers, and they scaled that up very quickly. And then on the back of that, I would say, we saw quite a few new use cases for existing technologies. But newer technology is a little bit more on the back burner during the middle of the year. We started to see that come back at the -- towards the end of the year.

Got it. And you talked about, in Q4, starting to see some of that SMB or some of the verticals that might have been a little bit more impacted coming back. Is it, -- they had like now the stores are open, they've done that catch up? Just how do you see kind of that customer set progressing through the year now that there may be a little bit more of a position to spend?

Yes. So our SMB customers, the kind of what we call run rate for the business, came back stronger than we had expected in the second half of the year. As I said, they were part of the nonessential companies that more had to pause early on. And when they opened up, they had to retool, to some degree, to be able to be fit for business in this new COVID world. I would say that a lot of companies are eager to kind of position themselves to compete once we get out of COVID. So they wanted to -- they could see some of these new trends. We talked about e-commerce, omnichannel, buy online, pick up at stores as examples, but we have similar examples in pretty much all the verticals that we serve. And smaller companies wanted to make sure that they could also offer those types of services or solutions and wanted to retool themselves to be able to be ready for competition when the world kind of opens up again.

Got it. And a question we got from the audience was, just how would you characterize the state of the digitization across your customers? Just in terms of customers of -- certain customers took a big leap this year. Just where do you feel like your customers are, in general -- kind of what inning are we in, I guess?

Yes. I think it varies, to some degree, by vertical and by customer. If I were to generalize, I'd say, we're probably in the before the halfway point, but maybe not too far before the halfway point. And part of the challenge with that question is that it is a moving target. When we started talking about automation and digitization some 7 years back, take -- a regular retailer would have maybe 3, 4 applications and a handful of devices in the store. Today, they routinely run more than 50 applications on a mobile device, and they may have 80, 90 devices in the store. So that was not something, I think, any of us had expected to happen over this time period. So the rate of change and the rate that our customers are kind of expanding their ambition level has been increasing quite a bit, and I think that's going to continue.

Got it. That's helpful. We attended your sessions at NRF or kind of the Retail Federation's kind of Technology Conference. And one of the main themes that was discussed was getting kind of store associates out, but with better devices to track inventory, more analytics and kind of management of the entire retail experience. How does that evolve into your portfolio development? And how this reflects this, which has obviously been a big success kind of play into that?

Yes. We have -- starting with the kind of the device for all as a concept, that's a great opportunity for Zebra. We've estimated that about 1/3 of retail store associates in larger stores have access to a device. So we certainly see there's a great opportunity to continue to penetrate that deeper. The interplay between the software applications and devices is helpful to drive demand for both. But it really comes -- ultimately comes back to the kind of much more on-demand economy. If you go back not many years, you would have be able to kind of come in the morning and you get a printed sheet of actions that you are going to -- you can execute on during the day. But today, if you have buy online, pick up at store with a 2-hour pickup, and somebody dials in for -- enters an order at noon and wants to pick it up at 2:00, you have to dynamically be able to insert that actions into the workflows. So what we can -- what we help our customers do here is, starting with Reflexis now, Reflexis can much more dynamically allocate and assign actions to retail store associates. And we help Reflexis be both more intelligent in how it does that, so we can have a store associate go down an aisle and see that something is stocked out. They can scan that barcode and say that it's stocked out. Reflexis will then be able to put it into its analytical engine and say, this is a high ROI action, this should be prioritized higher than many other actions that already were out there and insert that into the stream. And similarly, if -- on a buy online pickup at store, it can -- it knows what store associates are doing, and can then identify here is a -- here's Anders. He is currently idle. He doesn't have a high ROI action that he's executing, so give me the task of picking somebody's order. So our portfolio is very synergistic in this way and help our customers manage their businesses much more dynamically.

Got it. And then, maybe is -- your Intelligent Edge Solutions has obviously been another area where you've kind of seen software insertion. Just -- can you give us an update on where we are in acceptance or deployment of some of the products you've had there like SmartSight or SmartLens?

Yes. We continue to be very excited about our SmartX solutions, and they also do fit into our broader portfolio of devices and fixed intelligent infrastructure and software applications. So SmartSight will be one retail application, which is a robot that can move up and down the aisles that we introduced at the NRF, I think, a year ago. Timing was not ideal for being able to get into stores and do pilots and proof-of-concepts. But we have been able to get into a number of stores with customers, and we've had very good results and feedback on that. So I do believe that there will be a great solution for us once we are able to more go into our customers' facilities and proper test and deploy. SmartSight is another example -- sorry, SmartPack is another example of Intelligent Edge Solutions, which is deployed in thousands of dock doors for transportation logistics companies to help assess how well they pack kind of more e-commerce parcels into trucks. So I would say, overall, these are early innings for our SmartX type solutions, our Intelligent Edge Solutions, but we feel that there's great opportunity to continue to drive those. They do help us in other ways, so quite a bit, and that we are perceived to be the thought leader in the industry. Our vision is quite compelling to our customers. And -- so they are eager to partner with us as a -- as somebody who can be -- who they can operate with, work with to develop future solutions. And in the meantime, we get to sell a lot of our core products.

Got it. I think, when people think of kind of public sector, they obviously think about your USPS deal. But you kind of highlighted more success that you're having in that vertical than just kind of traditional parcel delivery. Just what are you seeing in terms of maybe public safety or kind of other verticals? And how do you see the opportunity evolving there?

Yes. It's one of our, say, newer priority investment priorities. So on the back of our acquisition of Xplore, which is one of the leaders of rugged tablets, we got a position or stronger position, I would say, in public safety. We have continued to expand on that, and on our Q4 call, we talked about a couple of different wins. One was a large metropolitan police department. And they were buying tablets, but they were also buying other products. So it is a play for a large part of our portfolio. But I'd say, the -- at least an equally important and significant investment we've made in the go-to-market for this -- for public safety. It's a different market, different partners than we had before. So we've invested meaningfully in the last few years to build in that capability to make sure we have the reach and the knowledge to be able to go after those markets.

Got it. I mean, we spent a lot of time talking about retail. We touched on logistics a little bit and also, a little bit of public safety. Clearly, another big vertical for you guys is manufacturing. Just where do you see that market going? Clearly, there's areas like robotic automation. Just how do you see kind of what the pressing need is of that set? And how you're helping address that?

Yes. So when we talk about manufacturing, it is all aspects of manufacturing companies business, so it includes warehousing, where a lot of the robotics you talked about coming in, direct store delivery for some, so the whole logistics flow. And I'd say, the overarching theme would be around the need to continue to track and trace any asset from kind of the beginning of manufacturing all the way to delivering to the end channel, not the end customer. So we see track and trace as a big driver here and providing greater visibility into their workflows. Robotic solutions is something we worked on for, primarily, in retail so far with our SmartSight solution, but we also have investments in Fetch and Locus, which are 2 start-up robotics companies that help. And we have our -- some other software solutions that help to drive FulfillmentEdge, our software solution and heads-up display solution, which also helps augment kind of the warehouse workers' ability to be effective and drive and interface much more with other solutions there. So we see retail -- sorry, manufacturing as a good opportunity to continue to expand into new areas. And I think, we also perceived to be a thought leader in that industry.

Got it. I mean -- and let's just set on the last vertical of healthcare, obviously, a difficult taxing year for healthcare. Just how are the opportunities that you were seeing pre-COVID versus post-COVID? How is the need of that set changing? And I would assume, a lot of what they were planning to do was just kind of put on hold for a year. So just how are you seeing a lot of that business resume?

Yes. Healthcare is our one of our newer verticals, but it's been our fastest-growing vertical for the last several years. We saw a great change in the priorities and buying behaviors of healthcare customers over the last year. Historically, elective care was a driver for our type of applications. We have to digitize the entire patient journey from admission to discharge. But with COVID, obviously, elective care was put on hold or paused for several months. But we were able to pivot our operations and help healthcare providers to address more pressing COVID-related issues. So we supported pop-up hospitals, drive-through test facilities, other facilities to help promote social distancing in health care facilities, and even communications with patients and caregivers or the loved ones without having to actually be in physical contact. So very different type of solutions than what we normally did. In the second half, we did see elective care kind of come back again. Not quite to pre-pandemic levels, as I said, but -- so we had a mix of solutions there. But as we now kind of come on the back side of the real COVID pandemic, we do have some other solutions now around COVID vaccine distribution. We have our Temptime solutions, which basically can track the temperature over time. So it can either be a vaccine vial label on the vial or it can be in the box or in a container. To ensure that the cold chain -- the quality of control of the cold chain has integrity, our Reflexis software application also has modules to schedule COVID vaccinations in pharmacies or smaller clinics. So we remain very excited about our healthcare opportunity. We think that is a vertical that is still very underpenetrated and has great needs for more digitization and automation.

Got it. That's helpful. Nathan, maybe turning to you, you recently took over as full-time CFO. Just as you've stepped in and gotten more familiar, is there anything within the operating model you feel has room for kind of incremental improvement? Obviously, it's been a company executing on all cylinders for a while. So just how do you look at how to add value kind of as you come in?

Yes. I think, just for background, I was part of Zebra finance leadership team for 2.5 years before becoming the interim CFO, leading the FP&A as well as our business operations team. So I was intimately involved in the strategy and execution of where we're at today. I think, what you've heard over the last 2 earnings calls that I participated in as well as our '21 guidance, you wouldn't notice a very big difference in our strategy or approach, and that includes continuing to drive operating leverage in the P&L as a core principle. And so, the priority is really around, as Anders mentioned, how we continue to scale the business, drive profitable growth and advance our vision. So that's, I'd say -- I was always -- there'll be tweaks, but to a large extent, it's continued to run the playbook that's made us successful and go from there.

Got it. And as you guys were talking, you're talking about some acquisitions that you've done over time. How do you think about investing -- using the balance sheet to kind of invest more versus kind of maintaining profitability or maybe taking on some dilutive acquisitions to kind of expand the skill sets? And just how are you thinking about kind of balance sheet utilization at this point?

Yes. So I think, to start from a -- we're comfortable now where we're at from our debt levels and capital allocation approach we've used. The top priority continues to be organic investment as that gives us the highest ROI. But inorganic and M&A will continue to be a priority and a focus area for the company and looking for assets that will continue to enhance the strategy and vision to the company, just like the ones we've done over the last few years. So I'd say it's going to be a continuum of balancing both focusing on organic investments as well as continue to use M&A to grow the company.

Got it. And when we look at Zebra's gross margins, we typically think of larger deals as potential headwinds. But there's been puts and takes with COVID as well, some of the logistics challenges that everybody is seeing. Just kind of how are you thinking about gross margin trajectory as pandemic conditions normalize? And is there opportunity to deliver upside with more run rate business and newer products getting adopted?

Yes. We definitely believe there's opportunity to expand gross margin, not just in '21, but in the years to come. And as always, we have a series of initiatives we're working in the company from how we grow the higher-margin solutions, and software is a great example of that. This year's priority is getting our run rate business, as Anders has mentioned, growing again or recovering from the pandemic, which will be positive from a margin perspective as well as a series of initiatives around pricing, costs and really managing the freight headwind this year. And hopefully, as we come out of the second half at the end of 2022, that's a -- that could be a tailwind from a margin perspective.

Got it. And I mean, maybe this is a question for both of you guys and we, in some ways, addressed it. But just as you look at inorganic opportunities, is it largely thinking of tuck-ins that we can sell within the installed base that may be just kind of more software value? Is it kind of new verticals that you would want access to? Just how do you think about kind of M&A, given, obviously, your leverage is kind of no longer a concern, you have a great kind of balance sheet strength?

So I can start and then Nate can add some color to it. But firstly, we are very excited about the business and the growth opportunities we have. I don't think we have any particular gaps in our portfolio that we need to fill with -- through M&A, but we do see opportunity to expand. We have -- we often talk about our business around the sense, analyze, act framework. And the sense is kind of reading the barcodes, RFID tags, computer vision and so forth. We feel we have quite a strong portfolio of capabilities there. But over the last few years, we've invested more around the analyze and act side. So if you look at in the last 3 acquisitions we made have been pure software, and particularly, Profitect and Reflexis were very much around the analyze and the act side. So when we think about the future, we don't want to say, we will not do that or the other or be overly specific of what we might do. But we do see opportunities for us to continue to migrate kind of up the solution stack and take on broader workflow challenges for our customers. So building out our analyze and act framework would probably be a priority for us. But we do -- from a size perspective, we've done very modest ones like Cortexica, which was really to hire -- to get access to talent, more than anything. It was not so much of an ongoing business as it was talent. To Reflexis, which we think of as sufficiently large to provide really a platform where we can attach other software assets to and use that to get the scale we need around the software business. Yes.

Got it. Yes. And maybe just kind of a last question for me. You mentioned that some of your larger customers kind of maybe paused initiatives that they were thinking of to just -- we need to get curbside pickup into place, we need to kind of get some of the e-grocery, we need to get some of the stuff into place. And you've seen kind of smaller customers come back to maybe catch up to some of the capabilities those larger customers have. But just in terms of where do they go next? Like what are they thinking of? What are you helping them of as far as once things are opened back up, clearly, we're not going back to the way things were, but how are we advancing them past where we are today?

Yes. So I think, we help them in addressing -- first, I guess, it depends on the virtue, at some degree, but anything around the digitization and automation of frontline operations. So we're very focused on kind of providing the official performance edge to the front line of business. So we're focused on the store associates, the nurse in the hospital, the delivery driver, and making sure that we can help our customers to get those workflows to be as productive as they can be. We try to move up and be -- take on, say, bigger workflow challenges versus just a device or a more nichey type of application also. And the portfolio we've now put together is helping to -- it's very synergistic, and we can put all of these pieces together to really drive a broader set of solutions. If you look specifically to retail, if you do buy online, pick up at store, there's a lot of other things behind it that has to happen for that to be successful. Think of inventory accuracy, in-store inventory accuracy as an example. If you accept an order online and say, tell somebody to come back in 2 hours and pick it up and it's not there, that's a bad customer experience. So retailers see a lot of need for just greater inventory visibility, but also much greater efficiency around all the processes because the margins in some of these newer use cases are thinner.

Got it. Well, I can tell you that Brooklyn stores need much more inventory accuracy because I don't think I've got a single order fulfilled at 100%. But with that, I appreciate you guys being here today. And if you guys have any other questions, feed them through myself or feed them through Mike Steele, and we'll get you an answer. I appreciate you guys being here today.

Thank you.

Thank you.