Zebra Technologies Corporation (ZBRA) Earnings Call Transcript & Summary

Okay. Good morning, everyone. It's Paul Coster and Paul Chung from the IT hardware team at JPMorgan. It's the 45th, I believe, JPMorgan TMC Conference. It's May 25. And I'm delighted to have Anders Gustafsson, the CEO of Zebra Technologies, join us today. As I was saying to Anders just now, I think we've been doing this a very long time now, at least 10 years, possibly 15 years. He's been a continuous thread throughout for me and for the JPMorgan TMC team in general. And what a fantastic story it's been over those years. So Anders Gustafsson, good morning.

Good morning.

Good morning.

Yes. You've just done such a spectacular job. I guess, the question is can you keep it going? But let's start off by asking you for a brief overview of Zebra Technologies.

Yes. We offer a comprehensive portfolio of solutions for the enterprise that encompass purpose-built hardware, software, analytics and services that enable our customers to sense, analyze and act on critical data in real time to optimize workflows through the entire supply chain. Examples of use cases using Zebra's solutions are warehouse picking, omni-channel fulfillment, last-mile delivery, hospital patient care and vaccine temperature monitoring and tracking. We have many, many, many different type of applications and use cases. We are the leader in our primary core markets. We have over 50 years of history and innovation. And we have, I guess, developed over 5,000 patents so far. We have -- one of our real strengths is our partner or reseller community. We have about or well over 10,000 channel partners that help bring our solutions to thousands and thousands of customers and really helps expand our global reach and scale. In 2014, we made a transformational acquisition, which added mobile computing and data capture through our printing portfolio at that point. And following the integration of that business, we've been paying down the debt that we used to acquire the business with and resumed a meaningful investment in profitable growth. And this has included both organic and as well as 6 bolt-on acquisitions that really helped advance our Enterprise Asset Intelligence vision, which we define as enabling every frontline worker and asset to be visible, connected and optimally utilized. And our solutions enable our customers to connect the physical to digital, to help automate data collection, to reduce friction in workflows and provide users with actionable data.

Wow, I mean, it's such a dense statement of what the firm does. You can unpack just about every sentence there. And there are sort of layers of detail behind it. The reason I say that is that some people think that you make little devices, handheld computers and printers and scanners. And that's the end of the story. And it's not the story at all. And it's really been so transformational over the years. Can you perhaps tell us how -- does your -- I mean, the investors may be catching up with that. What about customers? Do they understand the scope of what you're doing now? Or is it still presented to them as a device solution?

Yes. I would say that our vision is something that resonates really well with our customers, the Enterprise Asset Intelligence vision. Do every customer know all the things that we do? No, they don't. But obviously, we try to make sure we provide a good overview for them as to kind of the broader scope and the direction. And I'd say we do sell a lot of our devices based on the vision. So many of our particularly larger customers, they want somebody who can provide the best device for the application they have today. But they also want to have a partner who they can work with for the next many years, who can help solve future challenges. And our vision resonates very well with them. So even if -- so yes, so we do certainly get a lot of value out of the vision even if many of our customers primarily buy our, say, core devices.

So I mean, you're layering in, through acquisition and through homegrown development, a lot of new capabilities all of the time. And so I assume what happens here is that your sales force then is sort of armed with this new capability and goes out and evangelizes. Is that how it works?

Yes. The -- we spend a lot of time trying to make sure that we structure our go-to-market organization in a way which enables them to be successful with such a broad portfolio. It's hard to find anybody who can be an expert in everything we do. So if you take an example now of the software acquisitions we made over the last few years, we created a separate software business unit for the development of those solutions. But we also created a software overlay team on the go-to-market side, on the sales side that are the -- who are the experts in that solution. So our broader sales organization, they can do lead generation, they have the right relationships and they can do a lot of the selling. But they bring in kind of the experts when they need to get it to the next level. And similarly, with the fixed industrial scanning portfolio and the Adaptive technologies acquisition we made earlier, I guess, it was last week, the -- again, we have a -- created a separate kind of unit -- business unit for the development of that and also a new overlay sales organization. And over time, we expect that, as these solutions become more part of our mainstream, those overlays will kind of migrate back into the regular organization and we create other overlays of new capabilities. And if we go back 3, 4 years, we had a number of other overlays that we now kind of have made part of our regular sales team.

So you've just come off financially an outstanding first quarter, 21% organic growth, 25% EBITDA margins and 80% EPS growth. And I don't think you were even lapping easy comps because the first quarter of 2020 was kind of an okay year period before we hit pandemic. So what's driving the super growth and outstanding margin contribution?

Yes. I'd say we have now fully recovered from the pandemic and our teams are executing very well and driving profitable growth. In Q1, we realized broad-based strength. We had double-digit growth in all our regions across all our products and solution categories and all our verticals. And we did see also the small- and mid-sized customers come back quite strongly. They had taken the biggest hit during the pandemic. But they're now coming back. And we -- some part of it was pent-up demand from that category. And we see the mix has been very good. It's been across all our products, not just kind of kind of the traditional highest runners, but the entire portfolio performed very well. And yes, we've a great start to the year, we've got to say. This -- always better to start the year strong.

Yes. Well, and the year, it looks like, is going to play out pretty well as well. You're guiding to 20% growth, which reflects some pent-up demand, I guess, but also 500 basis points of growth from the Reflexis acquisition. What was the Reflexis acquisition first? And well, how sustainable is this growth?

Yes. So Reflexis, first, was -- or maybe backing up first. When you look at our acquisition strategy, it's -- we're looking at -- for companies that can really help us accelerate our execution on our vision, the Enterprise Asset Intelligence vision. So companies that can help us in this -- execute on this sense, analyze, act framework that we have. We've made several software acquisitions, Reflexis being the largest one now. And they are the leader in workforce management and task management, so particularly in retail but also in health care, some banks, JPMorgan is a good customer of ours, so -- and how to make sure you can schedule your labor the most effectively but also making sure you can have a good task engine. So if you think of today's world, say, in retail, particularly, in an on-demand economy, you can no longer kind of rely on batch execution. It used to be that you came in, in the morning, you got a spreadsheet of actions to go do during the day. But if you have a customer that calls in and -- or enters an order online at 11 a.m. to have it picked up by 1 p.m., you have to be able to insert that order dynamically in the workflow. And Reflexis helps to do that and many other things. And this is another area where we see great synergy between kind of Zebra proper and Reflexis both. We have largely the same customer base, so we can bring Reflexis into a lot of our other customers. But the -- our device portfolio and Reflexis software portfolio are very synergistic, so the -- we can feed data to Reflexis to be able to incorporate that into their engine -- and prioritizing the highest ROI actions. But also, we help Reflexis able to mobilize those actions by knowing which device -- which worker is now available and best positioned to execute on a particular task. So it's been a great acquisition. We're very excited about it, and it provides a good platform to expand on. You also asked about how sustainable the growth is. And we raised our full guidance in our last earnings call here, which we're very pleased to be able to do. And we are, I would say, as excited as we've ever been about the growth prospects and the positioning we have in the market. There are a number of secular trends that are supporting our growth. The -- an increasingly on-demand economy is helping or ensuring that you need to have access to real-time information. So our sense, analyze, act framework of being able to sense what's happening in the physical world, analyze that information and enable our customers to act on it in real time is very attractive. And we've seen since the trough of the pandemic, the trends around automation and digitizing businesses strengthen overall and propel us forward. So we feel good about where we are and where we're going.

What is -- where are you going? I mean, it's sort of hard to pick your long-term growth rates, and maybe margins are a little easier really, I think, at your long-term target from an EBITDA margin perspective. But the growth rate, I mean, I've always thought of you as a mid-single-digit story. But I'm not sure that's right. It feels like you're quite often and sustainably exceeding that growth rate.

Yes. As I said, we feel very optimistic about the business. Our customers are prioritizing spending on our type of solutions. And that has accelerated, I'd say, during or after the pandemic. We have overachieved on our 4% to 5% organic growth target that we set when we did the Enterprise acquisition 6.5 years back. And we also do acquisitions, as I said. And that is another lever of growth on top of that target. We regularly assess our long-term targets, and we continue to do so. But we feel that at this stage, where we still feel we're kind of in the -- at the tail end, hopefully, of COVID but certainly still in a somewhat abnormal environment, we don't want to kind of come up with new targets at this stage. Maybe, Nate, you can also add a little bit. We have Nate on, our CFO. Or Nate, [ go ahead ].

Paul, no, I think, on margin, you mentioned, I think we have a strong track record of driving growth. And we aspire to consistently drive double-digit EPS growth through all the operating levers we have. For example, we can continue to expand EBITDA margin. We have many ways of doing that, growing and scaling new markets, software, Reflexis is a proof point. Entry into fixed industrial scanning, machine vision, that's another opportunity. The team focuses on where we can improve efficiencies across the operations. So we really haven't set a cap on or ceiling of where margin can go from here.

Okay. Got it. I mean, so it's interesting, the software acquisitions you've made previously have always felt like they were sort of tucked into the hardware business and it just added value and differentiation to product. But it does sound now like we're starting to create critical mass in software and Software as a Service, I guess. And so this will become a discrete business line, segment and it will drive both growth and margins moving forward discretely.

Absolutely.

Yes.

Okay. Got you. Yes. And so I guess, that going back to the secular trends here and as you talked about, the on-demand economy, are there any other sort of major trends you want to call out?

Well, I think, the first one, in Q1, we saw broad-based strength across all our vertical end markets. So there's strong secular trends working, I would say, in all our markets. At the highest level, I would say customers are increasingly looking to digitize and automate their businesses. There was a trend certainly prior to COVID, but I'd say that COVID accelerated that. Retail is probably the most kind of apparent example of that. If you go look back at the beginning of COVID, when people -- they weren't comfortable going to store and so forth, so buy online, pick up at store became a very popular use case or modality for shopping. Most retailers had -- very few retailers, if any, had rolled that out in a broad fashion. But that was something that scaled very quickly across grocery and general merchandise, certainly. And a good example of kind of something you can't really scale without having our type of technology. And that is how you digitize and automate retailers. But also if you think of that as kind of the very sharp end of the spear as far as applications, that is the customer-facing one. But if you're going to do that well, you need to also have better inventory visibility so that you can, with confidence, tell a customer, "If you enter this order, you can come back in 2 hours and pick it up, and we will have it ready for you with all the things you ordered that we confirmed." So you need to have technology to help automate inventory visibility, but you also have to kind of have quicker replenishment, so different technologies for warehouses and distribution centers. So it just kind of ripples through the entire supply chain with this on-demand economy and how it automates and digitizes it. Transportation logistics is another beneficiary of this, where the industry has very largely changed the operating model from having relied on corporations before as the customer, shipping or -- and a customer received many -- a few customers receiving many boxes per day like Zebra. Today, though, it's getting more and more to be every household gets one box per day. So the economics of delivering one box to every household versus many boxes to a few customers is quite different. So leveraging technology to be able to automate, digitize and probably to improve profitability and efficiencies is important there. In health care, I think digitizing the entire patient journey from admission to discharge is an important part. And bedside care is a great example of this and tracking and tracing every -- everything that kind of goes -- happens in the hospital. And lastly, I'd say, manufacturing. With manufacturing 4.0, there's a great focus on automation and digitization and having greater visibility into workflows all the way from kind of sourcing components to delivering the finished good to the end customer. So it's a broad set of secular trends, I'd say, across all our vertical markets.

Just got an inbound question here, which I'd like to relay to you, which is just looking at your product categories. What are your market shares in each of these, do you estimate? And how fragmented are the B2B three end markets?

Yes. So starting with mobile computing, we have a little bit over 50% market share overall for mobile computing and about 60% or a little higher in 60% in Android for the Enterprise. When we did the Enterprise acquisition back in 2014, we had, I think, 37% market share. So we've increased it by, give or take, 15% over the last 6.5 years. So that's been a great opportunity, a great market for us. #2 competitor has, I think, about 12%, 13%. And then it kind of drops down into the low single digits after that. So it's a quite fragmented market, but we have a strong position in it. In printing, similarly, we have a low 40% market share. There's, I think, one or two competitors in the maybe 12% -- 11%, 12% market share. And then it drops down into the more lower single digits. And in scanning, we have about 30% market share. And the #2 is more like 24%, I believe. So there, we have a little bit more -- not quite the same gap, but we're the clear leader in each of our three main product categories.

Got it. Now acquisitions of -- actually two things have figured quite prominently in your growth. One is -- and I think I quote you. I don't think I quote any other CEO as much as I do you, Anders. Your willingness to play in adjacencies where -- move into near adjacencies where you have the right to play. And you've always said that and you've been pretty consistent. The other is you've made acquisitions also in near adjacencies, I think. And this has figured -- both of these have been material contributors to growth. Can you talk first about the acquisition strategy? It feels like it's moving more and more towards software.

Yes. Firstly, our acquisition strategy is intended to help accelerate our Enterprise Asset Intelligence vision. So it's not -- we're not looking to do acquisition for the sake of acquisitions but really to see how we can help enhance our vision, very much focused on how we can then strengthen the sense, analyze, act framework of sensing what's happening in the physical world, analyzing the data and enabling our customers to act on it in real time. Our heritage is more on the sense side, reading barcodes, reading RFID labels. We've now expanded that with machine vision capabilities. But I would say the last 4 acquisitions have been more on the analyze and act side, some pure software acquisitions that leverages the data that we can -- that we have access to that we read and enabling our customers to then act on that in real time. So we talked about Reflexis as part of that. We have also Zebra Prescriptive Analytics, which looks at -- uses machine learning and AI to look at all sorts of data inputs to find anomalies that our customers can look at to identify stock-outs or any other kind of things that they need to go act on. And this past week, we -- or last week, I guess, we acquired Adaptive Vision, which is a machine vision company that fits great with our new line of fixed industrial scanners or machine vision scanners and makes those -- makes it much easier for us to design workflows and analyze the images and video from those.

Yes. This was really interesting. So in the past, I've sort of asked you about sort of the move into machine vision. And you previously have always stressed it's been computer vision. But now you're starting to flex your muscles a bit and say, "No, actually, we can do machine vision as well." So the way I think of this is that you're moving from a sort of macro understanding of your environment to much more micro understanding of your environment, much higher volume as well. Is that a fair statement? Are you actually moving into territory that's currently known to be occupied by companies like KEYENCE and Cognex and SICK in Germany?

Yes. I mean, firstly, these are fairly large markets, and we think that there's a number of kind of white spaces. So we're not looking to just kind of go head-on against where other competitors have strong positions. But our first use cases for our fixed industrial scanners or machine vision portfolio is around being able to read barcodes, so over-the-belt type of situations, other use cases. But they also have the capability to look at fill levels in a bottle, in a soda can. Or is the cap put on properly? Is the brake assembly done properly? Is it missing a rivet? Or is it of the proper quality? So it has a broad range of things. But so we are certainly moving into spaces where people like Cognex and KEYENCE play.

Well, of course, I can't help but observe that their gross margins are in the 70%-plus range versus yours in the 50% kind of zone. So it makes you quite -- it empowers you to be somewhat disruptive, doesn't it?

Yes. We certainly see the fixed industrial scanning, machine vision portfolio to be margin accretive to us. We see great opportunities to be disruptive and not by price so much as by the solution, the ease of implementing the solutions, the ease of setting up new use cases and workflows, the flexibility of our products and solutions here. So we think that we have a great value proposition to end users.

All right. So as I kind of hear your story, it sort of feels to me like the prior segmentation of Enterprise Visibility & Mobility and Asset Intelligence & Tracking, which is quite a new way of thinking about the company, is itself starting to be displaced by these other things, digital transformation, workforce -- workflow optimization, real-time actionable insights, et cetera. I'm just wondering, is it -- you must have a little bit of a struggle sometimes to figure out how you really should be segmenting this business. Are we sort of -- is it somewhat arbitrary? Or do you feel like you -- that what we have today is what we're going to have in 5 years from now, these two major segments?

Nate, maybe you can...

If I can jump in, I think it's a fair statement that the overall vision spans both in the financial segments. If you look at across all the product solutions, they're highly synergistic. Anders has mentioned several of examples of how they combine to digitize and automate the supply chain and workflows. And the customers value that broad portfolio and having one vendor to offer that complete end-to-end solution. So -- and then you look at what we've built through acquisitions and the organic investment. That's really both segments elevating as solutions provider. So I think that's tend to how we look at it versus kind of a segment-to-segment. But I think it's fair to say that the vision definitely overlaps both and particularly how we go to market for our customers.

All right. Got it. And just, Nate, whilst we have you on, a couple of things. One is visibility and recurring revenues. Can you just talk to us about to what degree Zebra has either of those?

Yes. So just consistent with what we've said in the past, the visibility we have tends to go out 3 to 6 months. Longer term, we'll know for our large strategic customers when they plan to do a major rollout. But the timing of those can depend as they get closer in scope. But the sales team has pretty good visibility 6 months out. And that's really how we reflect and how we think about our guidance within the quarter. And then the recurring revenue business is still quite relatively small from a percentage of revenue. But we do expect that to grow faster and become a larger piece of the portfolio as we grow the software business along with our service, and continue to expand in those areas. So it will become a larger portion of the portfolio but still relatively small from a percent of revenue.

You have a pristine balance sheet really. I mean, I think you're down to about 1x net debt to EBITDA leverage or thereabouts. And you're looking at generating in excess of 900 -- well, at least The Street thinks you could be generating $900 million in free cash flow this year. What's the capital allocation strategy?

So our capital strategy has been pretty consistent, I'd say, over the last couple of years. And where we're at from a debt leverage, we're very comfortable at those levels. And it really gives us the ability to prioritize organic and inorganic investment. And so far, we've had two venture investments this year, Adaptive Vision last year. And we also look at share repurchase as a flexible way to return capital to shareholders. But as you mentioned, the free cash flow really gives us the opportunity to do all these things in a balanced and thoughtful way.

Now I'll just remind the clients on the call that you're welcome to submit questions through the JPMorgan TMC website. But with that, I'll just switch back to Anders, if you don't mind. Thanks, by the way, Nate. Anders, the acquisitions you've made have been -- you've made one absolutely huge acquisition, of course, which was Motorola Enterprise Solutions business (sic) [ Motorola Solutions' Enterprise business ], what, 5, 6 years ago. Since then, I think you've stayed into sort of tuck-in acquisitions. So I think the Reflexis one is borderline transformational. What about doing something big with this massive balance sheet? You've gotten this tremendous currency you've got with this stock now. I think I can think of some very large companies out there in the traditional IT hardware space that perhaps could do with your channel and thinking in sort of terms of headsets and desktop phones and video infrastructure and so on.

Well, as I said earlier, our -- when we think about acquisitions, it is really to accelerate our Enterprise Asset Intelligence vision. So there might be a number of companies that could be good financial fits, say. But if they don't really help us accelerate the vision, that will be kind of the first filter we have. If they do pass through kind of the strategy filter, we get into more of the financial aspects of it. And I think it's fair to say that the last 6 months after the Enterprise acquisition have been more tuck-in, as you said. When we do a risk-adjusted assessment of the returns we expect, and if something were to be much larger, we would certainly also take that into account from a risk perspective. So we -- it's not that we would say that we would never do something that was -- would be somewhat more substantive. I can't say that we would do something that is quite of the scale of the Enterprise deal, which was larger than Zebra at the time. But we want to make sure that we, first and foremost, find companies with a good fit that help drive the strategy and that the financials then have to also make sense. And size is a factor when we assess the risk factor or the risk profile of those.

I mean, it's Asset Intelligence, it's not Enterprise -- you're not looking to be all things in the enterprise.

No.

Okay. Got you. Okay, just a quick question. I think we've got about 3 minutes left. We had a reminder yesterday that all is not well in the world because Malaysia is entering another sort of partial lockdown. And I suspect your supply chain treads into parts of Asia, including potentially Malaysia. Any constraints on your business that you want to call out at the moment in terms of freight or components or COVID?

First, starting with kind of the COVID and, say, Malaysia as a trigger. Over the last 3 -- 2, 3 years, we have diversified our manufacturing footprint quite substantially. We used to do the vast majority of our assembly in China. Today, basically, we have moved all the volume expected for North America out of China. So we have set up new facilities in Vietnam, in Malaysia, in Taiwan, in Mexico so that we have a more robust, resilient supply chain. So if one facility would be impacted by COVID, as an example, we have redundancy to be able to manufacture in other areas. So that's -- that will be the first part. The other part you talked about, freight and component shortages, obviously there's been lots of press on this and we talked about it at the last earnings call, too. Freight is meaningfully higher. I think it's about 1 point of margin impact this year for us and basically, an outcome of COVID because there is so much less airfreight capacity available today. But since the world has also bounced back quicker, there's obviously more demand for it today than it was before. So pricing for -- particularly for airfreight but also for ocean freight has gone up meaningfully. We work hard on making sure that we find cost-effective ways of getting our goods here. But we have prioritized making sure that we can meet customer commitments. So in last year, we did charter airplanes from China to Europe and to the U.S. to make sure we could get our goods to our customers as they needed it. I think that's been -- that was a wise move from a business perspective. And on the component side, when we gave the guidance 2, 3 weeks back now, we had incorporated component supply tightness, I guess, you can say. So we are working at that, I think, quite well so far. We never took down our forecast during COVID for -- longer-term forecast with our supply -- component suppliers, so we -- where some other companies or industries kind of slashed their forecast and then tried to come back and jump the queue. So we tried to make sure we protect our position in the queue. And we were relatively early to start increasing our forecast. But it's fair to say that the business has rebounded stronger than we expected. So we hadn't quite expected this kind of growth in the first quarter and the guide that we gave for the second quarter either. But so far, we've been able to manage it quite well. But it's not without challenges.

Anders, with which we have run through the tape and our session is now over, I would like to thank you so much for participating today. Thank you so much.

Thank you. Thank you.

Thank you, Nate, as well.