Zebra Technologies Corporation (ZBRA) Earnings Call Transcript & Summary

Hi, everyone. Thanks for coming. Before we get started, I'm just going to read a brief disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Thanks. So today, we have Joe Heel and Nathan Winters with us today from Zebra Technologies.

Maybe we'll just start off with a high-level question. So you just finished a record year of organic growth and your longer-term guidance would imply you expect that growth to keep going. Can you start us off today with a brief interview of some of the trends driving that growth? And maybe what use cases you're seeing customers adopting that is helping the business keep growing?

Yes, I'll start. If you look, we continue to see strong secular trends driving our business and that really comes down to the need for our customers to digitize and automate their operations and ultimately, empower their frontline workers to meet their customers of increasing demands. And if you look back since the Enterprise acquisition now 7 years ago, we've outperformed our long-term growth target of 4% to 5%, growing about 7% organic each year over that time period. And as you mentioned, we had phenomenal growth last year. We saw double-digit growth here in 2022. I think Joe maybe touch on some of the use cases driving that underlying need to automate and digitize.

Yes. So if we talk about use cases, you have to talk about sectors and our biggest sector is retail. In the retail sector, we've seen a big boom in e-commerce. And of course, the long-term growth is for e-commerce to continue to grow, although maybe not quite at the rate that it did last year, but we're continuing to see growth in e-commerce. But on top of that, our biggest opportunity in retail is the fact that retailers continue to digitize their operations and expand into omnichannel retail. So buy online, pick up in store or if you're in Europe, the scan and go or self-scanning applications continue to drive growth in addition to e-commerce. But the real potential in retail is the phenomenal opportunity which we have because only about 1/3 of retail store associates today have any form of mobile device. And we're seeing retailers understand the fact that if they put a device into the hand of every worker, they can open up new use cases, like having workers communicate between one another. So the model is changing from a device that you pick up because you're one of the 1/3 of the associates that is allowed to use a device to do a particular task. It's moving towards everyone has a device, and it's always with you. So that's a phenomenal growth opportunity, and only a few of the retailers have actually made that transition. If you go into health care, health care has actually during the COVID time been relatively less in terms of growth rate because they had to concentrate all the resources on COVID care, but now that elective procedures are back in -- our regular growth rate has picked up again, and we're starting to see strong growth out of health care again. But in health care, the same opportunity exists that I mentioned before about with the retail store associates. Only about 1/3 of workers, which are the nurses, have devices. All the others, all the people who do cleaning or transportation, right, facility services don't have devices yet. So another great opportunity. And when you go into manufacturing, in manufacturing what's happening is automation. Automation is driving growth in manufacturing because the manufacturers are now seeing demand off the charts, and they can't get workers. So they're doing automation, which is exactly where we come in. So those are some of the use cases.

And Nathan, you briefly touched on the -- just the growth rate you've achieved is closer to 7%. You actually recently increased your longer-term growth target from 4% to 5% previously to 5% to 7%. I guess when we think about that longer-term growth target first, should we think of that as a compounding growth rate? Could there be cyclical drivers that vary -- that cause that to vary in any given year? And then second, just as Joe was mentioning on the different end markets, is that growth rate universal across the different end markets or are some growing faster than others?

Yes. So in our February earnings call, we updated our long-term growth guidance to 5% to 7% organic -- annualized organic growth over a cycle. So in any given year, there will be fluctuations to that based on macroeconomic events, replacement cycle. If you look back over the last 3 years, 2020 was 0% growth; this past year, over 20%; and now back to mid-single digits. So again, those fluctuations will be driven by a combination of factors. But if you look at our underlying business, we have tampered because of the cyclicality within the business as we've diversified the portfolio, both on the product offerings we have as well as geographies and markets we serve. So we'd expect less cyclicality in kind of the underlying business. If we look at where that growth is coming from, we still expect robust growth in our core business. Even with our market leadership, we see plenty of opportunities to grow share across those markets. Geographically, you can look at a place like Japan as a good example where we have relatively low market share or in manufacturing, we have relatively low share compared to the rest of the portfolio. So again, two examples of where we can continue to grow there. And then we expect outsized growth within our adjacent markets, whether that's RFID or in our new expansion markets. So fixed industrial machine vision, which we launched this past year. Robotics and automation, both a combination of organic investment as well as our acquisition of Fetch Robotics. And then now the software portfolio, we have built on recent acquisitions as well as organic offerings we developed ourselves.

And then just in that context, when we think about your 2022 growth guidance of 3% to 7%, is the lower end of that a factor of some of the supply chain issues you're seeing and just potential risk around that? Or is it that you're coming on back of an outsized growth year and kind of feeding into the way to think about the longer-term target?

So I think both. When we look at our guide for the year, both of those dynamics definitely play a part in terms of the growth rate we expect here in 2022. Like every year, we do a bottoms-up roll-up of what's the pipeline and visibility we have coming into the year. This year, we're starting off with a record backlog due to the supply constraints as well as our customers putting in orders early, so to ensure that they get in line from a product availability. You also have the price increases we put in place over the past 6 months that's adding about 1 point of growth. So again, an invisibility to our larger customers, but again, some of that is tampered by the supply constraints as well as coming off tough comps. So again, very excited about the growth for the year. Q1 has been tampered because of supply constraints, but we expect that growth rate to pick up here as we move into the latter part of the year.

Got it. And when we think about some of the backlog you're seeing, are orders still coming in, in the typical cadence they would? Or are you seeing maybe customers more strategically planned further years out? And does that give you better visibility?

Yes. So first of all, our order flow has continued to be very strong and shows no signs of slowing down at this point. And the visibility, though, that customers are giving us has increased significantly. So customers are realizing that in order to secure supply from us in a constrained environment, they need to work with us to give us advanced notice. And so we're seeing people give us as much as a year's advanced supply visibility and in some cases, orders where they will give us their orders for an entire year. So that has definitely improved from our perspective significantly.

Great. And just maybe you could remind us, where do you think we are currently in the supply environment? Are we at a point where things have somewhat stabilized? Are they getting worse or better? And then maybe on that, if you could share with us with some of the most significant bottlenecks you see are.

Yes. So it's obviously a dynamic environment, as we talked about in our earnings call and is still only become that much more dynamic here over the last couple of weeks. So we tend to think about it in two buckets. So there's the logistical bottlenecks. And what we're seeing there, we saw those couple of weeks when we had our earnings call is the rates per kilo we've experienced over, let's say, 4 to 6 weeks, are back to where we're experiencing the third quarter of last year. So well below kind of the peak rates that we experienced in November and December, and that's obviously in large part due to demand and year-end demand. So that's very positive. The other one which is in our control is, we're still shipping about 100% of our printing business on air, which I think big tabletop printers. We prefer to have that on ocean, and we had to shift that to air in the second half, both because of demand as well as just the constraints in the ocean market. So getting that back on to ocean in the second half of the year, that is our plan and expectation. That's another driver and catalyst for reduced cost. On the flip side, just from a component shortage, we're definitely at a peak here in the first quarter. The team's worked every angle over the past year to redesign components, add second, third tier supply. And the confidence comes is, we now have committed dates here later this month and into the April and May around the most constrained parts, which is, again, confidence in the uptick in growth rate for the remainder of the year to get to our full year guidance expectations.

Got it. And then Joe, you briefly touched on this before when we talked about retail. Obviously, that's a very large end market for you, and you could argue that the omnichannel transformation of retailers would also impact your manufacturing and transportation segments and what they're looking to invest in. Just as we think about customers on their omnichannel journeys and whether it's in any of those segments, where do you think customers are? And how is it different from maybe your most advanced customers to some of more of your run rate average customers?

Yes. So when you think about the retailers, there are clearly different tiers or segments of the retailers when it comes in particular to their sophistication on omnichannel or e-commerce. And so early even in mid-2020 when nobody was buying anything, our most sophisticated and advanced customers started buying large chunks of technology in order to expand their presence because they saw that either e-commerce or buy online, pickup in store type of solution would be needed. Other retailers, smaller second-tier retails lagged behind that and didn't do that until 2021, and some are still doing that today where they're catching up on that front. But there's another important trend that's happening here and that is the fact that the retail transportation and manufacturing sectors are all merging in many cases. And the most advanced retailers that we work with today, if you think about fashion, for example, in fashion retail, the most advanced retailers are vertically integrated. I'm talking about people like Zara, which is part of Inditex or Uniqlo. They're vertically integrated into manufacturing, which allows them to operate a supply chain which is extremely streamlined and 100% visible. They basically use RFID tagging on their entire supply chain. It's far superior to what other retailers can do, and it's going to create a big gap between them. And we're seeing that same integration in -- vertical integration in other spaces where manufacturers are becoming retailers because they have their own e-commerce presence. Think Nike, right, or Adidas. And sometimes with storefronts as well, right? Those are all changing the landscape that's happening, and they're all terrific trends and opportunities for us, right, because we have to enable and automate those supply chains that are emerging.

And you also mentioned the low device penetration rate at this point. And when we think about the growth in the retail segment, maybe specifically, how much of it is coming or do you expect to come from device penetration increasing versus maybe some of your newer solutions like the Intelligent Edge portfolio? And maybe if anything you could tell us on the timing of adoption for those newer solutions that you would expect versus the device penetration rate?

Yes. So device penetration rate, as I said today, we still see that there's a significant opportunity to expand device penetration over time, and I gave you some examples in retail and health care earlier. So that's a very big growth opportunity. The new solutions basically contribute to that. So they're a part of that. They're not a separate phenomenon. Why is that, right? So if you're a Home Depot or a Lowe's and you have -- 1/3 of your workers today have a device. They come in the morning, they pick it up from a cradle and they go and scan inventory, and they replace it in the cradle. Now what you're trying to do is, everyone will carry a device all the time and you want them to do additional use cases. You want them to talk to each other, for example, right, and get -- at least you want them to perhaps assist a customer when the queue is particularly long at checkout and checked them out while they're waiting with your device, which you can do, right? And we're assisting this with both the software capabilities that we're putting in place as well as the hardware that we're putting in place. I'll give you one example that is probably the most powerful. We just announced earlier this year a partnership with Microsoft. What does Microsoft do? They have the Teams application, and they have a special version of Teams called Frontline Worker, and it goes on the types of devices that we do for people who work in a warehouse, who work in a store. And if you now think of the device as it's always with you, then that becomes your one point of collaboration with the Teams application on top of a Zebra device connected to a Workforce Connect, which is one of our voice applications. So you can talk to each other, connected to a Reflexis, which is the other software acquisition we made. Task Manager that assigns you your tasks for what you do during the day, it's all on one platform. It's the ideal platform to go give a device to every worker, right? So those aren't disconnected things. They're actually one furthers the other, right? And altogether, they have a tremendous growth potential for us.

That's a good segue into my next question. And obviously, on the software side, Reflexis has really been a home run for you guys, and it makes sense where it fits into the portfolio across customers in almost any end market. One thing we've struggled to understand is, because your devices have such a universal applicability to your different end customers, where you can find software solutions that fit that same bill? So -- and obviously, you have partners. How do you think about where to partner versus what makes sense to build internally or acquire?

Yes. So if you look at the whole portfolio, I think this probably makes a tough question to answer or to understand is, everything we do is really driven with a software layer. What makes our project -- is what makes our product easy to use, intuitive to manage. It's what allows us to drive a premium in the market with a market share, the leadership position we have. So it's really embedded in everything. If you look at our engineering base, 2/3 of our engineers are focused on software systems or user interface development. So again, it's part of our DNA. And if you look at particularly the acquisitions we made, we think about what software applications kind of standalone software platforms that have scale across different segments or different customer base. We're not trying to buy unique niche applications for a specific customer or a specific geography. And if you look at Reflexis, you can scale it to banking, retail, task management within a warehouse. Same thing with Intuit. There's multiple different applications that cut across the portfolio and are complementary to our core offerings. And then bundling that, as Joe mentioned, with things we've built organically like Workforce Connect, with other third-party applications, we think is really powerful. So it's something we spend a lot of time on as we look for potential acquisitions is that is it scalable and give us the breadth we want or is that more of an application that's best served with one of our partners due to the unique application.

And so we touched on retail a bit. Maybe we should turn over to manufacturing. It appears there's a reinvigoration there an investment. We've typically thought of that as being more of a replacement cycle oriented business for you guys, What is affording the new growth there? Is it the next wave of technology being adopted by customers? Is it labor constraints and just the need to find efficiencies, something else?

Yes. I think you mentioned probably the one of the two most important ones, which is automation that's occurring in manufacturing, right? So manufacturers, which -- those who are already freed from the supply constraints are already seeing it. The others expect to see it very soon, and they have -- so they are expecting a surge in demand or seeing a surge in demand. And at the same time, their labor is constrained so they have to increase the productivity. If you put robots into a warehouse in addition to humans, you can increase the productivity of that warehouse by 2 to 3 times. That's a huge solution to a big problem that manufacturers have. So automation is clearly one of them. The other one, though, is track and trace. I think one of the things that COVID has brought about is the need to be able to see and follow a product all the way through the supply chain, both for purposes of streamlining it, but also for purposes of security, safety, those kinds of things, right? And that's where we obviously play a very big role. If you just think about a little known part of our business, which is the Temptime tags, right, which allow you to track a medication and see if it's been exposed to temperature for more than a certain period of time. You can see that -- just from what we all have learned over the last few years, that's a tremendous application, right, that we can now support.

And then, Joe, I think something that when we have initial conversations with investors sometimes comes as a surprise. It's just that so much of your sales model is run through a distributor partner network, and you've been involved in the organization for, at this point, the better part of the decade. Could you talk to us a little bit about how that evolved? And maybe where you could see further evolution in the sales model going?

Yes. So one of the things that surprised me when I came to Zebra was the degree to which Zebra was a channel-centric company. And I've worked at other channel-centric companies before, but Zebra took that muscle to a totally different level, and they're really good at it. I have to say, there are people there in my sales organization that really know how to run the channel, and we've made that a strategy. So we've gone out and we said, we're going to be channel-centric. We will be at your side as a channel partner, and we're going to deliver more than 80% of our revenue. We are delivering more than 80% of our revenue through the channel. We've done so consistently since I've been there. That's very important to channel partners, right? Because one thing the channel partners really fear and they've seen it from many other companies is that once they get bigger, they start taking business direct. And we don't do that, and we've been very clear about not doing that. Now that's only one part. That's generated a very loyal base of 10,000 partners plus -- 10,000-plus partners that are part of our program and over 30,000 partners that sell for us altogether, right? And that's a more traditional VAR base that buys through distribution. But one of the things we've been doing is to expand that partner base quite significantly. And we've done it basically in two directions. One direction is, we've on-boarded specialists for the various technologies that we have. So if you think about RFID or machine vision, you need people that are really good at lighting and setting up manufacturing settings, and we've recruited those partners. And we've been able to recruit them, in some cases, from strong incumbent competitors because they know our channel model, and they trust our channel model that we will be at their side and sell with them. And the other one is, we've gone in the direction of large systems integrators. So our large customer business, as you've probably seen in our announcements, has grown faster than our medium and small customer business, right? And the large customers demand increasingly complex projects to automate their operations, right? If you want to put in a robotics capability into your warehouse, that's not something you do on the side with your IT group, right? You need systems integrators that are capable of integrating into a warehouse management system. And so we are aligning with those large systems integrators. We may not always do press releases about it, but we -- that's a big expansion area for us. And that also, I would say, includes large ISVs. I mentioned Microsoft before, right? Aligning with them and going to market with them is a big part of how our channel is going to evolve.

And then you obviously have partnerships with some of your customers where maybe it does still make sense to use a direct model on the larger customers. If we think about something like SmartPack and the Intelligent Edge portfolio, I think you've developed that kind of in partnership with one of your larger customers. Can you maybe talk a little bit about just how that is different. And where it makes sense to do that and some of the traction you're seeing with those solutions?

So generally, there are -- we have some large customers who would like to work with us direct. We generally -- and you might be surprised by this, resist that. We generally tell them, no, you should work with a partner as a part of that strategy I mentioned earlier. But even whether we work with a partner or not, always, we have our salespeople working with those end-user customers. And that -- so some of those co-developments that we've done have done are with customers that are direct, some of them are indirect, like the one that you mentioned, we sell to, in part, indirect, okay? So our sales people are still involved and I would say, ingrained into those large customers to do that co-development. A good example was SmartPack that we developed with one of our large logistics customers which automates or improves the loading of a container -- a truck container. And there are other examples of things that we've developed together, like, for example, our autonomous mobile robots. We're developing the first fulfillment robot effectively together with one of the large shipping customers -- shipping companies in the world. So that is a part of what we do because we have this strong presence, right? It's very, very natural for us with the strong presence we have among large customers to co-develop with them.

And then, Nathan, in a similar vein to the distributor-led sales model and the flexibility that provides, you guys have a very flexible operations model and I think it makes it more nimble than a typical hardware company. And that's something you probably need to tap into over the past few years, whether it was tariffs or supply chain issues. Did those challenges present opportunities to create and find incremental operating leverage and just efficiencies in your model?

Yes. So if you look, a very light capital business model. So we outsource the vast majority of our manufacturing to our manufacturing partners. And as Joe mentioned, most of our -- 80% of our revenue goes through our Tier 2 distribution model. And it really provides a lot of advantages to scale as we grow as we've experienced here over the last 7 years, but also the flexibility in the downturn we saw in 2020 to scale back costs. And so that's been a big advantage for us. And one thing that has changed over the last few years -- in 2019 and 2020, we worked with our manufacturing partners to diversify part of our capacity out of China, primarily to Vietnam, Malaysia and Taiwan to offset tariff from a tariff perspective, but two things come out of that on top of the mitigating the tariff impact. One was going through COVID, being able to flex capacity between the different sites based on the COVID outbreak or where we were unable to get supply in and out of a country has been hugely advantaged -- a big advantage for us. The other one is, it taught our engineers that you could do all this remote. So we finished all of those manufacturing sites, basically the tail end of it when you had to do test, validation, the first production runs, we were doing all of that remote training with the site. So now as you get into how do you redesign a product, test it, validate it, working with our partners around the world, doing that without having engineers fly around, something I like very much. So again, that's a new capability that our teams have really learned to do in this environment and had to finish those -- building out those capabilities into 2020.

And then maybe as we're coming up on time, just the last question for you. I mean I think you've done a really good job affording investors with continuity and being a new CFO and ultimately, still delivering on the model that they've come to expect from Zebra. And now that you've been in the role a bit longer, is there anything that you'd be thinking about doing differently and just that you could talk about? Or do you -- should we expect the same stability?

Well, thank you for that. And so just for background, I joined Zebra in 2018 as the Head of Corporate FP&A and business operations. So I was in the middle of a lot of the decision-making we were doing up and to the point where becoming the CFO. I think one of the things we've done over the last couple of years is more prioritizing or reprioritizing focus and investment around those expansion markets, right? And those are large, attractive markets. That's why we highlighted it in our long-term growth. So ensuring investments are reprioritized around machine vision, fixed industrial software and now robotics, where you can combine -- or organic investment along with the Fetch acquisition that gives us a powerful platform. And then the other one, which, again, is just a continual evolution is what we do around talent and our people. Our goal is to recruit and have people and processes to support a much larger business in enterprise over the coming years. So I'd say, those are two things that I get more evolution than revolution, but are top of mind.

Awesome. Well, thank you, and thanks for staying with us today and participating in our chat. I think we can cut it there. Thank you.

Thank you very much.

Thank you.