Zebra Technologies Corporation (ZBRA) Earnings Call Transcript & Summary

Okay. Thank you very much for joining us today. I'm Sami Badri with Credit Suisse Equity Research, and we have the Zebra Technologies team here. We have Joe Heel, Chief Revenue Officer; and Mike Steele, VP of IR. So thank you both for joining us today.

Pleasure.

So I want to kick kind of things off and talk about or understand a little bit more about Zebra's Enterprise Asset Intelligence. And how does that specific business resonate with your customers?

Yes. So we put forward a vision that we call Enterprise Asset Intelligence vision. And what it's really about is about connecting assets and people to make them more productive. And it's rooted in the fact that what we do as a company is we improve the productivity of workflows. We digitize and automate workflows with solutions that range from handheld mobile computers like this one, barcode printers and scanners, but have extended, in recent years, far beyond that to software and services that enable productivity across workflows. Think about things like taking inventory in a retail store or picking in a warehouse. Those are workflows that we optimize and automate, and the vision of Enterprise Asset Intelligence is that all of the assets and the workers are connected and digitized using these types of tools. And that resonates with our customers actually more with every day, especially in times when labor is short, labor productivity is at a premium and digitization and automation can provide efficiencies in times when expenses are short. And so this vision seems to resonate particularly well even in difficult environments like the current one.

Got it. Got it. So I guess an interesting question at this juncture, at least is, if we are going to a more economic downturn or economic pressured environment, how does Zebra's products or tools tend to perform in that kind of an environment?

Yes. So as I said, productivity and automation are really the center points of what most of our customers try to do. And if you think about where customers are spending their investments in times that are more economically challenged, it is to improve productivity and to digitize and automate workflows. And so our value proposition actually plays well in both positive and challenging cycles. And we're seeing that in our business today is that we continue to see strong demand even though some of the macroeconomic environment is more challenging.

Got it. Got it. One thing I wanted to hit is maybe you could help explain to us the challenges with the North American distribution center, and this was actually discussed in Q3. And can you just also maybe discuss if Zebra has actually recovered from that?

Yes. So we sell a significant portion of our business through distribution centers where we take product from our factories and then send it out to our end users and our distributors and partners. We have 3 major locations. North America is one of those. In July of this year, we had planned to transition our distribution center from a location in Fort Worth, Texas to a location in Kenosha, Wisconsin. This was both to modernize the warehouse as well as to reduce certain costs around it, labor costs, transportation costs. And we did run into some difficulties. We had some significant problems that we had not anticipated and planned for in that transition. And in the month of July, we discovered or decided that this transition was not going to be effective because we weren't able to ship out as much of the product as we needed to, to satisfy demand. So in the middle of that quarter, we made the decision to revert back to our distribution center in Fort Worth, Texas. That did cost us the ability to supply some of the demand for the quarter and was a reason for some of the shortfall that we had in Q3. We have, in the meantime, fully reverted back to our distribution center in Fort Worth. We are supplying all of our North and Latin America demand with very little exception now from Fort Worth at the capacity that we had before we attempted this change. And therefore, we think that this transition problem is behind us. We're still in the process of deciding of what our distribution center strategy will be for the long term, but for operational purposes, we are stable back again in the Fort Worth facility.

Got you. One thing just on the topic of demand. In the Q3 earnings call, there was a discussion point around demand starting to change or at least come in a little bit lower at the end of Q3. Could we just discuss what you're seeing regarding demand? And then maybe if you could break it down by region and industry vertical as well, so we can characterize where kind of the slowdown or reduction of demand is coming from?

Yes. So we had said in our Q3 earnings call that about 10% of our Q3 shortfall was due to slowing demand that occurred late in the quarter where certain North American customers, primarily retail customers, there was also one T&L customer in there, but primarily retail customers decided to slow down some purchases. For the most part, the slowing down of purchases meant that they either postponed the purchase into Q1 of next year, where they split the purchase between the fourth quarter and the first quarter. So we have relatively strong reason to believe that this demand is still live. It's real demand, and we'll get it, but at a different timing and it's been concentrated in a very small number of large North American customers.

Got it. Got it. The one thing I want to hit on is the $100 million revenue miss relative to guidance in Q3. How should we be thinking about that miss and in the context of the year, what you're seeing from a visibility perspective?

The year meaning the coming year or the full year '22?

Full year '22.

Yes. So we're not going to update in any way our perspective on the full year at this point, obviously. But in -- we do think that this occurrence in this miss in Q3 was an exceptional piece. We said it was driven by three things: it was driven by a component shortage problem; it was driven by the distribution center issue, roughly in equal parts, accounting for about 90% of the problem and then 10%, as I said earlier, was more of the demand issue that we saw. We already talked about the demand issue and we talked about the distribution center issue, the one we didn't talk about yet was the component shortage problem. And so the component shortage problem of the three is the one that has been somewhat persistent over the course of the last 4 quarters. We've had component shortages, mostly semiconductors that have affected our ability to supply. The component shortage, however, has gotten better over the course of those last 4 quarters. And it's gotten better really for three reasons: one is that the industry -- our component suppliers have added capacity; we have renegotiated some of the supply contracts; and we have redesigned our products to allow for alternate supply. So those three things have led to a continuous improvement. We do expect that those -- that element of the shortfall, which was the component shortages, will persist for a few more quarters and will sort of taper off, but it will continue to improve. And so we are already seeing a significantly better ability to supply both from component and from a warehouse perspective, in the current quarter. Our linearity is basically back to the normal linearity that we've had in quarters here in the fourth quarter. So maybe that gives you an idea of what we're expecting as a recovery from in Q3.

Got it. I want to shift over to Europe. And Europe is about 35% of revenue, 25% or 25 points is denominated in euro, 15% of revenues coming from Germany. Could we kind of just talk about what distributors and customers are actually signaling for 2023?

Yes. So the European demand situation has not yet shown the signs of softness that we indicated in our Q3 results, we have not seen that yet, nor have we seen it in any of the other regions, which has been -- we've been very pleased with that. And we think it's further evidence of what I said earlier, European customers are not necessarily concentrated quite in the way that your numbers would indicate because we do have two very large distributors that are located in Germany. And so a lot of revenue flows through Germany, but doesn't necessarily end up in Germany. So Germany is an important part of our European makeup, but it's not quite as important as the numbers might suggest. We're pretty broadly diversified with the U.K. actually being the largest of our country -- presence in Europe.

And then is there anything signaling 2023 trajectory in Europe from customers or distribution centers just to kind of get any kind of color on 2023?

Yes. As I said, we haven't, and we've been very pleased with this. We haven't seen customers yet slowing down in their demand in Europe. Where we've seen it has been in North America predominantly. And they're only in a few of the larger customers. That's what we're seeing.

Got it. Got it. Maybe looking at things from a small and midsized customer perspective versus large cap or large-sized customer. Zebra flagged that SMBs are actually outperforming the larger customer sizes. Could we kind of walk through that or maybe explain to us what you guys are seeing?

Yes. So our business is actually very diversified between, on the one hand, very large customers like Amazon or Lowe's or the United States Postal Service. And then on the other hand, we have a very long tail of customers who might only buy two scanners every 5 years, right, from us. Think about the restaurant on the corner where you'll find a Zebra scanner, that's a purchase that happens somewhat anonymously. They'll go to their local IT guy and buy it from a distributor and we'll never know who the customer even is. We have tens of thousands of customers of that sort. Now the -- and we have everything in between. We have midsized retailers who have 5 stores, right? We have those two. And there's a very beneficial cyclicality of those different customer tiers because they don't all accelerate at the same time. When we went into the pandemic, our largest customers, they accelerated first, even in 2020, they started to accelerate their purchases to put in place new use cases like buying online pick up and store or e-commerce type of use cases, right? And whereas the smaller and medium customers were more on the sidelines and more cautious. And so now as we're seeing some of those larger customers pause or potentially split purchases over time, small and medium customers are accelerating in a very strong manner, right? And we saw that in Q3, double-digit growth in that part of the customer segment segmentation. And if you're interested in sort of cyclicality and the long-term health of our business, you can see the same phenomenon across geographies, right, where North America was one of those that accelerated first and now it's showing sort of the signs of softness first, whereas our fastest-growing region in the last quarter was Latin America, which only a few quarters ago, was very far down, right? So the cycles of both customer size and regions tend to offset each other and allow us to generally drive some steady growth with macro being perhaps the only modulation of that steady growth.

Got it. Got it. I was hoping I could pivot to the -- an update on an acquisition you guys made, which is Matrox. Could we talk about how the progression question of signing both new and existing Zebra channel partners is going?

Yes. So Matrox is a company that does machine vision solutions. They've been in business for 40 years and they complement several other machine vision acquisitions and developments that we did in-house. We developed and launched a line of fixed industrial scanners, and we bought a company called Adaptive Vision that has a software portfolio, in particular around OCR and learning algorithms for machine vision. And so we're putting together a set of capabilities around machine vision, which we believe is one of the, what we call, expansion businesses and will drive future growth for us at Zebra. Matrox has been a quite successful company on its own. They had their most successful year that closed just before we acquired them. And they have a very strong position in some segments of the machine vision market, it's a relatively big market, about $2 billion in total, and they have a relatively prominent position in that market, having a reputation for very high-end capabilities in technological terms. As you mentioned or alluded to, the intent in bringing Zebra and Matrox together was really to use the breadth of our customer and channel partner presence to accelerate the growth of Matrox. So while Matrox had been in mostly manufacturing environments so far with very high-end applications, we have many customers in the T&L space, transportation & logistics, that are looking to deploy machine vision capabilities to further automate their processes. And so indeed, some of the first wins that we've been able to notch are with some of our big T&L customers who are now looking to adopt this technology. And the other path that we're going down is to use the strength of our partner capabilities. Now Zebra is known as a company that is extremely partner-friendly. We sell over 82% of our revenue through partners, and we have an ecosystem of over 40,000 partners worldwide. And in particular, we're known for putting partners first and making sure that we never compete with our partners. And in the machine vision space, there's a partner ecosystem, which is largely different from our partner ecosystem. By the way, there's some overlap, but those partners in the machine vision space have been looking for that kind of a relationship with an OEM, if I can say it sort of more neutrally. And we are making that central to our strategy to be attractive to partners, to be a trusted partner and to offer them a proposition of ease of use and ease of integration that enables them to make money in this business model. And so that -- the combination of that partner strength and that end user strength is what we're using to accelerate the Matrox business, and we're very pleased with how that's been going, even in the first 4 months now of having integrated Matrox.

Got it. On the subject of cross-selling and going through your channel, and one thing I want to talk about is cross-selling Zebra automation capabilities and products. So everything from fixed industrial scanners with autonomous -- I want to make sure I get this right, autonomous mobile robots, right, how do you guys target and execute cross-selling opportunities? And how has that kind of progressed over time?

Yes. So cross-selling in various different forms has been, I would say, the key driver of Zebra's growth beyond the Android mobile computer revolution that we've were central to. But what we have been doing is leveraging the strength in one area of the business into other areas quite systematically. The first one was really leverage our strength in printers into mobile computers and get mobile computers to all of our printing customers and then leveraging that into service, right, attaching service to every one of our mobile computers are, if you watch our service penetration, it's gone up dramatically because we've cross-sold services. Then we expanded into what we call adjacencies. So these are product areas that are very similar to our core portfolio, but adjacent. Tablets is a good example. RFID is a good example. And we've been cross-selling those technologies into our very large core customer base. And more recently, we've also then expanded this into our expansion businesses. So we think of our expansion businesses are three. One is Matrox, as we already talked about and machine vision. The second is autonomous mobile robots. We entered that through the acquisition of Fetch Robotics. And the third is retail workflow software, which we entered through the acquisition of Reflexis and Profitect, which we now call Zebra Analytics. And those are really capabilities that complement, if you think about it, they complement the automation presence that we already have in our core customers. So for example, the Reflexis offering, the software offering is one that puts task management and workforce management into the hands of workers, right? They can receive their tasks, their schedules directly onto their mobile computers, and it's one of the big use cases for our mobile computers in a retail environment. And so going to our retail customers and bringing them this software capability is a natural cross-sell. The other one that you talked about is automation, right? And we're in most of the warehouses all around the world. So as those warehouses are now adopting robotics in order to further automate their processes and machine vision to do inspection and rapid scanning applications, we are a natural cross-sell partner to bring those kinds of solutions to them. And recently, we had our first win where we -- for the first time, we sold both technologies that you mentioned, autonomous mobile robots and machine vision into one customer and it was a manufacturing company in the U.S., and they are using machine vision on the one hand to acquire information about packages that are arriving and then putting them on a mobile robot that transports them to another place of the warehouse. That kind of capability is one that we are going to see increase in warehouse settings, I think, at a very rapid pace. And so this is, I think, an example of what's to come.

Got it. One follow-up question is when you look at the customer base that's buying multiple products for multiple Zebra businesses, is there any way to quantify that or characterize that?

There is, but I don't have the data here as to tell you that. But we know that the number of customers that buy more than one product from us has increased dramatically. And we also know that the profitability of those customers is higher. So it's very strong support for the cross-selling strategy that I described earlier.

Got it. Got it. I want to take a pause and open up to the audience. If you have a question, you can raise your hand and we can get a question your way, and I'll just take a pause for like 5 seconds.

Maybe just a question on channel visibility. Do you guys have the capability to [indiscernible] distributors? And is there like a unique [indiscernible] your products actually get live in the field?

So just maybe we should repeat the question. So it's about either frequency of visibility across warehouses was it? Warehouse and...

But I think you're talking about the distributors, right? So you should picture the following. About 80% of our revenue goes through partners, and about 60% of our revenue goes through distributors, right? So where there's two tiers between us and the end user, distributor and then a reselling partner. So distributors are a very important part of our go-to-market. And we have a limited number. Like in North America, we have three. In Europe, we have more to cover more regional -- areas are covered. Generally, our interaction with those distributors is extremely tight. So we know for the most part of what they're doing, by name and end user application. And the way that works is only about 1/3 of our revenue in total, all of our revenue, 1/3 of our revenue, is what we call run rate. This is a product that is purchased from a distributor largely at list price, not exclusively, but largely at list price in relatively small quantities, go back to the 1 scanner every 5 years. We don't know who those people are. And that's much more of a retail model, if you think where the distributor acquires a certain amount of stock and sells it out. So there, we have relatively little visibility to who the end user is and when it's selling out. But for all the rest, so think about 2/3 of the revenue, it's done on what we call price concession. And a price concession would mean it's done off -- not on the list price, and the distributor has to come to us and say, I want to sell it to company X and I need an extra discount. And we know and approve the pricing level, the quantity for that particular transaction. And so that gives us pretty good visibility as to what end user demand is actually out there, where it's coming from and what the pricing dynamics in the market are. And we do use that. That's an important part of our business model. And then the other part of your question was around...

It was just to gain some visibility. I wasn't sure if you would have like a warranty that you [indiscernible]

Yes. So the technical visibility to the product usage typically comes because most of our products are connected and the majority of our mobile computers also have a service contract on them. And so when you want to -- when you have a service contract, you have to activate it, right? And it's kind of like when you -- to activate your warranty on the product that you buy at retail, you have to let us know where you are and who you are and what device you have, register your serial number is typically the case, and then you're entitled for service. And we have a very high attach rate on service in the meantime on all of our mobile computers. And that means when they activate the service, we know that the product where it is and who has it. And the other thing we've been significantly expanding is the online connectivity of our products. So all of our products have the ability to be online connected and be visible to us. Now that's only if the customer gives us the right to do so, right? But we have been giving customers benefits and value for connecting their products. We have entire software capabilities that we give them that show them where the products are, how they're being used, how they can improve the productivity of those products, how they can improve the usage of the batteries on those products. We give them that value if they connect the products. And those connection rates have been going up, which gives us not only visibility, but real-time visibility to what the products are doing, right? And that is another trend that you think you should expect will continue to expand over time.

Any other questions? All right. I wanted to talk about public safety markets. So Zebra has said that it generates about 15% of revenues from other markets. How much of Zebra sales into public safety governments is there?

Yes. So Public safety -- the four core markets, they're not other, right? They're retail, transportation, logistics, health care and manufacturing. And then the 15% other, the largest single portion of that is public markets, government customers. And among that, the biggest use case you can imagine is public safety. So the -- I'm sorry to tell you that the next time you get a parking ticket, it's very likely to have come because someone has a Zebra mobile computer and is walking around taking a picture of your license plate and then automatically printing your ticket or sending it to your e-mail. So that's a use case that's become increasingly popular with law enforcement agencies all around the world. For example, the NYPD uses this type of a solution now. But there are also other use cases if you think about military applications, most military applications are big logistics organizations, right? And they have to do exactly the same thing that happens in other warehouses, which is to maintain stock and move stock and they're using Zebra solutions to do that kind of application as well. So that gives you a bit of an idea of some of the public use cases that we have, public safety being the largest one of them.

Got it. Well, I think you're rounding out on time. Thank you very much, Joe and Mike for joining us today. Thank you, all, also in the room for joining us.

Thank you.