Zebra Technologies Corporation (ZBRA) Earnings Call Transcript & Summary

I think we'll go ahead and get started. I'm Rob Mason, the senior analyst at Baird, covering the advanced industrial equipment sector as well as coverage of Zebra Technologies. Zebra is a global leader in enterprise asset intelligence and a provider of tools to enable companies to digitize operations and transform their workflows. Very pleased to have with us from Zebra today, Bill Burns, CEO, who is going to open with maybe just a couple of comments or we could jump right into the questions.

Yes. Thanks, Rob. Zebra's focus really is our vision of Enterprise Asset Intelligence, as you said, really that talks about the idea that we look to digitize and automate customers' environments. And the way we do that is providing every asset and worker on the edge, allow them to be visible, connected and optimally utilized within the environment. So if you can digitize an asset, if you can know where a worker is with a mobile device, then ultimately, you can optimize your workflows within the environment. But 86% of the Fortune 500 are our customers today across hardware, software. You see us in everyday life. So devices used to check out scanners in retail. You see us -- our mobile devices used with parcel delivery in inside transportation logistics, you see our hospital wrist bands printed inside hospitals. And our most recent investments beyond our core areas have been in robotics, AI, retail software and then machine vision, fixed industrial scanning is the latest investments. I'd say a difficult year from a demand perspective that we're coming off really the highs of COVID and ultimately, the demand driven by e-commerce and parcel delivery during COVID. And now we're seeing those declines impact our business in 2023. So a difficult environment at the moment, but the future is bright as our customers continue to look to digitize and automate their environments to get more visibility, smarter supply chains, better visibility into inventory and retail, more connected associates and more visibility to assets across their environment.

Yes, yes. Like you noted, I think everybody is aware, revenues have been under some pressure as we traverse through the year. But during the third quarter, it looked like perhaps there's some stabilization there. Are you comfortable at this point saying based on replacement, new project activity that you are seeing come through, are you comfortable seeing markets are at or near or bottom at this point?

Yes. We've used the word leveling at level off. I think that we saw broad-based decline starting in the beginning of Q2 and going into Q3. Now we've seen end-user demand leveling overall. I think that typically, in fourth quarter, we'd see more year-end spend by our customers. We haven't quite seen that and aren't planning that for Q1. And I think we've got tough compares going into the first half of 2024. But I would say leveling, bottoming, you can use those words. That's how we see it. It's also the peak of our distributors kind of destocking in Q3 as well. So this phenomena destocking, as demand goes down or distributors hold less inventory ultimately. So it's not like they had too much stock, but as demand drops, they just put less on stock as they think of holding about 60 days of inventory in stock. We saw about $140 million in that destocking in Q3. We're forecasting about $100 million in Q4 that kind of goes away into 2024. So bottoming, leveling, yes, bolt-on end user demand kind of leveling out and then ultimately, the peak of destocking within our distributors coming out of Q3 and Q4.

And as you think about again in this bottoming process, certainly around maybe replacement activity as well, what insights can you glean from the field in terms of how your products are being utilized, underutilized, we give you, again, some more comfort around that.

Yes. I think that we saw this significant uptick in revenue in 2021 and '22 by our customers really to meet the demands of e-commerce, buy online, pick up in store, parcel delivery, all the places that are our largest customers. Manufacturing ,T&L are two largest segments. Healthcare and Manufacturing and Government are the smallest segment overall. So those customers bought a lot during 2021 and '22. And what they're using is that capacity being used off now. So it's not as much they have excess devices sitting around somewhere. The largest e-commerce supplier North America really said that across all vendors, I've got excess capacity and extra equipment. I don't need more for a while, and we've seen that behavior. Most others are using the devices they have from us today. They just don't need more. And the idea of a service-based economy versus a goods-based economy, they have -- don't have a lot of confidence in their top line of their business, so they're holding off from a capital perspective. They're sweating assets a little bit more. They can do that with our devices as well, and we're seeing that happen. But it's predominantly using the capacity they have. We can tell through managed services software where we manage devices for our customers. But those dices are pretty much being used. So our number of installed devices that eventually upgraded again over time is increased significantly because of its increased demand in 2021 and '22. And eventually, that's good for our business longer term.

And we're talking millions of devices in this installed base as well. Okay. Maybe just -- is there any distinctions you would make regionally? It seemed like Europe was a little bit softer or at least from a comp standpoint, but any distinctions you would make recently across your...

I would say broad-based demand started more in our larger customers, which then impacts more of North America first. Typically, Europe saw more in Q3, more distributor destocking than the other regions. I think that's predominantly as we got into Q2, we saw kind of mid-tier business and then run rate business kind of catching up in the slowdown, I guess, I'll call it, to large deals, which is more North America focus. So nothing really different across Europe and North America only, timing is a bit different on when we're seeing things slow down. We believe, ultimately, large deals and large customers will come back first. So it will reverse the other direction. And the mid-tier run rate will follow is how we see it.

And so to the extent customers have clearly slowed what they're willing to spend, have they -- have you seen that slow in terms of what's entering the project funnel? Does that need to pick up again before we see spin flow through or [indiscernible]?

Yes, typically -- we talked about this kind of in first quarter call and in the second quarter. I think that the -- the good example is our sales teams typically have about 6 months visibility to large projects when our customers and are pretty confident around those. They're putting their sales funnel is kind of secure and they go happen, right? This year, we just didn't -- it turns out that we didn't have the confidence in those as we got into the year that customers started saying, "Hey, my CapEx budget was pulled back. I just don't have the money to spend on that project. I still ultimately believe in it. I'm going to go push it out, but I can't tell you when. So I think we see -- we don't see orders being canceled. We see projects that customers plan being pushed out and the visibility today is still challenging as we look out in the future. We know that there's refresh opportunities that our customers have coming up in -- they had in '23 that they've pushed out. There's more in '24 that will come up. Could they sweat those assets a bit longer, especially in mobile devices, sure. That time frame typically is 12 to 18 months. Service contracts go up in cost because ultimately, we charge them more because those devices are older. Those devices get broken, they get -- they want new security patches. They have new OSs. They have new applications that require faster processing speed, more memory, all those things drive them to refresh and upgrade those devices. But can they hold off in a short term, yes. Have they been holding off on those project yes, both refreshes and new projects for the minute as their budgets are challenged, but those will come back in and they'll buy those projects again because they have solid ROIs and use cases for our products.

Yes. In terms of just inbound projects into the funnel that maybe they don't flow through the normal timeline. How is that activity such that projects are getting [ tiered ] up for [ win ].

Yes, I would say we still have a lot of conversations with customers today on what's their future plans. I think there's less things entering the funnel, right? I think that that's been the challenge we had in Q2 was that there wasn't many opportunities as they grow through the funnel, typically, if a secure opportunity doesn't happen, then you drop down to the next tier in your funnel and you can replace it with something else. Those opportunities just -- there's not that many opportunities to do that in the short term. So I'd say less entering the funnel, we'd like to see more. We'd have liked to see more year-end spending, but intentionally, we didn't call that in the number because we just haven't seen enough changes in the environment to have confidence that the market is at a different place than it was kind of in Q3 and Q4. And we clearly see the back half of next year, at least to easier comps but the first year -- first half of the year we grew in first quarter in '23. So it's tough to compare in the first quarter.

Is it fair to say that most of your customers will enter the new calendar year, perhaps with a new capital budget. That budget probably is not finalized on January 1. They go through with that process during the quarter as well.

Yes. So many of the retailers, their year-end is the end of January, right? U.S. retailers example. Typically, our customers have their budget set in Q1 we typically have visibility then to what they're going to spend in Q1, what their plans are, at least Q2 and for the remainder of the year, the projects they have in front of us, those projects didn't go through in 2023. We expect that if there's some confidence in their end business and they only can hold off so long that we expect clearly a pickup in business in 2024 as they move ahead with some of those projects as we see some of these refreshes moving forward. So -- there's lots of opportunities out there. Our customers are still buying from us. They're just not buying in the levels they were in the past.

And maybe just one last point around this topic. Just -- as you think about replacement cycles in general, you mentioned they could push out 12 to 18 months. Is there any sense when this big larger surge of devices went into the market in 2020, '21? And that some of the older, maybe they weren't quite ready to be -- did they get replaced? Or are those still working their way through?

Every customer is on a different cycle. And even within a customer base, you think of different applications in different cycles. So front of store retail and a large retailer is in a totally different cycle than think of distribution center and their transportation networks, think of transportation logistics inside the four walls compared to their drivers themselves. And then you have contract drivers many times inside T&L as well. So they're all on varying different degrees of refresh cycle even when they refresh, they refresh in large quantities, but then they continue to buy. They add additional devices, they break devices, they lose devices, those kind of things through the cycle. So typically, an upgrade 4 years ago turns into a much larger upgrade 4 to 5 years later, that's typically the refresh cycle across our products. Printing is may be a little bit longer, mobile computing, a little bit less, but they can only hold off so long. And -- and we know when our largest customers are going to refresh those devices, they're all on different cycles. We track those work with them. We know that -- a couple of ways. One is we know when they refresh last time. We know how many devices they bought, they're typically under service contract with us. So now we're working with them on, okay, if you want to extend the service contract for a year, it costs you a bit more. Are you sure you don't want to refresh, these are benefits you get from it. And do we want to go do that sooner. So it's all about them having the capital to go and do, what's the time frame of that rollout. And then ultimately, what are they getting for at faster speeds, memory, security, all the things they care about and the devices just get beat up. I mean they're used for -- I think of even a rugged mobile device used in an environment for 4 to 5 years, that's a tough environment in most work instances.

Right, right. Maybe we'll zoom out a little bit. You've been in the CEO position, not quite a year, obviously. But you previously had the ability to influence strategy as well at Zebra. So I'm just curious, as we go forward, what should investors consider about any perhaps shift in influences? We've -- you've gone through a lot of challenges broadly. But just around strategy as we go forward.

I mean we feel good about the -- our core business, we've typically said that through cycle, we would see 5% to 7% growth through cycle. We still feel good about that. Ultimately, our core markets, our printer, scanners, mobile computing devices are market-leading across each one of those segments and that there's still opportunity for us to continue to take share across those markets because we have different share across the vertical markets. We serve retail, [ transport & ] logistics, manufacturing, health care. I talked about before in different places around the world, and we still see growth in those markets and places we can continue to take share. So we think of that as kind of 4% to 5% growth across our core. We think of the strategy of our adjacencies that ultimately tablets, bioptic, scanning supplies, RFID adjacencies to our core and they typically grow low double-digit kind of growth. And then we've got these new areas we've invested in across robotics and retail software and machine vision, all would be much higher growth rates, but of a much smaller base. So we married all those together, and we think the strategy is sound, that we think we have the right investments in the area with the -- to service our customer, leverage our installed base, leverage our trusted relationships with our customers around the globe to enter new markets such as machine vision and software leveraging those devices ultimately, robotics to work along with workers that have mobile devices that are equipped with those today. So cobots working with workers. So we think a lot about what are the adjacencies in the areas you want to enter, how do we leverage our core markets where we have strength and strong customer relationships. And how do we take those and leverage those into new areas for Zebra. And we feel good about the strategy we've had in place and we'll continue on that path because we'll see the business return to growth. This long-term trend of digitizing and automating environments and giving assets a digital voice and having visibility across the entire supply chain and continue to upgrade people's workflows to become more effective and more efficient is what we do and our customers need that.

Is this cycle that we're going through right now, this down cycle? Has it caused Zebra to think differently about how it approaches recurring revenue or the amount of recurring revenues that would be appropriate in this portfolio?

Yes. I mean everyone like to have more recurring revenue. I think our core products around mobile computing, printing and scanning will be our core products for some time in the majority of our revenue just because we believe they'll continue to grow. So it's the largest predominance of revenue. We think of recurring revenue in a couple of areas. Our services business is really a recurring revenue multiyear contracts on our mobile device. And in our -- in that business is growing and continue to improve on grow margins in services. Our software business leverages the mobile device. So think of the retail associate using our mobile device and communication collaboration software, task management, workforce management or all the software assets we have. Those are true SaaS recovering revenue. We think of our supplies business is recurring revenue with our printing devices because those orders continue to come in, even though they're multiyear contracts for supply so that's recurring as well so. We'd always like to have more recurring revenue. Robotics is sold on a revenue -- recurring revenue and the idea that people are leasing robots for a 3-year period because the customer base is predominantly 3PL that have multiple year contracts with their customers. So that's recurring. We'd love to have more recurring revenue. We focus on it all the time, but the predominance of our business will be printing, scanning, mobile, computing and devices for some time.

So around these adjacent and expansion areas that you've outlined, the ones that you would expect to grow potentially double digits. You've added market positions, as you said, around machine vision, robotics added to the software, they've had stronger uptake in tablets, which one of those stands out is in type of environment, which is challenging -- is having better opportunity to kind of grow through some of the end market headwinds.

I would say, if you look at market size, our machine vision and fixed industrial scanning portfolio, which is about $100-million-ish today is a place that has the biggest market potential, right? We address about $3 billion of that market TAM today. We're only $100-plus million in revenue. The market is fairly fragmented. There are strong competitors in that market, as we know, but we've been able to win opportunities. That's a growing market. We've seen a pullback in semiconductor in the short term, but I think other areas will continue to grow long term as there's opportunities across fixed industrial scanning inside transportation, logistics and warehousing and really machine vision inside manufacturing, which we see as an opportunity for Zebra. The manufacturing floor continues to be more automated, things like machine vision. We're seeing opportunities for tablets on the manufacturing floor as opposed to fixed infrastructure and screens. We're seeing robotics for line side replenishment. So that's an attractive market to us in general manufacturing but I'd say the most attractive from a market size perspective is machine vision. We continue to take share in tablets. That's another use case closely adjacent to mobile devices, a lot of use cases. We call it bigger screens. So if you're a manager in a retail store, you want a larger screen format, not just a mobile device. If you're on the production floor, that we're seeing, as I mentioned, this idea of moving from fixed infrastructure screens to production workers have in tablets. So they can communicate, collaborate, be able to use guides to -- as production is down or something happens in production line, a worker kind of assistant kinds of things. So more communication, the way we've seen in retail happening in manufacturing. So -- we think of these as all adjacent to what we do with lower share, which then creates an opportunity across all of them to be -- to continue to grow our business. The largest market is probably machine vision.

And the source of the share gains in tablets is your legacy position in mobile computing, you're already there. They just want an extension or...

And a shift in android. So we're seeing a shift in the tablet area that was really used on more PC Windows-based. We're seeing a lot of our customers saying, okay, just like my mobile devices, I'd like my tablets to be on Android and then use the applications across Android inside those environments.

And then within the machine vision or fixed industrial scanning, is there a way to differentiate the growth trajectory right now on those machine vision, I thought was -- like you said, maybe a little more semiconductor experience -- is it fixed industrial scanning seeing better?

Yes. I mean we've -- we entered at marketplace in kind of 3 different areas. One was our organic investment in fixed industrial scanning. So think of it as taking a handheld scanner and making it a fixed device or unit. There's some software changes because it's faster barcode reads over conveyance and things, [indiscernible] scanner, but it pretty much is reading a bar code. And we entered that market organically. And then we married to that, the next step up in that is think of a smart camera. So it can read barcodes, but also can do some vision system that can read optical character recognition, they actually read text, right? It can do some inspection. And we did an acquisition of -- to add software, adapt a vision to that in the kind of the middle of the market. And then we had an acquisition of Matrox at the very high end of the market. So I think a very high-end vision systems are doing things like semiconductor, they're doing multiple camera images together pulling all those together and do an inspection to the very high end of the market. So we've got a pretty full portfolio of products today across from low end of barcode reading all the way to the very high end of the market. And I think we've got we believe, ease of use, a portfolio where you can upgrade from a low-end fixed industrial scanner to a smart camera and then ultimately leverage our broader vision systems. So we feel good about the portfolio overall. Semiconductor, we knew when we acquired Matrox, was heavily customer base was in the semiconductor area. We had hoped we'd we have a bit longer before the semiconductor market declined to diversify that business. But we've worked hard to diversify outside of consumer conductor and that's what we're continuing to do today, and we see opportunities in electric vehicle manufacturing. There's a lot of inspection around things like battery and others, pharmaceutical, food and beverage, a lot of spending still happening to upgrade production lines, they're kind of longer-term projects, and not held back as much as other areas today across our customer environment. So we're excited about the machine vision market. We're excited about the portfolio we have. We have very low share today. We have formal competitors, but the market is fragmented. And we think there's an opportunity for us to leverage our installed base of the rest of what we do across our customer base and grow our machine vision in fixed industrial scanning market. Those same T&L customers are buying fixed industrial scanning from someone else today, and we want them to buy from us inside manufacturing. We got a strong position inside distribution and warehouse. We want to have a stronger position on the manufacturing line. We have that today in scanning and printing, not as much on the mobile computing because they're not used as much, but we are used in the distribution. So how do we leverage that to do more machine vision and manufacturing.

Just with respect to machine vision or fixed industrial scanning AI, deep learning tools have become more germane to that -- up that market to help integrate those products. Where -- what inning is Zebra in terms of being able to integrate those type of capabilities into the...

Yes. So I mean today, across the product portfolio, I'll use traditional AI as the example is being used for things like machine learning and others across the portfolio. So we use that today in things like optical character recognition and robotics, navigation across our machine vision portfolio. That's an important piece of what we do. We use it in our planning software where our Intuit AI software offering, which really allows for demand planning and then we leverage demand planning into execution. So if you order the products they get put out of shelf. So you tie execution back to planning. So traditional AI is used throughout the portfolio. We're excited about the idea of using generative AI on our mobile devices. So we recently made an announcement along with Qualcomm, where we can actually run models natively, generative AI models on the device without connecting back to the cloud. So the idea of that is that many of our retail customers, many of these warehouses don't have a lot of connectivity back to the cloud and expensive if I got to go back to the cloud every time to be able to run a generative AI model, but if I can run it on the mobile device locally, and I can have that as a copilot to anybody using a mobile device that can look up what do I do when I get a store return without a receipt? What I do when production goes out of alignment, what do I do in a retail store, if I've got to go fill the stock, where is it within the store. Hey, what happens when it's the holiday weekend. I'm out of strawberries, what's the best practice for a produce manager to go get additional strawberries quickly back in the store. Anything that would be leveraging a copilot with a worker. And if I can do it locally, I can do it much faster, and I can do it at lower cost. And we think that's a huge accomplishment working with Qualcomm and announcing that over the last couple of weeks.

Did have one question from the audience will work in is around your mobile devices. Just in terms of what customers are looking for most, is it around batteries, around security, I guess what are the features that drive them to that device the most right?

Yes. I mean it's all of the above. I mean, first and foremost, the high-quality hardware and software is what are our customers are looking for us from us. They're rugged mobile devices. They have a scan engine. So they're purpose-built for scanning within our customers' environments. They have accessories that allow them to do things like RFID tags and others. They look for us to provide long life cycle devices. So we work with Qualcomm and Google to get to the front end of chipsets and longer life chipsets. We do the same thing with the front end of OS releases because these -- unlike a consumer device that changes in the marketplace every year to our customers want to use those for 5 years by the same device, upgrade the OS, be able to get security patches on those devices for 4 to 5 years. Those are really important to our customers overall. Our service agreement, our services support we provide them is also critical to their environment. So ultimately, these are mission-critical in what they do. They're picking orders. They're supplying inventory. They're servicing their customers. And ultimately, they expect that from Zebra. So it's all of the above. And I would say as well as being the market leader across the areas in which we engage our customers, make us more trusted adviser in our customers' environment where we lay out things like our modern store initiative, where we talk about what the future retail looks like? What does it look like to have an engaged associate with our mobile devices and our software. What does it look like to have better inventory accuracy in your store and your distribution center? And how do you maintain that in a better way to always know what you have on the store floor. How do you engage your customers in a different way using a mobile device for things like payment or being able to order something online if they don't have it in the store. So we think of just a different conversation we have with our customers even above the device being a trusted adviser to them because we are the market leader.

Just to return back to the machine vision portion of the portfolio, again, because you outlined that maybe where you have the most market runway. How would you describe the completeness of the portfolio today as well as your maybe the maturity of the go-to-market strategy there between distribution as well as your direct effort.

Yes, I think that as I talked about the portfolio before kind of low-end fixed industrial scanning, smart camera all the way to the high end of the portfolio. I think we've got a pretty good portfolio of products that we can have offerings to our channel partners than ultimately end customers. So we feel good about the portfolio. Could it be more broad, it could it be more expansive, sure. But we've just entered this market a year, 1.5 years through organic and investment. I think go-to-market, we have work to do, right? Ultimately, building out our channel partners in this area, continue to build relationships. We've got overlay sales teams that leverage the relationships of our broader sales teams into our T&L and manufacturing customers today. Those are smaller teams today. In the Matrox acquisition, they're a very small sales team, right, with a private business. And ultimately, we've expanded those sales teams and channel partners, but more work to do. That's the biggest opportunity for us is to literally see more opportunities, see more customers and be more visible to our customers in these offerings across machine, vision, fixed industrial scanning and leverage the customer relationships we have today in the new buying personas to know and ultimately consider our products compared to our competitors. So that's the biggest opportunity with to go to market for us.

Maybe somewhat relatedly, I'll just show this out there because it was an announcement yesterday. Just Chief Revenue Officer is transitioning to an employee that's been with the company a long time and coming over from Europe, I think -- just any takeaways we should have from that announcement?

Yes, just Richard Hudson is a great leader. He's led our European sales team for the last 7 years or so. He led Northern Europe before that. He was on the forefront of the transition to Android and one of the early. I think it was the biggest win in the history of the company at the time with Royal Mail transitioning to Android and is a strong channel leader as well. So even more of our business in Europe is channel-led as opposed to direct. But as been certainly a leader led both direct customer relationships, large deal as well as understands our channel. He's well respected throughout the region in the company. He's the right choice to lead our go-to-market moving forward.

And as you think about kind of other efforts that you would like to add investment into as maybe machine vision is one, you've also taken about $100 million of cost out this year. How should we think about the reallocation of resources going forward here?

Yes. We continue to look across the portfolio and say, in our customer base, both vertical markets and geographies and say, are there opportunities to accelerate revenue? Because we've got to sell our way out of this. You can't save your way out, right? Because we got to be cost conscious in the short term. As you said, we've got $100 million in run rate. We've taken cost out into 2024 as we saw the declines in Q2. We've taken decisive actions around cost. We continue to be cautious around the cost base, but a lot of focus from the executive team on how do we drive more revenue. What are the customers we're going to buy? What are the opportunities for us to enter new markets? How do we drive market share in places where -- with lower market share. So that's our -- our primary focus is how to return to revenue growth. That's really what we need to go do.

Excellent. Well, we need to pause there. There is a breakout session. You can join us there afterwards. Thank you Bill.

Thanks Rob.