Zebra Technologies Corporation (ZBRA) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome. I'm Toni Sacconaghi, Bernstein's IT hardware analyst. Really excited to have Bill Burns, CEO of Zebra Technologies, joining us this afternoon. Welcome, Bill.

Thank you, Toni.

Bill came to the conference last year, and I think you had been in the CEO seat for 3 months.

Yes, about that.

And so I teased him saying, well, now you've been in the seat for over a year, so the bar is much, much higher in terms of the answers we're going to get. So let me remind folks that, if you do have questions, the easiest vehicle is to submit via Pigeonhole. I pick them up here. Quite frankly, it's an intimate enough group that if you do have a question, why don't you just raise your hand if you don't want to do the Pigeonhole or that's inconvenient, and I'll call upon you then.

So maybe, Bill, we can just start with -- obviously, it's been a really tough demand environment for Zebra on kind of both sides of the business, maybe you can just talk a little bit about it. Is it macro? Is it COVID digestion? Is it select end market pressure? What are you seeing just broadly around demand?

Yes, I would say that we look at end market demand today, it's certainly challenging. But I think that the real story is back to kind of pre-COVID, right? If you look back to the business and the enterprise acquisition that Zebra did back in November of '15, the business grew about $1 billion, this 5% to 7% growth rate we talk about from '15, '16 through '19. And then it was flat '19 to '20, and then grew $1 billion in a single year in '21, really as the trends that we saw prior to COVID had accelerated, buy online, pick up in store, more e-commerce orders, transportation logistics building out to truly meet the demands of e-commerce, health care spending, customers or consumers spending on their homes, and manufacturing. All that drove our business to grow $1 billion in a single year in 2021. And then as we came into '22, I think the belief of our customers, e-commerce, T&L, manufacturing that, that growth was going to continue, and the challenge of supply chain drove them to buy even more product ahead, thinking that growth was going to continue. So they built out capacity and then bought ahead as well. So I think you saw growth on top of that $1 billion in 2022. And then 2023, resetting back to what '19 and '20 was, because '19 was $4.5 billion, '20 was $4.5 billion with the pressures from COVID, $1 billion up, up higher than that, then back to about $4.5 billion, which is painful in the short term, but really explained by the idea that this overcapacity was built out and people went back to stores. The e-commerce growth continued, but not at the rate it was. Parcel delivery reset back to 2019 levels. The economy shifted from a goods-based economy to service-based economy. People are traveling more. They were spending more on experiences and less on goods overall. So I think the challenges around the economy played a role into it. I think as we got into kind of end of first quarter and the second quarter last year, we saw demand drop off very quickly. So we saw a lot of optimism at the beginning of the year at National Retail show early in the year. And then we saw our customers pull back starting with retail and then moving into the T&L and manufacturing and others. And then what that drove was the level of inventory within the channel, our distributors that hold inventory, they like to hold kind of 60 days of inventory we talk about, they pulled back, because ultimately demand dropped. So they weren't overstocked before, but suddenly they were as demand drop. So we saw about $300 million in destocking in 2023 on top of softer demand levels. So I think that's really the story around it. I think that as we enter 2024, I think we see a lot of optimism on the part of our partners, our distributors and others in the marketplace. But I think the recovery has been like we've kind of called it, kind of slow and steady. We've seen retail customers pull back first. In first quarter, our largest orders were from retail. They were mobile computing focused, which was really the first to decline as well. That's where we believe would kind of lead the recovery. We're seeing the capacity in e-commerce that was built out during the pandemic now being used and them beginning to buy again. And I think we're seeing -- we'd like to see even more activity and larger orders in retail, but we'd like to see T&L and manufacturing and health care really see more green shoots from those areas before we call it a full recovery. So I think we'll see clearly growth. We've guided to growth in 2024. It will be a -- it will be 2 halves, a story of 2 halves. Down in first half because of the easier compares in the second half, so up 20% in the second half of the year. As that stocking goes away, inventories right now are at the right level. We're working closely with our distributors to keep them there, so inventories don't get ahead of sales out and what they're selling. And we feel good about kind of a continued progression of sequential increase in revenue growth, is what we're looking to target. And then the same thing from a profitability perspective as the end markets continue to recover, and recover meaning use the capacity built off of COVID and, from an economic perspective, a bit of a shift back to a goods economy from services, people feeling better about their businesses, they'll spend more money with us.

And you talked a little bit about almost this some initial excitement at the beginning of '23, and then some weakness following that, almost like a false demand signal, right? And I guess the question is, why did that happen? And is there a risk that, that could happen again? Obviously, you're acutely sensitive to that. And how do you just feel broadly about just sort of the economic backdrop, what are companies telling you about their spending levels, et cetera?

Yes. I think that from a customer perspective, I think that they expected the growth to continue. And I think that we saw people begin to pull back and then it kind of read on itself. So I think that as e-commerce slowed, suddenly parcel delivery slowed, suddenly the orders on manufacturing, and I think we saw that happen through kind of Q2 and Q3 as businesses really saw this slowing down. I think that the optimism we saw this year were on the backs of really a lower year in '23 or '24. So I think we've been more conservative than our partners have been. I think that was -- is prudent. I think everyone wants to have optimism for the year. But ultimately, you got to say, hey, we come back to the level of truth is really what sales out look like. Our distributors today are asking us for more stock, because they have more confidence in the end market. They want to make sure they have the inventory when the market comes back. We're looking at the sales out demand, meaning what's the true end demand of the end customer, and we're saying, let's go track and work with you closely on inventory to make sure you have the right amount of inventory to meet the very end demand and not get overstocked again. So I think from our perspective, we've been cautious about inventory levels, continue a tight focus on what are the indicators that look like across -- retail is our biggest segment. What are the different segments of retail? What does that look like? Are they seeing real growth in their business or is it really inflationary growth? What are metrics like IT device spend and what direction are they going in? Because that's highly correlated to our business overall. So we're watching those trends very closely. And that's why we feel good about our guide for the year, is that we think we've been a bit more conservative than our partners have felt. I think our customers have been in kind of the same camp as us.

And when you -- and you talk about the channel and the risk of not being aligned with proper end market forecasts. What kind of metrics do you have in terms of either pipeline of business that they're working on or backlog committed orders or deal size deployment? Like what are the metrics that you're able to observe that can help create incremental confidence beyond just the sellout metrics?

It's rare in our business that an order is ever canceled. So I think you got to start there. So it's definitely not kind of cancellation or pulling back of an order that's placed. What we see more is the confidence we see of things getting better as we are seeing clearly more deal opportunity quotes happening, more working with our customers to price out different scenarios or different projects that they're doing, much of which have existed in 2023, but they haven't moved ahead with, right? It's kind of this pent-up demand that they're working with us on. So that's a positive sign. We're still looking at the run rate business that goes through the channel that we don't touch as much, but ultimately happens through our partner community, and we're monitoring that kind of very closely. So all those things are things that we look at to give us signs that ultimately our customers are buying in. We also spent a lot of time talking to them, right, ultimately, understanding what's happening from a T&L perspective, have they used the capacity they built up, what's happening with parcel delivery today? Is it quickening or slowing? Some customers are doing well. Airlines, for instance, are continuing to buy, right? We're still seeing technology pilots for things like RFID inside transportation logistics, where they see, as the market comes back, they want to be more effective and more efficient within their business. So they're still buying a lot of product from us. They're still doing a lot of pilot activity in certain areas. They're still pricing out and using our teams to scope out new technology deployments for them. We just want to see more of those turn into real orders for us. That's the real gauge. And if we look back to Q1, and we talked about this on our earnings call, our top 10 largest orders across the world were all retail. It's 100% retail for our largest orders. And they weren't even the largest size orders we typically receive, I'd call them medium-sized orders, right? $5 million to $10 million projects as opposed to $30 million to $40 million to $50 million projects overall, but all retail centric. I want to see more of that come through in retail. I want to see more quote activity. But I really want to see the real orders from T&L and manufacturing and health care of size and scale. Are they out there? Some are, but not to the -- not when your top 10 orders are all retail, you kind of say, okay, I expected this to happen, I expect it to be around mobile computing. So it's playing out the way we expected. We just want to see more of it.

Right. You've also talked about continued weakness in China. But what is happening there? Is it macro? Is there any incremental competitive or geopolitical overlay? What do you think is underpinning the China weakness?

Yes. I mean China today represents about 3% of our business, right? But I think us like most other companies are saying, hey, it's an important market to continue to do business in, but it continues to drive pricing downwards in that market, kind of a race to the bottom on price. And I think that everyone is trying to figure out, post-COVID, I think multinational companies in China are still buying Western product, because they see the return on investment being there. I think Chinese companies within China have reverted to more Chinese suppliers of technology and kind of are okay with that, but at a much lower price point. So we've continued to tier our portfolio from good, better, best to kind of value tier that ultimately we sell in China in places like India and South America. Now we've done ultra value tier for the China market. I think the way to really get after that market is to really move away from some of our traditional JDM partners and our traditional contract manufacturers, and literally for the China market use, China JDM specific partners where you can drive the lowest cost for a device using Chinese components, and moving outside of some of the overheads that multinationals have, and attack that market at the price points that the Chinese competitors are, but build that product just for China.

And do you have the same challenges in other emerging markets, whether it be India or other emerging markets? Or is it really unique just given the sort of the nature of competition in the electronics industry?

Yes. I think it's, as you said, we don't see -- we see our value tier product being used across the portfolio in multiple applications across geographies. More price sensitive in a place like India or Latin America, but I think that the tiering of the portfolio helps us protect the ASPs of the higher end of the portfolio. So we didn't have value tiered product, we'd find ourselves taking our mid-tier product and lowering it to a price to compete in those markets and taking lower gross margin. I think in this case, you build a product for a value tier, you want to -- you're price sensitive, well, you get a less robust device, you get less OS upgrades, you don't quite get the longevity or security upgrades or guarantees around that device. So you don't get the same device. You get a smaller screen, you get less memory, all those things, that protect the ASPs of our higher products. So I think there's value to our products in the rest of the world. I think China is at this ultra value tier.

But is there -- I guess the question is, if it's not necessarily leverageable or unique to other countries, like is China even worth it at 3% of revenues? You probably wrestle with that a little bit internally, if you really are kind of developing a separate supply base there and, in some cases, go-to-market base, and you're really only coming in at the super value level, does part of you think, do I need this?

Yes, I think that we're no different than most others. I think that there's still a multinational market there. So the Foxconn's and Jabil's and the contract manufacturers that are on a global scale still buy Western products into their environment and they see that value. So there's clearly a market there. I think second is, can you learn something from doing those low -- building those lower-cost devices? You can't take those devices and go sell them into a Western market, because they don't have the quality that you'd really need somewhere else, but there are things ultimately you can learn, I don't know. This housing and this plastics and what we're using in this, I actually couldn't use it for $0.50 or $1 less into my broader designs without taking a risk. So I think there's more to be learned by the experience there. I think that the other thing is you want to be careful that those suppliers don't get a foothold in China and get big enough and then move outside of China, right, and go compete with you somewhere else. So I think it's a big enough market that's worth competing in. At some point, you say that price point is just not worth it. But I think for the moment, I think we're in the same position most are, is to go figure it out. But today, it's 3% of our business, I think that there's an opportunity there, but there's lots of other opportunities. Japan is a good example. Higher margin, other places in the world I've got 50% market share, in the Japanese market I have 6%. So we're working hard to win more opportunities there. We won the largest postal carrier there. We won the largest retailer in Japan really by working with larger system integrators in Japan, like NTT DOCOMO, or working with Sharp into retail where we've used smaller channel partners, and not being a Japanese company and the amount of large companies within the Japanese market, leveraging system integrators is a better way to market for us. So we're growing our team in Japan to grow the Japanese market, which is higher margins, fits what we have, high-quality hardware and software, that's what Japanese customers come to expect at the highest level, quite honestly. And it's a good market for us. But we just haven't really focused on it. Second largest market in Asia with real ASPs.

Right. Makes sense. So that kind of leads us maybe in this discussion of your longer-term revenue growth target of 5% to 7%. If I go back to the Symbol acquisition in '15, I look at your CAGR, it's actually been closer to 3%, which is below that 5% to 7%. And so I guess the obvious questions coming out of that observation are, are you at sort of this cyclical low and sort of your baseline business actually should be higher and you'll grow into that recovery? Or are you doing things differently now that you think will lead to a higher growth rate over the next 8 or 9 years? And it has been endpoint to endpoint over the last 8 or 9 years.

Yes. Sure. Yes, I think that if you look kind of pre-COVID, we had guided to 4% to 5% growth across the business, so think about this the '15, '16 to '19, '20 range, and the business delivered 5% to 7%, right? And that's where that number comes from. And it adds up to a couple of ways, I'll take you through. I think that when you marry in the extreme upward movement and downward movement associated with COVID, you come back to this 3%. And I think that we're likely -- what we see is getting back on this trajectory of 5% to 7% moving forward from here. And there's no reason why we shouldn't do that and continue to improve EBITDA margins to back to pre-COVID levels and then continue to grow. We look at the portfolio across our core products, which is the biggest piece of our business. So rugged mobile devices, we're the global leader. Inside industrial printing, we are the global leader. Inside industrial scanning or handheld scanning, we're the global leader. RFID readers, we are the global leader. So all of those, we think across the portfolio in our core as growing it 4% to 5%. That means that the market growth, plus we continue to take share around the world, and the example of Japan is a good example of differing shares around the world that creates opportunities to grow at 4% to 5%. Then we think of places like RFID or our tablet business where either I have less share or they're growing faster than our core. So we think of those as adjacencies, our supplies business to go along with our printers. And we think of that as growing high single digits. And then there's expansion areas, the new areas we invested in. So robotic automation, machine vision, around retail software that marries up with our devices. And we think those as growing double digits. So we marry 4% to 5% in the core and we see the core still having a tremendous opportunity to grow. Plus these adjacencies and these new expansion areas, that adds up to this 5% to 7% growth rate. And while COVID's caused the wrinkle in that and it's 3% through that time frame, I think that we'll see us get back to this 5% to 7% growth rate. There's no reason why we shouldn't.

Right. But is there -- like is there a catch-up in the sense that, well, if really you had been 5% to 7% the whole time, and you've really done 3%, then maybe your 7% to 9% over the next 5 or 7 years.

We'll see. So I don't think we're there yet. I mean I think that ultimately we'd like to see the markets continue on a pace where we deliver increased revenue kind of quarter-on-quarter, and the same thing from a profitability perspective. At some point, there's a refresh cycle that comes as we go over the next couple of years. There's more devices in the market. Clearly, the amount of product bought in 2021 and '22 is not sitting on someone's shelves, it's being used. They just don't need more of it at the moment. That capacity is being used, which means that like in the mobile computing space, there's a significant more number of devices that will be upgraded sometime in the future. So will there be a bit of catch up? We'll see. But that remains to be seen.

And when you think about your mobile compute versus your scanning and printing core businesses, do you see them both as sort of 4% to 5% grower? Or do you see a little faster on the handheld side? And how do you parse that out?

Yes. I mean we think that each one of those has an opportunity to grow at 4% to 5%. It's the -- that's kind of the market growth rate. Typically, we see kind of a base market growth rate of 3%, you see new applications about 1 percentage point above that, and then taking some share around the world. So 4% to 5% is what we've seen over time across each one of those segments. So it hasn't differed much. They're pretty closely related in the applications that they serve, the vertical markets they serve, and they're about the same.

And is there any -- I mean, I'm sure you think and analyze this all the time, but how do you think about the -- just the average replacement cycle and whether that structurally elongates over time, right? Because I'm a computer hardware analyst and PC replacement cycles have elongated. Consumer smartphones have seen elongated replacement cycles. Is there a risk? Or why is there not a risk that you see the same thing happens, particularly if you're innovating and adding more value to your products and making them even more rugged and more condition-sensitive, is there a risk to that? And how do you measure and analyze that?

Yes. So we look at it all the time. The mobile computing refresh cycle is typically 4 to 5 years. You see that about the same in inside scanning or mobile printing, and you see it elongated a bit in industrial printing just because they're sitting on a tabletop or an industrial environment and they're pretty robust. So you see a bit longer there. We've seen that trend continue over time. I think these devices are used in a pretty tough environments within our customer environment. So devices get lost, beat up, stolen in the environment. So we're always seeing continued refresh within our customer base with the same model because they don't want to change kind of midstream. So refresh isn't just a refresh, it ultimately comes with continued add-on devices every year. What you also see along with that is new applications being used. So a refresh of 40,000 units 4 or 5 years ago could be 60,000 units the next time we refresh. But that time frame hasn't really elongated for a couple of reasons. One is that chipsets, speed, memory, screen size, just use of those devices, things like WiFi 6 and 5G, upgrades to OS and security, which is really, really important to our customers, ultimately, can I get security patches, especially endpoint security these days, becomes ultimately important. So we've seen just the number of applications being used, the number of use cases, the fact that I want to make sure the OS is not out of date, it's secure. There's more focus on those devices than there've ever been in the past. And we see new catalysts for upgrades as well on things like AI, right? So I think we could talk more about that. But the idea of leveraging large language models on the device without connectivity to the cloud is also going to drive a refresh cycle within these devices. But I think it hasn't really changed over time. And 4 to 5 years is a pretty long time to begin with.

And would most of your customers say these are -- I guess, if I'm a CIO and I'm saying, look, we think the world is changing, we really need to invest in AI broadly, and that's going to take up more of our budget, is there a risk that Zebra products are deemed less mission-critical than those initiatives? Have you heard that at all?

Yes. No, I don't think we see real trade-offs to workers at the edge getting work done and that competing spend with infrastructure or AI or other areas. Because ultimately, we're at the point of productivity where ultimately a customer has to digitize and automate that environment and truly get work done. So we're in the hands of a retail associate, we're being used to pick an e-commerce order. We're ultimately on the production line and inspecting production with machine vision. We're moving goods within a warehouse or a production facility using robotics. All those things are necessary for our customers to run their business. And we haven't seen that competition. And in fact, we see the opportunity with AI being the opposite. This idea that the mobile device in the hands of an associate, think of a retail associate or someone on a production line having a digital assistant on that mobile device. So think of running a large language model, not in the cloud, but actually on the device itself, which means I don't have to go back to the cloud every time I need to go ultimately interface the model. I can interface it in a normal language or text way. I can populate the model with the standard operating procedures of the individual customers. So what do I do when I have a return without a receipt? What happens when this production metric goes out of sync? What do I have to do to perform maintenance on this machine? What do I have to do when I'm out of strawberries and I'm the new produce manager at the Walmart store, right? So all those examples are how can I create a digital assistant on the device. And many of the locations like our retail stores don't have a lot of connectivity back to the cloud. And it saves you a lot of money if I don't have to go back to the cloud every time if I can use a large language model on device. Now I got to be able to manage that model. I have to manage the data associated with that model. I need to be able to continue to input that model. So how great would it be if I took my most experienced produce worker or produce manager and they put information around what the new person would do. So can I make my newest worker as good as my best or most experienced worker within the environment? So I think this digital assistant is a way to leverage AI and drive more devices in the hands of more associates versus, quite honestly, less. So in a production environment today, there's a lot of fixed screen environments. Now we see the move to more tablets, more mobility, around communication collaboration, around management being able to talk to employees, employees being able to talk to each other, gamification. But also now this digital assistant. The same thing in retail. If you think about 100% turnover in retail associates, how do I keep those associates engaged? Well, our retail customers would tell us, if you and I are 2 aisles apart working, we may as well be a forest apart. And we don't want us using our mobile devices -- our personal mobile devices, because they want to focus on working. But if there's camaraderie between you and me, we can text each other or we can use push-to-talk or we can at least have some communication across each other. There's some gamification within the environment that ultimately I feel more connected than I would have just working in an aisle by myself. So things like communication collaboration, task management, how does the -- the #1 set of things said over Walkie Talkie in a retail store is, Toni, where are you? Not because they don't think you're working hard, it's just the manager wants to have a conversation with you and doesn't want to have it over a Walkie Talkie. So how do I send tasks to you? How do I ultimately communicate and collaborate from a manager perspective? The only way to talk to a shift in a big box retailer is beginning of shift to get everybody together in this little tiny break room and have a conversation, as opposed to how great is it if I can go communicate to everybody 5 minutes after their shift starts through a collaboration and communication tool. But everybody has to have a device to go do that. And if I add AI on to that, then there's no reason to use the device. So we think AI is a positive for us versus a competitive threat to somebody spending money somewhere else.