Zebra Technologies Corporation (ZBRA) Earnings Call Transcript & Summary

All right. Good morning, everyone. So continuing on today, day 2 of the conference. My name is Brad Hewitt on the multi-industry and industrial tech team here at Wolfe and very pleased to have Zebra Technologies with us. We have the CFO, Nathan Winters. Nathan, thanks for coming.

Yes, it's great to be here this morning.

Great. Well, maybe just kind of getting into it. I guess curious, just sort of state of the union, can you talk about sort of your assumptions on 2025, revenue growth guidance of plus 3% to 7%. And kind of what are the potential market conditions that could cause you to deviate to the high or low end of the range.

If you look at our guide for the year of 3% to 7%, we held that guide from the beginning of the year. But I'd say the demand trends we've seen year-to-date have remained strong. We had a really solid Q1 coming at the high end of our guidance range, guided Q2 for mid-single-digit growth. And we really haven't seen any of our customers delay or defer projects due to tariff uncertainty. So I think we're pleased with the momentum of the business we've seen year-to-date. Obviously, with that said, tariffs are top of mind and customers are still digesting the impact to their overall business. So we're obviously monitoring the macro economy, staying close to those customers and seeing how those plans kind of play out through the balance of the summer. And within our guide, we have, I'd say, pretty modest growth in the back half of the year. And given the market uncertainty, and I think that's really what we're keeping our eye on is how the pipeline of projects really kind of evolve here over the summer as we get into the back half of the year.

I guess just sticking along that topic of the customer uncertainty that you mentioned, curious if you could talk about kind of what level of cushion or conservatism you've incorporated into the guide as it relates to the customer uncertainty?

Yes. Look, I think going back to the uncertainty, it really does all evolve around the impact of whether it's the direct impact of tariffs or the indirect impact on your volume. And I think it's -- Bill mentioned this in our last earnings call, conversations he's had with CIOs of some of the large U.S. retailers and similar conversations I have with some of my CFO peers, which is you spend the first half of the conversation talking about tariffs, the state of what's happening, the impact to your business, how you're mitigating and then you jump into the business at hand. So again, it's top of mind, and that's creating the uncertainty. But if you look at what we've delivered year-to-date in terms of the outperformance in Q1, FX is in a much better position than it was at the start of the year. We have the acquisition of Photoneo that's included. So in a normal environment, we would have raised our guidance between February and May, all things equal. But we thought it was appropriate at that time to kind of say, bank -- take some of those upsides to the bank and derisk the back half of the year. So that's kind of -- I think, again, a lot of positive momentum relative to where we were in February, but just still being thoughtful around the uncertainty in the back half of the year.

Okay. And then maybe can you talk about how demand is trending by vertical and how you think about -- I know manufacturing has been kind of one of the slower verticals to rebound. Just how you see the demand picture playing out by vertical and how you see the rebound in manufacturing.

Yes. So if you look across each one of our vertical markets, we saw really accelerated growth and recovery across each one of them through the back half of last year and into the first quarter. And I think we kind of pick on manufacturing because all the other verticals were growing double digit and manufacturing grew high single digits. So it's not as if I think it's lagging relative to the other growth in the other vertical markets. But I think what's consistent across each one of the vertical markets, you look at our business is every one of our customers are looking at how they digitize and automate workflows, how they empower their frontline associates to have increased visibility to whether it's inventory, assets, parcels, how they drive productivity for their frontline workers, drive efficiency in their operations, improve the experience to their customer and our solutions do that for each one of our customers across those vertical markets. And again, while manufacturing is lagging, it's still a great opportunity for us. It's relatively lower market share in our core business in manufacturing versus the other verticals. Now with our expansion into machine vision, it gives us kind of a new opportunity to have a different conversation with those customers. And RFID is another one where as manufacturers look at how they leverage RFID, again, it's another opportunity to have a different conversation with those manufacturing customers. So again, we're excited about that opportunity. It's, again, I think, lagging relative, again, versus the growth in the other vertical markets.

I guess curious if you could give us a sense of where the large order activity stands by vertical relative to the 2021 and 2022 peak levels.

I'd say large orders -- as we think about large orders in our business, think of projects that are $10-plus million kind of deployments across an enterprise and well below where they were in '21 and '22, but -- and I'd say even still below where they were even pre-pandemic. And so really, what we saw was an acceleration of deployments kind of in that peak '21 and '22, which grew the installed base tremendously. And now customers are still absorbing those, and that really represents the next opportunity as those refreshes come available here in the next several years is a real opportunity for us as we move out in the next couple of years.

Okay. Great. And then maybe switching over to the tariff side, which is obviously a topical part of the equation lately. Maybe just start by walking us through your latest thinking on the tariff math, both in terms of the gross headwind and the net headwind for the year.

Yes. So what we said in our guidance, it was the one change we made to our guide was to reflect the update in direct cost of tariffs to the business. And so we said what was embedded in the guide was, let's say, what was in effect as of beginning of May. And we didn't assume any changes through the balance of the year. So that was 145% on exports out of China, which is obviously now down to 30%, 10% across most other countries. I think the one important to note is our mobile computing platform is currently exempt under the electronics exemption with the exception of the 20% on fentanyl tariffs. And then we have exemptions from USMCA out of Mexico. So it's again, a pretty complex equation. But if you look at the balance of that, it's about a $70 million impact for the year at that time. That includes about $50 million of benefit from pricing increases that went into effect at the beginning of the second quarter. And if you annualize that, obviously, there's some timing impact, that would equate to about $80 million to $90 million of annualized impact. Again, all that's subject to change based on changes in tariff rates as well as we have a series of ongoing actions to further mitigate that exposure as we go into the back half of the year and into 2026.

And the mobile computing exemptions on the tariff side, maybe just talk about how you're thinking about that, the duration of the exemptions.

Yes. I'd say how we're thinking about it is we raised prices for most of our mobile computing platform by at least 10% kind of with the assumption that no matter where the dust settles, you'll probably have a minimum 10% tariff rate when the dust settles. So I think that's kind of our ongoing assumption is that at some point, things will level out at, at least 10% across the board. And that's why we went ahead and proactively raised the prices across that portfolio. And I'd say we'll adjust those plans though once the -- that exemption turns into a full-term policy, but hard to predict what that could be.

I guess curious if you could walk through the gap that you're assuming in terms of gross price that you're putting into the market versus net price. So you mentioned the 10% price increase on all the U.S. products. I mean, I think the math would suggest that's about $200 million plus of annualized price versus the $80 million annualized that you cited in the slides.

Yes. So if you look -- again, all the prices went into effect in the U.S. at the end of April, I said it was 10% across most of our product portfolio, excluding supplies as well as our production out of Mexico given the USMCA exemption. But what that represents is about 60% of our North America business because that excludes service and software and other parts of the portfolio. And then we never model in 100% realization, primarily due to customer contracts, competitive bids, less to do with kind of price volume trade-off, but it's really around where we have contractual commitments. So that's what ultimately gets you down to the kind of $80 million on an annualized basis versus kind of where you would expect it to be or where the math might say it would be on a gross basis.

Okay. And how do you guys think about demand elasticity in response to these price increases?

If you went back, we didn't really see a huge change in demand if we went back to the price increases we put in place back, whether it was 2019 or '21 and 2022. But I'd say not naive to the fact it could have some impact on our run rate business. But it's something we watch every day, every week, and we haven't seen an impact to date. Obviously, we're a few weeks into the price increase. But we'll monitor and adjust, right? And if we start to see some declines in volume, right, or we're losing to competition, we'll adjust and remain agile on those pricings for better or worse. So I think that's still too early to see how that's going to shake out.

Okay. Great. And then I guess curious if you could talk about, obviously, early to provide 2026 thoughts on the tariff math. But I mean, is the expectation that you would get to net dollar neutral on the price/cost side of the tariff equation?

I'd say way too early to predict what the impact would be in '26 or the timing of when we'd fully mitigate. Obviously, we need some clarity around what the long-term policies will be and the tariff rates, but that is the ultimate objective, right? I think once there's clarity around the long-term tariff rates and what the global landscape looks like, the plan will be what actions do we need to do to mitigate that in full. But I'd say too early to predict what that would be here within 2026. And hopefully, we'll get that clarity here over the next couple of months and put a plan in place and communicate that here as we go into the second half of the year.

Okay. And then, of course, we've gotten the headline about the 90-day pause on the China tariffs. How do you think about the stickiness of price following that tariff rollback. And then if we were to get any other rollbacks in tariffs, is the price going to stick for you guys?

I think first, the rollback is -- maybe the de-escalation globally is positive and going from 145% to 30% is a big impact on our direct cost. Too early to kind of predict or tell you what that impact will be. I'd like to see what all the other rates shake out. But the pricing impact had little to do with the 145%. Obviously, we didn't raise price 150% to fully mitigate that. So I'd say that change in the rollback has no impact on our decisions around pricing. It's really more of where those final rates land and where does mobile computing land after the electronics exemption. And look, I think the pricing impact at 10% is pretty material. And so historically, it's been pretty sticky and held. But I think just given the size of the increase, we'll adjust those as necessary higher or lower depending on where the final tariff rates shake out.

Okay. And then maybe from a sourcing perspective. So I think China now accounts for about 30% of your U.S. imports. You brought that down a lot over the last couple of years. Maybe talk about potential scope to reduce that China sourcing even further.

Yes. The goal is to reduce it further. And I think we have a series of actions we're ready to execute. It's just where do you execute to, right? Do you move that to which country. And if you don't know what the tariff rate is on the other side, it's hard to make that. So we had a series of actions that are being executed now to get us down to that 30% here in the second quarter. And we got, again, a series of actions ready to execute. But there's still going to be some portion of that, that remains. The components, some of the service parts, they're just so deeply embedded in China. We're not going to move those or the volumes of certain products are too low to make kind of the justification to move. So there will still always be a portion of coming out of China, but getting from 30% down to something less, we'll start to execute here in the back half of the year once we know where the best landed cost would be for the business.

And could you get China down to 10% of imports?

Tough to say. Again, not only the cost of tariff, but you also have to look at what's the overall resiliency, what's the overall efficiency you gain or lose in terms of if you have a production -- a product with lower volumes, moving that out and disaggregating North America volume for the rest of the world, it may not make economic sense irregardless of the tariff cost. So that's what the team got modeled out under dozens of scenarios. And so I think we'll be able to move pretty quick once some of the clarity comes out of the administration.

And then how do you think about balancing any incremental shifts away from China, whether that be to Southeast Asia? Or could you potentially move to North America, some of that production?

I think our goal is to have, I'd say, balanced production around the world. We haven't set out a target that says, here's what each kind of country or region needs to be from a percentage basis. Domestic production is pretty challenged just given the predominance of our components out of Southeast Asia, right? And so until you see some of those, whether that's memory, semiconductor move out of Southeast Asia, it's makes the domestic option pretty challenging. But again, there's a whole host of options, and we're working with -- I think the benefit we have is because we don't own our manufacturing, we leverage third parties, JDMs that have global footprints that allow us to kind of flex across their manufacturing sites. So the benefit I have is I'm not thinking about me building a plant on my own in a country and picking the wrong one. It's leveraging the footprint across our partner network and being able to flex across those across a variety of regions that I think gives us a lot of flexibility that you wouldn't have if we were manufacturing on our own.

Okay. I guess we'll pause there and see if there's any questions from the audience. We do have a mic that we can bring around if we have any questions. All right. I guess I'll keep going then. So we think about your long-term organic growth target, 5% to 7%, the midpoint of your 2025 guidance would imply about a 2.5% CAGR versus 2019. So how do you think about the setup? I mean, as we get into 2026, 2027, do you think we could see a snapback in growth towards those higher levels?

We've committed to 5% to 7% over a cycle. Obviously, this past cycle has been pretty dynamic if you go back to 2019 from COVID to the e-commerce boom and the exceptional growth we saw in '21 and 2022 to severe supply disruption, which kind of disoriented revenue for a period of time, followed by everyone absorbing that capacity that was built out and now the recovery. So it's been quite a dynamic cycle over the last 5 to 6 years. I think the one thing that if you look back and kind of normalize that demand, I think you get back to that similar curve. And the large deal, I'd say really that refresh cycle is probably the biggest gap we have if you compare back to 2019. And so that is the one thing we're obviously spending a lot of time with on our customers who have those large installed bases that were refreshed in '21 and '22, which is what are those plans, what's the value we can add with the changes in the portfolio over the last 5 years that can add increased benefits to their operations when they do refresh. And so now it's just a matter of working through their capital -- their budget cycles and what their plans are. So I think it is the opportunity we have ahead of us here for the next couple of years. It's the timing of when that accelerates and kicks in. I'd say the one thing that would be different is I don't expect it to be this bubble that comes and goes. I think what you'll see is if you had 5 customers that all refreshed and there were more in '21, some may be on a shorter cycle. So if you think about a retail environment, they're going to be in the shorter end of a refresh because they may be using 70, 80 applications on the device. It's being used on 2 shifts across multiple users. So the wear and tear on the device, the need for more computing power, the need for some of the new AI agents is going to drive maybe a higher value on that refresh on the shorter term, where if you go to the other end of the spectrum and the device is used on -- only has a handful of applications. It's a single device owned by, let's say, a parcel delivery driver who kind of -- that's their -- they care for it. You get a little bit of a different wear and tear on the device that might be on the longer end of the spectrum. So I think what I'd expect is you wouldn't see this kind of bubble again, but more of get back to more of a steady cadence of large refreshes. And that's what we had pre-pandemic. And I think that's what we'll get back to here in the next couple of years to drive more of a sustainable growth versus kind of these big peaks and valleys like we saw in '21 and '22.

So as we think about kind of the weighted average age of the installed base, is there any sense you can give us in terms of where that stands today versus kind of normal history?

Yes. I'd say we're right on par. If you look -- obviously, the devices that were deployed in '21 and '22 are getting to that kind of 5-year, 4- to 6-year sweet spot depending on when the installations were completed. So we're right there. And if you look, our mobile computing installed base is 35% higher than it was in 2019, right? So that is really the opportunity. And the other gives us confidence in that kind of longer-term growth rate is if you kind of take that on a CAGR basis, that gets you back to that 5% to 6% with obviously some lumpiness there in '21 and '22. So again, that's what we're working with each one of those customers around how do we obviously incentivize them with the technology benefits in the portfolio to move forward with those refreshes here as we get into next year and into 2027.

Okay. Maybe switching to the margin side of things. So you're guiding to about 50 basis points of EBITDA margin contraction this year. I know the tariffs weigh on that by about 100 basis points. So on a core ex tariff basis, you're still doing 30%-plus incrementals this year. But just curious how you think about kind of the moving pieces on the margin side.

One of the pieces that kind of -- unfortunately was kind of passed over -- Q1 was our record gross margins, the best gross margin we've had in the company back since the Motorola acquisition, so over a decade. I think you finally got a quarter where you didn't have headwinds from supply chain disruptions or tariffs. And of course, you have a record gross margin and then you roll right into incremental tariff costs. So I think that, again, just demonstrates, I think, the opportunity we have as a business and when we execute and deliver on our plan. So there's a whole host of opportunities we have to expand profitability, not only with the growth of some of our new expansion businesses, whether that's machine vision, software that have, I'd say, an inherently higher margin profile. Obviously, we're continuously working on our own productivity initiatives and driving operating efficiency. But the one benefit we have is because of our capital-light business and our fixed cost structure, volume leverage is really the name of the game. So any type of growth on top of things from our really basic ERP system to our supply -- our service capabilities to our distribution network, all that comes at kind of that incremental profitability. So that's really the opportunity we have is as we grow, we'll continue to see kind of EBITDA expansion over the next couple of years.

Okay. It looks like we have a question there in the audience in the back.

So the question on just machine vision software and the mix of the business. I think on machine vision, we're really excited about that business being a driver of long-term growth and profitability, and you see that with the acquisition of Photoneo. If you look at that business today between the Matrox acquisition, we did a little acquisition called Adaptive Vision, which was really around machine vision software and the image library. And then Photoneo was a leader in the 3D machine vision business. And then our own organic investments in fixed industrial scanning. So now we really feel like we have a complete solution from very high-end technical machine vision that you need for semiconductor, which is what Matrox brought. We have an elaborate portfolio of software across all those different assets. I'd say, down to maybe the lower end of machine vision, which is fixed industrial scanning. So we can really go into any customer's environment from very low end to high-end solutions. And that's where I think our customer relationships and brand get us in the door to win those new opportunities. So that's what we look at, which is a number of proof of concepts, logos and really expanding from what was Matrox' core business around semiconductor and electronics. And then again, part of that recurring revenue business is the software underlying it, right? That is kind of the differentiator in machine vision. You need the camera and the computer to process the image, but it's the software behind it that tells you what to do with the image. That's really the secret sauce within that business. And then software, it's been a long journey to bring that portfolio together of kind of disparate applications under -- moving to a common cloud portfolio. We launched earlier this year. Workcloud Sync, which brings together our task and communication together under a singular platform. We're excited about how that integrates with our mobile computing business. And you saw the value of having a software business over the last couple of years as kind of the rest of the business was down, software kind of -- and that's obviously the value of that recurring revenue model that comes from it. But I think if I balance between the 2, I think a little bit more on the machine vision opportunity. And then software just, again, I think, gives us a nice recurring revenue business that's very complementary to our mobile computing platform and being able to offer that comprehensive solution to our customers.

Maybe switching over to capital allocation. Your balance sheet is in a really good spot. How have your -- if at all, how have your capital allocation priorities changed? And how do you think about what's the right mix of capital allocation going forward?

I think we've obviously spent a lot of time over the last couple of years getting back to -- '23 was a tough year from a free cash flow perspective, but we generated over $1 billion of free cash flow over the last 4 quarters that allows, again, put our balance sheet and capital structure, I think, in a great place to be more active in returning capital. So Photoneo is a great example of getting back. It's been a couple of years since we've had an M&A, although it'll be a smaller acquisition. We have returned $200 million over the last 4 months in share repurchases, so $125 million in Q1, $75 million in April to take advantage of the stock volatility with the strong cash position. So I'd say the priority right between those 2, I'd say, is pretty balanced as we go through the balance of the year. So we're actively looking at opportunities from an M&A perspective, but also being active in the market and taking advantage of where the stock is and the volatility that we've seen over the last couple of months. So I think it's being balanced between the 2. But we're not impatient. We're comfortable with the debt levels. We're comfortable with -- we're about 1.2x debt leverage. So we don't feel like we're in a position where we need to rush to do anything on either side.

In terms of M&A, can you just remind us kind of what the main criteria are that you look for in potential deals?

The main criteria is that any one of you would look at an acquisition and say that makes sense to be part of Zebra. It sounds simple, but we're not a portfolio company that's just looking to add any asset that says print or scan or because it's a part of a certain vertical market, right, that we really spend a lot of time of does it make sense to be part of Zebra. Is there synergies between our core business, customers that we can accelerate growth? Is it a fit culturally. So all those things is really what kind of dwindles down a lot of opportunities out of the funnel. And then obviously, can you drive an attractive return over the long term for our shareholders. But that #1 criteria is, does it make sense? Is it a fit within the portfolio and that we can integrate and look and feel like the rest of the company.

Okay. And I guess you mentioned Photoneo earlier, one of your recent acquisitions. Can you walk us through like what's been the historical organic growth rate of that business, margin profile and how you think about kind of the year 5 ROIC math on that acquisition.

Obviously, a smaller -- so it had double-digit growth, obviously on a smaller base, it's adding 30 bps of revenue, so it's -- call it, less than $20 million of revenue. So it's a relatively small asset. And like anything, we expect to have returns greater than our WACC over the next couple of years. I think the real opportunity, though, was it really put us in a -- it fits just very perfectly with the portfolio in terms of within 3D machine vision. We've been partnering with them for the last several years. So they were -- in fact, we were selling their products on an OEM relationship. So where we had opportunities for 3D, we would leverage their 3D capabilities, and it works perfectly with the Matrox frame grabber, so the computer. So once you take the image and take the 3D image of whatever it is you're looking at, you need the processing in the back end, which is what Matrox provides. And so we knew the solutions work together because we've demonstrated that out in the market. And so it made sense to be part of the portfolio where we can really then kind of harden that solution together and take advantage of those opportunities in the market. And what it does is it gives us also, I'd say, a unique value proposition relative to some of the other traditional providers in machine vision. So where you're trying to go and displace an incumbent, you're really looking for where are those net new opportunities and 3D is one of those where you can get a foothold into an account. So that's really what the long-term value proposition was for Photoneo.

Maybe in terms of free cash flow generation, how do you think about kind of the structural free cash flow conversion profile of the business? I mean, should it be greater than 100%?

It should be. And that's one of our primary long-term metrics is driving greater than 100% free cash flow conversion. And nothing has fundamentally changed about our business over the last several years that should prevent us from doing it. If you look at the buying cycle of buying a finished good from one of our JDM suppliers, being able to quickly turn that through our distribution network through to our distributor on the other end of it. And that's what allows you to generate that positive cash, right, of a lot of times, we're collecting before we pay. And that's kind of the beautiful thing about the business model. So nothing has fundamentally changed about that. That's the long-term objective for the management team. And that's what we're going to generate over the last 4 quarters, and I would expect us to continue to be able to do that as we kind of continue to work down some of our working capital balances, particularly in inventory.

I think we have maybe 30 seconds left. Just on channel inventory, kind of where does that stand today?

Yes. So inventory, we -- back with some of the supply chain challenges, like many, we had to make some long-term commitments in order to get supply, and then we quickly followed with the downturn in the market. So it put us in a tough spot within our own inventory balance, but we've made tremendous progress over the last couple of years. I'd say we're not quite where we want to be. We're probably another $50 million to $100 million of inventory that we'd like to work out. And I think we'll get there as we move into 2026. Some of the timing of that is just obviously, with -- any time you're changing production sites, trying to manage tariffs of pulling in inventory and getting ahead of changes in tariff rates. I think this year will be a little -- we'll have a little bit of flux up and down as we kind of work through those and make sure we have the right safety stock as we do any kind of production moves to protect the company. But I think there's still opportunity there to get back to kind of our long-term working capital levels on the inventory side.

Great. I think we'll draw the line there. Thanks, Nathan.

Thank you.