Zebra Technologies Corporation — 2024 Q1
Transcript
Each turn shows the speaker, their inferred role, the section, and that turn's net sentiment (×1000).
Good day, and welcome to the First Quarter 2024 Zebra Technologies Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded.
Good morning, and welcome to Zebra's first quarter earnings conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least 1 year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially, and we refer you to the factors discussed in our SEC filings.
Thank you, Mike. Good morning, and thank you for joining us. As expected, our first quarter performance was impacted by continued broad-based softness across our end markets and regions, which we began to experience in the second quarter of last year, resulting in a double-digit decline in sales and profitability. However, we are beginning to see a modest recovery in demand as we saw sequential improvement from the fourth quarter. We are particularly encouraged by the better-than-expected large order activity, which drove the upside for the quarter. That said, we are not yet seeing a broad-based recovery. And as a result, we continue to take an agile approach to navigating the current environment.
Thank you, Bill. Let's start with the P&L on Slide 6. In Q1, sales decreased 16.8% with declines across our regions, major product categories and customers of all sizes. Services as a Software were a bright spot in the quarter, with growth driven by increased units under support contract and retail software wins. Our Asset Intelligence & Tracking segment declined 25.3% primarily driven by printing.
Thank you, Nathan. As we look longer term, we continue to be well positioned to benefit from secular trends to digitize and automate workflows for our customers. We remain focused on elevating Zebra as a premier solutions provider through a comprehensive portfolio of innovative solutions and our go-to-market ecosystem. Zebra empowers workers to execute test more effectively by navigating constant change in real time through advanced capabilities, including intelligent automation, machine learning, prescriptive analytics and artificial intelligence.
[Operator Instructions]
[Operator Instructions] The first question comes from the line of Jamie Cook with Truist Securities.
Nice quarter. I guess first question, can you just call out how much freight helped the first quarter lower freight cost? And then what's implied in the guide relative to how you guided last quarter? And then I guess just my second question. The gross margins in the quarter struck me, in particular, the sorry, the EVM margins, which were up year-over-year. And so I'm just wondering if you could help us understand what drove the gross margin improvement on the sales decline there?
Yes. So, Jamie, I'll take that. So if you look for the -- particularly the freight in Q1, it was about 1 point year-on-year improvement just given the cycling through, now that we fully neutralize the premium supply chain costs between the operational actions and the price increases. So year-on-year, that was about 1 point of benefit in the quarter.
And then just a follow-up, sorry, the larger order activity that you talked about in the quarter, which obviously isn't in the guide, and I guess would reflect some conservatism in the guide? If that continues, I mean, what's preventing you from putting that in that -- in the guidance if that continues, how would we think about the sales guidance relative to your sales growth of 1% to 5% ex-FX?
Yes. I think as we stated, we've seen some improvement in demand, particularly in mobile computing and retail, which drove the beat in Q1 as well as what we're expecting to see come through for the remainder of the year, driving the raise for the full year from 1% to 3%.
The next question comes from Damian Karas with UBS.
I was wondering if you could maybe elaborate a little bit on the large order activity, which you spoke? Could you give us a sense, right, is this sort of 1 or 2 customers that are placing rather large orders or are you kind of seeing just your larger customer base in general, start to bring back a larger quantity of project activity? If you could just maybe elaborate and provide any detail like which end markets and regions you're seeing some of these larger orders as well?
Yes. I'd say overall in Q1 and into -- as we entered '24, we've really seen demand stabilize and we've seen modest improvement in large order activity overall. And it's been particularly in mobile computing, and it's been specific to retail as they've kind of wrapped up their year. So we're certainly encouraged by the better-than-expected sales results in Q1 as a result. And we'd expect modest improvement in demand as we continue to progress throughout the year.
That's really helpful. And then a follow-up question on your guidance, just maybe ask a little bit differently. I know you guys have spoken of, right, this really large funnel, but just kind of a lack of conversion to orders. Guidance sort of has you sequentially second half sales comparable to the first half. Could you just tell us like what you're assuming for that funnel conversion, kind of a probability of some of those projects hitting in the back half?
Yes, I'd say the -- as I mentioned earlier, really the second half, I would call it, grounded and based on what we see today, both in terms of the orders velocity, what we're seeing in terms of being sold out through the channel as well as the conversion rates that we've experienced now over the last 2 quarters.
The next question comes from Keith Housum with Northcoast Research.
In terms of Asia Pacific region, obviously, underperformed compared to the rest of the company. And I understand China is challenged right now, but perhaps can you just expand a little bit on what you're seeing here? And expectations for us and the pressures perhaps be a little bit longer lasting versus short-lasting? And just more color about the performance in that area, please?
Yes. I mean, Keith, it's Bill. I think that overall, the Q1 performance was continued to impact by soft demand across all of the regions. So I think we start there. I think that as we've said, the relative outperformance was really in mobile computing, and we saw some bright spots in services and software clearly in the quarter.
All right. And just as a follow-up, Nathan, in terms of adjusted EBITDA, a little bit decline in the guidance you've given for 2Q versus 1Q. Sequentially, how should we think about the moving parts and the reason for a little bit lower adjusted EBITDA margins in the second quarter?
Keith, as you mentioned, our Q2 guide slightly above 19%, so down from the 19.9% in Q1. That's entirely driven by the seasonality of our retail software business, which you probably recall, but is seasonally higher in Q1 at accretive margins, just given the timing of retailers when they've performed their cycle counts and physical inventories, which is where that platform really focuses.
The next question comes from Tommy Moll with Stephens.
You've given us some context on the omnichannel retail and e-commerce end markets, but I wanted to ask for any other detail you could provide. In particular, on the e-commerce side, there are some anecdotes regarding finally hitting the end of this absorption phase from some of the overbuilding in years past. Are you seeing any signs of that on your side?
Yes. I would say that overall, retail relatively outperformed, as we've talked about already. And we're seeing encouraging signs, right? We saw some modest year-end retail spending across Q4 and Q1. Some customers clearly have absorbed the capacity and it begin to buy again, as you've kind of referenced, Tommy.
That's helpful. As a follow-up, I wanted to ask about the channel inventory levels. It sounds like there really wasn't any noise from a destocking perspective in the first quarter. But I'm curious what's your view on how many days on hand in the channel currently?
Yes, Tom, I think ending the Q1, somewhat to exit in Q4 that the global channel inventories measure that on a days-on-hand basis is normalized to support the current demand. So I'd say within the range that we'd expect on a global basis, there's puts and takes if you go by region and product families. So I think a nice improvement from where we were just 6 to 9 months ago.
The next question comes from Brad Hewitt with Wells Fargo.
So you just talked about a return of some of the project deferrals from last year. I guess, how would you describe your pipeline and sort of overall visibility versus 6 months ago? It kind of feels like visibility across the space has been generally trending in a positive direction, but just any color on how your visibility looks relative to history would be helpful.
I'd say that overall, we'd expect orders -- customer orders that continued to resume overall. I think that as I just talked about with Tommy's question, we've seen customers absorbing the capacity that's previously been built out. That's been more, again, focused on retail and e-commerce as opposed to the other verticals so far. I would say that the macroeconomy, kind of the uncertainty around that abating will certainly help as well. We're viewed as a trusted partner of our customers, and we're staying close to them across each of the verticals as we would see this order momentum picking up across other verticals as we progress through the year.
You see it in the pipeline in terms of where the deals are at in the deal stage. So you qualify versus where we'd like to see them more in the validate secure. So earlier stages of the funnel, particularly in the second half, than where we'd like to see it at this point in the year or relative to what we've maybe seen in prior years.
Okay. That's helpful. I think you guys had some retail orders that you expected to convert to revenue at the end of Q4 that were pushed into Q1. Would you be able to quantify the magnitude of that deferral? And then when you talked about the uptick in the large order activity on the retail side, was that inclusive of some of that year-end spending? Or was that a separate bucket?
I would say that year-end spending across retailers that their years and differently, whether it's the truly year-end or into first quarter. So I think we typically see orders that bridge both on an annual basis. So I don't think there was much that move between Q4 and Q1 as much as just customers need product before they have their year-end from a retail perspective.
The next question comes from Jim Ricchiuti with Needham & Company.
Maybe I missed it. Did you comment about the activity you're seeing in the SMB market? Is that -- is the recovery you're seeing in ports to retail, also impacting that part of the business?
I would say that SMB would fall kind of in this mid-tier to run rate business. And I think we've seen, again, more recovery in large opportunities. I think we're seeing optimism clearly on the part of our partners and our distributors. That business will continue to progress and get better through the second half year.
Got it. How would you characterize the RFID business in the quarter, level of activity you're seeing and just the trends in that business, we're starting to see more activity, it sounds like on the T&L side with the big customer moving out of the distribution center into the package delivery side of the business? How would you characterize RFID for you?
Yes. I would say RFID, clearly, we see as an opportunity in across multiple verticals now, not just retail and retail apparel, where it was originally focused and we're clearly seeing opportunities across track and trace and supply chain. You mentioned parcel tracking with the transportation logistics, airports and airlines with baggage tracking inside manufacturing work in progress in tools and over. So a whole series of different applications we're seeing, quick-serve restaurants.
The next question is from Joe Giordano with TD Cowen.
Just -- I know people are hesitant to lay out big capital still, like you said a couple of times. But as you get into like next year, just considering the large-scale increase in your installed base that happened in the immediate aftermath of COVID. Like should we be thinking refresh cycle is kind of like in play for 2025?
I think overall that the EMC clearly, across mobile computing is really what you're talking about in kind of large refresh cycles. And as I've said a couple of times already, we're seeing that as the first signs of recovery. And really in retail to start, I think that the customers in have begun to absorb their capacity, certainly in e-commerce. We'd like to see that happen across T&L as those customers build out a lot of capacity as well during the pandemic.
Fair enough. And then maybe just shifting to the balance sheet quickly. With your key markets, at least we get the data magnitude of recovery, but it seems like deterioration has kind of stopped. It was good to see you pay back some debt here. Cash flow looks strong. So is there an appetite for buybacks to kind of increase your leverage on a recovery as you come out of this?
Yes. As you mentioned, we finished the quarter at a little over 2.5x leverage ratio, so slightly above the target range. That begins to move back within the range, particularly as we roll through Q3 of last year. Today, we feel like we have ample flexibility with the revolver. As you mentioned, we are prioritizing debt paydown just given the debt leverage ratios and the current interest rate environment, but we do plan to reassess buybacks as the year progresses, particularly in the second half.
The next question comes from Andrew Buscaglia with BNP Paribas.
So I just want to check on -- you commented on the guidance. You're seeing a sequential step down in margin seasonally. It seems like -- the comment on the Q3 looking more like looking similar to Q2, just to clarify, you're talking about run rate on sales? And then what about margins? Because it does seem like you're expecting some lift in Q4. I'm wondering what's behind that.
Yes. No, you're absolutely right. So the comment on Q3 similar to Q2 was on -- from a revenue perspective, we do expect an uptick in margin as we go through the year. Some of that just similar to what we talked about in the last call, which is phasing of some of the incremental cost actions that will be coming through late this quarter and early part of Q3 as well as our, say just normal project timing between things, like payroll taxes and just the typical funding cycle with -- as you get into Q3, Q4, you get into holidays, so it tends to be a little bit of a downtick in terms of just seasonal spend.
Okay. And then maybe along the lines of Joe's question, heading into your cash flow is improving, you raised it a bit. What about M&A now? I think the software story has been nice. It's helping you lately. So what's the environment like as you see it with deals?
Yes, I'll take that, Nate. I would say that organic growth continues to be our first priority overall. I think our M&A philosophy really hasn't changed much. We're clearly targeting assets that are clearly adjacent and synergistic to our portfolio today, as you've seen us acquiring kind of these adjacent and expansion areas. We have a strong balance sheet, obviously, that could support that over time here.
The next question comes from Brian Drab with William Blair.
So clearly, I just want to clarify one thing. So clearly, you're seeing the recovery in retail, and you said you expected that to play out this way where retail comes back before manufacturing and T&L. Are you -- does that mean that you're not seeing recovery in manufacturing and T&L yet or that the recovery in retail is just stronger at this point than those 2 categories?
Yes, I would say that we're not seeing it there yet. I would say that the T&L customers are clearly still absorbing capacity built out during the pandemic and that they're continuing to take actions to optimize their operations overall. I would say that manufacturing is impacted by the broader market trends of uncertainty.
Okay. And then I wonder if I could ask a question this way. You have that good slide that you used where you talk about the core and the adjacencies and expansion markets and growing expected longer-term mid-single, high single and low double digit, respectively. I'm just wondering, in your outlook for the next year, can you frame it in terms of those 3 categories, what you're expecting for growth in those 3 categories?
I'd say overall that it's hard to predict where each is going to end up. I would say, overall, the core and mobile computing has become -- is recovering first. I think each has a different dynamic. So I think that things like tablets and others in the expansion categories will be closely connected to things like mobile computing. RFIDs in that category, and that will continue to be an opportunity.
The next question comes from Meta Marshall with Morgan Stanley.
I think you alluded to this in kind of the replacement cycle question earlier in the call. But just any trends between kind of mobile computing and printing as we think about kind of some of these renewal cycles coming up?
Yes. I'd say that as we talked about mobile computing clearly showing the first signs of recovery as expected, and we talked through that a fair amount. I would say that in printing, we saw kind of broad-based declines, but has stabilized now in Q1. There was a difficult compare in Q1 for both printing and DCS as a year ago, first quarter '23, we saw supply chain challenges abate in both those areas. So we shipped a lot of printers and scanners in the quarter a year ago. So the compares were pretty tough.
The next question comes from Rob Mason with Baird.
Bill, you've touched on it a couple of times, just the run rate business, you haven't necessarily seen signs of recovery there yet. I would just want to see if you could put a finer point on the expectations there for the year, just in the context of your overall guide -- sales guide up 1% to 5% relative to the -- maybe the large deal side of the business?
Yes, I would say that our thought is probably relatively flat. I think we expected large deals to recover first. We expect mid-tier in run rate to recover after as we've talked about already. I think there's been a lot of optimism on the part of our partners and our distributors in this area, and we just want to see more progression, I think, more than anything else. That's kind of where we're at.
Yes. I think, Rob, you said that play when you say the flat, right kind of Q1 to 2 to 3 in terms of overall revenue. Flat, just because that's what we see in terms of the trajectory across all the different categories of business without seeing an inflection point of a dramatic uptick. Again, that's how we feel it. That was the appropriate guide based on what we're seeing today across all those different categories.
Yes. Understood. And then just as a follow-up, Nathan, could you tell us what the placeholder you have slotted into the guidance for debt reduction is for the year?
I would assume that the vast majority of the cash -- the $600 million of free cash flow will either go to debt pay down, maybe a little bit in terms of held in cash at some modest interest rate, but the vast majority would go to debt pay.
The next question comes from Ken Newman with KeyBanc Capital Markets.
Most of my questions have been asked, but I just wanted to ask a longer-term higher-level question. Obviously, you've got some very significant operating leverage implied for the back half, and I think that's mostly just on easier comparisons on the volume side.
Yes. As we mentioned, obviously, the volume leverage or the margin expansion in the second half is highly correlated with the increased volume along with -- coupled with the restructuring actions we took throughout last year. And really, for us, the target was to get back to above 20% as the baseline so that we can grow and scale from there. And I think still too early to tell in terms of what exactly that framework looks like.
Thank you. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Burns for any closing remarks.
Yes. I'd like to thank our employees and partners for the stronger-than-expected start to the year and positioning Zebra to return to growth in the second half of the year. We look forward to seeing analysts and investors at our Innovation Day in 2 weeks. Have a great day, everyone. Thank you.
Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.