Zebra Technologies Corporation (NASDAQ:ZBRA) Q1 2024 Earnings Call Transcript

Zebra Technologies Corporation (NASDAQ:ZBRA) Q1 2024 Earnings Call Transcript April 30, 2024

Zebra Technologies Corporation misses on earnings expectations. Reported EPS is $1.71 EPS, expectations were $2.46. ZBRA isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and welcome to the First Quarter 2024 Zebra Technologies Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead.

Mike Steele: 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. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of this slide presentation and in today’s earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales performance are year-over-year and on a constant currency basis.

This presentation will include prepared remarks from Bill Burns, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Bill will begin with a discussion of our first quarter results and strategic actions. Nathan will then provide additional detail on the financials and discuss our second quarter and full year outlook. Bill will conclude with progress on advancing our vision. Following the prepared remarks, Bill and Nathan will take your questions. Now let’s turn to Slide 4 as I hand it over to Bill.

Bill Burns: 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. We also delivered another quarter of sequential improvement in profitability as a result of our restructuring actions and improved gross margin.

Services and software were a bright spot in the quarter with improved sales and profitability, helping to offset the year-on-year sales declines across all product categories. For the quarter, we realized sales of $1.2 billion, a 16.8% decline from the prior year and adjusted EBITDA margin of 19.9%, a 150 basis point decrease and non-GAAP diluted earnings per share of $2.84, a 28% decrease from the prior year. We are pleased with the progress we have made on our previously announced actions to improve profitability and drive sales growth as our end markets recover. Our restructuring plans to deliver $120 million of net annualized operating savings is on track to be completed midyear. On the supply front, we made substantial improvement in our working capital driven by our renegotiation of long-term supply commitments and ongoing work to drive down component inventories with our contract manufacturers.

We have also driven both tactical and strategic sales initiatives, including reallocation of resources to accelerate growth. Given the progress on our actions, we are raising our full year outlook for sales, margin and free cash flow. I will now turn the call over to Nathan to review our Q1 financial results and discuss our revised 2024 outlook.

Nathan Winters: 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. Enterprise Visibility & Mobility segment sales declined 11.8% with relative outperformance in mobile computing. Our Asia Pacific region saw the steepest sales declines led by continued weakness in China. From a sequential perspective, total Q1 sales were 16% higher than Q4 as distributors had completed their destocking process by year-end and we realized modest improvement in demand.

Adjusted gross margin increased 60 basis points to 48.1% supported by higher services and software margins and cycling premium supply chain costs in the prior year, all of which were partially offset by expense deleveraging from lower sales volumes. Adjusted operating expenses delevered 230 basis points as a percent of sales. The impact was mitigated by approximately $25 million of incremental net savings in the quarter from our restructuring actions. This resulted in first quarter adjusted EBITDA margin of 19.9%, a 150 basis point decrease versus the prior year and a 450 basis point sequential improvement from Q4. Non-GAAP diluted earnings per share was $2.84, a 28% year-over-year decrease. Interest expense contributed to the decline, offset by a lower adjusted tax rate.

Turning now to the balance sheet and cash flow on Slide 7. We generated $111 million of free cash flow as we begin to realize benefits from reducing inventory levels. We ended the quarter at 2.6x net debt to adjusted EBITDA leverage ratio which is slightly above the top end of our target range. And we had approximately $1.3 billion of capacity on our revolving credit facility as of quarter end, providing ample flexibility. Let’s now turn to our outlook. For Q2, we expect sales to decrease between 1% and 5% compared to the prior year. We entered the second quarter with a solid backlog and pipeline of opportunities, particularly for mobile computing in retail and e-commerce. This outlook assumes a modest improvement in demand trends across our major product categories, with mobile computing and the EVM segment returning to growth as we cycle easier compares.

We anticipate Q2 adjusted EBITDA margin to be slightly above 19% driven by expense deleveraging from lower sales volume with the benefit from restructuring actions and lower premium supply chain costs, offset by normalized incentive compensation expense. Non-GAAP diluted earnings per share are expected to be in the range of $2.60 to $2.90. We have raised our guide for the full year, reflecting our progress on actions to drive sales and profitability as our end markets have stabilized. Although there is optimism from partners and customers regarding recovery in the second half of the year, we would like to see additional momentum in large orders before factoring in a broader recovery. We now expect sales growth between 1% and 5% for the year, with adjusted EBITDA margin now expected to be approximately 20%.

Non-GAAP diluted earnings per share are expected to be in the range of $11.25 to $12.25. And we now expect our free cash flow for the year to be at least $600 million, including the impact of our final $45 million settlement payment in the quarter. We have been making progress rightsizing inventory in our balance sheet and improving cash conversion and have been prioritizing debt paydown in the near term. Please reference additional modeling assumptions shown on Slide 8. With that, I will turn the call back to Bill.

Bill Burns: 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. As you see on Slide 11, our customers leverage our solutions to optimize workflows across a broad range of end markets. We empower enterprises to increase collaboration and productivity and better serve their customers, shoppers and patients.

In March, at the MODEX Manufacturing and Supply Chain trade show, Zebra, along with our partners, showcase our expanded portfolio of solutions that are modernizing workflows across the broader supply chain. Managing operations has become complex with increased consumer expectations for inventory visibility and same-day deliveries. The event provided an opportunity to demonstrate how we improve key outcomes such as production quality, supply chain agility and capacity utilization. Machine vision was one of the many solutions we featured where we have enhanced our capabilities to address emerging use cases. We continue to build our market presence with a few notable wins. A large state-owned European logistics company recently invested in thousands of Zebra machine vision cameras to enhance the speed and efficiency of inspections of government bonds and transaction documents.

Additionally, an Asian manufacturer incorporate our machine vision cameras and frame grabbers, into their product sorting and quality control processes. This solution is significantly faster and more accurate than the previous manual approach. At HIMSS, the leading Global Healthcare Conference, Zebra and our partners demonstrated how our solutions improve the patient journey from check-in to bedside point-of-care as well as medical equipment track and trace. Additionally, the University of Maryland Health System shared how they are utilizing our clinical communications platform which includes our mobile computers and work cloud software. I’d also like to call out a win with a North America hospital network, who recently implemented thousands of Zebra printers, specifically enhancing its specimen tracking and labeling processes.

These printers integrate with the electronic health record system facilitating noticeable organizational improvements across departments. Zebra’s reputation for ease of use helps secure this win. Recent wins in retail, demonstrate how customers are driving productivity, improving asset visibility, enhancing the experience for associates and shoppers. The European retailer selected thousands of Zebra mobile computers to replace their legacy devices from a competitor. The customer plans to pair our new mobile computers with their Zebra mobile printers to improve their price markdown, labeling and online order-picking processes. The North America-based retail department store chain enhanced thousands of Zebra mobile computers by incorporating our device tracking software.

Prior deployment of this software, the retailer experienced issues with misplaced devices in stores and fulfillment centers, resulting in wasted time and resources. Additionally, a North American grocer has expanded their installed base of Zebra mobile computers with thousands of additional units and implemented our work cloud software. The solution is expected to enhance operational efficiency among associates, improve employee communication and streamline inventory management within their stores. On Slide 12, we highlight secular trends that we expect to support long-term growth for Zebra as we drive value for our customers. These include labor and resource constraints, real-time supply chain visibility, track and trace mandates and increased consumer expectations.

We are hosting an innovation day on May 14 at our headquarters near Chicago where Nathan and I will be joined by other members of our leadership team to discuss how we digitize and automate workflows to drive positive business outcomes for customers across our end markets. In closing, as we look forward to a long-term opportunity for Zebra, our conviction in the business remains strong. We continue to elevate our strategic role with our customers through our innovative portfolio of solutions while our cost and go-to-market actions are positioning us well for profitable growth as our end markets recover. I will now hand it back to Mike.

Mike Steele: Thanks, Bill. We’ll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up so that we can get to you as many as possible.

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Q&A Session

Operator: [Operator Instructions] The first question comes from the line of Jamie Cook with Truist Securities.

Jamie Cook: 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?

Nathan Winters: 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. Yes, I’d say the other drivers for the relative strength in Q1 was both from the slightly higher volume as well as some favorable mix. Along with the service and software profitability and the strength we saw there which is primarily in EVM which is, I think, driving the benefit both sequentially as well as relative to our guide in the quarter.

Jamie Cook: 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?

Nathan Winters: 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%. And so the way we think about the full year was we’d expect Q3 to look very similar to Q2 which looks similar to Q1, just in terms of run rate and trajectory which as they maintain that relative strength in some of the large orders we’ve seen come through in the first quarter. But I would separate that from what we have yet to see, I’d say what’s still kind of waiting to look at is the larger mega deals, mega deployments, that’s still not coming through.

The deal sizes are still in the, let’s say, $1 million to $5 million range, some of the initial phases of the deployment. So that’s what you see carry through for the remainder of the year and inflected in the guide but not that uptick in terms of the larger deployments.

Operator: The next question comes from Damian Karas with UBS.

Damian Karas: 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?

Bill Burns: 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. However, H2 is — the growth there is primarily driven by lapping through the prior destocking activity that we’ve seen. So overall, I think as we anticipated, mobile computing is the first place that we’re seeing recovery. We’re seeing it in retail. Both of those were the first to be impacted coming through the cycle with COVID.

And what we’d like to see is more visibility and momentum in order activity beyond what we’ve seen so far. And I think we’d like to see it move from retail to T&L and manufacturing in other verticals before we’d call it kind of a broad-based recovery.

Damian Karas: 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?

Nathan Winters: 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. I’d say still lower conversion rates on our pipeline than we would have historically assumed based on what we experienced in the second half. But again, aligned with what we’ve experienced over the past 2 quarters. I think the big difference is, we’re not assuming, we’re making an assumption around a mega deployment just given that we’ve yet to see kind of firm commitments from our customers. There’s a lot of optimism, discussions around those.

But in terms of committing to move forward those projects or ensuring that they have the budget available in the year, that really remains the uncertainty and the way you look and see the second half look very similar to the first half because that’s what we’re experiencing and what we’re seeing play out in the market. We think that’s appropriate for the guide for the year.

Operator: The next question comes from Keith Housum with Northcoast Research.

Keith Housum: 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?