Zebra Technologies Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
April 30, 2024

There are 16 speakers on the call.

Operator

After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations.

Operator

Please go ahead.

Speaker 1

Good morning, and welcome to Zebra's Q1 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.

Speaker 1

During this call, we will reference non GAAP financial measures as we describe our business performance. You can find reconciliations at the end of 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 Q1 results and strategic actions.

Speaker 1

Nathan will then provide additional detail on the financials and discuss our Q2 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.

Speaker 2

Thank you, Mike. Good morning and thank you for joining us. As expected, our Q1 performance was impacted by continued broad based softness across our end markets and regions, which we began to experience in the Q2 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 4th quarter. We are particularly encouraged by the better than expected large order activity, which drove the upside for the quarter.

Speaker 2

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 $1,200,000,000 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.

Speaker 2

Our restructuring plans to deliver $120,000,000 of net annualized operating savings is on track to be completed mid year. 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 draw 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.

Speaker 3

Thank you, Bill. Let's start with the P and L on Slide 6. In Q1, sales decreased 16.8% with declines across our regions, major product categories and customers of all sizes. Services and software were a bright spot in the quarter with growth driven by increased units under support contract and retail software wins. Our Asset Intelligence and Tracking segment declined 25.3%, primarily driven by printing.

Speaker 3

Enterprise Visibility and 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 margin 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.

Speaker 3

The impact was mitigated by approximately $25,000,000 of incremental net savings in the quarter from our restructuring actions. This resulted in 1st quarter adjusted EBITDA margin of 19.9%, a 150 basis point decrease versus the prior year and a 4 50 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.

Speaker 3

We generated $111,000,000 of free cash flow as we begin to realize benefits from reducing inventory levels. We ended the quarter at a 2.6 times net debt to adjusted EBITDA leverage ratio, which is slightly above the top end of our target range. And we had approximately $1,300,000,000 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% 5% compared to the prior year.

Speaker 3

We entered the 2nd quarter with a solid backlog and pipeline of opportunities, particularly for mobile computing and 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.

Speaker 3

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 $600,000,000 including the impact of our final $45,000,000 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 pay down in the near term. Please reference additional modeling assumptions shown on Slide 8. With that, I will turn the call back to Bill.

Speaker 3

Thank you, Nathan. As we

Speaker 2

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 tasks more effectively by navigating constant change in real time to advanced capabilities including intelligent automation, machine learning, prescriptive analytics and artificial intelligence. As you'll 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.

Speaker 2

In March, at the MODEX manufacturing and supply chain trade show, Zebra along with our partners showcased our expanded portfolio 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.

Speaker 2

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.

Speaker 2

I would also like to call out a win with the North American hospital network who recently implemented thousands of Zebra printers, specifically enhancing its specimen tracking and labeling processes. These printers integrate with 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.

Speaker 2

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 American 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 WorkCloud software. The solution is expected to enhance operational efficiency among associates, improve employee communication and streamline inventory management within their stores.

Speaker 2

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 the long term opportunity for Zebra, our conviction in the business remains strong. We continue to elevate our strategic role with our customers through innovative portfolio solutions, while our cost and go to market actions are positioning us well for profitable growth as our end markets recover.

Speaker 2

I will now hand it back to Mike.

Speaker 1

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

Operator

Thank you. We will now begin the question and answer session. The first question comes from the line of Jamie Cook with Truist Securities. Please go ahead.

Speaker 4

Hi, good morning. Nice quarter. I guess first question, can you just call out how much freight helped the Q1 lower freight costs 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?

Speaker 4

Thank you.

Speaker 3

Yes. So Jamie, I'll take that. Good morning. So if you look for the particularly the freight, in Q1, it was about drove about 1 point year on year improvement, just given 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 a point of benefit in the quarter.

Speaker 3

Yes, and 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.

Speaker 4

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 the guide? And if that continues, how would we think about the sales guidance relative to your sales growth of 1% to 5% ex FX? And sorry, then I'll get back in queue.

Speaker 3

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 is 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 Q1. But I would separate that from what we have yet to see, and 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 that, let's say, $1,000,000 to $5,000,000 range, in some of the initial phases of deployment.

Speaker 3

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

Thank you. The next question comes from Damon Karas with UBS. Please go ahead.

Speaker 5

Hi, good morning everyone. Nice to see the improvement.

Speaker 2

Good morning. Good morning.

Speaker 5

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

Operator

a larger quantity of project activity.

Speaker 5

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?

Speaker 2

Yes, I'd say overall in Q1 and into as we entered 'twenty four, 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.

Speaker 2

So overall, I think as we anticipated, mobile computing is the 1st 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 and L and manufacturing in other verticals before we'd call it kind of a broad based recovery.

Speaker 5

That's really helpful. Thanks, Bill. And then a follow-up question on your guidance, just maybe asked a little bit differently. I know you guys have spoken of, right, this really large funnel, but just a kind of a lack of conversion to orders. Guidance sort of has you sequentially second half sales comparable to the first half.

Speaker 5

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? Thank you.

Speaker 3

Yes. I'd say that as I mentioned earlier, the second half, I would call you 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 it's 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.

Speaker 3

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 why 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

Thank you. The next question comes from Keith Housum with Northcoast Research. Please go ahead.

Speaker 6

Good morning, guys. I appreciate it. Thanks. In terms of Asia Pacific region, obviously, underperformed compared to the rest of the company. And I understand China's challenge right now, but perhaps can you 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 shorter lasting?

Speaker 6

Just more color about the performance in that area, please?

Speaker 2

Yes. I mean, Keith, it's Bill. I think that overall, the Q1 performance was continued to be impacted by soft demand across all of the regions. So I think we'd 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.

Speaker 2

I would say the regions pretty much look the same except Asia was, as you said, impacted probably more through the declines in China. I would say that we see Asia overall having China continued to a longer recovery for the a positive a positive for the Asia market. I think we continue to see opportunities outside of China. So Southeast Asia and India with the investments in manufacturing there. We continue to see Japan as the longer term opportunity for us as we're making investments there and we have lower share there than other places.

Speaker 2

But I think we expect that China continue to remain challenging moving forward.

Speaker 6

All right. Appreciate it. And just as a follow-up, Nathan, in terms of adjusted EBITDA, there's a little bit decline in the guidance you're giving for 2Q versus 1Q. Sequentially, how should we think about the moving parts and the reason for a little bit lower adjusted year margins in the Q2?

Speaker 3

Hey, 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 and accretive margins just given the timing of retailers and when it performed their cycle counts and physical inventories, which is where that platform really focuses. So, that's the adjustment from Q1 to Q2. And the way I characterize it is, the Q2 guide is fairly in line with how we structured the full year going into it.

Speaker 3

And I'd say Q1 was benefited by some of the cost actions coming in earlier, giving us confidence in the remainder of the year as well as some of the benefits and just a little bit better mix and revenue start up the year. So I think Q2 in line with where we expected the year to play out and the sequential decline is entirely driven by the seasonality of our retail software

Operator

business. Thank you. The next question comes from Tommy Moll with Stephens. Please go ahead.

Speaker 7

Good morning and thank you for taking my questions.

Speaker 2

Good morning. Good morning, Tommy.

Speaker 7

You've given us some context on the omni channel 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? Thanks.

Speaker 2

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 have begun to buy again as you've kind of referenced, Tommy. We've also seen some of the push outs that took place in last year and really over the last 18 months or so begin to come back.

Speaker 2

So we've seen those projects as we expected and we talked about for a long time, those projects will come back. What we've seen mostly is initiating of really Phase 1 of those projects and the customer is not quite ready to commit to the full deployment. So we've seen deployments that in the past would have been larger even larger orders and full rollouts immediately. Now a more conservative, let's start with that project, but roll it out over time and complete the deployment kind of later in the year. So we have confidence that there will continue to be a recovery.

Speaker 2

I think we anticipated retail would recover first, followed by T and L and manufacturing and Healthcare, and we're seeing that play out. And we also anticipated that we'd be mobile computing first as well, and that's what we're seeing. So the bright spots are really mobile computing and retail, retail and e commerce. That capacity is being used off. Retailers are beginning to bring those projects back, but they're doing it in a very measured way.

Speaker 2

And I think what we want to see is retail, T and L, manufacturing, more of the vertical markets come back and more of that order activity even more than we're seeing today and the uptick in orders before we call a broad based recovery.

Speaker 7

That's helpful. Thank you, Bill. 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 Q1. But I'm curious, what's your view on how many days on hand in the channel currently?

Speaker 7

And if you think historically, do we sit today below what that historic level is? And does that imply at some point there may need to be a restock? Thank you.

Speaker 3

Yes, Tom. I'd say, ending the Q1, somewhat exiting 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.

Speaker 3

And as you said, I'd say no meaningful impact in the quarter or assumed in the full year guide in terms of changes relative changes in the distribution inventory levels.

Operator

Thank you. The next question comes from Brad Hewitt with Wells Fargo. Please go ahead.

Speaker 8

Hey, thanks. Good morning, guys.

Speaker 2

Good morning.

Speaker 8

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.

Speaker 2

I'd say that overall we'd expect orders customer orders to continue 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 macro economy kind of the uncertainty around that abating will certainly help as well. We're viewed as a trusted partner to our customers and we're staying close to them across each of the verticals as we would see this order momenting picking up across other verticals as we progress through the year.

Speaker 2

We've got a large installed base, right, with growing solutions. So we're continuing to work with our customers as well, kind of on new solutions and new use cases. So overall, I would say that we anticipated large deployments kind of starting to come back and we anticipate it in retail. We want to see more of that across manufacturing and T and L as I said. We'd like to see more of it too in kind of different size deals, so mid tier and run rate deals come back a bit.

Speaker 2

But I would say overall, we're our engagement with customers have been encouraging. There's certainly uncertainty remains around timing of some of the projects. I think Nate covered that earlier. And I think it's reflected in our year end outlook overall.

Speaker 3

Yes. You see it in our you see it in the pipeline in terms of where the deals are at in the deal stage. So a lot of you qualify versus where we'd like to see a 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.

Speaker 8

Okay, that's helpful. And 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?

Speaker 2

I would say that year end spending across retailers, their years end differently, whether it's the truly year end or into Q1. 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. And again, I think those are all encouraging signs, whether it was Q4 or Q1 to us the retailer are beginning to buy again. And I think we continue to want to see more of that momentum.

Speaker 2

I would say that even those orders are measured, you know what I mean? So it's it was year end spending, but it was the first phase of a project and we want to see those continued projects moving forward. We believe they will. So I would say nothing really in movement of Q4, Q1 as much as just normal activity around that where some customers in retail ended the true year end December 31 and others end in the Q1.

Operator

Thank you. The next question comes from Jim Ricchiuti with Needham and Company. Please go ahead.

Speaker 9

Hi, thanks. Maybe I missed it. Did you comment at all about the activity you're seeing in the SMB market? Is that is the recovery you're seeing in parts of retail also impacting that part of the business?

Speaker 2

Yes, 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. But I think at the moment, we have not seen the uptick we've seen in large orders across mid and in run rate business, which really falls in this SMB category. So I'd say not yet.

Speaker 2

I would say there's optimism on the part of our partners, but I think that we want to see more of that. As large orders typically are the first to decline, they're the first to recover. Retail was the first to pull back and now we're seeing the first to recover. And I think that SMB, call it, mid tier and run rate business will fall.

Speaker 9

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 and 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?

Speaker 2

Yes. I would say RFID, clearly, we see as an opportunity 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 transportation logistics, airports and airlines with baggage tracking, inside manufacturing work in progress and tools. And over so a whole series of different applications we're seeing quick serve restaurants.

Speaker 2

Clearly, the move ahead of large retailers like Walmart or UPS's smart package initiatives are causing others to continue to look at what they're doing in RFID and move things along across multiple industries and verticals. Zebra has the broadest and deepest set of RFID solutions in the market today. So whether it's fixed or handheld readers, industrial and mobile printers, our software that we utilize to for reads and locates and then then our labels printed through our printers. So we've seen strong growth across the portfolio over the past few years. We continue to see the drivers being the fact that the technologies continue to improve with greater re rate accuracy across the development of new tag types that make that more efficient in the reading of the tags.

Speaker 2

I think we're seeing more software applications being available today serving these different markets. We're clearly overall the idea that the number of tags, I think what excites all of us is the fact that readers follow tags, right? So from our perspective the adoption of tags and source tagging of items at point of manufacturing, the number of tags being sold is certainly going to allow more applications of those tags in customer environment. So we remain excited about this space overall and I think we're going to continue to see growth across RFID.

Operator

Thank you. The next question is from Joe Giordano with Citi Cowen. Please go ahead.

Speaker 10

Hey, guys. Good morning.

Speaker 2

Good morning.

Speaker 10

Just I know people are hesitant to lay off 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?

Speaker 2

I think overall, 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 and L, as those customers build out a lot of capacity as well during the pandemic. And we'd like to see manufacturing be a bit more healthy in the idea that moving from a services based economy to more goods based economy overall.

Speaker 2

I'd say that the refresh cycle, our sales teams are focused on that with our customers and ultimately mobile computing are mobile computers are essential to their operation. They have worked with us across multiple generations of products. We've got a healthy pipeline of opportunities, but we'd want to see those move ahead through this year and into next year as you described. So clearly there is a refresh cycle out there. The embedded base is larger than it's ever been as people have deployed more applications for mobile devices in their environment, so the installed base is larger.

Speaker 2

So those will continue to refresh and every customer is on a different cycle. So I think that whether you're talking about a postal environment in a specific country or a T and L provider or a larger retailer, What we have seen is that even in retail, these larger orders have been more measured as I talked about. So haven't been large scale as they've described kind of mega deals, they've been smaller in size and rolling out over time. We'd expect probably that same thing will happen in places like P and L. So I think it will be a measured overall recovery.

Speaker 2

And I think we feel that we've got a strong base to continue to refresh, but it's going to take time.

Speaker 10

Fair enough. And then maybe just shifting to the balance sheet quickly. With your key markets, at least we could debate the magnitude of recovery, but it seems like deterioration has kind of stopped. It's good to see you pay back some debt here. Cash flow looks strong.

Speaker 10

So is there an appetite for buybacks to kind of increase your leverage on a recovery as you come out of this?

Speaker 3

Yes. As you mentioned, we finished the quarter at 2 a little over 2.5 times 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 pay down just given the debt leverage ratios and the current interest rates environment, but we do plan to reassess buybacks as the year progresses, particularly in the second half.

Operator

Thank you. The next question comes from Andrew Buscaglia with BNP Paribas. Please go ahead.

Speaker 11

Hey, good morning, guys.

Speaker 2

Good morning.

Speaker 11

So I just want to check on your comment on the guidance. We'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 margin? Because it does seem like you're expecting some lift in Q4 and wondering what's behind that?

Speaker 3

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's 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 I would 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.

Speaker 3

So it tends to be a little bit of a downtick in terms of just seasonal spend. So I'd

Speaker 2

say there's no magic bullet there

Speaker 3

in terms of the actions we need to take in order to deliver that sequential improvement from Q3 into Q3 and Q4.

Speaker 11

Okay. 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 and A now? I think the software story has been nice.

Speaker 11

It's helping you lately. So what's what's the environment like as you see it with deals?

Speaker 2

Yes, I'll take that, Nate. I would say that organic growth continues to be our first priority overall. I think our M and 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.

Speaker 2

I think in the short term, there's clearly a higher bar as given the macro environment and the debt leverage that we're at today. So I think we're continue to be inquisitive and look what's out there. I think we see it as an opportunity to be strategic and add to our portfolio, our products and solutions that we have in the marketplace. And I think that in the short term, I think it's just a higher hurdle.

Operator

Thank you. The next question comes from Brian Drab with William Blair. Please go ahead.

Speaker 12

Hi, good morning, Bill, Nathan, Mike. Thanks for taking the questions. So clearly, I just want to clarify one thing. So clearly, you're seeing the recovery in retail. And you said you expected that it to play out this way where retail comes back before manufacturing and T and L.

Speaker 12

Are you does that mean that you're not seeing a recovery in manufacturing and T and L yet or that the recovery in retail is just stronger at this point in those two categories?

Speaker 2

Yes, I would say that we're not seeing it there yet. I would say that the T and 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 and clearly still a services based economy versus a goods based economy. But I think overall, our value proposition remains strong in both markets. We've got strong relationship across T and L, and I think that we'll see them continue to buy again once the capacity is built out.

Speaker 2

I would say manufacturing is an opportunity for us overall that As customers continue to buy again, they are will invest in automation and things like traceability and resilient supply chains. Those themes haven't gone away, but we've seen just a conservative nature of spending based on the uncertainty. So that represents an opportunity for us. I would say that manufacturing unlike T and L is kind of under penetrated for us that there's an opportunity for us. And we've got new solutions within so they can machine vision, robotics automation.

Speaker 2

Our demand planning strengthens our offering there as those markets recover. So and we've also shifted additional sales resources through this to manufacturing. So I think that we expected retail was the first to decline. It's the first to recover. T and L and manufacturing will follow.

Speaker 2

I would say we've got strong relationships across T and L, but lots of opportunities there when it does recover. And manufacturing will continue to be a focus area for us because we see it as an opportunity longer term.

Speaker 12

Okay. Thank you very much. And then I wonder if I could ask a question this way. You have that good slide that you use 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 three categories, what you're it's

Speaker 2

hard to it's hard to predict where each is going to end up. I would say overall that the core in mobile computing has become is recovering 1st. 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.

Speaker 2

I would say, if you think of the kind of last circle to that, software and our services business had a positive quarter in Q1 overall. So I think that's more recurring revenue based. Machine vision has been challenged in the short term with areas like semiconductor and manufacturing being down. So I think it varies by each segment. I think there's gives and takes in each.

Speaker 2

I think the core mobile computing first, the others still down, but will recover. I think in the adjacencies RFID and others will be bright spots. And I think software was a bright spot, but machine vision challenged in the short term. Robotics still read at its infancy. So I think kind of mixed across those, but I think that it's going to be all will recover over time.

Speaker 2

It's just different timeframes for each.

Operator

Thank you. The next question comes from Meta Marshall with Morgan Stanley. Please go ahead.

Speaker 13

Great, thanks. I think you alluded to this in kind of the replacement cycle question earlier in the call, but just any trends between mobile computing and printing as we think about some of these renewal cycles coming up? And then maybe second, you haven't touched on the healthcare market. That's clearly been an area of expansion for you guys. Just any investment or kind of progress that's being made on that opportunity?

Speaker 13

Thanks.

Speaker 2

Yes. I'd say that as we talked about mobile computing clearly showing the first signs of recovery as expected. We talked through that a fair amount. I would say that in printing, we saw kind of broad based of Q1 2023, 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.

Speaker 2

So the compares were pretty tough. I would say that in printing specifically, clearly still challenged by the softer economic conditions and then particularly by manufacturing, but I would say stabilized overall. We'd expect that recovery in printing and scanning would follow mobile computing as we kind of talked about. Specific to healthcare, I would say that impacted by the same trends, the broader market overall, clearly tighter budgets, thin margins within healthcare, we would see that we continue to drive productivity solutions within healthcare, which allows healthcare providers to be more efficient, which is certainly appealing to them on tight margins and clearly to enhance patient safety. We see home healthcare is an opportunity for us.

Speaker 2

So we're clearly seeing some of our partners address that market. So think of tablets as an example around home health care opportunities. So I think we see optimism. We were at the HIMSS trade show, which was well attended in Q1, largest retail show as we mentioned in the script earlier. But I think that we've seen optimism on the point of our partners and our customers just like the other verticals in manufacturing and T and L.

Speaker 2

We'd like to see more of that optimism turn into real orders like we're seeing in retail.

Operator

Thank you. The next question comes from Rob Mason with Baird. Please go ahead.

Speaker 14

Yes, good morning. 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 just wanted 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?

Speaker 2

Yes, I would say that our thought is probably relatively flat. I think we expected large deals to recover first. We expect mid tier and 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.

Speaker 2

That's kind of where we're at. We typically large deals are the first to decline and then followed by mid tier and run rate because run rate is kind of a longer tail. And I think we're going to see that same thing in recovery. We haven't seen it yet. So I think that that's the challenge we're seeing.

Speaker 2

I wish the visibility was better through the year. And I think consequent with our guide is that we're kind of guiding to what we see from a visibility perspective and we just haven't seen the recovery in mid tier or run rate yet. And the optimism is out there, the opportunities seem to be there. Everybody wants to go after it. We just need to see more of it really happen and turn into worse.

Speaker 2

Yes.

Speaker 3

I think, Rob, you said that when you say the flat, right, kind of Q1 to Q2 to Q3 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. And without seeing that inflection point of a dramatic uptick. Again, that's why we feel like that was the appropriate guide based on what we're seeing today across all those different categories. Yes, understood.

Speaker 14

And then just as a follow-up, Nathan, could you tell us what the placeholder you have slotted in to the guidance for debt reduction is for the year?

Speaker 3

I would assume that the vast majority of the cash convert the $600,000,000 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 down.

Speaker 2

Very good. Thank you.

Operator

Thank you. The next question comes from Ken Newman with KeyBanc Capital Markets. Please go ahead.

Speaker 15

Hi, good morning guys. Thanks for squeezing me in. 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 comparison to the volume side. As we think about maybe returning more towards a normalized operating environment, how do you think about the run rate operating leverage or the run rate incremental EBITDA margins, just given all the cost out initiatives that you've executed on?

Speaker 15

Would you think that structurally higher than what we've seen in past cycles or is that still too early to tell?

Speaker 3

Yes, as you 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 get back to above 20% as the baseline so that we can grow with scale from there. And I think still too early to tell in terms of what exactly that framework looks like. I'd say historically, we've been looked at 30% incremental decrementals in a normal quarter, quarter in, quarter out. Fundamentally, the business hasn't changed in terms of what you would expect.

Speaker 3

Over time, we'd expect that to be a little bit greater as we scale some of these new emerging markets like machine vision or software that have inherently higher gross margin. But I think that's probably the best way to think about it now until the dust settles and we get to some normalcy both from a year on year as well as a sequential perspective.

Speaker 15

Very good. Thanks for the help there.

Operator

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.

Speaker 2

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 second half year. We look forward to seeing analysts and investors at our Innovation Day in 2 weeks. Have a great day everyone. Thank you.

Operator

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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Earnings Conference Call
Zebra Technologies Q1 2024
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