Zebra Technologies Corporation

Good day, and welcome to the Zebra Technologies first quarter 2023 earnings conference call. Today, all participants will be in a listen-only mode. Should you need assistance during today's call, please signal for a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note that today's event is being recorded. And at this time, I would now like to turn the conference over to Mike Steele, Vice President of Investor Relations. Please go ahead.

Good morning and welcome to Zebra's first quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to 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 growth are year-over-year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. This presentation will include prepared remarks from Bill Burns, our Chief Executive Officer, and Nathan Winters, our Chief Financial Officer. Bill will begin with our first quarter highlights. Then Nathan will provide additional detail on the Q1 results and discuss our revised 2023 outlook. Bill will conclude with progress made on advancing our enterprise asset intelligence vision. Following the prepared remarks, Joe Heal, our chief revenue officer, will join us as we take your questions. Now let's turn to slide four as I hand it over to Bill.

Thank you, Mike. Good morning and thank you for joining us. Our team executed well in a challenging macroeconomic environment, delivering first quarter sales and earnings results above the midpoint of our outlook. For the quarter, we realized sales of $1.4 billion, approximately in line with the prior year. An adjusted EBITDA margin of 21.4%, 150 basis point increase, and non-GAAP diluted earnings per share of $3.94, a 2% decrease from the prior year. Regional sales performance was mixed, with growth in Asia-Pac and North America mostly offsetting declines in EMEA and Latin America. From a solutions perspective, printing, data capture, and RFID were bright spots, while sales of mobile computers declined. we continue to see cautious spending behavior by enterprise customers with a decline in large orders and growth in small to mid-size orders. From a profitability perspective, improved gross margin drove our EBITDA margin increase. Higher interest and tax expense resulted in a slight earnings decline. I would now like to spend a moment on our sales outlook. As the risk of broader softening of industry demand has materialized, we have reduced our full-year outlook. Late in Q1 and into Q2, demand trends softened across our end markets, particularly for mobile computers in EMEA and North America, as customers' CapEx budgets tightened and IT device spending contracts. We are mitigating the impact of softer sales with targeted go-to-market actions to drive additional demand and incremental cost actions. We will continue to take an agile approach to managing throughout this uncertain near-term environment. I will now turn the call over to Nathan to review our Q1 financial results and provide additional details on a revised 2023 outlook.

Thank you, Bill. Let's start with the P&L on slide six. In Q1, net sales decreased 1.9%, including the impact of currency and acquisitions, and were 0.3% lower on an organic basis. Our asset intelligence and tracking segment increased 28.4%. led by strengthened printing as we lapped significant supply constraints in the prior year period. Enterprise visibility and mobility segment sales declined 11.2 percent, with mixed performance among our offerings. We realized strong growth in data capture solutions and RFID. Mobile computing sales declined, primarily due to large customer order deferrals, slowing demand through distribution, and the impact of ceasing sales to Russia in March of 2022. Additionally, we also drove growth across service and software with strong service attach rates. Performance was mixed across our regions. North America sales increased 1% due to strength in printing and data capture, helped by the recovery from supply chain challenges. EMEA sales declined 4%, primarily due to a 350 basis point impact of our suspension of sales into Russia. Asia Pacific sales grew 6%. driven by strong mobile computing growth in Japan. In Latin America, sales decreased 1%, with relative outperformance in Brazil and Mexico. Adjusted gross margin increased 290 basis points to 47.5%, primarily due to lower premium supply chain costs, partially offset by FX, and lower service margins. Adjusted operating expenses increased 130 basis points as a percent of sales, primarily due to a return to normalize sales and marketing activity and strategic investments in the business, partially offset by a reduction in G&A expense. First quarter adjusted EBITDA margin was 21.4%, a 150 basis point increase driven by gross margin expansion. Non-GAAP diluted earnings per share was $3.94, a 1.7% year-over-year decrease due to increased interest expense and a higher tax rate. partially offset by fewer shares outstanding. Turning now to the balance sheet and cash flow on slide seven. In Q1, we had negative free cash flow of $92 million, which was unfavorable to the prior year period, primarily due to the timing of inventory payments, higher interest costs and cash taxes, and $45 million of previously announced quarterly settlement payments, which are scheduled to conclude in Q1 of 2024. all of which was partially offset by favorability in the timing of customer collections and lower incentive compensation payments. In Q1, we also made $15 million of share repurchases and invested $1 million in our venture portfolio. We ended the quarter at a comfortable 1.6 times net debt to adjusted EBITDA leverage ratio, which is well below the top of our target range of 2.5 times. and had approximately $1.3 billion of capacity on our revolving credit facility. On slide eight, we highlight premium supply chain costs, which have continued to improve from peak levels. The actions we have taken to redesign products, along with the improving freight rates and capacity, have enabled us to reduce component purchases on the spot market and reduce freight cost impact. In Q1, we incurred premium supply chain costs of $15 million as compared to the pre-pandemic baseline and $53 million lower than the prior year. We are expecting these premium supply chain costs to continue to decline. Let's now turn to our outlook. We continue to see enterprise customers defer large orders and are also realizing lower sales into the channel as distributors adjust to softer demand trends as well as our improved product lead times and their higher cost of capital. For the second quarter, our sales are expected to decline between 9% and 11% compared to the prior year. Our outlook assumes a two-point negative impact from foreign currency changes and a one-point additive impact from recent acquisitions. We anticipate Q2 adjusted EBITDA margin to be approximately 20%, driven by expense deleveraging from lower sales volume partially offset by higher expected gross margin from improved supply chain costs. We expect premium supply chain costs to be approximately $15 million in Q2, a more than $40 million year-on-year reduction. Non-GAAP diluted EPS is expected to be in the range of $3.20 to $3.40. We are reducing our full-year 2023 sales outlook by three points. We now anticipate net sales to decline between 2% and 6%. This outlook assumes an approximately 50 basis point net negative impact from foreign currency changes and acquisitions. Second half sales are expected to benefit from easier year-on-year comparisons or recently announced price increase in evading FX headwinds. We have a solid pipeline of opportunities that gets us to the high end of the sales range. but are embedding caution in our outlook given recent demand trends and the uncertain macro environment. We expect full-year adjusted EBITDA margin of approximately 22%, which is the low end of our previous outlook. We now expect premium supply chain costs of approximately $40 million for the year, as we are seeing faster-than-expected supply chain recovery. We have been proactively managing operating expenses through targeted restructuring actions and discretionary cost controls, and we expect sequentially lower operating expenses in the second half of the year. We now expect our free cash flow to be between $450 and $550 million for the year, which reflects increased caution in our revised full-year outlook. As a reminder, cash flow is impacted by increased cash taxes and $180 million of previously announced settlement payments. We continue to be focused on right-sizing elevated inventory on our balance sheet as component lead times have normalized. Working capital variability over the past year has been significantly impacted by global supply chain dynamics. Our fundamental business model is unchanged, and we believe the actions we are taking will enable us to deliver greater than 100% free cash flow conversion as we normalize inventory levels. We are focused on achieving 100% conversion over a cycle, which is now included in our long-term executive incentive compensation plan. Please reference additional modeling assumptions shown on slide nine. With that, I will turn the call to Bill to discuss how we are advancing our enterprise asset intelligence vision. Thank you, Nathan.

While customer spend is pressured near-term, our solutions are essential to our customers' operations, and we are well-positioned to benefit from secular trends to digitize and automate workflows across our served markets. Slide 11 illustrates how we digitize the front line of business by leveraging our industry-leading portfolio of products, software, and services. By transforming workflows with our proven solutions, Zebra's customers can effectively address their complex operational challenges, including scarcity of labor and improving productivity in challenging times. We empower the workforce to execute tasks more efficiently by navigating constant change in near real time. utilizing insights driven by advanced software capabilities such as artificial intelligence, machine learning, and prescriptive analytics. Now turning to slide 12. We are focused on advancing our enterprise asset intelligence vision by continuing to elevate Zebra as a premier solutions provider through our compelling portfolio. In March, at the Promat Manufacturing and Supply Chain Trade Show, Zebra, along with our partners, showcased the depth and breadth of our innovative solutions for manufacturing, logistics, and the broader supply chain. Our industrial automation solutions, including autonomous mobile robots, machine vision, and fixed industrial scanning, are synergistic with technology-equipped frontline workers. At the show, we featured Zebra solutions at each stage of warehouse operations, including receiving, storage, and fulfillment. It demonstrated how we improved key outcomes for our customers such as enhancing supply chain agility, improving production quality, and maximizing utilization and productivity. As you can see on slide 13, Zebra empowers the frontline of business across retail and e-commerce, transportation logistics, manufacturing, healthcare, and other markets. Businesses partner with Zebra to optimize their end-to-end workflows as they strive to meet the increasing demands of customers across a variety of vertical end markets. The business challenges we are solving have expanded through our investment in complimentary offerings, enable us to further penetrate customer accounts. I would like to highlight several wins across our end markets. We are beginning to deploy the record RFID win we mentioned on our last call. This global transportation logistics provider plans to tag every package that enters their facilities with RFID encoded labels to enhance tracking visibility. Zebra solutions improve productivity, enable faster error detection, drive in cost savings, and increase customer satisfaction. In addition to our RFID offerings, this customer is also deploying our mobile computers as an integral part of the overall solution. A major e-commerce provider in Europe recently expanded their use case of Zebra's fixed industrial scanners at several thousand packing stations. This enables the customer to continue to significantly reduce scan time and increase throughput, particularly for their more complex packing needs. The support and collaboration with Zebra and our partner was a key differentiator among our competition. A large Australian supermarket chain has replaced consumer-grade devices with our Zebra rubbing tablets and scanners to enable faster and more accurate buy online, pick up in store, and home delivery fulfillment. Zebra's enterprise-grade solution, along with our commitment to sustainability, including our recycling program and eco-friendly packaging, were competitive differentiators in securing this win. The Latin American manufacturing company recently selected Zebra mobile computers and mobile printers to help streamline delivery and warehouse operations. Delivery personnel will benefit from synergies between these products, while warehouse employees realize similar efficiencies with Zebra scanners and desktop printers. This manufacturer shows our products for reliability and durability and considers us a strategic partner in their technology journey. The regional bank recently selected our workforce management software for all branch locations, displacing a competitor. Our solution is expected to drive cost savings through more efficient scheduling and allocation of people resources. We are pleased about the benefits our solutions are delivering in our customers' mission-critical operations. Slide 14 reiterates challenges that have materialized since our last guide. We believe the actions we are taking, which include working closely with our customers as they look to deploy solutions to drive efficiency within their businesses, increasing our focus on accelerating growth in under-penetrated markets, and driving incremental cost actions within our business will allow us to exit 2023 stronger, positioning us to deliver profitable growth, increased market share, and improve free cash flow. In closing, we are facing near-term headwinds and have taken actions to drive a stronger second half. Our long-term conviction in our business is unchanged. Moving forward, we are focused on driving profitable growth in our core and expansion markets, collaborating closely with our customers and partners to continue to elevate Zebra as a premier solutions provider in attracting, developing, and retaining top global talent to drive innovation.

I will now hand it back to Mike. 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 as many of you as possible.

We will now begin the question and answer session. As a reminder, to ask a question, you may press star then one on your touchtone phone. If you're using your speakerphone, please pick up your handset before pressing the keys. If you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Today's first question comes from Tommy Mull with Stephens. Please proceed.

Thanks for taking my questions. Morning. Morning. Morning, Tommy. Bill, I wanted to start on the topic of run rate versus large customer demand. It sounds like the run rate business might have been a little bit stronger in Q1, but maybe also got a little weaker toward the end. So any commentary you could give us on one versus the other would be appreciated, and specifically when you're talking about the potential for channel destocking. Is that more a run rate-driven phenomenon, or is that not the right way to think about it? Thank you.

Yeah, Tommy, I would say that, you know, in the first quarter, our sales growth and, you know, we saw sales growth in run rate or non-large deals, which moderated towards the end of the quarter. And I would say that, you know, if we kind of characterized, you know, where we're at today, that through the majority of Q1, we saw that our sales opportunities were developing as we had, you know, expected, and it allowed us to deliver on our first quarter guide. And I think that as we got later into the quarter, towards the end of Q1 and into April, while our run rate continued to be strong in first quarter, we saw that begin to moderate. But the real challenge has been around large customers and really tightening their CapEx budgets further You know, as we got to the second, you know, the end of Q1 and into Q2, and we saw, you know, new projects not receiving, you know, the funding that our sales teams had expected in the near term. So we saw a number of projects really, you know, in our sales funnel that were planned for Q2 and early Q3. really become, you know, deferred. And we especially saw this in retail and, again, specifically in North America anemia. So that ultimately, you know, that slowing demand of larger deals and overall a bit of moderating of our run rate has really impacted our distributors that are looking to adjust their working capital levels that you know, to really these, you know, the slowing demand of large deals and some of the moderating of run rate. We've also seen, you know, our lead times improve. So our distributors are having to hold less inventory as our lead times improve. And, of course, you know, they've got an increase in cost of capital and holding costs as they, you know, adjust their, you know, days on hand to the right level. So, you know, overall, these pressures really led us to say, hey, You know, our Q2, you know, guiding that, you know, down further and then ultimately looking at the full year is, you know, despite run rate being strong in first quarter, we saw it moderate and large deals are really in large customers specifically around retail in EMEA and North America are really driving, you know, our guide for the full year.

Just to continue with that theme, Bill, as you mentioned earlier, some of the incremental weakness that drove your revision to the full-year outlook really didn't manifest until late first quarter into the second quarter, it sounds like. Nonetheless, the outlook does imply a fairly healthy improvement in terms of revenue in the second half versus the first half. At this point, though, how much visibility do you have there? It feels like some of these conversations, particularly on the large customer side, may still be early with a lot of question marks. But if I'm wrong in that characterization, please let me know. Thank you.

Hey, Tommy, this is Nathan. And then just a little color on the full year guide. So if you look for the full year down 3.5% on organic sales in the midpoint, as we said in prepared remarks, we do have the pipeline of opportunities and actions to get to the high end of the range. However, being cautious in the assumptions and what we expect out of the pipeline due to the uncertain macro environment and the cautious behavior we're seeing. I think the other thing that's important to note is, as we go into the second half, we have easier year-on-year comps, particularly in Q3, as well as we have the recently announced price increases that will benefit in the second half, as well as the favorable FX from our last guide helping offset some of the macro headwinds. So all those factors, you know, the latter factors play into some of the first half or second half dynamic, as well as what we believe we've taken a, you know, a conservative view at the pipeline and actions we have as we looked at the second half guide. Thank you both. I'll turn it back.

The next question comes from Damian Karras with UBS. Please proceed.

Hey, good morning, everyone. I have a follow-up. Good morning. Just a follow-up question on your comment, Phil, about some of these project deferrals. Just for clarification, right, are we talking about the same kind of select handful of large customers, you know, North America retail and EMEA retail, or are there additional large customers that are mimicking these behaviors or just kind of a combination of both of those factors? And I'm curious if, you know, thinking about, you know, kind of future execution and delivery. Do you have any kind of sense on timeline on that, or are they just kind of on pause for the moment?

Yeah, I think maybe it's worth, you know, covering the vertical markets in what we saw in Q1. So, you know, predominantly retail. I would say that, you know, from a T&L perspective, we continue to see customers, you know, invest in visibility and productivity solutions. And, you know, transportation logistics was up in Q1. In Q1, we also saw strong growth, you know, across manufacturing as well. they continued to invest in, you know, industrial automation and productivity within manufacturing. And healthcare also, you know, continued to be strong. So, it really was, you know, around on retail and those, you know, customers ultimately, you know, not all retail customers, but, you know, significant number of those across EMEA and North America. had pushed out projects that, you know, were in our sales funnel for Q2 and Q3, you know, out. And I think that ultimately, as Nathan said, allowed us to take or, you know, drove us to take a more conservative view of the funnel and pipeline for second half year. And, you know, maybe Joe wants to comment more on that. Sure.

So, Damian, I want to underline one thing first, and then maybe I'll give you some examples, because I thought someone might ask these questions. I put together a few examples to illustrate what we're seeing. I want to underscore that, by and large, we're not seeing cancellations from these large customers. We're seeing deferrals of the decision, and in some cases, deferrals of the deployment. And the majority of those deferrals are to the second half of this year, to Q3 and Q4, which goes in part also to Tommy's earlier question about what confidence do we have, right? That's where we're seeing most of those push. I'll give you two examples. One of our large U.S. customers in the retail space, by the time we last spoke here in the first quarter, had ordered about $3 million from us. And they had told us that they were going to be ordering, by the end of Q2, an additional $20 million. Since then, in the last three months, they've taken $6 million and said, we're still going to order that in Q2, but we still don't have the purchase order yet. They're still trying to secure the budget for it. They have $10 million that they moved to Q3, and another $4 million that they moved to Q4. At least that's what they've told us so far. Of course, to your point about the visibility, will they actually order it then? we will see, but that's the current state of what we know and what's changed since we last spoke. Another even larger customer in the U.S., also a retailer, had ordered $5 million by the time we were speaking last year in February and had indicated that they were planning to buy $35 million by the end of Q2. Since then, they've said $11 million of that we're going to order in Q3, and $24 million, we will not have budget for this year, but we plan to order it in 2024. That gives you an idea of how things are moving and how these deferrals are happening, hopefully.

I think just one thing to add, those two good examples of the decline for the overall year and the full year guide, but at the same token, while we have a pipeline and actions that are above you know, towards the high end of the range, but, you know, being conservative on assuming all those deals won't get pushed further. So I think that's the trying to find the balance there around, you know, what we're hearing from our customers and the visibility with also understanding it's not certain until we get to PO.

Understood. Appreciate that, caller. I also wanted to ask you about your margin guidance. It seems you're actually expecting higher gross margins than previously. So is that – the case? And could you maybe walk through the changes underlying your margin guidance for the year? Thank you.

Yes, we've looked at our full year EBITDA guide of 22%. That was the low end of our prior range. We are seeing favorable gross margin trends, but that's being offset by the lower volume. So, again, if you look at an aggregate, nearly a point higher than last year, primarily due to the supply chain improvements. And you can see that from our versus our prior guide of reducing those transitory or premium supply chain costs for the year from 50 to 40, as both the freight rates improved and we're having to buy less components on the spot market. And that's still being offset. Those two points of improvement are being offset by about a point of FX. Despite the improvement in FX with our hedging program, there's still a headwind for the year on FX. Again, I think a couple of things. The pricing actions we've taken over the past year and a half are offsetting the material and labor cost inflation or recouping some of that degradation over the past year. And we have actions identified to adjust our cost structure with the lower volume.

The next question comes from Jim Ricciuti with Needham & Company. Please proceed. Thank you.

Hi, thank you. I just wanted to fill down a little bit more, if I can, on the deferrals. And you may have mentioned this, and I apologize if you did. But are the deferrals that you're seeing, are they skewed more in North America, or are you seeing that same kind of level of deferrals in EMEA?

Yeah, I would say, Jim, it's really both. And again, it's, you know, centered predominantly around, you know, retail. We believe ultimately have seen some moderation of demand in the other vertical markets, T&L and manufacturing, but it's predominantly retail and it's predominantly, you know, North America and EMEA. And I think it's important, as Joe said, to say that, you know, These projects haven't been canceled, and our customers still have conviction about the value we ultimately deliver to them around, you know, improved productivity, increased visibility across supply chains, more effective and efficient operations within, you know, retail. All those are important because these projects, while they're moving out, are still, you know, have strong return on investments for our customers. They're making tough decisions around efficiency. CAPEX in the short term to adjust in a macroeconomic environment. But what they're telling us is that, you know, as their CAPEX, you know, loosens up inside their organizations, they expect to move ahead, you know, with these projects. And the challenge in retail is because we've seen them continue to move out, we've had to take a conservative, you know, view of the outlook. And as Joe said, some of those projects have moved into 2024, but our customers are still committed to do those. So, I think that we're seeing that ultimately, you know, our customers can only hold off from buying for so long that we have mission critical solutions and they truly deliver, you know, value to our customers that make them more effective and more efficient in their business each and every day. And I think we feel that ultimately they are going to buy these projects and they're going to move forward. It's really an issue around timing and it's really, you know, North America and EMEA in retail is the primary challenge at the moment.

And I wanted to just follow up with a question, only because you mentioned it several times, the strength in RFID. Is that mainly from this large North American logistics customer, or are you seeing the strength in other areas of logistics, or is it also a function of what we're seeing and hearing in retail? And is that sustainable as you go through the year?

Yeah, I would say that, you know, we're seeing, you know, broad-based demand for RFID, you know, across, you know, supply chains in general. So, all the way from retail through transportation logistics, all the way back into manufacturing. So, you know, it is broad-based. We have the broadest and deepest RFID portfolio of solutions of, you know, fixed readers, handheld readers, mobile printers, you know, software and solutions as well as, you know, our labels. So, you know, we expect that, you know, we'll continue to benefit from the strength in RFID. I know, Joe, you want to add anything to that, but I think that we feel good about the RFID portfolio beyond this large win in T&L.

We do, and I would underline, Jim, the broad-based nature of this demand. We're seeing it in healthcare, for example. We're seeing it in T&L, where entire package operations that were previously barcode-based are being driven online. by RFID now for greater efficiency and fewer errors, and we're seeing it in multiple regions of the world. We're seeing it strong in Asia Pacific, but also strong in Europe where labor costs are high, and RFID can have an outsized impact. This is a broad-based movement. Thank you.

Our next question comes from Keith Howsam with North Coast Research. Please go ahead.

Good morning, guys. In terms of looking at the guidance for the full year, can you kind of help me with some context in terms of how you're thinking about the overall macro economy and how changes in the macro economy may affect your guidance to the good and the bad?

Yeah, I'd say, Keith, that, you know, I'll start and then I'll let, you know, Nate or Joe want to jump in. But, you know, we're clearly seeing a softer macroeconomic environment that, you know, is, you know, having our customers take a more, you know, conservative view of their CapEx budgets and, you know, in first half year. And we're seeing less certainty in those budgets for second half year. So a bit of the unknown, mostly in retail, and again, mostly in North America and EMEA is where We're seeing this. It's most pronounced there. What it results to for us is directly elongated sales cycles and, you know, opportunities that we thought were going to close in Q2 and be deployed in early Q3 as moving out. And Joe gave the examples of all the businesses that are moving out. Some portion of it is doing that, and some is moving into Q3 and Q4 from Q2, and others is moving into 2024. You know, we think that ultimately, you know, we've taken a more conservative view of our pipeline and the opportunities we expect to close in second half year. There's lots of reasons why we believe that guide is the right one, as Nathan covered. But we also believe that our T&L manufacturing customers, where we saw, you know, strong growth in first quarter, Even at the end of Q1, we're seeing them moderate a bit due to the macro environment. And we're taking a, you know, cautious view overall of what our pipeline and the projects within it because of it. But I think ultimately we feel good about our business. We feel good about, you know, the value we bring to our customers. And this is really all about the macro environment and specifically in, you know, more pronounced in retail in North America and EMEA.

Maybe if I can tweak that question just a little bit. I guess, does your guidance include, I guess, a soft or a hard landing in the U.S. and Europe? Or do you look at that context?

Well, I'd say that, you know, we've had, you know, a tough Q1 from a mobile computing perspective. You know, with double-digit declines in Q1, we see, you know, Q2, to continue to be challenged from a mobile computing perspective. But, you know, we saw strong growth in other parts of the portfolio, like, you know, data capture and print. So I think overall, you know, what we're seeing is, you know, mobile computing remaining challenged in first half. And then, you know, in second half, we see some of these projects, you know, moving forward and then continuing into 2024. So we don't see the environment being, you know, a hard landing or much different than what we're guiding to at the moment, which is, you know, we were delivered on our first quarter guide, you know, which, you know, ultimately was, you know, down. But we see Q2, obviously, we knew was going to be our toughest quarter. And we see, you know, recovery in the second half, but, you know, modest. And we believe we can deliver on our guide.

Great. Thank you.

The next question comes from Joe Giordano with TD Cowan. You may proceed.

Hey, good morning, guys. So I'm just curious on, you know, coming out of COVID, you put in a ton of assets, and I'm just curious on thoughts on the replacement cycle of that. So as we go into a, you know, a soft patch here, what's the ability of customers to, like, extend, you know, when they need to refresh this stuff? And just curious, the deferrals that Joe mentioned, Are these like new expansions, or is this like refresh of old product that is getting pushed out? Just curious there. Thank you.

Yeah, why don't I start right away? This is Joe Hill. The investments we've made over the last few years in customer success have given us a really good insight as to what our installed base is and how our customers are using it. And that has generally revealed to us that the usage cycles have shortened and that the replacements that are being contemplated now are things that have gone in approximately three years ago or even less than that. and of course we have just launched a brand new set of our mid-range and high-end mobile computers and the value tier was released last year so those are coming right into that refresh cycle that we're seeing from those customers and that's another reason why we're quite confident that while these customers are deferring decisions and deployments as we speak, they will have to purchase shortly. And we have, you know, pretty good confidence in that. It's the timing that we're uncertain about.

And then just to follow up, Nathan, if things do get cyclically worse here, how should we think about risk of, like, inventory obsolescence on things that you have on the books if the channel stays stuck, things like that? Thank you.

Yeah, I would say there's always a risk in a technology business of excess and obsolescence, but that's something the team actively manages in terms of when we put something in, a lot of that's in our control in terms of the lifecycle of a product, when we end of life a component or a finished good. And today we looked and say there's still demand for what we have in inventory and a component level. The team has a series of actions working with our suppliers to reduce purchase commitments where we can and drive programs where we have available stock with the commercial team. So, you know, today I don't feel, you know, I think there's, again, there's always risk given our business model, but I would say nothing more, you know, not more than we've had in other times. Thanks, guys.

The next question is from Mita Marshall with Morgan Stanley. Please proceed.

Great. Thanks. You know, you guys noted the benefit of price increases in the second half and just wondered, given the macro environment, if there's been any pushback to that or kind of shrinking of amount of units to kind of keep with the same dollar amount that you've seen in response to that. And then maybe just as a second question, you noted backlog was a benefit to printing. Kind of in Q1, just wondered, is there any meaningful kind of backlog or pent-up orders kind of across the space that we should be mindful of for the year? Thanks.

Joe, you want to take the price increases? Yes. So, Amita, we increased prices last year outside of North America towards the end of the year, and we have increased them in North America here in the first quarter. We have a very analytical approach to doing this where we literally analyze by product and by region where we stand competitively and what economics we can afford for our channel partners because we want them to thrive. And as a result, we looked at that and we said we have additional headroom in North America, just as we saw that at the end of the year outside of North America. We have implemented those and we have seen generally good traction with those and they're going to have a meaningful impact in terms of helping us to mitigate the challenges that we outlined earlier.

And if you look at the overall backlog position, it's normalized from where we were over the past several years. in line with what we need to deliver for the second quarter. I think that, you know, the positive news, both for print and DCS, is we've largely worked through our delinquent or age backlog. As supply has improved, still have some backlog to work through for both of those business. But in aggregate, I think we're back more to normalized levels, if not a little bit higher than we were pre-pandemic, but enough to definitely support our Q2, our 2Q guide.

Great. Thanks.

Our next question comes from Rob Mason with Baird. Please proceed.

Yes, good morning. I had a question just around your thought process on the channel distribution level, I guess, destocking. Is that a process that you think can be complete here in the current quarter, or does that extend into the second half as well?

I think a couple of things. I'll start with one. If you look at our overall inventory, I think in aggregate remains healthy. However, as we highlighted before, the DCs are realigning or aligning their days on hand, I should say, with the moderating demand as well as the improved lead times and the cost of capital. So we work closely with all the distributors so they have the appropriate days on hand levels. And that is recalibrating to the slower demand. you'll definitely see variations across distributors or regions due to the various dynamics. And that's why we look at it as a range in aggregate. But I'd say overall, we think those levels are in line with where we were pre-pandemic. But obviously, we think that is definitely have an outsized impact in Q2 relative to the rest of the year as the demand has softened here over the past month or two.

Does your guide at the midpoint take it down 4%. Does that assume that the run rate business would be down this year also?

I think that we've seen, you know, moderating Robin in the run rate business. We saw, you know, in Q1, um, You know, small to medium deals continue to grow. But as we got later into first quarter, we saw some moderating of that run rate business. So I'd say that, you know, we see it moderating. The real challenge seems to be around, you know, large customer orders and larger deals. And, you know, run rate, because we're continuing to see, you know, growth in DCS growth across our printing business. You know, we hadn't talked about it, but, you know, services and software were, you know, positive and delivered growth in first quarter as well. So we continue to see that throughout the year. So, you know, there's certainly bright spots, but the challenge isn't as much around run rate, I would say, is really around, you know, larger deals and larger customers.

Understood. Maybe just the last question to follow up on that. How do you think about, again, in a situation like this where deals are being pushed and conservative, you know, outlooks on IT budgets, how do you feel about how the adjacent expansion areas perform relative to your core business? Are those, you know, Are those at the same level of risk, or how do you view those differently just given different growth dynamics there?

Yeah, I'll start, and then I'll let Joe jump in. I think, as I said, we saw growth in services and software in first quarter, so we continue to – see that our software value proposition to our, you know, retail customers across, you know, our Flexus offering, our prescriptive analytics, you know, our Antuit AI offerings, our Workforce Connect has, you know, value to our retailers. And, you know, that falls into really, you know, an OpEx spending versus CapEx inside retail. We're seeing that, you know, strong, you know, interest in our fixed industrial scanning and machine vision solutions, as we said, manufacturing continues to be more, you know, spending and focused on continuing to, you know, drive productivity inside their, you know, environments. So we're seeing, you know, opportunities there inside fixed industrial scanning, inside TNLs, another opportunity. Again, we have, you know, lots of places where we can, grow our market share across both those, you know, two segments. And, you know, we're seeing that, you know, fetch from a autonomous mobile robot and warehouse automation perspective, both, you know, fulfillment and material movement. And that applies again to, to T&L with three PLs and then manufacturing with good movement. You know, again, strong interest there. So, you know, those businesses are much smaller, but I think we're continuing to see interest across our customers. And then we have lots of room to grow market share on things like machine vision and fixed industrial scheme.

Yeah, Rob, I would also point out some of the near adjacencies have been very strong contributors for us, not just in the last quarter, but recently. Tablets, for example, has become our fastest growing mobile computing category, and we now have a number one market share position in tablets. That's been a terrific contributor. We're seeing those use cases only expand in areas like healthcare, in areas like manufacturing that we hadn't even considered initially. And I mentioned earlier RFID, right, how that's been a broad-based growth driver for us. And by the way, the same is true for what we did in bioptic scanning, where we now have a very strong market position. So those adjacencies that are close to our core have contributed very nicely.

The next question comes from Brian Drab with William Blair. You may proceed.

All right. Good morning. This is Blake Keating. I'm for Brian.

Good morning.

Just wanted to dive a little bit into the second half implied guidance. I know it's already been asked a little bit, but I was curious to hear outside of retail what's driving your confidence in that second half revenue guide, if there's any in markets that are growing or any color you can give there, and then how we should think about that in volume versus price.

Yeah, I would say that, you know, across T&L that, you know, our customers continue to struggle with labor constraints and, you know, are looking to, you know, add to visibility across the supply chain and across their networks. We've seen some positives where, you know, T&L customers continue to make investments despite, you know, some of the challenges around the macro environment. So, you know, two examples of that is our postal win in Japan and the RFID win in North America. T&L show, you know, that some large projects and outside of retail are clearly continuing and our customers see the value in our solutions. So I think that, you know, T&L manufacturing is another area where, you know, we're seeing really investment in that business around industrial automation and opportunities, as I mentioned before, around fixed industrial scanning and machine vision. So they delivered solid growth in Q1, and they continue to invest in infrastructure to be more effective and, you know, efficient and productive within both their environments, T&L and manufacturing. And we expect that to continue to grow, but, you know, to moderate from the strong growth we saw in in Q1 to, you know, do the macro environments. Healthcare is, you know, we saw strong results in Q1 and it's less sensitive and less correlated to the macro environment. So we feel good about, you know, healthcare, you know, as well. So I think those are areas that outside of retail that we've taken into account for our second half guide.

And so by, and what I would add, Joe Hill here, by and large, we have not seen the deferrals of either project decisions or deployments nearly to the same degree in any of the three verticals Bill mentioned, T&L, manufacturing, or healthcare. They've had steady demand. Now, we're expecting that some of that may moderate a bit, but because it was, you know, they were all up very strongly in Q1. But nevertheless, we expect those will continue to contribute. One other area that we're investing in that we think has some good growth potential is government. We're seeing some, for reasons that are probably obvious, we're seeing some strong demand in the government sector.

And one thing I'd add, just on the second half, I mean, for the full year, we're expecting about a point and a half of benefit in price, including the most recent announcement. And I think I just came back, if you look at the second half, the implied guide's around minus 2%, again, but on a much easier comps. If you look at just the trajectory of the business last year and the first half growth versus second half, as well as the favorable effects impact. So those are again, some different dynamics when you look at the first half versus second half, um, for the year.

Got it. Thank you. And then just lastly on the Matrox acquisition, I was just curious how the business was trending and how we should think about it moving forward.

Yeah, I think, you know, I would say overall, um, You know, with the matrix acquisition and adaptive vision, it really creates a comprehensive portfolio of solutions across fixed industrial scanning and machine vision, so we marry our organic investment plus the acquisition of Matrox and Adaptivision to the portfolio. It really is what our customers and partners were looking for is to, you know, some of our customers are just beginning their automation journey. Others are, you know, have increased complex use cases that they're trying to deploy solutions and they're looking for a provider, both our channel partners and our end customers that can provide the breadth and depth of that solution from hardware to software. From a Matrox perspective specifically, we've seen continued progress. It's performed as expected, and the integration is proceeding as planned. We're looking to diversify our customer base there and really continue to grow the top line of that business, and that means that how do we extend our channel network and our partner community? We're working on expanding that. we're focusing on, you know, manufacturing opportunities. Examples could be, you know, automotive or, you know, battery manufacturing are two, you know, areas in which we see opportunities for us. And then, you know, ultimately, you know, leveraging the synergies I said across the two acquisitions in our organic portfolio, we're seeing, you know, strong interest, you know, from our customer base. We were just at ProMat, a you know, manufacturing and supply chain trade show, and we saw a strong interest from our customers. So we feel good about where we're at with Matrox and, you know, the opportunities we have ahead of us for machine vision and fixed industrial standing.

Got it. Thank you. I'll pass it along.

Today's last question comes from Guy Hardwick with Credit Suisse. Please proceed.

Hi. Good morning. Good morning. Good morning. I think three months ago you guys said on the Q4 call that channel inventories were only a few days higher than pre-pandemic levels. But I think Nathan said in answer to Rob's question that channel inventories are now back to pre-pandemic levels. Did I hear that correctly, first of all? And it sounds like in your prepared remarks that Q2 guidance in particular assumes further destocking. So based on your Q2 guidance, can you quantify what the difference could be between sell-in and sell-out in Q2?

Yes, I think, again, just to maybe clarify the comment in terms of, you know, we look at it in terms of an absolute range. So I think, you know, it still isn't that same range we were in from a pre-pandemic, no different than we were in Q4, maybe just a a little bit on the higher end. And so, you know, we don't have a sales out to sales in reconciliation. I would say that, you know, historically that when the velocity of the channel slows, we see an outsized impact as the disease moderate and manage their days on hand. So if they're, you know, filling slower sales out of the channel that requires less inventory to support that, which means they're not going to make the same type of stocking orders. So it has an outsized impact in what we see from a sales end. So there's always a, a disconnect there based on, you know, as you see the markets improve or decline. I think in Q2, that's amplified a bit by the improving lead times and their higher carrying costs. And I would say the opposite is true. When the macro improves, we tend to see an accelerated recovery. But again, that's not assumed in our full year guide.

So there is a assumption of destocking in Q2. So it suggests the underlying demand is better than your sales guide.

As you would expect with That's right. As you would expect, if you have lower sales out of the channel, that requires less inventory in the channel to support that business.

Sorry, Nathan, the last question for me is just what is your FX assumption, FX rate assumption for the rest of the year?

Yeah, we take the spot market, you know, as we put the guide together. So sitting around, you know, whatever, just around $1.09 to $1.10 for the euro. Okay, thank you.

This concludes today's question and answer session. I would now like to turn the conference back over to Mr. Burns for any closing remarks.

Yeah, I'd like to thank our partners, our customers, and employees for their support and dedication in this challenging and uncertain environment. It's an honor to serve as CEO, and I'm excited about the opportunities ahead of us. Thank you. Have a great day.

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