Mike Steele:

Good morning, and welcome to Zebra's second quarter earnings 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 and we refer you to the factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of this slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales performance are year-on-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 second quarter results. Nathan will then provide additional detail on the financials and discuss our third quarter and revised full year outlook. Bill will conclude with progress on advancing our strategic priorities. 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.

Nathan Winters:

Thank you, Bill. Let's start with the P&L on Slide 6. In Q2, total company sales were approximately flat, reflecting early signs of momentum demand beyond retail and e-commerce. Our Asset Intelligence & Tracking segment declined 14.4%, primarily driven by printing and RFID on challenging prior year comparisons. Enterprise Visibility & Mobility segment sales increased 8.2% with double-digit growth in mobile computing partially offset by a decline in data capture solutions. We saw modest growth in services and software. Performance was mixed across our regions. In North America, sales decreased 7% with fewer large orders in retail and transportation and logistics, partially offset by strong growth in healthcare. In EMEA, sales increased 10%, driven by mobile computing. In Asia-Pacific, sales declined 3% with continued weakness in China and challenging compares in Australia and Japan, partially offset by growth in Southeast Asia. And sales increased 7% in Latin America led by Brazil. From a sequential perspective, total Q2 sales were slightly higher than Q1, with growth in nearly all product categories as we realized modest improvement in demand throughout the quarter in manufacturing, healthcare, and transportation and logistics. Adjusted gross margin increased 60 basis points to 48.6% as we benefited from cycling premium supply chain costs in the prior year in favorable effects. Adjusted operating expenses as a percent of sales increased 110 basis points. This was driven by normalized incentive compensation expense partially offset by approximately $25 million of incremental net savings from our restructuring actions. This resulted in second quarter adjusted EBITDA margin of 20.5%, a 70 basis point decrease versus the prior year, and a 60 basis point sequential improvement from Q1. Non-GAAP diluted earnings per share was $3.18, a 3.3% year-over-year decrease. Turning now to the balance sheet and cash flow on Slide 7. In the first half of 2024, we generated $389 million of free cash flow as we drove improvements in working capital. We ended the quarter at a 2.4x net debt to adjusted EBITDA leverage ratio, which is within our target range and we had approximately $1.5 billion of capacity on a revolving credit facility as of quarter end. We diversified our capital structure during the second quarter by issuing $500 million of senior unsecured notes, while retiring a receivable financing facility that matured in May. We also terminated our remaining interest rate swap agreements for $77 million of cash proceeds. We have been prioritizing debt pay down and now have increased flexibility given our lower debt balance and improved cash flow. Let's now turn to our outlook. For Q3, we expect sales growth between 25% and 28% compared to the prior year. This outlook assumes continued stability of demand trends across our major product categories with broad-based growth as we cycle easier compares across the business, including significant destocking activity by our distributors during the second half of last year. We entered the third quarter with a solid backlog and pipeline of opportunities. That said, we are not anticipating an increase in large order activity considering the conversion rates on our pipeline remain lower than historical levels as customers continue to be cautious in what remains an uncertain environment. We would like to see additional momentum in large orders before factoring in a stronger recovery. Q3 adjusted EBITDA margin is now expected to be between 20% and 21%, driven by expense leveraging from higher sales volume with benefits from restructuring actions partially offset by normalized incentive compensation expense. Non-GAAP diluted earnings per share are expected to be in the range of $3 to $3.30. We have raised our guide for the full year, reflecting our second quarter performance and early signs of momentum and demand. We now expect sales growth between 4% and 7% for the year and adjusted EBITDA margin to be in the range of 20% to 21%. Non-GAAP diluted earnings per share are now expected to be in the range of $12.30 to $12.90. Free cash flow for the year is now expected to be at least $700 million. We have been making progress rightsizing inventory in our balance sheet and improving cash conversion. Please reference additional modeling assumptions shown on Slide 8. With that, I will turn the call back to Bill.

Mike Steele:

Thanks, Bill. We'll now open the call to Q&A. We ask that you limit yourself to one question and one follow-up to give everyone a chance to participate.

Damian Karas:

Hey, good morning, everyone. Congrats on the quarter.

Damian Karas:

Bill, I wanted to get your thoughts on what you suspect it's going to take to bring some of the larger project activity back into the fold, and maybe you could just give us a sense on, it sounds like you're not expecting much this year. How much upside to your guidance do you think there would be if you do in fact start to see a return sooner rather than later?

Damian Karas:

Great. That makes sense. And I just want to ask you on the cost front, it seems like there's been a pick back up in shipping rates, and I know that was a little bit of a headwind for you guys in past years. To what extent have you been maybe experiencing some of that cost inflation and maybe just talk through what's kind of in your guidance for the rest of the year? Thanks.

Operator:

The next question comes from Jamie Cook with Truist Securities. Please go ahead.

Nathan Winters:

Good morning, Jamie. So, yes, if you look at overall gross margins at 48.6%, this is our highest gross margin quarter in three years, benefiting from the level of large deals. So the strength in run rate and mid-tier is a positive for gross margin in particular within the EVM segment. We're also seeing continued strength in our service and software margins again, which is heavily less more weighted towards EVM, as well as now fully rolling over all the premium supply chain costs. So again, I think it was part of that was just the strength in the quarter and really seeing the incremental volume fall through to the bottom line, driving the sequential improvement in gross margin both within EVM particularly.

Nathan Winters:

Yes. If you look at our EBITDA guide for the third quarter of 20% to 21% again year-on-year, that's up primarily due to volume leverage, nearly 9 points. And I think we expect similar deal as well as business mix Q2 to Q3 such that you get a similar margin profile from Q2 to Q3. So if you look at the Q3 guide, effectively flat to Q2 based on that assumption of kind of the underlying mix of deals as well as the business unit mix gives us that similar profile. And I'd say the other really don't expect the same level of incremental benefits sequentially as we were able to realize some of the incremental benefits in Q2 from the restructuring actions. And then you do see that modest uptick implied in the guide for the fourth quarter on the incremental volume.

Tommy Moll:

Good morning and thank you for taking my questions.

Nathan Winters:

Good morning, Tommy.

Bill Burns:

I think that, Tommy, I'd say that customers continue to scrutinize their budgets even as we're well into the year, right? And I think that some of those have to do with, in the past, we've seen kind of year-end spending from our customers, but I think that the uncertainty around the economy is still kind of weighing on them in large deployments and what will happen in kind of second half of year here. So I think that we typically not have visibility quite yet into whether there'll be year-end spending by our customers. We're talking about certainly a pipeline of opportunities that they see. And then the question is, do they move ahead with those in late 2024 or into 2025. I think that from a macro perspective, whether it's interest rates or presidential election or manufacturing production, all those shipping parcel, parcels, shipments have just started to inch up and turn to more positive volumes or growth in volume. So I think all those kind of weighing on their business, and I think there's even though they've got budgets, it's kind of the reluctance to move ahead with those, really because of the macro factors overall. And I think that we'd expect those to continue to kind of stabilize. They can get more confidence in their business and then abate as we get into kind of second half year and into 2025. But I'd say, overall, many discussions with our customers regarding projects; it's really about just taking longer to kind of move those forward still. Now, again, we saw a large order activity about flat Q1 to Q2 overall, and we saw this pickup in mid-tier run rates. So these are all positive signs. Growth outside of retail, which we really saw in first quarter into a broader segment. Mobile computing was the first to decline and the first to return to growth we expected that. So I think everything's moving in the right direction. So I think that -- I think our customers just don't know for kind of year-end 2024 and into 2025, but we're optimistic, I would say, that everything's moving in the right direction.

Bill Burns:

Yes. No, I would say that really the competitive environment hasn't changed a lot. Overall, we're certainly continuing to maintain share in the marketplace. We feel good about our differentiation that we bring to the marketplace with the depth and breadth of our solutions, our competitive advantages, scale, technology, leadership, our partner community, our go-to-market, our relationships with our customers. So the large deal, phenomenon not coming, not returned to historic levels is not really about Zebra. It's truly about the market. And we don't really see any mark change from a competitive perspective. We're always going to have competitors out there, large and small, and then that continues to be the case. So nothing there. And we feel good about our market position and continue to win in the market.

Joe Giordano:

Hey guys, good morning.

Nathan Winters:

Good morning, Joe.

Nathan Winters:

Yes, Joe. This is Nathan. I can take that. I'd say overall, the global channel inventory as we look at it from days on hand is still at a normalized level. I think you have pockets around the world, where there's still a little bit of rebalancing both driving down inventory in the channel as well as where there's incremental needs. And I think similar to where we were last quarter, it's working with each one of those partners across the region to ensure that they have the appropriate level of inventory for the demand they're expecting and that we see in the pipeline. So again, it remains very collaborative. I'd say similar position where we were in Q1, where there's always some that want a little bit more. And again, just trying to make sure we have the right amount in the channel to support our end users, but not getting ahead of ourselves, given some of the uncertainty that we've talked about.

Bill Burns:

Yes. I can take that, Joe. I'd say, RFID challenging kind of second quarter on compares from cycling large opportunities a year ago. I would say that overall would expect return to growth in second half year. We're continue to -- we move into the second half really with strong backlog and pipeline of opportunities across not just retail but transportation, logistics, manufacturing. So we're seeing continued use cases across RFID, including moving beyond apparel to general merchandise inside retail. Clearly track and trace across the supply chain, parcel tracking within T&L, baggage tracking within airlines, so lots of opportunities across RFID. I would say machine vision. We continue to be excited about the opportunity within machine vision, challenging market at the moment. And our Matrox acquisition, when we acquired that asset, we knew was heavily weighted towards semiconductor equipment manufacturing, which is still a challenge segment as well. So decline in the quarter in machine vision, but we feel good about it overall. We saw strength in our Adaptive Vision acquisition. So software -- machine vision software in the quarter that was a bright spot. I'd say that the diversification of that business, which was our focus all along with the Matrox business diversify into areas like automotive and logistics into new areas. We also had our organic investment in machine vision, which really applies more to logistics area. That diversification is going well. Ultimately, we're calling on more customers. We're seeing more opportunities. We're continuing to invest in go-to-market across the globe in just seeing more opportunities is across machine vision. So we feel good about that in a great opportunity for Zebra overall. I'd say software -- our software assets, we're seeing the combination of our mobile devices, especially in the wearable space now with some of our assets in software that we're pretty excited about. So the word cloud solutions really focus on retail and then leveraging our mobile device in the hands of retail associates. And we continue to advance and bring those solutions together and combine that with things like wearable mobile computing. We've seen some early wins there. So we feel good about the portfolio. They're a smaller segment of the market, right, or, sorry, our not market, meaning smaller segment of our business overall or piece of our business. So really mobile computing returning to growth, other segments being more challenged. These are areas that we see as driving the future growth of Zebra.

Andrew Buscaglia:

Hey, good morning, guys.

Nathan Winters:

Good morning.

Bill Burns:

I'd say overall we're, from a mobile computing perspective, I'd say that our customers have really been absorbing the capacity that they've built out during the pandemic more than anything else. So I think there's clearly continued upgrade cycles across all of our customers. But from the idea that they built out so much capacity during the pandemic that they're using that capacity today, and then as the economy slowed, that created even more capacity, so they're ever using that capacity off, I think we're seeing customers move into the idea that they've absorbed some of the capacity and are beginning to buy again. But that's kind of early signs of what we're seeing. I'd say that there's a solid pipeline of opportunities for mobile computing overall, both in kind of refresh new use cases continue to add to the number of devices inside our customer base. And we continue to see competitive wins across the portfolio. So I think the upgrades are out there, the refreshers are out there, and ultimately some customers are sweating assets a bit more, others are leveraging what they have today. And I think that we're confident that as the macro environment gets better, our customers will continue to upgrade our devices and we'll see an uptick in large orders within our business, which will marry with what we're seeing as kind of medium in run rate business growing in second quarter.

Nathan Winters:

Yes. So I think on the first part, again, please raise the guide for free cash flow to over $700 million, including the final settlement, as well as the swap sale in the second quarter. So -- and the improvement overall in working capital to get us above the 100% free cash flow conversion. And as you say, the -- really the prior -- we've prioritized debt paydown as well working on our capital structure in the first half of the year. So ending the second quarter just under our below the target range of 2.5x debt leverage, and that will sequentially improve as we move through the year. I think in terms of overall priority, they remain unchanged. The first is organic growth getting the business back to the growth trajectory we need it to be and want it to be along with the right profitability levels. M&A continues to be a lever. And I think now with the improved cash flow as well as our overall capital structure, we have additional flexibility for share repurchases as we move through the year. So Bill, you want to touch on the M&A brochure?

Operator:

And the next question comes from Meta Marshall with Morgan Stanley. Please go ahead.

Bill Burns:

Yes. So I'll start with healthcare and then jump to EMEA. Healthcare, I'd say overall, mobile computing drove the growth in healthcare. It really is our team's focus on clinical mobility and really total cost of ownership. We've seen in the past a significant number of consumer devices used in that space. And I think that we're seeing healthcare systems realize that the total cost of ownership of Zebra devices is well-positioned for them in an environment of tighter budgets and thinner margins overall within healthcare. And we add a lot of value, ultimately by improving productivity of healthcare workers, getting data into electronic medical record systems, and then ultimately enhancing patient safety overall. So I think the automating of workflows, the digitizing the information around assets and patients and staff is of value that our healthcare customers are seeing. I think a medium to longer-term opportunity we're now seeing is things like home healthcare that remains an opportunity for us. So things like tablets in that area, in home healthcare. So we're excited about that. Healthcare has always been a smaller piece of our business, but in one of the faster growing areas, and certainly that happened in Q2. I would say, if we move to EMEA, say overall strength in EMEA was relatively easy compare in Q2 compared to the other regions. Overall, the positive, I'd say in EMEA is that we saw some larger projects move ahead outside of retail. So this is one of the places where we've seen some growth in P&L outside of retail, and some competitive wins in EMEA. So we feel good about that. Manufacturing remains challenging in EMEA today. So I think that kind of mixed overall feel good about some P&L orders, large P&L orders, easier to compare where manufacturing makes challenging. So I think overall, I think we want to see North American EMEA, we'd expect to come out of this first, but we saw some strength in Latin America too. So I think mixed results across the region.

Brad Hewitt:

Hey, good morning, guys. Wolfe Research, not sure what happened there.

Brad Hewitt:

Yes, sorry. So, just curious if you could elaborate a little more on what you're assuming in the second half from the top-line perspective. So at the mid-point of your full year guidance, it implies revenue in the second half, essentially flat with the Q2 run rate. So can you help me reconcile that versus kind of the early signs of momentum in mobile computing and also given the typical positive seasonality in Q4?

Brad Hewitt:

Okay. That's helpful. And then you guys have talked in recent quarters about your expectation for seasonally lower OpEx spend in the second half of the year. Just curious if you could kind of shine some more light on that. And then if we look at the implied Q4 EBITDA margins about 21%, can you talk about some of the puts and takes there on a sequential basis?

Operator:

And the next question comes from Keith Housum with Northcoast Research. Please go ahead.

Bill Burns:

Yes. Keith, this is Bill. I would say that overall, we've seen consistent growth in software and services over the last several quarters. So we feel good about that. I'd say we continue to see strong attach rates with mobile devices. So the revenue lags that, of course, right? So ultimately, the strong attach rates continue with uptick in mobile computers. So no real change there. It's just not tied directly to revenue in the exact quarter depending on when the mobile devices are sold. So I wouldn't take anything away from that. We're continuing to see strong attach rates, really driven by things like upgrades around OS and security patches and so forth continue to be an important aspect of our customers buying service from us. I can say that we've seen in the past some customers extend their support agreements, and I think we're seeing a little bit less of that now, which is again a good sign for ultimately our customers looking to upgrade the mobile devices in the future. So maybe a little bit of less of that, if anything else. Overall, I'd say software and services, an important piece of our business, recurring revenue that we and others like. So I think all good there, nothing really to read into it, Keith.

Bill Burns:

Yes. I think we're -- obviously, there's customers are making choices on the type of device they need in their environment. So I think that we continue to see that. So if somebody needs a more rugged device, and their experience was they had a lower tier device and they beat those devices up, they'll move to a higher tier device and you'll see the reverse. If they had a good experience with a more rugged device, could they go to a more mid-tier type device? I think that happens all the time. I think we continue to focus on value that the devices bring to our customers to keep ASPs as high as we can, and then if we can't, to make sure that we're getting the same gross margin out of each tier of the portfolio. In the past, we've tiered the portfolio kind of good, better, best, or all the way down to kind of value tier. And I think that's allowed us to keep our pricing and margins higher. So if you want a higher spec device, you pay us a higher price for it. In the early days, call it, eight, nine years ago of -- eight years ago, nine years ago on Android, we didn't have as many flavors of devices. So you're discounting higher end devices to meet value to your players. We don't do that today. We're really tearing the portfolio has allowed us to kind of have conviction around our prices at the higher end, and we feel good about our customers and working closely with them to select the right device for the right use case.

Brian Drab:

Hi, thanks. You mentioned that you're seeing sequential improvement in all the end markets, including T&L and manufacturing. There have been some signs of further softness across the manufacturing industry in recent weeks, and I'm just wondering if you are seeing any of that show up in your customers buying patterns or if it really does feel like a pretty stable sequential improvement environment now.

Brian Drab:

Okay. Thank you. And then for follow-up, are you seeing opportunities potentially to gain share when we come out of this tougher environment? I mean, you obviously have a great balance sheet. You're not letting up in terms of investment in technology and customer service. Can you comment on how you might be potentially better positioned in both AIT and EVM ultimately?

Operator:

And the next question comes from Rob Mason with Baird. Please go ahead.

Nathan Winters:

Yes. Rob, I'd say just if you look, I would say, no structural difference in terms of maybe the differential between the margin we'd expect on a large yield versus kind of the run rate business. So that hasn't structurally changed. The one thing, if you go back, I think the one aspect, particularly if you go from 2019 -- since 2019, whether that's tariffs, the supply chain, challenges the rapid growth. So it's pretty challenging to find what's the right baseline. And if you go back to 2018, right, so I'm just the lower rev -- lower base. So I think, if you look at the business today, I think the strength across the portfolio is -- we have strength across the portfolio in terms of the underlying gross margin and being able to leverage the scale and leverage our distribution network as we've grown to inherently build a higher gross margin profile company. But again, I think it will be somewhat decremental as we in gross margin once large deals recover, but still incremental, as you think about it from a EBITDA rates. So I think there's the balance of -- there's still incremental margin to the total -- to the bottom line, but slightly dilutive in gross margin.

Bill Burns:

Yes, Rob, North America was down year-on-year. I'm not sure it's sequentially -- down sequentially as well. Nate's warning to me, I would say, overall mobile computing return to growth in North America, again, just like we saw across the other regions. So that clearly was positive. The other product categories were down, as a year ago, in first and second quarter, we saw supply chain challenges abate from a print and a scanning perspective. So the compares were pretty challenging for both those businesses. They had really good Q1 and Q2s of last year. So I think that impacted North America. In North America typically has an overweight on large deals as well. So growth in North America, we really like to see kind of run rate, mid-tier and large deals because the large deals are overweight typically in North America. So we saw kind of flat sequentially, as we said before, large deal activity, Q1 to Q2. And really, North America would like to see more large deal activity come back here in kind of second half, and then hopefully some year-end spend and then growth into 2025. So that's really the story of North America.

Chris Grenga:

Hi, good morning. This is Chris Grenga on for Jim. Most of my questions have been addressed, but maybe just one for me. The chart with the touchpoints is very helpful. Just wondering, as you look ahead to seeing larger projects return, are you preparing for large project activity to be in any one of these particular nodes, whether it's factory, warehouse store, or last mile, et cetera, or do large projects generally entail a broad coverage of one or many of those nodes, or just how you're thinking about that? Thank you.

Operator:

And the next question comes from Guy Hardwick with Freedom Capital Markets. Please go ahead.

Bill Burns:

Good morning.

Bill Burns:

Yes. So we think of AI across the portfolio in several different ways. First is that just our core business really is about collecting real-time data, and that's used as kind of intelligence to feed AI models overall. So whether that's a barcode reading a printed label with the information on it back into the cloud, whether that's an RFID tag being read. So the idea of digitizing a customers' environment, getting real time data to AI models, and ultimately to generate insights in AI is a fundamental thing we do in our -- the value of our data that we collect feeds these models. So I think that's kind of the baseline of when we think about AI. Second is traditional, more traditional AI is used about probably in 50 different solutions across the portfolio today, whether that's optical character recognition or product recognition, navigation for autonomous mobile robots, package dimensioning inside our software around workforce planning and demand forecasting. So traditional AI is kind of the second piece that we think of across the portfolio. The third is what you're kind of referring to is the idea that it's AI assistant, right? Is that empowering the frontline worker through more information, leveraging a large language model on the device without connectivity to the cloud? Working closely with Qualcomm and Google, as you mentioned, to go do that. We've demonstrated that it -- at our National Retail Federation Trade Show in January. We demonstrated again at our Innovation Day. We also demonstrated at Google's Trade Show earlier this year as well. So I think we're excited about that opportunity. Today, it's not commercialized yet. We're continuing to work closely with our customers to really understand all the use cases, what's required around that. How do we best leverage which model in that case, how do we keep the model up to date? So a lot of different discussions with our customers about what that offering will look like. But we're excited to work with Google and Qualcomm on it. Our customers excited about having a digital assistant within retail or manufacturing. You think of all the use cases of making your newest worker as good as your most experienced worker, having all of your standard operating procedures at the hands of the associate or the frontline worker, being able to tie that back to what's the source of the data being restricted to the individual customer. So we think it's a driver long-term for our mobile devices and a differentiator for us. But today, still early days, more pilots and demonstrating and working with customers than commercialization.

Bill Burns:

Yes, no, likely -- like we're going to have more demonstrations around it that we're planning today with some of our customers at the National Retail show as we go the next step along with it next year in 2025, and then probably commercialization in likely in 2025 as I would see it today.

Operator:

And the final question comes from Rob Jamieson with Vertical Research. Please go ahead.

Bill Burns:

Thanks, Rob.

Bill Burns:

I think that clearly are strategic relationships with our customer creates an opportunity for us to deploy a broader set of solutions within those customers. That, that trusted partnership allows us to go do that. I think the backdrop of the environment hasn't been all that great. So machine vision is a good example of that. It's been kind of a challenging market and then our diversification just takes time where we were centered really around more semiconductor manufacturing and moving outside of that. So -- but that is -- our customers are giving us an opportunity to sell solutions in that space because we have a relationship with them already. I think we're seeing the same thing across retail software and robotics, as you mentioned. So clearly it matters. Our breadth and depth of our current portfolio, the relationship we have with them, the fact that we're a trusted partner to them; it's not always the same persona. So it's not -- I wouldn't say it's easy. Meaning we've got to get from our current buyer of our solutions and the person who deploys our solutions today to someone else within the organization. So if we're working with somebody inside a manufacturer more on the distribution of products at the end of the manufacturing line, we now need to form a relationship with somebody on the manufacturing line for things like machine vision solutions to stick with that example. So it's not easy, but it's certainly doable. And our -- because of our trusted relationship, they're willing to make that introduction. And then we've got to earn our way in and prove our solutions into that manufacturing space. But we're given that opportunity because of those relationships.

Bill Burns:

No, I think that again, it's -- we think of assets that are closely adjacent to the portfolio overall, and really synergistic to what we do today. We'd like to do things in the similar vertical markets for the reasons we just talked about. So all that comes into play. And then ultimately, as I said before, a little bit higher hurdles at the moment, given the macro uncertainty to make sure that if we were going to acquire something, or the certainty of revenue, and then ultimately higher risk interest rates weigh down on that a little bit. So I think overall, we continue to be inquisitive. It's got to be the right asset and the right fit for Zebra.

Bill Burns:

Yes. I'd like just to wrap up by saying thank you to our employees and partners for continued support of Zebra and execution in the second quarter. We're now positioned for growth in the second half year. So have a great day everyone. Thank you.

William Burns:

Thank you, Mike. Good morning, and thank you for joining us. As expected, our first quarter performance was impacted by continued broad-based softness across our end markets and regions, which we began to experience in the second quarter of last year, resulting in a double-digit decline in sales and profitability. However, we are beginning to see a modest recovery in demand as we saw sequential improvement from the fourth quarter. We are particularly encouraged by the better-than-expected large order activity, which drove the upside for the quarter. That said, we are not yet seeing a broad-based recovery. And as a result, we continue to take an agile approach to navigating the current environment.

Michael Steele:

[Operator Instructions]

Jamie Cook:

Nice quarter. I guess first question, can you just call out how much freight helped the first quarter lower freight cost? And then what's implied in the guide relative to how you guided last quarter? And then I guess just my second question. The gross margins in the quarter struck me, in particular, the sorry, the EVM margins, which were up year-over-year. And so I'm just wondering if you could help us understand what drove the gross margin improvement on the sales decline there?

Nathan Winters:

Yes. 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%.

Damian Karas:

I was wondering if you could maybe elaborate a little bit on the large order activity, which you spoke? Could you give us a sense, right, is this sort of 1 or 2 customers that are placing rather large orders or are you kind of seeing just your larger customer base in general, start to bring back a larger quantity of project activity? If you could just maybe elaborate and provide any detail like which end markets and regions you're seeing some of these larger orders as well?

Damian Karas:

That's really helpful. And then a follow-up question on your guidance, just maybe ask a little bit differently. I know you guys have spoken of, right, this really large funnel, but just kind of a lack of conversion to orders. Guidance sort of has you sequentially second half sales comparable to the first half. Could you just tell us like what you're assuming for that funnel conversion, kind of a probability of some of those projects hitting in the back half?

Operator:

The next question comes from Keith Housum with Northcoast Research.

William Burns:

Yes. I mean, Keith, it's Bill. I think that overall, the Q1 performance was continued to impact by soft demand across all of the regions. So I think we start there. I think that as we've said, the relative outperformance was really in mobile computing, and we saw some bright spots in services and software clearly in the quarter.

Nathan Winters:

Keith, as you mentioned, our Q2 guide slightly above 19%, so down from the 19.9% in Q1. That's entirely driven by the seasonality of our retail software business, which you probably recall, but is seasonally higher in Q1 at accretive margins, just given the timing of retailers when they've performed their cycle counts and physical inventories, which is where that platform really focuses.

Thomas Moll:

You've given us some context on the omnichannel retail and e-commerce end markets, but I wanted to ask for any other detail you could provide. In particular, on the e-commerce side, there are some anecdotes regarding finally hitting the end of this absorption phase from some of the overbuilding in years past. Are you seeing any signs of that on your side?

Brad Hewitt:

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.

Nathan Winters:

You see it in the pipeline in terms of where the deals are at in the deal stage. So you qualify versus where we'd like to see them more in the validate secure. So earlier stages of the funnel, particularly in the second half, than where we'd like to see it at this point in the year or relative to what we've maybe seen in prior years.

William Burns:

I would say that year-end spending across retailers that their years and differently, whether it's the truly year-end or into first quarter. So I think we typically see orders that bridge both on an annual basis. So I don't think there was much that move between Q4 and Q1 as much as just customers need product before they have their year-end from a retail perspective.

James Ricchiuti:

Maybe I missed it. Did you comment about the activity you're seeing in the SMB market? Is that -- is the recovery you're seeing in ports to retail, also impacting that part of the business?

James Ricchiuti:

Got it. How would you characterize the RFID business in the quarter, level of activity you're seeing and just the trends in that business, we're starting to see more activity, it sounds like on the T&L side with the big customer moving out of the distribution center into the package delivery side of the business? How would you characterize RFID for you?

Operator:

The next question is from Joe Giordano with TD Cowen.

William Burns:

I think overall that the EMC clearly, across mobile computing is really what you're talking about in kind of large refresh cycles. And as I've said a couple of times already, we're seeing that as the first signs of recovery. And really in retail to start, I think that the customers in have begun to absorb their capacity, certainly in e-commerce. We'd like to see that happen across T&L as those customers build out a lot of capacity as well during the pandemic.

Joseph Giordano:

Fair enough. And then maybe just shifting to the balance sheet quickly. With your key markets, at least we get the data magnitude of recovery, but it seems like deterioration has kind of stopped. It was good to see you pay back some debt here. Cash flow looks strong. So is there an appetite for buybacks to kind of increase your leverage on a recovery as you come out of this?

Operator:

The next question comes from Andrew Buscaglia with BNP Paribas.

Nathan Winters:

Yes. No, you're absolutely right. So the comment on Q3 similar to Q2 was on -- from a revenue perspective, we do expect an uptick in margin as we go through the year. Some of that just similar to what we talked about in the last call, which is phasing of some of the incremental cost actions that will be coming through late this quarter and early part of Q3 as well as our, say just normal project timing between things, like payroll taxes and just the typical funding cycle with -- as you get into Q3, Q4, you get into holidays, so it tends to be a little bit of a downtick in terms of just seasonal spend.

Andrew Buscaglia:

Okay. And then maybe along the lines of Joe's question, heading into your cash flow is improving, you raised it a bit. What about M&A now? I think the software story has been nice. It's helping you lately. So what's the environment like as you see it with deals?

Brian Drab:

So clearly, I just want to clarify one thing. So clearly, you're seeing the recovery in retail, and you said you expected that to play out this way where retail comes back before manufacturing and T&L. Are you -- does that mean that you're not seeing recovery in manufacturing and T&L yet or that the recovery in retail is just stronger at this point than those 2 categories?

William Burns:

I'd say overall that it's hard to predict where each is going to end up. I would say, overall, the core and mobile computing has become -- is recovering first. I think each has a different dynamic. So I think that things like tablets and others in the expansion categories will be closely connected to things like mobile computing. RFIDs in that category, and that will continue to be an opportunity.

Meta Marshall:

I think you alluded to this in kind of the replacement cycle question earlier in the call. But just any trends between kind of mobile computing and printing as we think about kind of some of these renewal cycles coming up?

William Burns:

Yes. I'd say that as we talked about mobile computing clearly showing the first signs of recovery as expected, and we talked through that a fair amount. I would say that in printing, we saw kind of broad-based declines, but has stabilized now in Q1. There was a difficult compare in Q1 for both printing and DCS as a year ago, first quarter '23, we saw supply chain challenges abate in both those areas. So we shipped a lot of printers and scanners in the quarter a year ago. So the compares were pretty tough.

Robert Mason:

Bill, you've touched on it a couple of times, just the run rate business, you haven't necessarily seen signs of recovery there yet. I would just want to see if you could put a finer point on the expectations there for the year, just in the context of your overall guide -- sales guide up 1% to 5% relative to the -- maybe the large deal side of the business?

Nathan Winters:

Yes. I think, Rob, you said that play when you say the flat, right kind of Q1 to 2 to 3 in terms of overall revenue. Flat, just because that's what we see in terms of the trajectory across all the different categories of business without seeing an inflection point of a dramatic uptick. Again, that's how we feel it. That was the appropriate guide based on what we're seeing today across all those different categories.

Nathan Winters:

I would assume that the vast majority of the cash -- the $600 million of free cash flow will either go to debt pay down, maybe a little bit in terms of held in cash at some modest interest rate, but the vast majority would go to debt pay.

Kenneth Newman:

Most of my questions have been asked, but I just wanted to ask a longer-term higher-level question. Obviously, you've got some very significant operating leverage implied for the back half, and I think that's mostly just on easier comparisons on the volume side.

Nathan Winters:

Yes. As we mentioned, obviously, the volume leverage or the margin expansion in the second half is highly correlated with the increased volume along with -- coupled with the restructuring actions we took throughout last year. And really, for us, the target was to get back to above 20% as the baseline so that we can grow and scale from there. And I think still too early to tell in terms of what exactly that framework looks like.

William Burns:

Yes. I'd like to thank our employees and partners for the stronger-than-expected start to the year and positioning Zebra to return to growth in the second half of the year. We look forward to seeing analysts and investors at our Innovation Day in 2 weeks. Have a great day, everyone. Thank you.

Mike Steele:

Good morning, and welcome to Zebra's fourth 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, and we refer you to the factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of this slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales performance are year-over-year on a constant currency basis and exclude results from acquired businesses for the 12 months following the 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 fourth quarter results and actions we are taking. Nathan will then provide additional detail on the financials and discuss our 2024 outlook. Bill will conclude with progress we are making on advancing our Enterprise Asset Intelligence 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.

Nathan Winters:

Thank you, Bill. Let's start with the P&L on Slide 8. In Q4, sales decreased 33% with distributor destocking accounting for more than one-quarter of the decline. We saw double-digit sales declines across our regions, major product categories and customers of all sizes. Our Asset Intelligence and Tracking segment declined 33.6%, primarily driven by printing. Enterprise Visibility & Mobility segment sales declined 32.7% led by data capture and mobile computing. On a positive note, we drove services growth with strong attach and renewal rates. From a sequential perspective, total Q4 sales were $53 million higher than Q3 despite a similar magnitude of distributor inventory destocking due to modest improvement in demand. Adjusted gross margin decreased 100 basis points to 44.6% and primarily due to expense deleveraging from lower sales volumes and the $10 million charge mentioned earlier associated with the renegotiation of a supplier agreement, all of which were partially offset by higher services and software margin and cycling premium supply chain costs in the prior year. Adjusted operating expenses delevered 670 basis points as a percent of sales. The impact was mitigated by more than $20 million of net savings in the quarter from our restructuring actions. This resulted in fourth quarter adjusted EBITDA margin of 15.4%, a 710 basis point decrease. Non-GAAP diluted earnings per share was $1.71, a 64% year-over-year decrease. Increased interest expense contributed to the decline offset by a lower tax rate from executing on a global tax strategy. Turning now to the balance sheet and cash flow on Slide 9. We ended the quarter at a 2.5x net debt to adjusted EBITDA leverage ratio which is at the top end of our target range. We generated $102 million of free cash flow in Q4 and had approximately $1.1 billion of capacity on our revolving credit facility as of year-end, providing ample flexibility. For the full year 2023, negative free cash flow of $91 million was unfavorable to the prior year, primarily due to lower operating profit, higher interest and tax payments restructuring actions and previously announced settlement payments, all of which were partially offset by lower incentive compensation payments. Let's now turn to our outlook. We entered 2024 with distributor inventory levels aligned with recent demand trends and improved backlog driven by modest year-end budget spending into January from certain retailers. For Q1, we expect a sales decrease between 17% and 20% compared to the prior year. This outlook assumes continued declines across our major product categories, particularly printing and a 50 basis point favorable impact from FX. We anticipate Q1 adjusted EBITDA margin to be approximately 18%, driven by expense deleveraging from lower sales volume, partially offset by lower premium supply chain costs. Non-GAAP diluted earnings per share are expected to be in the range of $2.30 to $2.60. Q1 sales and profitability are expected to sequentially increase from Q4 as distributor inventories and end market demand has stabilized, and we have realized incremental benefits from cost actions. For the full year 2024, we expect sales to be in the range of a 1% decline and 3% growth. Although we are beginning to see signs of improvement in order activity, we are not yet seeing signs of a broad market recovery. Consequently, we are taking a cautious approach to our guide until we have increased visibility to a sustained recovery in demand. Adjusted EBITDA for the full year 2024 is expected to be approximately 19%. We expect our restructuring actions and other profitability initiatives to drive improvement through the year delivering EBITDA margin of 20% in the second half. We remain cautious in our spending and continue to take an agile approach to navigating the environment. We expect our free cash flow in 2024 and to be at least $550 million, including the impact of our final $45 million settlement payment in Q1. We remain focused on rightsizing inventory on our balance sheet, driving 100% cash conversion over a cycle and prioritizing debt pay-down in the near term. Please reference additional modeling assumptions shown on Slide 10. With that, I will turn the call to Bill to discuss how we are advancing our Enterprise Asset Intelligence vision.

Mike Steele:

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

Tommy Moll:

I believe it was Bill who made the comment about the need to absorb some excess capacity in the e-commerce landscape and I'm curious, based on your discussions with end users in that ecosystem. Do you have any visibility into when most of that capacity will be absorbed? Is there any assumption in your 2024 outlook about a return to more normal levels of spending there?

Tommy Moll:

Yes. And one point I wanted to clarify, Nathan, I think in your comments, you talked to an improving backlog in January and that there were certain retail-related orders that drove that. But could you correct the record there, if I got it wrong and just give us any more detail there?

Operator:

Thank you. And our next question comes from Brad Hewitt with Wolfe Research. Please go ahead.

Nathan Winters:

Yes. Maybe I'll start with just kind of the framework for the guidance. So yes, you're right. If you look at our Q1 guide, down 17% to 20% sequentially, that does improve from Q4 as we are not assuming any additional distributor destocking. So that drives the vast majority of the sequential improvement, again, along with the some uptick in demand that we saw particularly around year-end spend. And then if you look at the full year guide of 1% at the midpoint as you noted, if you look we expect Q2 to look similar to Q1 with the modest sequential improvement as we move through the second half. And as we talked about in the prepared remarks, I think we're cautious given the lack of visibility and the commitment to the pipeline in the second half. So if you look kind of again at the balance of the year, as you noted, really the growth is entirely driven by the 2023 destocking with the market flat, maybe down a little bit in Q2, up a little bit in the second half. And we think that's appropriate given the visibility we have around the demand environment.

Nathan Winters:

I would say that overall, talking to our customers and spending a lot of time with our customers and partners through NRF that clearly, our customers see that there's tremendous value in what we do for them each and every day to make their businesses more effective and more efficient and to literally run their businesses. So, we see the opportunities across each one of our vertical markets as we see really retail likely returning first is where continuing to work with them as they've been holding off and sweating assets within their environments and our engagements with NRF, certainly, we've seen optimism by our retail customers in the second half of the year. We marry our mobile devices there with our software solutions. And what we talk about is really resonating with them around our modern store initiative. We see that in transportation logistics, our value proposition remains really to help our customers with things like labor constraints and additional supply chain visibility across their businesses and we're excited about opportunities there within opportunities in technologies such as RFID as they look to get more to productivity across their businesses. We've got the MODEX trade show coming up in transportation logistics, Expo coming up next month here. And will showcase our solutions to across transportation logistics. We've talked about manufacturing has really been an opportunity for us is that we're less penetrated in that market, and we've got new solutions around machine vision and robotic automation and our demand planning software offering inside manufacturing. So we see that as an opportunity for us. And then lastly, health care, as we continue to see ways to automate workflows and digitally connect assets and patients and staff within the health care environment. We see home health care and telehealth being an opportunity. So, there's lots of opportunities across each one of the vertical markets. We'd probably say that retail is a place that we've seen some of the positive year-end spending first. And then I think the other vertical markets will follow.

Meta Marshall:

Great. Maybe first question. Just -- you noted that the headwind from destocking was about the same in Q4 as in Q3. I think we had expected it to be slightly smaller understanding that's largely behind us. But just was that amount of destocking kind of greater than expected in Q4? And then maybe as a second question, obviously, the interest rate environment is maybe a little bit friendlier now your balance sheet, your interest rate is relatively heavy on your interest expense. Just wondering, if you've looked at any opportunities to refinance that at more attractive rates?

Operator:

Thank you. And our next question today comes from Joe Giordano with TD Cowen. Please go ahead.

Bill Burns:

Yes, Joe, I'd say that probably if you look back to January, we literally have met with thousands of our customers and partners across our channel partner summit in Asia Pacific and than in Europe and then North America, Latin America and then with the National Retail Federation show. And it's clear that our solutions are essential to what our customers are doing in their business every day and they're grateful to have gone honestly, Zebra is a strong partner along with them. And they're excited about the innovation that we're bringing to market and they're optimistic. So our partners and our customers are optimistic. They're happy to put 2023 behind them, quite honestly. And there's optimism for 2024, especially in second half year. However, I would say that from our perspective, and it's prudent to remain cautious and that we haven't seen a broader recovery. We've really seen some kind of green shoots here in the year-end of year-end spending across retail, mostly in North America. And we'd rather -- we'd like to see first some orders, projects, deployments really move forward before we get ahead of ourselves kind of for the full year. So, I think optimism, happy to put '23 behind us. I think we feel good about modest increases through the year as demand progresses throughout the year, but we'd like to get a little more confidence by having more orders, more projects, more deployments across our end customers move forward. And we think it's prudent and reflect in our guide to be a bit conservative at the moment.

Joe Giordano:

Okay. That's fair. And then if I look at the margin guidance for the year, the EBITDA at 19%, maybe I thought maybe a little higher at that level of revenue, particularly given an extra $20 million in costs. So can you just maybe talk through the gross margin if you're seeing any pressures anywhere? And then, if you could just touch on the working capital this year, just the free cash flow. How normalize is that going to look exiting the year?

Operator:

Thank you. And our next question today comes from Damian Karas with UBS. Please go ahead.

Nathan Winters:

Yes. So just as it relates to the one that was a onetime charge that's behind us in the fourth quarter, no change in our structural costs or that we did anticipate having moving forward. And we feel like we're, at this point, substantially complete, working with our suppliers around a lot of those longer-term supply agreements, and particularly the ones that we had to entered into in 2021 when we had kind of both a combination of peak demand as well as some of the extended lead times across the supply chain. And you'll actually see that if you look at we have also a 75% decrease in some of our long-term purchase commitments that we have in our 10-K. So, again, a lot of great progress by the team working through that throughout the year, and our focus really here this year is around components that we still have at our Tier 1 manufacturers. So that's a lot around just demand timing, working through that as well as a lot of the great work by the team to redesign those components into existing or new products as well as working with our manufacturing partners just around the safety stock that they hold. So I think we see a lot of progress there. And again, the charge we had in the fourth quarter was really associated with one supplier and one contract we signed back in 2021. And that was a combination of canceling as well as deferring some of the purchase commitments we had here in 2024 to mitigate some of the working capital pressure as well as it gives us a lot more flexibility around the mix of the components and again, the timing of when we expect to receive those or take -- or accept those components on our balance sheet. So again, we thought it was the right thing to do to kind of get that past us and move forward here as we move into.

Nathan Winters:

Yes, obviously, there's new concerns that we're monitoring with the risk of the escalating tensions in the Red Sea. So, we're monitoring the situation, working with our partners Today, we have mitigation plans, again, pending any further escalation of the situation. I think what's important for context is this really primarily impacts our printing business into EMEA. That's where we ship via ocean through the Red Sea and the Suez Canal. So again, the vast majority of our products are still air shipped or ocean shipped from the Asia into the West Coast of the U.S. So, we think it's -- as of today, it's a modest impact on extended lead times, which we've communicated to our partners, particularly in the EMEA region and a negligible impact expected on margin here in the first quarter.

Keith Housum:

Bill and Nathan, is there any reason to believe there's a change to your long-term guidance or an annual growth rate of 5% to 7% over cycle?

Keith Housum:

Okay. I appreciate that. Just as a quick follow-up. In terms of the software and services, obviously, it's been really resilient for you guys. As you think about that growth or what it does for 2024, can you unpack, I guess, your expectations there as we separate that from the rest of the hardware business?

Nathan Winters:

That's right. I think the other -- yes, the bright spot on the service and software is the improved margins. So a lot of great work by the team focus on the cost structure for both of those pieces of the business. So that was a nice improvement as we move to the second half, and it will be a tailwind as we move here into 2024, along with the expectation that those businesses will continue to grow.

Brian Drab:

I just wanted to clarify first on the cost savings. Exactly what is the incremental benefit that we'll see in terms of cost savings, OpEx savings in '24 versus '23 now that we've got these incremental savings coming on in the year, I guess?

Brian Drab:

Yes. Perfect, okay.

Brian Drab:

Okay. Got it. And that's all in OpEx and won't affect gross margin, I guess. And my next question was just going to be on gross margin. I guess the best assumption here for gross margin as we track through the year would be modest increases in sequential increases in gross margin as we move through the quarters on leverage and anything that you would correct me on there or add to that?

Operator:

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

Bill Burns:

Rob. So a couple of things kind of weaved into that. I would say, first, that our sales teams are working and our partners closely with those customers that we have identified that are -- have the devices in there in use longer than normal and working closely with them to understand how we can convince them to move forward with upgrades and lots of different ways to go do that. And -- but the driver really would be a couple of areas. One would be technology transitions. So I think 4G to 5G and wireless think of faster WiFi speeds like WiFi 6, OS upgrade. So as the devices become older, then there's Android releases aren't available. And then along with that, we extend the security with that OS so long, but eventually, the security patches aren't available. So from a security perspective, that's a driver as well. The other place is really around use case expansion, right? So that adding more functionality of the devices, things like authentication of facial recognition, think of Zebra Pay integrated RFID on those devices we're going to release here shortly. Over time, we'll be releasing. We showed this at the National Retail Federation Show generative AI large language models on the actual devices and an assistant. So we want this to really be about productivity and wanting more features and functionality within their environment versus just around security, right? And we're seeing that. I would say that in the area of leasing, what we're looking at is opportunities to marry our software with hardware, and we demonstrated some of this at the National Retail show as well is that Think of a wearable device that has our task management software, communication collaboration on that wearable device in retail, which would be sold as a service kind of offering to our customers, so not quite a lease. In most cases, our customers say, hey, I can -- I'd rather spend the capital than lease. But in this case, it would be an OpEx recurring revenue stream around software and hardware combined together. So sales teams have a lot of different plays they're running to try to move those customers forward with upgrades.

Bill Burns:

Yes, Rob, I'd say that there are opportunities for us as we look around the globe, and we have different market shares those are two good examples of really significantly lower share than we have in other places. But as we look at each vertical market as we look at each geography, we see places where we can continue to take share as a business. Japan is a great opportunity for us, as we've talked about for a while, second largest market in Asia, we won the largest postal carrier there. We've won the largest retailer we now have the attention of some of the largest integrators -- system integrators and cellular carriers in Japan to work in some new opportunities there beyond retail and postal. So those have gotten some more attention and we've changed our channel strategy there a bit to large work with larger SIs. We've just hired a new sales leader. If we look at government in the U.S., a new sales leader there is the refocus on government and building our partner community and expanding our reach inside government opportunities that includes public safety. So, we're excited about these markets because we have low share, and we know there's opportunities for our portfolio within those underserved markets.

Chris Grenga:

This is Chris Grenga on for Jim. Maybe just one for me. You had mentioned the trend of new automation use cases in RFID and machine vision could you talk about what you expect from these technologies in 2024? And what use cases are you having the most productive conversations with customers currently?

Operator:

Thank you. And our next question today comes from Ken Newman at KeyBanc Capital Markets. Please go ahead.

Nathan Winters:

Yes. So I think a couple of things. Just some of the sequential decline from Q3 to Q4 was related to the cost actions that we took and just the timing of those rolling into the P&L, which is, again, what we had expected coming into the quarter. You'll see it increase a bit here as we go through '24 just as we reset comp plans and things like that around incentive compensation. And typically, the first half is a little more front-end loaded just with the timing of projects and deployments. And then Q4 is always a little light just with holidays and whatnot from a project execution. So, I think I would think of similar trajectory from a sequential perspective as we move through the year, but maybe a bit of an uptick just as we kind of again reset all of our comp plans and whatnot for the year.

Nathan Winters:

Yes. So as you mentioned, we ended the quarter at 2.5x debt leverage, which is at the high end of our target range. We are prioritizing debt pay down of our variable rate debt here in the short term. And we would expect the debt leverage to increase a bit here through the first and second quarter really just as we lap on the profitability side, not so much debt will come down, but the ratio will increase, but then will decline through the second half as we kind of lap Q3 and Q4's lower profitability. And so that is really the priority here starting out the year as debt pay down but as always, we're going to reassess overall capital deployment and opportunities we have, whether that's share buyback or M&A as the year progresses.

Bill Burns:

Thank you. As we look towards the long term, the opportunity for Zebra is bright. I'd just like to thank our customers, our partners and employees for their support. We look forward to returning to growth in 2024. Have a good day, everyone.

Michael Steele:

Good morning, and welcome to Zebra's third 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, and we refer you to the factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales performance 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 third quarter results and actions we are taking. Nathan will then provide additional detail on the financials and discuss our Q4 outlook. Bill will conclude with progress we are making on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer will join us as we take your questions. Now let's turn to Slide 4 as I hand it over to Bill.

Nathan Winters:

Thank you, Bill. Let's start with the P&L on Slide 8. In Q3, net sales decreased 30.6% and 29.6%, excluding the impact of FX. Our Asset Intelligence & Tracking segment declined 25.8% primarily driven by printing. Enterprise Visibility and Mobility segment sales declined 31.4% with pronounced weakness in mobile computing. On a positive note, we drove growth across service and software with strong attach and renewal rates. We saw double-digit sales declines across our regions. In North America, sales decreased 25%. EMEA sales declined 39% with broad-based declines across the region. Asia-Pacific sales decreased 32% driven by China and Southeast Asia, and Latin America sales decreased 15%, driven by Mexico. Adjusted gross margins decreased 100 basis points to 44.8%, primarily due to expense deleveraging from lower sales volumes, partially offset by favorable premium supply chain costs. As these supply chain costs have been fully mitigated, we are no longer including a slide as part of our earnings presentation. Adjusted operating expenses delevered 910 basis points as a percent of sales. Note that the bulk of the previously announced restructuring plans to drive operating expense savings were implemented in late Q3 and early Q4. Third quarter adjusted EBITDA margin was 11.6%, a 950 basis point decrease driven by expense deleveraging. Non-GAAP diluted earnings per share was $0.87, a 79% year-over-year decrease. Increased interest expense contributed to the decline, offset by a lower tax rate. Turning now to the balance sheet and cash flow on Slide 9. For the first nine months of 2023, negative free cash flow of $193 million was unfavorable to the prior year period, primarily due to lower earnings, including the impact of restructuring actions and higher interest costs. Greater use of net working capital due to higher cash taxes and payments for inventory and $45 million more of previously announced quarterly settlement payments, all of which was partially offset by lower incentive compensation payments. We ended the quarter at 2.2x net debt to adjusted EBITDA leverage ratio, which is below the top end of our target range of 2.5x and had approximately $1 billion of capacity on a revolving credit facility providing ample flexibility as we navigate a challenging environment. Let's now turn to our outlook. As we enter the fourth quarter, we are seeing sales velocity out of the channel stabilize on a sequential basis and destocking activity moderate as expected. Our Q4 sales are expected to decline between 32% and 36% compared to the prior year. This outlook assumes double-digit declines across our major product categories, with distributor destocking accounting for approximately one-fifth of the sales decline. We are in Q4 with the necessary backlog and pipeline to support our guide. That said, we are not seeing compelling signs of a market recovery as we look to the first half of 2024. We anticipate Q4 adjusted EBITDA margin to be approximately 16%, driven by expense deleveraging from lower sales volumes, partially mitigated by the benefits of our cost restructuring actions. Despite anticipated expense deleveraging, we expect year-on-year gross margin improvement as we cycle $25 million of premium supply chain costs in the prior year period. Non-GAAP diluted EPS is expected to be in the range of $1.40 to $1.80. Our Q4 outlook translates to an expected full-year sales decline of approximately 21% at the midpoint, which is 50 basis points favorable to our prior guide and an EBITDA margin of approximately 18%. We expect our free cash flow to be positive for the second half of 2023 and negative for the full-year. We continue to be focused on rightsizing inventory on our balance sheet and in driving 100% cash conversion over a cycle. Please reference additional modeling assumptions shown on Slide 10. With that, I will turn the call to Bill to discuss how we are advancing our Enterprise Asset Intelligence vision.

Michael Steele:

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

Brad Hewitt:

Hi, thanks. Good morning everyone.

Nathan Winters:

Good morning, Brad.

Nathan Winters:

Thanks, Brad. I guess I'd start with what we're seeing today. And from a Q3 perspective, we finished at the high end of our outlook in a challenging demand environment. And as we said, we're seeing leveling of demand trends overall and really in Q3, the peak of distributor destocking, but we're not yet seeing signs of market recovery based on our customers' behavior. So we saw really all region verticals declined in Q3 and along with customers of all sizes, but it was most pronounced in large enterprises. There were some bright spots in the quarter. Services and software are examples of that. I'd say is we're certainly not guiding to '24 at this time. But we're not seeing really compelling recovery yet and the idea that we're going to remain cautious for the remainder of the year. And really, as we look into the first half of '24, we're seeing very -- we have very challenging compares ahead of us. So I'd say that for the moment, still challenging demand environment that we would see that in '24 and the remainder of the year, we're going to remain cautious.

Nathan Winters:

I would say that, again, with demand challenging from that perspective, bookings were as we expected going into -- during Q3 and then as we enter Q4, we've got the bookings trajectory to feel good about our guide for Q4 overall. But again, not seeing quite signs of recovery yet, but feel that we've got the order velocity to be able to deliver on our guide for Q4.

Tommy Moll:

Good morning and thank you for taking my questions.

Tommy Moll:

I think I heard in your prepared comments, you described the velocity on the sell-through as having stabilized. And I wanted to circle back to that topic. One, just to make sure that, that's correct. And two, if you think about that sell-through velocity at some point, and maybe you could tell us when that is when would you expect an acceleration there, just given that you'll have some product refresh cycles where a lot of your installed base is approaching end of useful life, and it's less of a discretionary spend on the part of the customer.

Tommy Moll:

And to follow-up on the destocking theme, it sounds like you expect most of that to be behind you by the end of the year. And my question is just relating to the visibility there. If 60 days on hand is typical or something in that ZIP code for your channel, broadly speaking, do you have any idea where you sit today? And is there a view that, that will remain the "normal level," or could there be some period of time where we end up below that, just given conservatism among your channel partners at this point? Thanks.

Operator:

And we move to a question from Damian Karas from UBS. Damian, please go ahead.

Bill Burns:

Good morning, Damian.

Bill Burns:

Yes. What I'd say is that overall, we'd have to see strengthening certainly of a goods based economy. And our customers overall will resume deployments as they -- some of the macroeconomic uncertainty around the good based economy abates. And in T&L and e-commerce, we've seen significant capacity built out during the pandemic and that excess capacity has to be used within their environment. And that's across their entire environment where we've built that capacity that now is more being used and demand is more normalized levels than the accelerated levels through the pandemic. I would say overall, when we see the broader demand across the industry, we're seeing that where first, likely large customers first is what we'd expect that large customers, the first area where we saw it challenging from a demand environment, so we'd expect that to return first. And then from their midsize and run rate would follow. I don't know, Joe, if you want to add anything.

Damian Karas:

Got it. That's really helpful. And then maybe if we could switch gears and talk about gross margins. Curious how you are thinking about what those look like from here, is there a further downside from the third quarter just based on the volume levels you're seeing? And how should we think about the kind of the new baseline or normalized gross margin?

Operator:

We now have a question from Keith Housum from Northcoast Research. Keith, please go ahead.

Nathan Winters:

Keith, so just on our own inventory, as expected, our inventory balances stayed relatively flat to where we were at the end of the second quarter. We don't expect to see a material change as we exit the year. And as we said before and as you stated, the primary increase from where we'd expect to be is all around component -- consigned components that are at our Tier 1 manufacturers. So these are inventory that we made purchase commitments on going back to a year, 1.5 year ago at really the peak demand as well as the peak supply chain challenges and issues where the lead times were out greater than a year. So really absorbing those inbound components as our demand decrease. I think the team has done a phenomenal job working with all of our partners to reduce those purchase commitments. If you look at our outstanding purchase commitments, we've cut those in half since the beginning of the year. We've driven down finished good balance since the beginning of the year. So we're making traction, although you don't see it in the headline numbers. So really now, it's around getting stability in the demand signal to our suppliers so that we can in right size those inbound components. If you -- to your last question, we don't have a minimum purchase agreement that it has penalties. Obviously, we work with our Tier 1 manufacturers to have different tiering in terms of volume on our purchase price to cover their overhead. But there's not a, I'd say, a penalty per se at certain volumes, it's just making sure that they have the right capacity within their cost structure.

Nathan Winters:

Yes. So I would say, if you look at base, if you go back to our historical turns and you account for some of the M&A over the past couple of years, we said about a $200 million reduction would get us back to say, normalized levels. When and how quickly we can achieve that is the question. And some of that depends on, again, some of the demand stability as we go into next year. But that $200 million reduction would be entirely in consigned inventory components at our manufacturers.

Joseph Giordano:

Hey, good morning guys.

Joseph Giordano:

So I'll ask a couple of higher, bigger picture kind of questions. We've dug into the near term dynamics quite a bit here. I've had a lot of questions about like longer term, what is a shift from potentially into kind of fixed automation mean for you guys? So you have huge share in mobile computers. And then what happens as you get more and more of these kind of big RFID-type fixed mounted scanners instead of having a person make scans. Like what does that mean for you over time if the percentage of scans being done by humans goes down?

Joachim Heel:

And Joe -- this is Joe Heel, I'll add. I think this is also an opportunity for us to add additional value to our customers, specifically because in both areas, the customers will need more than just the hardware solutions that they might buy from us today as a handheld reader, for example, they will need, in particular, software and other accessories. And so if you think about our machine vision business, a very important part of that is the software component, which, by and large, we don't provide today when it comes to a handheld scanner. But in the machine vision, environment, we do provide that. So it's a great opportunity for us to create additional value for customers, but also for us at Zebra.

Bill Burns:

I think that overall, we would expect to see continued progression in margin as our markets recover overall. So I would say that we would expect to get back to the levels that we've had in the past, and there's no reason why we wouldn't. There's been a lot of challenges in moving pieces over the last several years, including tariffs, supply chain challenges that the significant increase demand we saw over the last two years driven by the pandemic and building out of capacity. But I think that returning to the profitability levels that we've had prior, we see that continuing to progress throughout in 2024 as we get back to more normal levels of demand and our customers begin to buy again. And as we continue to be very thoughtful around our costs, right? So I think we're going to continue to be cautious in spending as we have been. We are taking $100 million of annual cost out of the business in 2024 and that will also add to profitability along with demand returns. So we see profitability to continue to progress, and there's no reason why we can't get back to past levels. That's how we see it.

Meta Marshall:

Great. Thanks. Maybe a couple of questions for me. The health care market has been kind of a source of strength over the past couple of years. Just wondering if there's kind of any commentary about that market maybe being less consumer goods related than the others? And then maybe the second question, you noted kind of a step-up in investments in the manufacturing market. That's already kind of a pretty strong market for you. So I guess, is that kind of a combination of bringing robotics machine vision into that market, or just kind of what are kind of some of the areas that you think are unexploited there? Thanks.

Operator:

Thank you. We will take a question from Andrew Buscaglia from PNB Paribas. Andrew, please go ahead.

Bill Burns:

Good morning, Andrew.

Joachim Heel:

Yes. So I can address some of that, Andrew. Over the course of the last few quarters, we've gotten a lot tighter with our distributors in both understanding and agreeing on the objectives that they have in their business, which have changed. And in particular, the increasing cost of capital has led them to set very aggressive inventory targets for their business. And then using those targets, to ensure that we stay in sync as demand has been relatively volatile, right? So demand has come down, they have adjusted their inventory to match that, and that's what we're calling destocking. So if you now think about that in reverse, what has to occur is that they have to start seeing improvements in sales out, which we, of course, are working very heavily. We generate the majority of our demand with our sales force working together with our partners. So we're working with them to generate that sales out demand. As soon as they see that tick up again, we're pretty confident that they will follow with stocking in lockstep to achieve those DIO or days of inventory outstanding targets that we have now really good visibility to and a clear understanding with them as well as incentives in place for them to reach those. So it's really generating that demand and seeing it. We think the inventory will just follow.

Nathan Winters:

Yes, Andrew, I would say they're tied a couple pretty tightly together, especially when you consider e-commerce versus buy online and pick up in store or brick-and-mortar retail. So I'd say e-commerce and trans logistics tied together because of really parcel delivery. And I think in that case, both had built out e-commerce providers and transportation logistics built out significant network capacity across everything they did, their networks, their capacity around logistics and others to be able to meet the demands during COVID, which now kind of reset to pre-COVID levels and are going to grow from there. And I think you've seen moderating demand across e-commerce overall. So I think those two are tied together. I think brick-and-mortar retail, think of in-store, I think that's really more tied to the goods economy. So goods versus service-based economy, which is still relatively challenged. So I'd say e-commerce and translation districts tied hand-in-hand, brick-and-mortar retail, a little bit more goods economy focused. I wouldn't see much difference in those two. The recovery really is going to be driven by using up this excess capacity we talked about or and a recovery from more positive signs in from an economic perspective overall for those markets to come back.

Operator:

And our next question comes from Rob Mason from Baird. Rob, please go ahead.

Bill Burns:

Yes, I'd say that, Rob, what we said is we're not guiding to 24% as we've talked about before. I would say, again, from a color perspective, that on average, I guess, it would be the same. What we're seeing today is our customers sweating some of their assets longer than they normally would. They can only do that so long. Devices get older, they want to use more applications requiring faster processor speeds, more memory, you see OSs moving forward, so security and others. So there's reasons for them to upgrade those devices over time. Could they sweat them for a certain amount of time, yes. But then eventually, that kind of comes our way, and they go ahead and upgrade. So I would say average life cycle of demand in second half, nothing changing there. We're working closely with our customers to make sure we understand their refresh cycles. And I think that while there's very little visibility in the second half of the year, I think the biggest thing to remember is we're going to cycle compares that are easier and this destocking moves away. So I think that's positive. But I would say average number of refreshes out their average length of the devices in service and today, customer sweating assets.

Robert Mason:

Understood. That's good color. Bill, I wanted to go back to one of your earlier comments in the opening remarks. I thought I heard you mentioned a shift in go-to-market resources. And I was hoping you could put a little more color around that. And maybe just jointly, you talked about also accelerating growth in some of these underpenetrated markets, and I'm just curious if there's a connection there. And how are those underpenetrated markets performing right now relative to some of your more traditional markets?

Operator:

We will now take a question from Brian Drab from William Blair. Brian, please go ahead.

Bill Burns:

I think we can -- starting maybe with software is the largest segment and some of the acquisitions we did around Reflexis and Antuit prescriptive analytics in that area. We continue to focus on the retail associates and really enabling the retail associate through a suite of products and solutions portfolio around work cloud as we've announced at our recent customer user event around software, and that seems to be resonating well with our customers. This idea that taking task management, workforce management, communication, collaboration, demand planning combining that into a single application, leveraging our mobile devices in the hands of the associates in retail, and it plays into what Joe talked about earlier, this idea for a device for everyone within retail. So we see our software assets being important part of marrying with our mobile devices within retail and the idea of putting devices in the hands of more retail associates. I would say machine vision, $100-plus million market to us attractive, fragmented market overall. The focus there is manufacturing. We've talked about that earlier in the call, but also logistics and the idea of fixed industrial scanning, they continue to both look to ways to automate, to drive productivity, to improve quality across their organizations. I think the challenge to machine vision in the short term is the same as others are seeing, certainly, cyclical weakness in semiconductors where when we acquired the asset in machine vision, we knew Matrox was heavily weighted towards semiconductor and our objective there is to not only scale that business, but to diversify the offerings outside of semiconductor into new attractive markets. They could include automotive, food and beverage, inside fixed industrial scanning warehouse and distribution. So all those are represent opportunities for us, and we're excited about that market and our focus there is really diversification scale in driving share gains across machine vision. I would say Fetch and robotics automation or warehouse automation perspective, it's the smallest, still nascent in that area. I would say we're focused in two areas predominantly. First is Goods Transport. And again, we talked about that playing in line side replenishment, for instance, inside manufacturing, but also just good transport in general, of moving goods from A to B of varying sizes, that's an attractive market for us. The other market is e-commerce. So think of e-commerce picking, cobots and humans working together within that environment, where our devices today are being used by those workers to pick orders and adding additional productivity using automation and robotics is an interesting opportunity for us longer term. So it's the smallest of the segment. We don't see any impairment opportunities there or issues or concerns. We really find these three as attractive long-term growth opportunities for Zebra overall. And some are challenged in the short-term. As I said, machine vision is a good example of that with semiconductors, but we have the long-term prospects of the machine vision and fixed industrial scanning market remain very attractive to us.

Unidentified Analyst:

[Indiscernible] on for Jim. Most of the questions that I had have been addressed, but maybe just one for me. for the incremental $15 million of savings, is that in any one particular area or just a broad deepening across the existing targeted areas? Thank you.

Operator:

And this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Burns for any closing remarks. Please go ahead.

Operator:

Goodbye.

Mike Steele:

Good morning, and welcome to Zebra's second 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 and we refer you to the factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of the slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth, our year-over-year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition. Additionally, note that our Asset Intelligence and Tracking segment now includes our RFID solutions and we have recast quarterly segment results since 2021 in a schedule included in the Appendix of our earnings press release. 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 second quarter results. Then Nathan will provide additional detail on the financials and discuss our revised 2023 outlook. Bill will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer, will join us as we take your questions. Now, let's turn to Slide 4 as I hand it over to Bill.

Nathan Winters:

Thank you, Bill. Let's start with the P&L on Slide 7. In Q2, net sales decreased 17.3% including the impact of currency and acquisitions and were 16% lower on an organic basis. Our Asset Intelligence and Tracking segment was flat, strengthen in RFID and supplies was offset by a decline in printing as we lapped particularly strong prior year results. Enterprise Visibility & Mobility segment sales declined 23.6%, driven by a sharp decline in mobile computing, partially offset by growth in data capture solutions. Additionally, we drove organic growth across service and software with strong service attach rates. Sales declined across our regions driven by broad-based double-digit declines in mobile computing. In North America, sales decreased 11%. EMEA sales declined 24% with pronounced weakness in Eastern Europe. Asia-Pacific sales decreased 17% driven by China and India with growth in Japan and Australia. And Latin America sales decreased 6%, partially offset by growth in Brazil and Mexico. Adjusted gross margin increased 200 basis points to 48%, primarily due to lower premium supply chain costs in favorable business mix and pricing, partially offset by expense de-leveraging and unfavorable FX. We are pleased to see gross margins recovering from the inflationary headwinds we experienced over the past couple of years. Adjusted operating expenses deleveraged 310 basis points as a percent of sales, partially offset by lower incentive compensation and cost controls. Note, that as we began to see demand soften, we announced incremental restructuring plans that are expected to drive $65 million of net annualized operating expense savings as they're implemented. Including previous actions taken over the past year, our total net annual cost savings is $85 million. Second quarter adjusted EBITDA margin was 21.2%, a 70 basis point decrease driven by operating expense de-leveraging partially offset by improved gross margin. Non-GAAP diluted earnings per share was $3.29, a 29% year-over-year decrease. Increased interest expense contributed to the decline partially offset by fewer shares outstanding. Turning now to the balance sheet and cash flow on Slide 8. For the first half of 2023, negative free cash flow of $144 million was unfavorable to the prior year period, primarily due to a greater use of networking capital due to higher cash taxes and payments for inventory. And $45 million of previously announced quarterly settlement payments, which are scheduled to conclude in Q1 of 2024, partially offset by lower incentive compensation payments. In the first half of 2023, we also made $52 million of share repurchases and invested $1 million in our venture portfolio. We ended the quarter at a 1.8x net debt to adjusted EBITDA leverage ratio, which is below the top end of our target range of 2.5x and had approximately $1.1 billion of capacity on our revolving credit facility. On Slide 9, we highlight the impact of premium supply chain costs on our gross margin over the past 2.5 years. The actions we have taken to redesign products and increase price along with improving freight rates and capacity have enabled us to avoid component purchases on the spot market and reduce the freight cost impact. In Q2, we incurred premium supply chain costs of an incremental $5 million as compared to the pre-pandemic baseline and $51 million lower than the prior year quarter. As we enter the third quarter, we believe these costs will have been fully mitigated, which is the key lever to margin recovery. Let's now turn to our outlook. As we enter the third quarter, we are seeing sharp broad-based declines across most of our product offerings, which continues to be amplified by distributors recalibrating their inventory to lower demand trends. Our Q3 sales are expected to decline between 30% and 35% compared to the prior year. This outlook assumes double-digit declines across each of our core product categories with distributor destocking accounting for approximately one-third of the decline. We anticipate Q3 adjusted EBITDA margin to be between 10% and 12% driven by expense de-leveraging from lower sales volume, partially offset by higher gross margin from cycling $30 million of premium supply chain costs in the prior year period. Non-GAAP diluted EPS is expected to be in range of $0.60 to $1. Given our Q2 results in the continued challenging demand environment, we are significantly reducing our full-year outlook, expecting a sales decline between 20% and 23%. This assumes the Q3 sales trajectory continues through the remainder of the year. We're seeing broad-based declines across our end markets as we enter the second half with significant uncertainty in this environment. We expect full-year adjusted EBITDA margin of approximately 18%. We expect increased de-leveraging on significantly reduced sales volumes expectations partially offset by early benefits from cost reduction actions as most of the actions will be implemented by early Q4. We plan to continue to align our cost structure with the long-term trajectory of our business. We now expect free cash flow to be positive in the second half, but negative for the year given lower sales and earnings expectations. Our cash flow will be impacted by new restructuring charges, increased cash taxes due to change in R&D expected regulation and $180 million of previously announced settlement payments. We continue to be focused on rightsizing inventory on our balance sheet as component lead times have normalized. However, we now expect minimal inventory reduction in 2023 due to our lowered sales outlook. We are focused on achieving 100% cash conversion over a cycle, which is one of the metrics in our long-term incentive compensation plan. Please reference additional modeling assumptions shown on Slide 10. Note that we have improved our expected 2023 non-GAAP tax rate by 1 point due to favorable geographic mix. With that, I'll turn the call back to Bill to discuss how we're advancing our Enterprise Asset Intelligence vision.

Mike Steele:

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

Tommy Moll:

Bill, you referenced the reset of the trajectory for e-commerce including parcel. I wanted to dig in on that a little bit. Do you have any sense of how long that reset appears to need going forward. And how widespread is this? And I ask that second part because there's certainly one fairly high profile, maybe the most high profile end user there where these trends I think are well known at this point. But anything you could do to highlight and maybe other examples would be helpful as well. Thank you.

Tommy Moll:

Bill, you mentioned an inflection point, which is the theme for my second question here. I'm using the mid-points of your revenue guidance for the third quarter and the full-year, and just looking at what's implied in the fourth quarter. And at least on the mid-points, it looks like the implication is from third quarter to fourth quarter revenue steps up somewhere in the mid-single-digit range on a percentage basis. I just want to unpack that a little bit. Is that an inflection that you think you have visibility too? Is it just there's some ranges in here and it depends on what you want to assume within those ranges, or is there anything you can point to maybe that's impacting 3Q disproportionately, but not 4Q? Thank you.

Operator:

Our next question comes from Damian Karas with UBS. Please go ahead.

Bill Burns:

Yes. Maybe I'll start and then I'll add Joe can jump in as well. Really, if we look back to our May call, we talked about broader softening of industry demands. And those trends really have accelerated in Q2 as we saw more cautious spending on the part of our customers, again, after two years of really strong demand for our products and solutions. And we see this as really broader global macro weakness, but we've seen particular impact from that in EMEA and in China and China we expected more recovery out of COVID that we haven't seen in slower economic factors within China. Retail and e-commerce, as we've talked about a little bit earlier on Tommy's question really is driving that, that trend as they're absorbing capacity, but coming out of the pandemic, but we've seen it more broad across other industries as well as we worked our way through Q2. We're seeing an increased number of push-outs from a project perspective as well, or those projects being reduced in size. And Joe will talk a little bit more about that overall, but I would say that, the dynamics that we're seeing around distribution is one element of it, but the end demand clearly is slowed, and that's what's driving the distribution destocking of inventory is really about end demand. That's really, and after two years of really strong demand, we're now ultimately seeing that it really is in Zebra, we're seeing this across industry trends like IT device spending that ultimately our -- we're seeing that same trend that that IT device spending is correlated to our mobile computing market, which we see as the biggest impact of this slowdown. But it's really broad-based across IT devices and through that we expect to continue to outperform our competition, but clearly disappointing demand levels from an end market, but maybe Joe wants to jump in.

Damian Karas:

Yes. That's all very helpful. So could you maybe tell us like what proportion of firm orders you've actually seen canceled?

Damian Karas:

Got it. Okay. Appreciate it. And then I -- the bright spot in the quarter seems to be the gross margin recovery. So should we be thinking 48% is the appropriate run rate for gross margin or given your portfolio of assets now with machine vision and Amer's [ph] and so forth, is there possibly some upside to gross margin down the road?

Operator:

Our next question comes from Jim Ricchiuti with Needham & Company. Please go ahead.

Nathan Winters:

Yes. Maybe I can give just a little bit more color on the guide and then to your point on the some of the regional dynamics is just to read what Bill mentioned earlier, the guide is supported by the most recent sales and bookings velocity and we're not assuming any type of recovery as we enter the quarter or as we move through the quarter. So you really see that I'd say across all our geographies. So I think that it's -- if you look at the similarities across each region, they're very similar in terms of being impacted by mobile computing tougher year-on-year comps for the business like print. So what we've effectively done is said, what is that velocity we're seeing in the end markets? How does that continue through the third quarter and into the fourth quarter? And again, removing some of the upside or opportunities to ensure that we have the right baseline to build from here, but I'd say the dynamics are very similar across each of the regions as we go through the second half.

Bill Burns:

Yes. I would say that, RFID continues to be a bright spot and continue to see growth across multiple applications, not just retail. Our supplies business continues to be positive from not just an RFID perspective, but a broader supplies business in our Temptime acquisition as well. Services and software we think will be clearly bright spots in the second half year. Data capture is a tougher compare in second half. So I think what you're still seeing is in print and data capture solutions a fair amount of variation across supply chain availability in 2022 that were cycling through in 2023, so you see strong growth in first half with tough compares in second half across those businesses, which still remain challenging from as you look at the numbers overall that you're seeing -- still seeing the supply chain dynamic take place in comparison from prior years. So data capture solutions is just a tough compare in second half.

Meta Marshall:

Great. Thanks. I guess just putting into context, do you think you're seeing the greatest impact to the refresh business, which with just elongating hardware cycles, is this just slowdown in new builds or slowdown in new use cases? I guess I'm just trying to get a sense of you prepared yourself to the mobile IT market. We've seen some lengthening and refresh cycles in those markets over time as devices improve. And so is this just lengthening refresh cycles that may be more permanent or just kind of more macro impact to new builds or new use cases?

Joe Heel:

Yes. I would underline that specifically that I think we're seeing is an extension of the sales cycles not a diminishing set of use cases in any way. In fact, I think it's almost the opposite. So the examples I gave earlier were all examples of extending sales cycles. And what we're seeing with our customers is that in fact they're discovering during this period how they can use their devices and the Zebra solutions for more use cases. So we're seeing more use cases in the store like communication or flexible checkout advising customers on where to find goods and products in the store are being added to the devices that they have. And we're of course fueling that because we're releasing new use cases. For example, we just released the ability to take payment directly on our devices, right? So I would say very clearly it's an elongation of sales cycles, new use cases are alive and well.

Bill Burns:

No. Not as part -- not as part of the restructuring, Meta in terms of obviously the team's working on renegotiating supply agreements to maximize cash with the demand changes. But we'll work each one of those and make sure it's the right economic decision for the short and long-term. But those -- that is not included as any part of the restructuring charges.

Tyler Hutin:

Good morning. This is Tyler Hutin on for Brian. Thanks for taking my questions.

Tyler Hutin:

Hi, just starting off with pricing, I believe you may have mentioned the full-year benefit before, and I was just wondering if that has changed due to even more softening in what you would expect from volume growth. So is there any -- can you give us a expectation for full-year benefit from pricing?

Tyler Hutin:

Okay. Thank you for that. And just following-up, can you describe the opportunities that you're seeing with the government like what products, et cetera? And has this been an unexpected contribution in 2023? And will that be supplemental to your sales volume when other demand picks up? Thank you.

Operator:

Our next question comes from Keith Housum with Northcoast Research. Please go ahead.

Bill Burns:

Good morning, Keith.

Bill Burns:

Yes, Keith, I mean, I -- they're not questioning the ROI at all. They're clearly seeing the benefit of our devices that are mission critical in their environment. What they're really seeing is that, that extends beyond e-commerce to parcel delivery for instance. So we're seeing that in our T&L customers that are saying if you look at what they've said around parcel delivery, the entire industry's down as the result of kind of e-commerce resetting to kind of pre-pandemic growth rates, and they build out capacity, assuming it was going to be much stronger than that. I would say in retail, they've bought the devices they have, so I wouldn't say it's absorbing beyond what they need in most cases. Now, some bought ahead because of supply chain challenges, right? They knew that they needed the devices they bought ahead for a project, but in most cases, they just have what they need. And they're -- I think to the earlier question continuing to use those devices in other applications or just making tough budget decisions that ultimately they'd like to buy more, but they're leveraging what they have today instead of purchasing new because there's pressure from either their CFOs and others on IT, spending and CapEx within their environments and a certain macro environments. So I think it's in some cases using capacity. In other cases, it's just leveraging what they have today and they don't need anymore. In some cases they bought ahead because of supply chain challenges. But we saw a significant increase in demand over the last two years and now we're seeing ultimately that demand slow and then we'll see growth from here. Joe may want to add something.

Keith Housum:

All right. I appreciate that. As a follow-up, is the same issues extending to the machine vision and robotics segment, perhaps any commentary you can offer on how that's progressing?

Operator:

Our next question comes from Joe Giordano with TD Cowen. Please go ahead.

Bill Burns:

I mean, I think we're seeing it, and I think you're seeing more people point to this, that it really is the service economy that's holding up, right? It's -- I think coming out of COVID, people are looking for more experiences. They're doing more travel this summer. They're saying, look, I'm going to take that trip no matter whether the cost of the flights or vacation are more expensive than it was in the past. I'm going to go do that. I mean, I don't know about you, but every flight I get on, every seat's taken, right? But I think from a goods perspective, we clearly are seeing a slowdown in customers buying goods. I think of Joe mentioned the DIY retailers, right, as is the interest rates have gone up, new housing sales have gone down and therefore people buy less from do it yourself retailers as an example. So I think people bought a lot of goods during COVID for their homes that now they're spending on experiences instead. So I think that while we're seeing the broader economy hold up, I think we're seeing goods purchases decline, and we're seeing that in where e-commerce is still growing, it's now reset back to a more traditional growth rate off the very high as we saw through the pandemic, which has then flows through to how many parcels have delivered from e-commerce. And I think that the -- and as Joe said, the expectations within our retail customers brick-and-mortar retail of how much they are going to sell has slowed so all that is playing a role in this. I think that it's really around goods versus services in the macro environment.

Bill Burns:

Yes. So I think that I said earlier in the call that, we're happy with the machine vision progress we've made with the Matrox acquisition, the acquisition of Adaptive Vision and our organic investing in machine vision. We knew when we purchased that business that it was heavily weighted towards semiconductor. And one of the objectives we have is for Joe and our marketing teams to focus on expanding markets beyond semiconductor into pharmaceutical, electrical vehicle manufacturing, transportation logistics, e-commerce that are all big users of machine vision and fixed industrial scanning. And we're seeing early progress and wins in that area. So we're pretty happy with the progress overall, I think that we're excited about the machine vision business overall. It's closely adjacent to our scanning business and we're seeing good results so far despite the headwinds associated with semiconductor.

Brad Hewitt:

Hi, good morning, and thanks for taking my question.

Brad Hewitt:

I'm curious if you could elaborate more on what's embedded in your second half guidance in terms of pipeline conversion rates and any further project deferrals, and then also what drives your confidence that the full-year guide is properly derisked from here?

Joe Heel:

I'd say probably, as we look beyond, right, the second half, where our customers can only hold off so long on deployments of our products, they're really mission critical in their environments as they look to serve the other customers. And over time they will use the excess capacity they've purchased or we'll see the macro environment get better from a goods economy perspective, and they will begin to buy again. So I think that long-term we see that our value proposition remains very strong with our customers. Our relationships remain strong and across all of our core markets, our adjacencies to those core markets and our expansion investments will all continue to grow again as we see things from the macro environment improve, and our customers work through some of the demand that they've created over the last couple of years and the purchases they've made -- we'll continue to grow again.

Bill Burns:

Yes. So we -- again, as we said earlier, we saw reduction in the velocity of our run rate business particularly in the second half of Q2, so kind of late May and into June. And we're assuming that trajectory continues through the remainder of the year. So I'd say no further deterioration, but definitely not any type of incremental improvement. And also that's why you see as you go into the fourth quarter kind of the year-on-year comps get more challenging, which is why you see the increase in terms of the year-on-year decline in the fourth quarter greater than in the third quarter. Just as that, that velocity continues to no assumed improvement that the comps get tougher as we move through the end of the year.

Rob Mason:

So I mean, it looks like the run rate business has followed the large project business slower. I think you indicated earlier that's typically the pattern, but I'm curious if you think about a recovery scenario, perhaps looking out into next year or whenever this -- it happens, would you expect the run rate business to also follow the larger project business up or has just the -- what's happened in retail in particular changed that dynamic? I'm not sure that retail's overrepresented in large project, but maybe my impression is it might be.

Rob Mason:

Understood. And then just as a follow-up, Nathan, how are you feeling about inventory obsolescence risk at this point? And if a pause were to last multiple quarters, long of a pause, before that becomes a greater risk.

Operator:

Our last question comes from Guy Hardwick with Credit Suisse. Please go ahead.

Nathan Winters:

Yes. So maybe just to clarify, so if you look at the guidance assumptions for the third and fourth quarter, it assumes that similar velocity of demand, so that includes 80% of our business is the channel so that kind of similar velocity from Q3 to Q4. Then you have the -- again, the outsize impact of destocking in the third quarter. So we do not plan to destock as much in the fourth quarter as again the -- and that's really the driver of the sequential improvement in our revenue between Q3 and Q4 is that differential. So the expectation is that we will exit the year with our days on hand balance in the distributors at its normalized level where we expect the business to be so that we go into 2024 with both that kind of run rate trajectory and the inventory balances in the channel appropriately set so we have a clean slate as we enter 2024.

Nathan Winters:

Yes. So again, two different points. I think from a days on hand, we've always stayed relatively within the boundaries we have as a business, and that's -- we measure our partners and channel partners on that as part of their incentive plan. Again, the absolute dollars increased over the last two to three years in balance as our revenue increased. And those balances are declining now that our volume's declining. But the -- we -- again, we spent a lot of time with our partners ensuring that they have the right levels of days on hand inventory to support the business. And those vary by product family by region and what the business needs are. So again, we're a little bit higher than that range today, just given the velocity decline we saw late in the second quarter. We're going to get that corrected here in the third and then a little bit more in the fourth, so that we go into 2024 again with a clean sheet.

Bill Burns:

Yes. While our spend is pressured certainly in near-term, over the long-term, we believe that we are well-positioned to benefit from secular trends to digitize and automate workflows within our customers environments. To wrap up, I'd like to just thank our customers, partners, and employees for their support and dedication over to our long-term success. Have a great day, everybody.

Mike Steele:

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 the slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales growth, our 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 Heel, our Chief Revenue Officer, will join us as we take your questions. Now, let's turn to slide 4 as I hand it over to Bill.

Nathan Winters:

Thank you, Bill. Let's start with the P&L on slide 6. 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 strength in printing as we lapped significant supply constraints in the prior year period. Enterprise Visibility & Mobility segment sales declined 11.2%, 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. And 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 margin. Adjusted operating expenses increased 130 basis points as a percent of sales, primarily due to a return to normalized 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 7, 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 cost 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 8, 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 and 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, our recently announced price increase, and abating 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 in 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 million 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 rightsizing 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 a 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.

Mike Steele:

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

Tommy Moll:

Yes. Thanks for taking my questions.

Nathan Winters:

Good morning, Tommy.

Bill Burns:

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

Nathan Winters:

Yeah, 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 the prepared remarks, we do have a pipeline of opportunities and actions to get to the high end of the range, how we're 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 a favorable FX from our last guide, helping offset some of the macro headwinds. So all those factors, a lot of factors played into some of the first half or second half dynamic, as well as what we believe we've taken a conservative view at the pipeline and actions we have as we look at the second half guide.

Operator:

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

Bill Burns:

Good morning.

Damian Karas:

Morning. Just a follow-up question on your comments, Bill, about some of these project deferrals. Just for clarification, right, are we talking about the same kind of select handful of large customers, North America retail and EMEA retail, or are there additional large customers that are mimicking these behavior or just kind of a combination of both of those factors? I'm curious if thinking about kind of future execution and delivery, do you have any kind of sense on time line on that, or are they just kind of on pause for the moment?

Joe Heel:

Sure. So Damian, I wanted to underline one thing first, and then maybe I'll give you some examples because I thought you might -- 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 in most of those push. I'll give you two examples. One of our large US 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 US, 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 have 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. So that gives you an idea of how things are moving and how these deferrals are happening, hopefully.

Damian Karas:

Understood. Appreciate that color. 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.

Operator:

The next question comes from Jim Ricchiuti with Needham & Company. Please proceed.

Bill Burns:

Yes. I would say, Jim, it's really both. And again, it's centered predominantly around 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 North America and EMEA. And I think it's Important, as Joe said, to say that these projects haven't been canceled, and our customers still have conviction about the value we ultimately deliver to them around improve productivity, increased visibility across supply chains, more effective and efficient operations within retail. All those are important because these projects, while they're moving out are still -- have strong return on investments for our customers. They're making tough decisions around CapEx in the short-term to adjust in a macroeconomic environment. But what they're telling us is that as their CapEx loosens up inside their organizations, they expect to move ahead 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 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, our customers can only hold off from buying for so long, that we have mission-critical solutions. And they truly deliver 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 North America and EMEA in retail is the primary challenge at the moment.

Bill Burns:

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

Jim Ricchiuti:

Thank you.

Keith Housum:

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, the good and the bad?

Keith Housum:

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

Keith Housum:

Great. Thank you.

Joe Giordano:

Hey. Good morning, guys. So I'm just curious on -- 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 soft patch here, what's the ability of customers to like extend, when they need to refresh this stuff? I'm just curious the deferrals that Joe mentioned, are these like new, new expansions, or is this like refresh of old product that is getting pushed out? Just curious there. Thank you.

Joe Giordano:

And then just a 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 tough, things like that. Thank you.

Joe Giordano:

Thanks, guys.

Meta Marshall:

Great. Thanks. You guys noted the benefit of price increases in the second half. I just wondered, given the macro environment, if there's been any pushback to that or kind of shrinking of the 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. I 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 Heel:

Yeah. So Meta, 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 partner's 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.

Meta Marshall:

Great. Thanks.

Rob Mason:

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?

Rob Mason:

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

Rob Mason:

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

Joe Heel:

Yes, 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.

Blake Keating :

Hi. Good morning. This is Blake Keating on for Brian.

Nathan Winters :

Good morning.

Bill Burns :

Yes, I would say that across T&L, that our customers continue to struggle with labor constraints and are looking to add to visibility across the supply chain, across their -- your networks. We've seen some positives where T&L customers continue to make investments despite some of the challenges around the macro environment. So two examples of that is our postal win in Japan and the RFID win in North America. T&L show that some large projects and outside of retail are clearly continuing and our customers see the value in our solutions. So I think that T&L manufacturing is another area where 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 efficient and productive within both their environments, T&L and manufacturing, and we expect that to continue to grow. But to moderate from the strong growth we saw in Q1 due to macro environments. Health care is -- we saw strong results in Q1, and it's less sensitive and less correlated to the macro environment. So we feel good about health care as well. So I think those are areas that outside of retail that we've taken into account for our second half guide.

Nathan Winters :

And one thing I'd add, just on the second half, I mean for the full year, we're expecting about 1.5 of benefit in price, including the most recent announcement. And I think I'll just get back. If you look at the second half, the implied guide around minus 2% again. But on 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 FX impact. So those are, again, some different dynamics when you look at the first half versus second half for the year.

Bill Burns:

Yes. I think, I would say, overall, with the Matrox acquisition and Adaptive Vision, that 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 Adaptive Vision to the portfolio. It really is what our customers and partners were looking for is to -- some of our customers are just beginning their automation journey. Others are -- 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 manufacturing opportunities. Examples could be automotive or battery manufacturing are two areas in which we see opportunities for us. And then, ultimately, leveraging the synergies, I said, across the two acquisitions in our organic portfolio. We're seeing strong interest from our customer base. We were just at ProMat manufacturing and supply chain trade show, and we saw strong interest from our customers. So we feel good about where we're at with Matrox and the opportunities we have ahead of us for machine vision and fixed industrial scanning.

Operator:

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

Bill Burns:

Hi. Good morning.

Nathan Winters:

Yes. So, I think, again, just sort of maybe clarify the comment in terms of -- we look at it in terms of an absolute range. So, I think, we're still in that same range we were in from a pre-pandemic, no different than we were in Q4, maybe just a little bit on the higher end. And so, we don't have a sales out to sales in reconciliation. I would say that, historically, when the velocity of the channel slows, we see an outsized impact as the distis moderate and manage their days on hand. So if they're selling over 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 on what we see from a sales end. So there's always a disconnect there based on, 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 just 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.

Nathan Winters:

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.

Nathan Winters:

Yes, we take the spot market as we put the guide together. So sitting around whatever, just around $1.09 to $1.10 to the euro. .

Operator:

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.

Operator:

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

Mike Steele:

Good morning, and welcome to Zebra's fourth 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 Anders Gustafsson, our Chief Executive Officer; Bill Burns, our Chief Product and Solutions Officer; and Nathan Winters, our Chief Financial Officer. Anders will begin with our fourth quarter highlights and an update on the previously announced CEO transition. Then Nathan will provide additional detail on the Q4 results and discuss our 2023 outlook. Bill will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer, will join us as we take your questions. Now let's turn to Slide 4 as I hand it over to Anders.

Nathan Winters:

Thank you, Anders. Let's start with the P&L on Slide 7. In Q4, net sales increased 2.5%, including the impact of currency and acquisitions, and 3.9% on an organic basis. Our Asset Intelligence and Tracking segment increased 13.5%, driven by double-digit growth in printing. Enterprise Visibility and Mobility segment sales were approximately flat, with mixed performance among our offerings. We realized particularly strong growth in data capture solutions, including RFID as well as rugged tablets. Mobile computing sales declined, primarily due to challenging prior year compares, particularly in EMEA. We also drove growth across services and software with strong service attach rates. Performance was mixed across our regions. North America sales increased 11%, helped by the recovery from supply chain challenges and strength in data capture and printing. EMEA sales declined 7%, primarily due to the 5-point impact of our suspension of sales into Russia in March as well as lower sales to large customers in Northern Europe. Asia-Pacific sales grew 3%, with strength in Japan and growth in China despite COVID challenges late in the quarter. And Latin America sales increased 7%, with strong growth in Brazil and Mexico. Adjusted gross margin decreased 10 basis points to 45.6% due to FX, offset by lower premium supply chain costs. Adjusted operating expenses were lower, improving by 100 basis points as a percent of sales, primarily due to lower incentive compensation and effective cost management. Fourth quarter adjusted EBITDA margin was 22.5%, an 80-basis-point increase driven by operating expense scaling. Non-GAAP earnings per diluted share was $4.75, a 4.6% year-over-year increase. Turning now to the balance sheet and cash flow highlights on Slide 8. In 2022, we generated $413 million of free cash flow. Although Q4 was strong, the full year was significantly lower than last year, primarily due to a higher use of working capital due to elevated inventory, higher incentive compensation payments given our exceptional 2021 performance, and $135 million of previously announced settlement payments, which are scheduled to conclude in Q1 of 2024. In 2022, we invested approximately $880 million in the Matrox Imaging acquisition to expand our machine vision solutions offering. We made $751 million of share repurchases and invested $12 million in venture investments. We ended the year at a comfortable 1.6 times net debt to adjusted EBITDA leverage ratio, and with more than $1.4 billion of capacity on our revolving credit facility. On Slide 9, we highlight premium supply chain costs, which have continued to improve from peak levels. The actions we have taken to redesign products, targeted price increases as well as improving freight rates and capacity have enabled us to reduce component purchases on the spot market and reduce the freight cost impact. Additionally, we have increased the volume of printer shipments on Ocean Premier, which will contribute to reduced freight costs through 2023. In Q4, we incurred premium supply chain costs of $25 million as compared to the prepandemic baseline, which was favorable to what we had anticipated in our prior outlook, and $38 million lower than the prior year. We are expecting these premium supply chain costs to steadily decline in 2023. Let's now turn to our outlook. Customer demand and our order pipeline remained healthy, yet we continue to see some softening of demand and elongated sales cycles that we referenced last quarter through the uncertain macro environment. We are taking a cautious approach to our sales outlook and expense management while working to rightsize our inventory levels. For the first quarter, our sales are expected to decline between 4% and 1% compared to the prior year. Our outlook assumes a 3-point negative impact from foreign currency changes and a 150-basis-point additive impact from recent acquisitions. This translates to expectations of negative 1% organic growth, which includes a 1-point headwind from sales into Russia last year. We anticipate Q1 adjusted EBITDA margin to be approximately 21%, driven by higher gross margins from improving supply chain costs despite significant FX headwinds. We expect premium supply chain costs to be approximately $20 million in Q1, a nearly $50 million year-over-year reduction. Non-GAAP diluted EPS is expected to be in the range of $3.70 to $4. For the full year 2023, we anticipate net sales to be in the range of a 3% decline and 1% growth. This outlook assumes a 50-basis-point net negative impact from foreign currency changes and acquisitions as FX headwinds moderate throughout the year. We anticipate full year adjusted EBITDA margin between 22% and 23%. We expect premium supply chain costs of approximately $50 million for the year, with continued improvement in product availability. We have also proactively managed operating expenses as evidenced by OpEx scaling in Q4 and recent targeted restructuring actions as we enter 2023, which enabled us to preserve strategic investments in the business. We expect our free cash flow to be at least $650 million for the year, which reflects the benefit of working down elevated inventory levels through the year, higher cash taxes and $180 million of previously announced settlement payments. Please reference additional modeling assumptions shown on Slide 10. Note that the cost of borrowing is expected to be approximately 5% to 6% this year, and our non-GAAP tax rate is expected to be approximately 19% due to the United Kingdom corporate tax rate increase. With that, I will turn the call to Bill to discuss how we are advancing our Enterprise Asset Intelligence vision.

Mike Steele:

Thanks, Bill. We'll now open the call to Q&A. We ask that you limit yourself to 1 question and 1 follow-up so that we can get to as many of you as possible.

Damian Karas:

So my first question is related to your sales outlook. And in particular, we've heard some of your competitors and even one of your major distribution partners recently talking about inventory channel destocking taking place. I'm just curious if you guys are seeing the negative impact from that at all? And to what extent that's factored into your guidance for the year?

Damian Karas:

And then switching gears to the margin trajectory here. If we kind of look at the low end of that adjusted EBITDA guidance, it doesn't suggest much improvement, especially when you kind of look at the notable step down you guys are expecting in the premium supply chain cost. So I was wondering if you could maybe just give a sense on how you're thinking about that margin guidance range? And as it relates to the $50 million premium costs, are you basically assuming that, that's more or less eliminated by the third quarter?

Operator:

Thank you. And our next question today comes from Jim Rashidi at Needham & Company. Please go ahead.

Bill Burns:

Yes, Joe, I'd say -- this is Bill. I'd say overall that, from a macro environment, we're seeing really mixed signals. As you said, we're seeing, on one hand, really elongated sales cycles and some softening of demand, especially from some select large customers. That's resulting in some delays in pushouts. We saw that in first quarter -- sorry, fourth quarter, and it's reflected in our first quarter and 2023 outlook. On the other hand, we're really seeing that we've got strong backlog and the pipeline is healthy for projects for 2023. Our run rate sales in fourth quarter were strong, and we're continuing to see that in Q1. And as we just talked about, our global -- just the inventory levels are healthy. So it's really mixed signals out there that's keeping us cautious overall. And I think that our view of that is that we're going to continue to monitor the environment in 2023. We're going to take an agile approach to really managing expenses and focus on profit margin expansion and -- but at the same time, really preserving the strategic investments we're making throughout the year. So I think, overall, we're highly confident in our solutions offering and our ability to continue to take share in 2023, but it just makes sense for us to be cautious given the macro uncertainty that's out there today.

Jim Ricchiuti:

The follow-up question I have is just as you went through Q4 and thus far this year, have you seen any changes in demand, meaningful changes, either in some of your major geographic regions or major market verticals?

Operator:

And our next question today comes from Paul Chung at JP Morgan. Please go ahead.

Nathan Winters:

Yes. So Paul, if you look at the full year guide on EBITDA, I mean both the supply chain improvements and FX will flow through from a margin perspective. So I think we expect margin to -- gross margin to increase throughout the year because of those two dynamics. I think from an OpEx scaling, we'd say roughly flat to in line with prior year just as we work through some of the increasing compensation and incentive compensation year-on-year. But again, I think, largely, the benefit in EBITDA would flow through mostly in gross margin.

Bill Burns:

Yes, I would say that -- this is Bill, Paul. The low single digits is the size we think about. We're excited about the RFID opportunity. As we mentioned in the remarks that we've just won our largest RFID opportunity ever really in the T&L space. And we've seen RFID move from just really retail into retail supply chain, now into the broader supply chain and opportunities within transportation logistics, which is really around parcel and others that create really an opportunity of a wider served use cases. And in retail, we're seeing large retailers mandate the tagging of items within retail. We're seeing new opportunities there around loss prevention. As I mentioned, T&L opportunities, we're seeing quick-serve restaurants deploy RFID. In the NFL, we're doing both active and passive RFID. So we just renewed the contract there within -- in our relationship within the NFL. So we're excited about the RFID market. We've got the broadest and deepest set of RFID solutions today in the market, ranging and covering all those use cases I talked about. So the expansion of the use cases beyond retail is what's exciting to us, and we've got the portfolio really to go address it and we're excited about it.

Operator:

And our next question today comes from Keith Housum with Northcoast Research. Please go ahead.

Joe Heel:

Yes. Keith, this is Joe Heel again. What we're hearing from those customers is mostly that they are looking to adapt their spending to their budgets. And if we think about retailers, which probably make up a meaningful portion of some of those situations where we're seeing that, they are adapting their budgets to what they see as demand in for their business. And as they're doing that, they're asking to spread -- they still need our technology. I think that's the important piece that we see and why we're seeing a push out or maybe a delay in the deployment schedule. So they're trying to fit it in because they know they need this technology, but they're trying to adapt when they're spending the money to when they think it will be available in their business. I think that's the best description.

Bill Burns:

Yes. I think that -- I mean, from an availability perspective, I think we're pretty much there. I mean we're seeing components move into reasonable, much more reasonable lead times, not all, but many. The majority of our items have come back to normal delivery time frames overall. So I think that we feel good about our supply chain and the recovery of that, really almost the majority of almost everything really in first quarter is what I say, from our supply chain perspective.

Operator:

And our next question today comes from Meta Marshall with Morgan Stanley. Please go ahead.

Joe Heel:

Meta, Joe Heel here. In terms of the longer -- in terms of the nature of these longer deal cycles, generally, we have not seen downsizing of deals or down tiering of devices. I could think of maybe 1 or 2 instances. It's more what I was describing earlier to Keith where the deal is being elongated in terms of either the deployment schedule over instead of taking it all in Q1, they're going to take it over 3 quarters for the rest of the year, or they might say, I don't want to take it in Q1, I want to take it in Q2. That's the most common one. Downsizing, I would say not so much, right? We're not seeing that as much.

Operator:

And our next question today comes from Guy Hardwick at Credit Suisse. Please go ahead.

Nathan Winters:

So maybe just to frame the Q1 guide of minus 4% to minus 1%, again, as we mentioned before, we have, again, backlog and pipeline to support the outlook. We've actually had a solid start to the quarter, both in shipments into the channel as well as we're seeing nice momentum from a sales out, particularly on the run rate business. We're also realizing some nice price realization, which is about 1 point of benefit in the quarter. So I'd say, early on, again, seeing nice momentum both from a sales in and sales out. I'd say the -- but the guide also reflects, as we've talked about before, more the uncertainty in the environment and that cautious behavior, particularly as a lot of our customers are finalizing their capital budgets for the year. And the other thing important to note is that Q1 takes the full effect of the Russia headwind for the year, which is about 1 point for the first quarter. So I would say, no meaningful difference between what we're seeing within our own activity with the channel as well as from a sales out perspective, that's noteworthy.

Nathan Winters:

From a year-on-year perspective, if you look at the EBITDA guide of approximately 21%, the supply chain benefit or the premium supply chain benefit is about 3 points, but that's offset by 2 points of FX. So that's -- those are the kind of main drivers from a year-on-year. But yes, you're right. From a year-on-year perspective, Q1 last year was about the peak in terms of premium supply chain costs.

Rob Mason:

I just wanted to circle back again to your commentary around the run rate business. Several times you've commented on healthy sales there, sell out. I'm just curious, how much visibility do you have into the bookings trends in that part of the business? And is it seeing any of the elongated deal cycles or any sense of that?

Anders Gustafsson:

Maybe there's two further points on that. One will be that we don't necessarily have the same visibility into each and in every deal, but this is one where you have a large number of orders, so you get kind of a more statistical confidence from that. And if you look at historically, our run rate business tends to be more of a longer cycle business for us. If we have a strong quarter, it tends not to be kind of one strong quarter and then it drops down. It tends to be that we have four to six quarters of strength in those -- in that cycle. So it's followed by maybe one or two quarters of a little softer demand. So we would expect this to continue for a few more quarters.

Anders Gustafsson:

First, we're very pleased with the performance of the quarter. We had record sales. We came in above the high end of our outlook. We executed very well, I think, and recovered from the distribution network challenges that we had in Q3, and we drove double-digit sales in North America. We talked earlier about the strength we've seen in kind of run rate business, and we see that certainly in small and midsized customers. And we had particularly strong growth from a solutions perspective with print, data capture, RFID, tablets, but partially offset by lower mobile computing sales in Europe, due in part to the exit from Russia in Q1 of last year. Now Asia-Pac was -- had a good performance, particularly when you consider COVID in China. We have very broad-based growth, and we saw nice growth in China, Australia and New Zealand. But Japan, as you mentioned, is kind of the standout here. They have -- we had exceptional growth in Japan. We have invested in driving penetration in the Japanese market over the last several years, both from a go-to-market perspective, but also from a product perspective. And this large postal carrier win that we mentioned is kind of the latest evidence of that. So we now have a very strong position in Japan in mobile computing, which is one of the largest markets in the world that we really didn't have much of a presence before.

Operator:

And our next question today comes from Brian Drab at William Blair. Please go ahead.

Anders Gustafsson:

That can be a long answer. So I'll give you -- start a little bit high, and then we can pick up a couple of the verticals maybe here, but across all our verticals, as I said, we are seeing very strong secular trends to digitize and automate workflows and empower frontline workers in a much more labor-constrained environment. And these trends continue to drive an increased need for our type of solutions across a wide range of vertical end markets. You specifically mentioned manufacturing. We had a very strong performance in Q4 in manufacturing. We had a number of very significant wins that we were very proud of. We are mentioned the one in the automotive side in my prepared remarks. There are some attractive trends in manufacturing that are helping to drive our business here. One is around the business must invest in traceability tools to create more sustainable supply chains. Another one is around industrial automation investment trends in productivity and visibility. And those present opportunities for our solutions, including machine vision and our autonomous mobile robots or Fetch solutions. We've certainly seen very strong traction with machine vision in manufacturing and have some attractive early wins here. We are very excited about what we -- what and our Adaptive vision acquisitions can bring to our customers and partners here. I can dig into other verticals also, but see if you have any other questions here.

Anders Gustafsson:

I think that we probably will leave kind of the outlook around the overall corporate level. But maybe I'll just say that for -- in retail, in 2022, we had approximately flat sales in retail vertical with some very broad-based growth that offset the pullback of one very large customers. So you can see the strong momentum we have across the industry where we could offset a very large customer pulling back in a pretty big way. So the diversification we have across all of these verticals is definitely helping us to mitigate kind of volatility and drive more consistent results.

Thomas Moll :

I wanted to start on the revenue outlook you've provided for 2023, which you've described as embedding a cautious approach. When you use that word cautious, are you primarily referring to some of the spending patterns among the large customers that you referenced? Or is this more a philosophical adjustment you've made where you look at your opportunities and maybe you discount the probability of conversion on some of these deals higher than you typically would just given the macro uncertainty?

Bill Burns:

Yes, I'd just add that I think we feel good about our business. I think this is really all about macro uncertainty. I mean I think we think that we're going to continue to take share in 2023. That's how we see it. We're the leader across the core markets we serve. We've got attractive opportunities across the adjacencies and the expansion business we've invested in. So I think we feel good about our business. I think the uncertainty really is around what's happening around macro, and we're clearly seeing some of that come through in our results in Q4 and our guide for Q1 and '23.

Bill Burns:

I'm not sure we'd see it as separate verticals. What I'd say is that the across the diversification of our solutions and our verticals actually give us kind of resiliency in a downturn, which would dampen some of the cyclicality. So I think this diverse solutions based that we have in product portfolio and the new investments we're making is dampen cyclicality across that customer base. So I'm not sure we'd see it as one worse than the other. I mean, Joe may want to add to it. But I think that we think overall that we're going to take a disciplined approach to OpEx during the year and focus our investments. I think that, from that perspective, I don't think we see one vertical over another.

Operator:

And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Mr. Gustafsson for any closing remarks.

Operator:

Thank you. Ladies and gentlemen, this concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.

Mike Steele:

Good morning, and welcome to Zebra's third 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 Anders Gustafsson, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Anders will begin with our third quarter results. Then Nathan will provide additional detail on the financials and discuss our fourth quarter outlook. Anders will conclude with progress made on advancing our Enterprise Asset Intelligence Vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer, will join us as we take your questions. Now let's turn to Slide 4 as I hand it over to Anders.

Nathan Winters:

Thank you, Anders. Let's start with the P&L on Slide 6. In Q3, adjusted net sales declined 4%, including the impact of currency and acquisitions and down 3.2% on an organic basis, primarily due to supply chain challenges and lower sales to large customers. Our Asset Intelligence and Tracking segment increased 12.4%, driven by double-digit growth in both printing and supplies as product availability has continued to generally improve. Enterprise Visibility & Mobility segment sales declined 8.8% due to supply chain bottlenecks, including component shortages. We realized particularly strong growth in data capture solutions, including RFID and as well as rugged tablets. We also drove growth across services and software with strong service attach rates and attractive software offerings. Performance was mixed across our regions. Asia Pacific sales grew 20% with broad-based strength across the region, including China. Latin America sales increased 10% with exceptional growth in Mexico. And in North America and EMEA, sales decreased 9% and 2%, respectively, due to the supply chain challenges, lower sales to large customers and the suspension of sales in Russia. Adjusted gross margin increased 80 basis points to 45.8% and due to favorable business mix and lower premium supply chain costs, partially offset by unfavorable FX. Adjusted operating expenses increased due to acquisitions and delevered by 60 basis points due to the sales decline. Third quarter adjusted EBITDA margin was 21.1%, a 60 basis point decrease from the prior year period due to expense deleveraging on lower sales. Non-GAAP earnings per diluted share was $4.12, a 9.5% year-over-year decrease. Turning now to the balance sheet and cash flow highlights on Slide 7. For the first nine months of 2022, we generated $170 million of free cash flow, which was significantly lower than last year, primarily due to a higher use of working capital due to elevated inventory and sales volume shifting to later in the quarter. Higher incentive compensation payments given our exceptional 2021 performance and $90 million of previously announced settlement payments. We made $50 million of share repurchases and invested $6 million in venture investments in the third quarter. We ended the quarter at a comfortable 1.7 times net debt to adjusted EBITDA leverage ratio and with more than $1.2 billion of capacity on our revolving credit facility. On Slide 8, we highlight that premium supply chain costs have improved from peak levels. The actions we have taken to redesign products, targeted price increases as well as the improving freight capacity have enabled us to reduce purchases on the spot market and reduce the freight cost impact. We are on plan to move printer shipments to ocean from air late this year and into early 2023. For the full year 2022, we now expect approximately $190 million of premium supply chain costs over pre-pandemic 2019 levels, a $10 million reduction from our prior outlook. In Q3, we incurred premium supply chain costs of $30 million as compared to the pre-pandemic baseline, which was favorable to what we had anticipated in our prior outlook. In total, Q3 transitory items had a combined favorable gross margin impact of $14 million year-over-year. And in Q4 are expected to be approximately $35 million, which is a nearly $30 million reduction year-on-year. Let's now turn to our outlook. Q4 sales are expected to be approximately flat from the prior year period, with a range of negative 2% to positive 1% growth. As compared to our prior outlook, the lower sales growth is driven by softening demand, continued supply chain challenges and currency headwinds. We are confident in this guide given our relatively strong order backlog, improved quarter-to-date shipment activity and actions taken to stabilize North American distribution. We estimate a two-point additive impact from recently acquired businesses and a four-point negative impact from foreign currency changes. As a reminder, approximately 25% of our global sales are denominated in euros. We anticipate Q4 adjusted EBITDA margin to be between 22% and 23%, which is an increase from both the prior year and the prior quarter. Given our tempered view of the demand environment, we are taking a conservative approach to managing operating expenses while preserving strategic growth investments. Non-GAAP diluted EPS is expected to be in the range of $4.50 to $4.80. We now expect our free cash flow to be at least $400 million for the year, which we have significantly reduced from our prior outlook due to lower profits and elevated inventory levels that we will be working down into 2023 as we rationalize safety stock and execute on our North America distribution transition. Sales seasonality has improved to more normalized levels in Q4, which should drive the peak cash flow quarter for 2022. Please reference additional modeling assumptions shown on Slide 9. With that, I will turn the call back to Anders to discuss how we are advancing our Enterprise Asset Intelligence vision with our customers.

Mike Steele:

Thanks, Anders. 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.

Tommy Moll:

Good morning and thanks for taking my question.

Tommy Moll:

Anders, I wanted to start on the comments you made regarding some deferred projects from large North American customers. Any context you can share there on end market type of project visibility to picking back up on some of this work going forward would be much appreciated. And as a related point, would you say that these projects are all the majority of or a smaller part of the demand softening that you called out late Q3. I'm sure it's part of what you described there with the softening, but order of magnitude would be helpful. Thank you.

Joe Heel:

Yes. To put it in perspective, perhaps in terms of the miss to the outlook, the deferral of project was a minor contributor to that. Among these -- the deferral of projects, these late-in-the-quarter deferments were a relatively small number of larger projects, as Anders said, deferred primarily into 2023. That's probably as much as we can say.

Nathan Winters:

Tommy, this is Nathan. I'll start with the first part. Just a little bit of background. We selected a new DC location midway through last year. And as we said on the call, we had some issues with the transition impacting shipment volumes late in the quarter, and we've implemented corrective actions, particularly on ramping back our Texas facility. That gives us some additional time to work through the transition, both from a people and process perspective. So again, I'd say although we didn't deliver the shipment volumes necessary to meet the Q3 forecast. We are now operating at levels required to deliver Q4. Still not where we want to be. But again, the Texas facility is nearly staffed to full capacity and we've had a really nice recovery here in deliveries in October. Just as context, we've shipped out nearly $200 million more in October than we did in the month of July, which is giving us both confidence in the performance of the DC as well as confidence in the Q4 guidance. I'll pass it over to Anders.

Operator:

Our next question will come from Andrew Buscaglia with Berenberg. You may now go ahead.

Anders Gustafsson:

Good morning.

Joe Heel:

Yes. I'll add two things perhaps for perspective. One is an example of what we're seeing is a large customer who will take an order that they would have perhaps placed in Q3 or early in Q4. And now telling us we're going to split that order, and we're going to take 80% of it now and 20% of it later in 2023. That's an example of the type of thing we're getting. So it feels like there's real demand behind the order. The other thing that we're hearing from customers quite consistently is while some customers, in particular, retailers are being cautious about their business, about their revenue expectations, and those are obviously visible to you in what they say on their earnings calls. They are telling us that their investments in IT and in the types of solutions that we provide them are important to them even in more uncertain times because they need to improve their productivity, and we help them do that with our solutions. So that's certainly something we hear pretty consistently.

Nathan Winters:

Yes. So Andrew, maybe just context for the broader premium supply chain costs. I think what we saw in Q3 was a positive momentum, 50% reduction from what we experienced in Q2, decreasing from nearly 4% of revenue to just over 2%. And that was primarily driven by the declining shipping cost per kilo, which we're experiencing as well as benefiting from the pricing actions beginning to take effect with the price increase we did in July. Q3 shipping costs did come in below estimate. We also benefited, if you look at the mix and the $30 million for the quarter from lower North American revenue, and that's the other reason for it ticking back up in the fourth quarter in terms of overall transitory. And our Q4 guide assumes no improvement in freight rates. So it's something we're continuing to monitor it. But if you look at the overall reduction from $200 million to $190 million in premium supply chain costs, some of that's volume driven, just over half, but also $4 million of that or so was due to the lower rates we're experiencing. And I think our expectation is that we will see steady reduction into 2023 around these costs as long as the freight rates hold where they're at today. And then we're going to continue to transition from air to ocean, really late here in the fourth quarter. We did some ocean shipments into Europe in the third quarter but we really don't expect ocean shipments to pick up until late here in the fourth quarter and into 2023. And we've also seen a nice reduction in what we've had to buy in critical components on the spot market. So we're starting to see that loosen up as well. So again, we feel confident that we'll see a steady decrease. And EBITDA benefit as we go into next year.

Jim Ricchiuti:

Hi, thank you. First question, just again on the deferral that you're seeing among a few of these North America customers. When you talk about it, some of this business slipping into 2023, is the presumption that this would be slipping further into 2023 into the second half just given the seasonal investments that these types of customers may make?

Jim Ricchiuti:

Okay. That's helpful. And Anders, I wonder if you could talk to what you're seeing in the SMB market. It sounds like you're seeing relatively good demand there. I don't want to put words in your mouth, but if you could comment on that. And also in an economic cycle, which part of the business would you see impacted more immediately, the larger customer business or the SMB business?

Joe Heel:

Yes. Maybe I'll just amplify some of Anders' points. Number one, the growth in the medium-sized customers and also in the run rate has been particularly encouraging for us because that's where our supply constraints are particularly important, right? If you have supply, you get run rate. When we had supply return, our run rate rebounded. And that was a really good sign of the resilience of our run rate. That's very encouraging for us. You asked about which size of customer goes into the cycle first. And what we saw is that as we entered into the pandemic, the largest customers were the first to accelerate their purchases. And they were followed nine, 12 months later by medium-sized and smaller customers than also accelerating their purchases. Now as we're seeing some caution in the market, it's -- again, the largest customers that are being cautious first, some of the deferrals that we've referred to and that you asked about were larger customers with large orders while the medium-sized and small customers continue to go very strong with even double-digit growth. So that's the dynamic that we're seeing in the cycle. Hopefully, that's helpful.

Erik Lapinski:

Hi, team. Thanks. If I could go back to kind of the commentary on the run rate business you just made, I guess, just trying to get a better sense on the strength there. Do you think that's an element of customers being further behind on investments versus larger customers than And then maybe also on that point, like when we think about deferrals from the larger customers, is that related to a refresh or a new device deployment? Any kind of color you can give us there would be helpful.

Joe Heel:

Yes. When it comes to the run rate, it really matters what's on the shelf, right? You have small customers that are calling into distributor and what's on the shelf counts. And once we had product on the shelf again as our supply chain ramped up again over the course of the quarter, we saw that run rate rebounding. So I think that's the dynamic that there's no pull forward or that dynamic doesn't exist to that same extent in the run rate. When it comes to the larger customers, to the deferrals, we are talking about large customers that are typically doing deployments of mobile computers. You see it's pretty concentrated in the mobile computing segment. You have certain deployments that they have been planning and in some cases. But again, they were very few, and they were the minor reason for the miss in the quarter, right? But in those few cases, we're talking about deployments of mobile computers which are stretched out over a slightly longer time period, we think, into the first quarter of next year.

Nathan Winters:

Yes. A couple of drivers behind the OpEx flexibility. I mean the first is based on our variable comp structure, there's an element of variability in there relative to how we're performing for the year. The other one is, we did a hard look at where we're hiring and what roles and what positions around the world to ensure that where we're adding heads and investing is in our growth areas that we would kind of look at and say, there's no regrets in that in terms of those hiring. So it's a combination of those two, along with, again, continuing looking at discretionary spending where it makes sense. So I think those are the three main drivers here in the short-term. And as we go into next year, we're continuing to look at where we can drive efficiencies, looking at our real estate portfolio, but all the things you would expect us to do particularly as we go into a more challenging macro environment.

Damian Karas:

Good morning, everyone.

Damian Karas:

Good morning, good morning. Not to beat a dead horse here on the project deferrals, but could you just clarify -- one, you haven't seen any order cancellations. And two, just thinking about these customers that have pushed out orders, it sounds like you do have visibility in terms of timing of delivery in 2023, and it's not that the conversations have been, hey, let's just put this on pause until a later determined date?

Joe Heel:

Yes. But there are some indications, Damian, that give us confidence that the deployment will occur. One of them is that they're taking an order and splitting it into two, right, as I've described to you. The other is that they're already working with us on deployment plans. We do see those stock signs not in every case, but in the majority of cases. So that's why we're describing it as we are.

Nathan Winters:

So that's -- this was per our plan. We expected Q3 to start the modest shipments into Europe, which we did from an ocean perspective, but the plan and the guide around our premium costs had always assumed we wouldn't really feel any financial benefit to the move until we get into next year. As the priority for this year was to ensure we delivered enough printer volume to take care of our backlog as well as ensure we have the right products on the shelf to support our run rate business.

Brian Drab:

Good morning. I think most of the details come out here already, but I'm just wondering if you could give us a more specific update maybe on how Matrox and Fetch have been performing relative to your expectations? And again, in this difficult environment, I know Matrox committed about $100 million revenue run rate and Fetch about $10 million. I don't know if you could update those numbers directionally even. Thanks.

Joe Heel:

And maybe a little bit of additional color. With the business being in sort of the early stages of development, what you look for primarily are pilot deployments, right? And we're seeing a very good stream of these pilot deployments. We were also very pleased to have two larger deployments already that we mentioned, I think, in the earlier -- in the previous earnings call already that are anchor tenants, I guess, now for our Fetch Robotics business going forward.

Anders Gustafsson:

Yes. First, I'll say that we don't see this as a zero-sum game. There's a lot of white space for us to go after without having to kind of go up and seek out opportunities where we compete with any specific competitor. It is also a very fragmented market. I think that the market leader has probably about 20% or no more than 20% market share. So there's plenty of opportunities to pursue without having to do that. That being said, I think we feel good about the value propositions that we have with Matrox. It is known for having a very some high-quality, high-performance solutions that can solve some very complicated problems for our customers. We worked hard on -- across our fixed investors scanning machine vision portfolio to drive ease of use as a differentiator to make it as easy for our customers to deploy and get time to revenue for these solutions. And that's been, I think, resonating back very well. Also, the software upgradability of our products is a differentiator. And we've had some very nice wins against a variety of different competitors with some large marquee customers. So we feel quite excited about it.

Operator:

Our next question will come from Keith Housum with North Coast Research. You may now go ahead.

Anders Gustafsson:

The -- I would say, the mid-term outlook was predominantly explained by the supply chain challenges related to the persistent component shortages for certain products and the disruption in the transition to our new North America warehouse. And there's probably about 45% -- $45 million on each of those. And the smallest part was the deferral of projects with about 10% of the miss to our outlook. So clearly, the supply -- the DC move was the largest part of this.

Nathan Winters:

Keith, I would say it's relatively modest in terms of the cost structure we have with both of those facilities in terms of typically pay on a cost per unit with each of the facilities. So it's -- I think it's relatively modest in the -- from an overall profitability of managing both -- we had a little bit of extra cost here in the third quarter. We had to ship some products between the facilities to get the inventory rightsized moving forward. But now that, that's corrected, it's a relatively modest impact on overall profitability to manage both sites.

Rob Mason:

Hi, guys. Good morning. Just maybe just a follow-up on the last question. When will this North American distribution center transition be complete and I guess, consolidated into one facility?

Rob Mason:

Sure. Sure. There was also mentioned that you will be taking some pricing actions in Europe outside the US to address currency. When will those price actions be realized? Will start to show up? And then I'm just curious as well, what was the actual FX impact on your gross margin in the quarter?

Operator:

Our next question will come from Paul Chung with JP Morgan. You may now go ahead.

Nathan Winters:

Yes. So I'd say as we look at it going into next year, obviously, we think there's -- just based on the second half run rate, there will be a meaningful improvement from a year-on-year perspective. And I'd say at this point, steady is probably the right word in terms of how we're looking at it. And a lot of this has to do with how freight rates hold up. So I think based on what we've seen, they've held steady to slightly down since kind of middle of the second quarter, which is really positive. But at any moment, they can swing another way if there's any other type of supply chain shocks in the system. But yes, we would expect again, steady improvement from the second half run rate as we go into next year.

Nathan Winters:

Yes. So maybe I'll start with the second part of that. As we look at our inventory, we'd expect this to draw down through the first half and get to maybe, say, normalized levels as we enter the second half of next year, which we think is somewhere between $600 million and $650 million of inventory. That's based on the size of the company today plus the acquisitions, as well as intentionally holding more strategic component inventory than we have in the past to improve resiliency. We have a team dedicated and working on this. A big driver of that is finishing -- getting the DC move, stabilized. We've also made several moves within our supplies business in terms of manufacturing where we've had to build some buffer stock and working through that. And for the product categories or components that that have recovered, we are planning to draw down our safety stock at our manufacturing partners over the next several quarters. And that's really the big driver of where we'll see the reduction in working capital. But as you mentioned, we expect all these actions to enable us to significantly reduce working capital and deliver free cash flow conversion above 100% if you exclude the settlement payments. And then to your first question, we have no concerns that the inventory levels create any type of risk from an excess obsolescence perspective. We have strong demand for what we have in both finished goods as well as component parts. And then there's no intention of reducing pricing beyond what's normally required in the competitive environment. I'd say alternatively, we're pushing that we have stock available for customers who may have been waiting on certainty of supply before placing an order, so using it as an opportunity.

Operator:

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

Mike Steele:

Good morning and welcome to Zebra’s second quarter 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 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 the 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 Anders Gustafsson, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Anders will begin with our second quarter results. Then Nathan will provide additional detail on the financials and discuss our revised 2022 outlook. Anders will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer will join us as we take your questions. Now let’s turn to Slide 4 as I hand it over to Anders.

Nathan Winters:

Thank you, Anders. Let's start with the P&L on Slide 6. In Q2, adjusted net sales increased 6.4%, including the impact of currency and acquisitions, and 6.9%. on an organic basis as we secured a greater supply of certain products than we had anticipated. Our Asset Intelligence & Tracking segment, including printing and supplies increased 9.7%, driven by a strong recovery in printing as we secured critical components to better satisfy record levels of customer demand. Enterprise Visibility & Mobility segment sales increased 5.6% with solid growth in both data capture and mobile computing solutions. We realized particularly strong growth in RFID solutions as well as ruggedized tablets in Q2. We also continue to drive solid growth across services and software with strong service attached rates and attractive software offerings. We realized strong growth in three of our four regions. EMEA sales increased 17%, driven by particularly strong growth in mobile computing and printing, inclusive of the impact of exiting Russia in March. Asia Pacific sales grew 14% with particular strength in India. Latin America sales increased 16% with exceptional growth in Mexico. And in North America sales decreased 2% due to supply constraints. We also cycled particularly strong mobile computing sales volumes in Q2 of last year. Adjusted gross margin declined 200 basis points to 46% due to higher premium supply chain costs and China import tariff recovery in the prior year period, partially offset by higher service and software margin. Adjusted operating expenses as a percent of sales improved 60 basis points. Second quarter adjusted EBITDA margin was 21.9%, a 170 basis point decrease from the prior year period. Non-GAAP earnings per diluted share was $4.61, a 0.9% year-over-year increase held by lower share count and lower taxes. Note, that in the quarter, we entered into a settlement agreement resulting in a $372 million one-time non-GAAP charge, which will be paid out over eight quarterly installments. Turning now to the balance sheet and cash flow highlights on Slide 7. For the first half of 2022, we generated $123 million of free cash flow, which was lower than the last year primarily due to a higher use of working capital as sales volume shifted to later in the period due to the China lockdowns; higher incentive compensation payments given our exceptional 2021 performance; and the initial $45 million quarterly installment payment related to the settlement I just mentioned. From a balance sheet perspective, as previously announced, we have significantly increased our available borrowing capacity to align with our growing business to optimize our capital structure. Our new credit facility provides us ample flexibility for organic and inorganic investment, including the recent acquisition and Matrox Imaging, as well as share repurchases through our recently announced $1 billion incremental authorization. We made $300 million of share repurchases in Q2, and from a debt leverage perspective we ended the quarter at a comfortable 1.7x net debt to adjusted EBITDA leverage ratio. On Slide 8, we highlight that premium supply chain costs have sequentially improved from peak levels. Our team has been successfully working all avenues including product redesigns, and negotiating long-term supply agreements for critical components, which has enabled us to reduce our purchases in the spot market. We have been seeing steady improvement in the supply chain environment, which we continue to closely monitor. In Q2, we incurred incremental premium supply chain costs of $56 million as compared to the pre-pandemic baseline, which was favorable to what we had anticipated in our prior outlook. In total, Q2 transitory items had a combined unfavorable gross margin impact of $35 million year-over-year and in Q3 are expected to be approximately $45 million, which is a neutral year-on-year impact net of pricing. Let's now turn to our outlook. We ended the second half of the year with a strong quarter backlog and healthy sales pipeline supported by broad based demand for our solutions. We have been experiencing a steady improvement in manufacturing output, however, our sales growth continues to be limited by extended lead times and availability of certain component parts. Our organic growth has also been impacted by approximately 1 to 2 points after stopping shipments to Russia in March. For Q3, we are limiting our sales growth to a range of 2% to 4% due to actions to reduce expedited air freight costs, and shift our printer products to ocean shipments, which will improve both Q4 growth and profitability. We're also assuming a 2 point additive impact from recently acquired businesses and a 3 point negative impact from foreign currency translation. As a reminder, approximately 25% of our global sales are denominated in Euros. We anticipate Q3 adjusted EBITDA margin to be approximately 22%, which is an increase from both prior year and prior quarter. Non-GAAP diluted EPS is expected to be in the range of $4.35 to $4.65. For the full year 2022, we are reaffirming our outlook with a sales growth range between 4% and 6% inclusive of the impact of exiting Russia. We are also assuming 150 basis point additive impact from recently acquired businesses and a 225 basis point negative impact from foreign currency translation. We now anticipate full year 2022 adjusted EBITDA margin of approximately 22%, the low end of our prior guide primarily due to the significantly stronger U.S dollar. Profit margins are expected to improve in the second half of the year as we continue to shift to lower cost freight options and prudently manage operating expenses and investments. We now expect our free cash flow to be at least $650 million for the year, which we have reduced primarily due to the approximately $150 million of settlement related payments. Please reference additional modeling assumptions shown on Slide 9. With that, I will turn the call back to Anders to discuss how we are advancing our Enterprise Asset Intelligence vision.

Mike Steele:

Thanks, Anders. We will 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.

Tommy Moll:

Good morning, and thank you for taking my questions.

Nathan Winters:

Good morning.

Anders Gustafsson:

Yes, I'll try to give as much color as I can here. I'll start little bit more on current performance which we saw in Q2 and then try to give you a little bit of a sense of how the -- how we look at the future here. But first, I just say that the trends to digitize and automate workflows and empower frontline workers that continues to accelerate and in driving increased customer demand for our solutions across all our vertical markets. Retail and e-commerce grew faster than the corporate average in Q2 -- still very strong prior comparisons. We do continue to see strong momentum of omni-channel implementations, which is -- which are straining our customers resources and that's also driving investments in technology and automation that is necessary for retailers to continue to transform their businesses. If you look at the -- in the actual store, expanding buyer line pickup, install use cases and delivery use cases require retailers to equip more associated with mobile computers, along with -- also implementing more workflow software optimization solutions. And in the warehouse we see investments in productivity and visibility as essential to their transformation. We've also expanded with some new attractive go-to-market partnerships like Microsoft and Google that helps to elevate our strategic positioning within the retail vertical as well as other verticals. And we have a very diversified retail e-commerce customer base, and each of those customers are on their own refresh cycle, which helps to reduce volatility for us. I also say that our pipelines remain very strong. And although this is a quite a challenging environment, there are several retailers who have recently publicly talked about their intend to maintain investments in technology as they try to continue to drive or execute on their visions and their strategies. There are certainly a few customers that are ahead of their investment curves. But I would say most are playing catch up with investments in solutions like ours, particularly in a labor constrained environment, where they need to improve productivity, inventory accuracy and customer service levels. So as I would say, this feels more like a normal year for us and that most customers are investing and proceeding with healthy -- healthily with their plans. But there are some they're pulling back a bit. But this is the value that we have of a diversified customer portfolio that allows us to not be overly dependent on any one customer. And I'd say it's also noteworthy that, we continue to grow despite the cyclicality of some of these large customers that we have, and that it's a testament to our diversified customer base. I hope that helps.

Anders Gustafsson:

Yes, Tommy, if you look at our Q3 guide of 22%, I'd say just if you look year-on-year, it's up 30 bps from the last year. And when you dig into that, over 2 points increase from strong volume leverage, the pricing benefits, taking traction from what we've executed over the last 9 months, as well as we're seeing solid improvement in the underlying gross margin across the portfolio, but that's offset by nearly 2 points of FX, as we're forecasting slightly above parity. And Q3 is the first quarter where the premium supply chain costs have a neutral impact year-on-year. Sequentially from the second quarter, it's flat -- as you get some improvement from -- improvement in overall premium supply chain costs, but that's offset by FX and slightly unfavorable deal mix. So that's kind of your Q2 to Q3 dynamic. If you look at the fourth quarter, the rate increase is really driven by two dynamics. One would be continued improvement in overall premium supply chain costs, as we are taking actions here in the third quarter to reduce air freight, moving print ocean that you'll see the benefit for in the fourth quarter, as well as you get nice volume leverage sequentially in terms of revenue -- increased in revenue on a relatively flat OpEx profile. So a bit -- almost half the driver is volume leverage with the other half being continued improvement in overall cost position.

Andrew Buscaglia:

Hey, good morning, guys.

Andrew Buscaglia:

So I like to -- on that margin question. Just wondering throughout the quarter what you saw in terms of the higher supply chain costs and freight costs. Your guidance of $200 million it seems that would imply things hadn't really changed, or how would you characterize how the quarter went relative to your expectations?

Andrew Buscaglia:

Yes. Okay. Okay, great. And a question on the AIT segment. So that really surprised me positively and great margin performance. But as I understand it, that segment really follows GDP if you look back to the pandemic and the pre-financial crisis. And if GDP estimates are slowing broadly, what do you foresee in that segment going forward? Are we seeing -- is there a lag here where that might deteriorate that growth?

Joe Heel:

Yes. Andrew, I might also point towards opportunities that we have to continue to expand in areas beyond a pure GDP growth. I'll give you two examples. One would be a use case expansion, where we can continue track and trace is becoming increasingly important, for example, in pharmaceuticals, and expanding in those use cases can help us grow beyond GDP. And another one would be a segment expansion, for example, our entry into the SOHO printer market would be evidence of that. So I think we have opportunities to weather volatilities in a GDP.

Erik Lapinski:

Hi, team. Thanks for taking my question, and congrats on the quarter. I'd like to ask for just a little bit more detail on some of the varying regional growth drivers you saw in the quarter. International growth is particularly strong and understand different regions are in different phases of their investment cycle. So are you seeing similar trends driving growth in each region on a vertical basis? Are there certain verticals driving the strength in whether it's EMEA, or Asia Pacific that you saw in the quarter?

Joe Heel:

Yes, I would only emphasize that the regional distribution of growth that we saw in Q2 is not reflective of the underlying demand situation, but much more reflective of how we allocated supply in times of shortage based on the shortest path that we have to get supply into a market.

Anders Gustafsson:

We think similar priorities as normal, we were comfortable with the overall debt levels and cash positions that gives us a lot of flexibility as we enter the second half and into next year. To continue to priorities investment in the business both inorganic, organic, we have exciting opportunities in both of those and share repurchases will remain a nice flexible way to return capital to shareholders. So I'd say no change in the overall capital allocation approach as we go into the second half of the year.

Operator:

The next question is from Brian Drab of William Blair. Please go ahead.

Anders Gustafsson:

So, if are you looking at our visibility into kind of our pipeline, it certainly varies to some degree based on customer and so forth. But for our larger customers, and a large part of the market, we start the year by going through and having detailed reviews about their outlook, their investment profiles already in November, December the prior year. So we have a good perspective of what they expect to do for the year, and we stay close to them to see if there are changes. Obviously, they can always change, but it's we tend to have a good visibility from those. And we work very closely with our reseller partners to develop a pipeline for that is more than 12 months out. And we qualify that round, we are in the sales pipeline those deals are, so they something we feel we can commit to or they are more in the exploratory phase. So we tend to have a pretty good handle on that. We also have such a large volume of transactions, so we get statistically some differentiation or diversity from that, which helps. So we're not overly -- we don't -- we wouldn't necessarily over read any one signal here. I don’t know, Joe, do you want to comment on that, add anymore?

Anders Gustafsson:

And I'd say the bookings velocity has remained pretty stable this year. So it's very strong. We haven't seen evidence of a recession or predict a slowdown.

Brian Drab:

Okay, thanks. That's all very helpful. And then can I just ask if you can, and I know that’s sensitive because it's a legal issue, but around the settlement, it seems like a pretty big, big deal. And it's a large -- very large settlement. And can you make any comments as to what happened there? I guess it's primarily with the related to the scanner product line. And just wondering, can you comment at all, does that change the competitive dynamics going forward for that product line?

Operator:

The next question is from Paul Chung of JP Morgan. Please go ahead.

Nathan Winters:

Yes, so if you look at our free cash flow, again, the -- for the first half decrease in relative to what we expect in the second half was really around the higher use of working capital and the timing of sales, as particularly in the second quarter with the China lockdown. I mean, June was one of our, I think, our highest revenue quarters on -- in history, just given the delay of getting products out of China into ship. And that obviously has a drag on from a collection of timing. And we expect that to normalize as we go into the second half of the year. And so that's -- that'll be a big driver of the increase in cash flow as we go to the second half of the year. And I would say, overall we target 100% free cash flow conversion over a cycle. We've been over 100% the last several years, if you go back to 2020 over 130 last year over a 100. This year if you normalize for the settlement around 80%. So I think, again, what we'd expect next year to recover back closer that 100% range is that we target. But obviously you can't say above a 100% forever. So this is a little bit of a year of catching up for the outperformance in the past couple of years.

Nathan Winters:

Yes, I'd say if you look at from a gross margin perspective, I think actually look at total Q3, both gross margin and OpEx from a scaling and rate perspective will be similar to Q2 and thus the similar in terms of EBITDA rate of around 22%. And as we go into the fourth quarter, you'd expect both to improve as the -- as we're able to lower some of the supply chain costs, that'll be an improvement on gross margin. And then we'll get some nice OpEx scaling as we head into the fourth quarter as we expect costs to remain relatively -- OpEx remain relatively flat from a dollars perspective as we go through the second half of the year. So those be some of the dynamics as we play through the third and fourth quarter.