Zebra Technologies Corp

NASDAQ:ZBRA

Earnings Call Transcript 2023-Q2

[Operator]

Good day, and welcome to the Second Quarter 2023 Zebra Technologies Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be opportunity to ask questions. Please note this event is being recorded.

I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead.

[Mike Steele, VP, IR]

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.

[Bill Burns, CEO]

Thank you, Mike. Good morning and thank you for joining us.

Our second quarter results were impacted by weakening demand and cautious customer spending behavior across our end markets. While these results are certainly disappointing to us, we'll spend some time today discussing the drivers that are having the greatest impact, as well as the actions we are taking to control what we can in a difficult demand environment, including our expanded cost reduction initiatives.

For the quarter, we realized sales of $1.2 billion, a 16% decline from the prior year and adjusted EBITDA margin of 21.2%, a 70 basis point decrease, and a non-GAAP diluted earnings per share of $3.29, a 29% decrease from the prior year.

Let me now put these results in context. On our last quarter call, we discussed the broader softening of industry demand as customers tightened their CapEx budgets and IT device spending slows. During the second quarter, those trends accelerated as we saw more cautious spending behavior by our customers of all sizes across our vertical end markets and regions.

While all end markets declined, demand was weakest in retail and e-commerce and transportation logistics as many customers are absorbing capacity they build out during the pandemic. These dynamics have been exacerbated by our distributors focus on reducing their inventory levels, which accounted for approximately 20% of our Q2 sales decline.

Our distribution channel has been aggressively driving down inventory as end user demand has slowed, product lead times have recovered, and the cost of holding working capital has increased. Although global macro indicators have been resilient, the goods economy has underperformed the services economy, and certain key indicators most relevant to our industry have become significantly weaker, including IT device spending. This particular metric has been most correlated with mobile computing where sales declines have accelerated year-to-date following more than two years of very strong demand.

Growth across RFID, data capture, supplies, services and software were bright spots in the quarter.

From a profitability perspective, improved gross margin and cost controls enable us to achieve our EBITDA margin and EPS outlook for the second quarter. In our current market environment swift action is needed and we are taking a number of steps to position us to deliver profitable growth and improve free cash flow.

Slide 5 summarizes key industry challenges that have intensified since our prior update, and our actions to address and mitigate the impacts. These actions include reducing spending across the organization, including additional restructuring actions to drive an incremental $65 million of net annualized operating savings as we exit 2023, increasing our focus on accelerating growth in underpenetrated markets, and continue to work closely with our customers as we continue to digitize and automate their environments.

Our revised full-year outlook incorporates the slowdown and deceleration across our end markets, including a significant reduction in near-term demand in the mobile computing market, destocking buyer distributors, as well as a partial year benefit of our expanded restructuring actions.

Given our limited visibility in this environment, we are cautious in our assumptions and not expecting a recovery in 2023. We expect the reset of our cost structure and shift of our go-to market resources to drive sales growth and improved profitability as our end markets recover. We'll continue to take an agile approach to managing through this uncertain near-term environment.

I will now turn the call over to Nathan to review our Q2 financial results and provide additional details on our revised 2023 outlook.

[Nathan Winters, CFO]

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.

[Bill Burns, CEO]

Thank you, Nathan.

While sales are pressured near-term, over the long-term, our solutions remain essential to our customers' operations, and we are well-positioned to benefit from the secular trends to digitize and automate workflows across our served markets. We are focused on advancing our Enterprise Asset Intelligence vision by elevating Zebra as a premier solutions provider through our compelling portfolio.

By transforming workflows with our proven solutions, Zebra's customers can effectively address their complex operational challenges, including scarcity of labor and the need to improve productivity. We empower the workforce to execute tasks more effectively by navigating constant change in near real time, utilizing insights driven by our advanced software capabilities such as machine learning and prescriptive analytics.

Now turning to Slide 13. I would like to highlight several key mega trends, which supports Zebra's growth and customer value propositions over the long-term. These include automation, mobility and cloud computing, and artificial intelligence. Our customers rely on Zebra to help them take advantage of these key mega trends, which drive their growth strategies.

As you can see on Slide 14, Zebra's enterprise mobile computers are critical to the front line of business. We are excited about our innovation roadmap and new solution launches that advance our value proposition. Labor is a scarce resource and leveraging technology is a key way our customers can advance their operations.

Our solutions empower enterprises to increase collaboration and productivity and better serve customers, shoppers, and patients by enabling and expanding number of use cases across our end markets. Our enterprise mobile computing installed base has expanded significantly over the past several years due to the perforation of use cases and the investment in Zebra solutions should rebound as technology refreshes or reprioritized.

On Slide 15, we highlight a few areas that are advancing our capabilities to serve our customers evolving needs and are expected to be profitable growth drivers for Zebra as we continue to scale them. Collectively, these offerings are approaching $0.5 billion of annualized sales and have a long runway for growth.

First, we are a leader in advanced location solutions through RFID. We have been driving strong double-digit growth in recent years with the heightened importance of real-time inventory accuracy. We are now addressing an expanding set of use cases throughout the supply chain, including our previously announced large win with a global transportation logistics provider, which highlights the long-term growth opportunity for RFID solutions.

Second, we believe investments in our machine vision business, which is accretive to our growth and EBITDA margins, positions us well for long-term growth. We continue to invest in innovation and go-to-market efforts to further diversify and scale in attractive subcategories. Strong growth in certain end markets, including warehouse distribution, and electric vehicle manufacturing has partially offset weakness in the semiconductor industry.

An example of our recent success is a win with the U.S.-based global auto manufacturer who has been transitioning to electric vehicle production. The ease of use of our solutions was a key differentiator as the manufacturer capitalized on the disruption in the auto market to modernize its processes with more flexible solutions.

And lastly, our workflow optimization software offerings include workforce and task management, communication and collaboration tools, inventory visibility and demand planning. Recent notable wins include our workforce management solution for location staffing at a large North America bank and our retail demand forecasting solution for a North America consumer packaged goods company. The actions we are taking to improve profitability of our software offerings, including migration to a cloud-based platform are expected to enable software to become EBITDA margin accretive in 2024.

In closing, our long-term conviction in our business remains unchanged. While customer spend is pressured near-term, over the long-term, we believe we're well-positioned to benefit from secular trends to digitize and automate workflows. We'll work to continue to elevate our position with customers through our comprehensive portfolio of solutions while taking the actions needed to improve profitability and position us for success both in the current environment and in the future.

I will now hand it back to Mike.

[Mike Steele, VP, IR]

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.

[Operator]

[Operator Instructions].

Our first question comes from Tommy Moll with Stephens. Please go ahead.

[Tommy Moll, Stephens]

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.

[Bill Burns, CEO]

Yes. I think overall that we've said that what we've seen in the market is that as the goods economy is clearly weaker than the service economy, which is resulting in we're seeing more of our customers really absorbing the capacity that they bought through the pandemic, and that extends beyond just the largest e-commerce retailer we've talked about in the past, but to other e-commerce even our retail customers and into transportation logistics customers as well. And we've seen softness now spread into other markets.

But specific to your question, I think that I guess maybe a good example of that is recently we've seen a large logistics company talk about really what's been detrimental to their volumes, right? And I think it is this idea that the overall industrial economy is slowing, right? Clearly focused on goods and not services. And they've said, look, that's slowing obviously because of all the macroeconomic indicators, right?

Inflation interest rates slowdown in global trade. It's also being driven by consumers buying less, right? And then this reset of e-commerce coming out of the pandemic to the levels of purchases of goods slowing down transportation logistics package delivery as well, which has really been detrimental to the entire industry overall from a volume perspective. So we're seeing this additional capacity built out in e-commerce players. We're seeing it in retail, and I wouldn't say it as much as excess capacity is really, they have what they need for now, and as the goods economy slows, they eventually will come back and buy more.

But for today, they've got what they need. We're seeing it move into parcel delivery with transportation logistics, but also spread into other markets as well. As you know, in first quarter we talked about slowing down of large orders and large customers. We've seen that move into mid-tier and smaller customers as well. So it's more broad-based than we had seen in the past. And we think it really is the two years of very strong demand we've seen, especially in mobile computing across our entire customer base is now being absorbed and into the marketplace and then ultimately, that's why we're seeing the decline in the short-term. And that will come back as the macro indicators come back, as people buy more goods than services, as you know they use this excess capacity within their environment. They will buy more from us. And we'll see that inflection point at some point, but right now we're not seeing it. We're clearly seeing our demand be pressured because of it.

[Tommy Moll, Stephens]

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.

[Bill Burns, CEO]

Yes. Kind of a combination answers there probably is that overall, we would say that, why do we believe our guide, right? And as we looked at Q3 and Q4, clearly in Q3, you're seeing more destocking from a distribution perspective than you are in Q4. But I think that we've taken an approach that basically for the guide for Q3 and full-year, where we see the demand trends that we'll continue that begin to deteriorate really in Q1 and continue through Q2. We'll continue from a booking and sales velocity perspective, it'll remain about the same for the full-year.

We're assuming that a significantly lower conversion of opportunities within our pipeline than historical levels just because of these push-outs of large orders by our customers. And we've removed expectations really for recovery in year-end -- at year-end in fourth quarter. But the reason you see that the uptick there is really because we're seeing an oversize effect of our distributors destocking inventory levels as their end demand continues to slow.

So ultimately our sales out of distribution, when that slows, they hold a specific days on hand inventory and they need to buy less from us because they're selling less out. They need less in inventory. And I think that the -- we see an oversize effect when end demand slows. So in fourth quarter, we're seeing less of the destocking than we were in Q3.

The destocking is also driven by the fact that our delivery times have shortened and their cost of capital's gone up. So there's pressure on inventory and to lower those inventory levels really as their end demand is slowed and we're seeing a bit less of that in fourth quarter. So that's really the trajectory we're seeing around. We believe ultimately we're seeing -- in the process of seeing really the bottom in Q3 and Q4 and do see an inflection point in 2024. But the difference between Q3 and Q4 is really predominantly based on inventory destocking levels. And we expect to exit year-end with the right levels of inventory for what is the end demand that our distributors are seeing. So we see destocking taking place through the second half year, and then being really at the right levels for the demand that our distributors are seeing as we exit the year.

[Operator]

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

[Damian Karas, UBS]

Bill, maybe you could just elaborate a little bit on the demand environment for your end customers kind of moving past the distribution destocking impacts, but you talked about declines across all end markets and all customers. I mean, what do you think are the biggest drivers of that change over the past few months here? Is it your end customers really are facing sales pressures and budgetary constraints, or do you think to some extent your customers are just feeling a lot better about their productivity, now that supply chains have almost kind of uniformly eased across the globe?

[Bill Burns, CEO]

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.

[Joe Heel, CRO]

Yes. Maybe if a little bit of additional color. So first, the declines in our larger customers were larger than the declines in our mid-tier and small, run rate business as we would call it. And that helps us understand this better because we track, of course, we have direct contact with our large customers and we see what's happening to individual deals there.

Now what we've been seeing is that a lot of those deals hundreds of millions of dollars have pushed out of the first half into the future or in some cases have disappeared as deals altogether. I'll give you some examples of those, but before I do this behavior has accelerated in the second quarter. So, for example, in North America, the amount of push-outs that we've seen relative to the first quarter has tripled.

Now let me give you just a few examples, right? So you can -- you see what's driving this and what's happening, right? At the beginning of Q3, we had a grocer who came to us and said, I want to buy $4 million worth of your mobile computers. And midway through the quarter they said, we're not going to do this deal in Q2, we're going to do it in Q3. I'm sorry, I said Q3 at the beginning, my mistake. So they came at the beginning of Q2, said, we want to buy this. And midway through the quarter they said we now want to do this deal in Q3 rather than in Q2. So a good example of what we would call a push-out.

But we also had another grocer who at the beginning of the quarter was indicating that they're going to buy over $5 million worth of mobile computers. And they came and said, we now want to do take these $5 million of mobile computers, but we want to buy them over the next five quarters equally distributed, which of course, delays our revenue trajectory.

We also had a DIY retailer who wanted to buy $7 million at the beginning of Q2 and came to us during the quarter and said, my budgets have been cut. I can't do this project right now anymore. We'll do it sometime in the future, but I can't tell you when. So these are three different examples that all impact our Q2 revenue and indicate that our customers' budgets are under pressure to the extent that they're trying to extend out when they buy from us, which diminishes our revenue. Hopefully that's helpful.

[Damian Karas, UBS]

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

[Joe Heel, CRO]

I can answer that directly. We have had no or virtually no firm orders canceled. So all of what I was describing to you were movements in our pipelines. Generally, we have not seen orders that we've already taken or backlogged canceled.

[Damian Karas, UBS]

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?

[Nathan Winters, CFO]

This is Nathan. Again, as you mentioned, I'd say gross margin was a bright spot in the second quarter hitting 48%, which we haven't achieved that level since the first half of 2021 when we had a bit more revenue and the euro was at a $1.20. So obviously the bright spot in the quarter, including the reduction in the premium supply chain costs down to $5 million and then negligible as we enter the second half of the year due to all the nice work by the team redesigning products getting our printer capacity back on ocean.

So again, I think we feel good about gross margin. I think that's a -- the 48% is a new baseline. There will be fluctuations, as we move quarter-to-quarter based on deal size, that is one dynamic that's helping us with the lack of large deals is a benefit to gross margin. But there's other tailwinds that we have going through the remainder of the year, including FX assuming it stays at its current level. So I think that's the right watermark, but I'd say quarter-to-quarter there'll be fluctuations as with just general mix and business dynamics.

[Operator]

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

[Jim Ricchiuti, Needham & Company]

All right. Thank you. So as we think about the Q3 guidance and the implied outlook for Q4, it sounds like you're expecting at least geographically some worsening conditions in North America. Just if we look at what the organic decline was in Q2, is that the way to think about how the geographic distribution looks into the second half of the year?

[Nathan Winters, CFO]

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.

[Jim Ricchiuti, Needham & Company]

And does your guidance assume slowing in the areas of the business that have been relative bright spots, you highlighted data capture RFID and the recurring business, the supply service presumably holds up a little bit better. But what kind of assumptions are you making for these areas that, that have been more of a bright spot for you?

[Bill Burns, CEO]

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.

[Operator]

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

[Meta Marshall, Morgan Stanley]

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?

[Bill Burns, CEO]

I think we're seeing clearly the refresh cycles, we would say, are elongated as people are using those assets and making tough business decisions at the moment. They can only hold off so long in those technology refreshes. And you've got to remember the strong demand over the last two years has put a lot more devices in the hands of frontline workers. So when they go to refresh those devices that will be a higher number of devices that they refresh.

In the short-term, they're consuming capacity they built in e-commerce and transportation logistics and even our retail customers where they've bought a lot of devices through the pandemic and they've got to work through those devices, but eventually they will buy more. We're still seeing -- there's still a great opportunity for us to continue to underserved hands, more devices in the hands of frontline workers across all of our vertical markets.

And Joe can talk a little bit about more about that. So I think we're still seeing that there's plenty of bright spots for new applications for our devices and leveraging our retail software, for instance, on our devices within retail and communication, collaboration, visibility, AI and leveraging, workers with more information leveraging your mobile devices. So the longer-term trends continue despite the challenges in short-term demand. And Joe, do you want to add to that?

[Joe Heel, CRO]

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.

[Meta Marshall, Morgan Stanley]

Got it. And maybe just is -- do you expect any -- you noted that you were renegotiating some supply agreements. Is there expected to be any cash charges with those or just anything we should be mindful of as part of the restructuring?

[Bill Burns, CEO]

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.

[Operator]

Our next question comes from Brian Drab with William Blair. Please go ahead.

[Tyler Hutin, William Blair]

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

[Bill Burns, CEO]

Hi, Tyler.

[Tyler Hutin, William Blair]

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?

[Nathan Winters, CFO]

So we expect the full-year pricing benefit to be around 2 points. It's a little bit higher than our previous guide with the most recent price increases that went into effect late in the second quarter. But we're actually seeing those actions hold and stick in the market. So I'd say it's again about 2 points for the year.

And I think just to again these were very specific targeted actions, not broad-based, and it's something we monitor constantly to ensure that we're competitive in the market. And that the -- I wouldn't say any part of the volume decline is related to the pricing actions. Again, because most of these are broad-based across the industry and very targeted at where there's opportunity to ensure we maintain our market share position in each of the markets and products we operate in.

[Tyler Hutin, William Blair]

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.

[Joe Heel, CRO]

This is Joe Heel. Yes. So we've been working with governments around the world and have been seeing an increasing level of demand and opportunity there. And of course, we have commensurately increased the resources that we have put into this. Where we saw the North American government is the largest part of that. And of course, there are multiple different levels of that. State and local has been a growth area for us for some time.

Specifically for example, outfitting police forces with tablets in their cars or parking enforcement handhelds devices with mobile printers have been the staple of our business there. But recently where we've been successful and have extended our engagement is with federal and state governments.

And there are of course some very large contracts. You can see contracts with defense and in logistics areas that are increasingly important. And we've seen an increase in interest in those same levels in governments outside of the U.S. And of course, that has a little bit to do with some of the geopolitical situation that we find ourselves in and the governments needing in particular the types of solutions we provide to enhance the logistics behind some of those operations.

[Operator]

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

[Keith Housum, Northcoast Research]

Good morning guys. I was hoping you could unpack the --

[Bill Burns, CEO]

Good morning, Keith.

[Keith Housum, Northcoast Research]

I was hoping you could unpack the commentary regarding the customers digesting what they previously bought. Certainly, we're aware of one or two e-commerce guys that probably overbought, but I guess the people are digesting what they previously bought. Are they questioning the ROI that they previously experienced? I mean, perhaps just a little bit more color on the digestion commentary.

[Bill Burns, CEO]

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.

[Joe Heel, CRO]

Maybe to make it concrete, let me give again just a few examples, right? So if you're in a retailer, you buy our devices typically with an expectation of a growth trajectory, which means how many associates you will have in your store, or how many new stores you will open. And so those retailers that some of examples I gave earlier had planned for a certain growth trajectory, and then they've seen that growth trajectory change and lower.

And so as a result, the ROI hasn't really changed for them, but they just see a lower demand trajectory, which then they're translating into lower purchases with us, right? I'm looking at I have four pages of individual deals that we look through and where customers have done exactly this. And here's an example of one where it says, customers working through gear they already have on hand not ready for additional orders until Q3. That's literally the type of thing we're hearing. And I don't think it has anything to do with the ROI, it's simply about the expectation for demand.

[Keith Housum, Northcoast Research]

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?

[Bill Burns, CEO]

No. We feel good about our machine vision business. When we acquired Matrox, at the same time we developed organically solutions in the low end of that range in fixed industrial scanning. And we acquired Adaptive Vision, which gave us software capabilities around things like optical character recognition.

We knew when we acquired Matrox that they were heavily weighted in their sales to the semiconductor industry. And we all know that has slowed. But our objective all along was to really diversify that customer base as a smaller private company. Ultimately, they hadn't made the investments to go-to-market that we're making diversify it. We're seeing that the diversification is working.

Our focus on things like electric vehicles, electric vehicle battery manufacturing, pharmaceuticals, really a broader push for us into manufacturing is working. And as we're driving into also into e-commerce opportunities, T&L, so we're seeing that the traction of diversification work within the business, despite the challenges with semiconductor in the short-term, which we were well aware of when acquiring the business.

I'd say our organic investments as well are paying off in that space. From robotics perspective, I think it's just early days. We've got working solutions today moving pallets at customers for goods transport. We have goods being transported on smaller sized robots in multiple different applications. We're OEMing some of our robots in hospital environments delivering pharmaceuticals. We're picking e-commerce orders that that was one of the areas we've invested in since owning the business beyond just goods transport, but it's still early days. It's a small business and there's a large growth trajectory expected in that marketplace today. But it just takes time. You got to do early pilots with customers. You got to prove in the ROI and ultimately you see deployments and growth beyond that. So we feel okay about a robotics business. It's just small at the moment.

[Operator]

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

[Joe Giordano, TD Cowen]

Just I kind of wanted to just square up the commentary about push-out and your customers kind of changing. I guess like, if we step back, big picture, everything we hear, granted the industrial economy, the data has been pretty horrible, but every -- I guess the takeaway has been that the consumer's been really resilient and that the consumer recession that people saw coming isn't happening or hasn't happened. So like, how do you square that commentary with what you're hearing directly from your customers who are kind of leveraged to those consumers who maybe aren't getting as bad as people thought?

[Bill Burns, CEO]

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.

[Joe Giordano, TD Cowen]

And apologies if you said this already I'm kind of multi-tasking a couple calls here, but can you comment on what Matrox did specifically in a quarter on growth and maybe where they're at year-to-date?

[Bill Burns, CEO]

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.

[Operator]

Our next question comes from Brad Hewitt with Wolfe Research. Please go ahead.

[Brad Hewitt, Wolfe Research]

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

[Bill Burns, CEO]

Absolutely.

[Brad Hewitt, Wolfe Research]

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?

[Bill Burns, CEO]

So maybe I'll start. So again, if you look at the, what's embedded in the guide for the second half, one, it's supported by the most recent sales velocity. If you look, we are assuming significantly lower conversion rates on our pipeline of opportunities than we've had historically used due to the continued push-outs of orders that we've discussed earlier in the call.

So again, a much lower conversion rate assumption on those deals. And again, the other impact which is you have to include is this the overall size impact of destocking within the channel. But again, we're assuming kind of that similar type of velocity through the year-end. And I think the other important assumption is we're not having -- we're not assuming there's any type of potential year-end spending or new large deployments in the fourth quarter, which we typically see as we approach the end of the year.

[Joe Heel, CRO]

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.

[Brad Hewitt, Wolfe Research]

Okay. That's helpful. And then I'm curious what you're seeing in your run rate business and how you expect that business to trend in the second half of the year. And also, does your guidance assume any negative mix shift from a softening of run rate in the second half?

[Bill Burns, CEO]

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.

[Operator]

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

[Rob Mason, Baird]

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.

[Bill Burns, CEO]

Yes. I think in the -- historically we've seen large deals are the first to decline and the first to recover, right? So that's what we've historically seen and we'd expect the same here. The mid-tier and run rate has slowed clearly in second quarter and that likely you don't see as large an effect as quickly in that business you've seen see a longer-term trajectory. And then the reverse of that is it recovers, but as you said, we would expect large deals to recover first and then mid-tier and run rate to follow in that recovery is how we typically see it, but you see more pronounced swings in large deals than you do certainly in run rate or mid-tier.

[Rob Mason, Baird]

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.

[Nathan Winters, CFO]

Look, overall, I think the -- obviously, we would -- we were expecting better results on inventory as we entered the year. I think the team is doing everything in our control working with our suppliers to reduce the committed volumes that are coming in. It's obviously a challenge though as the volume has continued to decline. So we're kind of chasing and -- chasing down when it relates to the inbound inventory supply that we have coming in.

But like I -- when I look at E&O, I think again there's always risk in a technology business, so that's not different. But where we have supply, it's primarily in our run rate kind of high volume type of business. So when the volume returns, we have the components for it. So -- and this isn't unique SKUs or products for kind of one-off type products we have in the portfolio. The vast majority is around kind of our mainstream product portfolio. And so again, as the volume recovers, we'll burn through that component inventory, and that's their value. If you look at where the primary increase is at, it's in components. So this isn't fully finished goods, which again gives us that flexibility to flex between different SKUs, different customers that we have given that most of the increase is in components sitting at our Tier 1 manufacturing partners.

[Operator]

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

[Guy Hardwick, Credit Suisse]

Just trying sort of dissect your comments on channel inventories and runway business. I think Nathan, you said the guidance in Q3, a third of it's accounted for by channel destocking. And then -- but I think you said that continues at kind of a similar rate in Q4. So just wondering what you -- has there been any -- what are the kind of the very latest indicators you're seeing in terms of sellout from the channel? Has there been any signs of stabilization yet? And if not, I mean, what is your kind of view where channel inventories could be at the end of the year? I mean, will the destocking continue into next year?

[Nathan Winters, CFO]

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.

[Guy Hardwick, Credit Suisse]

I mean, if we take a kind of three or four year view on channel inventories, would you expect channel inventories to be back to pre-pandemic levels in terms of days on hand? Would it still be elevated relative to say 2019, 2020 levels?

[Nathan Winters, CFO]

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.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Burns for any closing remarks.

[Bill Burns, CEO]

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.

[Operator]

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