Zebra Technologies Corp Q3 FY2023 Earnings Call

Good day, and welcome to the Third Quarter 2023 Zebra Technologies Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. And I would now like to turn the conference over to Mike Steele, Vice President, Investor Relations. Please go ahead.

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.

Thank you, Mike. Good morning and thank you for joining us. As expected, our third quarter performance was impacted by broad-based softness across our end markets and elongated sales cycles. This resulted in a significant decline in sales with expense deleveraging impacting profitability. We will spend time today discussing our results, the demand environment, and the progress we have made to rationalize our cost structure and shift our go-to-market resources to drive sales growth and improve profitability as our end markets recover. For the quarter, we realized sales of $956 million, a 30% decline from the prior year and adjusted EBITDA margin of 11.6% and a 950 basis point decrease and non-GAAP diluted earnings per share of $0.87, a 79% decrease from the prior year. We saw broad-based softening of demand in late Q2, which continued throughout Q3 as customers demonstrated more cautious spending behavior across all our end markets and regions. These dynamics have been exacerbated by our distributors reducing their inventory levels, which accounted for about one-third of our Q3 sales decline. As a reminder, our distribution channel has been aggressively driving down inventory as end-user demand has slowed, product lead times have recovered, and cost of holding working capital has increased. We believe this reset will largely complete by year-end. Although we experienced declines across all product categories, services and software were bright spots in the quarter. As we enter Q4, potentially all the cost restructuring actions now implemented, we expect to see a significant sequential improvement in profitability. These actions are now expected to yield net annualized cost savings of $100 million, which is an increase from our previous expectation of $85 million. On Slide 5, we summarize drivers of demand trends across our end markets. Our three largest end markets, representing more than three-quarters of our sales volume are indexed to the goods economy, which has been significantly underperforming the services economy. While each of our primary end markets declined, demand was weakest in retail, e-commerce, and transportation logistics as many customers are navigating a challenging environment and absorbing capacity built out during the pandemic. As you see on the slide, despite current demand softness, there are several themes that we expect to drive investment in our solutions over the long term, including labor and resource constraints, real-time supply chain visibility, track and trace mandates, and increased expectations from shoppers and patients. Turning to Slide 6. I'd like to review the actions we are taking to address and mitigate the impacts of the soft demand environment and position ourselves for long-term success. In late Q3 and early Q4, we implemented most of the cost restructuring actions that are driving $100 million of net annualized operating savings. We are reallocating resources to accelerate growth in underpenetrated markets, including Japan, along with government and manufacturing sectors, and to capture the potential of new use cases that leverage our solutions to digitize and automate environments, including RFID and machine vision. We are also renegotiating long-term supply agreements and working with our contract manufacturers to drive down component inventories. And as part of our long-term incentive plan, we added a free cash flow conversion goal to improve profitability and drive sales growth as our end markets recover. While we believe we are seeing a leveling of demand trends and the peak of distributor destocking activity, we are not seeing signs of a market recovery based on customer behavior. Therefore, we remain cautious in our planning through the remainder of this year and the first half of 2024. We'll continue to take an agile approach to managing through this uncertain environment, and we remain disciplined with respect to our cost structure and cash flow. I will now turn the call over to Nathan to review our Q3 financial results and discuss our fourth quarter outlook.

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. The 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 was $193 million, 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 a net debt to adjusted EBITDA leverage ratio of 2.2x, 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 entering 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 guidance, 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 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.

Thank you, Nathan. While sales are pressured near-term, our solutions remain essential to our customers' operations, and we are well positioned to benefit from the secular trends that digitize and automate workflows. 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 the 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 advanced software capabilities such as artificial intelligence, machine learning, and prescriptive analytics. We continue to advance and innovate our offerings. This includes several product and solution launches across our portfolio, including our Zebra Pay solution, which equips retail associates, hospitality workers, and logistics employees with the mobile point-of-sale device that accepts a variety of payment options almost anywhere. At our Annual Software Customer User Conference, we unveiled our Zebra Work Cloud suite of software solutions, which address four critical enterprise functions: workforce optimization, enterprise collaboration, inventory optimization, and demand intelligence. The user experience is tailored to customer-specific business priorities and integrated into a single application. This unique software suite, coupled with our mobile computing platform, differentiates us and expands our market penetration opportunity. In collaboration with Qualcomm, we demonstrated a generative AI large language model for handheld mobile computers and tablets without requiring connectivity to the cloud. This is a competitive differentiator, which will enable Zebra partners and customers to create new ways of working by further empowering the frontline worker and driving additional productivity gains. We are confident that the innovation roadmap across our business will continue to elevate our customer value proposition. As you can see on Slide 13, customers leverage our technology to optimize workflows for the on-demand economy. Our solutions empower enterprises to increase collaboration and productivity and better serve customers, shoppers, and patients. I would like to highlight some recent wins by our team. A global technology provider recently selected Zebra's machine vision solution to automate a previously manual inspection process for the manufacturing of engraved component parts. Our solution ensures high quality and traceability, reducing expensive material waste and false errors. We look forward to exploring opportunities to expand our relationship with this customer. A large healthcare system in Europe is using our mobile computers, printers, and RFID solutions to enable real-time tracking of medical equipment, significantly reducing the time caregivers spend searching for critical assets throughout the hospital. A large retail pharmacy chain selected Zebra's Work Cloud task management software to improve store productivity and effectiveness by streamlining communication and accelerating on-site inspections and marketing promotion updates. Optimizing task assignments and store walks drives accountability and frees up staff to focus on customer-facing activities. A large North American retailer refreshed our mobile computers across their stores and added RFID technology to improve inventory accuracy, supply chain efficiency, and customer satisfaction, resulting in more frequent cycle counts. During the competitive review, Zebra demonstrated the most cost-effective solution for their needs. Lastly, a large Asian retailer decided to add Zebra's communication and collaboration software to their Zebra mobile computers. This subscription-based solution drives store-associated connectivity benefits while displacing the legacy phone system. In closing, our long-term conviction in our business remains unchanged. While customer spending is pressured near-term, over the long-term, we believe we are well positioned to benefit from secular trends to digitize and automate workflows. We will continue to elevate our position with customers through our innovative portfolio of solutions, while executing on actions to position us well for profitable growth as our end markets recover. I will now hand it back to Mike.

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

And we will now begin the question-and-answer session. Our first question comes from Brad Hewitt from Wolfe Research. Brad, please go ahead.

Hi, thanks. Good morning everyone.

Good morning, Brad.

Good morning, Brad.

So I was wondering if you guys would be able to provide some preliminary thoughts on the overall growth setup for 2024, and how we should think about that relative to the 5% to 7% long-term growth algorithm. You talked about the first half kind of being a little bit more challenging. And then of course, comps show in the second half, but any thoughts on the growth outlook for 2024 preliminarily would be helpful.

Thanks, Brad. To start, we finished Q3 at the high end of our outlook despite a challenging demand environment. We're observing a leveling of demand trends, and Q3 marked the peak of distributor destocking. However, we're not seeing clear signs of market recovery based on customer behavior. All regions and verticals experienced declines in Q3, particularly among large enterprises. There were some positive aspects, like in services and software. We are not providing guidance for 2024 at this moment, and we remain cautious due to the lack of strong recovery signals. Looking ahead to the first half of 2024, we anticipate challenging comparisons. Overall, we expect to see a continued difficult demand environment as we approach the end of this year and into 2024.

Okay. That's helpful. And then maybe if you could talk about what you saw in Q3 from a bookings perspective and how bookings looked sequentially as well as what you expect bookings to look like in Q4?

I would say that, once again, considering the challenging demand, bookings were in line with our expectations during Q3, and as we move into Q4, we have a positive outlook on the bookings trajectory that supports our Q4 guidance overall. However, we are not yet seeing clear signs of recovery, but we believe we have the order velocity needed to meet our Q4 projections.

And our next question comes from Tommy Moll from Stephens. Tommy, please go ahead.

Good morning and thank you for taking my questions.

Good morning, Tommy.

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.

Yes, Tom, we believe that the demand trends have stabilized in Q3 and are continuing into Q4. From a destocking perspective, the most significant impact has been in Q3, with less effect in Q4, and we expect this to be resolved by year-end. While we aren't providing guidance for 2024, I want to clarify that we do not see strong signs of recovery at this time, which is reflected in our forecast for the fourth quarter. Looking ahead to the first half of 2024, we anticipate challenging comparisons. However, we are not seeing customers cancel projects; they are simply postponing them. They cannot continue to do so indefinitely. We observe that the use cases for our products and solutions are growing among our customers, and they will resume deployment as they look to utilize excess capacity in retail, e-commerce, and transportation logistics, especially as macroeconomic uncertainties begin to ease. Historically, we've seen downturns last a few quarters rather than years. As we progress through the year, we expect some improvement. Although visibility for the second half remains challenging right now, we will be facing easier comparisons during that period, particularly due to the destocking we are experiencing in the latter half of this year. This is our current perspective.

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 range 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.

Hey Tommy, this is Nathan. As we mentioned, looking at global channel inventory measured in days on hand, the average is around 60 days, or two months, but this can vary significantly based on product type and region. So, it's not consistent worldwide. At the end of Q3, we performed better than in Q2, with days on hand and relative inventory balances decreasing throughout the quarter. However, they are still slightly above the normal range despite those reductions. That's why we anticipate that distributors will continue to reduce their inventory during the fourth quarter, but we expect to exit the fourth quarter within our normal operating levels. We are closely coordinating with our distributors regarding the products they need to support the markets. As we move into next year, we foresee the destocking process aligning with where it needs to be.

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

Hi, good morning everyone.

Good morning, Damian.

So not to beat a dead horse here on the demand environment and recovery. But Bill mentioned not seeing signs of that as you think about early 2024, I get that you're seeing that based on your order patterns, but based on your customer conversations, I mean, what do you think it's going to take to see that inflection of demand to drive that? And where would you see it first? Thinking about the various markets you play in and your diverse set of customers?

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 some of the macroeconomic uncertainty around the goods-based economy abates. 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 are the first area where we saw it challenging from a demand environment, so we'd expect that to return first. And then from there, midsize and run rate would follow. I don't know, Joe, if you want to add anything.

Yes. Maybe just a little bit on that point. During the supply-constrained phase, we had given some priority to some of our larger customers. So that's where a large amount of the volume and the capacity that went into the market went. And that's where we're seeing the steepest declines at this point. So I would expect that that's also where we would see the first signs of recovery, where those customers would begin purchasing again. And we are staying very close to those large customers as we're seeing them sweat their assets longer, we know exactly when they are reaching those points in the product life cycle where they will need to refresh. And we're working with them on plans that will fit their budgets. And you can imagine, as we're going into 2024, they're coming up with new budgets and we're working with them on doing that. So that's perhaps where I would look first.

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?

Yes, Damian. In terms of Q3 gross margin, it declined year-on-year by about one point to 44.8%. A significant factor contributing to this decline was volume deleveraging, although we did experience some positive impacts from premium supply chain costs, which have now been fully addressed. This had a two-point favorable effect. Additionally, we are observing positive results from the pricing strategies we've implemented over the past few years, which have enhanced our service and software margins. By focusing on our underlying gross margins and the pricing actions taken to counteract increases in component costs and inflation, combined with the reduction in freight costs, our current priority is to rebalance our manufacturing and distribution capacity to align with lower volumes. This approach will enable us to gradually see a recovery in margins as we move into next year. I believe that the second half of the year represents the lowest point due to the significant volume declines, and we need to adjust our capacity accordingly while ensuring we remain flexible to grow as the market starts to recover.

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

Thank you. Good morning guys. If you perhaps focus a little bit on Zebra's own inventory levels, which obviously are still high compared to historical levels. Is this more component cost product parts, or is it more finished goods? And then second to that is, do you guys have minimum purchase agreements with your OEMs where if you're not making the minimum purchases, you're going to have penalties you'll incur?

Keith, 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 consigned components that are at our Tier 1 manufacturers. So these are inventory that we made purchase commitments on going back to a year, one and a half years 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 decreased. 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 right size those inbound components. To your last question, we don't have a minimum purchase agreement that 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, 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.

Okay. If I could follow-up on that. And as we look forward to like 2024, is there a rule of thumb or where do you think your inventory level should be under optimal level? Because, of course, we'd assume that you'll have some positive free cash flow next year as that gets worked down?

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.

We'll take a question now from Joe Giordano from TD Cowen. Joe, please go ahead.

Hey, good morning guys.

Good morning, Joe.

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?

Yes, I would say that the investments we're making across the portfolio, including new areas such as RFID and machine vision both play to exactly that. We see a need for both handheld devices and fixed infrastructure, including fixed industrial scanning and machine vision as well as RFID readers. So that's why we've got a broad base across the portfolio as our customers continue to digitize and automate their environments. Ultimately, there are places where fixed solutions make more sense than handheld devices. RFID does very similar types of things, but you marry RFID technology along with barcode scanning. So we think of machine vision and fixed industrial scanning as closely tied to our scanning business, really fixed versus handheld, and we see our RFID portfolio the same way where we've got handheld RFID readers and fixed RFID readers across the portfolio just as we have tabletop RFID printers in mobile. So we think that mobility is going to continue to be an important aspect of our business, but fixed is as well as we're seeing more fixed infrastructure and more automation in our environments. And that's why we're invested in both. And I think that machine vision and RFID both represent attractive markets for us for that very reason.

And Joe, I'll add that this is also an opportunity for us to provide added value to our customers. Specifically, in both areas, customers will require more than just the hardware solutions they may currently purchase from us, such as a handheld reader. They will particularly need software and other accessories. If you consider our machine vision business, a crucial aspect of that is the software component, which we do not currently offer for handheld scanners. However, in the machine vision context, we do provide that. This presents a great chance for us to enhance value for our customers and for Zebra.

That was a very good answer. I would like to ask one more thing about the trends that are not yet improving, but some of the true weakness in the destock is diminishing. As we move beyond that, which I believe will happen eventually, when I reflect on your 2021 and 2022 performance, where you achieved earnings of $17.5 and $18.5, how would you classify those years? Revenue was strong, but margins might have faced some pressure due to supply chain issues and the measures you had to take to deliver. What kind of market dynamics do you think need to be in place to return earnings to those levels? I suspect that revenues don't necessarily need to reach such high figures.

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 continuing to progress, and there's no reason why we can't get back to past levels. That's how we see it.

And we will take a question now from Meta Marshall from Morgan Stanley. Meta, please go ahead.

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 and machine vision into that market, or just kind of what are some of the areas that you think are unexploited there? Thanks.

I would say that health care has been our fastest growing vertical market in the past, but it remains the smallest. As health care seeks to improve productivity and enhance patient safety, automating workflows and digitizing assets creates opportunities for our full range of solutions in scanning, printing, mobile computing, and RFID. We're also introducing new opportunities in health care, such as tablets for home health care and telehealth. We are committed to the health care market and continue to develop targeted products for it. In manufacturing, while we have a solid base with our manufacturing customers, much of our focus is on logistics and distribution networks rather than assembly lines. Machine vision and robotic automation in manufacturing, coupled with effective transport demand planning for our consumer packaged goods customers with Antuit, strengthen our ability to meet the market's demands. We have redirected sales resources to concentrate on manufacturing and are looking to expand our partner network in that field. We recognize manufacturing as an area for Zebra where we have less penetration compared to others, particularly in product areas like floor printing, and there is potential for us to do more with new solutions. Thus, we clearly see both manufacturing and health care as significant growth opportunities moving forward.

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

Good morning, guys.

Good morning, Andrew.

Yes. I understand that you do not provide guidance for 2024, but I am curious about your thoughts on trends leading into the New Year. Could you discuss potential scenarios regarding distributors possibly beginning to restock? What factors influence the pace of that restocking? Specifically, is the mindset of the distributor influenced by the confidence they receive from their end customers to restock their shelves? I would like to know how you perceive the timing of that restocking event if it happens next year.

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.

Okay. Very clear. And your two biggest markets, e-commerce and retail versus transportation and logistics, are you seeing any difference in the demand trends and dynamics driving those two areas? I guess, what is the key difference for you? Is one stronger than the other? Is one more likely to come back faster than the other? Yes, I guess could you parse that out?

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 is 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 transportation 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.

Maybe there's one area that you could see a slight additional opportunity on the retail front. And that is, of course, the one area where they don't overlap, which is the store. Retailers have been itching for some time, and we have had this vision that you can significantly improve the productivity of a retail store by having all of the workers in the store connected and collaborating. And they haven't yet realized that vision. That's been part of what's been deferred as they're going through the current phase of pausing and spending and scrutinizing their budgets. But they really do want to do that. I hear that from retailers all the time that they believe that there's a big productivity improvement to be had there, in particular, because some of their peers have done it, and they have seen those improvements. So that part of spending is still out there, and I'm convinced it will come our way, and that will create additional demand on the part of retailers with stores that transportation companies don't have.

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

Yes, good morning all. I wanted to maybe just probe again, your thoughts as we get into '24 and not to put a stake into the ground at midyear '24. But I'm just curious, as you think about normal replacement cycles, how would your average age of your installed base look midyear next year? Would it be at an average level or below average, above average?

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, and they want to use more applications requiring faster processor speeds and more memory, you see operating systems moving forward, so security and others. So there are 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 the average life cycle of demand in the 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.

Maybe I'll give you two data points to support that. One is in Q2, the pushouts that we had in Q1 tripled. And in Q3, the pushouts were about the same as they were in Q2, which was almost the same as what we had in the entire year of 2020. So you can see that there's a lot of demand being pushed out, and those are all refreshes that should be happening now to maintain the average life of our estate out there. And so the average life of our estate is likely going up. And at some point, and that's what we said a couple of times already, sorry to repeat it, is that at some point, they will have to buy and refresh those devices.

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 mention 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?

Yes, I would say that manufacturing is a good example of that. It has been less impacted, still down significantly year-on-year, but less than other markets. That is an opportunity we've talked about earlier in the call. I think there's other markets. Japan is an area that we're investing additional resources as well. And we've won a large postal opportunity there and the largest retailer in Japan most recently, and we're leveraging those wins and larger partners within Japan to do more business within Japan. Government is another area that we haven't had a lot of focus on in the past, but there remain opportunities for us to grow our business within government. I think from a product perspective, we talked a bit about RFID and machine vision as fixed industrial scanning and machine vision around inspection, but also RFID around automation and digitizing and automating customers' environments. Tablet is another good example of an area in which is closely adjacent to mobile computing and people want larger screen formats at times, and that creates an opportunity for us. So it's both a market perspective as well as a technology perspective. And tactically, we're reallocating resources across regions and areas to address these. We've started that already in Q3, and we'll continue to do that as we enter 2024. Some are short-term opportunities and others are longer-term opportunities. But we think it's important that we continue to be agile, not only in the cost side of things, but also on where we're deploying our resources to see and address the most attractive growth markets for us and stay close to our current customers, but really shift resources to the places that we see recovering the faster or that we're underpenetrated today, that's how we see it.

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

Thank you. Most of my questions have been addressed by now. Could you provide an update on Fetch and some of the other acquisitions from 2021? You invested a considerable amount in 2021, with the purchase prices averaging around 9x to 10x sales. How are Fetch, Matrox, and the other recently acquired businesses performing? Is there any potential risk of impairment as you approach the year-end?

I think we can start by noting that software is our largest segment, especially with our acquisitions of Reflexis and Antuit in the area of prescriptive analytics. We are continuing to focus on retail associates and enabling them through a comprehensive portfolio of products and solutions centered around Work Cloud, which we discussed at our recent customer event. This approach seems to resonate well with our customers. Our goal is to integrate task management, workforce management, communication, collaboration, and demand planning into a single application while leveraging mobile devices for retail associates. This aligns with Joe's earlier comments about providing devices for everyone in retail. We view our software assets as crucial for integrating with mobile devices and equipping more retail associates with technology. Machine vision is also a significant market for us, valued at over $100 million, but it remains fragmented. Our focus is primarily on manufacturing and logistics, specifically fixed industrial scanning, as companies seek to automate and enhance productivity and quality. The short-term challenge for machine vision is the cyclical weakness in semiconductors, particularly since Matrox is heavily linked to that sector. Our aim is to not only grow this business but to diversify beyond semiconductors into attractive markets like automotive and food and beverage, as well as fixed industrial scanning in warehouses and distribution. While Fetch and robotics automation in warehouse settings are currently our smallest segment and still in early stages, we have identified two key areas of focus: Goods Transport, which includes line-side replenishment in manufacturing as well as general goods movement, and e-commerce, where our devices aid in order picking. The collaboration of cobots and humans in this environment is a promising long-term opportunity for us. Although this is the smallest segment, we do not see any impairment risks or concerns. Overall, we view these three sectors as promising growth areas for Zebra and acknowledge that some may face short-term challenges, such as machine vision with the current semiconductor situation, but we remain optimistic about the long-term outlook for machine vision and fixed industrial scanning markets.

Ken Newman from KeyBanc Capital Markets has a question. Ken, please go ahead. I'm sorry. Let's go to Jim Ricchiuti from Needham & Company. Jim, go ahead.

Most of my questions have been answered, but I have one more. For the additional $15 million in savings, is that focused on a specific area or is it a general increase across the targeted areas? Thank you.

Not in one particular area, just broad-based, as we've worked through the plans throughout the third quarter and the fourth and scrutinized where we had to backfill certain roles with the retirement plans as well as just any open roles that have come along, just again scrutinizing that spend is really what drove it. So again, I would say fairly broad-based and in line with the actions that we're driving for the company.

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.

Thank you. I'd like to thank our customers, partners, and employees for their support and dedication to our long-term success. Have a good day, everybody. Thank you.

Goodbye.