Zebra Technologies Corp Q1 FY2024 Earnings Call

Good day, and welcome to the First Quarter 2024 Zebra Technologies Earnings Conference Call. 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.

Good morning, and welcome to Zebra's first quarter earnings conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least 1 year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially, and we refer you to the factors discussed in our SEC filings. During this call, we will reference non-GAAP financial measures as we describe our business performance. You can find reconciliations at the end of this slide presentation and in today's earnings press release. Throughout this presentation, unless otherwise indicated, our references to sales performance are year-over-year and on a constant currency basis. This presentation will include prepared remarks from Bill Burns, our Chief Executive Officer; and Nathan Winters, our Chief Financial Officer. Bill will begin with a discussion of our first quarter results and strategic actions. Nathan will then provide additional detail on the financials and discuss our second quarter and full year outlook. Bill will conclude with progress on advancing our vision. Following the prepared remarks, Bill and Nathan will take your questions. Now let's turn to Slide 4 as I hand it over to Bill.

Thank you, Mike. Good morning, and thank you for joining us. As expected, our first quarter performance was impacted by continued broad-based softness across our end markets and regions, which we began to experience in the second quarter of last year, resulting in a double-digit decline in sales and profitability. However, we are beginning to see a modest recovery in demand as we saw sequential improvement from the fourth quarter. We are particularly encouraged by the better-than-expected large order activity, which drove the upside for the quarter. That said, we are not yet seeing a broad-based recovery. And as a result, we continue to take an agile approach to navigating the current environment. We also delivered another quarter of sequential improvement in profitability as a result of our restructuring actions and improved gross margin. Services and software were a bright spot in the quarter with improved sales and profitability, helping to offset the year-on-year sales declines across all product categories. For the quarter, we realized sales of $1.2 billion, a 16.8% decline from the prior year, and adjusted EBITDA margin of 19.9%, a 150 basis point decrease and non-GAAP diluted earnings per share of $2.84, a 28% decrease from the prior year. We are pleased with the progress we have made on our previously announced actions to improve profitability and drive sales growth as our end markets recover. Our restructuring plans to deliver $120 million of net annualized operating savings is on track to be completed midyear. On the supply front, we made substantial improvement in our working capital driven by our renegotiation of long-term supply commitments and ongoing work to drive down component inventories with our contract manufacturers. We have also driven both tactical and strategic sales initiatives, including reallocation of resources to accelerate growth. Given the progress on our actions, we are raising our full year outlook for sales, margin, and free cash flow. I will now turn the call over to Nathan to review our Q1 financial results and discuss our revised 2024 outlook.

Thank you, Bill. Let's start with the P&L on Slide 6. In Q1, sales decreased 16.8% with declines across our regions, major product categories, and customers of all sizes. Services and software were a bright spot in the quarter, with growth driven by increased units under support contracts and retail software wins. Our Asset Intelligence & Tracking segment declined 25.3% primarily driven by printing. Enterprise Visibility & Mobility segment sales declined 11.8% with relative outperformance in mobile computing. Our Asia Pacific region saw the steepest sales declines led by continued weakness in China. From a sequential perspective, total Q1 sales were 16% higher than Q4 as distributors had completed their destocking process by year-end and we realized modest improvement in demand. Adjusted gross margin increased 60 basis points to 48.1% supported by higher services and software margins and cycling premium supply chain costs in the prior year, all of which were partially offset by expense deleveraging from lower sales volumes. Adjusted operating expenses deleveraged 230 basis points as a percent of sales. The impact was mitigated by approximately $25 million of incremental net savings in the quarter from our restructuring actions. This resulted in first quarter adjusted EBITDA margin of 19.9%, a 150 basis point decrease versus the prior year and a 450 basis point sequential improvement from Q4. Non-GAAP diluted earnings per share was $2.84, a 28% year-over-year decrease. Interest expense contributed to the decline, offset by a lower adjusted tax rate. Turning now to the balance sheet and cash flow on Slide 7. We generated $111 million of free cash flow as we begin to realize benefits from reducing inventory levels. We ended the quarter at 2.6x net debt to adjusted EBITDA leverage ratio, which is slightly above the top end of our target range. And we had approximately $1.3 billion of capacity on our revolving credit facility as of quarter end, providing ample flexibility. Let's now turn to our outlook. For Q2, we expect sales to decrease between 1% and 5% compared to the prior year. We entered the second quarter with a solid backlog and pipeline of opportunities, particularly for mobile computing in retail and e-commerce. This outlook assumes a modest improvement in demand trends across our major product categories, with mobile computing and the EVM segment returning to growth as we cycle easier comparisons. We anticipate Q2 adjusted EBITDA margin to be slightly above 19% driven by expense deleveraging from lower sales volume with the benefit from restructuring actions and lower premium supply chain costs, offset by normalized incentive compensation expense. Non-GAAP diluted earnings per share are expected to be in the range of $2.60 to $2.90. We have raised our guidance for the full year, reflecting our progress on actions to drive sales and profitability as our end markets have stabilized. Although there is optimism from partners and customers regarding recovery in the second half of the year, we would like to see additional momentum in large orders before factoring in a broader recovery. We now expect sales growth between 1% and 5% for the year, with adjusted EBITDA margin now expected to be approximately 20%. Non-GAAP diluted earnings per share are expected to be in the range of $11.25 to $12.25. And we now expect our free cash flow for the year to be at least $600 million, including the impact of our final $45 million settlement payment in the quarter. We have been making progress rightsizing inventory in our balance sheet and improving cash conversion and have been prioritizing debt paydown in the near term. Please reference additional modeling assumptions shown on Slide 8. With that, I will turn the call back to Bill.

Thank you, Nathan. As we look longer term, we continue to be well positioned to benefit from secular trends to digitize and automate workflows for our customers. We remain focused on elevating Zebra as a premier solutions provider through a comprehensive portfolio of innovative solutions and our go-to-market ecosystem. Zebra empowers workers to execute tasks more effectively by navigating constant change in real time through advanced capabilities, including intelligent automation, machine learning, prescriptive analytics, and artificial intelligence. As you see on Slide 11, our customers leverage our solutions to optimize workflows across a broad range of end markets. We empower enterprises to increase collaboration and productivity and better serve their customers, shoppers, and patients. In March, at the MODEX Manufacturing and Supply Chain trade show, Zebra, along with our partners, showcased our expanded portfolio of solutions that are modernizing workflows across the broader supply chain. Managing operations has become complex with increased consumer expectations for inventory visibility and same-day deliveries. The event provided an opportunity to demonstrate how we improve key outcomes such as production quality, supply chain agility, and capacity utilization. Machine vision was one of the many solutions we featured where we have enhanced our capabilities to address emerging use cases. We continue to build our market presence with a few notable wins. A large state-owned European logistics company recently invested in thousands of Zebra machine vision cameras to enhance the speed and efficiency of inspections of government bonds and transaction documents. Additionally, an Asian manufacturer incorporated our machine vision cameras and frame grabbers into their product sorting and quality control processes. This solution is significantly faster and more accurate than the previous manual approach. At HIMSS, the leading Global Healthcare Conference, Zebra and our partners demonstrated how our solutions improve the patient journey from check-in to bedside point-of-care as well as medical equipment track and trace. Additionally, the University of Maryland Health System shared how they are utilizing our clinical communications platform, which includes our mobile computers and work cloud software. I'd also like to call out a win with a North America hospital network, which recently implemented thousands of Zebra printers, specifically enhancing its specimen tracking and labeling processes. These printers integrate with the electronic health record system facilitating noticeable organizational improvements across departments. Zebra's reputation for ease of use helps secure this win. Recent wins in retail demonstrate how customers are driving productivity, improving asset visibility, enhancing the experience for associates and shoppers. The European retailer selected thousands of Zebra mobile computers to replace their legacy devices from a competitor. The customer plans to pair our new mobile computers with their Zebra mobile printers to improve their price markdown, labeling, and online order-picking processes. The North America-based retail department store chain enhanced thousands of Zebra mobile computers by incorporating our device tracking software. Prior deployment of this software, the retailer experienced issues with misplaced devices in stores and fulfillment centers, resulting in wasted time and resources. Additionally, a North American grocer has expanded their installed base of Zebra mobile computers with thousands of additional units and implemented our work cloud software. The solution is expected to enhance operational efficiency among associates, improve employee communication, and streamline inventory management within their stores. On Slide 12, we highlight secular trends that we expect to support long-term growth for Zebra as we drive value for our customers. These include labor and resource constraints, real-time supply chain visibility, track and trace mandates, and increased consumer expectations. We are hosting an innovation day on May 14 at our headquarters near Chicago where Nathan and I will be joined by other members of our leadership team to discuss how we digitize and automate workflows to drive positive business outcomes for customers across our end markets. In closing, as we look forward to a long-term opportunity for Zebra, our conviction in the business remains strong. We continue to elevate our strategic role with our customers through our innovative portfolio of solutions while our cost and go-to-market actions are positioning us well for profitable growth as our end markets recover. I will now hand it back to Mike.

Team to discuss how we digitize and automate workflows to drive positive business outcomes for customers across our end markets. In closing, as we look forward to a long-term opportunity for Zebra, our conviction in the business remains strong. We continue to elevate our strategic role with our customers through our innovative portfolio of solutions while our cost and go-to-market actions are positioning us well for profitable growth as our end markets recover. I will now hand it back to Mike.

The first question comes from Jamie Cook with Truist Securities.

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

Yes, Jamie, I’ll take that. In Q1, we saw about a 1 point improvement year-on-year in freight costs due to the adjustments we've made. Now that we've fully addressed the premium supply chain costs through our operational actions and price increases, that contributed to about a 1 point benefit this quarter. Additionally, the relative strength in Q1 was driven by slightly higher volume, a favorable mix, and improved profitability in our service and software segments, particularly in EVM, which helped us both sequentially and in relation to our guidance for the quarter.

I have a follow-up question regarding the larger order activity you mentioned for the quarter, which isn't included in the guidance. This seems to suggest some caution in the forecast. If this trend continues, what is stopping you from incorporating it into the guidance? How should we interpret the sales guidance in relation to your expected sales growth of 1% to 5% excluding foreign exchange effects?

Yes. I think as we stated, we've seen some improvement in demand, particularly in mobile computing and retail, which drove the beat in Q1 as well as what we're expecting to see come through for the remainder of the year, driving the raise for the full year from 1% to 3%. And so the way we think about the full year was we'd expect Q3 to look very similar to Q2, which looks similar to Q1, just in terms of run rate and trajectory, which as they maintain that relative strength in some of the large orders we've seen come through in the first quarter. But I would separate that from what we have yet to see; I'd say what's still kind of waiting to look at is the larger mega deals and deployments that still are not coming through. The deal sizes are still in the, let's say, $1 million to $5 million range, some of the initial phases of the deployment. So that's what you see carry through for the remainder of the year and is reflected in the guidance, but not that uptick in terms of the larger deployments.

The next question comes from Damian Karas with UBS.

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

Yes, I would say that overall in the first quarter and as we entered 2024, we've really noticed a stabilization in demand along with a modest upswing in large order activity. This has been particularly evident in the mobile computing segment and has been specific to retail as they concluded their fiscal year. We're encouraged by the better-than-expected sales results in the first quarter as a result of these changes. We anticipate modest improvements in demand as we progress through the year. However, the growth in the second half is mainly driven by the recovery from the previous destocking activity we experienced. Overall, as we expected, mobile computing is leading the recovery, particularly in retail, both of which were the first sectors affected during the COVID cycle. We hope to see increased visibility and momentum in order activity beyond what we've observed thus far, and we would like to see this momentum extend from retail to transportation and logistics and manufacturing in other sectors before calling it a broad-based recovery.

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

Yes, I would describe the second half as being grounded in what we observe today, considering the order velocity and what we see in terms of being sold out through the channel, as well as the conversion rates we've experienced over the last two quarters. The conversion rates on our pipeline remain lower than we would historically expect based on the second half experiences. However, this is still aligned with what we've seen over the past two quarters. The key difference is that we are not assuming a mega deployment at this time due to the lack of firm commitments from our customers. There is optimism and ongoing discussions, but in terms of actual project commitments or ensuring budget availability for the year, we still face uncertainty. Therefore, we anticipate the second half to resemble the first half based on current market conditions, and we believe this is a suitable approach for our guidance for the year.

The next question comes from Keith Housum with Northcoast Research.

In terms of Asia Pacific region, obviously, underperformed compared to the rest of the company. And I understand China is challenged right now, but perhaps can you just expand a little bit on what you're seeing here? And expectations for us and the pressures perhaps be a little bit longer lasting versus short-lasting? And just more color about the performance in that area, please?

Yes. I mean, Keith, it's Bill. I think that overall, the Q1 performance was continued to be impacted by soft demand across all of the regions. So I think we start there. I think that as we've said, the relative outperformance was really in mobile computing, and we saw some bright spots in services and software clearly in the quarter. I would say the regions pretty much look the same, except Asia was, as you said, impacted probably more through the declines in China. I would say that we see Asia overall having China continued to a longer recovery for the China market. We've seen some bright spots again in retail, again, in larger orders in Australia and New Zealand. So that was a positive for the Asia market. I think we continue to see opportunities outside of China. So Southeast Asia and India with the investments in manufacturing there. We continue to see Japan as the longer-term opportunity for us as we're making investments there, and we have lower share there than in other places. But I think we expect that China continues to remain challenging moving forward.

All right. And just as a follow-up, Nathan, in terms of adjusted EBITDA, a little bit decline in the guidance you've given for 2Q versus 1Q. Sequentially, how should we think about the moving parts and the reason for a little bit lower adjusted EBITDA margins in the second quarter?

Our Q2 guidance is slightly above 19%, down from 19.9% in Q1. This change is entirely due to the seasonality of our retail software business, which is typically stronger in Q1 due to the timing of retailers' cycle counts and physical inventories. This has impacted our margins. Essentially, the Q2 guidance aligns with our overall annual structure. Q1 was aided by earlier cost actions that instilled confidence for the rest of the year, along with a slightly better mix and revenue at the start of the year. However, Q2 is consistent with our expectations for the year, and the decline is solely a result of the seasonality within our retail software business.

The next question comes from Tommy Moll with Stephens.

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

Yes. I would say that overall, retail relatively outperformed, as we've talked about already. And we're seeing encouraging signs; right? We saw some modest year-end retail spending across Q4 and Q1. Some customers clearly have absorbed the capacity and it began to buy again, as you've kind of referenced, Tommy. We've also seen some of the pushouts that took place in last year and really over the last 18 months or so, begin to come back. So we've seen those projects as we expected and we talked about for a long time, those projects will come back. What we've seen mostly is initiating of really Phase 1 of those projects and the customers not quite ready to commit to the full deployment. So we've seen deployments that in the past would have been larger, even larger orders and full rollouts immediately, now a more conservative approach of starting with that project but rolling it out over time and completing the deployment kind of later in the year. So we have confidence that there will continue to be a recovery. I think we anticipated retail would recover first, followed by T&L and manufacturing, and health care, and we're seeing that play out. And we also anticipated it would be mobile computing first as well, and that's what we're seeing. So the bright spots are really mobile computing and retail, particularly in e-commerce. That capacity is being used up; retailers are beginning to bring those projects back, but they're doing it in a very measured way. And I think what we want to see is retail, T&L, manufacturing, more of the vertical markets come back and more of that order activity, even more than we're seeing today and the uptick in orders before we call a broad-based recovery.

That's helpful. As a follow-up, I wanted to ask about the channel inventory levels. It sounds like there really wasn't any noise from a destocking perspective in the first quarter. But I'm curious what's your view on how many days on hand in the channel currently? And if you think historically, do we sit today below what that historic level is? And does that imply at some point there may need to be a restock?

Yes, Tom, I believe that as we finish Q1, the global channel inventories measured on a days-on-hand basis have returned to normal levels to meet current demand. Overall, I would say we are in a range we would expect on a global scale, though there are some variances by region and product categories. There has been a significant improvement compared to where we were six to nine months ago. Additionally, I agree that there was no significant impact in this quarter, nor do we anticipate any in our full year guidance regarding changes in distribution inventory levels.

The next question comes from Brad Hewitt with Wells Fargo.

So you just talked about a return of some of the project deferrals from last year. I guess, how would you describe your pipeline and sort of overall visibility versus 6 months ago? It kind of feels like visibility across the space has been generally trending in a positive direction, but just any color on how your visibility looks relative to history would be helpful.

I'd say that overall, we'd expect customer orders to continue to resume overall. I think that as I just talked about with Tommy's question, we've seen customers absorbing the capacity that's previously been built out. That's been more, again, focused on retail and e-commerce as opposed to the other verticals so far. I would say that the macroeconomy, kind of the uncertainty around that abating will certainly help as well. We're viewed as a trusted partner of our customers, and we're staying close to them across each of the verticals as we would see this order momentum picking up across other verticals as we progress through the year. We've got a large installed base, right? We're growing solutions. So we're continuing to work with our customers as well. Kind of on new solutions and new use cases. So overall, I would say that we anticipated large deployments starting to come back. We anticipated in retail. We want to see more of that across manufacturing and T&L. As I said, we'd like to see more of it in kind of different size deals, so mid-tier and run rate deals come back a bit. But I would say, overall, our engagement with customers has been encouraging. There's certainly uncertainty remains around the timing of some of the projects. I think Nate covered that earlier. And I think it's reflected in our year-end outlook overall.

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

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

Maybe I missed it. Did you mention the activity you're observing in the SMB market? Is the recovery you're seeing in ports to retail also affecting that segment of the business?

I would say that SMB would fall kind of in this mid-tier to run rate business. And I think we've seen, again, more recovery in large opportunities. I think we're seeing optimism clearly on the part of our partners and our distributors. That business will continue to progress and get better through the second half of the year. But I think at the moment, we have not seen the uptick we've seen in large orders across mid in run rate business, which really falls under this SMB category. So I'd say not yet. I would say there's optimism on the part of our partners, but I think that we want to see more of that. As large orders typically are the first to decline or the first to recover, retail was the first to pull back, and now we're seeing it first to recover. And I think that SMB, call it, mid-tier and run rate business will follow.

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

Yes. I would say RFID, clearly, we see as an opportunity across multiple verticals now, not just retail and retail apparel, where it was originally focused, and we're clearly seeing opportunities across track and trace and supply chain. You mentioned parcel tracking with the transportation logistics, airports and airlines with baggage tracking inside manufacturing work in progress in tools and over. So a whole series of different applications we're seeing, quick-service restaurants. Clearly, the move ahead of large retailers like Walmart or UPS smart package initiatives are causing others to continue to look at what they're doing in RFID and move things along across multiple industries and verticals. Zebra has the broadest and deepest set of RFID solutions in the market today. So whether it's fixed or handheld readers, industrial and mobile printers, and our software we utilize for reads and locates and then our labels printed through our printers. So we've seen strong growth across the portfolio over the past few years. We continue to see the drivers being the fact that the technologies continue to improve with greater rerate accuracy across the development of new tag types that make that more efficient in the reading of the tags. I think we're seeing more software applications being available today to serve these different markets. We're clearly seeing the adoption of tags and source tagging of items at that point of manufacturing; the number of tags being sold is certainly going to allow more applications of those tags in customer environments. So we remain excited about this space overall, and I think we're going to continue to see growth across RFID.

The next question is from Joe Giordano with TD Cowen.

I understand that there is some reluctance to invest significant capital at this time, as you mentioned earlier. However, looking ahead to next year, given the substantial growth in your installed base that followed COVID, should we anticipate that a refresh cycle might be taking place in 2025?

I believe that the EMC is clearly a significant factor in mobile computing, especially during large refresh cycles. As I've mentioned several times, we are beginning to see the first signs of recovery. Initially, this is evident in retail, where customers are starting to absorb their capacity, particularly in e-commerce. We hope to see this trend expand to transportation and logistics as customers enhance their capacity, which they had built up during the pandemic. We also expect manufacturing to improve as we transition from a service-oriented to a goods-based economy. Our sales teams are concentrated on the refresh cycle with our clients. Mobile computing is crucial for operations, and our partners have collaborated with us through multiple product generations. We have a robust pipeline of opportunities, and we aim to see progress throughout this year and into the next, as you mentioned. There is clearly a refresh cycle underway, and the installed base is larger than ever, meaning more applications for mobile devices are being deployed. Each customer is on a distinct refresh cycle, whether they're in a postal environment, working with a government and logistics provider, or a large retailer. We've observed that larger retail orders have been more cautious, as I previously noted; they haven't been large-scale mega deals but rather smaller and more gradual in implementation. We anticipate that a similar approach will be taken in transportation and logistics. Overall, this suggests a steady recovery ahead, and we believe we have a strong foundation for continued refreshment, although it will take time.

Yes. As you mentioned, we finished the quarter at a little over 2.5x leverage ratio, so slightly above the target range. That begins to move back within the range, particularly as we roll through Q3 of last year. Today, we feel like we have ample flexibility with the revolver. As you mentioned, we are prioritizing debt paydown just given the debt leverage ratios and the current interest rate environment, but we do plan to reassess buybacks as the year progresses, particularly in the second half.

The next question comes from Andrew Buscaglia with BNP Paribas.

I want to clarify your comments on the guidance. You're observing a seasonal decrease in margins. When you mentioned that Q3 is expected to be similar to Q2, are you referring to the sales run rate? Additionally, what are your expectations regarding margins, considering you predict an increase in Q4? I'm curious about the reasoning behind that.

Yes, you're absolutely right. The comment on Q3, similar to Q2, is that we anticipate an increase in margin as we progress through the year. This is similar to what we discussed in the previous call, where we mentioned the timing of some incremental cost actions that will be implemented late this quarter and early Q3, as well as the usual timing of projects related to payroll taxes and the normal funding cycle as we approach Q3 and Q4, particularly with the holidays, which generally leads to a slight decrease in seasonal spending. There isn't a single solution for the measures we need to take to achieve that sequential improvement from Q3 into Q4.

The next question comes from Brian Drab with William Blair.

I want to clarify something. It seems like you're observing a recovery in retail, and you mentioned that you anticipated this happening where retail rebounds before manufacturing and transportation and logistics. Does this indicate that there's still no recovery in manufacturing and transportation and logistics, or is the recovery in retail currently just stronger than in those two areas?

Yes, I would say that we're not seeing it there yet. I would say that the T&L customers are clearly still absorbing capacity built out during the pandemic and that they're continuing to take actions to optimize their operations overall. I would say that manufacturing is impacted by the broader market trends of uncertainty. And clearly, still a services-based economy versus a goods-based economy. But I think overall, our value proposition remains strong in both markets. We've got strong relationships across T&L. And I think that we'll see them continue to buy again once the capacity is built out. I would say manufacturing is an opportunity for us. Overall, as customers continue to buy again, they will invest in automation and things like traceability and resilient supply chains. Those themes haven't gone away, but we've seen just a conservative nature of spending based on the uncertainty. So that represents an opportunity for us. I would say that manufacturing, unlike T&L, is kind of underpenetrated for us; that there's an opportunity for us. And we've got new solutions within manufacturing, so like machine vision, robotics automation, our demand planning strengthens our offering there as those markets recover. And we've also shifted additional sales resources through this to manufacturing. So I think that we expected retail was the first to decline. It's the first to recover. T&L and manufacturing will follow. I would say we've got strong relationships across T&L, but lots of opportunities there when it does recover. And manufacturing will continue to be a focus area for us because we see it as an opportunity longer term.

The next question comes from Meta Marshall with Morgan Stanley.

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

Yes. I'd say that as we talked about mobile computing clearly showing the first signs of recovery as expected, and we talked through that a fair amount. I would say that in printing, we saw kind of broad-based declines, but it has stabilized now in Q1. There was a difficult compare in Q1 for both printing and DCS as a year ago, first quarter '23, we saw supply chain challenges abate in both those areas. So we shipped a lot of printers and scanners in the quarter a year ago. So the compares were pretty tough. I would say that in printing specifically, clearly still challenged by the softer macroeconomic conditions and then particularly by manufacturing, but I would say stabilized overall. We'd expect that recovery in printing and scanning would follow mobile computing, as we kind of talked about. Specific to health care, I would say that impacted by the same trends, the broader market overall, clearly tighter budgets in margins within health care. We would see that we continue to drive productivity solutions within health care which allows health care providers to be more efficient, which is certainly appealing to them on tight margins, and clearly to enhance patient safety. We see home health care as an opportunity for us. So we are clearly seeing some of our partners address that market. So think of tablets as an example around home health care opportunities. So I think we see optimism. We were at the HIMSS trade show, which was well attended in Q1. The largest retail show, as we mentioned in the script earlier. But I think that we've seen optimism on the point of our partners and our customers just like the other verticals in manufacturing and T&L; we'd like to see more of that optimism turn into real orders like we're seeing in retail.

The next question comes from Rob Mason with Baird.

Bill, you've mentioned the run rate business a few times, and it seems we haven't yet observed signs of recovery in that area. Could you clarify your expectations for it this year, particularly in relation to your overall sales guidance of a 1% to 5% increase compared to the large deal aspect of the business?

I would say that our outlook is likely to remain relatively stable. We anticipated that large deals would be the first to recover, followed by mid-tier and run rate as we've mentioned before. There’s a lot of optimism among our partners and distributors in this area, and we just want to see more progress. That's our current position. Generally, large deals decline first, followed by mid-tier and run rate since run rate tends to be the longer-term aspect. We expect to see the same pattern in the recovery, but we haven't observed it yet. This presents a challenge for us. I wish we had better visibility for the rest of the year, and our guidance reflects what we see regarding visibility, which indicates that we haven't yet seen the recovery in mid-tier or run rate. Although the optimism and opportunities appear to be present, we need to see these translate into actual orders.

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

The next question comes from Ken Newman with KeyBanc Capital Markets.

Most of my questions have been asked, but I just wanted to ask a longer-term higher-level question. Obviously, you've got some very significant operating leverage implied for the back half, and I think that's mostly just on easier comparisons on the volume side. As we think about maybe returning more towards a normalized operating environment, how do you think about the run rate operating leverage or the run rate incremental EBITDA margins, just given all the cost-out initiatives that you've executed on? Would you think that structurally higher than what we've seen in past cycles? Or is that still too early to tell?

Yes. As we mentioned, the margin expansion in the second half is closely linked to the increased volume along with the restructuring actions we implemented last year. Our goal was to exceed a 20% baseline so we can grow and scale from there. It’s still too early to determine the exact framework. Historically, we expect around 30% incremental decrementals in a typical quarter. Fundamentally, the business remains consistent with expectations. Over time, we anticipate this to improve as we expand into new emerging markets like machine vision or software which typically have higher gross margins. This is likely the best perspective until things stabilize and we return to normalcy, both year-over-year and sequentially.

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

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

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