Q2 2022 Zebra Technologies Corp Earnings Call
Good day and welcome to the second quarter 2020 to Zebra Technologies earnings Conference call. All participants will be in listen only mode should you need assistance. Please signal a conference specialist by pressing the star followed by people at.
After todays presentation, there will be an 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.
Good morning, and welcome to Zebra second quarter Conference call. This presentation is being simulcast on our website at investors Zebra dot com and will be archived there for at least one year.
Our forward looking statements are based on current expectations and assumptions and are subject to risks and uncertainties.
Actual results could differ materially due to factors discussed in our SEC filings.
During this call we will reference non-GAAP financial measures as we describe our business performance.
You can find reconciliations at the end of this slide presentation and in today's earnings press release.
Throughout this presentation unless otherwise indicated our references to sales growth are year over year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition.
This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer, and Nathan Winters, Our Chief Financial Officer, Anders will begin with our second quarter results then Nathan will provide additional detail on the financials and discuss our revised 2022 outlook.
Anders will conclude with progress made on advancing our enterprise asset intelligence vision.
Following the prepared remarks, Joe heel, our chief revenue officer will join us as we take your questions.
Now, let's turn to slide four as I hand, it over to Anders.
Thank you Mike.
Good morning, everyone and thank you for joining us.
Our team delivered solid second quarter results in a challenging macro environment.
For the quarter, we realized sales growth of nearly 7%.
Adjusted EBITDA margin of 21, 9%.
170 basis point decrease.
And non-GAAP diluted earnings per share of $4 61.
A 1% increase from the prior year.
Customer demand remains strong for our solutions, which digitize and automate workflows.
We realized double digit sales growth in EMEA Asia Pacific and Latin America.
And a slight decline in North America on strong prior year comparisons.
We realized growth across all major offerings, including printing, where we recovered nicely from a challenging Q1.
Our healthcare manufacturing and retail and e-commerce end markets each grew faster than the corporate average.
Our team has successfully navigated the China, Covid lockdowns and our actions to redesign certain products and secure long term purchase agreements enabled us to generate more supply, particularly for printers.
We also scaled adjusted operating expenses to drive profitability, while continuing to prudently invest in our growth initiatives.
Overall, we are pleased that our second quarter sales performance was near the high end of our expectations and EPS exceeded our guidance range as our team executed well on our efforts to mitigate supply chain challenges.
With that I will now turn the call over to Nathan to review, our Q2 financial results in more detail and discuss our revised 2022 outlook.
Thank you Anders let's start with the P&L on slide six.
In Q2, adjusted net sales increased six 4%, including the impact of currency and acquisitions.
And six 9% on an organic basis, as we secured a greater supply of certain products than we had anticipated.
Our asset intelligence and tracking segment, including printing and supplies increased nine 7% driven by a strong recovery in printing as we secured critical components to better satisfy record levels of customer demand.
Enterprise visibility <unk> mobility segment sales increased five 6% with solid growth in both data capture and mobile computing solutions.
We realized particularly strong growth in RFID solutions as well as Ruggedized tablets in Q2.
We also continue to drive solid growth across services and software with strong service attach rates and attractive software offerings.
We realized strong growth in three of our four regions.
<unk> sales increased 17% driven by particularly strong growth in mobile computing and printing inclusive of the impact of exiting Russia in March.
Asia Pacific sales grew 14% with particular strength in India.
Latin America sales increased 16% with exceptional growth in Mexico.
And in North America sales decreased 2% due to supply constraints. We also cycled a particularly strong mobile computing sales volumes in Q2 of last year.
Adjusted gross margin declined 200 basis points to 46% due to higher premium supply chain costs in China import tariff recovery in the prior year period, partially offset by higher service and software margin.
Adjusted operating expenses as a percentage of sales improved 60 basis points.
Second quarter adjusted EBITDA margin was 21, 9%.
170 basis point decrease from the prior year period non-GAAP earnings per diluted share was $4 61.
Is <unk>, 9% year over year increase helped by lower share count and lower taxes.
Note that in the quarter, we entered into a settlement agreement, resulting in a $372 million onetime non-GAAP charge, which will be paid out over eight quarterly installments.
Turning now to the balance sheet and cash flow highlights on slide seven.
For the first half of 2022, we generated $123 million of free cash flow, which was lower than the last year, primarily due to a higher use of working capital as sales volume shifted to later in the period due to the China Lockdowns.
Higher incentive compensation payments, given our exceptional 2021 performance and.
And the initial $45 million quarterly installment payments related to the settlement I just mentioned.
From a balance sheet perspective, as previously announced we have significantly increased our available borrowing capacity to align with our growing business to optimize our capital structure.
Our new credit facility provides us ample flexibility for organic and inorganic investment, including the recent acquisition of matrix imaging as.
As well as share repurchases through our recently announced $1 billion incremental authorization.
We made $300 million of share repurchases in Q2 and from a debt leverage perspective, we ended the quarter at a comfortable one seven times net debt to adjusted EBITDA leverage ratio.
On slide eight we highlight the premium supply chain costs have sequentially improved from peak levels.
Our team has been successfully working all avenues, including product Redesigns and negotiating long term supply agreements for critical components, which has enabled us to reduce our purchases in the spot market.
We've been seeing steady improvement in the supply chain environment, which we continue to closely monitor.
In Q2, we incurred incremental premium supply chain costs of $56 million as compared to the pre pandemic baseline, which was favorable to what we had anticipated in our prior outlook.
In total Q2 transitory items had a combined unfavorable gross margin impact of $35 million year over year.
And in Q3 are expected to be approximately $45 million, which is a neutral year on year impact net of pricing.
Let's now turn to our outlook.
We entered the second half of the year with a strong order backlog healthy sales pipeline supported by broad based demand for our solutions.
We have been experiencing a steady improvement in manufacturing output. However, our sales growth continues to be limited by extended lead times and availability of certain component parts.
Our organic growth has also been impacted by approximately 1% to two points after stopping shipments to Russia in March.
For Q3, we are limiting our sales growth to a range of 2% to 4% due to actions to reduce expedited airfreight costs and shift our printer products to ocean shipments, which will improve both Q4 growth and profitability.
We are also assuming a two point additive impact from recently acquired businesses and a three point negative impact from foreign currency translation.
As a reminder, approximately 25% of our global sales are denominated in euros.
We anticipate Q3, adjusted EBITDA margin to be approximately 22%, which is an increase from both prior year and prior quarter.
non-GAAP diluted EPS is expected to be in the range of $4 35 to $4 65.
For the full year 2022, we are reaffirming our outlook with our sales growth range between four and 6% inclusive of the impact of exiting Russia.
We are also assuming a 150 basis point as of impact from recently acquired businesses and a 225 basis point negative impact from foreign currency translation.
We now anticipate full year 2022, adjusted EBITDA margin of approximately 22% the low end of our prior guidance, primarily due to the significantly stronger U S. Dollar.
Profit margins are expected to improve through the second half of the year as we continue to shift to lower cost freight options and prudently manage operating expenses and investments.
We now expect our free cash flow to be at least $650 million for the year, which we have reduced primarily due to the approximately $150 million of settlement related payments.
Please reference additional modeling assumptions shown on slide nine.
With that I will turn the call back to Anders to discuss how we are advancing our enterprise asset intelligence vision.
Thank you Nathan.
We are entering the second half of the year in a position of strength as we closely monitor the volatile global macro environment.
We have a track record of protecting profitability and cash flow in any environment, while preserving investments that drive sustainable profitable growth.
I am encouraged by the continued strong demand we are seeing across our business and the bold actions. Our teams are taking to mitigate the supply chain impacts.
Slide 11 illustrates how we digitize and automate the frontline of business by leveraging our industry, leading portfolio of products software and services.
By transforming workflows with our proven solutions <unk> customers can effectively address their complex operational challenges, which have been magnified since the pandemic.
As we have extended our lead in the industry and expanded our portfolio with compelling solutions.
We have elevated our strategic position with our customers.
Our trusted relationships with our 10000 plus partners across the globe augment our capabilities.
Enabling us to serve more customers worldwide.
And we are always excited to engage with partners who drive the value.
We are excited about our new global strategic alliance with Accenture, which focuses on solving complex operational challenges in retail and other end markets with Zebra solutions.
We are collaborating to advance our customers' strategies to drive productivity inventory accuracy and customer service levels. Among a variety of other benefits that can be realized by digitizing and automating workflows throughout the enterprise.
Now turning to slide 12.
Business is partner with zebra to help optimize their end to end workflows as they strive to meet the increasing demands of consumers.
I would like to highlight several recent key wins across our end markets.
The major global transportation and logistics company is expanding its relationship with zebra across multiple product lines to ensure more accurate packaged loading using RFID technology across many sites.
<unk> RFID printers, and scanners are integral to sagging packages loaded into the wrong truck in real time, using RFID technology before the vehicle leaves the location.
Steve you are also supplied more than 3000 tablets to assist associates moving trailers around the yard ensuring the most efficient placement of trucks trailers and packages.
The large supermarket operator in Europe with more than double its feet of zebra enterprise mobile computers in a multiyear rollout covering warehouse front and back of store and curbside pickup use cases.
Facing consumer cell phones.
The customer expects improved productivity benefits through better product availability.
Faster execution on click and collect use cases, and real time price checking as they drive towards that zero food waste goal.
This expansion when results from the exceptional service and trust established over a long standing relationship and throughout the RFP process.
In another recent win a major U S convenience store chain added additional mobile computers in each of its more than 2000 stores to augment its inventory management and merchandising use cases.
This customer has a deep penetration of zebra solutions, including our printers mobile computers, and scanners to digitize and automate workflows.
Several years ago. This customer had implemented other <unk> solutions in its warehouses.
And then subsequently selected zebra for additional use cases as it addressed other business challenges.
Additionally, a significant U S healthcare product distributor expanded their use of zebra solutions equipping their warehouse staff with risks and ring scanners to improve efficiency in the pick and pack use cases for their warehouse associates.
Seabra collaborated with the customer and the partner to ensure he supporting of the applications to the Android operating system.
We are also very pleased to be making progress in our most recent expansion markets fixed industrial scanning machine vision and autonomous mobile robots.
We closed on the purchase of matrix imaging in early June and we joined them at the automate the warehouse trade show in Detroit.
We are excited to add matrix imaging, leading comprehensive portfolio of machine vision solutions.
Along with many specialized channel partners to help us scale, our combined business.
At automate we also highlighted our fetch autonomous mobile robot fulfillment solution, which we have been deploying at third party logistics provider record <unk>.
And we are excited about the another recent key wins with Maersk and integrated logistics company.
Additionally, fetch more campaigns and material movement solutions continues strong traction and use cases for healthcare supply delivery automotive spare parts campaigns and waste removal.
In closing our actions have enabled us to begin to recover from industry wide supply chain challenges and we continue to be very excited about our growth prospects as we monitor the volatile macro environment.
The global labor deficit and supply chain challenges have escalated the need for enterprises to digitize and automate their operations with our solutions.
We have the broadest portfolio of tailored solutions to help our customers advance their strategies.
Now I will hand, the call back over to Mike.
Thanks, Anders will now open the call to Q&A, we ask that you limit yourself to one question and one follow up so that we can get to as many of you as possible.
We will now begin the question and answer questions to ask a question you May Press Star then one on your Touchtone phone. If you are using a speakerphone. Please pick up your handset before pressing the keys.
To withdraw your question. Please press Star then two.
Our first question is from Tommy Moll of Stephens. Please go ahead.
Good morning, and thank you for taking my questions.
Good morning.
Anders I wanted to start with a discussion of the Omnichannel and E Commerce and markets.
Underlying volumes from what we can tell seem to be pretty strong they're still at the same time, there's been some mixed headlines from some of the key players there so.
Just curious what can you tell us.
Anecdotally from from customers or across the business about the pace of that end market does it continue to grow as it feel healthy or are you seeing anything deteriorate in terms of the fundamentals.
The extent you can confirm on the guidance that you provided.
Do you still see that those end markets growing in the second half. Thank you.
Yes.
I'll try to give as much color as I can here I'll start with a bit more on current performance.
<unk>. So just saw in Q2, and then tried to give you a little bit of a sense of how the how we look at the future here, but first I would just say that the the trends to digitize and automate workflows and empower frontline workers.
That continues to accelerate and then driving increased customer demand for our solutions across all our vertical markets.
Retail and e-commerce grew faster than the corporate average in Q2.
On still is still a very strong prior year comparisons.
We do continue to see strong momentum of Omnichannel.
Implementations, which is which are straining our customers' resources and that's also driving investments in technology and automation that is necessary for retailers to continue to transform their businesses.
If you look at the in the actual store expanding buy online pickup in store use cases and delivery use cases.
Require.
Retailers to equip more associated with mobile computers.
Long, we'd also implementing more workflow software optimization solutions.
And in the warehouse, we see investments in productivity and visibility as essential to that transformation.
We've also expanded with some new attractive go to market.
Ships like Microsoft and Google that helps to elevate our strategic positioning within the retail vertical as well as other verticals.
Yes.
And we have a very diversified re.
Retail e-commerce customer base and each of those customers are on their own refresh cycle, which helps to reduce volatility for us.
I would just say that our our our pipelines remain very strong.
And.
Although this is a quite a challenging environment.
Several retailers, who have recently publicly talked about their intent to maintain investments in technology as they try to continue to drive.
Execute on their vision and their strategies.
There are certainly a few customers that are ahead of their investment curves.
I would say most are playing catch up with investments in solutions like ours, particularly in the labor constrained environment, where they need to improve productivity inventory accuracy and customer service levels.
So I would say this feels more like a normal year for us in that.
Most customers are investing in proceeding with healthy.
Hopefully with their plans, but there are some that pulling back a bit but.
But this is the value then we have a diversified customer portfolio that allows us to.
Not be overly dependent on any one customer.
And I'd say its also noteworthy that we continue to grow despite the cyclicality there as some of these.
<unk> customers that we have and it's a testament to our diversified customer base.
So I hope that helps.
It does thank you.
And as a follow up I wanted to pivot to the margin outlook that you gave.
So this is on an adjusted EBITDA basis, you've reported 22% in the second quarter guidance for third quarter is again at roughly the 22% level.
And then if you look at what's implied for the fourth quarter.
Just based on the full year.
It's a number well north of 22%. So a margin improvement from Q3 to Q4 would be implied by your outlook and I'm just curious what the drivers there might be is there incremental price you're assuming.
Is it just the supply chain elevated supply chain expenses, you expect to get better or is it something else. Thank you.
If you look at our Q3 guide of 22%.
Just if you look year on year.
Up 30 bps from last year, and when you dig into that over two points increase from.
Strong volume leverage the pricing benefits I'm, taking traction from what we've executed over the last nine months as well as we are seeing solid improvement in the underlying gross margin.
Across the portfolio, but that's offset by nearly two points of FX as were forecasting slightly above parity in Q3 as the first quarter were.
Premium supply chain costs have a neutral impact.
Year on year sequentially from the second quarter.
It's flat as you get some improvement from improvement in overall premium supply chain cost, but thats offset by FX and slightly unfavorable deal mix. That's kind of your Q2 to Q3 dynamic if you look at the fourth quarter. The rate increase is really driven by two dynamics one would be continued improvement.
And overall premium supply chain costs as we are taking actions here in the third quarter to reduce air freight moving print to ocean that youll see the beneficial benefit for in the fourth quarter as well as you get nice volume leverage sequentially in terms of revenue increased in revenue on a relatively flat opex profile. So.
Yes.
Almost half the driver is volume leverage with the other half being continued improvement in overall cost position.
The next question is from Andrew Buscaglia of bearing Berg. Please go ahead.
Hey, good morning, guys.
Good morning.
So I'd like to you on that on.
On the margin question, just wondering throughout the quarter what you saw.
In terms of the higher supply chain costs and freight costs.
Your guidance of $200 million debit things that would imply thing.
Haven't really changed your or.
How would you characterize how the quarter went.
Relative to your expectations.
Yes, if you look at the supply chain costs in the second quarter I think first.
We saw a 20% reduction in.
Cost profile from the first quarter on <unk>.
<unk>, 4% higher sequential revenue profile. So I think sequentially. We are seeing the improvement that we had anticipated in our guidance and things relatively played out how we expected for the second quarter.
You look at it from a elevated shipping cost per kilo. We noted that those costs were continuing to trend down throughout the first quarter and they held relatively flat to what we saw in March throughout throughout the throughout the second quarter and we expect those to hold.
Through the second half of the year.
The real benefit was and we were able to reduce purchases of some of the critical components on the spot market.
Elevated prices and again that was the primary driver from the improvement in Q2, and we expect that to continue to improve as we get to the second half of the year.
As I stated before the key driver now is.
Really managing as we increased our printer output.
Filling up the pipeline on the ocean and start to get that benefit in the fourth quarter as it's a fraction of the cost to ship some of the larger printers on ocean versus air.
Yes, okay.
Okay, great and.
A question on the AIG segments, so that they're really surprise me positively and great margin performance.
But as I understand it that segment really follows GDP, if you look back to.
The pandemic and the great financial crisis.
GDP estimates are slowing broadly.
What do you foresee in that segment going forward everything is there a lag here where that might deteriorate that growth.
Well first I'd say that.
To talk about all of our product categories here that we drove nice growth across all the major product categories in Q2, and we continue to drive innovation across across the portfolio.
That's all helping to digitize and automate our customers' workflows and.
Our solutions are that much more critical today as a.
Our customers are.
Fighting labor shortages and inflationary pressure for print specifically here, we did see very strong growth in Q2.
We had nice recovery from a challenging Q1 supply situation and we had record revenues and in Q2, Q2, and we manufactured and sold more printers than we've ever done in any quarter historically.
And we do expect the.
Backlog to continue to return to to more normal levels or recover the delinquent backlog and also to start shipping more on ocean in Q3 and Q4.
I would say printing has maybe has grown faster than GDP by a couple of percentage points at least over the last.
Many years, we continue to see print is having an attractive growth profile and we have we've been gaining share steadily over over a long period of time and I see no reason for why we shouldnt be able to continue to do that going forward also.
I feel good about our printing portfolio and the positioning and the growth we should be able to drive and I'll also ask Joe to to give some perspectives here Andrew.
Andrew I might also point towards opportunities that we have to continue to expand in areas beyond pure GDP growth I'll give you two examples one would be.
A use case expansion.
Where we can continue to track and trace is becoming increasingly important for example in pharmaceuticals and expanding in those use cases can help us grow beyond GDP and another one would be a segment expansion for example, our entry into the Soho printer market would be evidence of that so I think we have opportunities.
Two.
To weather volatility in GDP.
The next question is from Eric Lapinski of Morgan Stanley . Please go ahead.
Hi team. Thanks for taking my question and congrats on the quarter I'd like to ask for just a little bit more detail on some of the varying regional growth drivers you saw in the quarter.
National growth was particularly strong and understand different regions are in different phases of their investment cycle. So are you seeing similar trends driving growth in each region on a vertical basis or are there certain verticals driving the strength in whether it's EMEA or Asia Pacific that you saw in the quarter.
I would say there is certainly some some common themes across all.
You look at digital transformation that is a strong driver for us and they transfer.
<unk>, Ron Digitizing and automating meeting workflows are.
Across all regions and across all verticals.
So theres a lot of commonality USA and what's driving that each region has slightly different profile is as far as what what verticals are strongest and so forth, but if you look at Europe , or EMEA, which was particularly strong a great quarter.
We saw print mobile computers and services for very strong from a product perspective.
We secured a number of very attractive retail wins, and I'll say, the European or EMEA performance was particularly.
Noteworthy considering that we also had a low single digit percent in global impact on revenues from suspending shipments to Russia in March.
Asia Pac I would say.
So very strong performance.
Particularly if you think of the.
Shutdown in China, a good part of the quarter, we did see double digit growth across mobile computing and scanning.
We had record hardware and service revenues.
We did see very strong growth in India, and quite pleased actually with China, which was down low single digits, even though we were locked down for six to eight weeks and now we're seeing a very nice recovery in China as we move into the second half here.
And maybe on.
North America I would just say that we saw a very solid broad based demand.
We had strong wins across all our core verticals and we also saw attractive strength in our run rate business.
There are social here were impacted by supply chain constraints in some of our allocations to more of a timing.
But when it recovered very nicely in printing and so strong growth in data capture and or equity and for North America. The biggest impact was really recycled some very strong prior year compare says USPS was particularly strong in Q2 of last year.
Yes.
Joe do you have any I would only emphasized at the regional distribution of growth that we saw in Q2 is not reflective of the underlying demand situation, but much more reflective of how we allocated supply in times of shortage based on the shortest paths that we have to get supply into a market.
Got it thanks, Charlie that was actually going to be my follow up but maybe if I could also ask just on capital allocation as we think about.
Honeywell settlement, obviously, thats, a modest drag on cash flow, but.
Share repurchases in the quarter were maybe a little bit higher than expected M&A has been successful is there any change in over the last quarter or how youre thinking about allocating capital and cash flow.
Should we think similar priorities to normal.
I would think similar priorities as normal we are comfortable with the overall debt levels.
Cash position that gives us a lot of flexibility as we enter the second half and into next year to continue to prioritize investment in the business both inorganic organic we.
We have exciting opportunities in both of those and share repurchases will arena.
Nice flexible way to return capital to shareholders. So I would say no change in the overall capital allocation.
Approach as we go into the second half of the year.
Thank you.
The next question is from Brian Drab with William Blair. Please go ahead.
Alright, thanks for taking my questions.
And they might seem to lean a little bit.
Cautious, but that's just because of that.
And what we're hearing from investors right now across the board, but first question just on your visibility can you remind us.
In general what is the lead time for the different product lines and.
Maybe for large orders versus the run rate business, just trying to get a sense for how.
Soon we will you know if there really are challenges in some of these end markets.
But.
So are you looking at at our visibility into kind of our pipeline, it's certainly various too to.
To some degree based on customer and so forth, but for our larger customers.
A large part of the market, we start the year by going through and having.
Detailed reviews about their outlook their investment profile already in November December of the prior year. So we have a good perspective of what they expect to do for the year and we stay close to them to see if there are changes obviously that can they can always change, but we tend to have a good good visibility from from those and we work very closely with R. R.
Recently partners to develop our pipeline.
That is.
More than 12 months out and we quantify that round.
We are in the sales pipeline those deals are so something we feel we can commit to where they are more in the exploratory pace.
So we tend to have a pretty good.
Good handle on that we also have such a large volume of transactions. So we get statistically some differentiation or diversity from that which helps so we're not overly we don't we wouldn't necessarily over read.
Any one signal here.
Joe do you want to comment on that anymore, Yes, I mean first I would just remind that we still have a record backlog.
In terms of what's driving our demand for the next quarters.
That is still a very dominant force.
Visibility to new orders.
One good thing about the pandemic is that it has driven our customers to be much more forthcoming with their expectations of their business. We now have much better visibility than we had before but some customers, giving us up to a year's worth of at least visibility in some cases even borders.
So that's.
Whether that will relax again, a little bit of supply becomes more available, we'll see but at the moment, we are enjoying much better visibility quarters.
And in many cases and I'd say the bookings philosophy has.
<unk> pretty stable. This year. So it is very strong we haven't seen evidence of a.
Recession or predictive slowdown yes.
Okay. Thanks, that's all very helpful. And then can I just ask.
And I know the sensitive because it's a legal issue but around the settlement.
Yes, it seems like pretty big Big deal and it's a lot.
Very large settlement and can you make any comment as to what.
What happened there I guess, it's primarily with the related to the scanner.
Product line and just wondering can you comment at all on does that change the competitive dynamics going forward for that product line.
So first you're right we should we can't say very much on that this is a confidential agreement, but what we did.
Settled a number of competing lawsuits with Honeywell regarding alleged patent infringement.
We agreed to pay $360 million paid over eight quarterly installments, starting in Q2 of this year, so last quarter and going forward, we have a royal decree both of us enjoy a royalty free cross license that means Theres no few.
Future impacts or payments and.
You should just remember them from a from a size of the payments here.
Now this is reflecting the relative size of our business. We are that much bigger market is that much larger so that has a direct impact on that.
From a competitive perspective, I don't see that having an impact.
<unk>.
We feel very good about our portfolio of competitive positioning and our innovation our customers.
Certainly resonate with our vision and our direction.
Direction. So we feel good about where we are.
The next question is from Paul Chung of Jpmorgan. Please go ahead.
Hi, Thanks for taking my question so.
Just on your EBITDA guide, it's at the low end guide, though youre free cash flow kind of adjusting for the.
The settlement was unchanged. So if you could talk about the execution on free cash flow.
And kind of your expectations of how working cap levels kind of trend as we move into 'twenty three.
Yes, so if you look at our.
Free cash flow again.
For the first half.
Decrease in relative to what we expect in the second half was really around the higher use of working capital and the timing of sales, particularly in the second quarter.
With the China Lockdown.
June was one of our I think our highest.
Revenue quarters in history, just given the delay of getting products out of China into ship and that obviously has a drag on from a collections timing and we expect that to normalize as we go into the second half of the year.
And so that'll be a big driver of the increase in cash flow as we go to the second half of the year and I'd say overall, we target 100% free cash flow conversion over a cycle, we have been over 100% the last.
Several years, if you go back to 2020 over 130 last year over 100. This year, if you normalize for the settlement around 80%. So I think again, what we would expect next year to recover back closer to that 100% range.
Range is that's what we target, but obviously you can't you can't stay above 100% forever. So this is a little bit of a year of <unk>.
Catching up for the outperformance in the past couple of years.
Gotcha and then another question on guidance for both Q3 and the year can you help us kind of understand the gross margin versus kind of opex dynamic.
Should we expect kind of a more.
Modest progression here from two key on gross margins you mentioned, some lapping of high freight costs from Q4 of last year, but you have some FX impact here so.
How do we think about gross margins for the year is it down maybe 100 basis points for the full year, then opex pace may be similar to the last quarter. I think you said flat was that quarter on quarter. Thank you.
Yes, I'd say, if you look at it from a gross margin perspective, I think you actually look at total Q3.
Both gross margin and Opex from a scaling and rate perspective, it will be similar to Q2.
And thus the similar in terms of EBITDA rate of around 22%.
And as we go into the fourth quarter you would expect.
To improve as the as we're able to lower some of the supply chain costs that would be.
Improvement on gross margin and then we will get some some nice opex scaling as we head into the fourth quarter as we expect cost to remain relatively opex will be relatively flat from a dollars perspective as we go through the second half of the year. So.
Those would be some of the dynamics as we play through the third and fourth quarter.
The next question is from Keith <unk> of Northcoast Research. Please go ahead.
Good morning, guys I was hoping to unpack your second your third quarter guidance with more of a 2% to 4% I think Nathan you referenced that you guys are limiting growth to that so you guys can move more toward the ocean freight I guess, how much of the of.
That movement actually is impacting your guidance there in terms of your topline guidance.
But if you look at again, just to restate Q3, 2% to 4%.
We said we are entering the quarter with a strong backlog bookings around 4% organic growth.
Nice results considering the loss of Russia about one to two points as well as the strong prior year compare.
For Q3 and again the actions, we're taking are really around late in the quarter.
To avoid some of the premium are costs that are sometimes necessary to get product over in <unk>.
Before the end of the quarter as well as the shift in moving printer Ocean. So obviously it takes a few extra weeks.
From a timing perspective. So this is really around what will be delivered late in September versus into October and we think that's the right trade off for the business long term is at some point you have to rebuild that funnel and that value and benefit will obviously impact Q4 and be a big driver as we head into next year as well.
Tough to quantify what that is and we're still working those plans out here over the next months in terms of exactly.
How much we anticipate to get onto the ocean, but.
Again, that's where we're really limiting that sales growth too.
Pushed some of that volume to the fourth quarter to take advantage of the lower freight costs.
We do have we have the order coverage for this business.
Looking at supply chain and optimizing our cost profile.
So are you, saying then others, it's not impacting your growth would have been higher in the third quarter. Your guide if not first mover.
Alright.
That's right yes.
<unk> decision to limit Q3 growth in order to improve the cost profile as we go into the fourth quarter. That's also a driver for why you see the relative strength of Q4 versus Q3 on the top line growth right. So will the entire move to the ocean be complete then by the end of the third quarter.
No I would think by the end of the fourth quarter.
It will be building the pipeline in the third quarter. So that as we go into next year, we're in a healthy position.
The next question is from Jim Ricchiuti of Needham <unk> Company. Please go ahead.
Hi, Thank you.
It's early days with the main trucks acquisition, but I wonder.
How you would characterize the.
The progress you're making in the machine vision.
Market and that tends to be industrial machine vision tends to be a little bit more sensitive to economic cycles and I wonder.
How youre viewing the demand trends in that part of the business. Thank you.
We closed on eight trucks in early June .
So we are two months into this.
It helps to create a very comprehensive portfolio of both fixed industrial scanning and machine vision solution for us.
I'd say it'd be very encouraged by the first two months the integration is going well.
The feedback from our customers have been very positive and we will continue to build out.
Our network.
Yes.
That's a great story really around how.
The partners, we have started to sign up for our fixed industrial scanning portfolio see great value of being able to add a machine vision to their portfolio. So they can address many more of the opportunities to see from customers with our solutions and equally from from a metrics perspective that they would have the same opportunity to add.
Fixed industrial scanning to their fixed industrial.
Machine vision.
Portfolio.
Feel very good about where we are and I think the culture has.
Meshing very well.
Hey, Joe.
Yes, I would.
Perhaps add the following from the outlook perspective.
<unk> is very focused on the manufacturing sector and has a good strength there and we complement them very well because we are now able to introduce them to customers in the P&L sector in particular and.
And the cyclicality of those two is again different and therefore.
<unk> us with some opportunity to continue growth through diversification between the two companies. So that's our strength we are building up and is there also.
Matrix has similarly as strong backlog as we have on a relative basis of course.
Thank you and just follow up question on RFID, which you called out and have been calling out as strong over the last several quarters. I know you don't break out the size of that business. It straddles both areas of the.
But both parts of the business, but in general can you give us I wonder.
Our growth rate for that business and are you seeing the profile change in terms of the types of applications.
Ed.
RFID is we've had seen great momentum around RFID for several years now with a little pause in Q2 2020, I think when it couldnt really go in and work directly with customers, but it's been a.
Very strong.
Part of our portfolio and end market.
Growth has been double digits and solidly in the double digits for us for quite a quite a while so it's still a relatively small part of our portfolio, but it is a growing part of it.
Sure.
You've seen some large companies publicly announced plans around RFID is like Walmart and GPS, which is helping to drive greater momentum also around it. So retail has been the primary.
The first vertical to really deploy RFID around inventory visibility some.
Somewhere around the checkout area as well so.
But we are seeing the <unk>.
Expand into health care transportation logistics manufacturing and also globally.
It's not a this is not a U S phenomenon and say this is something we've seen across the world and Joe Joe any more color I think you've covered.
Yes.
Yes.
The next question is from Rob Mason of Baird. Please go ahead.
Yes. Good morning, just one quick question on May trucks.
In the reference around full year EBITDA margins.
And how youre guiding there you did reference FX, but as well as <unk>.
The recent matrix acquisition.
How long should we think about that.
<unk> <unk> acquisition being a headwind.
EBITDA margin to the extent, that's the case should we start to see that.
Yes, not be so as we move into next year is it youre going to continue to invest there.
Yes, So I think if you look at the guidance for the second half matrix is.
Accretive to our overall EBITDA margin, so thats, but it was more than offset with the impact of FX just given the relative.
Our relative size and impact so.
It's not a it's not a headwind from an EBITDA rates.
But its neutral from an EPS perspective, particularly with as we until.
So we pay down the debt.
From a debt costs, so but from an EBIT guide it was partially accretive from the last outlook, but again that was more than offset with the headwind from FX. Okay. Okay. Thanks for clarifying that.
And then just a.
Stay on maybe the cost side, just as the logistics or the premium.
Logistics costs come down.
It looks like they will continue to trend down into the fourth quarter.
And again as you maybe referenced.
Realigning your.
<unk> transportation mode.
Should we expect that those logistic cost would continue to decline into 2023 ish just based on what Youre seeing right now Nathan.
Yes, I think if you look at the if we break it into three components.
One of those is one of the things we can control, which is limiting the amount of buyer with you on the spot market.
As we work with our direct suppliers and that's one of the benefits you saw from Q1 to Q2 in the second half so that we expect to continue to decline.
Moving printer Ocean that again is another thing that we can control that we would expect to improve I would say, we're not expecting at least anytime in the near future the kind of the underlying rate or cost per kilo to improve I don't think you'd see.
Until there is a significant increase in capacity global air capacity.
You see that rate improve and Thats part of the reason we did the price increase in July was to begin to offset that with the pricing increase. So that's that's the other benefit driving some of the margin as we get into Q3 and Q4 as the overlays are the pricing action. So again.
Two of the three variables, we can control we would expect to continue to improve the one around kind of that underlying error rate I don't expect to see material improvement in that until you see something change in capacity and that's the reason for the price increase.
On our side.
Very good thank you.
The next question is from Damian Karas of UBS. Please go ahead.
Hey, good morning, everyone.
I just wanted to ask a follow up on the changes that you ship product.
Nathan I know you've mentioned in the past I'll for your business.
Increasing passenger travel are the key to getting that improved cost and margin profile and it does seem consumer travel is picking up a bit. So just curious this decision around the ocean shipments.
Would you view that as more transient kind of a tactical change or are you really making a more permanent structural change to the business.
The move of our.
Moving our printing you can think the large tabletop desktop printer.
<unk>, that's how we have historically shipped it.
Before the third quarter of last year, so 80% to 90% of that we shipped on ocean just given its relative weight. So irregardless of the rates cheaper to put on the ocean versus air given the size and density of those products.
The rest of the portfolio has always primarily been shipped on air.
Air and so that's again, where those air rates play a part so the I'd say, we are going back to <unk>.
Our normal modes of normal modes of transportation.
This shift here as we go into the second half to the second half of the year just one more comment on that the reason we started putting.
Princess on Air was basically the long lead times, so that wants to make sure they could prior to us meeting customer expectations and customer demand, but the intent was always to move it back to two ocean as soon as the supply chain constraints start to ease up a bit and on the air capacity.
In the U S and I think part of Europe , you're seeing passenger travel increase.
In and out of China, I don't think we've seen a big increase and Thats, where the biggest bottleneck is but we do hear that's a Hong Kong is looking to add more more air capacity, so that will be a slight benefit to us.
Got it got it and just to clarify.
You haven't taken any further pricing actions are planned to.
Taking further pricing actions until kind of the three rounds of increases that you.
Previously spoke to.
That's right. The last one just went into effect at the beginning of this month and again, we'll we'll.
We will continue to.
Monitor if any or additional necessary on Joe you want to.
We're just saying that last month, beginning July filling a July excuse me.
[laughter].
Yeah.
This concludes our question and answer session I would like to turn the conference back over to Mr. Gustafsson for closing remarks.
And to wrap up I would just like to thank our employees and partners for their extraordinary efforts to serve customers and deliver better than expected Q2 results.
And we continue to focus on prioritizing our customers' mission critical needs and scaling our vibrant expansion markets.
And we would also like to wish a warm welcome to the matrix imaging team.
Thank you everyone.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.