Q3 2022 Zebra Technologies Corp Earnings Call
Good day and welcome to the third quarter 2022 Zebra technologies earnings Conference call.
All participants will be in listen only mode should you need assistance. Please signal conference specialist by pressing the sparky followed by zero.
After today's presentation there'll be an opportunity to ask questions. Please note. This event is being recorded I would like to turn the conference would make steel Vice President of Investor Relations. Please go ahead.
Good morning, and welcome to Zebras third quarter Conference call. This presentation is being simulcast on our website at investors that 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 the slide presentation and in today's earnings press release.
Throughout this presentation unless otherwise indicated our references to sales growth are year over year on a constant currency basis and exclude results from recently acquired businesses for the 12 months following each acquisition.
This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer, and Nathan Winters, Our Chief Financial Officer.
Anders will begin with our third quarter results.
Then Nathan will provide additional detail on the financials and discuss our fourth quarter outlook.
Anders will conclude with progress made on advancing our enterprise asset intelligence vision.
Following the prepared remarks, Joe heel, our chief revenue officer will join us as we take your questions.
Now, let's turn to slide four as I hand, it over to Anders.
Thank you Mike.
Good morning, everyone and thank you for joining us.
For the quarter, we realized a sales decline of 3% and.
And adjusted EBITDA margin of 21, 1%, a 60 basis point decrease and non-GAAP diluted earnings per share of $4 12, since a 9% decrease from the prior year.
We were unable to fulfill all orders due to supply chain challenges related to persistent component shortages for certain products as well as disruption in the transition to our new North American distribution center in the Chicago area.
These challenges led to lower throughput than planned late in the quarter.
This along with orders from some large customers being deferred contributed to the lower than expected results.
In North America, and EMEA selecting to prior year large mobile computing deployments and suspension of sales in Russia resulted in the sales declines.
Our Asia Pacific and Latin America regions were bright spots in the quarter with double digit sales growth.
Globally, we realized sales growth with our small and medium sized customers, which was more than offset by a decline from our large customers.
From a solutions offering perspective, we drove growth across data capture printing supplies service system software.
These helped to partially offset the sales decline in mobile computing.
We expanded gross margin over the prior year, despite significant FX pressure, yet EBITDA margin contracted and EPS declined due to the deleveraging of operating expenses from the sales decline.
We haven't initiated meaningful actions to address the supply chain challenges, which was the primary driver for our results.
These include <unk>.
Organizational changes and the reallocation of resources to drive improved focus and execution in our supply chain initiating.
Initiating specific actions with our supply chain partners to improve operations.
And extending the planned transition of our North America distribution center to mitigate the execution risk.
Customer demand and our order pipeline generally remains healthy yet has slowed since late Q3.
Given the macroeconomic uncertainty, we see elongated sales cycles and certain projects being deferred.
So we are taking a cautious approach to our Q4 sales outlook and expense management.
We're working to right size, our working capital levels in the coming quarters to improve free cash cash flow conversion.
At the same time, we continue to prudently invest in initiatives that advance our solutions offerings.
With that I will now turn the call over to Nathan to review, our Q3 financial results in more detail and discuss our fourth quarter outlook.
Thank you Anders let's start with the P&L on slide six.
In Q3, adjusted net sales declined 4%, including the impact of currency and acquisitions and down three 2% on an organic basis, primarily due to supply chain challenges and lower sales to large customers.
Our asset intelligence and tracking segment increased 12, 4% driven by double digit growth, both printing and supplies as product availability has continued to generally improve.
Enterprise visibility <unk> mobility segment sales declined eight 8% due to supply chain bottlenecks, including component shortages.
We realized particularly strong growth in data capture solutions, including RFID as well as rugged tablets.
We also drove growth across services and software with strong service attach rates and attractive software offerings.
Performance was mixed across our regions.
Pacific sales grew 20% with broad based strength across the region, including China.
Latin America sales increased 10% with exceptional growth in Mexico, and in North America, and EMEA sales decreased 9% and 2% respectively. Due to the supply chain challenges lower sales to large customers and the suspension of sales in Russia.
Adjusted gross margin increased 80 basis points to 45, 8% due to favorable business mix and lower premium supply chain costs, partially offset by unfavorable FX.
Adjusted operating expenses increased due to acquisitions and de Levered by 60 basis points due to the sales decline.
Third quarter adjusted EBITDA margin was 21, 1%.
The 60 basis point decrease from the prior year period.
Due to expense deleveraging on lower sales.
non-GAAP earnings per diluted share was $4 12, since a nine 5% year over year decrease.
Turning now to the balance sheet cash flow highlights on slide seven for.
For the first nine months of 2022, we generated $170 million of free cash flow, which was significantly lower than last year, primarily due to a higher use of working capital due to elevated inventory and sales volume shifting to later in the quarter.
Our incentive compensation payments, given our exceptional 2021 performance and $90 million, a previously announced settlement payments.
We made $50 million of share repurchases and invested $6 million in venture investments in the third quarter.
We ended the quarter at a comfortable one seven times net debt to adjusted EBITDA leverage ratio and with more than $1 $2 billion of capacity on our revolving credit facility.
On slide eight we highlight the premium supply chain costs have improved from peak levels.
The actions, we have taken to redesign products targeted price increases as well as improving freight capacity have enabled us to reduce purchases on the spot market and reduce the freight cost impact.
We are on plan to move printer shipments to ocean from here late this year and into early 2023.
For the full year 2022, we now expect approximately $190 million of premium supply chain costs over pre pandemic 2019 levels.
A $10 million reduction from our prior outlook.
In Q3, we incurred premium supply chain costs of $30 million as compared to the pre pandemic baseline.
Which was favorable to what we had anticipated in our prior outlook.
Total Q3 transitory items had a combined favorable gross margin impact of $14 million year over year and in Q4 are expected to be approximately $35 million, which is a nearly $30 million reduction year on year.
Let's now turn to our outlook.
Q4 sales are expected to be approximately flat from the prior year period with a range of negative 2% to one to positive 1% growth.
As compared to our prior outlook the lower sales growth is driven by softening demand continued supply chain challenges and currency headwinds.
We are confident in this guide given our relatively strong order backlog improved quarter to date shipment activity and actions taken to stabilize North American distribution.
We estimate a two point additive impact from recently acquired businesses and a four point negative impact from foreign currency changes.
As a reminder, approximately 25% of our global sales are denominated in euros.
We anticipate Q4, adjusted EBITDA margin to be between 22, and 23%, which is an increase from both the prior year and the prior quarter.
Given our tempered view of the demand environment, we are taking a conservative approach to managing operating expenses, while preserving strategic growth investments.
non-GAAP diluted EPS is expected to be in the range of $4 50.
To $4 80.
We now expect our free cash flow to be at least $400 million for the year, which we have significantly reduced from our prior outlook due to lower profits and elevated inventory levels that we will be working down into 2023, as we rationalized safety stock and execute on our North American distribution transition.
Sales seasonality has improved to more normalized levels in Q4, which should drive the peak cash flow quarter for 2022.
Please reference additional modeling assumptions shown on slide nine.
With that I will turn the call back to Anders to discuss how we are advancing our enterprise asset intelligence vision with our customers.
Thank you Nathan.
The long term fundamental drivers of our business remained strong.
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 without proven solutions.
<unk> customers can effectively address their complex operational challenges, which have been magnified through the pandemic.
This value proposition resonates with customers in any macroeconomic environment as it improves productivity and inventory accuracy. Among an extensive list of other operational benefits.
As we have expanded our portfolio with compelling solutions, we have elevated our strategic position with our customers.
Our trusted relationships with our partners across the globe augment our capabilities, enabling us to serve more customers worldwide.
Our new fixed industrial scanning and machine vision solutions resonated well with customers and partners at recent trade shows in Stuttgart, Germany, and Boston, Massachusetts Eye.
Our booths featured advanced optical character recognition supported by deep learning capabilities gained through our 2021 Adaptive addition acquisition.
Our comprehensive offering has put us in a strong competitive position.
Now turning to slide 12.
Business this partner with zebra to optimize their end to end workflows as they strive to meet the increasing demands of consumers.
<unk> solutions continued to represent and necessary investment and I would like to highlight several recent key wins across our end markets.
A large north American retailer recently selected Zebra TC 52 mobile computers for their stable network connection durability and camera performance.
This customer maximizes value from zebra solutions by combining our mobile computers without reflects this workforce and task management.
Seabra prescriptive analytics and Intuit software.
This combination enables the retailer to improve inventory accuracy and the omnichannel shopping experience for their customers.
The North American based fast food chain has chosen zebras handheld RFID solution to enhanced inventory management.
This solution will enable each restaurant to reap the benefits of a more digitized supply chain by streamlining the process to track and trace inventory from its suppliers to the restaurant.
Adoption of this technology will assist the customer to comply with the food safety Modernization Act.
A transportation company in Europe has begun rolling out approximately 20000 mobile tablets to streamline their vehicle rental process.
<unk> has exceptional service and integrated product offerings displace the competitor and will enable associates to come.
Complete vehicle walk Arounds inspections, and the reservation process more efficiently.
The convenience store chain in Latin America is expanding their use of zebra solutions from the distribution center to the front of store with more than 50000, zebra mobile computers printers and tablets.
Deployment of these zebra solutions is expected to significantly increase productivity inventory accuracy and improve shopper satisfaction.
<unk> mobility, DNA software, which enables intuitive device management and our compelling customer value proposition were key differentiators in this competitive win.
Apparel manufacturer BMC recently selected Zebra autonomous mobile robots and fixed industrial scanners for their new 50000 square foot North American facility.
<unk> collaborated with a major partner to develop a solution that would enable a flexible workflow and enhanced visibility along each step of the production line.
By combining our autonomous mobile robots and fixed industrial scanners.
AMC will realize powerful synergies with scanners tracking each step of production and directing the robots along the workflow.
The robots streamline associates movements, enabling faster fulfillment.
This flexible and scalable solution was preferred to a traditional fixed conveyance system, because it saves baidu warehouse space and adjust to demand.
Additionally, we recently secured a large win with a major European retailer, who selected zebra fixed industrial scanners to significantly reduce scan time, increasing throughput at several thousand packing station.
Resulting in a faster than one year payback on investment.
Steve brass collaboration with the customer and a valued partner was integral to this competitive win.
As we turn to slide 13, I want to reiterate that the actions we have taken to address our challenges with North American distribution.
<unk> inventory levels and increased macroeconomic headwinds.
We have executed key organizational changes and have initiated a specific actions with our supply chain partners to stabilize operations and reallocate resources to address immediate challenges.
We are also taking decisive steps to rationalize inventory, while maintaining optimal levels of strategic components.
Additionally, we are taking prudent cost actions as we realized softening demand and implementing additional pricing actions to address FX and inflation.
In closing, we continue to be very optimistic about the prospects and opportunities for our business.
We have the broadest portfolio of tailored solutions to enable our customers to improve their operations in any environment.
The global labor deficit and on demand economy have escalated the need for enterprises to digitize and automate their operations with our solutions.
Now I will hand, the call back over to Mike.
Thanks Anders.
We will now open the call to Q&A, we ask that you limit yourself to one question and one follow up so that we can get to as many of you as possible.
We will now begin the question and answer session.
To ask a question you May Press Star then one your Touchtone phone.
If you're using a speakerphone please pick up your handset before pressing the keys to withdraw your question. Please press Star then two.
At this time, we will pause momentarily to assemble our roster.
Our first question will come from Tommy Moll with Stephens you May now go ahead.
Morning, and thanks for taking my questions.
Good morning, Tom.
Anders I wanted to start on the comments you made regarding some deferred projects from large north American customers any context, you can share there on end market type of project visit.
Visibility.
To picking back up on some of this work going forward would be much appreciated and and as a related point we would.
Would you say that these projects or are all the majority of or a smaller part of.
The demand softening that you called out late Q3 I'm sure. It's part of what you described there with the softening but order.
Order of magnitude would be helpful. Thank you.
Yes, first I'd say the.
Yes, we're getting some mixed signals.
From the market on on demand pictures and some to some degree clouded by the supply chain challenges we are seeing.
Most signals most demand signals, we are seeing are constructed and our backlog is healthy.
Our pipeline is building nicely that our run rate business is strong.
And we continue to see some some nice areas of strength in each region.
And our retail vertical grew just even though we had a very large customer pulling back into court or this year in predicting the quarter.
But we have also seen some.
Elongated sales cycles, and a bit of a softening in demand.
Some customers have pushed out.
Some orders from from Q3 into 2023, so the.
I think most I'll ask Joe for some extra color here also as are most of those push outs are come from.
The retail segment, but its also our largest segment so it wouldn't be surprising and they tend to have more of the year end spend that there.
We're working on so.
The.
The overall environment is still quite quite healthy, but <unk> seen some select pushups Joe.
Yeah.
Excuse me to put it in perspective, perhaps in terms of the Miss to the outlook. The deferral of projects was a minor contributor to that.
These deferrals.
<unk> these late in the quarter deferments.
We're a relatively small number of larger projects as Andrew said deferred primarily into 2023.
That's probably as much as we can see.
That's helpful. Thank you.
As a follow up I wanted to pivot to supply chain and you.
You gave us quite a bit there on the North American distribution center transition.
Can can you give us any more.
Just on the ground context in terms of the transition that's underway some of the changes.
That you've made.
As a consequence of some of the challenges that you called out and then I think Andrew as I heard you referenced that there have been some personnel changes on this front anything you could highlight there would also be helpful. Thank you.
Tommy This is Nathan I'll start with the first part.
Just a little bit of background reflected a new DC location midway through last year.
And as we said through the call we had some issues with the transition impacting shipment volumes late in the quarter.
And we've implemented corrective actions in particular on ramping back our Texas facility.
It gives us some additional time to work through the transition both from a people and process perspective, So again I would say, although we didn't deliver the shipment volumes necessary to meet the Q3 forecast. We are now operating at levels required to deliver Q4 still.
Still not where we want to be but again, the Texas facilities nearly staff to full capacity and we've had a really nice recovery here in deliveries in October just as context, we shipped out nearly $200 million more in October than we did in the month of July which is giving us both confidence in the performance of the D C as well as confidence in the Q4 guidance.
Pass over to Andrew.
Yes.
Our organization perspective, we have the.
<unk> made some changes we have promoted a new supply chain leader.
Our global operations and supply chain team so.
We have also streamlined the organization a bit then move some some function of functions or responsibilities out of our supply chain to other areas to make sure we can get greater focus and better accountability around those.
We we've also worked closely with our supply chain partners to make sure we take some actions with them to help improve the operations.
So Nathan talks about was ramping up our our Dallas Fort worth facilities, so they're back.
Close to full capacity that almost fully staffed and operating very well at the moment and we're working with our Chicago area.
D C partner also to see how we can best helped.
Help them scale their operations there.
Our next question will come from Andrew Buscaglia with Baron Berke, You May now go ahead.
Hey, good morning, guys.
Good morning.
So.
Just trying to get a sense of how much.
The sales change that you've seen.
Is it related to like I.
I guess, the nature of the deferrals and the confidence that youre going to get these.
These orders in 2023 and I guess.
Great and the other way how much is kind of the beginning of.
More to come or based on the visibility you have with these customers do you have confidence.
Yes. This is I guess short term.
Issue.
Yes.
Yes.
I don't think we want to get into too much up to 2023 outlook yet but.
I think these have been.
More select customers.
There is not a broad based.
Save pushout or deferrals, just being much more selective on certain customers.
And some and some tougher project.
Predicting Q3, we also have some very.
Difficult comp from two large customers.
Particularly strong in the third quarter, but as I said the email most of our.
Demand signals are still very strong and encouraging.
And.
We see.
It's been this was really very.
Very very narrowly focused in North America.
Yes, I'll add two things perhaps for perspective, one is.
An example of what we're seeing is a large customer.
We will take an order that they would have perhaps placed in Q3 or.
Or early in Q4, and now telling us we're going to split that order and were going to take 80% of it now and 20% of it later.
2023, that's an example of the type of thing we're getting.
So it feels like.
Real demand behind water.
The other thing that we're hearing from customers quite consistently is mild.
Some customers in particular are retailers are being cautious about their business about their revenue expectations and those are obviously visible to you in and.
What they say on their earnings call. They are telling us that their investments in <unk> and in the types of solutions that we provide them are important to them even in more uncertain times, because they need to improve their productivity and.
And we help them do that with our solutions. So that's that's certainly something to hear pretty consistently.
Okay. That's helpful.
And you talked about last quarter, I guess this quarter again being able to ship.
Shipped by mostly by Ocean exited in Q4, I guess, where do you stand with that.
And then and then.
Tailwind why it's only three I know you want to give guidance for next year, but.
What how do you expect the cost environment to shape up for next year.
Hopefully maybe do you think that offset some of this volatility around the sale youll see over the next six.
Six months or so.
Yes, so Andrea maybe just a context for the broader <unk>.
Premium supply chain costs.
We saw in Q3 was.
Positive momentum of your 50% reduction from what we experienced in Q2 <unk>.
Decreasing from nearly 4% of revenue to just over 2%.
That was primarily driven by the declining shipping cost per kilo, which we're experiencing.
As well as benefiting from the pricing actions beginning to take effect with the price increase we did in July Q.
Q3 shipping cost did come in below estimate and we also benefited if you. If you look at the mix and the $30 million for the quarter from lower lower North American revenue and that's another reason for it is ticking back up in the fourth quarter in terms of overall transitory.
And our Q4 guide assumes no improvement in freight rates. So it's something we're continuing.
<unk> to monitor monitor it but if you look at the overall reduction from $200 million to $190 million and premium supply chain costs.
Some of Thats volume driven just over half, but also $4 million or so was due to the lower rates, we're experiencing I think.
Our expectation is that we will see steady reduction into 2023 around these costs.
As long as the freight rates hold where they are at today.
We're going to continue the transition from air to Ocean really late here in the fourth quarter and we did some ocean shipments into Europe in the third quarter, but we really don't expect ocean shipments to pick up until late here in the fourth quarter and into 2023.
And we've also seen a nice reduction in what we've had to buy a critical components on the spot market. So we're starting to see that loosen up as well. So again, we feel confident that we will see a steady decrease and.
EBITDA benefit as we go into next year.
Our next question will come from Jim Ricchiuti with Needham <unk> Company you May now go ahead.
Hi, Thank you.
First question just again on the on the deferral that Youre seeing among a few of these north American customers.
When you talk about it.
Some of this business slipping into 2023.
Is there a presumption that this would be slipping further into 'twenty three into the second half just given the seasonal investments that these types of customers may make.
I think it's.
Probably don't want to give too much color on that also here at this stage, but.
The expectation is I won't say they are slipping from this year into.
The beginning of next year not the end of next year I would I would agree with that yes.
Okay. That's helpful and Anders I Wonder if you could talk to.
What youre seeing in the SMB market it sounds like you're seeing a.
Relatively good demand there I don't want to put words in your mouth, but if you could comment on that and also in an economic cycle, which part of the business would you see impacted more immediately the larger customer business or the SMB business.
Yes, starting with SMB business, Yes, we did see strong growth globally for our small and medium sized customers I.
I think thats, a good indication of kind of the confidence the broader market has in there in the outlook and the value that our solutions offer.
The secular trends that we talked about to digitize and automate workflows and to empower the frontline workers are I would say much more important today in a labor constrained environment as that drives a greater increase for our type of solutions across all verticals and all sizes of customers.
<unk>.
I think the.
<unk>.
Our run rate business performed particularly well globally this quarter, which I think is.
It gives us confidence around the health of the business.
If you talk about kind of which which.
Verticals would be more or less impacted I would say.
We probably get them the most questions around our retail customer base historically on this.
And here so I had mentioned earlier, our retail and E. Commerce business grew in Q3, despite very very challenging comps from the from the very large, particularly large retailer that has been pulling back and I think that highlights the value of having a very diversified retail e-commerce customer base, where the the <unk>.
<unk> of their refresh cycles.
Spread out and that helps to reduce.
Volatility risks.
I think the.
In retail specifically.
The focus on the importance of our type of solutions to enable our customers to execute on there.
Omnichannel and e-commerce strategies is very important.
I've talked about how we believe that our.
Our solution now.
More like say in the ERP implementation is hardest to dial them up and down and I think the results from Q3, indicating it give some some credence to that that expectation.
I'd say, our healthcare business, which performed very well in Q2 and Q3, sorry. It was up double digits that is probably the the vertical we expect to be the least.
Sensitive too.
222 kind of recessionary forces.
And here. We are also very very focused on helping to transform that industry to to be able to improve the patient journey and drive greater productivity for healthcare providers.
P&L vertical.
The most wanted to what was the hardest hit was the only vertical that was down for us in Q3.
But e-commerce volumes are expected to continue to increase and that drives greater need for real time visibility into their overall supply chain and.
Key driver for customer investments and we enabled the last mile fulfillment for those customers, which is an important fact.
<unk> as consumers are expecting faster and faster deliveries and lastly, Ron manufacturing that's also tends to be.
It's a market that is more say largest in Asia for us, but it is global and it's done very well for us over the last year.
A year or so and still good double digit growth this quarter.
We've made some.
Both.
Some of the new acquisitions around from Mitch may trucks and.
Fetch are.
Expanding our offering and we're getting a lot of interest.
And early orders from manufacturing those areas and we've also made some some quite significant very deliberate investments in our go to market resources to help grow our share in manufacturing and Joe can provide some more color on that.
Okay.
Yeah.
Maybe I'll just amplify.
Some of Andrew's point number one.
The growth in the medium size customers and also on the run rate has been particularly encouraging for us because that's where our supply constraints are particularly important right. If you have supply you get run rate. When we had supply return a run rate rebounded and that was a really good sign of the resilience of our run rate.
That's very encouraging for us.
You asked about.
Which size of customer goes into the cycle first and what we saw is that as we entered into the pandemic. The largest customers were the first to accelerate their purchases.
And they were followed.
12 months later by medium size and smaller customers then also accelerating their purchases.
Now as we are seeing some caution in the market again, the largest customers that are being cautious first some of the deferrals that we've referred to in that you asked about where larger customers with large orders, while the medium sized and small customers continue to go very strong with even double digit growth. So that's the dynamic that we're seeing in the cycle.
Yeah.
Our next question will come from Eric Lapinski.
Ski with Morgan Stanley .
Please go ahead.
Hi team. Thanks, if I could go back to kind of the commentary on the run rate business. You. Just made I guess, just trying to get a better sense on the strength. There do you think that's an element of customers being further behind on investments versus larger customers. Then and then maybe also on that point, Mike when we think about deferrals from the larger customers is that related to.
Refresh or a new device deployment.
Color you can give us there would be helpful.
Yes first on the.
Strengthened.
On a run rate basis here and I think that the.
We I will say, we don't see.
Our customers large or small having.
Say pulled forward demand and invested ahead of their capacity utilization curves with probably one exception one large exception.
And specifically for for a large for our small and mid sized customers. They tend not to have the.
Financial capacity to invest for in advance so that tend to be much more asset projects rollouts to address more urgent business needs for them. So that would be one point on that.
And in Germany.
Yes.
When it comes to the run rate it really matters, what's on the shelf right you have small customers that are calling into distributor and what's on the shelf counts and once we had product on the shelf again as our supply chain ramped up again over the course of the quarter. We saw that our run rate rebounding. So I think that's the dynamic that theres no coal.
Forward or that dynamic doesn't exist to that same extent in the run rate.
When it comes to the larger customers.
The deferrals, we are talking about large customers that are typically doing deployments of mobile computers, you see it's pretty concentrated in the mobile computing segment, you have certain deployments that they have been planning and in some cases, but again there were very few and they were the minor reason for the Miss in the quarter, but in those few case.
We're talking about deployments of mobile computers, which are stretched out over a slightly longer time period, we think into the first quarter of next year.
Got it Okay. That's really helpful. Thank you and then maybe just another one on kind of some of your Opex flexibility you did take down kind of expenses in the quarter and proved to be pretty nimble. There I guess, just like where did you find those efficiencies in context of maybe some of the supply chain changes you are making.
And how should we think about your ability to control opex in future quarters kind of sensitive to revenue.
Yes.
The drivers behind the Opex flexibility.
First is <unk>.
Based on our variable comp structure.
Element of variability in there relative to how we're performing for the year.
One is we did a hard look at where we're hiring.
And what roles and what positions around the world to ensure that where we're adding heads in investing is in our in our growth areas.
That we kind of look at it and say there's no regrets in that in terms of those hiring so it's a combination of those two along with again <unk>.
Looking at discretionary spending.
Now where it makes sense. So I think those are the three main drivers here.
Here in the short term and as we go into next year, we're continuing to look at where we can drive efficiencies looking at our real estate portfolio, but all the things you would expect us to do.
Particularly as we go into.
More challenging macro environment.
Our next question will come from Damian Karas with UBS you May now go ahead.
Hi, good morning, everyone.
Good morning, good morning, <unk> morning.
Morning morning, not to beat a dead horse here on the project deferrals, but could you just.
Clarify.
Why you Havent seen any order cancellations and and to Jeff.
Thinking about these customers that have pushed out orders it sounds like you do have.
The ability in terms of timing of delivery in 2023, and it's not that the conversations have been hey, let's just let's just on pause until a later determined date.
Yes, the first on the cancellation, we have not seen any any large order cancellations I think the cancellations have been.
Very very modest and to the extent, we've had any and we didn't what we would consider to be normal every every quarter. We have some people who cancel an order or something like that but that's been that way that's not been a factor in the results are and the outlook here.
And the.
The first half they have.
They are not.
They are not passed they just differed so they are we expecting them to come back in.
In the first part of next year and.
The.
It's not like they are.
Are they are deploying in the meantime, not just at the same pace as they had otherwise expected yes.
There are some indications damian that give us confidence that the deployment will occur one of them is that they're taking an order and splitting it into two right. As I described to you. The other is that they are already working with us on deployment plans, we do see those stop signs not in every case, but in the majority.
A case so that's why we're describing it as we are.
Okay got it that's really helpful.
And then Nathan I think you suggested earlier that the <unk> the.
The ocean freight that transition is happening late this year.
Correct me, if I'm wrong I thought that that was supposed to kind of play out in the third quarter. So is there any sort of delay there or am I missing something.
No that's it.
This was per our plan we expected in.
For Q3 to start the.
The modest shipments into Europe .
Which we did from an ocean perspective, but the plan and the guide around our premium costs had always assumed.
We wouldn't really feel any financial benefit to the move until we get into next year.
As the priority for this year was to ensure we delivered enough printer volume to take care of our backlog as well as ensure we had the right products on the shelf to support our run rate business.
Our next question will come from Brian Drab with William Blair You May now go ahead.
Good morning, I think most of the details come out here already but I'm just wondering if you could.
Give us a more specific update maybe on how may track.
In fact should have been performing relative to.
Your expectations and again in this difficult environment I know matrix came in at about 100 million revenue run rate and fetch about 10 million I don't know if you could update those numbers directionally even.
Thanks.
And we close the matrix in early June and such.
We are very pleased with how that's going is creates a.
Very comprehensive portfolio of both fixed industrial scanning and machine vision solution for us.
South are offering very nicely.
I'd say, we're very encouraged by by progress.
Mkay trucks is performing very well and the integration is proceeding as per our plans I think there is a very good cultural fit between our organizations.
We are also building out our partners.
And that's going well.
Sure.
Specialized partners, who provide these types of implementation and design services and <unk>.
We've been seeing good traction in being able to recruit those partners to our program.
We certainly are very excited about what's going on with matrix and similarly on pitch said theres a lot of interest from.
From from warehouse operators across all our vertical markets.
<unk>.
In manufacturing for four hours.
Fetch robotic solutions.
And our ability to really combine the.
The frontline worker.
The automation of the frontline worker and the pet's robots to automate and orchestrate and automate the broader workflows has been resonating very well and we're seeing yes, we're seeing a lot of a lot of interest interest and it's obviously, a smaller business, but its ramping quite nicely now.
Maybe as a little bit of additional color with the business being in the early stages of development.
What you look for primarily our pilot deployments right and we're seeing a very good stream of these pilot deployments. We were also very pleased to have two larger deployments already that we mentioned I think can be earlier in the previous earnings call already.
Our.
<unk> tenants I guess now for our Petro Biotics business going forward.
Great and then I guess, just as a follow up.
You think about matrix and some of the.
Incumbents in that space.
What.
What have you found it has been.
Successful for you and going up against some of these incumbents and bidding on projects what differentiates may tracks from from a company like Cognex and others in the industry.
First I'll say that we don't see this as a serious some game, there's a lot of white space for us to go after without having to go up and seek out opportunities, where we compete with any specific competitor and there is also a very fragmented market I think that the market leader has probably about 20% of no more than 20% market share. So.
There's plenty plenty of opportunities to pursue without having to do that you know.
That being said I think we feel good about the value propositions that we have with matrix.
It is known for having a very.
So high quality high performance solutions.
Can solve some very complicated problems for our customers.
<unk>.
We've worked hard on across across our fixed industrial scanning and machine vision portfolio to drive ease of use as a differentiator to make it as easy for our customers to deploy and get time to revenue for these solutions and that's been I think resonating back very well.
Also the software upgrade ability of our products.
Differentiator.
And we've had some some very nice wins against a variety of different competitors with some large marquee customers. So we feel quite quite excited about it.
One other strength, Brian to add perhaps.
This is a business that is conducted predominantly through the channel.
We have used our strength in the channel too.
Recruit a strong number of channel partners, many of which are somewhat disillusioned with other incumbents in the market and that's been a great attraction for people to come to us because they know us as a very good channel partner for them. So thats helped us all.
Our next question will come from Keith <unk> with Northcoast research.
Go ahead.
Thanks, Good morning, guys I'm.
Hoping to understand a little bit more of the North American warehouse issue.
It looks on the slide deck in North America was down 9%.
I would say a vast majority of that decline was.
Due to that North American warehouses sure what would that number have been without that issue.
But the.
I'd say the Mr outlook was predominantly explained by the supply chain challenges as it relates to the persistent component shortages for certain products and the disruption in the transition to our new North America warehouse and there is probably about 45%.
$1 million on each of each of those and the.
The smallest part what was the deferral of projects was about 10% of the.
<unk> of the <unk>.
As to our outlook so.
Clearly the the.
<unk>.
The DC move was the largest part of this.
I appreciate that it sounds like you're going to be forced to operate both the Texas facility in Wisconsin facility.
I guess in parallel for the next several quarters, what's the what was the impact on profitability. This quarter, we think it's going to be going forward.
Thank you Keith I would say, it's relatively modest in terms of the <unk>.
Cost structure, we have with both of those facilities in terms of.
The typically pay on a cost per unit with each of the facilities. So it's I'd say, it's relatively modest in the from an overall profitability of managing both.
A little bit of extra cost here in the third quarter as we had to ship some products between the facilities to get the inventory right size moving forward, but now that that's corrected.
Relatively modest impact on overall profitability to manage both sites.
Our next question will come from Rob Mason with Baird. You May now go ahead.
Yes. Good morning, I was just maybe just to follow up on the last question. When will this north American distribution center transition to be complete and I guess consolidated into one facility.
So we don't we don't we do not have a timeframe lineup of when we will completely exit we've signed an agreement to stay down in Texas for the foreseeable future to ensure that we properly ramp the new facility.
In the right way.
And make sure it's.
We fully mitigate any potential risk to the future operations and so once that once that's clear.
We're in a state that's when we'll start to work on whether that how to complete the transition, but there is no timeline set today.
Sure sure.
There was also mentioned that you'll be taking some pricing actions.
In Europe outside the U S to address currency win win.
When will those.
Price actions be realized will start to show up and then I'm just curious as well what the what was the actual FX impact on your gross margin in the quarter.
Yes. So if you look at the two latest price increases we announced they really will have no impact until we get into next year just based on the timing of the agreements we have with our distributors and I would say, it's relatively modest compared to the previously announced price increases as it's focused around Latin America business as well as in Europe , where we've already made several other.
Their pricing action so it's.
Modest compared to the three.
We've done up to this point if you look at from a from an FX perspective.
In the third quarter. It was about a one point negative impact on EBITDA margin.
And as we go into the fourth quarter FX has about a two point negative impact year on year.
On EBITDA margin.
Our next question will come from Paul Chung with Jpmorgan you May now go ahead.
Hi, Thanks for taking my question. So you mentioned kind of a steady reduction.
In 2023 out of supply chain costs here and nice execution here in the second half but no.
Can that costs move down materially in 2020.
On a quarterly run rate from that 30% to $35 million.
Especially as you move more products to see.
I assume there'll be some lingering cost are moving forward, but just any comments there would be helpful.
And so I'd say as we look at it going into next year. Obviously, we think there's just based on the second half run rate there will be a.
A meaningful improvement from a year on year perspective, and I'd say at this point.
Steady is probably the right word in terms of how we're looking at it in a lot of this has to do with how freight rates.
Hold up so I think.
Based on what we've seen they've held steady to slightly down since.
Kind of middle of the second quarter, which is which is really positive but.
At any moment they can swing in other way if there's any other type of supply chain shocks in the system, but yeah, we would expect against steadying steady improvement from the second half run rate as we go into next year.
Great. That's helpful. And then on inventories I know theres a lot of moving pieces, but can you give us a sense for kind of timing of more accelerated harvest full I mean.
Do you see any risk to kind of discounting or given the elevated level steroids, that's more about converting on some larger.
Deferred products and then as we look to 'twenty three when can we expect to see kind of more north.
Normalized free cash flow conversion or is this more of a second half 'twenty.
'twenty three kind of excluding that Honeywell payment. Thank you.
Yes, so maybe I'll start with the second part of that.
As we look at our inventory, we would expect us to draw down through the first half and you get to maybe see normalized levels as we enter the second half of.
Of next year, which we think is somewhere between six and $650 million of inventory Thats based on the size of the company today plus the acquisitions as.
As well as intentionally holding more strategic component inventory that we have in the past to improve resiliency.
We have a team dedicated in working on this a big driver of that is finishing getting the DC move stabilized and we've also made several moves within our supplies business in terms of.
Manufacturing, where we've had to build some buffer stock and working through that and.
And for the product categories or components that have recovered we are planning to draw down our safety stock at our manufacturing partners over the next several quarters and Thats really the big driver of where we will see the reduction in working capital, but as you as you mentioned, we expect all these actions to enable us to significantly reduce working capital in and deliver free cash flow conversion.
Above 100% if you exclude the settlement payments and then to your first question.
We have no concerns at the inventory levels create any type of risk from an excess ops lessons perspective.
Now we have a strong demand for what we have in both finished goods as well as component parts and then theres no intention of reducing pricing beyond what's normally required in the competitive environment I'd say Alternatively were pushing that we have stock available for customers, who may have been waiting on certainty of supply before placing an order so using it as a.
As a as an opportunity.
This concludes our question and answer session I would like to turn the conference back over to Mr. Gustafsson for any closing remarks.
Thank you so to wrap up I would like to thank our partners customers and employees for their continued support.
Our top priorities to meet our customers' mission critical needs as we take bold actions to address our supply chain challenges.
And we look forward to a strong finish to the year.
Everyone.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.