Zebra Technologies Corporation

And welcome to the second quarter 2020 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 key followed by zero. After today's 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. Thank you for joining us today. Before we begin, I need to inform you that certain statements made on this call are forward-looking and subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially due to the factors discussed in our filings with the Securities and Exchange Commission. During this call, we will make reference to non-GAAP financial measures as we describe our business performance. You can find reconciliations of our GAAP to non-GAAP results in today's earnings press release and at the end of this slide presentation. This presentation will include prepared remarks from Anders Gustafsson, our Chief Executive Officer, and Olivier Leonetti, our Chief Financial Officer. Anders will begin with our second quarter results. Then Olivier will provide additional detail on the financials and discuss our outlook. Anders will conclude with progress on advancing our enterprise asset intelligence vision and trends we are seeing in our end markets. Following the prepared remarks, Joe Heal, our Senior Vice President of Global Sales, will join us as we take your questions. Also, 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 is being simulcast on our website at investors.zebra.com and will be archived there for at least one year. Now I'll turn the call over to Anders.

Thank you, Mike. Good morning, everyone, and thank you for joining us. First, I would like to emphasize that our top priority continues to be the health and well-being of our employees customers, and partners. I am particularly grateful for all of the frontline workers, including medical professionals, who continue to serve our communities and keep us safe. Zebra and many of our customers' workplaces have commenced reopening plans, and I am very proud of the ability of our teams to effectively serve our customers and partners while working remotely through the peak of the pandemic. In Q2, our teams remained agile and executed very well through the pandemic. It has been inspiring for me to see our employees rally to keep the business and each other moving forward. Although the financial results we published this morning reflect a challenging second quarter environment as we navigated through the peak of the crisis, Zebra's longer-term prospects have strengthened as secular trends to digitize and automate workflows have accelerated with the pandemic. In Q2, we realized a net sales decline of 12%, adjusted EBITDA margin of 18.3%, which contracted by 290 basis points, and non-GAAP diluted earnings per share of $2.41, a 20% decrease from the prior year. As the virus spread and market weakness affected all of our major geographies, particularly our Asia-Pac and Latin America regions. The impact was most pronounced in our run rate business, which required our distributors to reduce their inventory levels. However, sales growth in services was a bright spot, and enterprise mobile computing relatively outperformed. Although premium shipping costs due to the pandemic impacted gross margin more than we had anticipated, We diligently managed discretionary costs across the company to preserve profitability and cash flow. Despite the challenging environment, our enterprise customers have been prioritizing spend with Zebra. Our solutions are a key enabler of their strategy to digitize their operations, as well as supporting essential use cases during the pandemic. Large order volume was strong across vertical markets, increasing over the prior year. I would like to highlight some notable Q2 wins from large customers supporting critical use cases. The leading home improvement retailer expanded their relationship with us by purchasing 10,000 of our printers to address multiple front of store use cases, including curbside pickup and in aisle label printing. Their shift to mobile on demand printing is expected to significantly improve worker productivity and replaced a competitor's stationary printers. We also secured a competitive takeaway win with a federal retail commissary to deploy more than 7,000 mobile computers. Our solution enables this customer to satisfy multiple use cases, including curbside pickup. We were pleased to support a large healthcare organization by providing a wide range of mobile computers, scanners, and printers to quickly ramp their point of care and clinical communication needs as they added 4,000 hospital beds to treat COVID patients. Additionally, as expected, we began deploying TC7 series mobile computers to USPS postal carriers in late Q2. We expect the majority of the deployment to occur in 2021. We continue to collaborate with these customers to support their essential needs and drive further improvement in their workflows. I am pleased that we have substantially completed our global product sourcing diversification initiative despite modest delays due to the pandemic. Replicating production lines outside of China into broader Asia mitigates supply chain risk and enables us to avoid tariffs on our U.S. imports. With that, I will now turn the call over to Olivier to review our Q2 financial results and discuss our outlook.

Thank you, Anders. Let us walk through the P&L on slide six. Net sales declined 12.9% in the second quarter, which is 12% before the impact of currencies and acquisitions. Despite our sales decline, we believe that we continue to outperform the market in this challenging environment. As Anders mentioned, large order volume was stronger than the prior period. Our performance was entirely due to a sharp decline in small and mid-sized business through the channel, which disproportionately impacted printing and data capture. We are encouraged that distributor inventory levels are healthy and sales hour trends have been improving. Our enterprise visibility and mobility segment sales decreased 5.4%. We grew services revenue and mobile computing relatively outperformed. Our asset intelligence and tracking segment has been most impacted by the global recessionary environment, with sales decreasing 24.9%. Printing and supplies each declined double digits. Services was a relative outperformer. Managed and professional services performed particularly well with growth driven by strong product attach rates over the past 12 months. Our location solutions and Zebra retail solutions offerings were extremely soft due to a pause in project activity due to the pandemic. Turning to our regions, in North America, sales declined 7%. Services grew and mobile computing was a relative outperformer. EMEA sales declined 13%. We achieved solid growth in services and slight growth in mobile computing. We saw strength in Central and Northern Europe. Sales in our Asia-Pacific region declined 21%. driven by COVID-19 impacts. China improved sequentially from Q1, but was the largest contributor to the regional sales decline. Japan and Korea were bright spots in the quarter, where our go-to-market investments are delivering results. Latin America sales have been hit particularly hard by the pandemic and macroeconomic factors. and declined 33%. All geographies declined double digits, with the exception of Mexico. Adjusted gross margin contracted 360 basis points to 44.1%, driven primarily by two points of impact from unfavorable business mix, two points of impact from premium freight costs, other COVID mitigation and China import tariffs, partially offset by improved services margin. Adjusted operating expenses declined $44 million from the prior year period and improved 50 basis points as a percentage of sales. This improvement was primarily due to prudent cost management and lower incentive compensation. We were able to accomplish this while preserving our research and development projects. Second quarter EBITDA margin was 18.3%, a 290 basis point decrease from the prior period, driven entirely by lower growth margin. We drove long gap earnings per deleted shares of $2.41. a 61 cents or 20% year-over-year decrease, which is inclusive of 27 cents negative impact from the transitory effects of premium freight expense and tariffs. Turning now to the balance sheet and cash flow highlights on slide seven. We generated $322 million of free cash flow in the first half of 2020. This was more than double the prior period, primarily due to a lower use of working capital and our expanded accounts receivable factoring program. Additionally, in Q2, we made a $31 million incremental investment in Locus Robotics, a market leader in autonomous mobile robots for fulfillment warehouses. From a debt leverage perspective, we ended the quarter at a modest 1.3 times net debt to adjusted EBITDA ratio, which provides us ample financial flexibility. Turning to slide eight, we have been successfully navigating this unprecedented global environment. As I just mentioned, our balance sheet is in excellent shape with low debt levels and $950 million of availability under our revolver, allowing ample capacity for business investment. Our capital-light business model, flexible cost structure, and strong free cash flow profile allows us to preserve profitability and cash flow in challenging times. The reliable cash flow generation gives us a competitive advantage as we prioritize investment in the business through any environment. Let us turn to our outlook. We believe Q2 was the peak impact to Zebra from the pandemic. We remain in the recovery phase and expect sales trends and profitability to improve in the second half of the year. We entered the third quarter with a solid backlog. We have seen an increase in business activity and our deal pipeline is building nicely. Based on these factors, we expect Q3 net sales to decline between 3 and 7%, which is a meaningful sequential improvement from Q2 trend. This outlook assumes an approximately 50 basis point negative impact from foreign currency changes. We will continue to preserve profitability while doing no harm to the business. This enables us to prioritize strategic investment so that we emerge stronger as the market rebounds. We believe Q3 adjusted EBITDA margin will be approximately 19%, which assumes lower operating expenses and a lower gross margin reflecting higher large-order mix. and approximately $9 million of transitory premium freight expense. Non-gap deleted EPS is expected to be in the range of $2.65 to $2.95. The premium freight cost expectation equates to 14 cents EPS impact. You can see other modeling assumptions on slide nine. Note that our outlook does not include any projected results from the pending acquisition of Reflexes. Anders will discuss the strategic acquisition in a few moments. With that, I will turn the call back to Anders to discuss our enterprise asset intelligence vision and end market trends.

Thank you, Olivier. We are excited to announce the acquisition of Reflexes this morning. which we expect to close by early Q4. Reflexys is the leading provider of intelligent workforce management, task execution, and communication solutions for the retail, food service, hospitality, and banking industries. Combining Reflexys' market-leading platform with Zebra's complimentary software offerings, including Zebra Prescriptive Analytics and Workforce Connect, provides us the unique opportunity to unify the store associate experience. We also expect that Zebra's scale, vertical market expertise, and go-to-market footprint will drive substantial synergies, not only in retail, but in other key vertical markets, such as healthcare. Reflexus is a high-growth recurring revenue business with sales of $66 million in 2019, which doubled over a three-year period. and a gross margin profile approximately 20 points higher than Zebra's corporate average. The next slide illustrates how this acquisition fits into our broader vision. Slide 12 highlights how we are building our capabilities as a solutions provider. Our deep understanding of workflows and unmatched access to frontline operational data from our vast installed base uniquely positions us to solve complex challenges at the edge. It is our top priority to invest in software solutions and services that help our customers leverage real-time data to better orchestrate their workflows and gain a performance advantage. Methods for sensing, analyzing, and acting on operational data from the frontline of business are transforming with emerging technologies such as computer vision and machine learning. Increasingly large volumes of data are generated and captured from our products. Enterprises are asking us to help them put that data to work by amassing disparate points of information to drive actions to their frontline workers in near real time. Our intelligent edge solutions, including our SmartX and MotionWorks offerings, demonstrate how we are enhancing the value proposition for our customers by addressing a wide variety of use cases across their business. This evolving suite of solutions enables Zebra to fuel our customers' workflows with data so they can be fully optimized. Reflexes capabilities will be enhanced when they are combined with Zebra prescriptive analytics, worker collaboration, and physical inventory software solutions. For example, Reflexes can provide dynamic prioritization of tasks extending across a broader set of data-driven activities, such as stocking shelves, receiving a truck, or delivering an order curbside, when integrated with our Zebra Prescriptive Analytics and Workforce Connect applications. Ultimately, through this acquisition, we expect customers to find even greater value in equipping all of their associates with mobile computers. On slide 13, we highlight the primary vertical markets that we serve. We are excited about our longer-term opportunities in our end markets as customers are driven to improve their technological capabilities in an increasingly on-demand economy. Since our last quarterly update, we are seeing improvement in this challenging global environment, although it is still a mixed picture depending on the sector. In healthcare, our fastest growing vertical, clinical care remains critical and is the primary area Zebra serves. Our healthcare solutions help hospitals flex their capacity needs as the pandemic evolves. Our solutions are being used in labs and drive-through testing facilities to provide safe and efficient care. Non-critical care in elective procedures are resuming. Longer term, we believe the need for increased visibility into the entire patient journey will drive increased demand for our solutions. Approximately two-thirds of our business in retail is to mass merchants, grocers, and e-tailers who have been prioritizing investment in our technology for their omnichannel fulfillment. E-commerce and buy-online pickup at store transactions have increased dramatically through the pandemic. Department stores and apparel retailers have been reopening their doors, which has been critical to those heavily reliant on brick-and-mortar sales. In the transportation and logistics space, strong e-commerce growth continues to drive parcel volumes and last mile delivery, which is favorable to Zebra. Conversely, passenger airlines, rental car providers, and parts of the distribution industry are resuming activity, yet far from capacity. The manufacturing sector continues to be the most impacted in the current environment with COVID-19 and global trade tensions. Discrete manufacturers in aviation, auto, and discretionary specialty goods have been particularly challenged during the heart of the crisis. Many segments within process manufacturing, such as food and pharmaceutical companies, have been less impacted. In closing, we are successfully navigating through this challenging environment and are confident that our business fundamentals and strategy are sound. By continuing to focus on advancing our enterprise asset intelligence vision and addressing our customers' needs, we expect to emerge from this crisis in a stronger competitive position. We continue to be very optimistic regarding our longer-term prospects as secular trends to digitize and automate workflows accelerate with the pandemic. Now I'll hand the call back over to Mike.

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

We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw from the question queue, please press star then two. The first question comes from Andrew. Please go ahead.

Hey, guys. I just want to dig into your guidance a little bit. So I'm having a hard time with your guidance for Q3 getting to that 19% EBITDA margin in that I feel like it could be higher. So I'm wondering with your top line sales guide where it was or where it is, much better than expected. It really implies not much expansion in Android's margins, if I'm correct there. Can you first confirm that and talk a little bit about why you can't do or why you wouldn't expect to do a little bit better there in margins?

Good morning, Andrew.

There really is great cost and stuff in there.

Yeah, good morning, Andrew. So you're right. We expect in the quarter EBITDA margin to be around 19%. OPEX as a proportion of revenue will decline year on year, and gross margin rate should decline due to two factors. First, premium freight, that would be about the point of impact in the quarter, but also amenity. higher level of large deals in the quarter. We have mentioned that now for two quarters. Our business, large deal business, is doing very well, actually growing year on year, expected to grow in Q3 and Q2. And our home rate business has been impacted mainly by the pandemic. We believe that this trend will not last. That's point number one. We believe that run rate is starting to increase and will keep increasing. And an important point, on a like-for-like basis, margin has been improving.

Okay. Okay. So the source margin sequentially will be up. Correct. Okay. And then if you could just talk about your – backlog. It sounds like you have a strong backlog. Any way you can quantify that? Is there visibility beyond Q3 there? You mentioned some large orders or you talked to some potentially larger orders. Can you just provide some additional commentary on that?

We entered Q3 with a solid backlog position. It was, you know, quite strong considering the overall environment, but I was driven by the high proportion of larger deals. So we've seen a lot of our larger customers, particularly in retail and T&L, accelerate their investments. And they also then, in this case, gave us the orders prior to the start of the quarter. And that gives us obviously a great deal of confidence in the outlook we give for Q3. Joe, I don't know if you have any further comments here.

Well, we have a strong backlog position, as Anderson already said. Some of the projects are multi-quarter, so we do have some backlog already building for future quarters, but it's too early to determine how strong relatively our future quarter backlog will be. But it's great to say that...

The pipeline for Q4 is good. So we feel encouraged about the way the market seems to be recovering.

And a final comment, Andrew. We're not giving, of course, a guide for Q4. Too many uncertainties at the moment for obvious reasons. But we believe that Q4, from a revenue standpoint and profitability standpoint, will be an improvement relative to Q3.

All right. Thank you, Olivier.

The next question is from Jim Rashudi of Needham & Company. Please go ahead.

Hi. Good morning. The question I have is just as we've gone through the pandemic and seen the impact on brick-and-mortar retail, e-commerce, I'm wondering if you could talk a little bit about the changes in customer behavior. I mean, if you could talk in terms of things that you see changing in the market as we start coming out of this, what do you see it doing to the business? And I assume you've seen some early indications of this, things like ship from store and whatnot.

Yeah, I'd say in this environment, our solutions have become even more critical for our customers than they were before. And we are uniquely positioned to empower frontline workers across all our end markets. So I'd say the crisis has been accelerating a number of secular trends around digitization and automation. And I think that probably spans all our vertical markets, all four key vertical markets. If we dig in a little bit deeper on retail, I'd say, you know, grocers, which were certainly on, you know, a large part of our customer base before, you know, retailers, grocers, mass merchants are about two-thirds of our business. But the, you know, growth in just grocery revenues, but particularly buy online, pick up in store, has been quite significant. And We've seen grocers across the, particularly in the U.S., but across certainly Europe and the U.S., invest materially in enabling, you know, scaling up their ability to do omni-channel and particularly buy online and pick up at store. So that has been a big, big change. I think buy online, pick up at store has gone from being more of a niche application before to now mainstream. And I'd say across the board in retail that customers who say were in segments that were struggling a bit more before or during the downturn, I think everybody recognizes now that they can't be 100% reliant on in-store purchases that omnichannel and the e-commerce sides of their businesses needs to grow or expand. So we see people giving more attention to the omni-channel part of their business and how to be able to respond to situations like the one we had in Q2.

Maybe I can add one or two things to that. This is Joe Hill speaking. Generally speaking, besides the buy online, pick up in store, productivity and resiliency are at a premium for retailers. And think not only of the store, but also of the warehouses. So the types of solutions that we have in improving productivity in warehouses where there's less reliance on workers to do tasks, including things like the investment that we made in Locust Robotics, are going to be an increasing trend in retail, which also helps improve their resiliency when there are incidents, for example, in a warehouse. And this also extends to contact-free solutions. One of the features of BOPIS is that it's contact-free, and there are other contact-free elements of the retail interaction that we think will be here to stay, for example, payment transactions or contact-free kiosks as opposed to interaction with workers. So those are a few other trends that we're seeing that generally benefit us in retail.

And my follow-up question is on Reflexus. How long have you known them? And is this acquisition, does it fill in some areas of your solution set that maybe where you had some holes? And is there any customer concentration within Reflexus that you can talk to? Thank you.

Yeah. So, first, we're very excited about the addition of the Reflexus team to Sebra and that business. We've known each other for quite a long time. Reflexus has been a premier ISV partner of Zebras, and we've been in dialogue with them about this transaction for some time. The transaction very much helps to augment our enterprise asset intelligence vision of empowering every worker at the edge with insights that drive real-time action. So this is entirely consistent with our broader vision, and it leverages our existing software assets and some of our hardware. So if you think of Zebra prescriptive analytics, which looks at all sorts of data sources to glean insights and drive actions, that can now fuel reflexes, engine of driving actions too. And our Workforce Connect can be one of the ways that we augment the Reflexus platform to have a more efficient way of communicating between employees and workers to ensure the right person gets the right action at the right time.

And in terms of customer concentration, Jim, the asset has a low level of concentration of sales towards a few customers and Reflexys has been performing extremely well during the pandemic.

We serve most retail customers, so there's a lot of overlap and we think there's great opportunities for us to do some cross-selling and upselling across the portfolio. If you look specifically at how the customer base of Reflexys has performed during the lockdown, Two-thirds of their customers were open and operated like normal. About one-sixth had some partial shutdowns or slowdowns, and one-sixth were fully shut down but are now open.

The next question is from Paul Koster of J.P. Morgan. Please go ahead.

Hi, good morning. This is Paul Chung on for Koster. Thanks for taking my questions. So just to follow up on Reflexus, it's kind of somewhat of a departure from your typical acquisition as it's mostly software. Should we kind of expect a shift to the software to continue? And if so, if we think about gross margins longer term, should we expect kind of a a structural step up to your current gross margins of, you know, 47% as your strategy evolves and have a follow-up?

So, first, I think the, you know, the acquisition of Reflex is very consistent with our broader approach that we've talked about for some time to align with our strategy of either, you know, driving growth in our core, identifying acquiring companies that expand our leadership in the core, or rapidly grow in near adjacencies or accelerate the enterprise asset intelligence vision. And Reflexis fits into accelerating the enterprise asset intelligence vision. We don't think of it as a big departure from how we have thought about the business or how we have executed over the last few years. Software has become a bigger and bigger part of it. The last Three acquisitions now, including Reflexis, have been pure software acquisitions. Although I'm not saying that that by any means is going to be, you know, that's the only thing we're focusing on for the future. But we are building more and more software assets and software capabilities. And even internally, you know, more than two-thirds of our engineers are software engineers. So software is clearly a very important part of how we deliver value to our customers, even if that is as a standalone software offering or as a more integrate the solution between hardware and software?

We believe that the asset will indeed increase the overall margin of the business. I mean, not only because it's software, but also because of the impact it will have on the hardware part of the business as well. So very synergetic from a revenue and margin standpoint.

Okay, great. And then just on your SMB channels, are you starting to see demand pick up in July as business starts to reopen? Have you also kind of seen some consolidation in the channels, maybe some of the smaller players kind of given some liquidity concerns we've been hearing about, and how does that kind of impact your pricing over time in your view? Thank you.

I'll let Joe comment here also afterwards, but we have seen, I guess, first stabilization and signs of improvement in our run rate business, which we tend to kind of talk about as run rate and SMB as being the same, but they're not necessarily the same. I think the SMB segment was harder hit by the shutdown. Most SMB companies were not deemed essential and had Therefore, we're shut down harder. And we have also more manufacturers that's part of our SMB or runway business. But we are seeing them return to more healthy outlook and sequential growth. We've also said that we work hard to make sure that we maintain healthy inventory levels within our channel. Sales out numbers went down a little bit in Q2. Sales in went down more. So the end markets were somewhat healthier than our sales numbers would indicate. But now we're in a position to start growing with them as the economy expands.

Two additional comments. Remember that nearly half of our business is outside of the U.S. and in regions including Asia as well as in Europe. we are seeing the run rate business improve, whereas in the U.S., it's still a bit too early to say that we have sustained improvement. But, for example, in several countries in Asia, we are seeing growth in our run rate. Second, in terms of the channels themselves, it is fair to say that our channel business among our larger partners has been stronger than it has been among our smaller partners. It may be too early to speak of a consolidation, but it would be – but at least that is what we're seeing.

Thank you.

The next question is from Keith Housem of North Coast Research. Please go ahead.

Good morning, gentlemen. I'm glad to hear that the large deals are holding up strong. I guess, Anders, are you seeing any large deals being pushed off because of the current environment? Or are you finding that the prioritization of these projects holds better than, I guess, what they might see for other products or projects?

Yeah, we have seen larger deals push into future quarters, you know, more dependent than on the type of customer. So if, you know, some would be Retailers that had to shut down altogether in Q2, they tended to push if they had bigger orders on the books into future quarters. Another example would be around, say, RFID, which often requires more in-store activities and also focus more on apparel or fashion retailers. So, you know, anything that had to do with where we had to go into our customers' facilities to set up and implement the solutions would get pushed. But that's been offset by other customers that were operating and had to really scale up their operations to deal with the increased business they were getting as part of the shutdown.

Great. Glad to see that. And as you look at – Yeah, I guess the intelligent edge solutions. Can you discuss the progress you had with those solutions during the quarter versus the services growth? I think if I heard right, the managed services were grew during the quarter, but how did intelligent edge solutions do, like Savannah, most importantly?

Yeah, I think many of our software solutions did very well. If you look at, say, Zebra Prescriptive Analytics as an example, We were able to win several new customers in Q2, and we were able to win and implement those customers without actually having to go on-site. So that was one of the benefits of having a software solution like that. But other intelligent edge solutions that require on-site proof of concepts, pilots, and so forth, they tended to be pushed out and were not growing the way we had expected.

Great. Thank you.

The next question is from Mehta Marshall of Morgan Stanley. Please go ahead.

Hi, team. This is Eric on Fermita. Thanks for taking our question. Maybe we could just go back to the retail side. Quickly, I mean, given some of the drivers you had noted, do you expect any sort of digestion period with some of the e-commerce or grocery customers following the investments that they have been making? Or do you think that kind of those investments just continue to scale as kind of the economy recovers?

Yeah, I'd say the larger orders that we've seen in retail in the last quarter or plus are really to help our existing customers scale their operations. So they're not necessarily building ahead or anything like that, so I don't see a need for them to, say, pause or deploy and catch up on the operations side with what they have deployed. But obviously there's many customers and some have different profiles than others, but generally they're just basically trying to deploy devices into existing use cases where they scale in line with the number of headcount they have or the revenues they have for those applications.

Got it. That's very helpful. And then maybe just a quick follow-up and kind of returning to some of the gross margin impacts from the larger deals. Was Was the initial shipments to kind of USPS also a factor in there, and should we maybe be expecting a similar impact to gross margins just as those shipments really ramp up into the first half of next year?

So Q2 had an USPS order. This order was shipped at the end of the quarter, so relatively material to the quarter. USPS is ramping in Q3, but as we have said before, the large majority of the USPS order would be shipped next year, probably in the first half of next year. And we're not going to talk about margin, of course, of USPS today, but usually large deals have a lower margin and run rate. So it would impact the company rate.

Got it. That's helpful. Thank you.

The next question is from Brian Drab of William Blair. Please go ahead.

Hi. Thanks for taking my questions. I'll just ask one question at the moment. And I apologize if you've discussed this to some extent. There's simultaneous calls going on. But I know you're expecting about $20 million in costs associated with the move of manufacturing out of China that are adjusted out of the adjusted EPS figure, but you have other costs that you're incurring this year. I guess there's about $19 million of premium freight and other costs in the second quarter, $9 million in premium freight coming in the third quarter. And just as we're trying to assess costs this year that likely won't be present next year, what is the estimate for total premium freight in 2020 and other costs in 2020 that likely won't be present in 2021? You know, for example, like incentive comp maybe down this year that comes back next year. And, you know, I can't remember what was the situation in the first quarter. Was there premium freight in the first quarter as well?

So let me try to cover the key points on this. So if you look at going forward in terms of transitory costs, we are now done and our supply chain did an amazing job in diversifying our supply chain out of China. So this work is done and we're not going to have any impact due to tariff going forward. So that's not part of Q3 and obviously forward P&L. So that's point number one. Point number two, we're going to have some impact due to premium freight in Q3. I mentioned in my prepared remarks that about 9 million, about 80 basis points worth of margin rate That will decrease towards the end of the year, and we believe that this trend should now stop going forward. So that would be a second item. When it comes to OPEX, we have been able to manage OPEX and adjust OPEX as revenue was declining. We'll keep doing that in the year. Now, you are asking, do we have some of those OPEX reductions which are going to be permanent? We believe so. It would be premature to mention a number today because we want to keep investing in the business as well.

Okay. But, Olivier, if I can just follow up. What I'm driving at is the transitory cost. What's the total estimate for 2020? So we can model 21. You called out 19 million in the second quarter. You called out 9 million in the third quarter. Those costs and also including tariff costs, it seems like there's going to be like 50 million, like 5-0 or something in that range of costs this year that we shouldn't expect and we shouldn't model for next year. Can you total it?

Yeah, your number is about right. I mean, if I was to give you the phasing, and maybe we can take that after the call of today, tariff impact in Q1 was about a point. That is transitory. In Q2, the impact of tariff and premium freight was about two points. Premium freight impact in Q3 would be about a point. And we believe that all those transitory costs to a large extent would be gone by Q4 onwards, and we take the details after this call as well. Sounds good. Okay, I'll talk to you later. Thank you. Thank you.

Again, if you have a question, please press star then 1. The next question comes from Richard Eastman of Robert W. Baird. Please go ahead.

Yeah, it's just a, I'm looking kind of at the decrementals, kind of similar line of thought here. But the decremental here in the second quarter at the adjusted EBIT line was about 40%, and that's obviously absorbing some of the tariff costs, the freight costs, probably offset by some OPEX reductions. Is the 40% decremental kind of run into the third quarter and then presumably and maybe

know fingers crossed here um you know decline in the fourth quarter with some of these transitory costs out of the number you're right rich if you look at today in term if you look at q2 and q3 we believe we're going to be able to scale opex as a proportion of revenue in about the same level and then in terms of margin we're going to have over those two quarters the same impact of large bid mix, which will impact gross margin. But we believe that largely those trends will stop as we enter into the fourth quarter. That's why I indicated during an earlier question that profitability in Q4 will certainly increase relative to Q3 and Q2.

Okay, okay, I got you. And then just maybe a quick thought around, you know, what appears to be maybe more cyclicality in the printer business in general, AIT, thought being that is that business impacted much more you know, as run rate business through the channel? Or is it, you know, is it just simply easier to defer purchase of a printer, you know, given the payback on a printer, just defer it, you know, for a couple quarters? I mean, how do you kind of view that on the printer side of the business?

Yeah, the printer business is – has a much higher proportion of run rate as part of its revenue stream. It supports more SMB and manufacturing customers. So the profile of the customer base was more exposed to COVID-19 shutdowns or slowdowns. I'd say if you dig into the printing portfolio a little deeper. You know, our card printing business was particularly hard hit. You know, card printing, they do, you know, they support events. Obviously, there weren't a lot of events in Q2. Badges for employees, driver's licenses, you know, all sorts of things that were, you know, hit more harder. But we did start to see particularly manufacturing opportunities to resurface in Asia-Pac later in Q2. And if you look at our supplies business, TempTime had a very strong Q2 and grew its viral monitoring solutions for existing vaccines. And we were doing things in emerging markets for COVID-19 test kits. And once we get the proper vaccine, we see opportunities for that to continue to do well. We also worked here on making sure that the channel had appropriate inventory positions. So we did reduce inventory in the channel, but kept the days on hand just stable. So we're coming out of this with a healthy inventory position where we can grow the business now in line with how the economy grows. But we do believe that we actually gained share in printing in the first half of this year. So based on all our data points, we believe that we actually gained some share.

And one further data point just on that. In China, our printing business is rebounding faster than our other businesses. So that gives you an indication that there is a positive trend that will likely come back at the end of this cycle.

I see. Okay. All right. Very good. Thank you.

The last question comes from Jeff Kessler of Imperial Capital. Please go ahead.

Thank you. Thank you for taking my question. Firstly, with regard to your TAM, a couple of years ago you gave a number with regard to $9 or $10 billion out of you know, out of a total market in the AIDC area, clearly with some of the new software that you've developed internally, but also with some of these acquisitions, you've expanded the total available market that you can play in, and also the niche, if you want to call it that niche, that you are actually directly affecting. Can you speak to how, particularly this last acquisition that you've just announced, can you discuss the size of the marketplace that you are now affecting relative to where you were just a couple of years ago?

We've talked about our core markets being about $10 billion in size and that we have you know, we've had an incremental 15 billion market size in our adjacent markets, right? And some of those adjacent markets that took us from 10 to 25 billion in total size would include tablets, supplies, RFID. Many of our software solutions are new and there's no, you know, it's a little difficult to say what the TAM is because they you know, you could calculate it by, say, if every, you know, retailer on the planet were to deploy it, the TAM would be very, very large. It's not quite that today, but it is a substantial TAM, and it's a faster-growing market than our core markets. So clearly this expands our addressable markets and positions us to participate in additional high-growth markets where we also get attractive, you know, synergies by being able to cross-sell and up-sell. Okay.

Thank you. And the second follow-up is, you know, you've talked about the recovery in your business, but the fact remains is that at least in the United States, maybe not in Asia or in parts of Europe where there seems to be recovery from the virus faster, we seem to be still in somewhat of a state of a mess here. And it may be some time before the virus allows business to operate at a more normal pace. Is the improvement that you're talking about in the third and fourth quarter, how much of it is basically based in the fact that that Asia, parts of Asia and parts of Europe are actually recovering and helping you relative to the U.S. And is your geographic pie going to shift at all in the second half of this year and perhaps into the first half of this year until there's some type of vaccine to, and more importantly, the U.S. kind of gets its COVID-19 act together, if you want to call it that.

I think you summarized it well. We see all the regions improving in Q3 and Q4 relative to Q2, but the main recovery is outside North America. You're absolutely right.

Okay. Yeah. Although I think in the second half we have a substantial number of large deals that are North America-centric, with North American customers having increased demand for the products that they have been buying from us previously. And so I think our overall geomix will not shift that much, even though the recovery, in particular the run rate, will be stronger outside of the U.S.

All right, great. Thank you very much. I appreciate it.

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

Thank you. So to wrap up, I would like to thank our employees, customers, and partners who are working the front line during this challenging time. And we're also looking forward to welcoming the Reflexes team once we close the transaction. Stay safe, everyone.

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