Zebra Technologies Corp Q2 FY2020 Earnings Call

Good day, and welcome to the Second Quarter 2020 Zebra Technologies Earnings Conference Call. All participants will be in a listen-only mode. 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 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 in advancing our Enterprise Asset Intelligence vision and trends we are seeing in our end markets. Following the prepared remarks, Joe Heel, 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 the 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 wellbeing 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 during 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, end-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 the 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 spending with Zebra. Our solutions are a key enabler of their strategy to digitize their operations, as well as supporting the central 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. A 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 replace a competitor's stationary printers. We also secured a competitive 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 impacted by a sharp decline in small and midsize business to the channel, which disproportionately impacted printing and data capture. We are encouraged that distributor inventory levels are healthy and sales trends have been improving. Our Enterprise Visibility & Mobility segment sales decreased 5.4%. We grew services revenue, and mobile computing relatively outperformed. Our Asset Intelligence & 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 caused by the pandemic. Turning to our regions. In North America, sales declined 7%. Services grew, and mobile computing was a relative out performer. 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 original 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 impacts from unfavorable business mix, premium freight cost, and China import tariffs, partially offset by improved services margin. Adjusted operating expenses declined $44 million from the prior year period and improved by 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 maintain 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 gross margin. We drove non-GAAP earnings per diluted share of $2.41, a $0.61 or 20% year-over-year decrease, which is inclusive of a $0.27 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, the 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 lower debt levels and $915 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 allow 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 would continue to preserve profitability while doing no harm to the business. This enabled us to prioritize strategic investment so that we emerge stronger as the market rebounds. We believe Q3 adjusted EBITDA margin would be approximately 19%, which assumes lower operating expenses and the lower gross margin, reflecting higher larger order mix and approximately $9 million of transitory premium freight expense. Non-GAAP diluted EPS is expected to be in the range of $2.65 to $2.95. The premium freight cost expectation equates to a $0.14 EPS impact. You can see other modeling assumptions on slide nine. Note that our outlook does not include any projected reserves from the pending acquisition of Reflexis. 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 Reflexis this morning, which we expect to close by early Q4. Reflexis is a leading provider of intelligent workforce management, task execution and communication solutions for the retail, food service, hospitality and banking industries. Combining Reflexis market-leading platform with Zebra's complementary 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. Reflexis is a high growth recurring revenue business with sales of $66 million in 2019, which doubled over a three-year period, and the gross margin profile is approximately 20 points higher than Zebra's corporate average. The next slide illustrates how this acquisition fits into our broader vision. We are building our capabilities as a solutions provider. Our deep understanding of workflows and unmatched access to frontline operational data from our vast install 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. Larger 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. Reflexis' capabilities will be enhanced when combined with Zebra Prescriptive Analytics, worker collaboration, and physical inventory software solutions. For example, Reflexis can provide dynamic prioritization of tasks extending across a broader set of data-driven activities, such as stocking shelves, receiving a truck, and delivering an order curbside when integrated with our Zebra Prescriptive Analytics and Workforce Connect applications. Ultimately, through this acquisition, we expect customers to find 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 and 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 omni-channel 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 still 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. The first question comes from Andrew Buscaglia with Berenberg. Please go ahead.

Hey, everyone. I'd like to discuss your guidance a bit. I'm finding it challenging to understand your Q3 guidance of reaching a 19% EBITDA margin because I believe it could be higher. Considering your top-line sales guidance is better than expected, it suggests that there isn't much room for growth in gross margins. If I’m correct in that assessment, could you confirm it? Additionally, could you explain why you don't anticipate improvements in margins, especially in light of premium freight costs and similar factors?

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 should decline due to two factors. First, premium freight, that would be about a point of impact in the quarter, but also mainly higher levels of large deals in the quarter. We had mentioned that now for two quarters. Our large deal business is doing very well, actually growing year-on-year and expected to grow in Q3 and in Q2, and our run 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 the like-for-like basis, margin has been improving.

Okay. Okay. So, the gross margins sequentially will be up.

Correct.

Could you discuss your backlog? It seems like you have a strong backlog. Can you quantify that? What is your visibility beyond Q3? You mentioned some large orders and potentially larger ones. Can you provide some additional commentary on that?

Yeah. We entered Q3 with a solid backlog position. It was quite strong considering the overall environment, but that was driven by the high proportion of larger deals. So, we've seen a lot of our larger customers, particularly in retail and transportation & logistics accelerate their investments. And they also 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 Anders and Olivier 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 correct to say the pipeline for Q4 is good. So we feel encouraged about the way that the market seems to be recovering. And the 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 Ricchiuti of Needham & Company. Please go ahead.

Hi, good morning. I'd like to ask about the impact of the pandemic on brick-and-mortar retail and e-commerce. Can you discuss the changes you've observed in customer behavior as we emerge from this situation? What changes do you see happening in the market, and how do you think this will affect the business? Have you noticed any early signs of this, such as ship-from-store initiatives?

In this environment, our solutions have become even more essential for our customers than before. We are uniquely positioned to support frontline workers across all our markets. The crisis has accelerated several ongoing trends related to digitization and automation, which affect all four of our key vertical markets. Focusing on retail, grocers, e-tailers, and mass merchants make up about two-thirds of our business, and the increase in grocery revenue, especially through buy online pickup in-store, has been significant. We've observed grocers in the U.S. and Europe investing heavily to enhance their omni-channel capabilities, particularly for buy online pickup at store. This shift has transformed buy online pickup at store from a niche option to a mainstream practice. Retail customers, especially those who faced more challenges previously, now understand they cannot rely solely on in-store purchases; they need to develop and expand their omni-channel and e-commerce businesses. Therefore, we see an increasing focus on the omni-channel aspect of their operations and how to adapt to situations like those experienced in the second quarter.

Maybe I can add one or two things. This is Joe Heel speaking. Generally speaking, besides the buy online pickup-in-store, productivity and resiliency are at a premium for our retailers and think not only at the store but also in the warehouses. And 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 investments that we made in Locus 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.

My follow-up question is about Reflexis. How long have you known them? Does this acquisition address any gaps in your solution set? Is there any customer concentration within Reflexis that you can discuss? Thank you.

Yeah. So, we are very excited about the addition of the Reflexis team to Zebra and that business. We've known each other for quite a long time. Reflexis has been a premier IC partner of Zebra, and we've been in dialogue with them about this transaction for some time. The transaction 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 Reflexis' engine of driving actions, too. And our Workforce Connect can be one of the ways that we augment the Reflexis 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 Reflexis has been performing extremely well during the pandemic.

We primarily serve retail customers, which creates significant overlap. We see a substantial opportunity for cross-selling and up-selling within our portfolio. Specifically, during the lockdown, two-thirds of Reflexis's customers were operating normally. About one-sixth experienced partial shutdowns or slowdowns, while another one-sixth was fully shut down but is now back in operation.

The next question is from Paul Coster of JPMorgan. Please go ahead.

Hi, good morning. This is Paul Chung filling in for Coster. Thank you for taking my questions. I’d like to follow up on Reflexis. This acquisition seems different since it primarily involves software. Should we expect a continued shift towards software? And considering long-term gross margins, can we anticipate a structural increase from your current gross margins of 47% as your strategy develops? I have a follow-up question as well.

The acquisition of Reflexis aligns well with our long-term strategy of enhancing growth in our core business, acquiring companies that strengthen our leadership in that area, and advancing our Enterprise Asset Intelligence vision. Reflexis contributes to this vision, and we view it as a continuation of our current business approach rather than a significant shift. Recently, our acquisitions, including Reflexis, have been exclusively in software. While this doesn’t mean that our focus will only be on software in the future, we are increasingly developing software assets and capabilities. Internally, over two-thirds of our engineering team consists of software engineers, highlighting the importance of software in delivering value to our customers, whether as standalone products or integrated hardware-software solutions.

We believe that the asset will indeed increase the overall margin of the business, 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 synergistic 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 businesses start to reopen? Have you also 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 add his thoughts later. First, we’ve noticed stabilization and signs of improvement in our run rate business. Although we often group run rate and SMB together, they are not the same. The SMB segment faced more challenges due to the shutdown, as most SMBs were not classified as essential and faced stricter closures. Additionally, we have more manufacturers involved in our SMB or run rate business, and they are starting to show a healthier outlook with sequential growth. We’ve worked diligently to maintain healthy inventory levels within our channel. Consequently, when our sales numbers decreased slightly in Q2, sales entering the market dipped even more. This indicates that the end markets are in a better state than our sales figures suggest. Moving forward, we are positioned to grow alongside them as the economy improves.

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 a sustained improvement. But 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 at least that is what we are seeing.

Thank you.

The next question is from Keith Housum of Northcoast Research. Please go ahead.

Good morning, gentlemen. 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 hold better than I guess what they might see for other products or projects?

We have noticed that larger deals are being delayed into future quarters, largely depending on the type of customer. Some of these are retailers that had to shut down completely in Q2, and they often chose to postpone larger orders to future quarters. For instance, deals related to RFID typically need more in-store activities and are more focused on apparel or fashion retailers. Any projects that required us to go into our customers' facilities for setup and implementation were also deferred. However, this has been balanced out by other customers who were operating and needed to significantly scale up their operations to manage the increased business stemming from the shutdown.

Great. Great to see that. And then as you look at 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 growing during the quarter. But how did intelligent edge solutions do like Savanna 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 onsite proof-of-concepts, pilots, and so forth, they tended to be pushed out and we're not growing the way we had expected.

Great. Thank you.

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

Hi, team. This is Erik on for Meta. 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?

The larger orders that we've seen in retail in the last quarter or so 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 catch or deploy and catch up on the operations side with what they have deployed. But obviously, there are many customers with different profiles. But generally, they are 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 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 a USPS order. This order was shipped at the end of the quarter, so it was relatively material to the quarter. USPS is ramping in Q3. But as we have said before, the majority of the USPS order will 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 than run rate, so it would impact the company.

Got it. That's helpful. Thank you.

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

Hi. Thank you for taking my questions. I have just one question for now. I apologize if you've already covered this to some degree since there are other calls happening at the same time. I understand that you are expecting approximately $20 million in costs related to moving manufacturing out of China, which will be adjusted from the adjusted EPS figure. However, I know you are also incurring other costs this year. I believe there is around $19 million in premium freight and additional costs in the second quarter, with $9 million more in premium freight expected in the third quarter. As we try to evaluate this year's costs that likely won't carry over into next year, what is the estimate for total premium freight and other costs in 2020 that are not expected to be present in 2021? For instance, will incentive compensation be lower this year but return next year? Also, could you remind me if there was premium freight in the first quarter?

Let me highlight the key points. Looking ahead, we have addressed the transitory costs, and our supply chain has effectively diversified away from China, so that issue is resolved. We won't face any further impacts from tariffs. Additionally, we will experience some impact from premium freight in the third quarter, amounting to approximately $9 million, which represents about 80 basis points in margin rate. This impact is expected to decrease towards the end of the year, and we anticipate that this trend will stop moving forward. Regarding operating expenses, we have been successful in managing and adjusting them as revenue has declined, and we will continue this approach. You asked if any of those operating expense reductions would be permanent; we believe so, but it's too early to provide a specific figure since we also want to continue investing in the business.

Okay. Olivier, if I can just follow up. I'm trying to understand the total estimate for transitory costs in 2020, so we can plan for 2021. You mentioned $19 million in the second quarter and $9 million in the third quarter.

Yeah. Your number is about right. I mean, if I was to give you the phasing, maybe we can take that after the call of today. Tariff impact in Q1 was about one point. That is transitory. In Q2, the impact of tariff and premium freight was about two points. Premium freight impact in Q3 will be about one point. And we believe that all those transitory costs to a large extent will 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.

The last question comes from Richard Eastman of Robert W. Baird. Please go ahead.

I'm looking at the decrementals in a similar line of thought. In the second quarter, the decremental at the adjusted EBIT line was around 40%. This is obviously absorbing some of the tariff and freight costs, likely offset by some operational expense reductions. Will the 40% decremental carry into the third quarter? And then, hopefully, we might see a decline in the fourth quarter as some of these temporary costs are removed from the equation?

You're right, Rich. If you look at today, in terms 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 would 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 thoughts around what appears to be maybe more cyclicality in the printer business in general, AIT. Thought being that, is that business impacted much more as run rate business through the channel? Or is it just simply easier to defer purchases of a printer, given the payback on the printer, just defer it for a couple of quarters? I mean, how do you kind of view that on the printer side of the business?

The printer business has a higher proportion of run rate revenue and it primarily serves small to medium-sized businesses and manufacturing customers. This customer base was more affected by COVID-19 shutdowns and slowdowns. If we examine the printing portfolio further, our card printing segment faced significant challenges, especially since it supports events, which were largely absent in Q2. There were fewer badges for employees, driver’s licenses, and other similar items that were affected more severely. However, towards the end of Q2, we began to see manufacturing opportunities emerging in the Asia-Pacific region. In our supplies business, Temptime performed exceptionally well in Q2 and expanded its vial monitoring solutions for existing vaccines. We also participated in emerging markets for COVID-19 test kits, and we anticipate ongoing opportunities with a proper vaccine. We focused on ensuring that the channel maintained appropriate inventory levels, reducing inventory where necessary while keeping days on hand stable. Consequently, we are exiting this period with a healthy inventory position, aligned with the potential for business growth as the economy recovers. We believe we gained market share in printing during the first half of this year, based on our data.

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 for taking my question. Firstly, regarding your total addressable market, a couple of years ago, you mentioned a figure of around $9 billion or $10 billion in the AIDC sector. It seems that with the new software you have developed and the recent acquisitions, you have broadened the available market and the specific niche you are influencing. Could you explain how this latest acquisition has changed the marketplace you are impacting compared to a couple of years ago?

We have previously mentioned that our core markets are approximately $10 billion in size and that we have an additional $15 billion available in adjacent markets. Many of our software solutions are new, making it a bit challenging to define the total addressable market because, theoretically, if every retailer worldwide deployed these solutions, the total addressable market would be enormous. While that's not the current situation, it still represents a significant total addressable market that is growing faster than our core markets. This clearly broadens our addressable markets and positions us to engage in additional high-growth areas where we can achieve attractive synergies through cross-selling and upselling.

You've mentioned the recovery in your business, but it's important to note that in the United States, we still seem to be facing significant challenges, unlike parts of Asia and Europe that appear to be recovering more quickly from the virus. It may take time before business can return to a more normal operating pace. In terms of the improvements you're discussing for the third and fourth quarters, how much of that progress is influenced by the recovery in Asia and Europe as opposed to the situation in the U.S.? Additionally, will the distribution of your revenue across various regions change in the latter half of this year and possibly into early next year until a vaccine is established and the U.S. manages its COVID-19 situation more effectively?

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.

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 deal mix will not shift that much, even though the recovery in particular on the run rate will be stronger outside of the U.S.

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. Gustafsson for any closing remarks.

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

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.