Zebra Technologies Corp Q2 FY2022 Earnings Call

Good day, and welcome to the Second Quarter 2022 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 and welcome to Zebra’s second quarter conference call. This presentation is being simulcast on our website at investors.zebra.com and will be archived there for at least 1 year. Our forward-looking statements are based on current expectations and assumptions and are subject to risks and uncertainties. Actual results could differ materially 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 second quarter results. Then Nathan will provide additional detail on the financials and discuss our revised 2022 outlook. Anders will conclude with progress made on advancing our Enterprise Asset Intelligence vision. Following the prepared remarks, Joe Heel, our Chief Revenue Officer will join us as we take your questions. Now let’s turn to Slide 4 as I hand it over to Anders.

Thank you, Mike. Good morning, everyone, and thank you for joining us. Our team delivered solid second quarter results in a challenging macro environment. For the quarter, we realized sales growth of nearly 7% and adjusted EBITDA margin of 21.9%, a 170 basis point decrease, and non-GAAP diluted earnings per share of $4.61, a 1% increase from the prior year. Customer demand remains strong for our solutions which digitize and automate workflows. We realized double-digit sales growth in EMEA, Asia Pacific, and Latin America and a slight decline in North America on strong prior comparisons. We realized growth across all major offerings including printing where we recovered nicely from a challenge in Q1. Our health care, manufacturing, and retail and e-commerce end markets each grew faster than the corporate average. Our teams successfully navigated the China COVID lockdowns and our actions to redesign certain products and secure long-term purchase agreements enabled us to generate more supply, particularly for printers. We also scaled adjusted operating expenses to drive profitability while continuing to prudently invest in our growth initiatives. Overall, we are pleased that our second quarter sales performance was near the high-end of our expectations, and EPS exceeded our guidance range as our team executed well on our efforts to mitigate supply chain challenges. With that, I will now turn the call over to Nathan to review our Q2 financial results in more detail and discuss our revised 2022 outlook.

Thank you, Anders. Let's start with the P&L on Slide 6. In Q2, adjusted net sales increased 6.4%, including the impact of currency and acquisitions, and 6.9% on an organic basis as we secured a greater supply of certain products than we had anticipated. Our Asset Intelligence & Tracking segment, including printing and supplies increased 9.7%, driven by a strong recovery in printing as we secured critical components to better satisfy record levels of customer demand. Enterprise Visibility & Mobility segment sales increased 5.6% with solid growth in both data capture and mobile computing solutions. We realized particularly strong growth in RFID solutions as well as ruggedized tablets in Q2. We also continue to drive solid growth across services and software with strong service attached rates and attractive software offerings. We realized strong growth in three of our four regions. EMEA sales increased 17%, driven by particularly strong growth in mobile computing and printing, inclusive of the impact of exiting Russia in March. Asia Pacific sales grew 14% with particular strength in India. Latin America sales increased 16% with exceptional growth in Mexico. And in North America sales decreased 2% due to supply constraints. We also cycled particularly strong mobile computing sales volumes in Q2 of last year. Adjusted gross margin declined 200 basis points to 46% due to higher premium supply chain costs and China import tariff recovery in the prior year period, partially offset by higher service and software margin. Adjusted operating expenses as a percent of sales improved 60 basis points. Second quarter adjusted EBITDA margin was 21.9%, a 170 basis point decrease from the prior year period. Non-GAAP earnings per diluted share was $4.61, a 0.9% year-over-year increase held by lower share count and lower taxes. Note, that in the quarter, we entered into a settlement agreement resulting in a $372 million one-time non-GAAP charge, which will be paid out over eight quarterly installments. Turning now to the balance sheet and cash flow highlights on Slide 7. For the first half of 2022, we generated $123 million of free cash flow, which was lower than last year primarily due to a higher use of working capital as sales volume shifted to later in the period due to the China lockdowns; higher incentive compensation payments given our exceptional 2021 performance; and the initial $45 million quarterly installment payment related to the settlement I just mentioned. From a balance sheet perspective, as previously announced, we have significantly increased our available borrowing capacity to align with our growing business to optimize our capital structure. Our new credit facility provides us ample flexibility for organic and inorganic investment, including the recent acquisition of Matrox Imaging, as well as share repurchases through our recently announced $1 billion incremental authorization. We made $300 million of share repurchases in Q2, and from a debt leverage perspective, we ended the quarter at a comfortable 1.7x net debt to adjusted EBITDA leverage ratio. On Slide 8, we highlight that premium supply chain costs have sequentially improved from peak levels. Our team has been successfully working all avenues including product redesigns, and negotiating long-term supply agreements for critical components, which has enabled us to reduce our purchases in the spot market. We have been seeing steady improvement in the supply chain environment, which we continue to closely monitor. In Q2, we incurred incremental premium supply chain costs of $56 million as compared to the pre-pandemic baseline, which was favorable to what we had anticipated in our prior outlook. In total, Q2 transitory items had a combined unfavorable gross margin impact of $35 million year-over-year and in Q3 are expected to be approximately $45 million, which is a neutral year-on-year impact net of pricing. Let's now turn to our outlook. We ended the second half of the year with a strong quarter backlog and healthy sales pipeline supported by broad-based demand for our solutions. We have been experiencing a steady improvement in manufacturing output, however, our sales growth continues to be limited by extended lead times and availability of certain component parts. Our organic growth has also been impacted by approximately 1 to 2 points after stopping shipments to Russia in March. For Q3, we are limiting our sales growth to a range of 2% to 4% due to actions to reduce expedited air freight costs and shift our printer products to ocean shipments, which will improve both Q4 growth and profitability. We're also assuming a 2-point additive impact from recently acquired businesses and a 3-point negative impact from foreign currency translation. As a reminder, approximately 25% of our global sales are denominated in Euros. We anticipate Q3 adjusted EBITDA margin to be approximately 22%, which is an increase from both prior year and prior quarter. Non-GAAP diluted EPS is expected to be in the range of $4.35 to $4.65. For the full year 2022, we are reaffirming our outlook with a sales growth range between 4% and 6% inclusive of the impact of exiting Russia. We are also assuming 150 basis point additive impact from recently acquired businesses and a 225 basis point negative impact from foreign currency translation. We now anticipate full year 2022 adjusted EBITDA margin of approximately 22%, the low end of our prior guide primarily due to the significantly stronger U.S dollar. Profit margins are expected to improve in the second half of the year as we continue to shift to lower cost freight options and prudently manage operating expenses and investments. We now expect our free cash flow to be at least $650 million for the year, which we have reduced primarily due to the approximately $150 million of settlement-related payments. Please reference additional modeling assumptions shown on Slide 9.

Thank you, Nathan. We are entering the second half of the year in a position of strength as we closely monitor the volatile global macro environment. We have a track record of protecting profitability and cash flow in any environment while preserving investments that drive sustainable, profitable growth. I am encouraged by the continued strong demand we are seeing across our business and the bold actions our teams are taking to mitigate the supply chain impacts. Slide 11 illustrates how we digitize and automate the front line of business by leveraging our industry-leading portfolio of products, software, and services. By transforming workflows with our proven solutions, Zebra's customers can effectively address their complex operational challenges which have been magnified since the pandemic. As we have extended our lead in the industry and expanded our portfolio with compelling solutions, we have elevated our strategic position with our customers. Our trusted relationships with our 10,000 plus partners across the globe augment our capabilities, enabling us to serve more customers worldwide. And we are always excited to engage with partners who drive value. We are excited about our new global strategic alliance with Accenture, which focuses on solving complex operational challenges in retail and other end markets with Zebra solutions. We are collaborating to advance our customers' strategies to drive productivity, inventory accuracy, and customer service levels, among a variety of other benefits that can be realized by digitizing and automating workflows throughout the enterprise. Now turning to Slide 12, businesses partner with Zebra to help optimize their end-to-end workflows as they strive to meet the increasing demands of consumers. I would like to highlight several recent key wins across our end markets. A major global transportation logistics company is expanding its relationship with Zebra across multiple product lines to ensure more accurate package loading using RFID technology across many sites. Zebra's RFID printers and scanners are integral to flagging packages loaded into the wrong truck in real time using RFID technology before the vehicle leaves the location. Zebra also supplied more than 3,000 tablets to assist associates in moving trailers around the yard, ensuring the most efficient placement of trucks, trailers, and packages. A large supermarket operator in Europe, doubled its fleet of Zebra enterprise mobile computers in a multiyear rollout covering warehouse, front and back of store and curbside pickup use cases, displacing consumer cell phones. The customer expects improved productivity benefits through better product availability, faster execution on click-and-collect use cases, and real-time price checking as they drive towards the zero food waste goal. This expansion win results from the exceptional service and trust established over our longstanding relationship and throughout the RFP process. In another recent win, a major U.S. convenience store chain added additional mobile computers in each of its more than 2,000 stores to augment its inventory management and merchandising use cases. This customer has a deep penetration of Zebra solutions, including our printers, mobile computers, and scanners to digitize and automate its workflows. Several years ago, this customer had implemented other Zebra solutions in its warehouses, and subsequently selected Zebra for additional use cases, as it addressed other business challenges. Additionally, a significant U.S. health care product distributor expanded their use of Zebra solutions, equipping their warehouse staff with wrist and ring scanners to improve efficiency in the pick and pack use cases for their warehouse associates. Zebra collaborated with the customer and partner to ensure supporting their applications to the Android operating system. We're also very pleased to be making progress in our most recent expansion markets, fixed industrial scanning, machine vision, and autonomous mobile robots. We closed on the purchase of Matrox Imaging in early June, and we join them at the automated warehouse trade show in Detroit. We are excited to add Matrox Imaging's leading comprehensive portfolio of machine vision solutions, along with many specialized channel partners to help us scale our combined business. At Automate, we also highlighted our Fetch Autonomous Mobile Robot Fulfillment solution, which we have been deploying at a third-party logistics provider, Rakuten. And we are excited about another recent key win with Maersk, an integrated logistics company. Additionally, Fetch AMR conveyance and material movement solutions continue strong traction in use cases for healthcare supply delivery, automotive spare parts conveyance, and waste removal. In closing, our actions have enabled us to begin to recover from industry-wide supply chain challenges, and we continue to be very excited about our growth prospects as we monitor the volatile macro environment. The global labor deficit and supply chain challenges have escalated the need for enterprises to digitize and automate their operations with our solutions. We have the broadest portfolio of tailored solutions to help our customers advance their strategies. Now I will hand the call back over to Mike.

Thanks, Anders. 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.

Good morning, and thank you for taking my questions.

Good morning.

Good morning.

Anders, I wanted to start with a discussion of the omni-channel and e-commerce end markets. Your underlying volumes from what we can tell seem to be pretty strong there still. At the same time, there's been some mixed headlines from some of the key players there. So I'm just curious, what can you tell us anecdotally, from customers or across the business about the pace of that end market? Does it continue to grow? Does it feel healthy? Are you seeing anything deteriorate in terms of the fundamentals? To the extent you can confirm on the guidance that you've provided, do you still see that those end markets growing in the second half? Thank you.

I'll provide an overview of our current performance in Q2 and offer some insights into our future outlook. The trends towards digitizing and automating workflows to empower frontline workers are accelerating, leading to increased customer demand for our solutions across various markets. Retail and e-commerce have experienced growth that outpaces the corporate average in Q2, with strong previous comparisons. We are seeing significant momentum in omni-channel implementations, which are taxing our customers' resources and driving them to invest in technology and automation necessary for their business transformations. In stores, expanding the use of buy online, pick up in-store, and delivery models requires retailers to equip more staff with mobile devices and improve workflow software solutions. In warehouses, investments in productivity and visibility are crucial for transformation. We've formed new promising partnerships with companies like Microsoft and Google, which enhance our strategic position within retail and other sectors. Our diverse customer base in retail and e-commerce, with each client on their own refresh cycle, helps minimize volatility for us. Our pipelines remain robust, and despite the challenging market conditions, many retailers have publicly expressed their commitment to continuing investments in technology to realize their visions and strategies. A few customers are ahead of their investment schedules, but most are catching up, especially in a labor-constrained environment, where enhancing productivity, inventory accuracy, and customer service is essential. Overall, this year feels more typical, with most customers actively investing and advancing their plans, although some are pulling back. Our diversified customer portfolio mitigates reliance on any single client, and it’s commendable that we continue to grow despite the cyclical nature of certain large customers.

Thank you. As a follow-up, I wanted to discuss the margin outlook you provided. You reported a 22% adjusted EBITDA in the second quarter. The guidance for the third quarter is again around 22%. Looking at the implied figure for the fourth quarter, it's expected to be significantly higher than 22%. This suggests an anticipated margin improvement from Q3 to Q4. I'm curious about what factors may contribute to this. Are you expecting incremental price increases, or do you anticipate improvements in elevated supply chain expenses, or is there another reason? Thank you.

Yes, Tommy, if you examine our Q3 guidance of 22%, it's up 30 basis points from last year. Delving deeper, we see more than a 2-point increase due to strong volume leverage, and the pricing benefits from our efforts over the past nine months are gaining traction. Additionally, we are experiencing notable improvements in the underlying gross margin across our portfolio, though this is offset by nearly 2 points from foreign exchange, as we anticipate being slightly above parity. Q3 marks the first quarter in which premium supply chain costs have a neutral year-on-year impact. Compared to the second quarter, it's flat since we have some improvement in overall premium supply chain costs, but this is countered by foreign exchange and a slightly unfavorable deal mix. This outlines the dynamic from Q2 to Q3. Looking at the fourth quarter, the increase in rates is primarily driven by two factors. The first is the ongoing improvement in overall premium supply chain costs, as we implement actions in the third quarter to reduce air freight and shift to ocean printing, which will yield benefits in the fourth quarter. The second factor is the nice volume leverage we experience, leading to increased revenue on a relatively flat operating expense profile. Thus, nearly half of the increase is attributed to volume leverage, while the other half is due to continued improvements in our overall cost position.

The next question is from Andrew Buscaglia of Berenberg. Please go ahead.

Hey, good morning, guys.

Good morning.

I would like to ask about the margin question. Throughout the quarter, what did you observe regarding the higher supply chain and freight costs? Your guidance of $200 million suggests that things haven't really changed. How would you describe the quarter in relation to your expectations?

Yes. In the second quarter, we experienced a 20% reduction in supply chain costs compared to the first quarter, along with a 4% increase in revenue. This aligns with our expectations for improvement. Shipping costs per kilogram have started to trend downward since the first quarter and remained stable through March and into the second quarter. We anticipate these costs will remain steady for the remainder of the year. A key factor in our improvement was the reduction in purchases of critical components from the spot market at higher prices. We expect this trend to continue as we move into the second half of the year. As we increase our printer output, we will benefit from more cost-effective shipping options, particularly for larger printers, which are cheaper to ship via ocean freight compared to air.

Yes, that sounds good. I have a question about the AIT segment. Its performance has been surprisingly positive, especially regarding margins. However, I understand that this segment tends to align with GDP trends based on historical data from the pandemic and the financial crisis. If GDP estimates are generally declining, what do you anticipate for this segment in the future? Is there a potential delay in how this slowdown might impact growth?

Well, first, I'd say that, to talk about all our product categories here that we drove nice growth across all the major product categories in Q2 and we continue to drive innovation across the portfolio. That's all helping to digitize and automate our customers' workflows. And our solutions are that much more critical today as our customers are fighting labor shortages and inflationary pressure. For print specifically here, we did see very strong growth in Q2. We had nice recovery from a challenging Q1 supply situation and we had record revenues in Q2, and we manufactured and sold more printers than we've ever done in any quarter historically. And we do expect the backlog to continue to return to more normal levels or recover the delinquent backlog and also to start shipping more on ocean in Q3 and Q4. As printing maybe has grown faster than GDP by a couple of percentage points, at least over the last many years, we continue to see printers having an attractive growth profile. And we've been gaining share steadily over a long period of time. And I see no reason for why we shouldn't be able to continue to do that going forward also. So I feel good about our printing portfolio and the positioning and the growth we should be able to drive. And I'll also ask Joe to give some perspectives here.

Yes. Andrew, I might also point towards opportunities that we have to continue to expand in areas beyond a pure GDP growth. I'll give you two examples. One would be a use case expansion, where tracking and tracing is becoming increasingly important, for example, in pharmaceuticals, and expanding in those use cases can help us grow beyond GDP. And another one would be a segment expansion, for example, our entry into the SOHO printer market would be evidence of that. So I think we have opportunities to weather volatilities in GDP.

The next question is from Erik Lapinski of Morgan Stanley. Please go ahead.

Hi, team. Thanks for taking my question, and congrats on the quarter. I'd like to ask for just a little bit more detail on some of the varying regional growth drivers you saw in the quarter. International growth is particularly strong and understand different regions are in different phases of their investment cycle. So are you seeing similar trends driving growth in each region on a vertical basis? Are there certain verticals driving the strength in whether it's EMEA or Asia Pacific that you saw in the quarter?

I'd say there's certainly some common themes across all if you look at digital transformation, that is a strong driver for us and the trends around digitizing and automating workflows are across all regions and across all verticals. So there's a lot of commonality, I'd say in what's driving that each region has slightly different profiles as far as what verticals are strongest, and so forth. But if you look at Europe, or EMEA, which was particularly strong, a great quarter, we saw print, mobile computers, and services were very strong from a product perspective. We secured a number of very attractive retail wins. And I’d say the European or EMEA performance was particularly noteworthy considering that we also had low single-digit percent in global impact on revenues from suspending shipments to Russia in March. Asia Pac, I'd say also very strong performance, particularly if you think of the shutdown in China for a good part of the quarter. Now we did see double-digit growth across mobile computing and scanning. We had record hardware and service revenues. We did see very strong growth in India and quite pleased actually with China, which was down low single digits, even though we were lockdown for 6 to 8 weeks. And now we're seeing very nice recovery in China as we move into the second half of the year. And maybe on North America just say that we saw a very solid broad-based demand. We had strong wins across all our core verticals, and we also saw attractive strength in our run rate business. The results here were impacted by supply chain constraints and some over allocations, some were on timing. But we recovered very nicely in printing and so strong growth in data caption or equity. And for North America, the biggest impact is really recycled some very strong prior year comparisons, USPS was particularly strong in Q2 of last year. I don’t know, Joe, would you have anything to add?

Yes, I would only emphasize that the regional distribution of growth that we saw in Q2 is not reflective of the underlying demand situation, but much more reflective of how we allocated supply in times of shortage based on the shortest path that we have to get supply into a market.

The next question is from Erik Lapinski of Morgan Stanley. Please go ahead.

Thank you, Joe. That was actually going to be my follow-up. I would like to ask about capital allocation in light of the Honeywell settlement, which is a minor impact on cash flow. However, your share repurchases last quarter were somewhat higher than expected, and M&A has been doing well. Has there been any change over the past quarter in how you're approaching capital allocation and cash flow? Or should we anticipate similar priorities as usual?

We think similar priorities as normal, we were comfortable with the overall debt levels and cash positions that give us a lot of flexibility as we enter the second half and into next year. To continue to prioritize investment in the business both inorganic and organic, we have exciting opportunities in both of those, and share repurchases will remain a nice flexible way to return capital to shareholders. So I'd say no change in the overall capital allocation approach as we go into the second half of the year.

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

Hi, thanks for taking my questions. And they might seem to lean a little bit cautious, but that's just because that's what we're hearing from investors right now across the board. But, first question, just under visibility, can you remind us, in general, what is the lead time for the different product lines and maybe for large orders versus the run rate business? Just trying to get a sense for how soon will you know if there really are challenges in some of these end markets?

If you look at our pipeline visibility, it varies somewhat by customer. However, for our larger clients and a significant portion of the market, we begin the year by conducting detailed reviews of their outlook and investment profiles as early as November and December of the previous year. This gives us a solid understanding of their expectations for the year, and we maintain close communication to monitor any changes. While adjustments can happen, we generally have good visibility from these engagements. Additionally, we closely collaborate with our reseller partners to build a pipeline that extends over 12 months. We evaluate whether the opportunities in the sales pipeline are commitments or still exploratory, allowing us to maintain a solid grasp of the situation. Furthermore, the high volume of transactions we handle provides statistical variation, which is beneficial. Therefore, we don't tend to overreact to any single signal. Joe, would you like to add anything?

Yes, I want to emphasize that we still maintain a record backlog. This backlog is a significant factor driving our demand for the upcoming quarters, providing us with strong visibility into new orders. One positive outcome of the pandemic is that our customers have become more open about their business expectations. We now have greater visibility than we did previously, with some customers offering us up to a year's worth of visibility and orders in certain cases. We'll see if this level of visibility relaxes a bit as supply improves, but for now, we are experiencing much better visibility for the quarters ahead in many instances.

And I'd say the bookings velocity has remained pretty stable this year. So it's very strong. We haven't seen evidence of a recession or predict a slowdown.

Yes.

Thank you for the information. I’d like to ask about the recent settlement, which appears to be significant. Can you share any insights on what transpired? I believe it primarily relates to the scanner product line. Additionally, does this situation impact the competitive landscape for that product line moving forward?

So first, you're right. We wish we can say very much on that. It's a confidential agreement. But what we did settle a number of competing lawsuits with Honeywell regarding alleged patent infringement. We agreed to pay $360 million, paid over eight quarterly installments starting in q2 of this year, so last quarter. And going forward, we have a royalty-free, both of us enjoy a royalty-free cross-license, that means there's no future impact or payments. And you should just remember that from the size of the payment here that this is reflecting the relative size of our business. We are that much bigger, our market is that much larger. So that has a direct impact on that from a competitive perspective, but I don't see that having an impact. We feel very good about our portfolio, competitive positioning, and our innovation. Our customers certainly resonate with our vision and our direction. So we feel good about where we are.

The next question is from Paul Chung of JP Morgan. Please go ahead.

Hi, thanks for taking my question. So just on your EBITDA guide, it's at the low end guide, though your free cash flow kind of adjusting for the settlement was unchanged. So you could talk about the execution on free cash flow, and kind of your expectations of how working capital levels to kind of trend as we move into '23?

Yes, if you look at our free cash flow, the decrease in the first half compared to what we expect in the second half was mainly due to the increased use of working capital and timing of sales, particularly in the second quarter related to the China lockdown. June was one of our highest revenue quarters in history due to delays in getting products out of China for shipping, which affected our collection timing. We anticipate this to normalize as we move into the second half of the year, which will significantly drive the increase in cash flow. Overall, we target 100% free cash flow conversion over a cycle and have consistently exceeded that, achieving over 100% in recent years, including over 130% in 2020 and above 100% last year. This year, if we normalize for the settlement, it's around 80%. We expect next year to recover back closer to our 100% target, but we recognize that we cannot maintain above 100% indefinitely. This year is more about catching up to the outperformance we experienced over the past couple of years.

Got you. And then another question on guidance for both Q3 and the year. Can you help us kind of understand the gross margin versus kind of OpEx dynamic? Should we expect kind of a more modest progression here from 2Q on gross margins? You mentioned some lapping of high freight costs from Q4 of last year, but you have some FX impact here. So how do we think about gross margins for the year down maybe 100 basis points for the full year then OpEx pace maybe similar to the last quarter. I think you said flat. Was that quarter-on-quarter? Thank you.

From a gross margin standpoint, if we examine the total third quarter, both gross margin and operating expenses are expected to be comparable to the second quarter, resulting in an EBITDA rate of approximately 22%. As we approach the fourth quarter, we anticipate improvements in both areas due to a reduction in supply chain costs, which will positively impact gross margins. Additionally, we expect to see some operational expense scaling in the fourth quarter, with costs remaining relatively flat in dollar terms during the latter half of the year. These will be key factors as we progress through the third and fourth quarters.

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

Good morning, everyone. I wanted to clarify your third quarter guidance of 2% to 4%. Nathan, you mentioned that you are limiting growth to facilitate a shift toward ocean freight. Can you explain how much this shift is affecting your top line guidance?

If you look again at this, we said Q3 2% to 4%, again, we said we're entering the quarter with a strong backlog bookings around 4% organic growth. So nice results considering the loss of Russia about 1 to 2 points as well as a strong prior year compare for Q3. And again, the actions we're taking are really around late in the quarter to avoid some of the premium air costs that are sometimes necessary to get product over and deliver before the quarter as well as the shift in moving print to ocean, so obviously that takes a few extra weeks from a timing perspective. So this is really around what will be delivered late in September versus into October. And we think that's the right trade off for the business long-term, as at some point you have to rebuild that funnel. And that value and benefit will obviously impact Q4 and be a big driver as we head into next year as well. So tough to quantify what that is. And we're still working those plans out here over the next month in terms of exactly how much we anticipate to get onto the ocean. But, again, that's where we're really limiting that sales growth to push some of that volume to the fourth quarter to take advantage of the lower freight costs.

Okay.

It's also a driver for why that you see a relative strength of Q4 rep versus Q3 on top line growth.

Right. So will the entire move to the ocean be complete then by the end of the third quarter?

No, I'd say by the end of the fourth quarter. It'll be building the pipeline in the third quarter, so as we go into next year we're in a healthy position.

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

Hi, thank you. I know it's early days with the Matrox acquisition. But I wonder how you would describe the progress you're making in the machine vision market. Industrial machine vision tends to be a bit more sensitive to economic cycles, and I wonder how you're perceiving the demand trends in that part of the business? Thank you.

We closed on Matrox in early June. And so, we have to 2 months into this and they've helped to create a very comprehensive portfolio of both fixed industrial scanning and machine vision solutions for us. I'd say we're very encouraged by the first 2 months. The integration is going well. The feedback from our customers has been very positive, and we are continuing to build out the partner network. So that's a great story really around how the partners we have started to sign up for our fixed industrial scanning portfolio. See great value in being able to add machine vision to their portfolio, so they can address many more of the opportunities they see from customers with our solutions and equally from a Matrox perspective that they would have the same opportunity to add fixed industrial scanning to their fixed industrial machine vision portfolio. So feel very, very good about where we are and I think the culture are meshing very well. And Joe any further?

Yes, I would perhaps add the following sort of from the outlook perspective. Matrox is refocused on the manufacturing sector, and has a good strength there. And we complement them very well because we are now able to introduce them to customers in the T&L sector, in particular. And the cyclicality of those two is again different, and therefore provides us with some opportunity to continue growth through diversification between the two companies. So that's a strength we're building on.

And there's also Matrox has similarly a strong backlog as we have on a relative basis, of course.

Thank you. Just follow-up question on RFID, which you call that and having calling out is as strong over the last several quarters. I know you don't break out the size of that business, it straddles both areas of both parts of the business. But in general, can you give us, I wonder, a growth rate for that business? And are you seeing the profile change in terms of the types of applications?

Yes, RFID has seen significant momentum over the past several years, despite a slight dip in the second quarter of 2020 when we could not engage directly with customers. It has become a strong component of our portfolio and has consistently experienced double-digit growth for an extended period. Although it remains a relatively small segment of our overall offerings, it is growing. Major corporations like Walmart and UPS have publicly shared their plans for RFID, contributing to increased momentum in this area. Retail has been the primary sector to adopt RFID for inventory visibility and some applications at checkout. However, we are also witnessing RFID's expansion into sectors like health care, transportation logistics, and manufacturing, and this trend is not limited to the U.S.; it is occurring globally. Joe, do you have any additional insights?

I think you've covered all of the areas.

The next question is from Rob Mason of Baird. Please go ahead.

Yes, good morning. I have a quick question regarding Matrox. In your discussion about full year EBITDA margins and your guidance, you mentioned foreign exchange and the recent Matrox acquisition. How long should we expect the Matrox acquisition to negatively impact EBITDA margins? Will we begin to see improvements as we move into the next years if you plan to keep investing there?

Yes, I believe that looking at the guidance for the second half, Matrox positively contributes to our overall EBITDA margin. However, this benefit was outweighed by the impact of foreign exchange due to its relative size and influence. It doesn't present a challenge from an EBITDA perspective, but it is neutral in terms of EPS, especially as we manage our debt costs. From an EBITDA standpoint, it was somewhat beneficial compared to the previous outlook, although this was more than countered by the negative impact from foreign exchange.

Thanks for clarifying that. Regarding the cost side, it appears that logistics or premium logistics costs will continue to decrease into the fourth quarter. Should we expect that these logistics costs will keep declining into around 2023, based on what you're currently observing, Nathan?

Yes, if we break it into three components, one aspect involves the factors we can control, such as limiting our purchases on the spot market while partnering with our direct suppliers. We saw some benefits from Q1 to Q2 in the second half, and we anticipate this trend will continue. Shifting print to ocean transport is another manageable factor that we expect to improve. However, we do not foresee any improvements in the underlying rate or cost per kilo in the near future. Significant enhancements in global air capacity are required for rate improvements, which is part of the reason we implemented a price increase in July—to help offset these costs. This pricing action is also contributing to some margin benefits as we approach Q3 and Q4. Therefore, we have control over two of the three factors and expect them to continue improving, but I don't anticipate any substantial improvements in the underlying air rate until there's a change in capacity, which justifies our price increase.

Very good. Thank you.

The next question is from Damian Karas of UBS. Please go ahead.

Good morning, everyone. I wanted to follow up on the changes in your product shipping methods. Nathan, you previously mentioned that increasing passenger travel was crucial for enhancing your cost and margin profile. It seems that consumer travel is starting to increase a little. I'm curious if your decision regarding ocean shipments is more of a temporary tactical adjustment, or if you are implementing a more permanent structural change to the business.

The moving or printing, you can think the large tabletop desktop printer to ocean that's how we've historically shipped it before the third quarter of last year. So 80%, 90% of that we shipped on ocean just given its relative weight. So irregardless of the rates, it's cheaper to put on ocean versus air, given the size and density of those products. The rest of the portfolio has always primarily been shipped on air via air and so that's again where those air rates were apart. So, I’d say we're going back to our normal modes of transportation with this shift here as we go to the second half of the year.

Just one more comment on that. The reason we started putting printers on air was based on long lead times. So that was to make sure we could prioritize meeting customer expectations of customer demand. But the intent was always to move it back to ocean as soon as supply chain constraints started to ease up a bit. And on the air capacity, certainly in, say in the U.S., and I think part of Europe, you're seeing passenger travel increase. In and out of China, I don't think we've seen a big increase and that's where the biggest bottleneck is. But we do hear, let's say, Hong Kong is looking to add more air capacity, so there will be a slight benefit to us.

Got it. Got it. And just to clarify, so you haven't taken any further pricing actions or plan to take any further pricing actions. It's still kind of the three rounds of increases that you previously spoke to?

That's right. The last one just went into effect at the beginning of this month. And again, we'll continue to monitor if any additional necessary. I don’t know, Joe, you want to …?

I was just saying this last month, beginning of July.

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

To wrap up, I would just like to thank our employees and partners for their extraordinary efforts to serve customers and deliver a better-than-expected Q2 results. We continue to focus on prioritizing our customers' mission-critical needs and scaling our vibrant expansion markets. And we would also like to wish a warm welcome to the Matrox Imaging team. Thank you, everyone.

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