Trimble Inc. (TRMB) Earnings Call Transcript & Summary

Hi. Good afternoon, everybody, and welcome to the Trimble fireside presentation. We're delighted this afternoon to have the CEO, Robert Painter, with us. Rob, I know you've been doing the group meetings all day. So I'm sure my questions will not be unique and probably have been asked by many investors already. But in the interest of time, I'll start right away.

Let's -- just maybe a recap to Q1. You beat expectations by about $0.11, but you raised the guidance by about $0.05. You did cite lower gross margins and increased R&D as the rationale for the revised guidance. Perhaps you could expand on both of those and what you're seeing, both in terms of higher cost, but also in terms of the increased R&D, where specifically you're going to increase R&D spending and why midyear? So I know that's a double-barreled question, but I'll hand it over to you to walk us through those.

In true Ann style, there's a few questions within the question, and thanks for hosting this today -- in our virtual fireside here we've got an, Ann. For coming out of Q1, we did have a strong Q1, significantly beat expectations, top and bottom line. We raised our guidance top line, about $100 million for the year. So we do see strength in the underlying end markets that we're serving. So we see a construction-led recovery coming out of the pandemic, and we see that in the bookings levels and the activity levels in the business. The backdrop of agriculture and commodity price strength is certainly a catalyst of growth for that business and really just on a broad base, in most markets are seeing good things in the macros. To the point of the guidance and what we talked about relative to margin progression for the rest of the year, we are seeing more pressure in supply chain. And so we do see a bit of a pinch that will happen at the gross margin level. And the reason that happens is the asymmetry between the cost increases that we're seeing, inflationary cost increases we're seeing from the suppliers relative to our ability to pass that along in realtime. So the nature of many of our contracts is they're longer-term contracts in nature that don't have an immediate ability to impact price. And we don't see it as a force majeure-type situation that would create any kind of customer goodwill where we break from that. So there is an asymmetry of when that -- the pricing will flow in. So like we have announced price increases, but we've held the prices where people have already booked the orders. So some of that will be temporal. We think by the end of the year, we would expect to start seeing -- or the fourth quarter, we expect to start seeing more of a match in the business or match of the price and the cost impacts in the business. Relative to the increased R&D in the business, so a couple of areas where -- well, there's a few areas where we're committed to, I'd say, stepping on the gas. One is in our overall cloud spending. So we've been spending disproportionately in our underlying cloud technologies really for a couple of years now. And I'm just such a big advocate of what's possible there. I think our Connect & Scale 2025 strategy is synonymous with a platform strategy, an industry platform strategy, the underpinnings of which are very much cloud-oriented. So we look to assert the strategy in that area. Autonomy is an area where we are stepping up some investments and actually in our agriculture business as well with the strength of the backdrop that we see there. We see an opportunity to increase investments there into some attractive segments of the ag tech industry. You asked, hey, why did we decide to increase investments, let's say, midstream in the year? I think I would say I was taught to generally view budgets as the root of all evil. Like so I really don't favor a budgetary mindset thinking. Of course, that has relevance, but at the same time, we really profess to operate in a 3-4-3 cadence, thinking about 3 months, 4 quarters and 3 years simultaneously, that ability to manage the polarity and optimize between the short term and the long term. And so when we see opportunities or in this case, when we see opportunity, we see need, and we see a backdrop that looks favorable. Like to me, it was a pretty easy decision that -- let's step up investment. I think another one that maybe would highlight the point well is we have expectations and optimism around an infrastructure bill in the U.S. passing. Somewhere between where the Republicans and Democrats are talking about right now, I've got optimism around that because we at least see a counterproposal. We haven't always seen that in the past. So that gives us some confidence, actually a great deal of confidence that something will happen. Of course, we're also going to have to renew the surface transportation bill by the fall as well. And we're adding resources in the area of infrastructure to go after segments such as ports, rail, mass transit, airports, in addition to the work we do with the Departments of Transportation. That'd be an example of investing ahead of the bill passing. Many of these programs will take a long time, maybe multiple quarters, if not years, to come to fruition. But the opportunity is enormous that we see with that. And that to me, that's a smart bet to make as an operator for the long -- mid- to long-term health of the business. And I got that conviction after seeing the bill really come out because it was more favorable than what I expected about then to be published.

Good. I just wanted to clarify on the increased costs. I'm assuming increased costs are hardware-related. And I don't think of your company as metal bending, as buying steel and that sort of commodity. So maybe you could just describe where you are seeing the inflation? I mean, I think of semiconductors as you either have them or you don't. So I'm not sure that they are the cause of the cost inflation per se, maybe inefficiencies in the supply chain. But if you could talk about where you see absolute cost increases that may sustain themselves versus maybe chip shortages, which hopefully dissipate or freight costs that should dissipate. So could you just talk about where specifically you are seeing cost inflation and whether you think they are temporary or more sustained?

Yes. That's an excellent clarification -- to ask that question. So the majority of Trimble business, as you know, is software today. More than 55% of our business is software and services. If we look at the hardware businesses at Trimble, that's where we're -- that's where I'm talking about supply chain inflation. While we do see some wage inflation overall, it's really more impacted in the component supply chain. So if you look at, call that shy of $1.5 billion of hardware revenue, you look at the COGS associated with that. We're talking plus or minus $600 million. So that's the zone of what we'd be talking about. We see -- so every 1% increase in cost of $6 million, we see order of magnitude in the rest of the year, it could be around 6%, so $36 million. Some of those, we believe, are transitionary or temporal changes so -- such as freight being more expensive. Even packaging material is more expensive and hard to get at the moment. And we think as the restart, let's say, gets a little further along, that, that should be one that would more naturally come down. Semiconductors, actually, I see that as something that's probably got many quarters, if not a couple of years associated with it. And where it's not a binary that you either have it or you don't. And one of the areas where we see increases and really, I'd say the whole market sees increases is where you have brokers in between and where you're paying a PPV or purchase price variance in order to get supply or we're expediting supply as we find pockets of supply available, like, in other words, it looks like airfreight, for an example, to get it to our production facilities in order to keep them running to meet the demand. I really see more of a supply-constrained environment in our hardware business than a demand constraint in the environment. Now luckily, the size and scale of Trimble does put us at an advantageous position relative to, I'll say, competitors in our industry, certainly smaller competitors in our industry. We work with some of the very large contract manufacturers. And in that respect, then we become a big -- a relatively big part of their ecosystems and can leverage the buying power and supplier influence that they have that has helped us at times. But it is challenging. It is difficult, and I think it will extend for some period of time. And we were, I think, reasonably early in coming out in that guidance and saying, "Hey, we see an issue here," and being transparent that it's there. And our teams are hard at work. I mean, I do believe it's possible we could do better than what we put forward. And at the gross margin level, we are willing to spend a little extra in order to meet the demand because we want to maintain the customer relationships and keep them working and keep them productive. And I think it's the right thing to do at the market levels, to do everything we can to secure the supply. We're also putting our balance sheet to work. So in some cases, it's taking many, many quarters of supply in order to get higher up in the queue. That is something that we're willing to extend, the commitments. We have a very asset-light business model. So extending the balance sheet is something that's very much at our disposal. So hopefully, that helps give you a little color around what's -- what we see and what we're doing.

Yes. So I think in summary, you'd expect to have covered the $36 million incremental cost by the year-end through price increases. And then when you say expand using the balance sheet, does that mean giving favorable receivables terms or favorable payable terms to suppliers? Is that what you mean by using the balance sheet? Or can you just expand on that?

Yes. By using the balance sheet in this case, I'd say, being willing to go longer on inventory. It's not so much about a receivable or payable, just willing to commit to taking volume for 12 to 18 months of components. The risk would be, okay, if we don't have the revenue there, then you could have some excess in obsolete inventory. But I don't really see that as a major risk in the environment we see now.

Okay. That's helpful. I appreciate that. Now switching gears a little bit and talking a little bit more long term. I want to talk about your Connect & Scale 2025 strategy. Could you just walk us through what that means for each of the businesses? And one of the things I was thinking about as we were coming into this meeting is, is it easier to scale a business if you have an ERP system in place that -- as kind of a backbone and then you can scale all of the other businesses onto somebody's ERP because they're totally invested in your backbone, and then you can convince them to buy SketchUp or e-Builder or whatever? Or vice versa, is it more difficult to get an entrenched customer who's already a client to expand and buy and subscribe to more of your products because they're already entrenched, and they have all their vertical needs met? I'm just curious, and maybe you can talk about that across each of the segments. Where are pain points? Where are the opportunities across each of the businesses?

Sure. So the connect -- I'll start with what I think is the connected tissue in Connect & Scale 2025. We said 2025 on purpose when we announced it and launched it in January of 2020. It was never meant to be the Connect & Scale Q2 2021 strategy. We always have this tension of managing the short-term and long-term and want to be more unbounded in the thinking of what's possible. Connect is about connecting the industry life cycles we serve. It's connecting stakeholders, end users and data across these industries. It's connecting workflow. Really, I think abstracting away not only from delivering point solutions, but abstracting back and looking at what customer -- what problem is the customer trying to solve. We think it's a very customer-oriented strategy. It guides us in our pursuit of the business model transformation. It guides us in how we're thinking about customer success and how we organize to deliver that over time because as you move more to the subscription models, you have to have retention of your customers. And so that's the point of customer success. And that moves us towards this platform thinking, the industry platform thinking. And that's very consistent across the major industries that we're serving. When we think about scale and connected scale, it's fundamentally about making ourselves easier to do business with. And we hear that from our customers. They want to buy more of what we have to offer, and they want it to be easier to do business with us. We're investing what will cumulatively be tens of millions of dollars into our own digital transformation. We're in the business of digitizing some of the most important industries on Earth. It might help if we look at digitizing ourselves as well along that journey to help better serve our customers, to help give them a single pane of glass where they can do business with Trimble, eliminate friction from the system, give us more insight into how our technology is being used and how it's not being used, so that we can help our customers be successful and get that ROI, that productivity, quality, safety, transparency and environmental sustainability out of the use of the technology. So that really is very similar playbook across the industries we're serving. Now if we -- if I now take that to the reporting segments, where we have the most recurring revenue in Trimble is 80% of our recurring revenue is coming out of our Transportation and our Buildings and Infrastructure segments, then Resources and Utilities, and then Geospatial has the smallest amount of recurring revenue. So from a connect and scale aspect and the ability to have more bundled solution offerings and the ability to deliver more connectivity of the hardware and the software and the office and the field that we can do as we connect that physical and digital, I would differentially expect to see opportunities in construction, our Buildings and Infrastructure as the reporting segment compared to, let's say, the other segments that we serve, other end markets that we serve. Then I would expect Transportation. I look at Agriculture and then Geospatial kind of in an order of priority there. So your question about ERP. So we have ERP technology and capabilities in construction as well as Transportation. These are really the main 2 places where we do that. We're not really doing that at a fundamental level in Agriculture or in Geospatial for that matter. So in the world of construction, where we can essentially have a -- it's almost like a Rubik's cube of the offering. We can deliver an integrated offering where we'll offer the ERP with project management and mobility, field mobility solutions or we could sell it independent and standalone. We do believe that it's stronger together when it acts as a platform, to your point, Ann. And we see where we have -- our win rates are higher when customers are looking to buy multiple solutions. When customers want to work in one ecosystem, we see that we win business. We're mining our own data. We think there's incredible opportunities to grow Trimble just from with the customers that we serve today. And that's one of the efforts that we've been working hard on is just to analyze our own customer data, and so we get it back into the databases. We do the analysis, and we can see the pattern recognition of the logical bundle offerings that customers themselves have already found. Plus we talk to enough of our customers for them to guide us where it makes sense to connect our offerings and integrate the offerings and make them work together more smoothly. And that guides our product managers then for the next set of efforts, which then guides our go-to-market teams on selling the bundled offerings. Very similar story in Transportation. We see the data when customers buy both the ERP, the transportation management system and when they buy the telematics or the mobility solutions. We see the revenue, monthly recurring or annual recurring revenue per vehicle when we do that bundled offering. We see the solutions being stickier, and we see them driving higher value to customers because there are workflows that we think we can uniquely do as Trimble when you're operating within our tech stack, when you can bring together things like the dispatch from the back office, meets the awareness of where the truck -- location awareness of where the truck is, meets our scheduling, routing, navigation engines, we believe we can create unique abilities to create dynamic estimated time of arrivals. For example, our unique ability is to manage dispatch and how that is done. So that you're better together, you're stronger together when you stay within our ecosystem. Now of course, there are cases when customers have -- already have an ERP that's not a Trimble ERP. And that's why openness and interoperability is an important principle for us because you won't always be able to change those underlying systems. So we are comfortable operating in both modes.

So yes, that's great. So Rob, on the evolution and the journey to connect and scale, it's digitizing yourself is the first requirement. Where are you on that continuum if you're in a baseball game? The first time I gave baseball game as an analogy, you had to say how many innings are there. I think I might have to ask again, but on the continuum of where you need to go, where are you on that evolution? And do you have to get that successful first before you really can succeed at connect and scale commercially with your customers? It doesn't have to be that seamless.

No, I totally understand the question. I would say we're in the early innings of our own digital transformation, where we've got -- we named a Chief Digital Officer last summer. And we've combined a number of teams that were working in different organizations under our Chief Digital Officer to help us deliver upon this. I think that the structure has to support and enable the strategy, and so we made the organizational structure changes. We've got a strategy for where we're going with this. It is not a build it, and they will come. These happen in parallel. One of the measures we track internally is our cross-sell and upsell ACV or annual contract value. So our divisions and our businesses plan for this and report on how they're doing with that cross-sell and upsell ACV. It is more manual than it will be when we have all the systems in place to actually be able to transact more seamlessly. But we're not waiting. I think that would be a mistake. So yes, it will be a little slower and would cost a little bit more money with more hands on the transactions. And we'll be able to increasingly automate those over time. Where we want to go if we look at our -- we call them our go-to-market motions, we sell direct to Trimble. We sell through channel partners at Trimble. We'll automate more of our direct selling motions, and then we'll go after the channel motions and automate more of those. So there'll be stair steps along the way of this progression, where I think we can accelerate our ability to execute on and deliver on the promise of connect and scale. It absolutely is not a build it, and they will come. We have to do them in parallel. And by the way, as we do them in parallel, we have good examples where we're seeing customers increase their ARR with us by 30% to 50% when we go in as one Trimble to work with customers. More customers are asking to work on a ratable basis with us. In other words, a subscription offering. And they're looking for simplification and the contracting mechanisms that we've historically put in front of them. And that gives us great directional insight of -- well, one, it gives us affirmation that we're heading in the right direction; and two, gives us directional insight in how to, I'll say, to tweak and manage the underlying digital systems offerings that we have and that we're putting together.

And Rob, as you continue down this journey, how will investors know that you've gotten there? What is the magic metric that investors should look for in January 2025 or December 2025? How will we know you've been successful?

Yes. The 2 measures that I really want us to -- myself and my colleagues to put forward more are ARR and cash flow. I think that's the tale of Trimble. Now we're in a world that wants to look first at revenue and EPS. So I'm not saying that we'd get rid of that. But at some level, they're secondary to me. They're kind of hindsight, they're lagging indicators. Frankly, ARR is a bit of a lagging indicator as well. Internally, we pay a lot of attention to the bookings levels, our total contract value or annual contract value. And we look at the intensity of usage of the systems that we have. We look at net retention ratio in the businesses that we have. And we selectively will disclose and talk about those to add color to individual businesses as we go. So -- and those are the ones that are important for me as the headline ones are the ARR and cash flow.

So ARR on an absolute basis or ARR growth year-over-year? And then cash flow, what kind of metric are you judging the success rate by?

Yes, good question. Well, I mean, I look at -- I'd say the growth in ARR, organic ARR, for that matter. I mean, at an aggregate level, we're $1.32 billion in ARR today. That puts us really amongst the largest software companies in the world at that level there and absolutely within the end markets that we serve, we're a top provider in terms of the scale that we bring today with recurring revenue at that absolute level. Having said that, I think the more interesting number that one needs to see around that is the growth within that ARR. So I'll say organic growth. At a cash flow level, we're asset-light. So you can look at operating cash flow and free cash flow, you won't end up with a different story, in my opinion, by looking at one or the other. When we look at operating cash flow, we've tended to look at it as a ratio of operating cash flow to non-GAAP net income and that being greater than about 1.1x. So we still continue to look at that as a measure of the cash generation and the cash conversion within the business. Just as a data point in Q1, we actually had negative working capital, and that's not normal across your coverage. We truly are asset-light, and the CapEx has historically run less than 2% of revenue. And I think that can sometimes get lost in the Trimble story as this kind of tweener of an industrial technology company.

That's a fair point, Rob. But since you were CFO, I think I will also call out the fact that if I look your days receivables are shorter than your -- your days receivables are longer than your days payables. So you are funding your suppliers out there. So you might want to take a look at that. That's one thing our...

It's the deferred revenue. It's the deferred revenue where we get prepaid from customers on the software.

Fair point. Good point. Now taking a step back, when we went into COVID a year ago, one of the priorities that you had set for the business was to accelerate the business model transformation. And you've done that quite successfully as shown by your earnings and your performance in Q1. Can you dig a little bit deeper into that? What exactly did the businesses do? What were you hoping they'd do? What did they achieve? What did they overachieve? What surprised you to the positive side over the course of the last year as you looked to accelerate the business model transformation?

Yes. I mean, if you look at the Trimble of 10 years ago versus the Trimble of today, it's certainly been a dramatic change in the business model, the move towards software, the move towards the recurring revenue business model. I think good news for us is we didn't wake up a year or 2 ago and say, "Oh my gosh, we got to find a way to become a digital company." We've been up to this for a long time now. As you know, I'm only the third CEO in Trimble's 42-year -- 43 now year history, which is a remarkable continuity that we've had in the strategic direction of the organization. And so this has been an intentional path that we've been on. I've worked at Trimble for 15 years, grew up in our construction businesses. If anything, yes, coming into the seats, I wanted to step, lean into this more, go faster with the conversions, but many of them have already been at play. Looking at the course of the last year, so that work, I think of all the years prior, created more resilience in the overall business. We certainly far exceeded the expectations we had during the pandemic. Our initial mappings were probably similar to what you and others did, was looking back at other crises that we had been through whether that was dot.com crash or 9/11 or the financial -- great financial -- global financial crisis or even our own moment in '13, '14 when commodities went down significantly. We expected that we would see more of a dip. And really, we saw such strength in the software businesses that provided a real strong foundation for us. And then I'd have to say, as you know, the industries we serve were deemed essential industries between transportation, still got to move those goods to commerce. People were back at work at construction. In some cases, projects were accelerated while there wasn't a lot of people on the roads. And then agriculture started really an up cycle that I'm not sure that any of us would have predicted a couple of years ago. So ag has been strong, and that's certainly been supported by commodity prices that you will -- that you all know about and the dynamics of China and how that's done a little better than -- well, actually a lot better than we've expected for American farmers of late. And the farmers in the U.S. also benefited from subsidy payments last year. I think that will be offset this year by higher commodity prices. So it looks like farm income will still be in a good place. And on the -- I'll say, on the backside of the pandemic, we do see this construction-led recovery. So projects like HS2 in the U.K. have been good for us on the strength of mining and commodity prices. That's building out infrastructure in Australia to get the ore to port. So we see good infrastructure work coming out of there. We see strong residential construction helping us in many parts of the world, Australia, but -- included, but here in the U.S., really have seen that in a few of our businesses. So a number of points of strength. And I might have just gone in a different direction, Ann, so the point -- course correct me back to where I should go.

Well, it's a slightly different direction, but that's okay. I'm just going to get to that question next anyway. So just -- you touched on where construction has been strong globally, including mining. In the U.S., are you seeing -- I'm assuming you're seeing strong construction impact demand, both on the construction business, but also on Buildings and Infrastructure business but also on the Geospatial business. Is what you're seeing in both of those business segments housing-related, both directly or indirectly where maybe you're building a road or leveling a deal in order to build houses? Or are you seeing any pockets of strength in nonresidential construction, things like maybe health care or education or any signs of life in either regionally or in nonresidential more broadly?

Well, for sure, residential, I think, is the strongest of the subsegments. General surface transportation though has held up really well. I was worried last year about tax receipts and how that would impact work, but the state and local governments stepped in with funding. Federal government did a nice job with backstops to give them their fair share of credit for providing more certainty in the environment. And we saw some -- I live in Colorado, and we saw here in Colorado, just as an anecdote, where the Department of Transportation took it as an opportunity to get some work done faster on some of the interstates and mountain highways while traffic was lower on it. So it's actually an opportunity for some work to be accelerated. So surface transportation overall is, I would say, a pocket of strength in addition to that residential. On a smaller basis, we do see -- well, we definitely see strength in data centers and logistics centers. Makes sense, right? E-commerce and how much more of us are remote and driving cloud computing. So that's going to flow through as those kind of projects are built out. So definite strength there and then to a lesser extent, hospitals and health care from there.

And what are you hearing from your construction-related customers, be they architects or contractors? You touched a lot on the contractors. I mean, the amount of inflation that they're seeing has got to be putting a huge stress on their profits. Does that make them less anxious to spend? Are they reining in spending elsewhere? Or does it give you the opportunity to step in and say, "Hey, I can help you save X amount of dollars if you buy or if you subscribe to these 3 pieces of software that previously you were buying or paying?" Is there an opportunity or a threat, I guess?

We see it as a net opportunity. I mean, certainly, for some, it will probably -- it could potentially be a threat, but we see it as a net opportunity. One of the challenges construction has is qualified labor at the moment, similar actually with agriculture as well. Some of that is the workforce availability. Some of that has been, I think, some immigration policy aspects aren't helping this either. Our technology and construction can make a good -- an inexperienced operator good and a good operator, great. So to the extent there's inexperienced operators coming into the market, the technology can surprisingly make the inexperience pretty good, pretty darn quickly. So it makes it less of a, I'll say, an art form to learn how to efficiently and effectively operate the equipment, and that can be a very big help. Survey businesses when you use a robotic total station instead of a mechanical total station, you turn a 2-person operation into a 1-person operation. Now that's primarily like a market like the U.S. has already been that, but other places around the world that are operating -- a 2-person workflow can move to 1, then they can be more productive. The core of Trimble ROI is around productivity, and productivity sells. We believe productivity sells, period, on its own merits. And then to the extent that there's optimism around, let's say, an infrastructure bill coming and where we think we could see benefits starting in, say, 2022, we see that as a net catalyst to buying technology. And again, we see -- think about how fast costs are changing at the moment, and they are changing to the up. We have estimating systems. We have systems that connect estimating systems to pricing engines. The ability to create an estimate off of a Trimble 3D constructable model is very powerful because we actually know, for example, the linear square feet of steel that are in a building, like pretend like it's the one behind you on your visual. In a dynamic environment, the tools become even more powerful. So we see it as a net positive.

And before we let you go because we're almost out of time, Transportation, 8% operating profit last year, 20% the average target. Can we get to 20% by 2025? Or will you be happy if you get halfway there and get the business back on track?

I'll be unhappy if we are not there by 2025. And certainly, the ambition is to be there before that. We hold conviction that we can improve the margins in the second half of this year and then on path again in 2021 and stepping -- or 2022 and stepping in to getting closer to where we want to be in 2023 and beyond.

Okay. And with that, I think we have to let you go, and I think you have more meetings coming up. So good luck with those, and thank you for taking the time to be with us this afternoon.

As always, Ann, thank you.

Yes, you too. Take care.