Trimble Inc. (TRMB) Earnings Call Transcript & Summary

Hi, everyone. My name is Jason Celino, and I'm the vertical software analyst here at KeyBanc. I am more than pleased to welcome Trimble's CFO, David Barnes, who is actually kicking off my string of presentations today. We do have this awesome feature at the bottom where you can submit questions. We try to keep this as interactive as possible. So with that, maybe we can start just with a quick warm up, David, just a brief intro to yourself and then Trimble.

Sure. Trimble, we're a industrial technology company transforming the way a number of critical end markets work. We're a global business pleased to last year have been added to the S&P 500 Index. And we went into this COVID pandemic period determined to exit stronger and through a combination of maybe some smarts and luck that seems to have been achieved when we've just reported a really strong quarter, and we're really optimistic about our prospects.

Okay. Great. Maybe we'll start with that with the demand environment. Maybe can you talk about the current demand trends you're seeing and maybe some of your main segments like construction, geospatial, ag, they all seem to be doing quite well.

Yes. I'll start by conceding this has been a very difficult environment to be a revenue forecaster at Trimble and maybe in a lot of other industries. We came into this year with the premise that what a lot of economists were telling us is right is that 2021 will recover back to where about 2019 was. What we've seen is a considerably stronger end market environment across the sectors we serve. And for those of you who don't follow Trimble carefully, our biggest end markets that we serve are the Buildings and Infrastructure, which is construction; Resources and Utilities, principally agriculture; Transportation or trucking; and then Geospatial serving the survey industry. We are seeing a really robust demand growth. In fact, so robust that in the 45-or-so percent of our business that's hardware related, we are unable to keep up with market demand. That's a function both of the supply chain being tight and demand being much more than we had projected. So with very few exceptions, we're seeing the end markets very strong. There's high conviction and optimism of the end users of our technology with that their prospects are good that they have money to invest, and they're excited to invest in digital technology to make their businesses better.

Okay. So maybe actually, if we could just touch on some of those ongoing supply chain challenges. It seems like it's a good scenario to have. Maybe what segments are primarily getting impacted? And what is Trimble doing in response?

I guess you could say it's a Class A problem to have more demand than you can handle. It's certainly a new thing for the Trimble organization to go from a demand-constrained environment -- severely demand constrained in 2020 with COVID to a supply chain supply-constrained environment. But if you look at our segments, all of them have some level of hardware. The ones that are most constrained in the current environment are in agriculture and in civil construction. And those are the ones where we're seeing the tightest demand. Our Geospatial segment is heavily hardware focused, but we have a -- we had a better supply chain situation going into the year, so that's been less impacted. But essentially, all of our business, including Transportation, rely, to some extent, on hardware and -- what we're seeing is shortages across the supply chain. The one you read about is semiconductors, and we're certainly feeling that. But we see limited supply across a number of very low technology components to what we sell, cables, battery chargers, plastic housing sort of everything is tight and the whole supply chain is pretty much hand to mouth as we work through it.

Okay. But I guess what matters most is these product delays or even these higher costs, are they deterring customers from placing orders?

Generally, no. And we're really encouraged by that. We haven't seen a lot of order cancellations coming through. We have implemented price increases. I don't think any customer out there likes a price increase, but we're not the only supplier to our end customers who are seeing cost and price increases. So the demand is still there. We're seeing our customers hang with us while we get through the constraints and the extended lead times. And that's why our backlog is so big. We ended second quarter with $300 million of backlog for our hardware products, and that's triple what it was a year ago, which would be a more normal level. So the backlog is there, and we will fulfill it as fast as we can, but we expect to see very strong demand and limited supply through this year and well into next year.

Okay. And I think on your earnings call, you mentioned that the expectation exiting this year is for that backlog to be kind of at similar levels.

Yes, hard to guess. And this is a very difficult environment to forecast. We struggled to forecast the strength of the demand markets. We struggle today to forecast just what our supply chain will be able to deliver. I'll say we've been over delivering on our internal forecast this year. That's part of why we were able to deliver 47% year-on-year hardware growth in the second quarter. We do think that the supply chain is pretty limited. So we're actually sequentially forecasting and embedded in our guidance is lower hardware sales in the second half of 2021 versus the first half. But as long as the end market demand hangs in there, which we see every sign that it will. And as long as we're able to deliver what we think we can get out of the supply chain, the net expectation of that is our backlog will still be about where it is now or very strong going into next year. If the supply chain challenges are -- end up being bigger in the back half than we expect, if the result of that is just more backlog, then that will be less bad news than it would be if we're seeing customers go somewhere else. But so far, that hasn't happened.

Okay. And then you kind of touched on it a little bit, but it sounds like Trimble is raising prices to reduce the offset you're seeing on the input side. But if that's the case, why are we seeing second half margins be impacted? And specifically, why is Q3 supposed to see the most pressure?

Yes. Well, I'll say one driver of our gross margins is product mix. Actually, our hardware is lower gross margin than our software, not unsurprisingly. And it's a Class A problem that the hardware demand is so strong. So that puts pressure on margins. And in fact, if you look at year-on-year, our gross margins were down in the second quarter. You can attribute nearly all of that to the mix shift. Back half of the year, good news is we'll see slightly less mix impact. The bad news is we'll see a full second half of the cost increases, but we won't have a full second half of our price increases. So we have notification periods in our agreements or in our practices with our end customers and then much of our price increases applied to the backlog that was already on order. So the simple way to think about it is that the meaningful majority of our price increase won't take full effect until the fourth quarter. So we do expect the third quarter to be the toughest from a gross margin comparison because we'll see all of the impact of the cost or nearly all certainly continues to evolve, but very little of the impact of our price increases. Fourth quarter should look better in that regard.

Okay. Excellent. And before we move on to maybe our next topic, I just want to remind everyone that we do have the ability to take questions if you guys have any. But I do want to kind of touch on the Connect & Scale 2025 initiatives. Trimble started these initiatives last year. Maybe can you tell us what these are about? And what is the reason to start the initiative at this particular time?

Sure. At Trimble, we have a uniquely broad offering for each of our core end markets, in transportation, in resources and agriculture and construction and Connect & Scale is all about bringing the point solutions together in a way that transforms the productivity, efficiency and safety of the end customers' products. So Connect & Scale is driven first by a real need that our end customers have, which is that their whole workflow is not optimized and then technology sold in discrete pieces won't get it there. Trimble, we have gone to market as relatively independent divisions, selling their own products often under their own brand names separately, and that's been a very successful business model, but it won't capitalize on or solve these new problems that our customers are facing. So the Connect & Scale strategy is all about bringing our point solutions together, integrating them in a way that solves more holistically the end market workflow optimization challenges they have. And increasingly, there's a go-to-market element, too, where we -- instead of going to market as loosely coordinated many separate businesses, we go to market together as Trimble. And that's Connect & Scale, and we are in the early stages, but with a lot of energy in making that happen.

Okay. Great. So to me, it sounds like a go-to-market kind of evolution. How does the model transition or the subscription transition or whatever you want to call it, kind of fit into that?

Yes. I would say it's equally go-to-market with product design, maybe even more on the product side. So the key insight is that to really optimize the end customer's workflow, you need the data talking to each other. And for that to happen, the data can't be sitting on the client server in their data center room. So bringing all of our business models into the cloud with recurring software offerings is what enables the data to come together to optimize the workflows. So our work is very much devoted. In fact, we're investing very heavily in creating a new and modern digital infrastructure with common infrastructure that will allow all of our solutions that push data into the cloud to work together to solve these problems.

Okay. And we've seen, I don't even know if the right word is transitions, but we've seen moves like this across software, investors are common to it. But what are some KPIs that you track internally or shared publicly showing the progress of these? And maybe the better question is, how should investors gauge the progress going forward?

I think when you're undergoing a transition as your investors will know revenue and profit often hide the progress. And so the key metric we look at is ARR growth. And we did achieve 10% organic ARR growth in the second quarter, which we think is, if anything, a more important indicator of our progress than our total revenue growth. Within the recurring revenue businesses, we look very heavily at the rate of growth of bookings. We look at our net retention and churn and a key metric that we're increasingly focused on is our ability to cross-sell our recurring offerings. We could sell dramatically more than we do today, grow our ARR just by selling more of our solutions to our existing, recurring revenue customers. So those are the metrics we look at every quarter in our business reviews and that allows us to best track whether we're making progress or whether we're stumbling.

Got you. Okay. I do want to talk about your B&I segment. That is one of your larger segments. Construction software, in particular, is one of the faster-growing opportunities that you have. While the construction industry has a lot of problems. It's there typically suffers from cost overruns, delays, highly labor-intensive. But what areas is Trimble most focused that trying to solve here?

Yes. Well, Jason, I'll start by saying before I joined Trimble 1.5 years ago, I was in the engineering and construction business. So I have a unique perspective to see upfront what the challenges are. The biggest challenges the industry faces all relate to being able to avoid rework and efficiently and reliably, predictably deliver project success. And that's hampered by the fact that there's so much discontinuity and disconnectedness of the solutions, the technologies that engineers and contractors and owners use. So at Trimble, we have an awful lot of point solutions that meet the needs of the end customers. So enterprise systems for contractors, machine control for civil contractors, program management software tools for owners where we're focusing in the Connect & Scale strategy for that end market is creating a common construction platform to meet the needs of the construction industry that will enable us to sell at a higher level to contractors, to engineers and to the owners. And we think we can -- we know our solutions can play a meaningful role in improving the reliability and predictability of project execution, improve cost and safety and sustainability of projects. So we think we're solving the really big fundamental needs of the end customers in that market and that we're uniquely positioned with the array of offerings we have and the way we can bring them together.