Trimble Inc. (TRMB) Earnings Call Transcript & Summary

Good afternoon. I'm Rob Mason, Senior Equity Research Analyst at Baird, Covering the Advanced Industrial Equipment sector. Very pleased to have Trimble with us this afternoon at the Baird Industrial Conference. Trimble is a leading provider of advanced location-based solutions that improve productivity through enhancements to workflows, thereby generating better productivity and profitability for its customers. Trimble solutions, both software and hardware have a tight vertical focus in core markets such as construction, agriculture and transportation and logistics as well as geospatial and survey. With this from Trimble today to answer your questions, is David Barnes, CFO. Good afternoon, David.

Good afternoon.

We are going to just dive right in here into Q&A. [Operator Instructions] David, I thought maybe just to start off, you can't avoid -- maybe one thing that's been most topical this week as I've conversed about your name or Trimble. And that's the infrastructure bill that was passed. There's some attachment to some of the vertical markets that Trimble participates in around that bill. And I know you, as a company, have commented on the opportunities that could emerge from that, very unique opportunities, just given the scope and scale of the funding around that. So I'm just -- I'm curious how you're approaching it at this point. You made reference to investing, reinvesting perhaps in some of that potential activity on your last earnings call. But just what -- what can you do at this point in time in the near term? And how should we think about scoping out what the opportunity could mean for Trimble?

Sure. First of all, we have been following this for a long time, as I'm sure many investors have, and it's been fits and starts and the promise has been sort of put off many times. So it's really pleasing for us to see that the policy has progressed. We think it's really a good program from the public interest. And we think it will be a meaningful accelerant of our business. I'll say that the policy experts within our company do make it clear. It will take some time for the funding to flow into hard dollars and projects. In fact, there will be a lot of planning and preparation and procuring in 2022. We don't expect the direct impact of the ramp-up of activity for Trimble and other players in the industry to occur until 2023, although I'll say I think there's a positive sentiment in all the constituencies we sell to designers and contractors and owners that they will have some qualitative impact even next year. As far as what we're doing, we think that the policy direction that the U.S. government has taken really reinforces and adds momentum to our strategy around connected construction and deploying digital technology to optimize processes. And in fact, there's a provision in the bill that provides direct funding of digital construction technologies. So we think that will be a catalyst for our business. We are adding to our corporate account selling resource so that we can have people who know these customers, who will be receiving the funding and have the wisdom and experience to sell the whole Trimble bundle. So as far as quantifying the impact that's tough to do, but we do believe it will be a meaningful catalyst. If you look at our recurring revenue business, which is the focus of our strategy. We think that when the projects are let over time, we can build $100 million range of ARR to the momentum we have otherwise. So that sort of brackets the opportunity. It is very meaningful for us and our businesses.

Okay. And when you spoke around potentially some mandates around digital construction, those technologies. What percent if you think about current civil projects that would be in the same genre, I guess, of these type projects? What percent of those projects have adopted those type technologies currently?

Yes. The way we think about it in the civil construction arena generally, which is the biggest focus of the funding. And it depends on how you define the potential market. But -- the United States is not the global leader in adopting digital construction technologies, there are some markets in Europe that are ahead. But sort of the overall technology adoption is at or around 50% and the requirement to do these projects, I think it's not clear how much mandates will drive it, but there is incremental funding within the bill that encourages the technology. But we think from a policy perspective, there's a powerful reason with this accelerated funding level for the departments of transportation to themselves require that their suppliers adopt connected digital technology to make these projects go well. We have been advocating with the people making policy that digital construction improves the efficiency, the environmental sustainability of project delivery, and we think that message is if anything, getting more and more accepted and will be more accepted because of this bill that's been passed.

Do you need to do anything different than, I guess, than you're already doing on the product side to accelerate certain efforts to be able to meet the opportunity?

On the product side, I think the direction we were going is really well suited to the policy direction of Connect & Scale. Probably the -- I guess you could say the enthusiasm and momentum to make the connected solutions a reality, if anything, the internal appetite is higher, where we've incrementally added resource is on the -- and are continuing to do so is on the go-to-market side with meaningful higher spending levels. We need to make sure that for all the departments of transportations and airport authorities and all the other agencies that are going to get this funding that we have the right people who can connect with those customers and represent our whole portfolio. So that's part of what we're investing in incrementally and operating spending going into next year as the go-to-market capability to sell our whole offering to these customers.

Yes. Yes. And maybe that's a good segue just to the broader Connect & Scale effort. That is a Connect & Scale 2025. So this is a multiyear effort. I'm just curious, if you snap the line today, what would you consider the major accomplishments? And perhaps what inning are we in of this effort? I know it's a as a data -- a 5-year effort, but are we running ahead of schedule? On schedule? How should we think about what the major successes are and just to mark the progress?

Yes. I would say using the baseball analogy, we're in a pretty early inning, but the game has begun. We -- I think we have some meaningful successes in demonstrating that there is a strong customer value proposition. I'll highlight one important development that just went to market in the past quarter. We have come out with a product offering we now call Trimble Construction One. The core of that is the Viewpoint product that came from an acquisition we made a while ago, 2 big differences. One is the branding and you'll see us more and more go-to-market as Trimble then the product or divisional brands that came many from acquisitions. But the breadth and the connectivity of the offering is broader than what we've offered contracting customers before. So the Trimble Construction One package includes offerings that were sold by different go-to-market teams under different product names and now it's bundled together under the Trimble name. So this is a real meaningful concrete step towards offering a connected solution that affords customers the value proposition that we've been talking about. So we're very excited about that. It's in the market. It's getting resonance with customers. I'll say to pick a different end market in transportation, where our business trends have been more difficult. We have a turnaround underway. And one of the reasons the business is improving is that the value of the connected solution, the industry platform is resonating with customers, and that's influencing their buying decisions. So we've made progress internally. We've made progress from a go-to-market perspective. We're demonstrating to ourselves and our customers the real value there. So that's really good progress. We have a lot more work to do, but we're very encouraged with the proof points of the strategy as they're emerging.

Just to stick on Construction One a second. Should we think that, that's the, I'll say, anchor platform within the -- at least the buildings, the vertical construction side of your B&I business and that most of your other applications, if they don't currently will start to feed into that platform?

Yes. The strategy for construction and the other end markets is to create industry platforms that connect data and optimize workflows. And so Trimble Construction One, what we have now is just the starting pieces of what will be foundational for that end market. And the idea is to have open platforms. So we acknowledge and expect that our customers will continue to use non-Trimble point solutions, but we will provide the platform that brings the data together to make the workflows much more optimized and more connected than they are today. So that's Trimble Construction One for construction, and we'll be doing the same things in our other end markets.

Just with respect to the growth uptick in investments that will take place next year. Any more specifics that you can help frame out where those are going to be directed. We have some increased sales count or headcount on the at least directed towards infrastructure-related type work, but some of the other areas that are going to be receiving some added growth investment?

Sure. I'll talk about thematic areas that are the most significant in driving our operating investments going into next year. The first and by far the biggest is our digital transformation in the cloud infrastructure around our recurring revenue models. The second is in autonomy where we're investing heavily and higher levels of autonomy, principally to support our agriculture and civil construction customers. And the third area of investment is the go-to-market for the big accounts and big projects, which we've already spoken about with regard to the infrastructure bill. So -- but the biggest of the 3 is around the digital transformation and the cloud infrastructure. And what I'll say there is that at Trimble, we have a proud legacy of a lot of businesses, many of them acquired, which have been relatively independent. And so think of the CRM systems, which they use to go to market, we have dozens of them in the company. And that infrastructure of having many, many disparate backbone systems makes it harder to Connect & Scale offerings with the industry platform strategy. It's hard for us, our go-to-market teams, it's hard for our customers, too. So the -- we're investing heavily toward a place where there'll be a common place for our customers to interact with us digitally and our common CRM platform for each of our end markets, where it's easy for us to see everything we do with the customer, for customers themselves to engage with a broader offering of Trimble products, and it will be connected and modern in digital. And that's a multiyear investment, we started heavily this year, and we will be investing on a continuing basis next year and thereafter.

Does that change the dynamic then as we go into next year since you started this year? Does it change the dynamic around what your CapEx would look like?

I think we are an asset-light business, and we made some investments just in the last year. One of them was in our distribution center in the U.S. for our hardware products. And I remember when COVID hit, we had to make a decision, do we continue that investment. And I'll say we made a good one, which is to continue that. And with the supply chain dynamics, we're much better positioned as a result of that capital investment. What you're going to see going forward is that I do think our CapEx will increase modestly, not dramatically, but the primary theme will be investing less in distribution centers and offices and the things that characterize the majority of our CapEx over the last few years and more in the digital platform. I do think we will be investing against our internal environmental sustainability efforts in making our footprint more environment sustainable. So there'll be some facility-related investment in that area. But the bulk of the spending and the driver of the increase will be the digital backbone to support the Connect & Scale strategy.

Okay. Okay. And within that, there's been -- under the Connect & Scale effort, there's been this effort to move more of at least the perpetual license software towards a subscription model. In that effort, you would quantify it at the outset of the year, I think maybe you update this midyear, but that was about 150 basis point headwind that conversion dynamic. Is that where we're playing out as you come to the close of the year? And then should we think that's a similar dynamic amount next year?

Yes. Actually, as it's playing out this year, the impact is a little bit less than we had projected principally because we had higher-than-expected last time sales of some of our perpetual offerings that we're transforming to subscription. So we're closer to 100 basis points this year. We actually will see a higher number in Q4 because we've stopped selling some of the perpetual offerings. Going into next year, we're still in the early phase of planning, but I think it's logical to assume that we'll have 100 to 150 basis points, somewhere in that range of impact of model conversion.

And just Tekla was another big effort to move that over. How was that going that was -- that started earlier this year?

Well, that's the principal driver where I said the total subscription impact is less than we thought. We did see an uptick in the purchase of perpetual when we announced that we were sunsetting that offering. So I guess you could say that some customers loading with their wallet that they like that model, and they're comfortable with it. But we're getting to the point now in the Q4 where we're -- to the vast majority of customers were not offering the perpetual solution. And the customer acceptance is very good. It's a slightly different model. But the market is getting more and more accustomed to those -- to that business model and it's -- we're on track with Tekla.

Yes. Okay. Okay. Just to step back and think about just the overall demand environment as you came through certainly the third quarter. Supply chain-related issues aside, just on the demand side, it seemed like pretty broad-based strength. Your backlogs, of course, were increasing. Now that we have infrastructure at least in the U.S. on the construction side, again, not near-term financial impact, but probably near-term sentiment there. So as we try to just consider the various puts and takes that could play out next year, where -- I'm trying to identify some areas where maybe areas of risk because there does seem to be pretty broad-based momentum. How should we think about potential puts and takes. Where do you have extra focus your antenna up, would it be potentially ag or somewhere outside in one of the other China, you don't have much China exposure? So -- just maybe a few thoughts around momentum into next year.

Yes. Look, the big end markets that we serve in construction and agriculture, transportation in geospatial surveying broadly, the demand is incredibly strong. And we look at a lot of leading indicators. We look at project backlog of our end customers. We look at their sentiment and it's very strong. And I think all of us should be reluctant to make firm predictions in this unusual world we're in. But we see mark the end customer demand sustaining very strongly through -- well into 2022, by the end of 2022, none of us is counting on this cycle never ending. But there are no signs really that the end customer demand will abate anytime soon. So the biggest risk in our business is around the supply chain. And the supply chain is sort of manifests itself in several ways. We have a meaningful part of our business that's hardware and we're hand to mouth as our most manufacturers and distributors of hardware. Semiconductors are a major issue, but even connectors and plastics and cables and things like that are very constrained and there's a product cost inflation and freight cost inflation. So that's the biggest issue we're wrestling with. And you see that reflected in our backlog, which is incredibly high by historical standards. So what's holding us back a little bit from even higher numbers this year in Q3 and Q4, is the supply chain environment and that continues to represent a very significant challenge next year. We have seen the overall supply chain dynamic impact the demand side, principally in the transportation business because the OEMs are struggling to keep up with their production schedule and even some of the end customers are so busy themselves. They're not in a place where they can take assets off the road to implement new technology. But in the other end markets, we can sell more and more if only we can source it.

Yes. And agriculture in particular, they're dealing with supply chain constraints at the OE level. Or not just supply chain, labor as well at the OE level? But you're principally not an OE supplier, you're more of an aftermarket supplier into the agriculture market. How could that dynamic either help you or hurt you to the extent that the OE side maybe is constrained?

Yes. We do have a meaningful business with OEMs in agriculture. It's not the majority of our revenue in that segment, but it is meaningful. And one of the big OEMs has a labor situation that they're not our principal customer. We are seeing very robust business with the OEMs that we do serve. So they're muddling through with their supply chain issues well enough that it's not impacting sort of the pace of our demand. As far as the aftermarket goes, we're watching farmer sentiment and the farmers are unsurprisingly focused on the cost inflation that they're seeing, but their posture towards investing in solutions that improve their productivity and efficiency is very strong. And I think having an aftermarket focus is good for our business, and we see really strong aftermarket demand. Again, we are supply constrained for -- in the agriculture business for what we can -- what we can get. If we had a more even supply chain, we'd be selling even more than we are now.

Are each of your segments, your 4 segments have a different proportion of their business that is hardware. I guess, the resource utilities, perhaps one of the highest on the hardware side. Is it fair to think of each of your -- all of your hardware business is equally constrained? Of course, that will flow through differently to the segments? Or are some of the hardware businesses feeling it more?

Yes, the dynamics do differ from segment to segment. I'll say the Geospatial segment is very heavily hardware focused. We are blessed by having that business driven now by new products, and we made very large initial buys of components, even before we knew the COVID supply chain constraints. So that put us in a good position in that business. But you're right, we're very hardware dependent in the agriculture business, and that is the one that have all of them surprised us the most on the upside. So we had a much more cautious demand forecast that we were doing our supply chain planning against when the COVID recovery phase kicked in. So we've been, in some ways, the furthest behind. We see actually the highest cost increment in that business, and our backlog has really grown a lot. But look, the fundamental dynamic of the hardware businesses being constrained is true across all of our segments.

And that's -- I guess that's beneficial to have a rising mix of ARR and recurring revenue. And then you've already spoken to your view on ARR, looking into next year, at least with a double-digit perspective. And I guess you'll be around double digits, maybe a touch above this year. How should we think about what a range of double digits could look like next year? And just mechanically within that business, how quickly can the rate accelerate? Is there some limitations just again, mechanically on how that would work in that bucket of what is now, what, $1.3 billion in revenue?

Yes. So we had organic ARR growth of 11% in Q3, and we've guided to over 10% for the year, so that's the momentum we're building off. I'll resist the temptation to give a point forecast for next year because we're engaged in our planning. But I'll say there are a number of reasons that we're confident that ARR growth will accelerate. The first is that we have a big recurring revenue business in transportation, and that's been a challenged business, which has reduced our overall ARR growth rate. Our non-transportation businesses are already growing at a high teens rate. So just getting the transportation business more healthy will naturally improve the rate of ARR growth. And what we're seeing in that business is customer churn coming down as we've made improvements in the performance of our product and the success of our customers we saw in the last quarter, actual positive net customer retention, which is a great milestone for that business. And we're migrating our enterprise software business in transportation to a more recurring focused revenue model. So transportation coming up helps us. We've got the momentum of the business that exists now in the transitions that are underway. And then layering on top of that, as I mentioned earlier, is that the residents of the connected platform strategy is taking hold with customers, and we're going to make some progress in making those solutions more effective and easier for customers to buy next year. So all of those factors together give us confidence that we'll see meaningful ARR acceleration in next year.

Okay. Okay. How has connected scale impacted the M&A perspective? Certainly, on the outbound side, we've seen some pruning of the portfolio, I guess, as you've gone through that process. But you're so internally focused on making these transitions, as it placed M&A a lesser priority, how is the pipeline currently look? Or just bring us your current thoughts there?

Sure. And I'll add the thinking on divestitures to the acquisition side of that question. I would say the Connect & Scale platform strategy is the central filter through which all of our acquisition and divestiture thinking is -- goes through. And so where you've seen us divesting businesses, it's where we don't see an effective way for them to contribute to the platform strategy. Even if they're good businesses, they just aren't central to our strategic focus, and that's where we've done some pruning of the portfolio and there's more that can be done there. From the acquisition side, though, we are active. The world did kind of pause for a while in COVID and -- but our strategy is clearer than ever, and we do think that there is a potential for acquisitions to add momentum to our Connect & Scale platform strategy. So the M&A strategy continues to be focused on the end market verticals that we're in now. So we think those are great markets. I don't see us adding an entirely different vertical end market. But within the existing vertical end markets, if there are product capabilities or geographic presence that make the connected platform more effective, that's where we're focusing our energy, and there's a pipeline of interesting businesses, and we continue to be very active.

Excellent. Excellent. Well, we need to pull up there, at least for this session, there is a breakout session that follows. So if you have any questions, join us there, and David will take them there. So thanks, David.

Yes. Thanks, Rob. Thanks, everybody.