Trimble Inc. (TRMB) Q2 2019 Earnings Report, Transcript and Summary

Good afternoon. My name is Sarah, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Trimble Second Quarter 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now turn the conference over to Mr. Michael Leyba with Investor Relations. Please go ahead sir.

Thank you, Sarah. Good afternoon, everyone and thanks for joining us on the call. I'm here today with Steve Berglund, our CEO; and Rob Painter, our CFO. I would like to point out that, our earnings release and the slide presentation supplementing today's call are available on our website at www.trimble.com as well as within the webcast and we will be referring to the presentation today. In addition, we will also be posting our prepared remarks on our Investor Relations website at investor.trimble.com shortly after the completion of this call. Turning to slide 2 of the presentation, I would like to remind you that the forward-looking statements made in today's call and the subsequent question-and-answer period are subject to risks and uncertainties. Trimble's actual results may differ materially from those currently anticipated, due to a number of factors detailed in the company's Form 10-K and 10-Q or other documents filed with the Securities and Exchange Commission. The non-GAAP measures that we discuss in today's call are fully reconciled to GAAP measures in the tables from our press release. With that, please turn to slide 3 for an agenda of the call today. First, Steve will start with an overview of the quarter. After that Rob will take us through the remainder of the slides, including an in-depth review of the quarter, our guidance and then we will go to Q&A. I would also like to briefly mention that during the month of September, we will be attending the J.P. Morgan All Stars Conference on September 18, in London. Please turn to slide 4, and I will turn the call over to Steve.

Good afternoon. Last November, we reported strong third quarter 2018 results, but noted a number of issues worth monitoring, which were broadly characterized as discrete, geopolitical and trade. In the last nine months, these effects have intensified and were material in our most recent quarter. They are mostly unique effects that are neither classically cyclical nor secular. Although, leading to some disappointment in the short-term, they do not impact our long-term strategic or business models. Offsetting the negativism is our continuing strong progress on the fundamentals including the conversion of the business model into higher recurring revenue levels, strong cash flows, ongoing innovation, and our success with recent acquisitions. In addition, our core revenue performance in the Buildings and Infrastructure and Transportation segments remain good – remains good. Let me recite the three factors, which are creating the strained results. The first is broadly geopolitical. U.S. trade policy continues to create significant uncertainty for U.S. farmers and are resulting in reluctance to invest. This hesitancy is impacting our resources in utility segment revenue performance, although we are maintaining margins. A China-U.S. trade agreement, which looked probable a few months ago, and more uncertain now would create clarity for U.S. farmers, and provide us with immediate upside potential. This uncertainty in agriculture is being compounded by distortions in worldwide commodity inventories and regional droughts. Other politically-driven decisions have resulted in a number of puts and takes. Outside the U.S. we have encountered abrupt political decisions or declared political intent, one example being the cancellation of the Mexico City Airport and another being the declared skepticism around the HS2 rail project in U.K. by the new government. Obviously, Brexit is the most traumatic event in the political realm. Brexit uncertainty combined with slowing international trade is causing hesitation to make new investments in European plant and infrastructure, which impacts us. Against this backdrop of uncertainty, there have been some countervailing positive political developments as well. For example, the U.S. multiyear budget deal will significantly improve our ability to pursue projects that require federal funding. In addition, although the U.S. infrastructure bill, which was a stretched possibility at the trailing dollar level last quarter is no longer a real possibility. But America's Transportation Infrastructure Act of 2019, which was introduced in the Senate earlier this week increases spending by 27% over FAST Act levels. Although, the legislation may not be enacted this year, it is a sign of an improving bipartisan consensus around infrastructure. The additional positive effect for us beyond the possibility of increased spending level is that the proposed legislation contains specific funding to promote digital construction. Beyond the federal efforts, we also see – we are also seeing increased dynamism from the states and funding infrastructure renewal with growing enthusiasm for digital construction. So far in 2019, five states have raised gas taxes to help fund increased infrastructure spending. The second factor is China. This takes the form of declining growth and an intensification of Chinese government policies that create explicit preferences for Chinese companies over non-Chinese companies. As a result, our first half Chinese revenue was down approximately 40% year-to-year given that our Chinese revenue is now only 2% of total company revenue that this short-term downside is limited. Current conditions are nonetheless unfortunate because they make it unclear when China may return to its role as a source of long-term growth. The third factor impacting us is OEM demand which was an aggregate trade on the second quarter. Our more traditional OEM markets and timing subsystems and embedded components are being impacted by lower Chinese demand and an inventory overhang in a major customer. In addition, demand from our agricultural OEM partners is being impacted by lower demand in the U.S. which is in the short term, also being impacted by high inventory in the channel. On the positive side, we continue to establish or extend significant new OEM partnerships in construction and agriculture driven by the need to integrate the machine into the workflow of the connected construction site and the Connected Farm. The present more negative environment will require us to sharpen our execution which will emphasize a commitment to the financial model, a commitment to our long-term strategy and a commitment to exiting the period with an improved competitive position. Over the last 20 years, Trimble management has faced similar periods of ambiguity and consistently emphasized these same principles with a resulting acceleration of performance coming out of slow periods. The balance required to do this is consistent with our 3-4-3 philosophy which places equal weight on short-term and long-term results. Our commitment to maintain and extend our financial model includes a combination of prioritized efforts to capture incremental revenue, optimize the business portfolio and to control costs. For example, by redirecting efforts to upsell our substantial installed user base, we can potentially generate additional revenue and losing our linkage to new equipment sales. Portfolio evaluation is a constant activity within the company, but the current uncertainty will place special emphasis on underperforming product lines that are not core to our strategy. Cost control is implicit in our culture and we will methodically look to take structural costs out. For example, we have recently consolidated our autonomy in-cloud activities both to speed outcomes and to ensure cost-effectiveness. In pursuing cost -- improved cost-effectiveness, we will not compromise our three-year core innovation road map which remains compelling. Beyond our overall focus on transforming workflows in construction agriculture and transportation through technology we are intensifying our efforts in focused areas such as autonomy, mixed reality in the cloud. Although we have a role to play in on-road autonomy by providing precise position, our bigger play is in off-road autonomy. Although selected sensor development will be part of our contribution our primary focus will be on the higher-value objective of integrating autonomous machines and tools into the management of the construction or farm site. I'll let Rob speak to the details. The second quarter and most probably the third quarter represent a pause in our secular progression with a modest rebound expected in the fourth quarter. Nothing has changed structurally or strategically and we remain on course in achieving our objectives. Rob?

Thanks Steve. Let's start on slide five with a review of the second quarter results. Starting with the topline, second quarter total revenue was $856 million up 8% year-over-year. Breaking that down currency translation subtracted 2% .acquisitions added 7% and organic growth was 3%. ARR or annualized recurring revenue grew to $1.1 billion in the quarter up 28% year-over-year and up organically in the low teen. Gross margin in the second quarter was 56.9%, down 40 basis points which was driven by revenue mix in the quarter. Adjusted EBITDA margin was 23.1% in the second quarter up 10 basis points year-over-year. Operating income dollars increased 7% to $175 million with operating margins up 20.4%. Net income was up 3% on a year-over-year basis and earnings per share of $0.53 was up 4% year-over-year driven by revenue growth while being offset by higher interest expense and the increase in our non-GAAP tax rate from 19% to 20%. For context, on a trailing 12-month or TTM basis, revenue was up almost 12% EBITDA margins have expanded by 170 basis points and EPS has increased over 13%. Cash flow from operations was $178 million in the quarter up 22% year-to-date. Free cash flow which represents cash flow from operations minus capital expenditures was $154 million in the quarter, up 24% year-to-date. Cash flow growth has been driven by EBITDA growth and favorable working capital dynamics as our business continues to move towards higher levels of software and recurring revenue content as well as lower M&A expenses and lower tax payments. Moving to the balance sheet. Deferred revenue was $452 million up 27% year-over-year. This correlates to the increased recurring revenue mix in the business. Net working capital inclusive of deferred revenue stands at less than 2% of revenue on a trailing 12-month basis. Next a few comments on debt and liquidity. We closed the quarter to gross debt level of just over $1.74 billion and net debt of $1.54 billion representing 2.08 times net debt-to-adjusted EBITDA on a TTM basis. We paid down over $150 million of debt in the quarter and have reduced our gross debt by approximately $415 million, since we closed the Viewpoint acquisition in the third quarter of 2018. Our S&P credit rating was recently updated to reflect the stable outlook which we were pleased to see. With our strong cash flow and full availability over $1.25 billion revolving credit facility, we remain well positioned to weather any debt, economic disruptions and continue our disciplined capital allocation strategy. Looking at slide 6 from an overall financial performance perspective the two standout metrics from the quarter include the $1.1 billion in ARR which continues to demonstrate strong and consistent growth and the 24% growth in our free cash flow year-to-date. Moving to slide 7. We have revenue details at the reporting segment level. Overall revenue was in line with expectations, albeit towards the lower end of the guidance range. Like many other companies, we experienced a significant late quarter slowing trend across some of our businesses and markets. Of note, we continue to see softness in the OEM portion of our Geospatial business particularly in China. We also experienced continued softness in the North American agriculture market which continues to be adversely impacted by the trade situation with China, as well as impacts from droughts in Brazil and Australia. In terms of where we performed better than or according to expectations, I'd like to highlight Buildings and Infrastructure as well as Transportation. In Buildings and Infrastructure, we performed well in the aftermarket in both our civil and building construction businesses. Our SketchUp transition continues to proceed as planned and our Viewpoint and e-Builder acquisitions continue to be in line with expectations. In Transportation, we had broad-based growth across the portfolio. Turning to slide 8. We experienced growth of 17% in North America driven by construction and transportation growth in the U.S. In Europe, we experienced growth of 6% driven by construction, transportation and agriculture. In the Asia Pacific region, we saw a headwind of negative 16% driven primarily by difficult conditions in China, while other major regional markets were mixed on a year-to-date basis. For context on a TTM basis revenues in the Asia Pacific region excluding China are up 7% year-over-year. Lastly in other regions, we were flat year-over-year. Please now turn to slide 9 for a review of our revenue mix by type which is presented on a TTM basis. Software services and recurring revenues continue to grow, up 27% with organic rates in the low teens and now represents 55% of total Trimble revenue. Within that, recurring revenue which includes both subscription as well as maintenance and support revenues grew 31% year-over-year and now represents 32% of total Trimble revenue. Software and services grew 22% year-over-year and hardware contracted by 3% reflecting in large part the recent headwinds in our OEM-related businesses particularly in China. Finally, I'd like to reiterate that we now disclose additional revenue details on the summary tables provided on our Investor Relations website. These revenue details correspond to the numbers on the slide. Moving to slide 10 for operating income by segment. Of note Geospatial margins were particularly -- were primarily impacted by the weakness in our OEM components business in China, whose effects were partially offset by operating and expense reduction within Geospatial during the quarter. In Transportation, margins were negatively impacted by spend associated with increased customer support to engage our customers through the software conversion to ELD compliance. The standout positive performer in the quarter was Buildings and Infrastructure. Let's close this guidance and move to slide 11. First to comment on how our management of the business translates into our financial model, strategically we developed endgame visions and strategies. Tactically, Steve reviewed our 3-4-3 operating philosophy, where we simultaneously assess and balance the model across the timeframe of three months, four quarters and three years. At our 2018 Investor Day, we've put forward a model that will produce 23% to 24% EBITDA margins by 2021. We reiterate our commitment to being well within this range in 2021. Working backwards from 2021 current EBITDA margins on a TTM basis are 22.8%. Three comments; first, we will continue to migrate business model towards subscription. Second, we will continue to invest in R&D initiatives such as Autonomy and Cloud. Third, we will manage our cost structure as well as underperforming parts of the portfolio to position ourselves to meet our long-term commitments. With that in mind third quarter and 2019 annual guidance has been reduced to reflect the trends we saw at the end of the second quarter which we expect to impact demand through the second half of the year. With the prevailing uncertainty, we believe the prudent path forward is to de-risk the revenue model and to plan accordingly around that. For the third quarter, we expect revenue of $789 million to $819 million and EPS of $0.45 to $0.49 per share. The third quarter revenue range implies total company growth of minus 2% to plus 2% with flat organic growth at the midpoint, plus about a point of growth from acquisitions and a negative point of growth from FX due to the continued strengthening of the U.S. dollar. For the full year we expect revenue of $3.255 billion to $3.315 billion which represents total growth for the year of 4% to 6% and organic growth of 2% to 4% and EPS of $1.91 to $1.99 per share. This implies a fourth quarter where we expect organic growth to modestly rebound. Our assertion is at the second half of the year is more indicative of the environment than a discrete quarter, as we see a pause in the third quarter that will naturally drawdown inventory. Further, our fiscal year this year is 53-weeks, which includes an extra week in the fourth quarter. For the same reason, we would expect operating margins to be strongest in the fourth quarter given that the fourth quarter normally has the highest proportion of software-related revenues and the extra week will bring in an extra week of recurring revenue with healthy margins. Projecting a cautious tone for the third quarter and the second half of the year, we anticipate the following three discrete aspects. One, the combination of drought in Brazil and Australia coupled with trade impacts in the U.S. make for a challenging environment in the Agriculture business. Two, we expect our OEM-centric businesses, which represent a minority of our revenue to continue to face headwinds and uncertain macros. Third, our transportation customers who are migrating to full ELD software functionally have in aggregate back-loaded their ELD conversions meaning our support costs will run higher the next two to three quarters. We will not let our customers down and are committed to their successful migrations. On the other hand, we are optimistic in a few specific areas as well. One, we will -- we expect continued growth in ARR providing us further visibility and predictability into our business. Two, from a cash flow perspective, the strong first half of the year has reinforced our expectation. The cash flow from operations and free cash flow will comfortably exceed net income during 2019 and that cash flow from operations will exceed net income. Three, we expect that cost-containment measures that we have begun in the third quarter will begin to materialize in the fourth quarter and into 2020. Let's now take your questions.

[Operator Instructions] Your first question comes from the line of Ann Duignan from JPMorgan. Please go ahead.

Hi, good afternoon.

Hi, Ann.

Hey.

Hi. Maybe you could comment on the outlook for the buildings business in the back half. The organic growth seemed to slow significantly there. And we considered that Viewpoint is going into that business and considered organic. We would have expected a boost in organic revenue for Building and Infrastructure in the back half. So maybe if you could just talk about the fundamentals in the Buildings and Infrastructure sector please?

Sure. So actually, the first quarter double-digit organic growth in Buildings and Infrastructure had a couple points of growth in that. We had e-Builder come in as organic in the first quarter, but it had -- it was two -- had been two months in 2018 and three months in 2019. So the 11% organic we had in B&I in the first quarter adjusted for that e-Builder impact was between 8% and 9%. So if we look at that as a baseline coming into Q2, it's not the drop that it optically would look like. And then as we play that forward into the back half of the year, it's largely in line with expectation. It'd be a modest tick-down but really no fundamental change or conviction of where we are in Buildings and Infrastructure. I would expect the fourth quarter to be a higher number in B&I with or without Viewpoint, partially because of that 14th week impact and that we also tend to see a good amount of business in Viewpoint in the fourth quarter. So this factors together actually I think largely smooth what may be look optically off when you look Q1 to Q2.

Okay. And could you remind us what the organic growth looks like today for Viewpoint?

So the Viewpoint organic growth is in the single-digits -- in the low single-digits. As a reminder with the Viewpoint business going through the model conversion from perpetual to subscription that's the impact where we continue to see the bookings grow stronger well in excess of the recognized revenue growth and ARR, which I think is really the metric to look at in the Viewpoint business as up double-digit as is the e-Builder business. So in aggregate the ARR growth year-over-year is above 15% in those businesses.

Okay. I appreciate it. So I'll get back in line. Thanks.

Thanks, Ann.

Thanks.

Your next question comes from the line of Jerry Revich from Goldman Sachs. Your line is open.

Yes. Hi, good afternoon and good evening. I'm wondering if we could talk about the SketchUp transition. Can you talk about the date that had your user growth look like for that business? Last time we connected, it was really strong in the first quarter. Did that momentum continue into 2Q? And how does the success in that SketchUp transition move up the time lines for additional SaaS transitions for other parts of the portfolio?

Thanks Jerry. So, the second quarter was a positive repeat of the first quarter. And the first quarter was the official launch and we saw unit growth in excess of 50% year-over-year. That's not my intention to let's say I'm on a long baseline go through unit growth -- year-over-year unit growth. But I can tell you in Q -- in the second quarter, it also was another repeat of the 50% unit growth year-over-year. So what that tells us is two things. One the team did an excellent job in the launch. And the second is that it's expanding the addressable market which of course is one of many reasons why it's an attractive conversion to make. In terms of how that impacts our view on other aspects of the portfolio, it's certainly a positive indicator to us from a strategic standpoint that it's a good thing relative to that addressable market expansion. We had a launch in the second quarter in our Transportation business. And the enterprise or we call it transportation management system part of the business began a subscription offering. And that's an offering that would be about getting us into I would say into the medium-sized truck market whereas today our sweet spot would be more in let's call it the large fleet. And then in our mechanical electrical plumbing business it's also within Buildings and Infrastructure the beginnings of subscription offerings happened as well in the second quarter. Those two aren't needle-moving at this point and so I wouldn't comment on how they are moving Trimble numbers yet like the way that we have been around SketchUp. But again the short answer on SketchUp was a very successful second quarter.

Okay. Thank you. And then as we look at the performance of your subscription business, specifically, can you talk about what organic growth would have looked like in the quarter since we still have a couple of the acquisition moving pieces? And then within that organic subscription growth can you just slip us through some of the better performing and standouts on the lower side as well please?

So, the ARR was up 28% year-over-year. Break that down organically, organically was in the low teens was the growth year-over-year. So, a very solid performance from this aspect of the portfolio. If you source-trace the ARR into the reporting segments, more than 70% of that ARR is coming from Buildings and Infrastructure and Transportation. So, those would be the two specific places to look. In Buildings and Infrastructure, we already talked about SketchUp and that would be one to highlight and then to the Ann's first question the ARR growth in e-Builder and Viewpoint combined. So, you take the growth we had there plus SketchUp, that's going to be what moved Buildings and Infrastructure positively -- quite positively on the ARR. And in the Transportation business, the routing mapping navigation optimization business we have as well as the telematics fleet mobility business is also a recurring revenue business the sum of which grew organically year-over-year. So, this really is a good thing for us to be highlighting in this call is this aspect of the portfolio.

And any pause in the pipeline or activity levels heading into 3Q given some end market soft spots that you mentioned that impacted quoting activity or backlogs in your subscription businesses at all?

In the subscription businesses, I wouldn't say in any discernible fashion. The big movers of that are going to be in -- well, it's just -- really be actually the same parts of the business I referenced. And with that unit growth for example in SketchUp, that's obviously a very positive sign for us if we look at the e-Builder and Viewpoint. And we see these as fundamentally untapped markets, so let's say the quoting activity around that continues to grow. So, no overall -- Jerry on that side of the business, yes, it is let's say different than what we've seen on some of the more OEM or hardware aspects of the business.

Thank you.

Your next question comes from the line of Gal Munda from Berenberg Capital Markets. Please go ahead.

Hi everyone. Thanks for taking my questions. The first one is just if I think about the guidance change so maybe that's one for you Rob you guys called out accelerated model transition and how successful it has been. At the same time it's been providing headwinds right because the better the model transitions the worse the short-term numbers. So, how do we think about the model transition impact that it has had on H2 guidance potentially? Because you didn't mention it was one of the factors, but could that be one of the factors for the downgrade of the guidance or is it now having an impact itself?

It's having a small -- hi Gal, it's having a small impact. I think it's not material enough to have sorry fundamentally altered the guidance. As a reference point we believe that the transitions that we've been talking about this year, the incremental transitions would have about a point negative impact to operating margins overall for the business and would impact operating leverage five to eight points. And that's about in the range. Mathematically with the hardware business contracting a little bit and let's say full steam ahead on subscriptions, okay, that would incrementally have a bit more impact.

Okay. That's helpful. And then just as a follow-up. If my math is correct, you're implying kind of similar type of growth for Q4 sequentially -- sorry -- year-on-year. But in terms of the number you -- in organic terms similar type of growth as in Q3, even though the comp does look a bit easier in Q4, is there a level of preservatism baked into a bit more for Q4, especially because you don't have visibility there, or what's the kind of thought process behind actually Q4 potentially being weaker than Q3?

Well, if we break down the Q3 to the Q4, in Q4 we would look at about 2.5% would come from that 50, excuse me, from the 14th week, so call it $20 million of revenue. So if I pull that out and I'm looking at midpoints, it would have -- it would actually be a step-up in organic growth in the fourth quarter. So call it 1.5% organic at a mid and of course plus or minus that on the book ends. So it is a step-up from the third quarter even when we back out the impact of that extra week in the fourth quarter albeit modest. And I think at that level I would reference the view on guidance what we have of taking a bit of a derisking the model and making sure we have the cost structure around that because holding the model is really central to our operating principles.

Okay. That's helpful. Thank you. Thanks for answering my questions.

Thanks Gal.

Your next question comes from the line of James Faucette with Morgan Stanley. Your line is open.

Hi. This is Stefan [ph] dialing in for James. Similar to the prior question, would you say it's -- how much would you say is macro that's really driving the reduced guidance versus something like the transition from subscription to perpetual or any kind of delay in the project?

I think we were trying to characterize this fairly carefully and that there's a macro environment, but what we see is it is kind of a series of episodes more than let's call it a general macro conclusion. I think Europe, okay, is probably well in terms of rank order, and China is our biggest concern because of the economy slowing. But then I think this increased economic nationalism we are certainly being targeted there. So I would call that -- it kind of looks like a macro effect but in reality it's a combination of macro and specific circumstances. I think Europe, which is the second point of concern really is something the same, which is the -- particularly the German economy is very tied to international trade flows, China being at the top of that list. That's being affected and I think there is an element of conservatism relative to investment in Germany. And then you couple in Brexit. So I think we're not necessarily looking at broad macroeconomics here. I think macroeconomists still tend to be relatively positive, but it's a combination of situations. There's the China situation. There's a set of couple specifics relative to Europe. There are the U.S. farmers. So I think we're pointing at that and not necessarily saying, okay it's a macroeconomic event, but a series of specific instances around the world. And I think as -- I'll turn it over to Rob relative to the kind of the model effects. But I think we're pointing to the external environment. I think our market share is strong. Fundamentally our view in the markets, particularly construction and transportation remains pretty buoyant. It's just a series of if you will events that are -- I think are causing a certain amount of short-term pain. I'd throw kind of specifics relative to OEMs, which was not necessarily strategic to us. I'd throw that into the mix. At some point we're going to lap those and we're going to return to let's call it a new normal and I suspect, I would anticipate rebound at that point in terms of our results. So we're avoiding the use of the word macro here, and just kind of pointing at these events or these special issues around the world. Go ahead Rob.

So if I was to take call it a pie of 100, I'd put -- I'd allocate a 50, 25, 25. And then I would say 50% of that would be OEMs as Steve mentioned particularly that intersection of China and our Geospatial business. And it's more embedded components, so it's not talking about new machinery sales per se, it's really specific to OEM-embedded components in the China market. I'd put 25 on ags -- at the agricultural market. And that's a function really of tariffs when you look at North America and whether -- or drought specifically when you're looking at Brazil and Australia. I'd put 20 call it a little bit of other from across the businesses, and then maybe five I would put towards the subscription transition. So as per Gal's question, I would put just a small amount towards that. So that if you kind of just kind of get a broad strokes of how we see that delta. You have the pieces there. And as Steve said, it is important to note the lapping effect that you could map out going forward. So for instance, if you were looking at 2018, and we had double-digit organic growth Q1, Q2, Q3 when we got to Q4, it went down to 3.5. So you can start to get a view forward as we come into Q4 and into next year that we're lapping lower single-digit organic numbers as opposed to double-digits. And as Steve said that some of these things will clear themselves out when we lap them.

That's helpful. Thank you. And just a quick follow-up. Would you -- are you modeling in these kind of unique macroeconomic circumstances through the next few quarters, or how are you thinking about that?

The way I'd answer that is, we've modeled them through the rest of the year the unique aspects. And then if we look -- it's hard to look to 2020 at this point with the -- say the number of ambiguities in the market. And so what we step back and look at is the underlying fundamentals of the business, the ROI that we deliver, the go-to-market we have around that, the new products that will be introduced as we come into the fourth quarter of this year. And then as we come into 2020, it's a CONEXPO year in the construction world. It's a Trimble Dimensions year from a user conference perspective. And there tends to be quite a lot about around these events. And so we would -- you come into a view of next year of modest expectations, but also with a level of conviction and confidence.

Thank you.

Your next question comes from the line of Colin Rusch from Oppenheimer. Please go ahead.

Thanks so much. Can you talk a little bit about where the R&D money is going in the Transportation sector? How we should think about the ramp-up in software revenue and margin expansion in that part of the business over the next several quarters?

Hi, Colin. So if you look at the -- I'll say the top level at Transportation, it's clearly the segment whose -- from looking at operating income that needs to get closer to the company average or let's say get to the company average margins. Okay. Now you double-click there and look at where we put the OpEx to work. And you're correct, that a good amount of that is put to work in the R&D realm. So, a couple of things to comment on there. From a -- I'll say from a strategic aspect in Transportation, we believe we have a unique ability to connect capacity with the demand. So in other words, call it supply and demand capacity. We would have a good insight on North America based on the on-highway technology we have, the back-office technology we have. And so it's a natural extension to optimize the supply chain. And we talked about connected supply chain to also have a view into the shippers and to be able to help match the shippers and the carriers, let's say, call it a digital freight cloud. And so R&D work is being put towards that. Also, on the R&D side would be getting the enterprise or the back-office part of Transportation ready for a subscription offering. So that's an important part of the business for us to put money into. And as I mentioned in one of the Q&As, we started selling that in the second quarter, albeit in a modest fashion, but in a way we believe that that will start to ramp its opportunity to expand the addressable market. And the last comment, I'd have in R&D in Transportation is, there's certainly been a lot of work in the world of well it's ELD meets our international markets. And we have businesses now in Brazil, India, Europe and we think we have an opportunity to drive velocity and efficiency by consolidating some of the platforms that we have across the businesses. And so we've been making some of the spend to help drive those efficiencies that we would expect to see. And so from an incremental perspective as we come into next year it's certainly a segment overall that we would say needs to have that demonstrated in the bottom line margins.

Okay. That's helpful. And then regarding your comments around off-road autonomy applications and interest there clearly you guys have a long history in machine control and off-road applications. Where in -- how do you want to play in the space? And how do you see that opportunity evolving for Trimble?

Well, first of all, relative to off-road autonomy, I think, our view is maybe a little nonlinear from what would be intuition otherwise, which is, yes, we can make machines operate autonomously. We demonstrated that capability at Dimensions last November in Las Vegas. We had a number of autonomous pieces of machinery working. That is not what our -- what we consider our principal value to be, is the machine manufacturers are certainly all in one fashion or another working to make the machines autonomous. I believe a goodly number of them will end up working with Trimble to achieve that. But I think the wider play, the real value added is in terms of fitting autonomous vehicles into the workflow, which is, it's a great thing to have an autonomous excavator or compactor or whatever, doing a single act. Okay, but what comes next? After it's done there where does it go? And what does it do? And how does it fit into the schedule? So we're saying, the larger opportunity, which is consistent with what we've done with Viewpoint in particular and our other software elements, is to look at the site management, to look -- actually look at how site functions and to, yes, have our presence on the machines, but then have that machine communicating with the scheduling, communicating with cost collection functions, all of that. But to integrate that autonomous machine into the overall solution for the site, I think, that is where the real value add. And I think we're getting increasing corroboration from the marketplace in that, which is simply a simple machine operation, is not sufficient. It really comes down to how that machine is fitting into the site operation. And so, we think our ultimate value-added role is more at fitting autonomy into a site scheme, if you will.

That’s very helpful. Thanks so much guys.

Your next question comes from the line of Rob Mason from Baird. Your line is open.

Yes. Thanks for taking the question. I wanted to understand the OEM decline a bit better and how that plays into the second half guidance outlook. I know it sounds like, at least with respect to China that's a Geospatial-concentrated impact, but we were talking about that coming out of the first quarter. So I'm curious, how it degraded from there, or if it's spread to other parts of the business, or if it's impacting the survey business as well, which was flat after growing in the first quarter and if it has any ramifications for any of the other segments more so. Because it didn't sound like in the Buildings and Infrastructure, you're planning for the second half that it was taking you markedly off-track there. So, just, if you could clarify that where the incremental impact is coming, relative to what we were thinking coming out of the first quarter.

Sure, Rob. So I can give you the, I'll say, the quantitative view of that and Steve can give you kind of a historical qualitative overlay. The aspects of the business in OE -- yes, so we talked about OEMs, Geospatial, China and really it's referencing some of the -- I'll say the older Trimble businesses, traditional businesses, selling more components as opposed to end solutions. And if I look at the delta Q1 to Q2 and what we're talking about the rest of the year it's -- I don't know that I'd say it degraded so much as it didn't come back, with maybe at semantics, but that's really what played out to some degree as what we thought would be a rebound in the business, didn't happen in that aspect of the business. And I want to be real careful to isolate what I mean by, or what we're referencing when we say OEMs in Geospatial and historic -- I'll say, historic businesses we've had in Trimble, because there's really not a larger story in Trimble that -- or a thread to pull there in terms of bigger Trimble. They're really quite different. So I'd want to anchor you there and, I mean, Steve, maybe overlay context if --

Sure. So I would generally -- in terms of OEM, we're using the term fairly expansively here, but I would break the OEMs -- OEM category into two. And I think Rob was saying, let's break it into two categories, if you will. I think there's a realm here that's opportunistic, which doesn't -- which isn't core strategic to the larger Trimble. Things like the embedded, which are printed circuit board level, maybe just IP sales to OEMs. There is the timing business, which would be -- fall into the category of opportunistic. There is our, what we call, InTech which sells board-level product around the world. I would say, those are opportunistic from the standpoint that, okay, there is not a larger strategy or source of revenue in there, source of profitability, in fact a good source of revenue and a good source of profitability. Then there's a realm of OEMs that I would call -- OEM activity that I would call strategic, which are the construction and agricultural OEMs. There it's – yeah, it's a source of revenue and it's a source of profitability, but the larger play for us is to okay get basic capability and let's call it a basic level software installed in the factory, so that we can go to the aftermarket and sell the ecosystem that goes around it again integrating the machines into the work site. So I'd say, where we're seeing – we've called out the agricultural OEMs okay that's a U.S., and I'd argue trade policy issue okay that is impacting the core OEMs. But overall, the trajectory in that category of OEMs is quite strong. Let's call it, the opportunistic OEMs timing embedded kind of the Board level OEMs, where we're having significant issues in China, it does – and we're calling it Geospatial, but it's how we define the segment. It does not relate directly to survey instruments. That's where we haven't recovered from the levels that we established in the first quarter. So I think there's a dynamic here, but I think again, it's not – yeah, it's unfortunate that there has been a revenue decline in the short-term but it is – it doesn't really flow over into what I would call anything strategic at this point.

Okay. Understood. Just as a follow-up. You had also spoken earlier about redirecting some of your focus – sales focus, I guess, back into the installed base, maybe areas more healthy and just curious what you're doing there and where you think that might be most impactful near-term?

Well, I think – I think the two obvious areas are agriculture because – and construction, but let's maybe put the emphasis in agriculture as the farmers do not buy new tractors okay? And I think by a matter of arithmetic the average age of the equipment out in the field in agriculture is getting longer. They're getting older. Therefore, the technology on those tractors is getting older. And so I think there is a significant opportunity go back and say – as opposed to making an expenditure – a significant expenditure on the tractor make an expenditure at 10% or 15%, or whatever of the tractor, which gets to be a little bit more discretionary even during times of uncertainty and significantly improve your performance. I think that is available to us. Again, the numbers of tractors out there with Trimble technology on it are numbered in the hundreds of thousands. So I think that it's a matter of kind of redirecting. It's always easier to sell into a shiny new piece of equipment. So I think we have to redouble our efforts as a company, but then also get our third-party channel engaged on this. But I think there's an opportunity set. And depending how – right now construction is going well, but I think the same opportunity is implicit in construction, with maybe a slightly different argument. But I think the installed base is a potential source of additional revenue for us. We just have to redirect ourselves a bit to get it.

Again, thanks for taking the question.

Thanks.

Your next question comes from the line of Jonathan Ho from William Blair. Your line is open.

Hi, good afternoon. Could you maybe discuss a little bit – I guess, you guys referenced increased funding support for digital construction. I guess a little bit more color in terms of the trends that you're seeing from constituents that are demanding technology-assisted programs and whether you're seeing construction companies actually start to think more about investing around these trends?

Well, I think – okay kind of breaking your question down into two parts, I think our specific reference was to public funding from either the Feds or the state level. We have – okay, we have acted as missionaries to a certain extent for now two to three years fairly actively making case in Washington and at the state DOTs and I think it's beginning to catch hold. I think is – the appeal is pretty intuitive, I think both at the Congressional and at the administration levels. It's appealing so I think okay we're starting to see some tangible outcomes from that the new legislation as declared by the Environment and Public Works Committee in the Senate, okay, it did have specific language about digital construction in it. And so I think that, the idea here is to provide an encouragement for the state DOTs would actually be acting out that. And I think the same is true at the state DOTs. Some are more advanced than others, but I think there is a growing enthusiasm now, okay? How quickly does that lead to tangible outcomes? Okay, that's a little less certain, but I would say it will be progressive and I think really starting about now. So I think there's the public funding aspect of it, but then the other part of your question in general I think again it's a continuum. It's progressive, but I think there is – we're seeing in a fairly tangible way we're seeing kind of the dialogue with contractors really taking – continually progressing in terms of the desire for technology. And if things slow down at all, it's going to become a competitive necessity. So again, no, it's not a consumer product. There isn't a magic moment when it takes off, but I think it is steady. It's progressive and -- but I think we're getting real traction now in a way that we haven't ever seen before.

Got it. And then also with regard to potential cost-containment initiatives, could you maybe give us a little bit of sense where those might fall within the business units?

Yes, I would break it into -- take a few categories. So one, I would call discretionary, the second I would look at structural and the third I'd look in the areas in the COGS. So from the cost of goods sold perspective, okay it's the usual. Let's say on the purchasing side for example okay, so we recently have consolidated some of our cloud spending as an example. If I look at discretionary, of course those are the first things you look at in your control. And that's all out of let's say travel. And then from a structural aspect, you're predominantly looking at things. Let's say you look at headcount, but you also look at things like let's say real estate. So if we look at the real estate footprint we have we're consolidating that and you can look at the list of offices and make moves that we should be working on. And then from a headcount perspective, we look at it both from an aspect of -- and it's also maybe not the numbers ahead. That's what we spend on OpEx and the velocity and productivity you get out of that headcount. So it's a mix of attrition, hiring and location is what we've tried to -- the equation we try to optimize among the structural cost side. And then when we map those levers to the businesses then what I would want to communicate is that for the software aspects, if you look at the businesses, we don't have it modeled that says, we're going to do a peanut butter smoothie and treat everything the same. That would not be a wise way to manage the business. So let's take the recurring revenue business for example, the ARR that's up 20% every year up organically in the low teens. We look at our software engineers in Trimble. Two-third of our engineers are software engineers. We will continue to make sure we're doing the right things to spend and invest in that business both on the people and development side as well as in the back-office systems and plumbing that will allow us to continue to maintain and scale that growth. I think we wouldn't want to let up on that. We look at things like subscription conversions that have short-term negative impacts. The last thing we would want to do is pull that back to manage to a short-term uptick which would look better in the short term to do nothing. So we'll manage in that 3-4-3 context to do the right thing for the overall businesses. And then as you work down the portfolio, now you're looking at some areas like Steve talked about, whether it's geographies or product lines or divisions that aren't performing to their potential or/are let's say the level of patients becomes let's say smaller and tighter -- and if the environment is going to prove to be tighter, then we know the places to look. So it kind of gives you an intersection of where we would look in the portfolio and the levers we would map against that. And we go through it in business-by-business.

Thank you.

You bet.

Your next question comes from the line of Rob Wertheimer from Melius. Please go ahead.

Thanks. Rob, you mentioned the R&D work on the transport side of kind of matching up shippers and carriers and we've talked about that in the past. And obviously, the big revenue industry with some inefficiency they can be wrong out. Do you have any desire to share a time frame on when that might become a more interesting opportunity for you guys?

I think you'd be looking into the second half of 2020. It would be sort of a placeholder to start to see more, I'll say tangible revenue progress. We have our users conference in Transportation in September in Houston. It's in North America. It's the largest transportation technology user conference. And that's an opportunity at that conference we'll talk about the integrated offerings we have across the portfolio we have and how that's beginning to extend into a broader ecosystem. That extension into a broader ecosystem isn't really -- to date isn't a needle-mover on the revenue, but we remain -- we have conviction that this is the right place to go strategically with the business. And I do appreciate that we've been talking about it. And so it's a fair question to ask okay when do we start to see where the benefits of that were?

No, that's helpful. And then I mean just for pure clarity. Obviously, across the economy maybe the industrial economy there's been excess inventory that's getting wrung out and maybe you guys have a little bit of extra issue going on in China. But just in terms of the sentiment in Buildings and Infrastructure in what people are buying on the software side, whether it's through conversion or license or whatever, are you sensing any shifts there or is that still steady as she goes? I heard the comments obviously on 1Q having the step-down to 8%. Am I understanding that? I'm just looking for the sentiment among your customers on the software side.

Let's say the -- in aggregate the sentiment on the software side is positive. Of course, the software side's where we have the -- that $1.1 billion of ARR. And we've looked in some of the businesses like we've talked about Viewpoint or e-Builder before that have net retention ratios above 105% and those are obviously very good indicators when we look at that. We look at the bookings pipeline that we've had. And in the software businesses, we look at the contracted backlog, which is a recorded metric in the Q. That's over I think $1.1 billion and there's a good amount of visibility that we would have into that business. That's the comment. So a delta between what would be on the books and what we aim to get or what we commit to get becomes that go-get revenue. And against that go-get revenue, now you're managing a pipeline through that conversion into recognized revenue. So in aggregate, yes, we feel good about that. You're right there is a delta versus some of the hardware side and I think you pegged it on the way you characterized inventory. So those two pieces come together and get to the guide we have for the remainder of the year.

Perfect. Okay. Thank you.

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