Trimble Inc (TRMB) — Q1 2016 Earnings Call Transcript

Good afternoon. I'm here today with Steve Berglund, our CEO; and Rob Painter, our CFO. Before we begin, I'd like to remind you that the forward-looking statements made in today's call and the subsequent Q&A 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-Ks and 10-Qs or other documents filed with the Securities and Exchange Commission. During this call, we will refer to a press release which is available along with additional financial information on our website at www.trimble.com. The non-GAAP measures discussed in the call are reconciled to GAAP measures in the tables to our press release. Now let me turn the call over to Steve.

Good afternoon. Although the first quarter provided some puts and takes from our original expectations at the beginning of the quarter, we remain on track for the 2016 scenario we laid out in prior calls. Our themes remain the same. First, the worldwide economic environment remains a challenge and is generally providing us with no favors. The expectations may be improved in Europe, which is continuing to show signs of recovery in our markets. Second, our focus remains on the recovery of our financial model in the short and long term. Third, our strategic position remains advantaged and the market potential significant. We're therefore mindful of balancing short-term financial progression with strategic outcomes. While the first quarter results were within guidance, they are only a way station on a return to the financial performance we're capable of reestablishing and maintaining. Rob will speak to some of the complexities and limitations associated with the income statement in the midst of a changing business model. For example, we recorded an all-time high deferred revenue balance in the quarter which grew by $37 million from the first quarter last year. This in combination with the first revenue growth quarter since 2014 supports our view of mid-single-digit growth for the full year absent significant currency impacts. We understand that arithmetically the total year view imbeds an expectation of a step up in growth in the second half, which is supported by what we see as improving trends in transportation logistics, buildings, heavy civil, and agriculture. Providing additional encouragement is demand in the month of April, which has been more robust than prior years in the seasonal businesses of construction and agriculture. This could be weather, secular trend, or a combination of both. It is nonetheless encouraging if precise. We have repeatedly spoken of regaining our financial model during 2016, with the definition of success being in the neighborhood of 20% non-GAAP operating margins. Neighborhood in this case implies being within a point plus or minus and convincing enough to remove any doubt about our having reset our structural model back to that level. From a portfolio perspective, Field Solutions and Advanced Devices were both above 30% for the total year 2015 and our contributors to the model. Mobile Solutions was at 16.5% for the total year 2015 and only 13.9% for the first quarter. The major reason was the receipt of multiple large contracts with a heavy weighting toward hardware in the quarter that will lead to richer software subscription margin later in the year. With the dynamics at play, Mobile Solutions should be within striking distance of the 20% threshold later this year. E&C is at the core of our margin restoration efforts. The segment produced operating margins of greater than 20% in 2012, 2013, and 2014 and fell to 17% in 2015. We believe we have specific steps in place to restore the E&C model and thereby elevate the entire Company. In prior quarters, we have recited a list of rationalization actions we're taking. Let me reiterate that list. The first is cost reduction. We took steps throughout 2015 to bring spending in line with altered realities and this process is continuing into 2016. The reductions have been focused in those areas that are facing revenue issues, particularly Field Solutions and Mobile Solutions. On the other hand, we have continued selectively to add in areas such as transportation and logistics, which has significant revenue momentum. We're also running R&D hotter than our base model with the expectation of having a rich product release year. It is still our intention to dial R&D back to our traditional levels of 14% to 15% of revenue. The second initiative is the pricing of the portfolio of non-strategic businesses, products, and product categories. During the first quarter, we announced the divestiture or shutdown of three product lines. The first was a part of our public safety business; the second was a planning software package for transmission lines; and the third was Trimble Outdoors. This process will continue as we focus more intently on our franchise business in a handful of emerging businesses. The third initiative is the consolidation and leaning out of the organizational infrastructure that has grown up through our acquisitions. One significant element of this will involve the elimination of unnecessary legal entities acquired through acquisitions with our corresponding costs. The fourth initiative is to consolidate organizations and operations into more cost-effective configurations where possible. Some of this effort is already complete and some is ongoing. This has involved consolidating a number of selling and manufacturing organizations to gain better cost leverage. A fifth initiative is the ongoing consolidation of product platforms by sharpening focus on decisions for hardware elements of our product solutions and the reduction of redundant or low-value R&D activity. Across the regions, the story remains a collection of pluses and minuses. The U.S. is positive but somewhere short of robust. Canada reflects the commodities bust and is struggling. Europe reflects improved momentum in our major businesses but remains in our mind tentative pending events such as the upcoming U.K. vote. China remains a positive in the mid to long term, but short-term decision-making is paralyzed due to market volatility in policy and decision. Russia may slowly be coming off the bottom and was a growth market for us in the quarter. Other markets such as Brazil, Australia, and South Africa are problematic, although Australia showed strong growth in the quarter. The outlook for Argentina, which is a significant agriculture market, is now hopeful. The E&C segment is a mixed story. Heavy Civil delivered the strongest relative quarter we have seen in almost two years and surprised us to the upside. This momentum appears to be continuing into the second quarter across all major regions. Also adding momentum in Heavy Civil are the recent boosts to our mixed fleet strategy in construction through the announcement of OEM deals with Volvo, Hyundai, and others, with more in discussion. While the incremental revenue from these deals is a plus, the greater significance is that they are placing Trimble at the center of the construction information ecosystem, which we can exploit in the aftermarket over an extended period of time. The unique advantage in developing these OEM deals has been the SITECH channel, which allows Trimble to supplement the OEM dealers with additional support as needed or desired. Last quarter, we described the likely year for Heavy Civil as muted given the headwinds in core markets such as Australia, South Africa, and Canada, with some potential uplift from the U.S. Highway Bill. Our expectations have improved in the last three months, and we expect a greater contribution from Heavy Civil during the year. Although the BIM-centric buildings business remains a strong plus for the year and into the future, it stumbled in the quarter due in part to the GAAP revenue accounting for delays in receiving customer acceptances, which either have arrived after quarter end or are expected in this quarter. Overall, we expect the buildings business to generate double-digit revenue growth for the remainder of the year. We were anticipating a relatively strong comeback for the Geospatial business in the quarter, which did not materialize particularly because of continued slowness in North America. The used equipment market has become saturated with equipment surplus from the oil-producing areas, and it will take some time for the overhang to work itself through the market. Last quarter, we described the outlook for Geospatial for the year as relatively robust single-digit growth. With a better understanding of current circumstances, our revised view is probably best reflected as modest single-digit growth. Overall, we see E&C back on the growth path for 2016 with the potential for significant expansion in margins. Our view on agriculture remains unchanged from prior quarters with the expectations for the year being flattish at the revenue line, with flattish implying a relatively narrow range around zero. Although agriculture was down in the first quarter as expected, our view for the rest of the year is for consistency with last year's revenues, which may contrast with equipment manufacturers' views results from a combination of new products, strong performance in some regional markets, and expected actions in the aftermarket. There are dynamics at work for us that contrast with a simple correlation to new machine sales. For example, units installed in the worldwide aftermarket on equipment more than two years old is running at more than 50% of the total, with a substantial portion going on units more than five years old. This demonstrates the continuing viability of the aftermarket channel as a technology delivery mechanism and the penetration potential on the installed base. The vantage channel, which is our third-party agriculture distribution channel focused on technology, is providing early and still tentative superior results to other channels, which reinforces our belief in the effectiveness of the channel. Overall, for the Field Solutions segment, we expect revenue to be up low single digits for the remainder of the year with an assist from acquisitions. The Mobile Solutions segment first quarter growth rate was consistent with the fourth quarter's rate. We exited the first quarter with record backlog, and we continue to expect an acceleration of growth through the remainder of the year based on recent transportation logistics wins, some of them unannounced. The new product pipeline consisting of the mobile gateway and video intelligence has been well received. We continue to anticipate this segment to be the strongest performer within the Company for total 2016, producing both double-digit revenue growth and margin expansion. The Advanced Devices segment does not typically enter our quarter-end commentary because it is peripheral to our end-user strategy focus and not particularly significant against the scale of the other segments. However, this year with the significant year-to-year drop in the first quarter revenue, the segment affected the optics of the aggregate financials. The segment tends to be inherently lumpy because of the nature of its product and customer base and its reliance on large contracts and specific customer delivery schedules. We're confident that the first quarter drop was a function of last year's very strong first quarter, and we expect to see modest full year Advanced Devices revenue growth, with the growth spread over the remaining three quarters. Let me turn the call over to Rob. Before I do, let me characterize the first quarter as being the quarter we expected, with again a couple of puts and takes with the recorded results providing a less than ideal set with our full year narrative of revenue growth and margin expansion. If one looks beyond the moving parts, we believe it does provide support to believe in progression quarter by quarter during the year.

Thank you, Steve. Before getting to the numbers, please note as usual that unless otherwise indicated, the operating results I will discuss today will be on a non-GAAP basis. The reconciliation from GAAP to non-GAAP numbers is in our earnings press release, along with the financial data by segment. Unless otherwise indicated, growth rates are meant to be year-over-year growth rates. Let's now turn to the first quarter results. Q1 total revenue was $583 million, flat year-over-year. Currency translation subtracted approximately 1% year-over-year, and the net effect of acquisitions and divestitures added approximately 2% year-over-year. Turning to our revenue by segment, I will start with engineering and construction. Engineering and construction segment revenue of $310 million was up 4%, with improved year-over-year growth. Currency translation subtracted approximately 1%, and the net effect of acquisition and divestiture added approximately 1% year-over-year. Within E&C, the revenue performance was mixed. Heavy Civil revenue grew double digits through a combination of organic and acquisition growth, with strength in most regions. Our confidence continues to grow in this business for the rest of the year with positive momentum as we enter our seasonally strongest quarters in the segment. Trimble Buildings grew single digits overall, lower than expected due largely to some renewal delays and delayed revenue recognition on a small number of large contracts. We expect performance to rebound to recent patterns. Geospatial revenue was down single digits in Q1 with continued weakness primarily in the North American market. We expect some improvement, but we have muted our growth expectations through the rest of the year. In the Field Solutions segment, revenue of $106 million was down 8%, currency translation subtracted approximately 1%, and acquisitions had an approximate 5% positive impact. In line with our expectations, the agriculture business was down high single digits, impacted negatively by difficult markets in North America and Brazil, with healthier markets in Europe and Asia. While the agriculture market remains very challenging, we continue to expect our year-over-year growth profile to improve during the course of the year. Mobile Solutions segment revenue of $136 million was up 6%. Currency translation subtracted approximately 1%, and acquisitions had an approximate 1% positive impact. Within the segment, T&L, which is our transportation and logistics business, was up high single digits as expected. We expect growth to strengthen through the year, with backlog at record levels as a result of large customer wins. The rest of the segment was relatively flat year-over-year. Advanced Devices segment revenue of $31 million was down 22%, due primarily to weaker OEM sales than we experienced in Q1 2015. As we have previously discussed, Advanced Devices revenue can be lumpy due to the timing of these sales. Note Q1 2015 was the strongest quarter last year in Advanced Devices and represented a very challenging comparison. We expect year-over-year growth rates to improve through the rest of 2016. By geography, our revenue split was as follows; 54% from North America, 26% from Europe, 14% from Asia-Pacific, and 6% from the rest of the world. North American revenue was up 1% year-over-year. E&C improved significantly, posting double digits led by strength in Heavy Civil, offset by soft performance in Geospatial. Field Solutions was down double digits in North America, with a challenging quarter as expected in agriculture. Mobile Solutions grew single digits, led by T&L. Europe continued to be a positive story with revenue up 5% year-over-year. Excluding currency translation effects, revenue was up approximately 8%. Geographic performance was mixed with the U.K. and Germany slightly down, improved by strong performance in France, Italy, and the Nordic regions. Russia improved in the quarter from the prior year. Asia-Pacific revenue was down 9% year-over-year as recorded. Currency translation subtracted approximately 1% year-over-year. Asia-Pacific performance was uneven and patterns are currently hard to establish with declines year-over-year in China, Japan, and Korea partially offset by the first quarter growth in Australia that we have seen in almost two years. The rest of the world was down 8% year-over-year. Currency translation subtracted approximately 2% year-over-year. Brazil was very weak, offset by growth in some areas of the Middle East and Africa. Turning to the rest of the P&L, gross margins at 55.9% were down 90 basis points. This is at the low end of our expectations, which was the primary reason for our performance on the low end of our EPS guidance. The biggest impacts on gross margin year-over-year were geographic mix in Field Solutions and the impact of increased hardware mix in T&L within Mobile Solutions. Furthermore, Advanced Devices with lower margins represented a smaller portion of the overall Company in Q1 2016. In Field Solutions and Mobile Solutions, we expect to see gross margin recover in the rest of the year as more traditional mix trends reestablish themselves. Next, to put non-GAAP operating expenses into context this represented a $3 million year-over-year increase in the quarter. Compared to last year, the numbers were roughly as follows. Restructuring activities reduced OpEx in line with the $30 million of annualized expense reductions we talked about last year. OpEx for newly acquired companies roughly offset these savings. Finally, we're investing in growth initiatives primarily in our T&L business which we expect to benefit us in the second half of the year. With respect to operating income, Q1 non-GAAP operating income was $88.5 million or 15.1% of revenue, as compared to 16.6% of revenue in the prior year. E&C operating margins were up year-over-year due to revenue growth and cost containment, with positive momentum as we enter our seasonally strongest quarters in that segment. Field Solutions margins were down year-over-year, impacted mainly by lower revenue and gross margins, but remained above 30% due to cost containment actions. Mobile Solutions margins were down year-over-year as we expected due to gross margins and operating expense investments related to growth in the business. Acquisitions closed in the last 12 months also had a slight negative impact on operating margins. Turning to tax, our non-GAAP tax rate was 24%. Note that our GAAP tax rate was 33% against a GAAP tax rate of 23% in the prior year, impacted by discreet items in the quarter which negatively impacted GAAP EPS year-over-year. So Q1 2016 non-GAAP net income of $64.5 million was down 11% as compared to Q1 2015. Diluted non-GAAP earnings per share were $0.25. Back to revenue, from a mix standpoint we're continuing to see an evolution to software services in recurring revenues and we're seeing that in all of our major segments. For the trailing 12 months through Q1 2016, the combination of software services and recurring revenue represents approximately 48% of total Company revenue, up from approximately 42% for the trailing 12 months through Q1 2015. Recurring revenue, which is a subset of that, represented approximately 27% of total Company revenue for the trailing 12 months through Q1 2016 against 24% for the prior year. It is increasingly clear that revenue mix shifts in our business towards software and services are positively impacting our deferred revenue and cash flow profile. Q1 operating cash flow was $113 million, up 6% year-over-year. Closely linked with the cash flow performance, deferred revenue increased to a record $320 million, up 13% year-over-year. The increase in deferred revenue primarily reflects changes in revenue mix, current large contracts and acquisitions. Debt decreased by $55 million sequentially, ending at $675 million. Our leverage ratio, defined as gross debt to trailing 12-month EBITDA, ended at 1.6, well within our targeted range. During Q1, we repurchased approximately 500,000 shares of our common stock for $12.2 million. Our capital allocation priorities are unchanged. Our first priorities are long-term investment in the business organically and through acquisition. We continue to produce strong cash flows. With relatively low levels of CapEx in our current acquisition pipeline, we expect to continue to be opportunistic with stock repurchases. Our current stock repurchase program has a remaining authorization of approximately $238 million. I will now turn to our guidance for Q2 2016. We expect second quarter revenue to be between $595 million and $625 million and non-GAAP earnings per share of $0.26 to $0.31. Second quarter guidance assumes current FX rates and a neutral impact from currency translation. Non-GAAP guidance excludes the amortization of intangibles of $40 million related to previous acquisitions, estimated acquisition costs of $2 million, the anticipated impact of stock-based compensation of $14 million, and approximately $4 million in anticipated restructuring charges. Second quarter non-GAAP earnings per share guidance assumes approximately 255 million shares outstanding and a 24% non-GAAP tax rate. I would like to take a moment to summarize the drivers behind our conviction of achieving upward momentum and operating margins during the remainder of the year. There are three main drivers: revenue growth, gross margin expansion, and expense management. I will provide a few examples of each of these drivers. First, revenue growth; we anticipate strong relative growth in the back half of the year. Drivers of this revenue growth include, but are not limited to, Mobile Solutions. We entered Q2 with a record backlog in T&L which is coming from recent large customer wins as well as from the software services. This backlog provides high visibility to revenue growth in the back half of the year. In E&C, Buildings and Heavy Civil have strengthening trends which will also drive material revenue growth. Buildings, for example, is largely a software business. Growth in 2016 license sales comes on top of a solid basis support in maintenance revenue. In TFS, we expect growth due to geographic shifts and new product releases. To be more specific, the addition of software and services is beginning to move the needle as are product releases which bring us into a new class of lower horsepower equipment. We also continue to see positive revenue growth in markets outside of North America. Second, for gross margin expansion in E&C we see growth in Buildings revenue driving overall margins up. We also see our Geospatial business returning to a more normal albeit more muted level of growth in margins. In T&L, the backlog I mentioned will turn into increased subscriptions with corresponding higher margins in the upfront hardware revenue. Lastly, in terms of expense management, we're implementing additional cost control to protect the model, and we continue to review our product and divisional portfolio for rationalization opportunities. Added together, these effects have the potential to deliver high single-digit revenue growth and significant operating leverage in the back half of the year. With that, during the second quarter, we will be presented at the JPMorgan Technology Media and Telecom conference in Boston on May 24th and the William Blair Growth conference in Chicago on June 15th. We will now take your questions.

Thank you very much. I just wanted to ask quickly about the confidence of improving mix in geography in the latter part of this year. Just wondering if you can give us a little color. Is that related to new product launches and ramps, etc.? Any color you can give there. I'm sure people will ask, it seems like your construction and engineering is decoupling a little bit from the other indicators that a lot of the time we see in the industry. So if you can talk a little bit about where you are seeing the drivers in construction engineering. Thanks.

Relative to the geographic mix, the specific market I highlighted in my comments was relative to Field Solutions specifically in the agriculture division. What we're seeing in agriculture, I will give you an example from Q1, is we experienced stronger revenue growth year-over-year in Europe, Russia, and Asia-Pacific whereas we saw negative year-over-year growth in North America. As you, of course, move through the year in agriculture and the planting cycles as they work around the world, that plays itself out in geographic mix in Field Solutions as we move forward through the course of the year. And that would be really the one geography I would point out outside of North America in one particular. The other one I did call out as well was in Geospatial. In Q1, our North America performance was weak relative to our expectations and we see that coming back as a percent of the overall business better in the rest of the year. So that is the geographic mix.

Sorry, just to interrupt. So basically, what you are looking at is the typical seasonality across geographies, so that should drive better performance later in the year, correct?

In Field Solutions, there are two aspects to consider. Firstly, yes, there is the typical seasonal mix. Additionally, we have observed a strengthening position, particularly in the agriculture sector. This improvement is not limited to the U.S. as we are also seeing more robust markets in other regions. Therefore, alongside the seasonal shift, we are experiencing stronger performance in those markets.

Regarding your question about civil construction, at a high level, we are selling technology that allows us to operate independently of traditional indicators related to equipment sales. This situation plays out regionally, particularly with the U.S. Highway Bill, which has been challenging to quantify in terms of its precise impact. However, anecdotally, the passage of the highway bill has increased confidence among contractors, who are now able to anticipate multi-year funding and evaluate their competitiveness for future projects. This has prompted them to initiate investments to prepare for the expected spending. The heavy civil sector's performance is also largely regional. For instance, Australia, while not thriving, is stabilizing after several tough years. Most of the early gains in Australia were driven by agriculture, but construction activity is stronger than it has been in recent years. Similarly, Europe is gaining strength. Recently, at the BOMA Exhibition, the largest construction show globally, the atmosphere in Germany was notably optimistic regarding future prospects. It seems we are witnessing a variety of factors contributing to this recovery, with different markets that have been inactive for a while beginning to show signs of improvement, even if it's at a level lower than two or three years ago.

Steve or Rob, could you go back over for a second the Mobile Solutions business? You addressed the op profits here, the non-GAAP op profit and the margin there. I think you said there was growth investments there which I think makes some sense and then some acquisition that closed in the quarter. The step down there year-over-year is noteworthy. I know the business is growing, you have a good backlog, but just speak to what the expectations are for the profit margin there as the year starts to play out here with the backlog in the growth.

Sure. This is Rob. I think Steve might have covered this as well in his comments. In Mobile Solutions we expect to be near a 20% operating income level; we see that as directionally achievable for the year. Now let's start to go back to the beginning of your question relative to the margin performance, the operating margin performance in the quarter, and how to put that in context. I do so in a couple of ways. Primarily let's talk about the hardware versus the subscription impact in the transportation and logistics. So the way the orders and really the revenue play out in that business is let's say you get an order. And in fact this quarter, we have had very large orders. We had our single largest order we have ever received, and we had record backlog coming out of the quarter. As you are fulfilling that hardware, you first fulfill the hardware before you turn that subscriptions on. That hardware has far lower gross margin than the subscription does on an ongoing basis. So the first dip you take when you have an order of magnitude, basically it was a nonlinear change in the hardware implementations that we did during the quarter that has an impact of driving the gross margin down. Now as the hardware units get installed and they come online into subscription, you now go the other way and margins come up in the business. That's the first part of the answer, and the second part would be, of course, it is a subscriber business; therefore, accumulative subscriber business and as that cumulative subscriber base grows and the revenue expands, now I have got that margin percent on a higher revenue base and I am getting operating leverage expansion out of that.

Is the subscription in your description actually comes online when the truck is sold? So in other words, we record the revenue and the op profit on the hardware to let's say PACCAR and then when that truck is sold to the end customer is that when the subscription comes on?

Let's talk about OEM versus aftermarket. The vast majority of our sales and transportation logistics are aftermarket sales. So depending on the customer, let's say they have a fleet of 100 or a fleet of 1,000, some customers may choose to roll out in waves or in stages, and others may choose to turn them all on at one time. There is not a singular prescription for that. In that case, it is not about the sale of a truck; it is about the fleet implementing or I should say installing the hardware and then turning on the subscription or turning on the software service. On the PACCAR side, the primary sale that we have is actually sales to PACCAR so they are placing orders or the OEM is placing orders with us. So upon delivery of our units to that customer, that's when we recognize the hardware revenue. There is a second part of it, which would be how do you turn those into subscriptions that would happen sometime in the future after the truck has been sold and the customer chooses to install or I should say turn it on.

Can I just ask a follow up, and maybe just to expand that conversation for one second. As a follow up when I look at the second quarter guide and I walk my way up the non-GAAP P&L I'm coming in to an EBIT margin that is 15.2% to 17.1%. Granted, there is not that much sequential revenue growth from the first to the second but obviously your comments about the second half and the margin improvement across the board in these businesses to get to 20% plus or minus a point for the full year your plan kind of dictates op margins, non-GAAP op margins in the second half that are 22%, 23%. That's what your plan looks like?

Let me jump in to clarify maybe on two points just because I think there is some poor communication on our part. First of all, I think clarification of what Rob said. What I heard Rob say could be inferred as 20% for the full year operating margins for Mobile Solutions when in reality we're talking about being there towards the end of the year. The second implies to the full Company, which is again maybe we miscommunicated here, but the idea here is to reestablish 20% by the end of the year as the norm for the Company. Yes, I would agree that the arithmetic for the full year would be daunting and not terribly credible. So what we're talking about is operating margins in the neighborhood of 20% by the end of the year, with particular emphasis on the second half of the year.

I was hoping you could flesh out what you see accelerating the growth in the ag business in particular in the second half. I know you have some new products. I am wondering if you can talk about any more specifics on them and how significant just comps are and how are the comps in the second half versus the first quarter which you saw the high single-digit decline. Thanks.

Let me talk about on the new product side. We have been increasing, I will give you a few examples, the software and services content that we have in the ag businesses starting to get to point of some significance; enough significance where it can start to move the needle. And we have talked about some of our acquisition I think over the course of the last few quarters I will give you one example being that we see that strategy playing out and starting to bear some fruit for us. On the hardware side, which is really the bulk of the business still today and probably what we're best known for in ag. From a new product perspective, we have a new display; it is called an MMX display. And with this MMX display, this gives us an entry price which is lower with a lower entry price point that helps us not only in emerging markets but also to get onto lower horsepower equipment in a market such as North America. And with that lower hardware platform, the way it has been designed and built is such that you can then expand the capabilities over time to allow for upgrades, for instance. So that is some color on the product side of agriculture that is driving our belief set in the rest of the year performance.

How about irrigation? That has been rolled out. Is that expected to get some traction here?

I think in general in terms of irrigation, yes, it will be a lift starting probably late second quarter into the year. The learning on irrigation, which probably follows very much the same pattern as we have historically discovered in construction, is that it is not a consumer product. It does not take off instantly. There is a trial period. So a farmers who may need 30 irrigation systems in total may try it out for the first year on one. So that process really began last year. We would expect pick up on that during the course of this year and continuing. It would be against maybe the expectations that we had maybe a year and a half or so ago where being an enthusiastic technology company we knew that demand was going to be instant and universal. It is turning out to be again a very classic Trimble sort of product which is prove it and build momentum over time by proving the technology. So it is a seasonal business. As we move deeper into the year, we'll be into what I really second effective selling season for irrigation. I would expect it will lift the second, third and fourth quarters particularly second and third quarters. But again I think it will be progressive as opposed to, let's call it a step function.

I'm wondering if you can bridge for us in buildings just some context behind slowing customer sign-offs. In the quarter it looked like you showed some progress in the back half of 2015 in getting the sign-offs done and I am wondering what drove the step back this quarter. And also based on your second quarter implied guidance for margins it looks like you are not counting on revenue burn accelerating sequentially; is that a fair way to interpret the mid of the guide?

So with the deferred revenue, I will start there, with the deferred revenue balance that we have that will play itself out over the course of the year more so in the second half of the year. This definitely doesn't just drop in Q2. There will be a linearity throughout the rest of the year. On buildings specifically, I will give you a couple of examples of what I was referring to in my comments. First if you look at our Manhattan Software business, basically that business has a relatively small number of transactions each with a high dollar amount associated to them. We had a small number of contracts where we had push out of customer acceptance from Q1 into Q2. What you have then is you have the accounting effect of taking the cost in Q1 but not the revenue that's associated with it. So come Q2 for that revenue stream, you would take the revenue with very little cost. That's one of the impacts. We had a small number of contracts where this happened. The biggest one we have already here in April, in the first few weeks achieved the acceptance from the customer on the contract and now have that in our April and therefore Q2 revenue. Another dynamic in the buildings business is about this time of year you are going out and you are getting maintenance renewals from customers, and if the customer pushes out that maintenance renewal from March and pushes out until April, I now pushed some revenue from March into April. And that is another one where we can look here in the first few weeks of the quarter and we can compare the April results we have in the first few weeks to that of April the first few weeks last year. It is up high double-digit, so I can see from a fact-based perspective that revenue is now in Q2. So those would be some of the examples to bridge your revenue questions in buildings.

And then in Field Solutions can you bridge for us the year-over-year margin performance you mentioned? I know last quarter you had a positive mix impact on a year-over-year basis, so I'm wondering what drove the variance. And I know you have been working on the cost structure over the past couple of quarters in Field Solutions and I'm wondering what was the offset; why didn't that drop through in the quarter? Thanks.

The main impact was related to the geographic mix. The products we sell outside of North America generally have a lower margin compared to those in North America. While we have seen higher growth outside of North America, North American sales decreased, which negatively affected our gross margin due to the geographic mix. Additionally, during the quarter, as shipments and orders were strong outside of North America, we expedited some orders, leading to increased shipping expenses that slightly impacted our gross margin.

Steve, just for clarification it sounded like you are actually seeing increased demand in heavy civil from contracts ramping up from the highway bill. Just wondering if that is correct. And if by any chance you can provide a little more color on your thoughts around what kind of growth you think that will drive.

I don't want to give the impression that we can measure foreign exchange with complete accuracy. We were pleasantly surprised by the strong demand both in the U.S. and globally. When discussing the reasons for this demand increase, many conversations point to the highway bill. I believe that a considerable part of the growth in the U.S. can be attributed to this bill, as it has instilled confidence in contractors, encouraging them to begin investing with the expectation of sustained spending over the coming years. This is quite significant. Notably, we're also witnessing an increase in heavy civil demand around the world, even in some markets where we haven't observed it before. Thus, this is a global trend, not just confined to the U.S. In a general sense, while we talked about muted growth a quarter ago, which we considered to be relatively low single digits, I would now preliminarily describe it as high single digits, with the potential for even more growth. This marks a significant shift in sentiment in the Heavy Civil sector over the past two years. While the highway bill plays a role, it is not the sole factor influencing this change in perspective.

You talked about some of those margin expansion initiatives at the very beginning. Can you talk about the removal of tax code basis and the reduction you are expecting this year and really the target you have in a given year of kind of cleaning up those legal entities? And then maybe with that if you can list the most important cost reduction or margin expansion efforts in that kind of portfolio rationalization, cost reductions, this legal entity reduction that would be helpful.

I will take the questions. There are a few parts there so you are probably going to have to remind me of one or two of them. You asked about the tax code and impact on sales. I presume you are talking about the ag business at the end of last year; is that right?

Yes.

Okay. So I would put that in the same category probably as highway bill as hard to characterize to a degree of precision of how much volume that drove for the business. I think it is fair to say that it had an impact; it had a positive impact at the end of last year which probably takes you to a logical conclusion to say that led to a drop-off in Q1. Our Q1 numbers from a revenue standpoint came in as per our expectations, so it didn't come to us as a surprise the Q1. How much it had an impact overall and whether you want to attribute it to Q4 or Q1, it would be in the low millions in our assessment of revenue. So your next question was relative to legal entities and simplification and what kind of opportunities for improvement that could lead to; is that right, Brett?

Yes, that's right, Rob.

We have acquired a number of businesses over the last 15 to 17 years, which has resulted in an increase in legal entities. It’s not simply about reducing these entities, as that alone is not a solution. Instead, it’s about understanding the overall complexity from our acquisitions. Having many legal entities can lead to numerous buying and selling structures, along with possible duplications in stock controls and ERP systems. We view the legal entity issue as a straightforward way to illustrate a broader set of simplification activities we can pursue. Like any significant initiative, we need to consider the cost-benefit aspect. Therefore, we have been cautious about the pace of our actions because we want to ensure we achieve a solid return on investment as we reduce the number of legal entities. Each year, we reduce both legal entities and bank accounts. In years with more acquisitions, we may find ourselves at a baseline again. Currently, with a lower number of acquisitions in recent quarters, we see this as an opportunity to get ahead. The exact outcome and potential savings remain uncertain, but we are confident that this is part of our strategy to enhance operating leverage and our capacity to scale as an organization in the future. You had another question, Brett.

Sorry, I didn't mean to wrap so many questions into one. I know that is difficult to deal with. But thanks for all that color, Rob. And I guess the last was out of all those initiatives what do you see as the lowest hanging fruit or the biggest opportunities in the near term?

Are you referring to the initiatives that Steve talked about?

Yes.

I would basically say the lowest hanging fruit would be just this pruning activity. Now it doesn't generate huge numbers, but it does actually move operating margin percentage, and probably when we're done it will have moved it by a point rounding up maybe a bit. So I think that's the lowest hanging fruit. I think the more significant in the short term is just let's call it increased cost rigor, just looking at cost categories and just putting them in the frame work of cost benefit. I think that we're doing it continually, but let's just say within the last year we have become more intense about it. But I think that in terms of short term significance, that is the most significant over the next couple of quarters.

Just a couple of points of clarification. On the Mobile Solutions business, as the backlog builds, how do you get comfortable that what's in the backlog doesn't have a similar effect? Or maybe better asked is what's in the backlog mix; heavy equipment, is it subscription? How should we think about it going forward as you grow the backlog each and every quarter as well?

So to put it in context, we have a record backlog in the business now. If we were to have, in principle, another step function level of backlog come in, it would be possible that we could have a shift out in the margin expansion, but then that would be offset by a higher cumulative subscriber base generating margins on that basis. The model as we have planned it for the quarter and for the rest of the year takes into account our current level of backlog and how that will play out; current and expected, I should say, level of backlog and how that will play out.

Rob, I guess as you get more into the role that you have today, how are you getting more comfortable with the forecasting across so many different businesses? And certainly in the case with Advanced Devices it was a shortfall and I think there were some other moving pieces across the cost structure. So maybe you can provide a little bit more clarity for us in terms of what you are doing to improve the forecasting.

If we look at forecasting, we can break it down into several components. At one level, we have our reporting segments and the divisions associated with them, and on the other level, we can examine the lines of the profit and loss statement. I believe it's essential to have a strong understanding of our costs; this predictability in our cost structure is our top priority. As a technology company, the majority of our expenses are related to personnel. Managing our cost structure rigorously across all divisions begins with a clear message from leadership. Next, when examining the profit and loss from a gross margin perspective, it's crucial to have a thorough understanding of our business. There is no single answer for Trimble given our diverse portfolio of different businesses, meaning that changes in the mix can affect the overall figures. It’s important for us to comprehend the margin drivers at the individual division level and how aspects like product mix or geographic mix influence those margins. Finally, as we progress to the top line, you would generally anticipate the most variability on the profit and loss statement, but we aim to manage that within a well-defined range of expectations. This is driving much of the rigor in our planning processes and communication within the team. Regarding the division-by-division roll-up, each business likely has its unique answers, so we certainly do not apply a one-size-fits-all approach across the various operations.

Maybe I can follow up later on. I was just trying to get a better sense in terms of what you are doing differently to tighten the process a little bit more, but I can follow up afterward in interest of everyone's time. Maybe on a cash flow side if you can just walk us through lastly. It is a great number for the quarter. What is your expectations in terms of free cash flow conversion for the year and as you go to the subscription and services business how should we think about that inventory number?

So we don't guide out on cash flow presently. I guess what I would tell you is the performance we saw in the quarter, that is not a fluke, and we would expect that kind of progression and performance over time.

I want to step back because I listen to the entire description and I look at what consensus numbers look at and I have to get back to some very basics. Based on what you are saying, wouldn't the probability of revenue in the second half of this year exceed the revenue in the first half of this year? Is that what you are implying? Because that is not what consensus is looking at, that is not what people, investors it is not what is in the statistics. But it almost has to be that you are expecting a much better revenue in the second half versus the first half of the year, not versus last year. We know versus last year but the second half would be a stronger revenue than the first half of the year, which is a little bit seasonal.

We don't have to imply it; we will say it outright. We do expect the second half to be stronger than the first half and for the reasons we tried to list here.

What I'm seeing is the way the estimates there is a $1.25 consensus on what I assume you missed the first quarter by $0.03, your guidance in the second quarter is a little bit less. So you are sort of still believing we're going to get to where we ought to get to, but based on a much stronger second half in the year; that is a fair statement I think at this point?

Yes, again all we have actually talked about up to this point in time is the first quarter and the total year. And I think for some of the reasons we talked about, the first quarter was in the midpoint of guidance, and there was a scenario that said it would have been stronger but in terms of late breaking customer acceptances and whatever influenced the number down. I kind of shrug my shoulders at that and say okay, I don't think that is part of the secular story here. But I think all along, given the profile of the year, is that when we have been talking about the full year, we believe there is underlying up to the right trend involved in this Company and it kind of plays out through 2015 and actually into the first quarter. It is not obvious, but particularly when you adjust for things like the deferred revenue effects and all those sorts of things we believe there is a trend here. And if you look at the franchise businesses of heavy civil, buildings, transportation logistics, even ag excluding geospatial, we believe that the outlook for the year is good in some of the cases improving. So, yes, without a doubt, without any ambiguity whatsoever management believes the second half of the year will be stronger than the first half.

Now can we just go through the Mobile Solutions business? You know truck markets you have gotten great OEM contracts and this is basically a penetration argument going on of a new product. Because we're entering a 20% to 30% decline in heavy truck production over the rest of this year and this product is not going into Europe from what I understand, which is where the market is strong. So this is really just a penetration of a new product that's driving the Mobile Solutions business growth.

I think the paradigm is larger than that, Eli. First of all, in terms of PACCAR, there is an OEM component here. But let's just say we're relatively immune overall from kind of what is happening in terms of the new truck market. As Rob said earlier, our fundamental market is the aftermarket. It is going to the operator of the fleet and selling functionality, selling value add. So I think we're not really totally aligned with the new truck market. Yes, it makes it easier when you are putting Trimble on the factory. But in reality, the market paradigm is larger than a single product. We're selling an enterprise solution to a large extent. We're selling a workflow solution. So a new product helps; a new product gives us a lift. But in reality, I think the paradigm we're actually out there selling is a larger paradigm and it really has to do with work flow and it has to do with enterprises level improvement and those sort of things. So, yes, product enters into it but it is more than just product.

So the big backlog and the step up there is OEM business directly, isn't it?

No, it is aftermarket driven.

Okay. So the bulk of that backlog is aftermarket as opposed to OEM?

Correct.

Same thing, can you give us some idea what you think your potential in the ag market? You talked about bringing the horsepower which is where the demand is growing. Can you talk about what the size of that market would be relative to the size of the normal tractor market, which is big dollar value? Do you sense that market could be some sort of reasonable percentage of the existing market in ag?

The answer would be yes. It is a reasonable percentage of that. And to maybe get our heads around that, not only would you look at a market where we have been for a long time such as North America, but now start to think about emerging markets where you need lower price points whether that is on lower horsepower or higher horsepower equipment that starts to open up a strategy at play we believe will open up doors that heretofore have been closed to us.

This is actually Kristin in for Collin. I appreciate you guys squeezing me in. Just a quick one from me on the E&C. I was hoping to dig in a little bit on your margin improvement story there. You called it out as the heart of the improvement area. And I want to ask how much of that is related to product mix versus what you are doing internally.

The margin improvement in E&C is driven primarily by the Trimble Building business, which is predominantly software, leading to high margins. The buildings business has experienced double-digit growth over the past couple of years, and we believe it will continue to grow at that rate through Q2 and the remainder of the year. This segment is the fastest-growing within E&C, driving margin expansion. Additionally, our Heavy Civil business has also seen year-over-year gross margin expansion, contributing to overall operating margins. This improvement is supported by cost reductions and the annual introduction of new products, along with a focus on enhancing our software and service mix.

Okay. And that sort of speaks to my next question which is just in the shift in the channel. I mean you are bringing in these more high value products with the software and the software as the service mix. How is that offset or where is the opportunity there on the operating margin standpoint? I mean those are presumably higher touch sales.

So the buildings business is predominantly a direct sales model. We do have a channel called Building Point in that business, but today it is predominantly a direct sale and for our professional services as well. It is not only direct but it is vastly direct sales business. And, yes, you are right, the nature of some of the complex software that requires high domain knowledge and touch leads to or has led over course of time to a direct sales model.

Thanks, Britney. And thanks everyone for joining us on today's call. We'll look forward to talking to you next quarter.