Trimble Inc (TRMB) — Q1 2019 Earnings Call Transcript

Good afternoon. We delivered the quarter we anticipated three months ago. Compared to the prior year, revenue of $805 million was up 8%. Annualized recurring revenue of $1.07 billion was up 30%. Adjusted EBITDA of 21.4% was up 60 basis points and trailing 12-month free cash flow was up 38%. We expect that growth and profitability metrics will be relatively stronger in the second half of the year than the first half. The quarterly results provide further evidence of the ongoing transition of the Trimble business model towards increased software content with a growing proportion in the form of subscriptions. Although, the change is taking place through relatively small quarterly increments, the aggregated multiyear effect is transformational. Rob will speak more specifically to the rest of the year, but the summary view is that the Building and Infrastructure and Transportation segments both continue to operate in healthy markets. The Geospatial segment is challenged by slower OEM demand. And Resources and Utilities is currently constrained by a U.S. agricultural market suffering from trade disputes. Although revenue growth was at the low end of our strategic growth model, we believe the fundamentals continue to support our long-term expectation of 9% to 12% combined organic and inorganic revenue growth. This optimism is driven by our estimate of the penetration still available in our targeted markets, which allows us to expect higher growth than standard GDP or industry-specific growth metrics. Innovation remains our principal mechanism to achieve market penetration and above-average growth. Our three points of emphasis on innovation are to increase reliance on platform technologies that have utility across the company, to use those platforms to create solutions targeted at individual protocol markets, and to discipline that innovation within our management construct of 3-4-3, placing equal weighting on performance in the next three months, the next year, and the next three years. Our innovation consists of a combination of transformative point solutions targeting individual operations within the workflow and comprehensive information solutions that unify office and field workflows. Beyond that, our competence in both hardware and software allows us to create value by integrating the physical and digital worlds into unique solutions. The strategic agenda was advanced through a number of actions in the quarter. Although this list is not complete, it represents Trimble's ability to bring together different elements to create unique and powerful solutions. In the Buildings and Infrastructure segment, the recent e-Builder and Viewpoint acquisitions continue to enable us to reinvent project delivery and construction by transforming workflows through a constructible model. These two acquisitions are now embedded within an integrated Trimble market concept, delivering a continuous flow of incremental functionality to the market. The Buildings and Infrastructure segment also had two significant product launches. The first was the beta release of WorksManager, cloud software that creates a two-way interlink between digital design and the office and machines in the field. The other meaningful product announcement was the XR10 with HoloLens 2, a mixed reality device in a hard hat that allows an on-site construction worker to utilize mixed reality and Trimble's unique construction workflows on the work site. Both technologies emphasize Trimble's comfort in both the digital and physical worlds as a source of relative advantage. In the Resources and Utilities segment, we released our first version of AutoSync software and firmware that synchronizes materials management and the management of farming implements. This allows us to leverage the installed base of field displays to provide common guidance lines, boundaries, and operational information across all connected devices. In the Transportation segment, we reorganized and integrated the mobile and enterprise businesses into a unified, more cost-effective organization with the expectation of accelerated progress. We have completed the process of combining the PeopleNet, TMW, and ALK brands into the Trimble identity. The Transportation segment also had a significant product release, Trimble PULSE Telematics in February. This connects data from the field to the back office, enabling workflow optimization for technicians providing field services. In the Geospatial segment, we expanded the vehicle-based mobile mapping portfolio that was successfully launched in 2018 by introducing a lower-priced version, expanding our addressable market to midsized surveying and engineering firms and state departments of transportation. In the last two quarters of calls, we identified several emerging watch list issues that might impact us. Four issues were identified as we left the fourth quarter that provide us with an inherent upside if the trajectory changes, as we embedded a level of conservatism in our forecast. The first was the impact of trade policy, creating significant uncertainty for U.S. farmers and reluctance to invest. This hesitancy to invest affected our Resources and Utilities segment's performance in the quarter, which was partially offset by better performance in other regions. The China-U.S. trade agreement is likely to create clarity for U.S. farmers and provide us with immediate upside potential. The second issue was Brexit, which remains unresolved albeit deferred. While the Brexit effect is hard to pinpoint in a generally upbeat quarter in Europe, uncertainty is impacting investment appetite to some degree. Beyond Brexit, the European export economy is exposed to a slower Chinese economy. If these issues impact decisions on new investment in plant and infrastructure, it affects us as well. The third watch list item was the combination of slower Chinese growth and intensification of Chinese government policies that create explicit preferences for Chinese companies over non-Chinese companies. Our first-quarter revenue in China was down significantly year-over-year, primarily due to the slower economic conditions impacting our Chinese OEM sales and secondarily as a result of the mandated preferences for Chinese-sourced products. The relative silver lining is that our downside exposure to China is limited, representing less than 2.5% of total company revenue in the quarter. The rest of Asia outside of China improved more than 10%, offsetting much of the Chinese impact. We continue to believe in China as a long-term growth market and think clarified trade expectations can provide us with a net upside. The fourth watch list item was OEM demand, which we anticipated would drag in the first quarter. This is mixed; on one hand, we are encountering short-term headwinds in our more traditional OEM markets in tiny and embedded components. On the other hand, we are establishing significant new OEM partnerships in construction and agriculture. Our improving profile was evident at Bauma, the world's largest construction show, where we were present as part of the machine solution in 20 OEM booths. Recent press releases of new or extended OEM partnerships have included Kobelco, Liebherr, Doosan, and Volvo. Strategically, our primary market focus is not on OEMs, but remains on the end-user, which accounted for approximately 85% of our 2018 revenue. The logic here is that those end users, primarily farmers, contractors, and trucking operators, live in a mixed fleet universe, and it's critical for OEMs to operate within an interoperable, hopefully Trimble-centric technology ecosystem. Another positive external consideration is the U.S. infrastructure bill, though with an unclear probability. Both political parties support a significant increase in infrastructure spending but struggle to find a funding mechanism. If a bill passes, we expect it will contain elements promoting cost-effective spending through an emphasis on digital construction. Passage of a bill would have an immediate move-the-needle impact on results in multiple reporting segments. In summary, despite some uncertainties, we remain strategically on track and anticipate strengthening organic performance throughout the rest of 2019. Let me turn the call over to Rob.

Thanks, Steve, and good afternoon, everyone. Let's turn to slide 5 for a review of the first quarter results. Starting with the top line, first-quarter total revenue was a little less than $805 million, growing 8% year-over-year. Breaking that down, currency translation subtracted 2%, and acquisitions added 7%. Organic growth was 3%. ARR or Annualized Recurring Revenue grew to $1.07 billion in the quarter, up 30% year-over-year and up in the low teens organically. Gross margin in the first quarter was 58%, up 90 basis points, which came from a combination of M&A and organic growth. The adjusted EBITDA margin was 21.4% in the quarter, up 60 basis points year-over-year. Operating income dollars increased 8.3% to $152.9 million with operating margins of 19%. While operating income dollars increased, net income was essentially flat on a year-over-year basis, with earnings per share at $0.45 also flat year-over-year. This was a result of higher interest expense and the increase in our non-GAAP tax rate from 19% to 20%. For additional context on a trailing 12-month basis, revenue was up by 15%. EBITDA margins have expanded by 220 basis points, and EPS has increased to $0.23. Cash flow from operations was $148 million, up 78% year-over-year and up 35% on a trailing 12-month basis. Free cash flow, which represents cash flow from operations minus capital expenditures was $133 million in the quarter and was up 38% on a trailing 12-month basis. Cash flow growth in the quarter was driven by operating income growth, favorable working capital dynamics, and lower acquisition expenses compared to the first quarter of 2018. Moving to the balance sheet, our business model continues to be asset-light. Deferred revenue was $464 million, up 29% year-over-year, correlating to the increasing recurring revenue mix in the business. Net working capital inclusive of deferred revenue stands at 3% of revenue on a trailing 12-month basis. Regarding debt and liquidity, we closed the quarter at a gross debt level of just over $1.89 billion and net debt of $1.68 billion, representing 2.31 times net debt to adjusted EBITDA on a trailing 12-month basis. Less than a year ago, we stated that we would delever to under 2.5 times within 24 months of our acquisition of Viewpoint, and we have achieved that in less than 12 months due to strong cash flow and EBITDA progression over the past few quarters as well as by continuing to pay down the debt itself. As evidenced, we paid down an additional $73 million of debt in the quarter and have reduced our gross debt by approximately $300 million since we closed the Viewpoint acquisition in the third quarter of 2018. For perspective on our liquidity, we have borrowing capacity on virtually all of our $1.25 billion revolver. The point is that our business model works, our balance sheet is resilient and well designed with well-staggered maturities on the debt and ample liquidity should we need it. In addition to the repayment of debt in the quarter, we also repurchased $40 million of our stock. From an overall financial performance perspective, I would like to highlight and emphasize three metrics from the quarter. First, our annualized recurring revenue continues to demonstrate strong and consistent growth, reflecting the ever-increasing software and subscription content within our business mix. Second, the growth in our free cash flow demonstrates our technology orientation and asset-light nature of our business model. Third, our ability to delever rapidly following a large acquisition, such as Viewpoint, further evidences the cash generation capability of our business model. Let's move to Slide 7. We have revenue details at the reporting segment level. Overall, revenue was in line with expectations. As is the case in every quarter, there were puts and takes. We continue to see softness in the OEM portion of our Geospatial business, particularly in China. We also saw continued softness in the North American agricultural market, adversely impacted by the trade situation with China. Lastly, we experienced discrete delays and project completion sign-offs that postponed the capture of revenue in the quarter. In terms of where we performed better than expected, Buildings and Infrastructure and Transportation were standout performers. In Buildings and Infrastructure, we outperformed in the aftermarket in both civil and building construction. Notable highlights included the subscription transition in the SketchUp business, which was successfully received with a better-than-expected mix of subscriptions, negatively impacting short-term revenue but was then partially offset by higher-than-expected unit growth. Our Viewpoint and e-Builder acquisitions were in line with expectations, and subscription bookings growth continued to be strong, with ARR for the two acquired businesses combined up approximately 20% year-over-year. In Transportation, the truck routing mapping and navigation business excelled in the quarter despite a difficult prior-year comparison. Moving to slide 8, our overall geographic revenue mix remained relatively unchanged year-over-year. We experienced growth of 10% in North America driven by construction growth in the U.S. In Europe, we experienced growth of 10% with general growth across the region, including the U.K. In the Asia Pacific region, we faced a slight headwind of negative 1%, driven mostly by difficult conditions in China, while other major regional markets were up. And lastly, in other regions, we were up 3%, including contributions from our recent acquisition of Veltec in Brazil. Please now turn to slide 9 for a review of our revenue mix by type, presented on a trailing 12-month basis. Software services and recurring revenue continued to grow by 28%, with organic growth rates in the low teens. This now represents 53% of total Trimble revenue. Within that, recurring revenue, which includes both subscriptions and maintenance and support revenues, grew 29% year-over-year, now accounting for 31% of total Trimble revenue. Software and services grew 27% year-over-year, while hardware has grown at a low single-digit rate, reflecting largely the recent headwinds in our OEM-related businesses and difficult comparisons in Transportation from the Phase I implementation of the ELD mandate a year ago. Lastly, I would like to mention that starting this quarter, we have disclosed additional revenue details in the summary tables on our Investor Relations website. These revenue details correspond to the numbers on this slide. Next, let's turn to slide 10 for operating income details by segment. In short, the operating income results align with the revenue commentary, with Buildings and Infrastructure as the strongest performer. Resources and Utilities and Geospatial margins were impacted by the aforementioned revenue dynamics, while Transportation margins were largely in line with expectations and expected to expand in the second half of the year. Moving now to guidance on slide 11, we continue to see the year playing out as discussed in last quarter's earnings call, with organic growth, margins, and earnings growth improving throughout the year, alongside a continued shift towards software and subscription revenues. For the second quarter, we expect revenue of $850 million to $880 million, with EPS of $0.52 to $0.56 per share. The second quarter revenue range implies total company growth of 8% to 12%, with organic growth in the 3% to 7% range, plus 7% from acquisitions, less 2% from FX due to the strengthening of the U.S. dollar. Our second quarter organic growth guidance reflects an expected improvement from the first quarter, driven by two factors: first, the second quarter is typically the strongest for civil construction; and second, in Transportation, we will have lapped the ELD-related installation surge. Please note that while we accrue interest quarterly, the cash interest payments take place in the second and fourth quarters. For the full year, we are reaffirming the view we discussed last quarter, expecting full year company growth in the 6% to 10% range, with organic growth of 4% to 7%, 3% or 4% from acquisitions, and a negative 1% from currency impacts. We expect organic revenue growth and operating margins to improve through the year, with EPS growth in the high single-digits for the full year and double-digit EPS growth in the back half of the year. From a revenue seasonality perspective, we expect second quarter revenue to be the highest in the year, which is normal given it represents the peak of the construction season. In the third quarter, we expect slightly lower sequential revenue, reflecting an expected seasonal summer dynamic. Finally, we anticipate fourth quarter revenue to be sequentially above third quarter revenue, in part because our fiscal year this year is 53 weeks, which includes an extra week in the fourth quarter. For this same reason, we would expect operating margins to be strongest in the fourth quarter, given that the fourth quarter typically has the highest proportion of software-related revenues and the extra week will contribute an additional week of recurring revenue with healthy margins. Strong first quarter results reinforce our expectation that cash flow from operations and free cash flow will grow faster than net income during 2019, with cash flow from operations expected to exceed net income. From a capital allocation standpoint, we expect to continue delevering while selectively evaluating buybacks and M&A based on market conditions and available opportunities. In closing, our guidance for the second quarter and full year reaffirms our previous guidance for the first half of 2019 as well as the overall year. Let's now take your questions.

Hi. Good afternoon. And just wanted to congratulate you on the solid results given the challenges that are out there. Can you give us a sense of how you see the situation around the macro unfolding and perhaps some of these headwinds from China? Are there steps that you can take to mitigate what's happening there, and just any broader thoughts around those topics?

While I don't know that we have particularly great insight compared to what is already available to you, we are seeing Europe continuing to remain generally strong. Germany is affected by China perhaps more than others in terms of its export markets, and whether that damps investment remains to be seen. However, so far it's holding up. There's, of course, the Brexit issue that will have a specific impact on the UK and potentially the rest of Europe. Yet, Europe seems comparatively robust with some puts and takes. Brazil is a strong market for us in agriculture, and we believe potential construction growth exists there. Argentina is, on the other hand, troubled at this time. Regarding China, it's a situation of waiting. Even in a diminished growth market in China, opportunities exist. We face specific OEM issues in China but expect to return to long-term trends. Access in any potential U.S.-China trade pact is crucial for confidence. Japan is currently looking attractive for us due to Olympic-related spending, while South Africa is struggling. In summary, we are steady as we go, watching China and the UK closely.

Thanks for the color. That's super helpful. Just one other one for me. Regarding the infrastructure bill, you talked about seeing potential immediate impacts. How should we think about those impacts?

If an infrastructure bill passes—we are emphasizing real infrastructure like roads and bridges rather than extraneous spending—it will likely create immediate impacts for us. With a more predictable project flow, contractors would invest in technology to compete effectively, leading to investment in tech as they prepare for upcoming projects. Therefore, we would see immediate effects in preparation for funding when the money eventually begins to flow.

Thank you.

Yes. Hi. Good afternoon and good evening, everyone. I'm wondering if you can talk about the bookings growth performance on e-Builder and Viewpoint, particularly with subscription bookings. What was that performance like this quarter? And you mentioned SketchUp being ahead of expectations—can you touch on that as well?

Jerry, we shifted the commentary on the acquisitions to focus on ARR since both businesses are over 75% recurring revenue. The bookings for Viewpoint and e-Builder continue strong, showing double-digit growth year-over-year. Regarding the SketchUp business, we entered the quarter expecting a higher mix of perpetual licenses but saw an inverse situation with a significant uptick in subscriptions, suggesting it's an effective way to grow our addressable market.

Okay. Rob, you mentioned ARR and organic growth was double-digits—can you provide specifics on major pieces, particularly in transportation and logistics? Any parts of the subscription portfolios that are weaker?

There are no meaningful weaknesses to note in the subscription business. In Transportation, we continue to grow the subscription base. Our enterprise offering is now offering a subscription model to a previously inaccessible customer base. Notable successes include our routing, mapping, and navigation software which continues to acquire new logos through market segmentation. In the Resources and Utilities segment, the correction service business continues to grow healthily.

And in your remarks, you included a lot of discussion on will drive the hardware part of the business. Can you comment on the subscription and recurring revenue piece's resilience amid slower growth expectations?

We believe that there is higher resilience in our recurring revenue stream. We believe we can confidently anticipate our $1.07 billion ARR for the next 12 months. Retaining that revenue base will be crucial, and our track record suggests a high degree of retention, particularly with Viewpoint and e-Builder, where our net retention ratio exceeds 100%. Overall, I'd say our recurring revenue is demonstrating higher resilience compared to other revenue streams.

Hi. This is Ann Duignan. Good afternoon, good evening. Steve, perhaps I'll start with your comments on infrastructure spending and infrastructure projects. Can you share why you think this upcoming infrastructure spending bill could be different from past ones?

You’re right to be somewhat skeptical—I can feel that skepticism. The 2008 shovel-ready program didn't yield positive outcomes because of mismatched spending between state and federal levels. We have no upside built into our forecast, so any outcome would be an upside. We've spent time with trade groups, and the tone within the Department of Transportation seems different this time. There’s a serious level of engagement, though the actual substance remains uncertain, and funding sources remain a divided issue. While the probabilities of passage aren't high, it's certainly more active than six months ago.

Thank you for the color and for addressing that skepticism. Switching gears, as Trimble continues to display its products on OEM exhibits, do you expect this to drive up your hardware percent of sales, and how does this change the mix?

In the abstract, it may boost hardware in the short term, but over time, the hardware equips the machine, integrating into a network and information system that leads us toward software sales. Thus, we perceive our long-term strategy as a software play rather than hardware.

Good afternoon. I have a higher-level question regarding operating profit in all four segments. It appears operating expenses have crept up in all segments. Given that gross margin increased 100 basis points to 58% company-wide, is the increase mainly due to software growth, or what are you seeing?

It's largely in line with our expectations coming into the quarter. As we lean towards software-centric models, R&D acts as a proxy for cost of goods sold. We expect higher gross margins but also higher OpEx due to the hardware business transitioning. We recorded a 90-basis point improvement in gross margins, reflecting that mix. The OpEx growth stems mainly from the B&I segment due to the Viewpoint acquisition this quarter. Transportation is also seeing increased R&D investment as expected.

Can you provide growth rates for the BIM and civil construction segments and how softness in the core engineering space affects civil construction?

The civil construction business encountered slight year-over-year declines but performed in line with our expectations for the quarter. The federal business is program-driven, resulting in variable timing affecting year-over-year comparisons. Overall, civil construction experienced double-digit growth year-over-year, with strong aftermarket performance in both civil and building construction.

Hey guys. Thanks for taking my question. How did the quarter performance compare to expectations for each segment, particularly Buildings and Infrastructure?

Buildings and Infrastructure and Transportation were slightly above expectations, while Geospatial and Resources and Utilities were slightly below. The performance of Buildings and Infrastructure was a standout, exceeding expectations across the board.

Regarding free cash flow, is it fair to say that net working capital should decrease as a proportion of revenue going forward?

It’s reasonable to assume working capital will continue to decrease. Our model is already asset-light at 3% of revenue. Moving to a subscription model offers an avenue for reduced dependence on working capital, potentially heading closer to zero or negative as we progress.

Do you have multiyear contracts or unbilled deferred revenues?

Yes, our disclosed backlog of over $1 billion shows that a significant portion is contracted. Approximately 76% of that backlog is within 12 months and does include some unbilled deferred revenue.

Hi, good evening. This is Kristen. I wanted to follow up on the organic growth in Buildings and Infrastructure. How much of that can you attribute to cross-selling opportunities from e-Builder and Viewpoint acquisitions, and what margins are you seeing on that cross-sell business?

We are in the early stages of capturing the cross-selling opportunities. We've initiated cross-selling incentives. We have seen a few million dollars in activity thus far. The strong organic growth hasn't fully reflected the integrations yet, but it presents significant future opportunities for us to build from.

In Transportation and logistics, after the phase one implementation, what kind of opportunity are you seeing following ELD device dissatisfaction in the market?

We’ve seen buyer’s remorse from customers stemming from capital spending efforts that fell short. This creates an opportunity for us as customers seek better functionality. The second phase of ELD regulations is going live in December, keeping the market dynamic and competitive. Our integrated offerings across management and field are creating a more favorable position for us.

Would it be fair to say incremental R&D spend in that segment is allocated towards this integration?

Yes, the R&D allocation is aimed at effectively linking our cloud offering and ELD compliance to drive additional functionality and value, ensuring that we remain competitive.

To the extent possible, can you comment on the issues surrounding OEM in the Geospatial segment? Are these losses permanent or is it more likely they’ll bounce back?

We view these challenges more as temporary setbacks rather than permanent losses. The nature of the OEM business mandates a focus on long-term relationships with verticals, though certain OEM circumstances can limit performance. Our key OEM partnerships continue to uphold expectations despite revenue fluctuations.