Trimble Inc (TRMB) — Q4 2021 Earnings Call Transcript

Welcome everyone. Before I get started, a quick reminder that our presentation is available on our website, and we ask that you please refer to the Safe Harbor at the back. Let's begin on Page 2 with the following key messages. Our team once again delivered outstanding results and did so amidst ongoing supply chain difficulties, delivering total organic revenue growth of 14% and organic ARR growth of 12% in the fourth quarter. We ended the year at a record level of ARR of $1.41 billion, and 2021 EBITDA margin of 25.6%, and operating cash flow of $751 million. Reflecting on our 2021 results in comparison to our May 2018 Investor Day plan, I am proud to say our team made a great deal of progress. In May 2018, we targeted 2021 adjusted EBITDA between 23% to 24% of revenue. We closed 2021 at 25.6% EBITDA. We targeted software services and recurring revenue mix at 55% of total revenue. We closed 2021 at 55%. We targeted the ratio of 2021 operating cash flow to non-GAAP net income at approximately 1.1 times, and we closed 2021 at 1.11 times. In July 2018, our net debt to adjusted EBITDA ratio stood above three times and we said we would delever below 2.5 times. Today we stand at 1.0 times. These proof points give us conviction that we are on the right strategic path with Connect & Scale 2025 that we can uniquely connect the physical and digital worlds, to deliver value to our customers, and that our asset-light business model works for our shareholders. Looking at current market conditions, the overall demand landscape remains robust and we enter the year with record hardware backlog and record ARR. Nevertheless, we are paying close attention to three obvious market factors: interest rates, supply chain and labor market dynamics. While the overall landscape presents material short to mid-term planning challenges, what is straightforward is that the global infrastructure spend is a positive catalyst for the long-term health of the business and that in a difficult economic environment our value proposition that delivers productivity and sustainability will remain a secular growth catalyst. Moving to page 3. I'll talk about the progression of our Connect & Scale 2025 strategy, as seen through the lens of the Trimble Operating System capturing strategy, people and execution. Starting with strategy. I'll provide three proof points of our progress in the quarter. First, we acquired AgileAssets, which provides SaaS solutions with analytical tools to manage roads, bridges, airports and rail assets, so customers can better plan, operate and report on those assets across the life cycle. The addition of AgileAssets to Trimble's platform will add the as-maintained model to our as-designed and as-built data. Availability of this data within the model creates a robust digital twin for owners throughout the asset life cycle, thereby providing greater predictability, sustainability and lower lifetime asset costs. Second, we have increased our ambitions in the area of sustainability both internally with our own carbon footprint and externally through the commercialization of sustainability. We have submitted our science-based targets for review, and we plan to reduce greenhouse gas emissions in line with the Paris agreement. In addition, our most recent score from the climate disclosure project went up again, marking two increases since we first submitted in 2018, and we continue to work diligently to further improve our score. With an external lens, customers are increasingly asking us to help them think about, manage and verify carbon reductions from the productivity and efficiency gains delivered through the use of our products. We have stepped up our ambition level to meet this market opportunity. Third, we have continued to transform our software and hardware business model offerings, which has translated into increased bookings and ARR, which in turn gives us visibility into continued growth in 2022. Our Connect & Scale strategy is a platform strategy, and we are executing that strategy in part by partnering to build ecosystems. As evidence, we have a new Microsoft partnership that will first focus on construction, and we established Trimble Ventures in the third quarter and made our first ventures investment in the fourth quarter. Moving to people in our operating system, I start by reflecting on our purpose in the world. We are transforming and digitizing industries that support how we live, what we eat and how we move. In a competitive labor environment, we continue to see people attracted to the why of Trimble. We won a couple of Global Culture Survey awards in the fourth quarter, both for overall company culture and for diversity. We made demonstrable progress in our DEI journey in 2021 and our team continues to engage in their local and global communities through company-sponsored days of service and through our Trimble Foundation. We believe the intersection of a great workplace environment and a purpose-driven organization provides a solid foundation upon which to lead, grow and compete for talent. We were also able to recruit Ann Fandozzi to our Board in 2021. And in January, we announced the addition of Tom Sweet, Dell's CFO, to our Board. I'm encouraged by individuals of this global caliber enthusiastically joining our Board and contributing to our ongoing growth. Moving to execution in the Trimble Operating System, we saw the benefits of ongoing innovation throughout the course of 2021. In the fourth quarter, we reached a milestone of one million monthly active users of Trimble Connect. With our digital transformation efforts making progress, we now have all of these users on common identity and entitlement stacks. We launched the new trimble.com web presence in December, the culmination of a couple of years' worth of work to modernize this important vehicle. We've also stepped up our outbound efforts to tell our story and to reach important new audiences. We look forward to hosting some in-person events in 2022, such as our Transportation User Conference in August and our Dimensions User Conference for engineering and construction in November. Finally, we see our fundamental responsibility to shareholders as being capital allocators, balancing short-term realities with long-term possibility. To this end, we divested three businesses in 2021 on top of the four divestitures in 2020. In 2022, we will disproportionately invest in areas of the company such as the infrastructure opportunity, autonomy and our own digital transformation. We make these investments and are accelerating the transition to recurring revenue models of a number of our software businesses in the context of a challenging supply chain environment, which is constraining our ability to meet customer demand and adding inflationary pressures. The steps we are taking will moderate our operating leverage over the next few quarters but will move us forward in our ability to reach the full potential of our strategy. Before I turn it over to David, a big shout out to all 11,500 plus Trimble team members for your ongoing dedication and execution to our global dealer partners and to our strategic partners for their efforts, and to all of you in the investment community who trust us with your capital. David, over to you.

Thanks, Rob. Turning to Slide 4. Fourth quarter revenue was $926 million, up 12% versus a year ago. Organic revenue growth was 14%. Our strong revenue in the quarter was enabled by the outstanding performance of our supply chain and operations team as hardware revenue grew by over 20% versus the fourth quarter of last year, notwithstanding the extraordinarily difficult supply chain environment. Backlog of unfilled hardware orders grew in the quarter, reflecting both the strong demand in our end markets and customers placing orders earlier than they would have in the past. Hardware backlog at the end of fourth quarter was nearly four times the level of a year ago before the supply chain challenges emerged. With this strong backlog, we have unprecedented visibility into demand for our hardware offerings going into 2022. ARR grew at an organic rate of 12% driven by business model conversions, strong bookings and healthy customer retention for recurring solutions in the quarter. Gross margins were 57.8%, down 90 basis points sequentially from third quarter levels and down 160 basis points from the fourth quarter of 2020. Gross margins were impacted by the mix of hardware revenue, higher inbound freight costs and our aggressive purchases of components in the broker market to support strong demand. Cost inflation was higher than our expectations and the price increases we took in our hardware offerings did not fully offset an unexpectedly sharp spike in cost inflation in the quarter. The price increases we have taken so far this year, averaging approximately 5% at the list price level across most of our hardware businesses and accompanied by reduced discounting have been accepted in the market. Given our leading position in the markets we serve, we are confident in our ability to maintain attractive margins. And we continue to adapt our pricing strategy to the cost outlook. Our EBITDA margin for the quarter was 24.1%, while operating income margins were 22.1%. As we expected, margins in the quarter were lower than the fourth quarter of 2020, but higher than Q4 of 2019. EPS was $0.62. We generated cash flow from operations of $155 million and free cash flow of over $140 million. Cash flow was lower than Q4 of 2020, driven by increased component inventory purchases. Turning now to slide 5, let's step back and review performance for the full year 2021. In the face of unprecedented challenges coming from the ongoing COVID disruptions supply chain shortages and accelerating inflation we achieved record results across a broad range of financial metrics. Revenue grew 16% to a record $3.66 billion and the ARR growth improved sequentially. While gross margins were down modestly, due to both inflation and the higher growth of our hardware revenues, EBITDA and operating margins ended the year above the levels of 2020 and at record levels in Trimble's history. Earnings per share were $2.66, up 19% versus a year ago. Cash flow from operations and free cash flow grew 12% and 14% respectively. Now on slide 6, from a geographic perspective, revenues were up in all regions with the highest growth rate in Europe. North America revenue in the quarter also grew at a double-digit rate. Turning now to other key operating metrics on slide 7, I'll note that backlog ended the year at $1.8 billion. This is up from $1.3 billion a year ago. While backlog and our recurring offerings continued to grow, the majority of this increase came from hardware. And year-end hardware backlog exceeded our expectations of a quarter ago. Our results for 2021 reflect the achievement of a meaningful milestone. On a trailing 12-month basis, our software services and recurring revenue exceeded $2 billion for the first time. Operating cash flow of over $750 million was also a record and exceeded 1.1 times non-GAAP net income. Turning now to our results by segment on slide 8, revenue was at or above our expectations in all segments. Buildings and Infrastructure revenue grew 14% versus prior year and 16% organically. Growth was strong across both hardware and software. Our sales of machine control solutions to civil construction customers grew by nearly 30% this quarter, despite supply chain constraints. ARR growth in the segment was strong with Viewpoint and e-Builder ARR together up at a mid-teens growth rate. SketchUp ARR growth was nearly 40%, while ARR gained momentum in our structures and MEP software businesses as they accelerated their transitions to recurring revenue models in the quarter. We ended the quarter with strong bookings momentum across our B&I Software businesses. Segment margins in the quarter were over 30%, representing a record fourth quarter for the segment despite cost inflation and the higher growth of hardware revenues. In B&I our price increases more than offset the hardware cost inflation we saw in the quarter. Geospatial segment revenue increased 15% overall and 16% on an organic basis. Demand for our core survey and mapping portfolio remains very strong across all regions driven by strong spending in residential construction, civil infrastructure and utilities. Segment revenues also benefited from shipments against several large government contracts. Operating margins were below the levels of fourth quarter 2020 and the third quarter of 2021, driven principally by a short-term mix shift. The cost inflation we experienced in this segment was largely but not entirely offset by our 5% price increase and lower discounting. Resources and Utilities revenue grew 18% in total and 21% organically. Hardware backlog grew in R&U, reflective of very strong demand across the agriculture sector. The outlook for capital investment in ag remains strong driven by high crop prices, low inventories and high average equipment age. Segment margins were below those of a year ago and sequentially below third quarter levels. Product cost inflation was particularly high in this segment, as the cost of many critical components in our ag product offerings increased substantially in the quarter. In this segment our price increases have not yet kept up with inflation and we continue to refine our pricing strategy going forward. We anticipate operating margins in this segment in the coming year to rebound from the fourth quarter 2021 levels, as our price realization and mix improve. Consistent with our expectation coming into Q4, revenues and margins in our transportation segment were adversely impacted by supply chain challenges, both within our business and at our OEM customers. On the cost side, we experienced meaningful component inflation and high freight costs and we incurred costs related to realigning our product portfolio toward available components. Slow production levels at our OEM customers also constrained our revenue of both hardware and recurring services in the quarter. The leading indicators from our transportation business continue to give us confidence that we are on the path to better ARR and margin trends, once the dynamics of the supply chain improve. We grew bookings year-on-year once again in Q4 and our net retention is at 100%. Our OEM customers are seeing stabilization in their own supply chain situation and we expect that orders from them will pick up early this year. Finally, on the cost side, we are introducing new products, which will support improved gross margins. For all these reasons, we project improved performance across the Transportation segment and ARR revenue and margins in the back half of 2022. Turning now to slide nine, I'd like to provide our financial outlook for 2022. We expect to see continued topline momentum. Demand from our end markets remains strong and so far, we haven't seen any signs of deceleration as a result of recent inflation and higher interest rates. Our backlog and forward-looking indicators of sentiment give us confidence in our prospects for ARR and revenue growth. As Rob and I have mentioned, we expect that supply chain disruptions will continue to be with us through 2022. There are signs that the pressure on component availability will abate in the back half of the year, but our plans presume that the supply chain will not be fully restored to equilibrium until 2023. With those factors in mind, we are initiating annual guidance for 2022. Excluding the impact of any additional acquisitions or divestitures, we project full year revenue of $3.95 billion to $4.05 billion, representing a range of growth outlooks of 8% to 11%. Our continuing transition of software offerings will present approximately 100 basis points of headwind to revenue growth. Organic ARR growth is expected to accelerate through the year to a mid-teens rate by year-end. We expect gross margins in 2022 to be comparable to or slightly better than 2021, with sequential improvement in the back half of the year. We expect that operating margins for the full year will be approximately 23%. Note that operating margins will be adversely impacted by the aforementioned subscription transitions, as well as investments we are making in support of our strategy and the acceleration of ARR. In aggregate, these factors present a headwind to operating margins of approximately 200 basis points. Income from equity investments is projected to be approximately $30 million, lower than 2021 due to higher product costs in our joint ventures. Net interest expense is forecast to be approximately $65 million and we project that our tax rate will be approximately 18%. Netting all this out, we project to achieve EPS in the range of $2.75 to $2.95. From a cash flow perspective, we project the free cash flow will once again exceed our non-GAAP net income. Our cash flow trends will be helped by the projected return toward equilibrium in the supply chain, as we anticipate needing lower component inventories by the end of the year. While we are focusing our guidance on expectations for the full year, I'd like to provide some color on the factors we expect to drive quarterly trends in 2022. Many of the normal seasonal patterns in our business are being disrupted by the impact of the constrained supply chain, so it is most helpful to think in terms of the expected sequential development from where we ended Q4 of 2021. We expect revenue to grow sequentially through each quarter of the year with ARR accelerating as well. From a product cost perspective, we expect to see inflation through the first half of 2022, similar to what we experienced in Q4 of 2021, with meaningful improvement in the second half. As a result, gross margins are likely to be relatively flat with Q4 of 2021 through the first half of the year and meaningfully higher in the second half. We expect that operating margins in the second half of the year will exceed the first half by approximately 150 basis points. I'll close by noting that we are planning an Investor Day in Colorado this September. And with that, I'll turn it back over to Rob.

We entered the COVID crisis almost two years ago. And at that time, we set an objective to exit the crisis on a stronger competitive footing. I'm proud of our accomplishments in 2021 and the progress and commitment we are making towards our Connect & Scale 2025 strategy. We are a purpose-driven company serving secularly attractive markets, pursuing a differentiated strategy to connect the physical and digital worlds, with a unique set of underlying capabilities. We deliver a compelling value proposition to our customers in the form of better, faster, safer, cheaper, greener and we deliver a compelling business model to our shareholders. No doubt, we expect to operate in a turbulent environment for the foreseeable future while simultaneously undergoing our own transformation. The last couple of years serve as evidence, that this team has the courage and conviction to rise to the challenge. Operator, let's please go to Q&A.

Hi, good morning, guys.

Good morning.

So my first question is just on the guidance. So what are you contemplating at the low end of your earnings guide? Because it implies about 3% growth and so as I'm kind of like looking through it, first of all, on the revenue side, at the low end you're at 7%. But if you're talking about price realization of plus 5% and then ARR growth in the teens it seems like that would imply a kind of low single-digit or flattish growth on hardware. So just hoping, you could just kind of just give me a sense for how you're thinking about that low end and the reality of hitting that.

Hi, Chad. This is David Barnes. I think the low end is 8% revenue growth. And I think your math is right there’s some pricing in there. I'll note that the revenue growth will be impacted by about 100 basis points of transition, from perpetual to recurring some of our software businesses. We do expect hardware growth to moderate versus what we've seen this year. We'll be working through the backlog, but those are some of the big building blocks.

Got it. Okay. And then just secondly, on your incremental margins. So the guidance implies about 18%. And during the third quarter, I believe you guys talked about being at the low end of 25% to 30%. So I'm just trying to understand, what changed and perhaps you could just help us bridge that gap.

Sure. The main change is that we are expecting more inflation than we originally thought for the first half of 2022. Our previous outlook was somewhat more optimistic. It's now evident that supply chain issues will persist at some level through the end of next year. We don't anticipate a significant improvement in inflation affecting our product costs. The guidance assumes that costs will level off at Q4 levels. We do expect to achieve some price realization. I mentioned during the prepared remarks that there has been a lot of backlog in our Ag segment. The downside of that backlog is that when a new price increase is implemented, it doesn't immediately reflect in revenue. These are the key factors that will lead to lower operating leverage than we previously indicated. However, it's important to note that the intentional decisions we are making regarding the transition from perpetual to recurring models, along with investments in our strategic initiatives, each will reduce margins by about 100 basis points next year if we weren't pursuing these strategies, which would otherwise lead to very strong operating leverage.

Chad, one other piece of color on that is compare 2022 in the mid guide to 2019 and we're talking over 45% operating leverage over that time.

Got it. Thanks I'll pass it on.

Thank you. There's a lot of obviously volatility in the supply chain. Could you be a little bit more specific, if you're willing on what is getting better into 2H, what you have visibility on? There's some talk on chips getting better. I don't know if that's been a big headwind. And then just your general feeling, is it stable in 1Q? There's obviously a lot of Omicron tick up potential and things like that. I don't know if it started getting better already in any ways? Thanks.

Yeah. Hey, Rob. I'll say that the supply chain challenges you hear a lot of talk about semiconductors, but the issues are broader than that. With regard to electronics, I would say things are already improving. Part of that is that we several months ago took a number of steps including raising our outlook and making commitments with vendors placing orders that actually impacted our cash flow. We've worked component by component. We've seen meaningful progress. We're actually seeing visibility to capacity on some of our individual constrained parts with specific vendors. So that's getting better. And the fruits of our effort to redesign our products around very scarce components all of those show signs of improvements. Actually, where things are stickiest now is the non-electronics. It's cables, it's brackets, it's other kinds of parts. And that is sort of the downstream impact of labor disruptions in many markets all around the world. So that probably has a longer fuse to it. But you put all that together, that adds up to the outlook we described in the prepared remarks, which is yeah, we'll see inflation in constrained overall supply through the first half of the year and we'll see meaningful improvement albeit not all the way back to normal by year-end.

And then begging your pardon, if you're willing to be so granular, you mentioned you have backlog so you don't have pricing coming through and resources and so on. The back half margin improvement, is that more pricing? Is that more like you assume expedite freight goes away? Is it more proven in all the things you just discussed, if you're willing? And I'll stop there. Thank you.

There are many factors involved. When considering inflation, it can be categorized into a few areas. First, there are the general price increases from our suppliers and freight providers. Then, there is expedited freight, where we opt for air freight instead of sea freight, for example. Additionally, purchasing components in the broker market can significantly elevate prices, often much more than the standard purchasing cost. The forecast for better margins in the latter half of the year hinges on our reduced reliance on the broker market and lower expedited freight usage. However, we do anticipate that underlying inflation will persist. You will see the cumulative effect of price increases, including those we haven't implemented yet or those that haven't impacted the backlog. Gradually, the composition of our business will improve. Notably, our revenues rose approximately 12% in the quarter, and hardware revenues in Q4 increased by 20%, which doesn't aid our margins. All these factors will eventually stabilize. In summary, we believe these elements will contribute to significantly improved margins in the second half compared to the first half.

Okay. Thanks.

Sure.

Thanks, so much. I want to ask about the AgileAssets acquisition. I just wanted to get a sense of the speed of the integration into the Trimble platform, and how you're thinking about the digital trend opportunity in terms of customer engagement and expansion of total addressable market?

Hi. Good morning, Colin. It's Rob. So hey, AgileAssets fits perfectly into our strategy. We think it's really in the center of the bull's-eye. It's a growing SaaS business and it connects well with the broader Trimble platform. So it is a growth story and we've got a high conviction that we can grow this business on its own and that it can be a catalyst for the growth of other Trimble solutions. When we put it in context of the digital twin in the prepared remarks, we talked about this intersection point of the as-maintained model with an as-designed and an as-built. So if you think about it from the life cycle point of view, which is really central to our strategy, this adds really that final step in the operations and maintenance phase. And so a digital twin in its truest form is much broader than a design model and often people will talk about it more in a design sense. We think the combination and intersection of the design with the as-built with the as-maintained is actually a true digital twin and the early indications we have from joint customers and from departments of transportation are quite encouraging to us.

Great. And then shifting gears to the transportation and logistics business. With the real progress that's being made around Class 8 trucking moving towards autonomy and the more comprehensive software systems that we're starting to see emerge in that space. How are you thinking about evolving the strategy for Trimble in that space? It seems like there's an awful lot to do, but also a lot to shift around. And so the cadence of change would be helpful just in terms of your internal thought process and how you see that business evolve for Trimble?

We see autonomy as it emerges in transportation. I'd say at some level similar to agriculture or construction. And that is in an autonomous world which by the way is probably really more of a more automated world in an autonomous world, the truck still needs to have a work plan. It still needs to understand how to route and how to navigate. It still needs to understand how to optimize within the entire fleet. It still needs to understand how to give a dynamic estimated time of arrival to the customer. It needs the brains behind it. Arguably, the autonomous vehicle or dozer or tractor is a dumb node. It doesn't know what to do. It needs a work order. It needs a work plan. It needs that brain. And that intersected with what we do at Trimble in the office the systems of record, the scheduling, routing, dispatch we think provide high relevance in a more automated world. In addition there's autonomous capabilities that we can provide companies on highway. So for instance in our correction services business, we now have over 10 million miles that have been managed through our correction services which are really providing ADAS capabilities.

That’s super helpful. I will follow-up offline. Thanks.

Hi. Good morning. Thanks for taking my questions. So the Resource and Utilities margins in the quarter came in below where we were expecting. Can you expand on that a little bit? And why do you expect unfavorable mix in the near-term? And related to that what is your outlook for agriculture demand longer term in light of farmers moving towards vision and AI technologies?

I'll defer the longer-term question to Rob. With regard to margins Tami, there's a story both of mix and of higher input costs. There are a number of key components in our displays for guidance in agriculture where the supply was particularly tight. I mentioned a moment ago that when the markets are tight we and other providers of hardware technology have to go to the broker market to fill the needs. And in some cases a part that would normally cost $3 costs $30 or $40. So it's easy to see really dramatic cost spikes that happened disproportionately in this segment. So we've taken pricing actions. But in this particular segment the cost increases are meaningfully higher. So we're relooking at our pricing strategy and we're going to have to take some actions to improve our margins going forward. We do think there's partly a story of mix here and what we were shipping in Q4 is disproportionately on the lower end of the margin scale. So it will get better. But no doubt we have a margin challenge to wrestle with in this segment. And Rob you want to talk about the longer-term outlook?

Yes. I can add that the revenue in the segment increased by over 18%. The Annual Recurring Revenue grew in the mid-teens, and agriculture hardware revenue exceeded 30%. This extraordinary growth helps contextualize our margins, as we are making intentional choices to satisfy the high demand in the market. We have seen our backlog continue to expand, which gives us confidence in the strong market demand. There is a link between this exceptional demand and our margins, influencing our belief that they will eventually reach a balance. Regarding our outlook for agriculture, the current indicators are positive. The macroeconomic conditions support our growth plans. Farm income is anticipated to remain robust, with projections for 2022 expected to be 20% to 30% above the ten-year average. This is a U.S. statistic, and this strong farm income can outstrip the increase in input prices that farmers face. The reason farm income can stay elevated is that commodity prices are rising and inventory levels are low. While input prices are higher, we believe technology adoption going forward is key. Technology can help minimize and optimize input usage, with less seed leading to higher yields and reduced herbicide application for spot spraying. This also offers sustainability benefits for farms. Overall, we remain optimistic about the adoption of Precision Ag technologies, both domestically and globally.

Understood. That's helpful. That's all for me. Thank you so much.

You’re welcome.

Hey, good morning. Thanks for taking my question. Maybe the first one just trying to understand a little bit the dynamics around the business model transitions, maybe if you can update us a little bit. And when you say expectations about 100 basis points headwind to kind of the margins and the growth for FY 2022, which are the brands that are mostly impacting that? And maybe, if we look forward, how long do you think that headwind still lasts? And at what stage it almost becomes a tailwind as well once you kind of cross that majority of the revenue being subscription based on some of those brands as well? Thank you.

Sure, it's David. I'll provide some insight into both our past and future performance. For the full year, our measurements indicate that the transition impact in 2021 negatively affected revenue by about 100 basis points, which is actually less than we anticipated at the beginning of the year. The reason for this lower impact is that we had higher last-time purchases of perpetual offerings in our structural design business. Currently, the majority of that 100 basis point impact, whether for 2021 or projected for 2022, is primarily in our building software businesses, with a significant portion also in the transportation sector. We're also expecting to see some impact in the civil construction software business as we implement our platform-as-a-service model. Regarding the longer-term outlook, our perpetual software revenue was just under $500 million for 2021, and we've already reached a point where 70% to 75% of that revenue comes from software bundled with hardware. This means that only 25% consists of standalone software offerings. By the end of 2022, we expect to have transitioned the majority of our straightforward software businesses. We're also working towards evolving to recurring revenue models with our platform-as-a-service approach, which should generate meaningful revenue in civil construction this year. Additionally, we have bundled perpetual software with hardware in the surveying and agriculture sectors, but that transition will take longer. It's still early to determine how long the overall transition will take, a topic we plan to discuss at our investor conference in September. This transition is more complex than a traditional software business due to the bundling with hardware and the involvement of various regions and dealers, making it a challenging issue that could take several years to fully address.

Got you. As a follow-up, when I look at the current situation, it still negatively impacts the margins. However, it appears that if the transition stopped today with what has already been done, the incremental margins are improving. If I'm calculating correctly, we have about four of these incremental margins that indicate a reduction of two percentage points in headwinds compared to what you expected, and 100 basis points of that is actually due to business model transitions. If I evaluate the current organic business as it stands, without the transition, is it reasonable to conclude that the margin outlook would have been higher than historically for incrementals?

Yes. So I think I'm following you Gal. The margins are really high on both perpetual software and recurring. The difference is that when you sell subscription, you recognize the revenue and margin over many years rather than upfront. So I think our math is good that the conversions we're doing reduce revenue versus if you'd stayed in the perpetual model by the numbers we're saying and it essentially all goes through to the bottom line.

And Gal, this is Rob. You're absolutely right by the math. If we were only targeting an op leverage number, you wouldn't do the transitions, that's the wrong decision to take for the customers and for the market. So you're absolutely hitting on an important point that we will all day long look to convert the business models for the long-term health of the business. And I think it's more important or certainly equally important that the Street is looking at the growth in the ARR, the look on our cash flow, the net working capital as factors to complement what an EBITDA percentage or an operating income percentage will tell you because it's an incomplete story.

Great. Awesome. Thank you.

Yes. Hi. Good morning everyone.

Hi, Jerry.

I'm wondering if you could talk about the outlook for mid-teens ARR growth exiting the year. Really interesting outlook considering e-Builder and Viewpoint are delivering that level of growth now. So I'm wondering what needs to happen in transportation to get to that run rate. Or are you looking for an acceleration or further acceleration in e-Builder and Viewpoint to get there? Maybe just give us a little bit more clarity on what drives the acceleration from 11% today?

Hey Jerry, this is Rob. The main highlight of this earnings release is that the level of ARR growth we achieved at the end of the year aligns with the ARR projection David mentioned in his remarks. The reported backlog in our financials indicates that we have a growing revenue stream ahead of us, providing us with significant visibility. We experienced strong overall bookings in the fourth quarter, and both the e-Builder and Viewpoint businesses continued to grow ARR in the mid-teens, with bookings increasing at an even faster pace. These bookings serve as a forward indicator of the revenue we will realize in the future. Another factor contributing to growth is our structures business, specifically the Tekla Structures unit, which made a model conversion in 2021 and will contribute to our growth in 2022. We do expect some improvement in transportation, but David's projection isn't fully reliant on that, as we have relatively modest expectations in that area. Any better performance there could offer some upside for us. Our primary focus remains on expanding recurring revenue, supported by our investments in digital transformation, about which David spoke. This investment, nearly 100 basis points, correlates with our ARR growth and is essential for driving these valuable revenue streams.

Yes. Rob got it right, Jerry. We're at or close to mid-teens in the ARR growth of our businesses other than transportation. We're much lower than that in transportation. And we do project a recovery. We don't think we'll get all the way to numbers we think are good long-term by the end of the year, but the outlook presumes that we maintain and put some momentum across the businesses that are growing well now outside transportation and the transportation begins meaningful growth. So you put all that together, we get to mid-teens. And if we do even more than that then we'll be on the high end of our outlook. But that's how we get there.

Very interesting. And David, based on the numbers you shared on SketchUp, it sounds like user growth has tripled in that business, give or take since the transition to subscription. Are you on track with that level of performance in Tekla? And are you thinking about the remaining conversions that are in front of us with that type of user growth potential, or were there any outliers on SketchUp that we should be thinking about?

I'd be careful about extrapolating from SketchUp to all the other businesses. Certainly, the SketchUp story is an amazing one. It really is sort of great flagship example of how changing the business model expands the addressable market on SketchUp. It has a quasi-consumer appeal, which Tekla would not. It's a very sophisticated product. So we're early days in the model conversion on Tekla. I don't think you'll see the expansion in the addressable market in that offering that we've had in SketchUp.

Okay. Thanks.

Great. Hi, Rob. Hey, David. Appreciate the morning call this time around. As it relates to M&A, the business has delevered very nicely over the past couple of years. And with these Connect & Scale initiatives and streamlining the business, how should we think about M&A strategy and specifically, where larger M&A might fit in?

In the context of Connect & Scale, I think about two dynamics. One is our own organic progression, the second is acquisition and the third is partnership. Regarding our organic progression, we see a significant opportunity to leverage the data and customer potential within our existing operations. This is reflected in our Trimble Construction One launch, where we are developing persona-based bundles aimed at serving the construction industry more effectively. This approach represents our primary focus on capital allocation. Concerning acquisitions, we are open to them, but only if they align with our strategic goals. We primarily consider two factors for acquisitions: product capabilities and geographic reach. These factors can overlap, but they don't always. Most of our past acquisitions have been smaller, more like tuck-ins rather than transformative large-scale deals, which we tend to pursue every few years based on availability rather than design. On the partnership front, in a platform strategy like Connect & Scale, forming partnerships is crucial for building our ecosystem. We have a solid history of partnerships, including joint ventures with Caterpillar in civil construction, Hilti in building construction, and Nikon in survey and mapping. Recently, we announced a partnership with Microsoft, which we view as vital for extending our capabilities. As we open our technology to third parties, this will further highlight the importance of our partnerships. Additionally, partnerships facilitated by our Trimble Ventures arm may evolve into acquisition opportunities in the future.

Okay. Interesting. And then when I think about this year and the focus on investments in infrastructure, economy and digital transformation, is the correct way to think about this maybe at the product level, the go-to-market level and then also at the back-end system level? Thanks.

Yes, that's a fair way to think about it. Internally, I refer to strategy, structure, and systems. I believe that organizational structure should align with the strategy, and the underlying systems should facilitate that structure and ultimately support the strategy. Regarding the strategy of Connect & Scale, we see significant opportunities related to the infrastructure bill, which I think is what you were asking about. You might have meant our internal infrastructure, but if we’re discussing the IAJA, there is a sizable opportunity connected to the acquisition of AgileAssets, which aims to integrate more elements of Trimble to enhance opportunities in construction. Therefore, we have organized ourselves accordingly. Additionally, this strategy also encompasses product and go-to-market initiatives, which I completely agree are essential. Our product resembles the Suite, comprising our technology collections, while our go-to-market approach involves a mix of direct and indirect strategies that come together. On the organizational structure front, we have organized by the industries we serve, appointing industry leaders for civil construction, building construction, agriculture, survey and mapping, and transportation. This setup provides a clear point of accountability for the markets we focus on. The underlying systems are designed to support our digital transformation efforts, enabling us to better serve our customers and scale effectively.

Thanks, Rob. Thank you.

Good morning. Rob, you've mentioned that the platform-as-a-service opportunity is still ahead of you for the most part. How should we understand its impact on the recurring revenue gross margin? The straightforward calculations indicate that some hardware will shift towards that area, but could there be a strategy to mitigate any potential dilution at the gross margin level, rather than what the initial numbers might suggest?

I'll provide the strategy outline and David can elaborate on the specifics. Platform-as-a-service is the branding we've adopted for our machine control and guidance business in the civil sector. This involves transforming our guidance business into a model that combines hardware and software. The core value for customers lies in technology assurance, allowing them to stay updated with the latest sensors and software versions. This enhances their connection to our office-based and connectivity solutions, effectively bridging the data flow between the field and the office, as well as integrating hardware and software. For example, consider a guidance system currently priced at $30,000. With this purchase, the customer acquires a collection of sensors, hardware, and embedded software, which is crucial for delivering value as it acts as the enabling component. Under current accounting methods, we recognize the entire $30,000 as revenue upfront, with a portion attributed to perpetual software and the remainder to hardware. This is why David describes it as a bundled offering. We observe that an increasing portion of value comes from the software component, and it's this software value from the $30,000 that we aim to recognize over time. Our newly announced global offering follows this model, where customers buy the hardware upfront, and the software revenue becomes ratable over time. Initially, this change may impact margins similarly to any software business transitioning from perpetual license to a ratable model. Our goal will be to show ARR growth linked to margin offsets in the numbers, likely reflected as a term license within the ARR figures. In the short term, as we build our cumulative base, margins may decline, but eventually, we expect to return to stable margins and have opportunities for value expansion, even before considering upsell prospects and connections to our broader offerings. Dave, would you like to add anything?

No, I think you addressed it perfectly, Rob. Even when you sell a package of hardware, software, and solutions together, the accounting dictates that you assess how much value is assigned to the hardware, which is recognized upfront. However, the major trend here, as Rob mentioned, is that an increasing portion of the value is attributed to software and solutions, while hardware constitutes a smaller share. This transition affects the profit and loss statement; traditionally, we recognize all hardware and software upfront. As we adopt a more gradual revenue recognition approach for software and services, it will impact our accounting similarly to our other software businesses. You'll notice that hardware revenue remains recognized upfront, even though it accounts for a diminishing portion of the overall solution value. Once we move to a more gradual approach for the solutions, the software component will be recognized over time.

Thanks for the explanation. I have a quick follow-up. David, as you consider the revenue guidance for 2022, what assumptions are you making regarding backlog reduction, specifically in the range of 9% to 12% organic?

I want to emphasize that the supply chain is unlikely to return to normal even by the end of 2022. Typically, the hardware backlog in a stable environment would be around $100 million, but we're currently facing a backlog of approximately $375 million, which is nearly four times that amount. We expect to recover to about halfway or more, but we will still be significantly above the $100 million mark.

Very good. Thank you.

Hi. Thanks for taking my question. I know you talked about ARR this year. But really I'm wondering if you could help us understand your revenue by segment in terms of which segments may grow faster or slower than the overall top line revenue. And the reason I ask is, just because you mentioned certain supply chain constraints worse in the agricultural area. And I'm just wondering how much that might slow down revenue in certain segments. So any help there would be great.

As a general trend, it's unlikely that we'll see hardware revenue surpass total revenue as we did in the fourth quarter. Transportation revenue trends have been more modest compared to other segments, but we anticipate an increase in transportation during the second half of the year. The other businesses are quite similar in that demand is strong and our backlog is significant. Geospatial, being the most hardware-dependent segment, has experienced extraordinary growth, outpacing the market in those solutions. Therefore, we expect this segment to slow down more than the others, though we have a substantial backlog in construction and agriculture. Consequently, growth in transportation will likely be the lowest, especially in the first half. Geospatial will be lower due to its dependence on hardware, while we expect the other segments to perform very strongly.

That's very helpful. And then, just to follow up real quickly. Gross margin you suggested it would be higher in the second half kind of similar to Q4 through the first half. What kind of level can you help us understand what kind of level gross margin could hit exiting the year as supply chain starts to get back to normal?

I believe the calculations are likely straightforward. If we perform similarly to Q4 in the first two quarters, we could finish the year at or possibly slightly above the total for 2021. This approach might not reach 60%, but it should bring us closer than the current 58%.

Perfect. That's helpful. Thank you.

Thank you everyone for joining us on the call. And we look forward to speaking to you next quarter. Thank you.