Trimble Inc. (TRMB) Earnings Call Transcript

Okay. Good afternoon, everyone. My name is Chad Dillard. I'm the lead analyst here at Bernstein for the machinery sector. And today I'm really excited to have Trimble. And joining from -- joining me from Trimble is Rob Painter, the Chief Executive Officer. And the way that we're going to operate this is that, Rob is going to start off with a couple of minutes slide presentation and then we're going to finish with some Q&A. And so for you in the audience to participate and for those of you online that are participating as well, you're more than welcome to [ ask your ] questions on Pigeonhole and I'll be able to ask it on your behalf. But without further ado, let me pass it on.

Chad. Hey, good afternoon to all of you. Thanks for coming and spending a little time with us. This is more humans that I've seen in a room in a while, which is nice. We're going to have a little game to see how long it takes Chad to ask me a question about his report on Trimble coming up soon. Timing Chad. Chad asked me to take the first 5 minutes or so and just give you a little bit of a background on Trimble. My understanding as a number of you may not know us or know us that well. Trimble was founded 43 years ago by Charlie Trimble. Just to give you a little background context. We make technology that impacts how we move, what we eat and how we live. We operate at the intersection of the physical and the digital world. This looks like the hardware and the software on the Trimble. That's digitizing large end markets such as construction, agriculture and transportation. To give you a 5-year snapshot on our business at Trimble -- actually give you a longer baseline. We're a company that's been growing mid- to high single digit organically over a 20-year plus baseline. We look over the last 5 years and the evolution of our business. We closed out last year at over $3.6 billion. I'll start with the numbers, it's over $3.6 billion in revenue. Our guide this year is in excess of that. When you look at the business model today, we're over 55% software as a business, 45% hardware. Therein lies a lot of the uniqueness of Trimble and differentiation. We do the hardware and the software that connects the office and the field and therefore the physical and the digital worlds. At the attractiveness of the business model level, fully 35% of our revenue today as ARR, annualized recurring revenue. So we stand at $1.47 billion of ARR that grew 14% organically in the first quarter. This comprises a bigger and bigger portion of our portfolio today. And along with that, we're a company that -- suddenly free cash flow and EBITDA positivity is back in vogue. So we're a company that is well profitable, closed last year 25.5% EBITDA. Over that same baseline $17 million to $21 million free cash flow was under $400 million in 2017 over $700 million in 2021. We run at 0 -- between 0 and negative working capital CapEx less than 2% of revenue. That's this definition, industrial technology company. This is the manifestation of a technology business model that is serving markets that are largely industrial in nature. So I talk a little bit about the markets that we're serving. Fundamentally, the markets we're serving are large, global, underserved and underpenetrated by technology. We're delivering a value proposition that manifests as better, faster, safer, cheaper, greener for our customers. So real tangible ROI that we're delivering to our customers for the real work they do in the real world. So these are -- these markets -- addressable markets are large, they're attractive. These businesses that we're serving, these industries are undergoing their own digital transformations and thus, that's our technology applied to that. We have a really connective tissue of Trimble. Think of an underlying technology stack that really is comprised of positioning technologies, and this gets through our roots going back 40-plus years, meets modeling technologies, meets analytics and optimization. So really a similar technology stack, delivering a similar value proposition to a set of attractive markets. If that still doesn't make sense, what I'm talking about at this intersection of the physical-digital world. Okay. Think of a survey or surveyor creates a digital model of the physical earth. What is that -- what do you do with that digital model that's been created. You turn it into a workflow. I'll start with an example of construction. On the bottom left, we take that engineering design. We make a constructible model that tells you that slope -- that cut fill profile of an alignment, let's say, a highway build. We take that literally to the blade of the heavy construction equipment. This covers -- intersects a lot of Chad's coverages or high precision GPS masked on the tip of that blade that models on the blade. It controls the blade. It moves the [ dark rate ] the first time. That same mentality, that same capabilities that sets the stage for what we do in agriculture. So that digital model of the farm, over the week, the strong part of the farm, and we control and guide the equipment as well as the implements that are behind those tractors on a farm. BIM is a space that some of you will know in the construction industry. It's a building information modeling, that's the top left. This is a constructible model. So this is a steel model. This is from the Bird's Nest stadium in Beijing. That's designed down to the -- engineered down to the level of the anchor bolt accuracy. So we're doing that for the highest value trades in construction, but 2/3 of the cost of the building we're in today are represented by the steel, concrete, mechanical, electrical, plumbing. So we've looked at those high-value trades, high cost of raw materials, high cost of labor, and we're optimizing them with the technology. What you design is what you build. With the technology we have we turn a steel fabricator into a 3D printer. And therefore, when the steel actually shows up on site, it actually fits and you can drive a job to be on time and on budget. Finally, I'll talk about transportation. Also a connection of the physical and digital world. Some hardware and software that we bring together with what we think is a unique technology stack, both in the field and in the back office and also managing the routes and the maps in the NAV for transportation companies. And finally, I'll close with talking about sustainability at Trimble and that better, faster, safer, cheaper, greener, right? We really operate well at the intersection of productivity and sustainability. So as you optimize the work that's done in the field, you're minimizing the use of fuel, you're minimizing the use of herbicides, pesticides, on farm, you're optimizing the use of water and all in creates a really profound sustainability benefit. I will pause there and go to you, Chad. I'll back that up maybe.

Great. That's super helpful. So what I want to do, I want to start off just with some of the near term and then we'll dive into some of the longer-term strategic questions. Thank you. One question that are on a lot of folks' minds right now, the near term is just a concern about like a cyclical downturn recession. So I guess my first question to you is just like based on what you're seeing in your business and some of the connected assets that you have out in the field, are you seeing any indication that some of the core activities in your business are starting to slow anything that was signal a recession?

Yes. So the demand drivers remain strong in the business. As noted, our recurring revenue was up 14% in the first quarter, organically the same for the total revenue of Trimble. Backlog that we have today in the business stands at $1.7 billion. It's the highest level of backlog we ever had in the business. A more normalized environment for us would be closer to $1.1 billion, $1.2 billion. Now the predominant amount of that backlog is software. However, the delta and that spread is largely from the hardware businesses. So that reflects demand and strength we see in markets, particularly in agriculture as well as in civil construction and the survey or our geospatial business. We look at the macro backdrop against that. We see ag commodity prices are high. There's a correlation, of course, with the war in Ukraine and #1 and #5 brand producers coming off the market. We've got conviction that we should see strong commodities through this year into next year. We look at the Construction businesses, and we see that our customers have healthy backlogs. We see a catalyst here in the United States with the Infrastructure Bill that we think will start to produce business for us in 2023. So it's a bit of a backdrop. It gives you a sense of what has us net positive and humble because you cannot deny that there's going to be some impact to the interest rates at some point and in some parts of the business. So residential construction would be an example of a place that we're looking. We don't see an inflection there at this point. I think that correlates with housing shortage in many markets, but there has to be some point at which that would roll over.

Got it. Okay. So let's just assume, if we do go into recession, are there any structural changes that you've recently made to your business that you would call out that would either dampen the cyclical amplitude or raise your trough earnings levels?

So here's a baseline I would give in a comparison to Trimble of 10 years ago. Today, we have about 35% of our revenue is recurring. That's about $1.47 billion of ARR. I think we're in pretty rare ARR in terms of the size of that recurring revenue base that we have that predictability and visibility that we get into the business is a huge change for us. 10 years ago, it was less than half of that as a percent of our revenue. Our business was about 32% software 10 years ago, over 55% today. These are percentages on dollar amounts that are much bigger today. 10 years ago, more than 2/3, almost 3/4 of the profitability of Trimble came out of our Geospatial and Agriculture markets. Today, that's half of that. We are more balanced as an organization where the profit comes from reporting segments and then double-click within that geographically, we are better balanced. For example, in ag, we used to have the majority of our business in the United States. Today, that's actually a minority of most of our business is outside the U.S. So there's a real change in that portfolio mix that's occurred over time to provide strength.

So the next question is about price cost. I think that's been something -- that's been a challenge for the broader industry for what seems like it's going on 2 years now. So my question is, do you think you'll be able to capture enough pricing at the back end of this year so that you're on track to hitting your kind of your operating model targets of 25% to 30% incremental margins as we roll into 2023?

So I have to first apologize about to start coughing. I know I'm not a super spreader. I like to just get the better part of me these days. So sorry, sorry, I have heard the question as I was trying to hold back cough. I'm all choked up about inflation. Sorry, you're asking...

Yes, let me run it back. So I mean, basically, do you think you'll be able to capture enough price at the back end of this year so that you can actually hit your longer-term operating margin targets of 25% to 30% incremental margins as we go into '23?

The short answer, yes. Long answer, with that backlog, I talked about a record amount of backlog we've had in the business. As we put the price increases into effect, we put them out at a moment in time. We didn't adjust the pricing -- for the most part, we didn't adjust the pricing on the backlog that we have. What that means is that we have a delay to the pricing coming into effect on a given cost base. So absolutely, the costs have gone up over the last -- I'm talking hardware, the costs have gone up more than double digit. We have had a series of price increases on top of that. What we see in the second half of the year, and as I said, you know, as the -- we know for a fact that those pricing increases will come into effect, and we see a stabilization in the cost increase the delta, which provides the gross margin delta that we talked about for the second half of the year.

Got it. Okay. Okay. And so maybe moving on to more like the longer-term part. I want to spend some time on the Construction side. So can you maybe just walk us through from like a product by product standpoint? And just talk about kind of like what are some of the problems that Trimble products solve in the construction sector? And how are you thinking about getting paid for that?

So the classic charts that many of you have seen would have shown the productivity index of construction industry compared to, well, let's say, all other industries. And on that same chart, you could see agriculture plotted and transportation plotted. We're serving markets that have been historically less productive than the overall economy there and provides what we see as an opportunity to change that in construction. The fundamental problem and cost drivers there. 80% of projects are late, 40% of projects are over budget. That's a big challenge in the construction industry. You could flip the access and look at the cost of, let's say, take a building, building the asset and operating it over the lifetime of that asset. 80% of the lifetime value comes from that operational and maintenance phase. We believe, to really drive improvement in the fundamental transformation in these markets. We need to connect stakeholders. We need to connect data across these industry life cycles, move from delivering task optimization to system optimization. This is what we're up to in the game. The value -- in terms of the value delivered to the customers. It is fundamentally coming through productivity. It's reducing the rework that you have on job sites. It's helping customers get the work done right the first time. What you design is what you build, right? I think we could probably talk about a digital twin in this context, build it virtually, then build it physically. Do it right the first time. And I talked about that steel design from the Bird's Nest Stadium. That's not just a pretty picture online showing you what the steel in that model is, that's accurate down to the level of the anchor bolt. It's geometrically accurate. Your ability to pull an estimate off of a model and get a real estimate. Think about the power of an estimate, the accurate estimate in an inflationary environment versus an estimate you pull off of just something that says a straight line, and you're just guessing on how much deal that is. It's a fundamentally big difference that you get from there. And the overlay models that are that accurate with a steel model in that example with the mechanical, electrical, plumbing, you can eliminate the rework before it ever happens because I can see where the clashes are going to happen ahead of time. Remember, these are different trades that don't communicate, that don't coordinate and they'll collaborate. The technology enables that to happen. Who pays for the inefficiencies that happen in construction? It's ultimately the owners of these assets. And we believe that there will be an increasing rise of influence and power by the owners because they are the ones who suffer the consequences of projects gone bad. We see how this is shaping in markets such as the U.K., which I would argue as the leader and the adoption of technology. We look to markets such as the Nordics, which are the power adopters of technology today, and we see that starting to spread to other parts of the world.

Got it. So I mean this sounds like a pretty revolutionary opportunity. So I guess why now? How close are we to an inflection point of adoption? And is there any evidence that you can point to that -- suggest that we're actually getting there? Or where they're already?

In terms of -- well, the reflecting in terms of mass adopting technology?

Exactly.

Well, our construction business is growing faster than the company average. So that 14% which represented the organic growth for the company, our construction business was in excess of that. So I can look at the underlying data, the ARR that's growing faster in that. And you can see demonstrable evidence that there's an acceleration of growth in the business. And again, those percentage growth is happening on top of a larger dollar amount. So I would call that good on top of good. From a more qualitative perspective, we spend a lot of time talking to our customers, some of the largest construction companies in the world working at some of the largest projects in the world. And they're asking for help as they digitally transform their business. They're asking us at Trimble to connect the solutions we have together better for them, so they can digitally transform the way they do their work. They're asking for openness and interoperability in their systems and in the data. They're asking us to help them with that. We know that COVID has been an accelerator of digital transformation. We see the data on how much more GDP, we think will go into IT spending. And so I'd say these percent a set of tailwinds for the business. Now remember, this industry of construction is a multitrillion dollar global industry, and we see it as underserved and underpenetrated still. And you can look at the competitive landscape and I will say, hey, look at a number of the public competitors, we've all been growing. So on the software -- I'm talking about the software side of the business. That tells me there's a rising tide of adoption. This is not just a share shift game.

Got you. Okay. And so on that, like what is your view on the market structure of the construction software market? I mean, is it becoming -- or will it become a race to reach scale? Or is there something -- some other structure that we should be thinking about?

So our strategy at Trimble is a platform strategy. We call it Connect & Scale 2025. We launched it about 2.5 years ago. To the extent you know Trimble, you know we do a lot of things in a lot of markets. I take a market like construction. We serve architects, engineers, contractors and owners across the life cycle, which you can represent to some design build to operate. So if I took that as a matrix and I built in the blanks in that matrix, we're serving almost every one of those capabilities in that 3x4 axis. Our opportunity, our strategic direction, our emphasis is to connect the data, the stakeholder, the workflow across this industry life cycle. That's where we're heading. We see it as a platform strategy. What's a platform strategy? A platform strategy represents a mindset of openness. It represents ecosystem. It represents a lot of API thinking extensibility solutions we have. It means integrating non-Trimble solutions into our platforms. It means very much cloud first, cloud forward thinking. It represents increasing emphasis and focus on delivering this value through subscription business models. I believe the subscription economy unlocks the data from machine and on-prem back to the cloud. Once we do that, that gets the opportunity to connect and redefine workflow -- and that's how I see the basis of competition shifting over time. And I don't think that there's many companies in the world to have the opportunity to do that. I don't see it as a winner take all, either. I do think there'll be multiple platforms that can coexist in this ecosystem. It's like we all have a mental image of construction. Like if any of you have ever done a construction project, put yourself in the mentality of that. How did that go? All right? And how many -- and just think of your mental image of how many people were involved, and how many contractors might have been involved in that. It's one we tend to be able to viscerally understand just how fragmented it is. We won't meet every need that a customer has. Therefore, our mentality is let's be more open in our thinking.

Got it. And on that, you guys recently partnered with Microsoft. So I was hoping you could talk a little bit more about like your product road map, particularly with them, Trimble Construction One. And how will that change the revenue growth algorithm of the Building and Infrastructure business?

Yes. So I talked about platform strategy being very much a cloud-oriented strategy to unlock the data. As you unlock the data and as you move towards cloud, it's logical to think that you might want to have a partnership with the cloud provider. Now we believe in a multi-cloud world. So we do work with multiple cloud companies, but we will be forward with Microsoft and the relationship. Okay. So think, for example, as we get more and more data, richer data set in our businesses, the ability to leverage, I'll say, the AI ML tools that the big cloud companies have, the compute cycles that they have. That's a powerful thing for us at a very attractive capability to be able to plug into. They're able to help us with some of the transitions of our business models and getting more of our technology to the cloud. And I'm very compelled to your point about the unlocking revenue opportunities at the global scale of their partner network and of their direct network. So a Construction -- a Trimble Construction Cloud powered by Azure that both they sell and that we can sell and that we can plug our technologies into, I think that does unlock opportunities. I also think if I really keep going forward with that, I think more and more for those of you who understand when I'm talking about microservices architecture, I believe in a future that looks more like a set of microservices that are extracted into the cloud and into the platform. It's a new way to consume the technologies that we have. So you may be able to go into the cloud, not even actually go into a Trimble specific application, actually just go into a cloud and say, "I want to pull data from A and B and they'll create C workflow from that, that's abstracted from a particular point solution. That's the direction that we see the future going.

Got it. Got it. And maybe can you talk a little bit more about that in terms of like how you plan to like monetize that type of opportunity?