P&F Industries Q2 2021 Earnings Call Transcript

Quartr
Provided by Quartr
August 4, 2021

There are 9 speakers on the call.

Operator

Good day and thank you for standing by. Welcome to the Trimble Second Quarter 20 21 Results Conference Call. At this time, participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. And please be advised that today's conference is being recorded.

Operator

And I would now like to hand the call over to Rob Nader, Chief Executive Officer.

Speaker 1

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. I'll begin on Page 2 with the key messages we want to convey today. In the Q2, Our team delivered outstanding results. We exceeded our expectations and delivered record ARR of $1,350,000,000 Up 11% year over year, total revenue growth of 29%, EBITDA margin of 26.4% And trailing 12 month operating cash flow of $798,000,000 We achieved record levels of revenue in many of our businesses, With exceptionally strong performance in machine control and civil construction, guidance in agriculture and survey and mapping.

Speaker 1

Our results demonstrate the quality of our strategy and our business model. On the basis of this strength, we are raising our guidance for the year. Turning to market conditions. The overall landscape is generally robust. Construction backlog is healthy, especially in residential and infrastructure.

Speaker 1

We remain optimistic that an infrastructure bill will ultimately be passed in the United States, which would further improve our long term outlook in our construction and surveying businesses. In agriculture and forestry, commodity price strength is translating into customer buying power. In transportation, market strength Shifted back to carriers, and this, in addition to improved execution, is translating into solid bookings growth. As discussed last quarter, we are investing in product development and go to market efforts around infrastructure and are stepping up investments in our agriculture business, all while continuing to invest in our Trimble Cloud Platform and our autonomy efforts. Our team is highly focused on executing our Connect and Scale 2025 strategy, which centers on building leading industry cloud platforms.

Speaker 1

Our strategy differentiates at the intersection of the physical and digital worlds. As an example, our hardware businesses allow us to capture data and execute work in the field, while improving the efficiency and efficacy of workflows between the office and the field. At Trimble, we develop our strategies with an end game backwards mindset. We balance short term and long term deliverables with our 3:43 operating model, 3 months, 4 quarters, 3 years. This is worth noting as quarterly comparables are skewed with COVID-nineteen and supply chain disruptions.

Speaker 1

We have to be able to see through the performance of any given quarter and play the long game, which we continue to believe presents a compelling We are focused on metrics such as ARR, backlog, EBITDA and cash flow as much as we focus on revenue and EPS. The combination of these metrics presents a more holistic picture of our performance. Let's turn next to Page 3 for some proof points that the Trimble operating system capturing strategy, people and execution is producing results. Starting with strategy. We continue to execute on revenue transition opportunities.

Speaker 1

In Buildings and Infrastructure, our structural steel, Concrete, Mechanical, Electrical and Plumbing businesses are hitting their stride with their business model transformations. Bookings, ARR growth and new logo wins are evidence that the team is expanding the addressable market. In Transportation, our recurring bookings were up significantly year over year, Also evidence that the conversion is working. On the divestiture front, we closed the sale of Manhattan Software in the 2nd quarter and Iron Solutions early in the 3rd quarter. Since January of 2020, we have divested or exited 8 businesses.

Speaker 1

We are focused on building out industry leading and cloud connected Technology platforms that enable customers to transform workflows by connecting Trimble and 3rd party capabilities. On People, I'm pleased to report that our leadership team was recognized by our employee base as one of the top leadership teams in a global culture survey. We were also recognized as a top performing company for women and diversity, and our engineering team ranked as a global leading team. I'm proud of my colleagues and our purpose driven culture. It's this team that is transforming the way the world works.

Speaker 1

In addition, we strengthened our Board of Directors with the announcement that Ann Fandosi will join our Board in the next couple of weeks. On execution, we continue to innovate. During the quarter, we announced an autonomy partnership with Horsch. We extended our machine control platform to soil compactors, and we introduced our infrastructure BIM collaboration software in North America. In addition, one of the proof points we monitor is cross sell annual contract value.

Speaker 1

Early wins in construction Increase our conviction that we are on the right track with our bundled offerings. Turning to Page 4. I'm excited to announce that earlier today, we launched Trimble Ventures, our corporate venture capital arm, with a commitment of $200,000,000 of capital. Our objective is to co invest in Series A through Series D rounds in Emerging Technologies as well as in companies that will extend our industry platforms. Our Co heads of Trimble Ventures include our Treasurer, Phil Cirenski and Ron Entebbe, Co Founder of our e Builder Business.

Speaker 1

In closing, it was the Q2 last where we face the initial and biggest uncertainty with COVID-nineteen. While the virus and its variants remain highly concerning around the world, I want to step back and reflect on an early principle we established, which is we said we would emerge from the pandemic on a stronger relative competitive footing than when we entered the pandemic. Our results demonstrate we are doing exactly this. My gratitude to my 11,000 plus Trimble colleagues and our global partners and customers. We've got this.

Speaker 1

David, over to you.

Speaker 2

Thank you, Rob. Let's start on 5 with a review of 2nd quarter results. 2nd quarter revenue was $945,000,000 up 29% on a year over year basis. Currency translation added 3% and divestitures subtracted 1% For a total organic revenue increase of 27%. Customer demand was healthy, rebounding across all of our end markets at a rate stronger than we anticipated.

Speaker 2

Gross margin in the 2nd quarter was 58.2%. Gross margins were down 70 basis points Year over year, driven by the shift in mix in our business with a higher percentage of hardware this quarter and the onset of product cost inflation given the disruptions we are seeing in our supply chain, partially offset by lower discounting. Adjusted EBITDA margin was 26 0.4%, up 70 basis points driven by higher revenue. Operating income margins expanded 110 basis points to 24.2 As expected, our operating costs were up meaningfully from the Q2 of last year when we had unusually low compensation spend a very tight focus on cost control in light of the COVID lockdowns. Net income increased by 40% and earnings per share increased by $0.20 to $0.72 per share.

Speaker 2

Our 2nd quarter cash flow from operations was $201,000,000 demonstrating the continued strong cash Generation of our business. Operating cash flow again exceeded net income in the quarter. Free cash flow was 190,000,000 Our net debt decreased over $225,000,000 in the quarter and our net debt to adjusted EBITDA ratio fell to 1. At the end of the quarter, we had the entire $1,250,000,000 available on our revolving credit facility and approximately $484,000,000 in cash. With a strong balance sheet, we are well positioned to continue to invest in our business, both organically and inorganically.

Speaker 2

Turning now to Slide 6, I'll review in a bit more detail our 2nd quarter revenue trends. As noted earlier, our ARR was up 11% in the with organic ARR growth of approximately 10%. Excluding our Transportation segment, Trimble ARR grew at a high teens rate in the quarter. Encouragingly, ARR trends in transportation improved with segment organic ARR approximately flat versus a year earlier. Our non recurring revenue streams experienced strong growth relative to the Q2 of 2020, during which our business was most negatively impacted by the COVID-nineteen shutdowns.

Speaker 2

Our hardware revenue grew 47% year over year, driven by strong performance in Civil Construction, Geospatial and Agriculture. From a geographic perspective, North American revenues were up 23%. In Europe, revenues were up 41%. Currency fluctuations positively impacted growth in Europe by about 9%, With the balance coming from catch up on project activity, which has slowed in 2020, fiscal stimulus measures and recovering demand in many end markets. Asia Pacific grew 19% year over year, driven by strong growth in Australia and New Zealand.

Speaker 2

The rest of world, which includes Brazil and Argentina, was up 49% year over year, driven principally by strong demand from the agriculture sector. Next on Slide 7, we highlight some of the other key Net working capital inclusive of deferred revenue was negative this quarter, representing approximately minus 2% of revenue on a trailing 12 month basis. Our deferred revenue grew 14% year over year. An important story this quarter is the growth of our backlog. Total backlog at quarter end was approximately $1,500,000,000 Of that total, approximately $300,000,000 relates to unfilled orders for hardware This compares with hardware backlog of about $100,000,000 at the end of the Q2 last year, which is a more typical level for our business.

Speaker 2

In this time of both exceptionally strong customer demand and increasing supply chain pressures, our operations team did an Extraordinary job, which enabled our record year on year hardware revenue growth of 47%. Turning now to Slide 8 For additional detail on each of the reporting segments. Buildings and Infrastructure revenue was up 22% on an organic basis. Revenue growth was strong in both our Building and Civil Construction businesses, with hardware revenue across the segment up greater than 40%. Segment margins were down 40 basis points due primarily to revenue mix.

Speaker 2

Across our recurring software offerings in this segment, Bookings were strong, up approximately 25% versus a year ago. Geospatial revenue was up 48% on an organic basis. We saw a rebound in demand across nearly all of the end markets for our geospatial offerings and our new products are generating significant customer enthusiasm. Operating margins were up 430 basis points due to strong revenue growth and the success of new products. Resources and Utilities revenue was up 32% on an organic basis.

Speaker 2

Revenue growth was strong in Precision Agriculture And Positioning Services. Margins expanded 160 basis points. Top line results in Transportation met our expectations. Revenue was up 9% on an organic basis year on year. The drivers of revenue growth were improved trends in both our Mobility and Enterprise businesses.

Speaker 2

Margins declined 170 basis points on a year over year basis due to increased mix of low margin hardware and increased operating costs, but margins improved sequentially over Q1 levels. We remain confident that we are on track for continued sequential improvement as the year progresses. Turning now to our outlook for the full year. Our performance in the Q2 and the strength of our backlog Give us the visibility and confidence to raise our outlook for the year. I'll point out that supply chain constraints continue to present us with meaningful uncertainty as the availability of some critical components remains unpredictable.

Speaker 2

The outlook I'll describe represents our best sense of this dynamic environment. I'll also point out that comparisons versus the quarters of 2020 are difficult to draw meaning from as the impact of the onset of COVID and the recovery Following market reopenings created large swings last year, we will focus more on sequential evolution from the second quarter through to the second We are raising our outlook for the full year revenue to between $3,550,000,000 $3,650,000,000 Demand remains resilient across all of our end markets, but our hardware revenues will likely be constrained by our ability to source key components. Note that this new revenue range incorporates our divestitures, including the recent divestitures of our Manhattan Software and Iron Solutions Businesses. Divestitures will reduce our revenue growth in 2021 by a little over 100 basis points, but are reflective of our increasing focus on platforms which Connect the workflows in our key end markets. Sequentially, we expect that revenue in the second half will be well above 2020 levels, but below the levels we realized in the first half of twenty twenty one.

Speaker 2

The expectation of lower revenue in the second half versus the first half is entirely driven by constraints in our supply chain. We expect to end the year with hardware backlog at levels similar to the end of the second quarter. Given our strong bookings trends across our recurring software businesses, we expect organic ARR growth of approximately 10% for the full year. We anticipate that second half gross margins will be down approximately 50 to 100 basis points below second half twenty twenty margins Due to the net impact of product mix and cost pressures, partially offset by price increases, we We are implementing price increases across many of the product lines impacted by the recent inflationary spike. But overall, the net the greatest gross margin pressure in the Q3 as we won't realize the full benefit of our price increases until the Q4.

Speaker 2

Our outlook for operating margins has improved as the leverage from higher revenue more than offsets the impact of mix shift, Increasing product cost inflation and the investments we are making in support of our strategy. We now expect that operating margin For the full year 2021 will be comparable to 2020. Note that our software business model transitions from perpetual to recurring are accelerating in the back half of this year. These transitions will adversely impact operating margins by 150 to 200 basis points in the second half of twenty twenty one. Our outlook for full year earnings per share has increased to $2.45 to $2.65 per share.

Speaker 2

From a cash flow perspective, given our strong performance in the first half So comfortably exceeding non GAAP net income. With that, I'll turn it over to the operator for Q and A.

Operator

Thank you, presenters. At And we have our first question from Jerry Revich from Goldman Sachs. Your line is open.

Speaker 3

Hi. This is Ashok Soh Mohan on for Jarevich. Can you talk about the ARR growth for e Builder and Viewpoint? And out of the growth, what proportion was from new logos?

Speaker 1

Hey, good afternoon. The total ARR growth for the combination of Viewpoint and e Builder was 17% in the quarter year over year. As it relates to new logos, we had actually strong performance in the quarter on new logo bookings. So it's a good sign that the Connect and Scale strategy is bearing fruit inside of construction.

Speaker 3

Okay. And in Resources and Utilities, one of your customers is acquiring a competitor. Can you talk about your views on the competitive landscape as it relates to Trimble?

Speaker 1

Well, to set context for the competitive landscape, let's start with the macros in the agriculture market. As we all know, it's the commodity prices are high and that is fueling positive farmer net income. So there's an attractive backdrop against that farmer sentiment is high, new machine sales are strong. So the place to start Is that the top level with the market conditions that are positive? And you see that playing through the results in the Resources and Utilities segment, and The team did a really nice job in the quarter and really through the balance of this year.

Speaker 1

From a competitive landscape perspective, Actually, what I want you to hear is that CNH is an important customer of Trimble. And so we expect that relationship to continue To go forward in a positive light and that's been that's consistent with the signals that we've received thus far.

Speaker 3

Okay. Thanks for the color.

Operator

We have our next question from Jason Celino from KeyBanc Capital Markets. Your line is open.

Speaker 4

Great. Thanks for taking my questions. Can we talk about this $200,000,000 venture fund? Should we think of these as moonshots? I mean, how does it fit in your Connect and Scale initiatives?

Speaker 4

And then with the business leader from e Builder kind of co leading it, is this going to be more targeted toward the Objection, sir. Thank you.

Speaker 1

Hi, Jason. So the I'll say the thesis behind Trimble Ventures is Twofold. It's to accelerate platform investments as well as the technology ecosystem. So from a technology ecosystem, think about emerging Technologies that could relate to augmented reality. It could be in blockchain.

Speaker 1

It could be in T or autonomy, and that plays across all of Trimble potentially. And then from a platform perspective, Connect and scale is synonymous with an industry platform strategy, and so I'll use the 2 interchangeably. We want this venture fund To participate with companies who can be part of the Trimble platform and extend the customer Value and value proposition. And that also, we could see playing across the breadth of Trimble. Having Ron Entebbe, who comes from the e Builder business, we think is a great thing because he's a lifelong entrepreneur Who plugged into the bigger company at Trimble, and we think he's got the right the mindset and the network to help companies Succeed inside the Trimble platform.

Speaker 4

Okay, great. And then one if I can sneak in for David. It sounds like the lower discounting is being able to offset some of the higher product costs, but it sounds like it's still kind of a negative Net impact with the mix, I guess, can you maybe provide a little more color on the level of discounting change Versus the higher costs?

Speaker 2

Yes. Hey, Jason. First thing I'd point out is that the Significant majority of the impact both on the cost and pricing side isn't yet reflected in Q2. It's Much more of the impact is in the back half of the year. We have been ratcheting down our discounting from the old prices Already for a couple of quarters now.

Speaker 2

And the way to think about it is that, that ongoing reduction in discounting Was sufficient to offset the cost most of the cost increases we had in the quarter. For the back half of the year, What's going to happen is that much more of the cost increases we're seeing for our hardware products, some of which by the way we believe are majority of which we believe are Temporary in nature and they're related to the dislocation of the overall supply chain. But those are kicking in, In full force, now here as we enter the Q3, we are taking top line price increases across Essentially, all of our hardware offerings that are impacted by the cost increases, those kick in gradually Slightly different approaches and timing from business to business. Overall, our outlook is that the top line price increases in the second half We'll offset most, but not all of the cost increase, but it will be reasonably close for the full year.

Speaker 4

Okay, great. Thank you.

Operator

We have our next question from Colin Rusch From Oppenheimer, your line is open.

Speaker 5

Thanks so much guys. Could you give us a bit more detail on the bundled Offerings, the scope of those customers, the potential for follow ons, anything around the individual end markets that are really leading the way. Just want to get a sense of where that traction is and how it might accelerate?

Speaker 1

Hi, Colin. It's Rob. Good afternoon. So we work backwards from the connect and scale strategy and the platform strategy, and we think about the bundled offerings and how they can be in service of delivering a greater value proposition to our customers. The primary places where we're seeing The fruits or the early fruits of the efforts are in construction and to a lesser extent in transportation.

Speaker 1

And we are measuring that success. So we'll measure cross sell ACV internally. We'll measure new logos For proof points that we're creating success, we're listening to our customers and our customers are telling This is how they want to do business with us and that they want to see us connect many of the point solutions that we have Together to provide really workflow productivity. So I'm quite encouraged that we're heading the right direction I'm here with Connect and Scale, and I'm encouraged that its potential really across a great deal of our portfolio.

Operator

Okay. That's helpful. And then we'd love

Speaker 5

to get a better sense of this infrastructure build that just is getting released with over $100,000,000,000 and might earmark for the roads and bridges. How does that potentially is different for Trimble versus past bills and what you're expecting given kind of the first read on what's in there.

Speaker 1

Yes, great question. So we continue to see this as a generational opportunity to increase The competitiveness of infrastructure in the U. S. And for the use of Trimble technology to help us build that infrastructure better, faster, safer, Cheaper and greener. There is a real value proposition to the technology being deployed against these projects.

Speaker 1

Now let's talk about the funding aspect of it. The way we see it is that we have had a baseline spend on surface transportation and that came in the form of continuing resolution last year. So now fast forward to 2021, the Surface Transportation Reauthorization Act will sets a new level of baseline funding that is more than 23% ahead of the previous continuing resolution level, so 23% ahead. Inside of that, that also contained an advanced digital construction management system provision, and that provision encourages the use of digital technology. So that's very favorable to us.

Speaker 1

And then on top of that, that's the Bipartisan Infrastructure Investment and Jobs Act, And that is set to provide an additional $550,000,000,000 over 5 years in infrastructure spending across segments such as Roads, airports, ports, public transit and rail. And so then if we just look at roads and bridges alone, that would be a 46% increase From the FastAct baseline. So we are building solution capabilities around this opportunity and we're staffing to support what we see It's an attractive opportunity in front of us because this is a fundamentally different level of funding that we believe, if passed, We'll have a meaningful positive impact to our engineering and construction related businesses.

Speaker 4

That's super helpful. Thanks so much.

Speaker 1

You're

Operator

welcome. We have our next question from Chad Dillard from Bernstein. Your line is open.

Speaker 6

Good evening, guys. Hi, Chad. So I wanted to dig into the Culture investment that you talked about that you're increasing. Can you just give a little more color on that? And could you just Frank order what the priorities are for that business right now?

Speaker 1

So When we look at the agriculture business and think about the priority investments, our leadership for going on decades now Has been in the guidance side of the business. So think of the controls in guidance. We will continue to invest in that business to keep us As the leader in guidance technology. So we're increasing our level of investment there. And think positioning technologies, think Ubiquity of coverage around the world with the positioning of correction services we have the fast convergence that we can provide to farmers to get that high level Accuracy, think about position under Canopy to provide better outcomes for farmers for Positioning.

Speaker 1

So we will continue to invest in the guidance side of the business. If I move next to Precision side of the business, I think flow controls, variable rate, which we see as the next really growth frontier Within the agriculture market, we've been investing in this for a long time. The Mueller acquisition we did a few years ago really brought us forward into the And we continue to see attractive opportunities there. And then the 2 other areas, I would put would be autonomy. In our autonomy efforts, we are developing really in the core part of Trimble that serves construction end markets and agriculture end market.

Speaker 1

So we could eliminate redundancy and duplication of efforts by serving multiple markets. So efforts and autonomy are important to us. And by way of example, the horse relationship that was announced, as it puts credibility behind the efforts we have there. And then finally, I would look at the software side of the agriculture business and the bundling. It's more than just a bundling, but if we look at the software The capabilities within agriculture, it's really that operational dashboard and operational management system For a farm and we believe deeply in the connection of what we're doing in the office and the field, the software, the hardware, the physical, the digital, making it easier for the farmers To buy the software, the services and the hardware together, so there's efforts in that front.

Speaker 6

That's helpful. And then can you help me think through the incremental margins in the back half of the year? My Very rough back of the envelope math. It sounds like it could be a little bit negative. So can we just like walk through just the puts and takes on net price, Quantifying materials logistics cost.

Speaker 6

And then just like how quickly do you think you can raise price and push that through to your customers?

Speaker 2

Hey, Chad, it's David. Let me offer a few observations. So, as you think about the dynamics In the back half, it's safe to say that cost impact will hit faster than our price Increases, so I said we would offset most but not all of the cost increase with pricing in the back half. And just the logic of that says gross margins will be under more pressure in Q3 and Q4. Another dynamic impacting the gross margin line is the mix of the business.

Speaker 2

We saw a pretty big spike up with 47% hardware growth, which comes in at lower gross margins and that will abate it a bit. So those are the key drivers on the gross margin line. OpEx is going up for the reasons that Rob mentioned and a few others. In part, we're restoring normalcy to compensation. Basin bonus compensation were really, really unusually low Last year, we're hitting our targets this year.

Speaker 2

So that accounts for about half of the OpEx increase that we expect. And the remainder is a function of the investments Rob mentioned and other costs that go up as our revenue grows. Margins will be impacted, have been impacted, will be impacted by the subscription transition. It will be a little more than 150 basis points in Back half of the year. So all of that complicated math gets you to a point where we now think operating margins for the full year will be roughly comparable to 20 And you might recall last time we said they would be between 2019 2020.

Speaker 2

But with the bigger revenue than we anticipated last time, we're getting more fixed cost leverage. So, hopefully that points you to most of the items you need.

Speaker 6

That's great. Thank you.

Operator

We have our next question from Meta Marshall from Morgan Stanley. Your line is open.

Speaker 3

Hi, team. Thanks for taking our questions. This is Eric on for Meta. Maybe if we could just dive a bit into the bounce back you're seeing in your perpetual software business. I'm wondering if any of the strength or some of those products are tied to hardware products.

Speaker 3

And if so, To that point, could there be some headwinds to that business if hardware is seeing supply chain bottlenecks?

Speaker 2

Yes. Hey, Eric, it's David. You're right. The meaningful majority of our perpetual software is sold together with hardware. So that's been a good news story.

Speaker 2

We do, by the way, continue to anticipate that hardware revenue will grow just Year on year, just not as much as it did in the second quarter. And we do anticipate lower Sequential revenue in the back half versus the front half. So that will have a direct correlating impact on perpetual software.

Speaker 3

Got it. That's helpful. And then if I could squeeze in another one. As we think about some of the perpetual sales coming back and I know ultimately longer term, the goal is Converge as much of the portfolio to subscription as possible. Is there a strategy around some of these products that are Still sold on a perpetual basis or do they kind of fall in the category of they'll likely continue to be purchased on a perpetual basis?

Speaker 1

Eric, this is Rob. I'll give you an example on our civil construction business. We have an offering we call Trimble platform as a service Where you can get technology assurance by subscribing to the machine control and guidance Solution. And when we sell that, that sells with software that comes along with it and actually a richer software offering that also can bundle some The software with that. We have examples and a few, they're not needle movers, but some examples in agriculture, where Some of the large enterprise farms are buying what we refer to as everything as a service.

Speaker 1

So we do have examples in the business Where the whether it's a one time sale or what would look like perpetual, can become ratable with it. And it works so we believe it works so long as you're providing a compelling value proposition and the root of that compelling value proposition in construction is around Technology assurance. So we will continue to push that forward. We've been really in North America and civil construction and that will now start To go out to more of a global model. And then if we look at the software that goes along with the hardware that you were just asking about, we also see opportunities that even for Hardware that continues to sell as a one time sale that perpetual software that goes along with it, much of that does We think have an opportunity to go ratable over time.

Speaker 1

I think we will be well on that.

Speaker 6

Thanks

Speaker 3

and congrats on the quarter.

Speaker 1

Thanks, Eric.

Operator

We have our next question from Gal Munda from Berenberg. Your line is open.

Speaker 7

Yes. Hi, team. Thanks for taking my questions. The first one was just maybe touch a little bit on the dynamics Of the bookings growth versus the ARR growth, when I look at your split and the commentary around different Segment results, both in Buildings, Infrastructure and Transportation, you're noting that bookings are actually growing faster Then the ARR, what's driving the dynamic? Is it kind of maybe in transportation still a churn that kind of is Leaking out there or is it duration or is it just the fact that it's kind of more upfront licenses that's kind of Providing the bookings growth ahead of the ARR.

Speaker 1

Hey, Gal, good afternoon. It's Rob. The Bookings growth ahead of ARR growth, actually, I see is very virtuous in the business. And the bookings is, of course, going to Precede ARR. So I look at the bookings growth that we're having as proof points that The strategy is working, both the strategy for individual products we have, proof points that the macros are there, the fundamentals are there For the underlying businesses, proof points that the bundling efforts are working, proof points that we're driving new logo Growth?

Speaker 1

Proof points as well, Gal, I'll give you a specific example. When we see we keep seeing when we have models that transition from perpetual to Subscription that we're increasing the size of the addressable market. So our architecture and design business, for example, Had yet another quarter of over 50% ARR growth. That's 6 quarters in a row. That doesn't happen unless you are expanding the size Of the addressable market, those growth rates exceed what we had before the model conversion.

Speaker 1

So that's going to show up in a booking growth Before it shows up in ARR, that's exactly how I would want to see this play out in the business. So I'm very encouraged by seeing that dynamic.

Speaker 7

Okay, perfect. So that's there is the upside to the ARR growth effectively in the sub segment. Exactly.

Speaker 6

That's good.

Speaker 1

Yes. The timing of when that bookings growth translates into the ARR, so you connected the dots correctly.

Operator

Yes.

Speaker 7

Absolutely. Okay. That makes sense. And then last quarter, when we talked a little bit about the supply chain issues and the headwind to the growth, I You were saying the reason why you didn't raise the guidance more last quarter was because of that. Is that Now you've obviously raised the guidance quite significantly after the first half.

Speaker 7

How much Is this still kind of providing how much is it putting brakes on your growth? Or how much could you grow if Supply wasn't an issue, but kind of demand would allow you to grow faster than you think you are. Can you quantify that still?

Speaker 2

Hey, Cal, it's David. Let me start with a couple of perspectives. Demand was more robust in Q2 than We thought a quarter ago. We also were able to squeeze more out of the supply chain than we thought we would a quarter ago. I'd point you to the comments we made about our hardware backlog.

Speaker 2

So in a normal year, hardware backlog At the end of Q2, it would be about $100,000,000 That's what we had a year ago. We actually saw it creep up as the supply chain issues Began to show themselves in Q1. It was about $200,000,000 Now we're at $300,000,000 So the simple way to think about it Is that an awful lot of that $300,000,000 or the $200,000,000 increment above a normal level is what customers want that our supply chain isn't letting us Get to them. And I'd love to say we're going to get through all of that in the back half of the year. But if you look through the guidance comments, you'll note that we're projecting We think we'll end the year with backlog somewhere about where it is now.

Speaker 2

So our lead times on some products are longer than we or our customers would like And we're working through it. But it's an interesting situation. We're not unique in facing these challenges. We've worked through it much Better than we thought, but it will be it will constrain the growth we otherwise could have in the back half.

Speaker 7

That's really helpful. Thank you so much for your perspectives.

Operator

We have our next question from Rob Mason from Baird. Your line is open.

Speaker 8

Yes. Good afternoon. Thanks for the question. First question is just around your operating expenses. You had noted as you go into the back half of The year, the second half, 150 basis points to 200 basis points around your growth investments as those are Increasing.

Speaker 8

Should we think that those are still scaling up as we exit the year and presumably those will carry over into next year? That's one question. And then relatedly, just around your compensation normalizing after the measures you Took last year. I'm just curious if there's anything around the incentive side that we should think about Perhaps resetting at a different level, lower level, next year

Speaker 1

as well?

Speaker 2

Yes. Hey, Rob, it's David. Let me frame this a little bit. If you sort of go through the outlook we gave on gross margins and operating margins, you'll see that We expect for the year operating expense to be up about $130,000,000 plus or minus for the year. About half of that is relating to restoring compensation to a normal level and We are beating our own benchmarks, so that will improve that Increases comp in a way that would likely normalize next year.

Speaker 2

The remainder of it is partly just the normal cost of growth and then about 20% or so of the $130,000,000 is relating to the growth initiatives. I'll probably look to Rob for commentary, But I will say, I think using Rob's word, this is a long game and we're engaged in a multiyear effort To create and exploit these platforms, the digital transformation we have underway, Spending by no means will be over. That's not what we're signaling this year. We will be spending against those initiatives Next year and thereafter.

Speaker 8

I see. Okay. Just Maybe a follow-up. Around the Geospatial business, in particular, obviously, very strong rebound of last year. But Noticing that across the industry as well.

Speaker 8

And historically, I know Rob, you've talked about that perhaps being the most penetrated vertical area you sell into from a technology perspective. So I'm just curious if there's is there anything changing Around the technology side, I know you yourselves have some new products there, but is there anything changing in the industry around the technology? Or is there possibly your customers or channel trying to get out in front of What may be coming from an infrastructure side?

Speaker 1

Yes, good question, Rob. I see three things happening in the market. I see the new product introduction, I see channel excellence and I see positive macros. The team did an outstanding job in the quarter. They've done an outstanding job really over the last couple of years.

Speaker 1

Couldn't be more proud of what this Group of colleagues is doing because they are defying the messaging I've had in the past about the nature of growth potential in the market and I follow the numbers that are published. We are outgrowing our competitors and peers In the market in this business. Now we'll eventually lap this and those numbers will get hard. On the new product introduction side, I'd say a couple of things. Yes, we have been mentioning many of the products that the team and the cadence that they've had Here over time and that does, let's say, create a replacement cycle opportunity.

Speaker 1

So whether we're talking our X7 laser scanner, we've got a new mobile mapping system, our R12i GNSS system, the TSC5 Han Hao, data collector, these are all driving excellent business. And this business was actually well positioned in context of supply chain constraints Because when you have new products coming to market, you're buying components well ahead of that. So that's the new product introduction side. The second on channel excellence, really kudos to the sales leadership and channel development team who works with our global dealer Partners, all of them, I think, are becoming more and more professional in how they run and manage their businesses and how they think about segmenting markets and addressing And then finally, the macros. Clearly, macros such as residential and infrastructure are driving Very positive benefits for this business.

Speaker 1

We saw oil and gas do better in the quarter. So in places like Texas, They were buying. I'll say they were buying again. So we saw some growth in that in the quarter as well. And we look at those macros, Rob, not only for the current sales of the surveying mapping products within geospatial, But we look at the correlation of how that might connect to the civil construction products that would be downstream of that from a workflow Perspective.

Speaker 1

So that gives us conviction in hope of an infrastructure bill getting passed That could that is a sign, an early sign of potential in our other some of our other businesses.

Speaker 8

I see. Okay. Very good. It's Good insight. Thank

Speaker 3

you. You're welcome.

Operator

There are no further questions at this time. I will turn the call over back to Michael Leyba of Investor Relations.

Speaker 2

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

Operator

Ladies and gentlemen, this concludes today's presentation. Thank you for participating. You may now disconnect.

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Earnings Conference Call
P&F Industries Q2 2021
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