Good morning. My name is Chris and I will your conference operator today. At this time, I would like to welcome everyone to the Trimble Third Quarter 2022 Results Conference Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] Thank you. Rob Painter, Chief Executive Officer, you may begin..

Welcome everyone. Before I get started, our presentation is available on our website; and we ask that you refer to the safe harbor at the back. Our financial commentary today will reflect non-GAAP performance metrics, including organic growth comparisons, which will relate to the corresponding period of last year, unless otherwise noted.

Let’s begin on Page 2 with our key messages. Total revenue in the quarter was $885 million, up 6%, yet short of our own higher expectations. Annualized recurring revenue met our expectations and grew 16% to a record level of $1.55 billion. Gross margin finished at a record level of 60.9%, exceeding our expectations.

ARR and gross margin are the two-highlight metrics of the quarter. Software, services, and recurring revenue comprised 60% of revenue in the quarter, and 57% on a trailing 12-month basis. EBITDA margins of 25.8% and earnings per share of $0.66 also exceeded our expectations in the quarter.

While ARR performed extraordinarily well in the quarter, demand for hardware and associated software fell short, especially late in the quarter. We expect this will continue through the fourth quarter. While detecting the signal through the noise is difficult at the moment, we attribute the weaker hardware demand to two factors.

First, we see a relative weakening of overall sentiment, especially in Europe and in other regions negatively impacted by the strength of the U.S. dollar. Second, we see our dealers, in aggregate, moderating their inventory levels in the back half of the year.

This reflects their current sentiment, and also factors in some good news from our supply chains, which began to ease up and offer shorter lead times on our products. We see many parts of the global economy through the industries we serve.

If we look at the overall economic indicators, I’d say that, in aggregate, the indicators went from great to good. In agriculture, farm income remains high, but so does inflation.

In construction, the overall indices are still net positive, but interest rates are beginning to have a negative impact on residential work, and inflation is eating into the increased funding from the U.S. bipartisan infrastructure bill.

In transportation, although spot rates in the truckload market have softened due to normalizing demand, freight volume remains steady along with contract rates. Higher fuel prices continue to inflate overall transportation costs, yet trucking margins have remained relatively healthy, due to the strength of freight demand.

Managing through these challenging economic and geopolitical landscapes presents a higher level of operational complexity. What is not complex is leading with guiding principles, which for us are threefold. First, we will take actions to exit an expected period of macroeconomic weakness on a stronger competitive footing.

Second, we will continue to allocate capital to key areas of the business, such as our digital transformation. Third, we will increase our operational and cost efficiencies and work to reduce our own complexities and redundancies.

With that in mind, I will comment on the business through the lens of our operating system, encompassing strategy, people, and execution. Let’s start with strategy. On September 7, we held an Investor Day, where we walked through our Connect and Scale strategy and how it manifests as an industry cloud strategy.

We talked about the unifying elements of Trimble and the market opportunity in front of us to digitize and connect some of the most important industries on the planet.

We also discussed how our digital transformation will enable connected sales of solutions across a growing portion of our business and shared examples where we are already winning with connected solutions in the market.

Finally, we talked about capital allocation and our commitment to transform more of our solution offerings to ratable revenue models, which we firmly believe offers customers more value while expanding the size of our addressable markets. ARR, EBITDA, and cash flow are key metrics for us in the coming years.

In the last couple of weeks, we exhibited at the INTERGEO geospatial conference and Bauma construction trade shows, both in Germany, both well attended, and both with high levels of customer engagement.

On November 7 through 9, we will hold Trimble Dimensions, our engineering and construction user conference, where we expect over 5,000 customers and partners to come together to connect and inspire transformation in our industry. Moving to people, on October 6, we announced that we changed our corporate headquarters to Westminster, Colorado.

We’ve also made some leadership changes. In August, Ron Bisio took over responsibility for our Transportation business. Last week, we announced that Peter Large will take responsibility for all of our construction assets, software and hardware, across civil and building construction.

Our Chief Digital Officer, Mark Schwartz, will take over responsibility for most of our construction software assets; and Pattie-Boothe will take over responsibility for our civil construction business. We now have single points of accountability to deliver outcomes in construction, agriculture, and transportation.

Finally, on the topic of execution, let’s review this in the context of our reporting segments. In Buildings and Infrastructure, we acquired Bid2Win on September 9, which is a great fit for our strategy. Bid2Win extends our software capabilities to estimating and operations in the heavy civil construction industry.

At the segment level, [ACV bookings] [ph] growth in the quarter exceeded the level of ARR growth, giving us visibility to continued growth. We also continue to see success in cross-selling and up-selling new and existing logos with our early version of Trimble Construction One.

We will continue to expand and automate this offering in the months to come. In geospatial, I spent three weeks in the Asia-Pacific region in September and met face-to-face with many customers there.

I saw first-hand how they are using our surveying and mapping instruments and software-driven workflows to build the largest infrastructure projects under development in New Zealand and Australia. In Transportation, the business achieved double-digit operating income margin this quarter, for the first time since the fourth quarter of 2019.

While we still have a lot of work to do, it is worth noting that we are headed in the right direction. In Agriculture, we announced that we signed an agreement to acquire Bilberry, which we expect to close in the fourth quarter.

Bilberry specializes in selective spraying systems utilizing artificial intelligence and machine learning for sustainable farming. We also signed an agreement with CLAAS to develop a next-generation precision farming system for their tractors, combines, and forage harvesters.

We launched our next generation GFX high-resolution touchscreen displays, targeted towards farmers that operate mixed fleets. These GFX displays are compatible with over 10,000 vehicle models across more than 40 equipment brands, and they are ISOBUS-compatible, which allows one display for ISOBUS implements, regardless of manufacturer.

Overall, Trimble customers see technology as an increasingly important tool to manage the inflationary and labor shortages they face and to achieve their sustainability commitments. Our bundled solutions represent a unique competitive strength as we compete for our share of the growing industrial technology market.

I’ll now turn the call over to David to review our financial results and outlook in greater detail..

Thank you, Rob. Let's start on Slide 5 with a review of third quarter results. Third quarter revenue of $885 million was up 6% organically. Changes in foreign exchange rates reduced revenue by 4%, while divestitures net of acquisitions also reduced revenue by 4%. Pricing drove slightly over half of our year-on-year organic revenue growth.

Software and recurring revenue continued to grow at a strong rate as reflected by the sequential acceleration of our organic ARR growth.

Ongoing transitions of software models from perpetual to recurring, principally in our Transportation and Buildings and Infrastructure segments, contributed to our ARR momentum, but reduced revenue growth in the quarter by approximately 100 basis points.

Hardware revenues grew modestly on an organic basis, enabled by reduced lead times and improving throughput from our supply chain. Supply chain constraints continue to be dynamic in nature, but our team made good progress in the quarter working around these constraints and executed well in a challenging and unpredictable environment.

Bookings for hardware products from our dealers declined sequentially from prior quarters and came in below our expectations, reflecting a softening demand environment in some of our end markets and lower dealer inventories.

Gross margin in the third quarter was a record 60.9%, up 220 basis points year-over-year, driven by an increasingly favorable business mix and the improving net impact of pricing and slowing input cost inflation. Adjusted EBITDA and operating margins were essentially flat year-over-year, and well above pre-COVID levels.

Strong gross margins and lower accruals against our annual incentive plans fully offset the year-on-year impact of spending against our strategic initiatives. Net income dollars decreased by 3% and earnings per share were flat year-over-year at $0.66 per share.

Our trailing 12-month cash flow from operations was $440 million, and free cash flow was $389 million, both of which are down versus prior year. As we outlined in our last earnings call, inventory dynamics and a change in the U.S. tax law are adversely impacting our cash flows in 2022.

Our inventories are well above the levels we held before the supply chain shortages emerged in 2021, as we have been buying to support improved hardware lead times. And a provision in the U.S. tax law has resulted in the amortization of R&D costs for tax purposes beginning in 2022, which has meaningfully impacted the timing of tax payments.

We expect both of these unusual factors will reverse in 2023, which will yield significant increases in cash flow and a more normalized relationship between earnings and cash flow going forward.

Note that the underlying working capital dynamics of our business remain strong, with essentially zero net working capital even at our temporarily higher levels of inventory.

Notwithstanding a reduction in backlog from improved hardware lead times, we enter the fourth quarter with $1.5 billion in backlog, $1.3 billion of which supports future software, services and recurring revenue.

We ended the quarter with leverage measured as net debt-to-EBITDA of 1.4 times, giving us a resilient capital structure and the flexibility to invest where we see opportunity. This quarter we funded our acquisition of Bid2Win and completed $90 million in share repurchases.

Turning now to Slide 6, I'll review in more detail our third quarter revenue trends. On this and the next few pages I will focus on organic growth rates, excluding the impact of acquisitions, divestitures, and currency fluctuations. ARR was up 16%, with strong bookings in construction and healthy net retention across our portfolio.

Our non-recurring revenue streams grew modestly, with hardware up 3% year-over-year. As Rob mentioned earlier, our non-recurring revenues were below our expectations, driven by weaker end market demand in some markets, especially in Europe, and growing caution among our dealers on how much inventory they want to hold.

From a geographic perspective, North American revenues were up 10%. In Europe, where the macro-economic outlook contracted the most, revenues were down 3%. Asia-Pacific was up 4%, and the rest of world was up 21%. Next on Slide 7, we highlight some of the key metrics that we follow.

ARR in Buildings and Infrastructure, Geospatial, and Resources and Utilities all grew at a mid-teens or above rate, while Transportation ARR growth was high-single digits and improved sequentially. Let’s turn now to Slide 8 for additional detail on each of our reporting segments. Buildings and Infrastructure revenue was up 12%.

Revenue growth was strong across our software businesses in this segment, while our Civil Construction hardware revenue benefited from improved supply chain throughput. Segment ARR was up in the [20’s] [ph] in the quarter. Geospatial segment revenue was up 1% over a very strong performance in the third quarter of 2021.

Resources and Utilities revenue was up 9%, driven by improved throughput from our supply chain, strong demand from OEM customers, and continued growth in our positioning services. Financial results in Transportation showed progression in a number of areas. ARR growth and margins both improved for the fourth quarter in a row.

We continue to progress in the conversion of our Transportation Enterprise software business to recurring revenue models. Turning now to Slide 9, I’d like to provide our updated financial outlook for 2022. I’ll start with ARR.

Driven by our momentum in bookings and sustained high levels of net retention, our outlook for ARR growth is unchanged from what we shared with you last quarter. We continue to expect organic ARR growth of approximately 16%.

Turning to revenue, we now project organic revenue growth of 6% to 8% for the full-year, which is 300 basis points below the outlook we shared with you in August. For the full-year we expect that changes in foreign exchange rates will reduce year-on-year revenue growth by 3%, while divestitures net of acquisitions will also reduce revenue by 3%.

We expect operating margins for the full-year of approximately 23%, which is consistent with the range we shared with you in August. Our outlook for gross margins has improved, driven both by an improving business mix and a more positive outlook for pricing and costs.

We project that our improving gross margins and strong operating cost control will offset the adverse impact of lower leverage on our fixed costs. Our forecast for income from equity investments is approximately $28 million and net interest costs are estimated to be approximately $66 million. Our tax rate guidance is a range of 18% to 18.5%.

Taken in aggregate, we now expect full-year 2022 non-GAAP earnings per share to be between $2.61 and $2.67 per share. From a cash flow perspective, we now expect the ratio of free cash flow to non-GAAP net income to be 0.5x to 0.6x for the year, with the primary impacts continuing to be Section 174 tax payments and inventory dynamics.

We continue to expect to deliver 2023 free cash flow well above non-GAAP net income as these factors reverse. From a segment perspective, in the fourth quarter we expect organic growth rates to moderate in the Buildings and Infrastructure, Geospatial, and Resources and Utilities segments driven entirely by lower year-on-year revenues from hardware.

In the Transportation segment, we expect the growth rate to improve sequentially. ARR growth should remain relatively consistent with recent trends in each of our segments. We expect to issue 2023 guidance in February, but at this point we anticipate a 2023 outlook for double-digit ARR growth and strong cash flow generation.

Rob, I’ll turn it back over to you..

Thanks David. Let me acknowledge that global market conditions have become more difficult. I also think that perspective is important. ARR at $1.55 billion and up 16% is a remarkable achievement and puts us in the upper echelon of technology companies.

Our survey, agriculture, and civil construction hardware revenues, when factoring in our current 2022 forecast, have grown at a compound annual growth rate of over 13% since 2019.

The data we have suggests that we have gained share in each of these end markets over the last three years, and we remain pleased with our performance and the strategic health of these businesses. Looking forward, we will stay true to our 3-4-3 model, simultaneously balancing a view on 3 months, 4 quarters, and 3 years.

In the short-term, we will more tightly manage headcount and discretionary costs, while continuing to transform our business models. In the mid-term, we are planning for persistent economic uncertainty, and we will be sharper on our capital allocation to invest in key areas of the business without cutting into any muscle.

In the long-term, the durability of our business is stronger than ever, and our markets are inflecting with the adoption of digital technologies. This remains our moment to Connect and Scale and we are as committed as ever to this strategic journey. Operator, let’s open the line to questions..

Thank you. [Operator Instructions] Our first question is from Jerry Revich with Goldman Sachs. Your line is open..

Yes. Hi, good morning everyone..

Good morning, Jerry..

Rob, I wonder if you can just say a bit more about the ARR performance in the quarter? What was it in buildings and infrastructure in particular and nice to hear about the double-digit outlook into 2023.

I'm wondering if you could just give us an update on what's the cadence of bookings growth? Are you seeing maybe into the first half of 2023? You probably have some pretty good visibility on putting a more precise number based on bookings where ARR could track over the next 6 to 9 months? Thanks..

Thanks, Jerry. So, ARR, for the total company organic was 16% in the quarter and Buildings and Infrastructure was 21% and it was actually also above 20% in the Geospatial reporting segment. So, it's a strong performance overall. ARR arguably is a lagging indicator, the leading indicator is bookings.

So, with respect to your question of looking into Q4 and into 2023, when we look at the ACV bookings, contract value bookings that we had in Q3, those grew faster organically in the ARR in the quarter and that's a really solid leading indicator for continued ARR growth to come..

Super. And David, can I ask about the fourth quarter? So, obviously, you took down expectations. Normally, when you have a destocking adjustment like we're seeing, you have generally a disproportionate impact on margins in the short-term.

Is that playing out in the fourth quarter? Anything we should keep in mind about the earnings cadence off of this fourth quarter levels as we think about the cadence into [2023] [ph], any costs or inefficiencies from making the adjustment that you folks spoke about in the prepared remarks?.

Yes, Jerry, I understand your question. There's no real negative margin impact to the outlook we have.

In fact, the embedded in our guidance as you do the math, you'll see we expect to have very high gross margins in Q4 even higher than Q3 and that's a function of a business mix, which will be more software centric and we'll have more of the net benefit of the prices we've taken and moderating cost inflation.

So, Q4 will be really good from a gross margin perspective..

And so the negative revision to full-year operating margins, was the third quarter versus your model, David?.

This is a little bit of, I'll call it [noise] [ph] between Q3 and Q4 with the reduction in our outlook or forecast for the year, we brought down our accrual against our incentive comp. So, just the incentive comp helped Q3 margins by a little under 200 basis points and that gets normalized in Q4.

So, that's really the driver of the expectation of lower margins in Q4 than Q3, but the underlying gross margins will be better and the OpEx as a percent of revenue will look higher, but that's the impact of the accounting for the bonus plans..

Okay. I appreciate the discussion. Thank you. The next question is from Rob Wertheimer with Melius Research. Your line is open..

Hi. Thanks and good morning everybody. Rob, I wonder if you could just drill down a little bit more on where you're seeing it going from great to good and the hardware weakness. I mean, I guess it wouldn't be surprising to see Europe or [European ag] [ph], but I don't know what sounds like maybe you're seeing more than just that.

So, that's just a starting point.

I think the quarter has generally been pretty okay across industrials and it seems like you're seeing a few more spots of weakness?.

Hey, good morning, Rob. Hey, the first comment on the great to good was at the overall company level. If I think about the dynamics and hardware revenue, let's say, compared to other companies that you're following. Let's talk about retail versus the wholesale and then I think you also have to take into account units and pricing.

So, at a retail sell-through like visibility we have is that the retail sell-through is quite solid. So, actually dealers are bringing down inventory levels, but the retail demand is still there. So, what I would characterize in my sentiment is that the goodness is still there.

So, our – and I've seen some others, the revenue in their third quarters was more to wholesale demand, meeting wholesale demand. In other words, building up dealer inventory at AR as we saw dealer inventory reduction, but the retail demand was a sell-through.

And then with respect to pricing in units, I think one thing that to me I'd characterize in the good side for our hardware business is, we're getting still a fair amount of our growth that's happening through unit growth. So, this is not all pricing.

And then another just thing in terms of setting perspective overall from the – if I go – we are going back to 2019 is, we've got a CAGR of 13% in [some of] [ph] our survey agriculture and civil construction hardware revenue. So, if I expand the horizon a bit, I can still see through what has been a very positive track record in the business.

So that's – Rob, that's how they come to the great to good and [indiscernible] to your question. Let me know if you have a follow-up..

Yes. Rob, that's helpful.

Is the dealer conservatism geographically in product equal or is it concentrated or heavily concentrated in a couple of products or regions?.

Well, for sure concentrated in Europe as a geography. And then if I took it at a product level, I'd say a mix of civil construction and agriculture..

Okay. Thank you. I'll get back in line..

The next question is from Kristen Owen with Oppenheimer. Your line is open..

Great. Thank you for taking the question. Good morning. Transportation margin, you called that out as having been one of the highest since 2019.

Clearly, there's some seasonality that we would expect to see in 3Q, but I'm wondering if you can talk about some of the successes that you're seeing in that business, where we are in terms of net new business and how we should think about the exit rate for that segment just given some of the changes you've made over the last two years? Thank you..

Good morning, Kristen. Yes, so, I guess a couple more data points in there, sequential growth in ARR. Our gross margins are the highest in that business since Q4 of 2018. Our OpEx is at the lowest level since the third quarter of 2020. We've seen net retention in a pretty good place.

In the enterprise business, I think of, essentially more of the ERP side of the transportation business. We continue conversions from our customers from on-prem to cloud. So, I like what we're doing there and we're moving more of our bookings, continue to move more of the bookings to subscription bookings.

So, that's a positive for us and actually that's of course that's a headwind to the margin. So, they would have been a probably 150 bps to 200 bps higher or not for that. So, if I look at the quantitative side of the house there, I like a level of the momentum or at least a direction, maybe I should call direction that the business is moving.

The mapping business that we have continues to perform extraordinarily well both in North America and in Europe. At our User Conference in August, we announced a number of new products integrations that we have, including the engage lane technology, which is coming out of some work that we have done with Procter & Gamble.

So, a number of good things happening, Kristen..

That's helpful and encouraging to hear. The follow-up question that I have is just around capital allocation location. You're now at nearly 400 million shares repurchased for the year, just remind us how you think about repurchases relative to intrinsic value expectations? Thank you..

Yes. Hey, Kristen, it's David. We have a model where we're looking at our cash flow with some moderation this year. We're a cash flow generating business. We did some divestitures earlier in the year.

And we look to make sure we have the right capital structure for our business and fund our growth plans and we use a matrix when the share price comes down that gives us an opportunity to be a bit more aggressive.

Over time, the focus of our capital allocation is on growth and we won't have share repurchase get in the way of giving us firepower to invest in growth. Our leverage at 1.4x is actually below where we think we could be on a long-term basis. And so, we were comfortable bumping it up a little bit based on all those variables..

That's very helpful. Thank you..

The next question is from Tami Zakaria with JP Morgan. Your line is open..

Hi, good morning. Thank you so much for taking my questions.

So, my first question is, this may be a little early to ask this, but how are you thinking about gross margin next year as cost inflation is retreating? Can you remind us how much of margin headwind you saw, let's say, in the past couple of years from cost inflation alone? And can you – do you expect to recapture most of it maybe over the next 12 to 18 months?.

Yes. Hey, Tami, it's David. I'll start by saying, I'm going to be careful not to give 2023 guidance. We will do that in February, but I'll talk about some broad trends that I think are likely to influence our margins going forward.

On the gross margin side, we think there's a macro trend here of higher growth in our software businesses and recurring, which has higher gross margins. So that will help us. We think with humility that the world is uncertain, but we're past the peak of input cost inflation on the hardware side.

We've taken price, I'll say some of you are comparing us with other industrial companies. We've taken actually less price if you just look as a percentage price increase than some of the big industrial players.

And we think that makes sense given our economics and our focus on staying competitive, but we think within hardware, we'll see continued moderation of costs and we'll have pricing that can keep up with that maybe do a little bit better. With that said, we're investing against our strategic priorities that we mentioned in the Investor Day.

And so, I think we have some levers to pull on with regard to margin. As Rob mentioned in his commentary, we're looking at the softening demand environment and we're being increasingly careful and prudent in our costs. We are every day, every month looking at our internal resource capital allocation.

We've slowed down the rate of our hiring and our cost additions and we will continue to be really prudent understanding that the demand environment next year is going to be hard to predict. So, hopefully that gives you the picture you need. We'll have more to say about this in February..

It does. It was very helpful. Thank you. And then a second quick one. Europe, I think organic growth was negative in the quarter. You call that civil construction and Ag demand, I think, you call that as moderating.

Did you see order trends sequentially get worse quarter to date versus 3Q? I guess what I'm trying to understand is, when do you think Europe can – how long do you think Europe will stay in the negative territory before it, sort of inflects and bounces back?.

Hey, good morning, Tami. This is Rob. So, that's a great question and I wish I had a crystal ball for everything you're asking inside that. Hey, the level set on the Q, the organic growth was about minus 3%. But I first want to make a note on that is that includes our Russia and Ukraine business, which went away.

So, we adjust for that and we were a positive 2% organic in the quarter. So, that's where we put our Russia and Ukraine numbers. And so, we haven't to try to make adjustments for that in any of the organic like we called it as it was. So, that loss of that business has been a negative for us both in Europe and obviously at the company level as well.

Now, the Europe growth is slower than what we saw organically, and rest of world, which is up [20%] [ph], which is mostly Brazil, APAC was higher than that in North America at around 10% organic level. I think there's an aspect first is the dealer inventory reset.

So, I think to really get ground truth as I go back to separating the retail and the wholesale demand. I'll say it is confusing at the moment. I'm a bit uncertain out there.

We walked away from the trade shows where we spend a lot of time with engineering construction customers predominantly European based at the two shows at the Intergeo and Bauma and actually sentiment and engagement in attendance was very high. We look at infrastructure projects, the HS2, the Grand Paris.

There is infrastructure work happening in Europe. So, in that sense, I'm positive on continued business in Europe residential I think is turning. Markets like EPC work are, I think will be solid for obvious reasons in Europe, but those do take time.

Farm income and farm sentiment, that has a [indiscernible] sort of correlate to harvest and whether as that comes together, it ended up being a harder year for European farmers than I think they thought earlier in the year. As you know, there was – so that was pretty dry in Europe and then that impacted sentiment.

So, we'll see how they [feel] [ph], let's say, coming into the spring planting season. So, there's little – some winds going, but winds going both ways in Europe at the moment.

But hey, despite all of that, I go back to what do we do at Trimble, we sell productivity and sustainability and I think the value proposition of technology is just as important as ever..

Got it. That's super helpful color. Thank you..

You're welcome..

The next question is from Erik Lapinski with Morgan Stanley. Your line is open..

Hi, team. Thanks for taking my question. Maybe just a quick one on, kind of operating margins more at the segment level and focusing on geospatial because that was particularly strong in the quarter. I guess just trying to understand maybe better the driver there, given revenue didn't increase as much? I know it's more, kind of hardware oriented.

So, volume, I typically think of as the driver there.

So, maybe if you could help us, kind of understand just that side of it?.

Yes. Hey, Erik, it's David. Margins were particularly good in geospatial and that's mostly a mix issue within the offerings and we think that's a little bit better than we're going to have in Q4. So, it's just a mix of the products that we sell and what we shipped in Q3 was particularly high margin..

Okay. That's helpful. Thanks. And then also you did mention some success on the recurring offerings within the geospatial segment. Can you maybe give us some color on to exactly, kind of where you're seeing that success? I know that's been an initiative for you guys..

Sure. Well, in the – of the four segments, the geospatial does start with the lowest base. So, in terms of percentage increase to be intellectually honest, it's coming off that lower base. And the team deserves credit for the pivoting of the business model.

So, when you buy our instruments and sensors like the hardware centric part of geospatial, so think the surveyors and the [Mappers] [ph] out there in the world, they're buying workflow, actually, they're not just buying an instrument and that workflow includes software. So, we have Trimble business and Trimble access.

So, these field to finish workflows that the field needs or if you're doing scanning data or mobile mapping, data collection, you need to be able to process that data.

So, the software that we have in that business is being converted more into ratable models, which we think is expands the size of the addressable market, turns the CapEx and the OpEx is helping us as a catalyst to move more of the work into to the cloud. So, in that sense, Erik, yes, I think it's a very good example of connect and scale at play..

Awesome. Thank you..

The next question is from Jason Celino with KeyBanc Capital Markets. Your line is open. .

Great. Thanks. Two quick ones for me. You know, there's been lots of questions on hardware already, but maybe I’ll ask it a different way. So, hardware was down 11% in Q3. And then Q4, I think you said it will be down high-single-digits.

Maybe this is just the function to compare, but I guess why? Why wouldn't or, I guess, high single-digit decline is [indiscernible]?.

Yes. Hey, Jason. I'll point out that really important when you look at hardware to get the organic math in your mind. And that's both FX and we divested businesses, which were heavily hardware centric. So, actually if you look at the organic numbers, hardware revenues were up 3% year-on-year in Q3.

And that does reflect that we were – our product supply improves a lot and we were able to draw down the backlog and meet the dealer needs where we've had extraordinarily long lead times.

So, that having said, embedded within our guidance is that hardware organic revenues are likely to be down in the fourth quarter and it's driven by all the dynamics Rob mentioned..

Okay. Perfect. No. That's actually very helpful. And then Rob, you know, two quarters in a row, 20% [indiscernible] in B&I and the leading indicators with ACV also look good, how much of the strength do you think is from some of the new bundling efforts versus strong environment for [construction market] [ph]? Thanks..

Good morning, Jason. I think there's some growth in that. Our crossed up bookings and part of the business within B&I that's selling Trimble Construction One, we saw over 20% of our ACV bookings coming from cross-sell.

And as we've talked about at Investor Day, we're still very early in the work with TC1, I’m expanding that offering into different geographies and broadening the scope and the automation of the offering. So, I think that there's only tailwinds behind the business model aspect of that.

And then if I flip it around, let's say, for the rest of the business. The software side at B&I does have incrementally more American centricity to it, which is the healthiest of the four geographies that we report. So that, I think would also help that as well..

All right. Thanks..

Thanks, Jason..

The next question is from Gal Munda with Wolfe Research. Your line is open..

Hey, good morning and thank you for taking my questions.

The first one, maybe Rob, if you think, you mentioned in Europe the infrastructure is actually looking quite good, but if I want to try to think about the infrastructure opportunity, right now in the way you've seen potentially, especially in the U.S., have you seen any of the tailwind from IIJA’s starting to come in or do you think that's something that could actually start being material to the business as we move into the 2020?.

Hi, good morning, Gal. So, we do continue to feel that the IIJA versus now, I guess, BIO, Bipartisan Infrastructure Law, [indiscernible] that's gone into law. We continue to believe it's a positive catalyst for business. And that 10% organic growth in overall North America at the total company level clearly has a B&I and geospatial aspect to that.

So, call that engineering and construction if we up level. Money is starting to flow from the federal government to the states. When you look again at the state level, some states actually have multiple funding sources for their infrastructure like they're not entirely dependent on the incremental money from the Fed.

And that's interesting to us because there are subset of states in the U.S. that are, I'd say, they're at work already and we're seeing good activity from those states.

If I take the majority of the states though, I think one of the things that's on the headwind side of the infrastructure bill is that material cost and labor cost are eating into some of the increased amount of the funding. And there still does seem to be a lag between the funding mechanism and the work actually starting to happen.

And so, we feel like there's been a lag and we're not really seeing the fruits of it at, at a – let's say a level we might have expected at this point. So, now you weren't asking so much about 2022 as looking forward.

So, if we go into next year, I think that that does provide us, let's say, a certain level of ballast to the business and our sentiment certainly for the North American side of Trimble engineering and construction. .

That makes sense. Thank you.

And then if I think about the pricing that you've mentioned as being, kind of one of the drivers and especially on the gross margin side, but if I take a step back and just think about the pricing in general, can you talk a little bit more about what you found on the pricing maybe when you look at hardware versus software split? Have you done any significant price increases in the software side or are you planning to do anything there as we ramp the next year? Thank you..

Hey Gal, it’s David. So, we've taken more pricing in hardware than software. Software pricing is a little, sort of amorphous because you're always adding more features and how much do you attribute to more functionality versus the price.

It's been our practice to increase pricing over time in our software businesses and we've [uped] [ph] that a little bit with the inflationary environment, but more of our price increases have been against our hardware. And just to put some numbers around it, if you look year-on-year and we've taken several ways of price increases.

Across our hardware portfolio, our prices year-on-year are up about 6%. So that's the rate of headline inflation. Good news for us is that the rate of inflation of our cost is actually less than that. So, we're getting some hardware margin benefit from the net impact of [pricing and cost] [ph].

But the pricing on the software is less than [six] [ph], where you can think of that in the low single digits or little less than 5% pricing on our software..

That's really helpful. Thank you, David..

The next question is from Jonathan Ho with William Blair. Your line is open..

Hi, good morning.

I was just wondering if you could maybe give us a little bit more color on your ARR growth and whether that's coming from net expansion versus new customers, as well as whether there's been any, sort of change in that dynamic?.

Good morning, Jonathan. Hey, it's Rob. So, there's certainly a number of, let's say, levers directions where we've seen the ARR grow. So, first, I'll take expanding the size of the addressable market and our best example of that is from our SketchUp product within buildings and infrastructure.

I think we're going on 13 or 14 quarters in a row of more than 40% ARR growth in that business is really remarkable. So, kudos to the team on that. And you're not doing that through pricing, you're doing that through unit and where those kind of unit growth, that's a clear sign to us of expanding the size of the addressable market.

We weren't expanding units at that level prior to the model conversion. We see it in our [indiscernible] business, as well as that we're seeing unit growth, which we think is showing a sign of expanding the size of addressable market. Second, I could put in a category of say, general market uplift or adoption of technology.

You can argue that's riding a wave, so to speak, of digitization and the market that provides a certain level of growth in the ARR and the business.

The third category I would call the cross-sell, and when we really get to the economics of the connected scale strategy and think about the 1.55 billion of ARR we're sitting on top of, we think that there's a couple hundred million plus of ARR to be mined, just from within the portfolio we have.

And so, as I think about economic scenarios if the economy were to take a turn for the worse, you know your classic play is to look what the customers you have and rethink the amount of capital you're putting to new logo generation. So, I'm optimistic that whatever the scenario is that there's a lot to be done from within our own portfolio.

And I'll say that fourth and last category is straight up new logo growth. So, the sum of those to me is the sum of parts that gets to the total company level..

That's helpful. And then you mentioned a number of management and leadership transitions at the beginning. Can you talk a little bit more about the dynamics there and maybe what you were, sort of looking for as you were, I guess, making some changes at the second tier management level? Thank you..

Well, I'd say congratulations to the folks who are stepping into new roles. 100% believers in them and the work that they've got ahead of them. So, I think that change can be a good thing. Change provides opportunity. Change provides a chance for a fresh look at some things.

Sometimes leadership transitions, I'd say, are – that's the right thing for the business. And as you proactively make them other times, you're reacting because somebody decides to leave the organization. So, there's a little bit of both of those that provide a backdrop in context for the transitions that we have in mind.

The tone I'd want to set on the transitions that we have is that it's about executing connect and scale at the strategy level. Our operating system talks about strategy, people and execution. So, the strategy is to connect and scale manifesting through these industry clouds that we're building, bringing the best capabilities we have together.

So, our leaders, all of us, myself included every single one of our operators and folks who work to support the operators are working to build the product offering to meet this platform and industry cloud direction that we're going.

At a people level, we aim to continue to be the employer of choice and technology and our rankings in that area continue to be world-class. So, I expect some leaders to lead, to inspire, to engage, to achieve. And then we've got to meet our numbers on the execution and so you know how much weight we put towards the ARR growth in the business.

When we talk about our three key metrics, we're talking about ARR, EBITDA, and cash flow. So, we have to not just talk in package, we have to deliver, and we have to deliver in an environment that's got an increasing level of uncertainty around it.

So, that's the expectation I have for the leaders who were in their roles and I got a great deal of belief in them to be able to do so..

Thank you so much..

You’re welcome..

The next question is from Chad Dillard with Bernstein. Your line is open..

Hi, good morning, guys..

Hi, Chad..

So, I just want to circle back on your implied guidance for gross margins in the fourth quarter and just how to think about that exit rate, just given that, it sounds like mix will be a tailwind, you get a little bit better price cost and start to think about that as a starting point as we look towards 2023?.

Hey Chad, it's David. As you do through the math, go through the math and look at our guidance, you'll see that we expect meaningful improvement in gross margins from Q3 to Q4 and that's driven by a mix, our hardware revenues even organically will be down in the fourth quarter for all the reasons that Rob mentioned.

So, the software to hardware mix is going to improve and we have the benefit within hardware, particularly of a favorable mix between pricing and cost. So that gets you to gross margins.

OpEx as a percent of revenue will be higher because we had – we have the bonus impact that I described to an earlier question where we had, call it, no bonus expense in Q3. That's the way the approval works. We also have some step-up in OpEx Q3 to Q4 sequentially. It’s the way holiday's work in Europe and we have a big user conference coming up.

So, those dynamics will drive our OpEx as a percent of revenue, higher in Q3 and Q4 with lower revenue unit that all out we expect operating margins to be lower in Q4 versus Q3..

Thanks. That's helpful. And then maybe, if you could just spend some time just talking about the impact of the digital transformation that you've been embarking on for the last 12 months.

Just trying to think about the incremental spend from, I guess 2021, 2022 and then just any early thoughts on how you think about that as we go into this coming year and just the cadence of the expected benefit?.

Yes. We are – I'll say the guidance, the framework we provided earlier in the year and last quarter still holds we're investing against our digital transformation and a handful of other strategic initiatives at a rate that's about 100 basis points of margin. So, that's what it was in Q3. And that's what it will be in Q4.

We're looking harder at OpEx everywhere, but as Rob said, what we're not doing is changing our fundamental priorities and progressing against the digital transformation is absolutely at the top of our strategic list.

So, that you can call that pressure is there and we're managing to hold our model within the context of sustaining that investment going forward..

Great. Thank you..

The next question is from Rob Mason with Baird. Your line is open..

Yes, good morning everyone. Apologies if this has been asked.

I’m toggling back and forth between calls, but there was the commentary around your backlog, I think David, I inferred about 200 million of hardware backlog, I'm just curious if that's the right number? And then two is, how are you thinking about where dealers are in terms of rightsizing their inventory? Just the dynamic there, is this situation that can be resolved, do you think here between third quarter and fourth quarter or does it stretch beyond that?.

Yes. So, I'll start with the numbers. You're about right. Our hardware backlog went from about 240 million at the end of last quarter to 180 million so down 60 million, which is a good thing that reflects the fact that our supply chain is improving. Pre-COVID, pre-supply chain, that number was closer to a hundred.

So, we will move in that direction, although I'm not sure we’ll ever get back to where it was because supply chains are likely to be different for everybody going forward. As far as dealer dynamics, it's a very dynamic situation. It varies dealer-to-dealer market-to-market.

I'd say overall most dealers are about where they have been and probably about where they want to be.

As Rob mentioned, the dealers are looking at their markets and are seeing some uncertainty and so their sort of set point for inventory is going down and that's somewhat accelerated by the fact that our supply chain has now gotten so good, not universally, but for most of our products, we have order lead times measured in days, not months.

And so, the need to hold a bunch of inventory for the dealer is less than it was. So, it's a mix. There are some dealers that are looking at uncertainty in their markets and will be inclined, particularly with our good supply chain to bring inventories down and some are in very good shape..

And just with respect to the agriculture business, there was commentary in the slides around softening demand in Europe, but did you comment on North America and how that market is faring for you?.

Well, hey, Rob, this is the other Rob. In the Ag business overall, actually the majority of our business, I want to frame is outside of North America today. So, strong double-digit growth in Brazil, really in South America, continued growth in Asia Pacific. Overall organically, the business was up in the high-single-digits for agriculture.

So, I think North America is holding its own as the punch line on that, but I want to put North America in the context of the bigger picture..

Very good. Okay. Thank you..

We have no further questions. At this time, I'll turn it over to Michael Leyba for any closing remarks..

Thank you, everyone, for joining us this quarter. We look forward to speaking to you again soon..

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