Trimble Navigation (TRMB) Steven W. Berglund on Q2 2016 Results - Earnings Call Transcript

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Trimble Navigation Ltd. (NASDAQ:TRMB)

Q2 2016 Earnings Call

August 02, 2016 5:00 pm ET

Executives

Jim Todd - Director-Investor Relations

Steven W. Berglund - President, Chief Executive Officer & Director

Robert G. Painter - Chief Financial Officer

Analysts

Jonathan F. Ho - William Blair & Co. LLC

Jerry Revich - Goldman Sachs & Co.

Paul Coster - JPMorgan Securities LLC

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

James E. Faucette - Morgan Stanley & Co. LLC

Richard Valera - Needham & Co. LLC

Colin Rusch - Oppenheimer & Co., Inc. (Broker)

Operator

Good afternoon. My name is Shakira, and I will be your conference operator today. At this time, I would like to welcome everyone to the Trimble Second Quarter 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

I would now like to turn the conference over to Jim Todd, please go ahead.

Jim Todd - Director-Investor Relations

Thanks Shakira. I'd like to point out that our earnings release and a slide presentation supplementing today's call are available on our website at www.trimble.com, as well as within the webcast and we will be referring to that presentation today.

Turning to slide two of that presentation, I'd like to remind you that the forward-looking statements made in today's call and the subsequent Q&A period are subject to risks and uncertainties. Trimble's actual results may differ materially from those currently anticipated, due to a number of factors detailed in the company's Form 10-Ks and 10-Qs or other documents filed with the Securities and Exchange Commission. The non-GAAP measures that we discuss in today's call are fully reconciled to GAAP measures in the tables to our press release.

With that please turn to slide three for an agenda of the call today. First, Steve will start with an overview of the quarter. After that, Rob will take us through the remainder of the slides including an in-depth review of the quarter and our guidance and then we will go to Q&A.

With that, please turn to slide four and I will turn the call over to Steve.

Steven W. Berglund - President, Chief Executive Officer & Director

Good afternoon. The second quarter was consistent with our expectations and supports the narrative for continued improvement in the second half of the year and into 2017. Overall, environmental uncertainty increased considering factors such as Brexit, recent U.S. GDP growth numbers and the U.S. presidential election. Nonetheless, our scenario for the second half of the year remains centered on a step up in revenue growth and margin expansion which Rob will explain in more detail.

A very early and obviously incomplete view of the first half of 2017 also appears positive for continued improvement, driven by a combination of new products, market initiatives and improvement programs. The worldwide economic environment remains a general challenge, although we see some points of light. Europe grew double-digits in the quarter with comparative improvement in a number of the major economies, in particular, the Nordic countries, Germany and France. In addition, regions that previously saw precipitous declines are showing growth, including; Spain, Ireland, Iceland and Russia.

The Brexit potential effects on investment confidence within Europe are at this point unknown. UK results were down in the quarter presumably as a result of pre-election uncertainty. Asia/Pacific was also up double-digits with strong contributions from Japan, Australia and Korea. Although the Australian recovery is fragile, the recent improvement is encouraging given Australia's relatively outsized role in Trimble's revenue and it's particularly weak performance in the last few years.

China also grew, although not at historical double-digit levels. South America was flat with a drop in Brazilian revenue being offset elsewhere. North America was flat with a number of puts and takes which I will let Rob explain. Our efforts to restore and improve our short and long-term financial model continued in the quarter. Rob will provide a more complete analysis, but our efforts remain centered on cost management, portfolio pruning, performance improvement in a couple of businesses and leveraging revenue growth to the bottom line.

Our anticipated rate of improvement in the model is being challenged by factors such as the temporary cost of our hang for new acquisitions and the load from hardware sales that are the front end to high gross margin software subscriptions. Overall, we expect to continue to restore our credibility in operating margin expansion through the rest of the year and into 2017.

Pruning the product and business portfolio has been in the works all year and will continue for the remainder of the year. Last quarter we announced the divestiture or shutdown of our public safety business, transmission line planning software and Trimble outdoors. Although some of this ongoing effort will not be press released, it will create a beneficial incremental impact on financial results, as well as improve operational focus.

Our strategic focus remains on our core businesses in construction, geospatial, agriculture and transportation and logistics as well as targeted emerging businesses such as forestry, electrical and water utilities, field service and railroads. The two significant businesses in the portfolio in which our emphasis is still on a performance fix are the field services business, which is in the Mobile Solutions segment and Manhattan software which is in the Engineering & Construction segment, both of which are not adequately contributing to financial performance.

Field Services has been demonstrating an improving trend on revenue and margins within a SaaS-centric model, which leads us to anticipate an inflection point for the business in the second half with positive contribution in 2017. Manhattan Software remains a meaningful element of Trimble's Design-Build-Operate strategy and we anticipate it will demonstrate consistent improvement in performance, while marching towards the later contribution.

The Engineering & Construction segment remains a mix story. Core civil engineering and construction delivered another relatively strong quarter with the momentum expected to continue. The underlying momentum is being enhanced by our success in advancing our construction mix fleet strategy through OEM deals. Last quarter, we discussed agreements with Volvo, Hyundai and Doosan. Other OEMs have been added but have not yet been announced. Others are in discussion.

While the incremental revenue from these deals is a plus, the greater significance is that they are placing Trimble at the center of the construction information ecosystem which we can exploit in the aftermarket over an extended period of time. The BIM centric building and construction business stepped up its revenue growth rate from the level in the first quarter.

Overall, we expect continued good growth for the remainder of the year. The geospatial business remains disappointing relative to the expectations we held early in the year largely because of the equipment overhang created by the oil and gas collapse. Our outlook for later in the year and into 2017 is somewhat brighter as the capacity surplus dissipates and as new products are released.

Overall, we see the E&C growth rate accelerating in the second half of the year with operating margin expansion. However, the segment is the most exposed to regional investment confidence and Brexit following or other shocks could alter this view. For E&C, we continue to pursue the belief that technology can transform construction project costs and schedules through the application of a constructible model in the connected construction site.

We made incremental progress in the quarter on developing this vision with the announcement of an enhanced collaboration with Autodesk and several product releases built on the Trimble Connect backbone. In addition, we announced work underway in mixed reality applications with Gensler, AECOM, and China State Construction Engineering Corporation.

After nine quarters of declines in revenue, the Field Solutions segment was flat in the second quarter and is anticipated to grow modestly in the second half boosted by acquisitions. Core agriculture revenue was effectively unchanged year-to-year and is expected to continue to be relatively flat for the second half of the year. This contrasts with equipment manufacturers' views based on our strength of new products, strong performance in some regional markets, and expected actions in the aftermarket.

The other elements of the segment had mixed performance with GIS trending down, both the emerging water and electrical utilities businesses demonstrating double-digit growth and expanding margins.

Our belief in the medium to long-term picture for agriculture remains buoyant as it utilizes more data and information for making decisions. We believe we currently have both unique insights and an advantage participation in the market.

For example, some form of Trimble hardware or software technology is used to farm 125 million acres worldwide, 250,000 Trimble displays are installed in farm equipment, and over 70,000 farmers use Trimble Positioning Services to achieve the accuracy required by their applications. This combination of sensors, analytical tools and physical control of applications places us in a strong position to serve in a primary role in the emerging, precision agriculture market.

A key element of success will be the go-to-market strategy to bring these capabilities to the farmer. Actions during the quarter included the establishment of a new organizational structure, which more clearly differentiates our agriculture software and information capabilities from sensors and hardware applications and enables tighter market focus. In addition, we further enhanced our go-to-market capabilities by announcing a number of new Vantage dealers.

The Mobile Solutions segment second quarter growth rate stepped up from the levels of the fourth quarters and first quarters and is expected to step up further in the second half of the year. We exited the quarter with strong backlog, which has been built on recent transportation and logistics wins, some of them unannounced.

Operating margin development for the segment has not been strong in the first half as we originally anticipated, because of hardware and SaaS interdependencies. Rob will further explain the dynamics, as well as our optimism about future margin improvements.

Our emerging strategic position in transportation and logistics is quite encouraging as a platform for growth. There are approximately 1 million vehicles with Trimble physical devices currently installed. More importantly, there are approximately 2 million vehicles in fleets being managed with Trimble Software Solutions.

To further emphasize the point, about 200 largest private and for hire long-haul fleets in the U.S., 178 are currently Trimble customers. The combination of PeopleNet and TMW provides us with the strategic scope to embrace demanding requirements for both mobile assets, as well as the enterprise.

In addition, the market is relatively fluid driven by factors such as the electronic logging device mandate and provides significant scope for innovation. The market opportunities are significant and we have added some discrete spending to pursue them, which has placed the model under some additional short-term pressure. We expect the model would begin falling back in place during the second half of 2016 and early 2017.

The Advanced Devices segment which was a negative growth factor in the first quarter returned to its Steady Eddie persona in the second quarter and has anticipated to be a growth contributor for the rest of the year.

Let me turn the call over to Rob. Before I do, let me characterize the second quarter as providing us with no major surprises other than Brexit, and fitting to the narrative of a steadily improving picture. Rob?

Robert G. Painter - Chief Financial Officer

Thank you, Steve. Turning now to slide five. This is an overview of our non-GAAP results. Overall, we delivered results that were in line with our expectations and we believe that we are poised to accelerate revenue growth and margin expansion in the second half of the year. Revenue growth is progressing as expected.

Second quarter total revenue was $610 million, up 4% year-over-year. Currency translation had a neutral effect on our revenue this quarter. Movements in some currencies like the UK pound had a negative effect while other movements such as the euro had a slight positive effect. Given the late timing of Brexit during the quarter, the impacts were minimal and largely offsetting.

Acquisitions contributed a little less than 2% to year-over-year growth and in combination with recent divestures the net effect of both was approximately 1%. Our second quarter gross margin was 55.9%, relatively flat as compared to prior year. Operating margin was 16.2% which was up approximately 100 basis points compared to the first quarter of 2016, but down slightly on a year-over-year basis. Within the quarter, we saw operating margin progression in many businesses and we see a clear path to continued expansion through the rest of the year, which I will speak to during guidance.

A natural question on our second quarter results will be to understand year-over-year operating expense growth in the context of revenue growth. There are roughly three drivers of year-over-year expense growth that offset our previously discussed restructuring events which reduced operating expenses by over $30 million on an annualized basis.

First, recent acquisitions had a negative margin impact year-over-year at the company level. Over the past year, we have made a few notable acquisitions, among them AGRI-TREND in our agriculture business, Vianova in civil engineering and construction and Sefaira in our building construction business. All of these acquisitions are software services oriented, and we believe they significantly extend our strategic position.

However in the short-term, these acquisitions are dilutive on the operating margin line as the businesses are integrated and as they cycle through purchase accounting effects. We see a clear path to cycle through these dynamics in the second half of the year and to increase margins in these businesses.

Second, as we discussed last quarter, Mobile Solutions' operating margins have been negatively affected by the strong growth we are seeing related to recent large customer wins, which involve installation of low-margin hardware before the subscriptions become active. In the short-term, this puts pressure on gross margins as well as operating expenses in the segment. Looking to the back half of the year, this dynamic should change as those lower margin hardware sales begin to transition to higher margin software subscription revenues.

Third, we have consciously chosen to make investments in a few key areas of our business where we see long-term opportunity. For example, we have invested in our Trimble Connect interoperability platform within our Engineering & Construction business. In Mobile Solutions, we have invested in head count to serve our existing backlog and to address new product opportunities.

Working our way down the income statement, we generated increased operating income and net income in dollar terms. Earnings per share were $0.29, $0.01 higher than the comparable period in the prior year. Please note that the GAAP tax rate in the second quarter was lower than the non-GAAP tax rate due to a one-time benefit associated with the divestiture of Advanced Public Safety.

Growth of software services and recurring revenue continues in our business. Related to that, our deferred revenue balance continues to grow up to $315 million in the second quarter, up 10% year-over-year. Cash flows remain strong in relation to net income, and in the first half of 2016, our cash flow from operations was $193 million. In addition, we repurchased $80 million of our common stock during the second quarter and we have repurchased $92 million year-to-date.

Turning now to slide six and our segment results. Engineering & Construction had revenue of $351 million, up 4% year-over-year. Within Engineering & Construction, we continued to see favorable trends in our civil engineering and construction, as well as building construction businesses.

Civil engineering and construction revenue was up double-digits and building construction revenue was up high single-digits. Both had a minor positive impact from acquisitions. The growth from these two businesses was partially offset by our geospatial business, which was down low single-digits in the quarter, but is showing a credible path towards growth and margin improvement. Overall, operating margins in Engineering & Construction were down slightly.

Organic operating margins are up, but overall margins in the segment have been diluted by the impact of recent acquisitions. Looking to the second half of 2016, we expect to achieve solid growth in Engineering & Construction with corresponding margin enhancement.

Moving to slide seven, we were pleased with our performance in Field Solutions. Revenue was flat at $87 million, in line with our expectations. That was partially assisted by acquisitions that had an approximate 3% positive impact year-over-year. Our agriculture business, the largest component of Field Solutions, was flat year-over-year as expected. We also ended the quarter with an increase in deferred revenue giving us increased visibility into third quarter revenue.

We experienced about 70 basis points of operating margin improvement in the quarter through gross margin expansion and cost control, despite a slight margin drag from recent acquisitions. Looking to the second half of 2016, we expect to maintain improvement on the revenue growth profile and we are focused on generating strong operating margins.

Moving to slide eight, our Mobile Solutions segment had revenue of $138 million, up about 8% year-over-year. The biggest driver of Mobile Solutions growth continues to be the transportation and logistics business, which was up in the low teens. Growth in the Mobile Solutions segment was also partially tempered by divestiture activity, primarily through the previously announced divestitures of Omega and Advanced Public Safety.

Operating margins in the segment were down about 1% year-over-year. Similar to last quarter, there were significant hardware shipments in the PeopleNet business, driven by the record backlog that we talked about last quarter from recent large customer wins; our contract with PACCAR and the rollout of our new video offerings.

As we previously discussed, these strong hardware shipments are causing temporary negative dynamics on segment gross margin, because gross margins on hardware tend to be low. Our inventory position was challenged in the quarter, leading to significant expenses expediting product in the second quarter. In addition, we are investing in new product development initiatives.

Looking to the second half of 2016, our inventory position is much improved and higher-margin subscription revenues will begin to have a positive impact leading to the expectation for operating margins to progressively improve in the segment with particular strength in the fourth quarter. Furthermore, in the fourth quarter, we have line of sight to upside from recent acquisitions where we can release high-margin revenue on previously deferred contracts.

Turning now to slide nine, Advanced Devices had revenue of $33 million, representing 4% year-over-year growth. Our operating margins in Advanced Devices held relatively steady. We have comparatively strong visibility to a pipeline that should generate modest revenue growth in the second half of 2016.

Now turning to slide 10, we provide details on our geographics performance. The events in the UK have stimulated some questions about our exposure to currency translation going forward, especially with regard to the British Pound. Of the roughly 25% of Trimble revenue derived from Europe, less than one-fifth of that comes from the UK and not all of that business is denominated in British Pounds. To the extent that the dollar moves against these currencies, we will see a positive or negative translation effect, but we also have significant cost denominated in those currencies. Given this, we have natural income statement hedges that should minimize the impact to our operating income.

Moving to slide 11. We continue to see an evolution towards a higher percentage of software and recurring revenue and we are seeing the evolution in all our major segments. For the current trailing four quarters, our revenue from software services and recurring revenue represented approximately 48% of total company revenue which is up from approximately 44% comparatively last year. That represents approximately $1.1 billion of annual revenue derived from software services and recurring revenue. Our recurring revenue streams, which are a subset of that, represented approximately 27% of total company revenue compared against approximately 24% in the comparable period last year.

I would like to put a little more color on our recurring revenue profile as it is both strategically and financially important. Financially speaking, it's a material driver of our revenue growth. Not only in terms of recognized revenue, but also in terms of our growing backlog and deferred revenue balance. By segment, recurring revenue as a percent of total segment revenue was highest in Mobile Solutions with the PeopleNet and Field Service management businesses leading the way.

In Field Services management, we recently pivoted the business model to ratably recognize hardware like we already do with the monthly subscriptions. While this creates a short-term decrement to revenue growth, we have been able to simultaneously increase our reported operating margins through cost control.

Our TMW and ALK businesses are also seeing sharp increases in year-over-year growth in subscription revenue and are doing so in business models that offer both perpetual and SaaS offerings. Case in point, an ALK in North America, the subscriber count of our co-pilot professional navigation and routing staff offering grew 47% year-over-year.

In Field Solutions, our growth starts from a low base of recurring revenue. We see the growth being driven by our Software Solutions group, which Steve highlighted earlier in the call. In Engineering & Construction, the predominant driver of recurring revenue comes from our building construction business. For new product development efforts, our bias is to invest in SaaS models. For example, this quarter, we released a beta version of our highly successful SketchUp product on the web, which we believe will be a transformative delivery model.

For many of our existing products, Tekla Structures for example, we offer both perpetual and subscription options. We find many of our customers require on-premise software, whether it be for reasons of connectivity and remote field conditions, or for reasons of customary buying behavior. In fact, we are seeing an increased take-up rate on the Tekla subscription offering. This is creating a slight negative drag on the year-over-year growth we would have otherwise experienced. In this soft transition towards subscription, we are able to preserve our operating margins.

In summary, we have a number of different reporting software delivering models across our reporting segments. Our view is that SaaS will continue to increase importance, and we will diligently work to plan for revenue and margin impacts associated with this growth and will also do so within the context of new revenue recognition standards coming online in 2018.

Moving to slide 12. Trimble is in a strong financial position. Our cash balance ended the quarter at $232 million. Our total debt balance at the end of the second quarter was $725 million, which represents a growth debt-to-EBITDA multiple of approximately 1.7 times within our target range.

Moving now to slide 13 and third quarter guidance. We expect third quarter revenue to be between $587 million and $617 million and non-GAAP EPS between $0.28 and $0.33 per share. Our third quarter guidance assumes current FX rates and a minor negative impact from currency translation.

To add color to our third quarter guidance, I'd like to walk through a bridge of how we modeled the second half of the year progression. In the third quarter, we see operating margins improving sequentially by roughly 150 basis points and in the fourth quarter, we expect both a sequential and year-over-year operating margin gain.

Looking forward to the third quarter and fourth quarters, I would like to break down the three levers of operating margin expansion, which are revenue growth, gross margin expansion, and cost management.

First, revenue growth. In Engineering & Construction, we expect continued growth in the building construction and civil engineering and construction businesses, factoring in some conservative for Europe, specifically in the UK. We expect an improved growth profile in our geospatial business, for example, government deals in the third quarter. While the oil and gas hangover effect has proved stubborn, the good news is that we have broadened our customer base, which we believe positions us well moving forward.

Within Mobile Solutions, transportation and logistics will be the driver with continued rollout of large deals. In Field Solutions, the story of agriculture continuing a path of flat or better year-over-year growth comparables.

The second lever is gross margin expansion, which is directly related to the revenue mix from the growth drivers I just discussed. We expect to see gross margins up sequentially in the third quarter and at a yearend high in the fourth quarter.

Finally the third lever is cost management. Earlier, I walked through a bridge on operating expenses for the second quarter. The same levers play out as we look forward into the third and fourth quarters.

Two things to emphasize here: one, product and portfolio review. We have discussed a few divestures and product line shutdowns this year, and we expect those to have a positive impact. We continue to diligently review underperforming parts of the business. Two, we will continue to take cost reduction actions as necessary to preserve and improve the business model. We take these actions on a business-by-business basis and the context of the growth and profitability profile. Also note that Q3 operating expenses are normally down from Q2 due to seasonal dynamics, and we are expecting that this year as well.

To conclude, between a favorable strategic position in our end markets and continued progression in the business model, we feel encouraged about where we are heading in the second half of the year and as we look into 2017. We will now take your questions.

Question-and-Answer Session

Operator

And your first question comes from the line of Jonathan Ho.

Jonathan F. Ho - William Blair & Co. LLC

Good afternoon, and congratulations on the strong results. I just wanted to start out with your comments around Brexit and some of the potential impacts. Can you maybe describe for us some of the slowness that you're potentially seeing and maybe where you see that impacting your business the most on the Brexit side?

Steven W. Berglund - President, Chief Executive Officer & Director

I don't think we have a particularly refined view of Brexit effects. I think that we did see the UK down a meaningful amount in the second quarter. We assume that the investment climate was such that everyone was waiting to see what happened before they made any investments. So I don't think there is any one-to-one correlation between what happens mechanically from the Brexit process onto our results. I think it's more a matter of whether Brexit triggers a set of wider issues, second or third order effects relative to the self-confidence within Europe and the willingness for businesses to invest. So I think it's more, let's call it, at the moment a more rhetorical question in terms of whether it affects the investment climate within Europe, particularly in places like Germany and France, and whether businesses postpone decisions waiting for clarifications.

So again, I don't think – there may be other businesses. There may be other industries where there is a more linear alignment between Brexit mechanics and business. I don't think we're one of those. So I think it's just more a point of caution at this point in time to see whether investment decisions in terms of investing in infrastructure or investing in capacity or the like are postponed and just waiting to see what happens when the dust clears a little bit. So I'm afraid I can't be very helpful on the question, Jonathan, just because I think it's just a generalized point of concern on our part, but nothing overly direct or at this point in time even meaningful.

Jonathan F. Ho - William Blair & Co. LLC

Got it. And I know you guys gave a lot of detail around your second half acceleration expectations, both for the top line and operating margin improvements. But you also talk about this persisting into 2017. So I'm just wondering what underpins your confidence around these trends continuing into the early half of next year and maybe what some of the top drivers are behind that confidence.

Steven W. Berglund - President, Chief Executive Officer & Director

Well, let me comment and then let Rob maybe get a little bit more surgical on it. I think part is where is the real Trimble, what is the real Trimble here. I think for the last 18 to 24 months is, okay, the dialog, the narrative around Trimble has been dominated by agriculture, first of all and on the first, second and third order effects from the oil and gas price collapse. And so I think that in part, I think what we're trying to communicate is the real personality, the real capability of the company is beginning to reassert itself, as agriculture is no longer a net drag on the company and as we touch zero on the oil and gas effects and there is no longer a net change there. So I think that the fundamental drivers coming out of E&C and out of Mobile Solutions in particular are asserting themselves with some potentially buoyancy coming out of Field Solutions. So I think the point is less a net change than a return to a level of normalcy within the company. But, Rob, do you have anything to add on that?

Robert G. Painter - Chief Financial Officer

I think, if you look at it from a reporting segment level, whether you're extending to the second half of this year or into 2017, you could really look at our three primary segments in the business between Engineering & Construction, Field Solutions and Mobile Solutions. And if you look at it from a Field Solutions, as Steve said, if as we return to let's say a better performance in agriculture, at least on a comparable basis, and we hold the margin, that's an important lever to the Trimble model expansion, business model expansion.

And Mobile Solutions, that of course has been the fastest growing segment in the portfolio this year, and as we see that growth continuing, it's also the lowest operating margin segment in the company at this time. And so that's the place where we have the headroom to expand the operating margins, and we have the growth profile we see behind that to support that.

And then Engineering & Construction, which of course is the largest reporting segment that we have, we see the positive trends that we talked about within the civil engineering, construction and building businesses continuing. We catch some wind in the sails on geospatial and generate operating margin expansions, and you've completed the, at least mathematically, the story to continue into 2017.

Jonathan F. Ho - William Blair & Co. LLC

Great. Thank you.

Operator

And your next question comes from the line of Jerry Revich.

Jerry Revich - Goldman Sachs & Co.

Good afternoon and good evening.

Robert G. Painter - Chief Financial Officer

Hi, Jerry.

Jerry Revich - Goldman Sachs & Co.

I'm wondering if you could talk about within the transportation and logistics business, how you expect the cadence of inflation to play out over the next couple of quarters. I would guess that the pipeline is building as we get closer to the regulations, but maybe you could flesh that out for us. And out of the total trucking fleet, I guess, how big do you expect the addressable market to be in terms of those that are expected to be required to install the electronic logging standards? Thanks.

Robert G. Painter - Chief Financial Officer

So if you were to look at the – I'll speak to North and well obviously I speak to the U.S. market, this is the U.S. regulation. We believe there's around a couple million vehicles that are impacted by the need for the electronic logging devices. Now of course, not all of those are relevant to Trimble. So when we segment that 2 million, there's let's just say less than 1 million that become more of a relevant market opportunity for Trimble. And so from an addressable market standpoint, there is certainly quite an opportunity out there. We see that reflected in the sales pipeline we have today as well as the bookings and the deferred revenues in the business.

You asked about how the installations play out here in the coming quarters. And we have spoken, as you know, to the surge in demand through a couple of the discrete large customer orders that we've had. And as those implementations continue really for the next, I'd say, two to three quarters, before were fully implemented on those couple large orders, then I would see returning to what maybe a little bit more of a linear path of growth in the implementations and then mathematically, right, as the subscriptions kick in at higher margin, that's where you get the margin expansion in the business.

Jerry Revich - Goldman Sachs & Co.

Okay. Thank you. And, Rob, on your comments regarding margins improving sequentially fourth quarter versus third quarter, can you bridge that for us? I think that's only happened once out of the past five years. So I'm wondering do you expect deferred revenue burn or just what gives you that visibility on margins improving sequentially versus normal seasonality in 4Q?

Robert G. Painter - Chief Financial Officer

Yes. Good question. So the first one, let's just stick with Mobile Solutions and the margin expansion in that business, particularly from the transportation and logistics business. So very discreetly just about the topic we were on with the – as more subscriptions come on top of the hardware. They're also in Mobile Solutions. I think I mentioned this in my script. We have, from an acquisition coming off, it's purchase accounting effects that will add back some positive operating margins for us in the fourth quarter. So there are some effects related to acquisitions rolling off the purchase accounting, that's a negative effect we experience usually in the first year or so in a deal on top of the growth in Mobile.

And Field Solutions really a story of let's call it stabilization but year-on-year progression from that perspective. And then E&C, of course, that has multiple pieces to it. One of the larger quarters that we have in Engineering & Construction is historically in our buildings business. And the buildings business is predominantly software business with associated margins that are higher than the rest of the portfolio. And as buildings becomes a larger portion of E&C, that plays out into the math to support the margin progression story.

Jerry Revich - Goldman Sachs & Co.

Okay. Thank you.

Operator

And your next question comes from the line of Paul Coster.

Paul Coster - JPMorgan Securities LLC

Yes. A question that's really a continuation of the last one, which is this next quarter, 3Q, you are calling for about 7% revenue growth at the midpoint year-on-year which is good. The narrative is uniformly good about the margin improvement that you anticipate for the three reasons that you stated. And yet the EPS guidance really does not call for much leverage. And so I'm just wondering is it just because it's going to take a while for the leverage to kick in or why is 3Q EPS guidance not a little bit more encouraging I suppose?

Robert G. Painter - Chief Financial Officer

So there is a time element of leverage kicking in. From an EPS perspective, there is a slight impact on the non-operating income side that we look at happening in Q3 relative to Q2.

Paul Coster - JPMorgan Securities LLC

Okay. Well, my other question is that, Steve, in your prepared remarks you talked about the momentum into first half next year. You talked of products innovations and of market initiatives. I was just wondering, can you just elaborate a bit? Maybe you already have answered this and just kind of semantics, but what do you mean by market initiatives?

Steven W. Berglund - President, Chief Executive Officer & Director

Yes. Well, yes, so I'm going to be decidedly vague here since I don't necessarily want to preannounce from a competitive standpoint products or market initiatives. But I would say is in the script I talked to both in Engineering & Construction and transportation and logistics within the Mobile Solutions segment talked to new products. I think that we believe we have some significant new ideas, both in terms of products themselves but also new product categories that can add incremental market pieces to the revenue flow.

I think I would say in particular in those areas, I would say within the Field Solutions segment, without necessarily hanging ourselves out too far, I think there is a steady progression within agriculture moving more and more towards precision agriculture. So I think the relative emphasis we're putting on AGRI-TREND, the fairly recent acquisition. And the fact that we're investing relatively heavily to build up this go-to-market capabilities also would be what I would call a meaningful market initiative of accelerating the movement into precision agriculture. The reorganization we did to put more emphasis on the software and solutions as part of that.

So I would say in each of those three segments, there are again I think meaningful developments on the product side, okay, which will tend to bring increments of revenue. But then I would also emphasize then in some cases there are new product categories that bring, let's call, potentially larger increments of revenue. But clearly, at this point in time, it would not be prudent for me to identify very specifically what those are. So I'll just have to leave you hanging, Paul.

Paul Coster - JPMorgan Securities LLC

All right, thank you.

Operator

And your next question comes from the line of Richard Eastman.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Yes. Good afternoon. Steve, could you put a little bit more color, or Rob, could you put a little bit more color around North America being flat? We've got some puts and takes there probably, but I'll let you just go through those real quickly, because I would think that some of the markets there would be showing some pretty good growth in North America, some of the end markets?

Robert G. Painter - Chief Financial Officer

Yes. Good question. At a high level, North America was flatter year-over-year. We had growth in Engineering & Construction and Mobile Solutions and I think that's what you would have been expecting as you were thinking about the reporting segments. The agriculture business is still weak in North America and maybe then the extension of that statement would be that for our ag numbers to have worked out, that meant outside of North America we have experienced good growth, relatively good growth.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Has the rate of decline in ag in North America, has it now flattened out in North America?

Robert G. Painter - Chief Financial Officer

I would say flattening out, yes.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Flattening out. Okay. All right. Fair enough. And then just I had a similar question on the op profit. I think you just covered some things at the highest level here for Trimble going forward. But what kind of cadence of improvement should we expect in the E&C op margin? If we are at 17.6% for the second quarter, the third quarter, I think, seems like it would be better, fourth quarter better yet. But is that mix with the geospatial business? You alluded to Manhattan needing some work. Maybe you could just refresh us there where Manhattan is and the impact there it will have on the improvement in E&C margin.

Robert G. Painter - Chief Financial Officer

Yes, sure. No problem. And in fact, when I talked about North America being flat year-over-year in Engineering & Construction, the point of particular weakness in Engineering & Construction in the quarter was in our geospatial business. That is where we still are seeing the hangover effect post the oil and gas I guess we call it a collapse or decline in North America.

As we're cycling through that, as we've broadened our customer base and we look forward into the second half of the year, we see improvement coming in the geospatial business. Third quarter also happens to be a time where, at least in this particular market, government orders typically occur. And so between that and the cycle-through dynamics on geospatial, we do see that being an important positive contributor to the progression of the E&C op margins in the second half of the year. You asked about one other thing. What was that?

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Manhattan's impact on that business. When you put the mix in there for geospatial and we start to be able to recognize more of the deferred on Manhattan presumably. Do we get to a 20% op margin in the E&C business in Q4?

Robert G. Painter - Chief Financial Officer

Let's say we're approaching that 20% level. And let me address Manhattan and then come back to the 20%. So the Manhattan Software business, I think, if you go back, no, it's not probably quite a year, but you go back some number of quarters, we talked about that and in the context of a margin point, it's less than a margin point now. So maybe it's a little less than half a margin point. It is progressing, but it's not where we want it to be or where we need it to be yet. From an accounting P&L perspective, and it's one of those businesses it's important to look at the deferred revenue that we have, the backlog, the pipeline and the cash flow that complements it, because the P&L can give us an incomplete view of the business. Nevertheless, of course, that's important and that business on an absolute basis, we continue to work at it to improve it.

And then your question about does that improve in geospatial when you take the pieces and you start to add up the margin progression. One of the things that happens in fourth quarter, say, from your modeling perspective is we have our Dimensions User Conference in the fourth quarter. So that's one where we will see a set of expenses come onto us on the fourth quarter that would otherwise mask some of the margin improvements that would get us closer to the level you're talking about.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Okay, all right. So maybe fair to just suggest maybe 100 bps in Q3 plus and then another 100 bps in Q4, I mean, that kind of cadence?

Robert G. Painter - Chief Financial Officer

I think I would, say, think about it from a whole second half of the year perspective on an out basis, and probably safer for you to model which quarter to quarter it happens.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Okay. Okay, fair enough. Thank you.

Operator

And your next question comes from the line of James Faucette.

James E. Faucette - Morgan Stanley & Co. LLC

Thanks very much. I had a couple of questions. As kind of staying on the topic of continued profitability improvement, can you talk a little bit about how much cost cutting has already occurred and it was fully built into the second quarter versus what is remaining and how much of a contributor continued efficiencies and OpEx may be able to contribute?

Robert G. Painter - Chief Financial Officer

So last year, the restructuring activities of 2015 were at a level of about $30 million on an annualized basis. That was from 2015 actions. Year-to-date, we have another set of actions that would be above that level. Now they're more recent, so we wouldn't have seen much of that in the second quarter. As we start to look forward into the back half of the year, we would start to see some benefit of that. So, the easy answer is to look at the $30 million, divide by four and you have got a quarterly progression there. We've also done some, the divestitures we talk about that add a little bit to that. And pretty soon you can be, depending on which quarter we're comparing, call it a $7 million to $10 million a quarter positive impact.

James E. Faucette - Morgan Stanley & Co. LLC

Got it. And then looking at your investment priorities, it seems like you've been making channel push for both BuildingPoint and Vantage. When should we expect to see benefits from those efforts? And is it appropriate to think about those or the leverage coming in on those once you have already surpassed your 20% target or do you think that eventually getting leverage on BuildingPoint and Vantage will be central getting to that 20% level? Thanks.

Steven W. Berglund - President, Chief Executive Officer & Director

Yeah. So first of all, I think particular, well, it's I think BuildingPoint, Vantage and SITECH's are all targeted third-party channels for us. And I think that our confidence is growing based on recent evidence that again from your perspective kind of disappears into the dust. But I think our confidence is growing that all three of them, SITECH's I think relatively well establish as being a competitive needle mover and creating a combination together with product. Of course that creates unique competitive differentiation.

It's still early for both BuildingPoint and Vantage, but the metrics are supporting the views that by putting a BuildingPoint in or putting a Vantage dealership in and getting, let's call it, the increased emphasis on technology, it does make a difference quantitatively in terms of the performance of a particular region. So I think our confidence level there is growing.

And again against our – it's not adding cost, so I think in terms of margin improvement, it would be really more of the effect of getting the incremental leverage from the channel and, okay, converting that into profit, that increased revenue with a operating leverage of hopefully 25% or greater and converting that into operating income. So I think the story is both dynamic in the positive sense and I think will increasingly be a factor in adding incremental revenue that will in turn turn into bottom-line results. So I think we're comparatively pleased with the progress in all three distribution channels.

James E. Faucette - Morgan Stanley & Co. LLC

That's great. Thanks.

Operator

And your next question comes from the line of Rich Valera.

Richard Valera - Needham & Co. LLC

I just wanted to revisit the operating margin progression question again briefly. Last quarter, you had mentioned a target of 20% plus or minus I think 100 bps exiting the year. And listening to your sort of qualitative commentary, it sounds like you could certainly be approaching that sort of 19% exiting the year, but you didn't mention that again. Just wondering if you could comment on that. Thank you.

Robert G. Painter - Chief Financial Officer

I think you probably characterized that correctly. But approaching that 19% exiting the year is a possibility for us. That's how we are thinking about the business in the second half of the year and trying to poise ourselves to exit the year as we come into 2017.

Richard Valera - Needham & Co. LLC

Got it. And then with respect to Mobile Solutions, certainly a lot of good qualitative commentary there in terms of converting from the real heavy hardware phase to more of a subscription SaaS. Can you give us any sense of, or kind of remind us where you see the operating margin for that business progressing numerically? Like what's sort of maybe your medium-term and longer term operating margin targets for that Mobile Solutions business? Thanks.

Robert G. Painter - Chief Financial Officer

Well, I would say it's safe to say that for what we would consider a threshold performance for any of the businesses would be 20%-plus operating margins, and higher the more software-centric given businesses and that's the nature of much of the business within Mobile Solutions from a working like endgame backwards, or let's call it, our intention level is to be above 20% in that business.

And I think you're asking how do you step into that from an operating margin progression. I think really, this is the game of cumulative subscriber base, and I call it new product developments that can extend the value of what's already on the vehicle. So, if you think about the video intelligence system that we launched earlier this year, and it's been a quite a successful launch we think by most any measure.

That's extending a capability to a current customer to further penetrating a customer with additional technology on the vehicle, on the fleet. So, between addressing new customers, additional technology under existing customers, looking at the portfolio, like Steve mentioned, how many of the top 200 for hire, and private fleets that we addressed today in the portfolio in Mobile Solutions, those customers that Steve talked about, the 170 plus where we have a customer touch point at Trimble, many of those may be just one of the products in a portfolio is at those 178 customers. So, there's an opportunity there in a sense, so you add that together and you start to have the pieces of the margin progression.

Richard Valera - Needham & Co. LLC

Any sense of the timing to get to that?

Robert G. Painter - Chief Financial Officer

To get to the level?

Richard Valera - Needham & Co. LLC

Yeah.

Robert G. Painter - Chief Financial Officer

So, from a reporting segment perspective, let's really think about it in two pieces. The transportation and logistics part of Mobile Solutions, which is the biggest part of the portfolio, and you'd have our Field Services Management business.

So, mathematically, we need both to perform. Field Services Management, as we mentioned, we believe has turned the right direction and will continue on that path.

So with the expectation of our Field Service Management business performing and the Mobile Solutions business performing to get, let's say, north of 20%, we don't see that, it wouldn't be our expectation for how we exit on a calendar year perspective, as we start to think about – we think about the business going forward. I'd probably tag another probably 12-plus months on to that.

And that could have a function of how much new sales we're getting from customers, how much hardware growth that we do get, continue to get, let's say, big orders that could be a bit of a throttle on to that. But that's a throttle I think we would be a good problem to have, let's say.

Richard Valera - Needham & Co. LLC

Right. Okay. Thanks for that color, Rob.

Robert G. Painter - Chief Financial Officer

Thank you.

Richard Valera - Needham & Co. LLC

Welcome.

Operator

And your next question comes from the line of Colin Rusch.

Colin Rusch - Oppenheimer & Co., Inc. (Broker)

Thanks so much, guys. Can you talk a little bit about the pricing dynamics by segment? Obviously, there's some fairly sizable strategic moves being made with some of your businesses by competitors. If you just talk a little bit about any pricing pressure, maybe opportunities to creep prices higher that would be great to get a little bit more detail on that?

Steven W. Berglund - President, Chief Executive Officer & Director

Sure. I guess, I would launch by just saying at this moment in time, I think pricing across all the segments is comparatively steady and stable. I think that when it comes to the hardware element, particularly in kind of the general telematics realm, the expectation is that hardware prices are going to drop. And potentially drops significantly. Now our strategy is comparatively hardware agnostic, so that is not necessarily a consideration. And as you've heard us during this whole session in effect playing up that hardware gross margins, there isn't a whole lot left to give out there.

So I would say, that is the one relatively dynamic element relative to pricing where we can expect significant pricing pressure, which is on the hardware elements, kind of the telematics realm. But again, it's not core to our strategy. I think otherwise I would tend to say that the environment is generally comparatively steady. In some cases we have successfully been able to raise prices, particularly upon release of new product generations where we are bundling significantly more value into the new product generation. And just looking at the elements within E&C, civil engineering, again, I would characterize it as there are dogfights on individual deals, but comparatively steady there. Kind of on the building side, I would say there's significant opportunity to maybe bundle different elements of the solution into a complete package and achieve a level, let's call, pricing leverage there just from the significant value by providing a bundle of capability playing well together.

So I'm actually saying the longer term there is potentially to realize more value through pricing on the building side and to some extent, even on the civil engineering side. Geospatial, I think in terms of base capability, instrument prices are likely to drift down over time. But I think the opportunity there is to bundle those relatively dumb instruments that provide positioning data together with software solutions and create kind of new bundles of value and with an opportunity to increase prices from the bundle.

And I think there are some fairly dramatic examples out there where dumb instruments have been coupled with software, incremental cost approaching zero and being able to double or triple prices of that otherwise dumb instruments. Agriculture, and kind of in the Field Solutions realm, I'd say that there is the traditional hardware elements, the guidance elements which has got a 15-year track record of being, again fairly stable from a pricing perspective in terms of at least not step changes.

I think the opportunity there is adding software content and essentially capturing more value and then on the mobile side, again, I think there is software element which provides value at the enterprise level. There's relative pricing leverage there through the value creating and then on the hardware side that's likely to see some pretty major decreases over time driven by technology. So overall, I would describe the environment as neutral to maybe positive in a three-year context.

Colin Rusch - Oppenheimer & Co., Inc. (Broker)

Perfect. Thanks so much for the detail on that. And then as you are introducing these new products, what's your expectation for the trajectory in R&D spending? Are there going to be a number of new initiatives once these products get launched or are we going to see a little bit of relief on that R&D line?

Steven W. Berglund - President, Chief Executive Officer & Director

I would say that in terms of percentage of revenues being spent on R&D, I would say that we are generally running hot at this point in time. And I think it would be our intention both by design and I think just circumstantially to see that number come down over the next 12 months.

Colin Rusch - Oppenheimer & Co., Inc. (Broker)

Okay. Great. Thanks so much, guys.

Steven W. Berglund - President, Chief Executive Officer & Director

Thank you.

Operator

And that is the last question. I would now like to turn the conference back over to Jim Todd.

Jim Todd - Director-Investor Relations

Thanks, Shakira. With that, we'll end today's call. Thanks for attending and we look forward to talking to you next quarter.

Operator

This concludes today's conference call. You may now disconnect.

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