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Trimble Navigation Limited (NASDAQ:TRMB)

Q2 2007 Earnings Call

July 31, 2007, 4:30 PM ET

Executives

Willa McManmon - Director of IR

Steven W. Berglund - President and CEO

Rajat Bahri - CFO

Analysts

William Benton - William Blair & Company

Benett Notman - Davenport & Company, LLC

Andrew Spinola - Needham & Company

Paul Coster - JP Morgan

Eli Lustgarten - Longbow Research

TRANSCRIPT SPONSOR
Wall Street Breakfast

Operator

Good afternoon. My name is Carol and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2007 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. [Operator Instructions]. Thank you. Ms. McManmon, you may begin your conference.

Willa McManmon - Director of Investor Relations

Thank you. Thank you for joining us on our second quarter 2007 conference call. I am here with Steve Berglund, our CEO and Raj Bahri, our CFO. A press release summarizing the financial results we are about to discuss is available on the IR section of our website.

Before we begin, I would like to remind you that during the course of this call, we may make projections on other forward-looking statements regarding future events or the future financial performance of the company. The words intend, expect, plan or similar expressions are intended to identify forward-looking statements. Such statements are subject to risks and uncertainties that could cause actual events or results to differ materially. Important factors relating to our business including factors that could cause actual results to differ from our forward-looking statements are described in our forms 10-Q, 10-K and other filings with the SEC. The company assumes no obligation to update these forward-looking statements to reflect actual results or changes in assumptions or other factors. Steve?

Steven W. Berglund - President and Chief Executive Officer

Good afternoon. Let me begin by acknowledging the passing of Bob Cooper, the Trimble Chairman of the Board who died on July 2nd. Bob had been on the Trimble Board since 1989 and had served as Chairman since 1998. His career spanned academia, government service and business. But whatever his role, technology was always his central passion. As the head of DARPA in the 1980s, he made decisions which were crucial to the creation of the GPS system. On the Trimble Board, he provided the visionaries perspective combined with linear common sense and profound humility.

Dr. Ulf Johansson was elected to replace Bob as Chairman. Ulf has been a member of the Trimble Board since 1999. He is a Swede who received his PhD in Communications. He spent the bulk of his early career at Ericsson, was the Founder of Europolitan, a Swedish wireless carrier and was Chairman of the University Board of the Royal Institute of Technology in Stockholm. He sits on a number of European boards, including Ericsson's. We believe his appointment reinforces a number of important themes. First is our continuing commitment to technology and in particular the growing importance of wireless technology. Second, by electing a European with an extensive international experience set, we are reinforcing our commitment to becoming a truly international company. Third, Ulf has been an active chair of the Audit Committee and his election emphasizes our fundamental commitment to good corporate governance.

The second quarter performance reflected continuing strong financial performance. Baseline quarter performance across all of Trimble segments demonstrated progression on both the top and bottom lines. Total revenue grew by 34% and non-GAAP operating margins reflected an improvement of 2.5 points over the second quarter of 2006 on the strength of operating leverage of 29%, which would have been higher without the impact of @Road.

The Engineering and Construction business continues to perform well with some changes in the mix of the business. Aside from the residential construction slowdown in the U.S., which has not had a material impact on our overall results, the construction market continues to be strong worldwide.

The pockets of slowness in the U.S. survey instruments market we reported last quarter continued in the second quarter, but was more than offset by strong international markets. With what we can see at this point, the changes in the U.S. survey instruments market do not appear to be a fundamental market or competitive shift, but are more in the category of a short-term market recalibration which doesn't change our views on longer term growth.

Our international sales growth in the E&C segment has been impressive with underlying factors allowing us to expect this growth to continue for several years. These factors include an improving European economy, generally robust economies in developing regions, significant planned infrastructure projects in Russia, Asia and Africa and a growing Trimble physical presence in the developing world. For example, in August, we will officially open a Trimble owned factory in Shanghai that will manufacture survey instruments for both the Chinese and international markets.

The Field Solutions segment demonstrate strong performance in the quarter with exceptional performance from agriculture, resulting from a robust worldwide farm economy and a strong Trimble product portfolio. Our EZ-Guide 500 Lightbar product, which was introduced late in the first quarter, was met by a very positive market reaction which drove much of the growth in the quarter. The other business in the segment, Geographic Information Systems, grew at a double-digit rate, driven by new products. The Advanced Devices segment also demonstrated significant growth in the quarter with the components business reflecting continuing strong demand for non-automotive embedded applications and timing products.

The Mobile Solutions segment continues its progression in line with expectations. The historical business, centered on ready mix concrete continued to build recurring revenues and underlying margins. Public safety demonstrated strong revenue growth and approving margins and direct store delivery remains a story in development as we await the full implementation of the next technology generation which will be completed in 2008.

@Road, which we acquired five months remains on track with our expectations at the time of acquisition and was profitable in the quarter. While the @Road margin is not yet at the Trimble average, the organization demonstrated meaningful progression during the quarter. We expect to see continual improvement in profitability during 2007 with significant profitability improvement in 2008 as we work through the effects of the accounting for deferred revenue, complete a number of large contracts with front-loaded costs and realize the efficiencies and synergies of programs that are being put in place in 2007.

The acquisitions and internal development of the last few years have shifted the profile of the E&C and Mobile Solutions segments. First, the mix of the business has shifted somewhat to larger contracts and have become lumpier. Second, the software and services content in these segments is growing rapidly. The lumpiness of the demand combined with the requirement to defer growing amounts of revenue makes it important to understand underlying trends and not to place excessive reliance on any given quarter.

That said, all Trimble segments are performing well with an improved overall outlook for 2007. If economic conditions remain relatively unchanged, we expect this trend to continue into 2008 as the strategic moves we have made in the last two years begin to pay off.

Let me turn the call over to Raj.

Rajat Bahri - Chief Financial Officer

Good afternoon. Second quarter 2007 revenue was $327.7 million, up 34% year-over-year. GAAP earnings per share were $0.28, up from $0.25 in the second quarter of 2006. When looking at year-over-year comparisons, it should be noted that the second quarter 2007 GAAP earnings were impacted by $0.05 per share due to high amortization of purchase intangibles and $0.02 per share due to impact of FAS 123R. Adjusting for these expenses, non-GAAP earnings per share were $0.35, up 21% over the second quarter of 2006.

The tax rate for the second quarter of 2007 was 38% compared to 31% in the second quarter of 2006. Looking forward, we expect the tax rate for the remaining part of the year to be around 38%.

Operating income for the quarter was $56 million, up 45% compared to the second quarter of 2006. Operating income in the second quarter of 2007 was impacted by amortization of purchase intangibles of $10.4 million in the second quarter of 2007, which represents an increase of $6.7 million over the second quarter of 2006 due to acquisitions, a $3.8 million impact from stock-based compensation in the quarter versus a $3.3 million impact from stock-based compensation in the second quarter of 2006, a $333,000 restructuring expense compared to no restructuring expense in the second quarter of 2006.

There was no in-process research and development expense in the second quarter of 2007, but there is a $1 million in-process research and development expense taken in the second quarter of 2006.

Adjusting for these factors, non-GAAP operating income was $70.5 million in the second quarter of 2007, up 51% from the second quarter of 2006. Operating income margins for the second quarter of 2007 were 17.1%, up from 15.8% in the second quarter of 2006. Again, adjusting for the factors I just mentioned, non-GAAP operating income margins for the quarter were 21.5%, an increase of 2.5 points over the second quarter of 2006. The margin improvement was driven by improvement of mix in the E&C business, higher subscription in software revenue and leveraging of operating expenses. This quarter, 29% of incremental revenue dropped to the operating income line.

Now I will turn to the results by segment, which include revenue less cost of goods sold and operating expenses excluding general corporate expenses, amortization of intangibles, in-process research and development and restructuring expense. In addition, for each segment, non-GAAP operating income excludes the impact of stock-based compensation expense.

Second quarter 2007 E&C revenue was $198.9 million, up approximately 18% when compared to revenue of $168 million in the second quarter of 2006. E&C growth was driven by growth in most product categories and particularly strong international sales.

Operating income in E&C was $52.4 million or 26.3% of revenue compared to $38.8 million or 23.1% of revenue in the second quarter of 2006. Non-GAAP operating income in E&C was $53.2 million or 26.7% of revenue in the second quarter of 2007 compared to $39.9 million or 23.7% of revenue in the second quarter of 2006. Growth in operating margin was mainly due to favorable product mix and leveraging of operating expenses.

Second quarter 2007 Field Solutions revenue was $55.3 million, up 52% when compared to $36.3 million in revenue in the second quarter of 2006. Revenue growth was driven by positive agricultural market conditions, robust new product agricultural sales, particularly the introduction of the EZ-Guide 500 and GIS products.

Operating income in TFS was $18.4 million or 33.3% of revenue for the second quarter of 2007 compared to $11.3 million or 31.1% of revenue in the second quarter of 2006. Non-GAAP operating income was $18.6 million of 33.6% of revenue for the second quarter of 2007 compared to $11.5 million or 31.8% of revenue in the second quarter of 2006. Growth in operating margin was driven by higher revenue.

Second quarter 2007 Mobile Solutions revenue was $40.9 million, up 176% from revenue of $14.9 million in the second quarter of 2006. Operating income in the Mobile Solution was $2.9 million or 7.1% of revenue for the second quarter of 2007 compared to $374,000 or 2.5% of revenue in the second quarter of 2006. Non-GAAP operating income in Mobile Solutions was $4.4 million at 10.8% of revenue for the second quarter of 2007 compared to $538,000 or 3.6% of revenue in the second quarter of 2006. Improvement in the operating margin was due to higher subscription revenue as well as increased profitability in @Road.

Second quarter 2007 Advanced Devices revenue was $32.7 million, up approximately 25% from revenue of $26.1 million in the second quarter of 2006, primarily due to strong sales of embedded products. Operating income in Advanced Devices was $5.4 million or 16.5% of revenue for the second quarter of 2007 compared to $2.2 million or 8.6% of revenue in the second quarter of 2006. Non-GAAP operating income in Advanced Devices was $5.7 million or 17.4% of revenue for the second quarter of 2007 compared to $2.7 million or 10.4% of revenue in the second quarter of 2006. Margin improvement was driven by mix of business in the component technology business and inclusion of Nokia licensing revenue.

For the overall company, gross margins for the second quarter of 2007 were 51% excluding the impact of amortization of intangibles and stock-based compensation. Non-GAAP gross margins were 52.7%. This compares to gross margins of 49.6% and non-GAAP gross margins of 50.3% in the second quarter of 2006. The improvement in margins was due primarily to higher revenue, product mix and improvement in the Mobile Solutions model.

Revenue break out by geography was 57% in North America, 26% in Europe, 12% in Asia Pacific and 5% in rest of the world. This represents a 26% increase in North America, 42% increase in Europe, 41% increase in Asia Pacific and 86% in rest of the world.

Total operating expenses for the second quarter of 2007 came in at $111.2 million or 34% of revenue, flat as a percent of revenue with the second quarter of 2006. Excluding acquisitions, operating expenses grew at a much lower rate than revenue. On a non-GAAP basis, operating expenses were 28% of revenue versus 31% of revenue in the second quarter of 2006 excluding acquisitions.

Non-operating income for the second quarter of 2007 was $271,000 versus $2.5 million in the second quarter of 2006. Higher profitability from the CTCT joint venture was offset by higher interest costs related to the debt for the @Road acquisition.

Now looking at the balance sheet, we finished the second quarter of 2007 with $73.8 million in cash compared to $63.6 million in the prior quarter. In the second quarter, net accounts receivable were $235.2 million compared to $216.1 million in the first quarter of 2007. Days sales outstanding this quarter were 56 days, essentially flat with the prior quarter. Inventory was $137.7 million compared to $127.6 million in the first quarter of 2007. Inventory turns were essentially flat at 4.3. Cash flow from operations for the first half of 2007 was $86.5 million, an increase of 46% from the first half of 2006. Our debt level due to the @Road acquisition is at $123 million, down from $170.5 million in the first quarter of 2007.

Turning now to our guidance for the third quarter of 2007. In the third quarter of 2007, Trimble expects revenue to grow 25% to 27% compared to the third quarter of 2006 with revenue between $294 million and $299 million. At a 38% tax rate with approximately 125.1 million shares outstanding, Trimble expects third quarter 2007 GAAP earnings per share between $0.18 and $0.20. Trimble expects third quarter 2007 non-GAAP earnings per share between $0.26 and 0.28 compared to actual split-adjusted non-GAAP earnings per share of $0.25 in the third quarter of 2006. Non-GAAP guidance for the third quarter of 2007 uses a 38% tax rate and excludes the amortization of intangibles of $10.5 million related to previous acquisitions and the anticipated impact of stock-based compensation expense of $4.5 million.

Thank you and we will now take your questions.

Question And Answer

Operator

[Operator Instructions]. Your first question comes from Bill Benton from William Blair.

William Benton - William Blair & Company

Hi, afternoon guys. Congratulations on a strong quarter. You didn't give us full year guidance. I know that's because it implies probably the fourth quarter, but is an event should we ignore the current full year guidance out there?

Rajat Bahri - Chief Financial Officer

Yes, I mean, Bill, if you take our first three quarters and take assumption in fourth quarter, it clearly implies that we will be above the $1.07 to $1.09 guidance that we had given in the previous call.

William Benton - William Blair & Company

Okay. You don't want to give a full year number, but you just take the old number [ph].

Rajat Bahri - Chief Financial Officer

That's right.

William Benton - William Blair & Company

And then if you could just talk about, obviously, the new products seem to have a particularly notable impact in the ag segment this quarter. I know you've got some new products in survey as well. Could you just talk about some of the new product impacts? If you could give us a little more color around there, then also the health of the channels.

Steven W. Berglund - President and Chief Executive Officer

Sure. As far as new products, I think the standout product in the quarter was this EZ-Guide 500 which was the new Lightbar product from agriculture. So that added a lot of boost to ag results in the quarter without a doubt. At the same time, there are other factors at work in ag. The economy, the farm economy is stronger than it's been for some time and there is probably more enthusiasm in the farm economy than there has been maybe ever. Ethanol and others have been contributing factors. At the same time, as our underlying baseline products called the EZ-Steer as well as the Autopilot, the high-end product are also doing very well. So it is actually a multi-faceted play here. But certainly what added luster to the quarter was the EZ-Guide 500. There were a number of new or relatively new products in the quarter, the new scanning Total Station in survey did not have necessarily a material... much of a material impact on the quarter. It's still relatively early days and still is getting in the ramp-up process. GIS products are relatively new and they added some luster to that line this quarter.

But primarily I think the standout was EZ-Guide 500, which due to maybe some special circumstances kind of perversely is that it rained more in early spring this year than it does most year, kept farmers out of the fields. They therefore had more of a tendency to buy things. So there were some special circumstances that may have boosted that. But that's the rough scan on new products.

In terms health of the channel, the channels are strong, nothing really new to report there. The channels are doing well. Do you have a specific point there, Bill?

William Benton - William Blair & Company

No, I just was curious, I guess, maybe two parts to it, as traditionally your dealers haven't carried much inventory. I presume that hasn't changed.

Steven W. Berglund - President and Chief Executive Officer

That has not changed.

William Benton - William Blair & Company

Okay. And then also, some of your competitors have been making acquisitions of their other dealers.

Steven W. Berglund - President and Chief Executive Officer

Okay.

William Benton - William Blair & Company

And I am just curious kind of your thoughts and then how that might be impacting the market.

Steven W. Berglund - President and Chief Executive Officer

I think it's really too soon to tell as there has been a tendency in the past 6 to 9 months for the competition, both Leica and Topcon have brought into their distribution. And I would say it has had no material effect or not even a noticeable effect at this point in time. So we'll have to see what the implications of that are. Our strategy in E&C, in GIS and ag is fundamentally remains a third party distribution model. We don't have plans to fundamentally change our strategy there. We'll enhance it as necessary, but fundamentally, our strategy remains intact and centered on third party in those markets.

William Benton - William Blair & Company

Very good. Well, congrats again.

Steven W. Berglund - President and Chief Executive Officer

Okay, thanks.

Operator

Your next question comes from the line of Benett Notman from Davenport.

Benett Notman - Davenport & Company, LLC

Good afternoon and congratulations on a strong performance. Could you talk a little bit about just the plan, the build out of the Mobile Solutions business, sort of where we should, I guess, view you as focusing your efforts and ay be what milestones we should be looking for over the next couple of quarters as you bring the business all together?

Steven W. Berglund - President and Chief Executive Officer

Well, I think the way we've characterized it is steady as she goes and continued progression. I think the milestones that we established early this year in roughly a two year context was the idea that you should be watching us move towards an operating margin in that segment that's consistent with the rest of Trimble and call it plus or minus say 20% operating margin excluding intangible amortization. So I think what we are aiming for here is a relatively steady progression towards that 20% operating margin number over the next two years. So aside from that, I am not sure that we have put any specific milestones in there. I think the strategy that we have been pursuing from the very beginning in the segment has been a relative affection for vertical markets where we can differentiate ourselves, build a unique value equation, whether it be in retail or direct store delivery, whether it be in public safety, construction supply, construction or others. And I think that @Road gives us a wider canvas on which to play that particular strategic theme. So I think without being overly specific here, I think that 20% operating margin, strong top line growth over the next year and a half is really what we are aiming for here.

Benett Notman - Davenport & Company, LLC

Should the top line growth come more from the penetration of new verticals and the build out sort of within public safety and direct store delivery or is a lot of that going to come from sort of the old @Road type of business, which was kind of bigger fleets, maybe things like utilities and cable TV, that kind of stuff?

Steven W. Berglund - President and Chief Executive Officer

I think the answer in the next 12 to 18 month context is probably both is that the overall market is certainly heavily unpenetrated at this point in time. There is loss of opportunity. @Road has given us a position with larger... with distribution channels that can enable us to deal with larger fleets. We are certainly not opposed to that, but at the same time these vertical plays also are extremely unpenetrated. So I would actually say it would be a balance between the two.

Benett Notman - Davenport & Company, LLC

Thank you.

Steven W. Berglund - President and Chief Executive Officer

You bet.

Operator

Your next question comes from the line of Jeff Evanson from Dougherty & Company.

Unidentified Analyst

Good afternoon. It's actually Charlie Anderson [ph] for Jeff here. How are you guys doing today?

Rajat Bahri - Chief Financial Officer

Fine.

Unidentified Analyst

Good. I just had a question about Mobile Solutions here again. I was wondering if you guys could break out what was the core there maybe versus @Road. I think you guys did that on the last call, and it was probably getting... and you're putting these together, but I wondered if there is any detail there.

Rajat Bahri - Chief Financial Officer

Well, [ph] I think we have the Mobile Solution numbers and we pointed to the margin improvement sequentially and versus prior quarter. And I would say the non-GAAP operating margins were already 10.8% this quarter versus a single-digit operating margin the quarter before and last year 3.6%. And a large chunk of that is driven by the increasing profitability in @Road. And as Steve pointed out, as you look at progression sequentially, slowly quarter-over-quarter, you should see increase towards a 20% margin over the next two years, and that would give a sense of... @Road is the biggest revenue generator in this whole segment at this point, and improvement in @Road over time will reflect on the total Mobile Solutions segment margins.

Unidentified Analyst

Got you. And then just a housekeeping question here. Can you say again what the mix was for North America revenue?

Rajat Bahri - Chief Financial Officer

Yes, on North America revenue, the regional spilt... let me just get my notes out so I can give you precise numbers... was 57% in North America, 26% in Europe, 12% in Asia Pacific and 5% in rest of the world. And this was a 26% increase in North America over last year, 42% increase in Europe, 41% in Asia Pacific and 86% in rest of the world.

Unidentified Analyst

Great. And then just a follow-up question on that. Steve, you talked about the trends being a little bit downward in North America right now, but you sort of called it a recalibration. Just kind of curious what your sense is of and how you guys are planning for how long might take before you see that on the upswing again.

Steven W. Berglund - President and Chief Executive Officer

Yes, so first of all, that comment specific to survey instruments, not for any of the other markets.

Unidentified Analyst

Sure.

Steven W. Berglund - President and Chief Executive Officer

And I think there is certainly... this is something fundamentally different than what we saw in 2001 in the first part of 2002, which was, what I would call, kind of a structural realignment. I think that survey instruments had a couple of very strong and relatively hot years. I think probably some of the effect is the residential, call it the third order or second order and third order, effects of the residential having floated through a bit. But the key drivers of heavy highway and commercial still are very strong. So I think our sense in a subject... we are watching and I think our sense is that there maybe two or three quarters here of what I will call taking a breath. But I would say is that with what we can see is 2008 what we'll see is, let's call it, a recovery maybe to kind of something more like former standards. So this is not widespread; it's pockets. We actually have remedies for a number of these pockets. So I think at this point in time, we are not looking at as widespread or necessarily structural, certainly not competitive. So I think that we work our way through it, and we are not looking forward to be particularly longstanding. Conditions will prove themselves out, but I think it's more of a, let's call it, the market taking a deep breath.

Unidentified Analyst

Great. That's very encouraging. Thank you so much guys.

Rajat Bahri - Chief Financial Officer

Thanks.

Operator

Your next question comes from Andrew Spinola with Needham & Company.

Andrew Spinola - Needham & Company

Steve, just to follow on that previous question, when you were talking about survey previously, you said that there is no change to your longer term. Could you just maybe elaborate on that, penetration, growth rates, geographic?

Steven W. Berglund - President and Chief Executive Officer

Yes. So keeping it specific to the U.S. is we still view the market for, let's call it, the key Trimble technologies, GPS and call it the more Robotic, Optical, Total Stations and such for survey. We still view those markets as being well less than 50% penetrated. Probably the penetration rates across the U.S. are 30% to 40% at this point in time, which means we have plenty of market left to conquer before we start to talk about product replacement cycles or saturation issues and such. So I think the key drivers are still there, productivity is still a key element in this. So I think that our view on the long term remains absolutely unchanged and I think we should be able to produce strong double-digit growth in this marketplace in the U.S. for us as far out as we can reasonably look. The interesting phenomenon reflected by some of those percentage growth numbers that Raj talked about is that in survey instruments at this point in time is we are now seeing the U.S. market as being a minority of the total. So the U.S. market in survey instruments is now less than 50% of the total sales in survey instruments by a fair degree. But, so the... this is becoming an international market very rapidly. But again, the key drivers are still in place in the U.S. So I think that over the next couple of years, we have no issues in terms of looking to the growth.

Andrew Spinola - Needham & Company

Okay. On capital allocation, would which you say excluding acquisitions, you would look to pay down the debt as fast as you can so that you can start working towards --?

Rajat Bahri - Chief Financial Officer

Yes, I mean if you look at our debt pay down, it's been significant in the first half of the year. But besides @Road, we just had one small acquisition. And our priority over the next six months is we are looking... we will be doing small acquisitions over the next six months and our priority would be to buy those companies. Any excess that's left over will pay -- we'll use it to pay down the debt.

Andrew Spinola - Needham & Company

Okay. And then just last question on the... you gave rest of world revenue as 5% of total. I have it as 11% in the first quarter, 9% in 2Q '06. It looks like that... is that number... has there been a change in the classification or anything like that?

Rajat Bahri - Chief Financial Officer

Yes. It's a little bit of apples to oranges comparison. @Road has added... well, if you look at versus last year, we didn't have @Road. So @Road is primarily a U.S. business. They have some revenue in Australia and revenue in UK, but it's primarily dominated by U.S. So the U.S., the North American portion has increased because of inclusion of @Road and the rest of the buy has shrunk somewhat.

Andrew Spinola - Needham & Company

Okay. Thanks a lot.

Operator

You next question comes from Paul Coster with JP Morgan.

Paul Coster - JP Morgan

Thank you. A few questions. Raj, you are approximating 20% operating margins on a pro forma basis in the first half of this year. Have you talked about a long-term operating model? If not, can you directionally sort of give us a sense of where you think this business is heading?

Rajat Bahri - Chief Financial Officer

Yes. Our long-term operating net model, Jeff, is that... I'm sorry, Paul, our long-term operating model is that every incremental dollar of revenue that we sell, 20% to 25% of that should fall to the bottom line, which equates to roughly 100 basis points improvement to the prior year operating margin number. So that's the operating model that we are shooting for going forward. Now we have driven historically better results than that, but at this point we feel that 100 basis points is what we are shooting for.

Paul Coster - JP Morgan

Okay. '08 tax rate, should we also expect 38% next year?

Rajat Bahri - Chief Financial Officer

Yes.

Paul Coster - JP Morgan

Okay. The last conference call, Steve, you talked about the contiguous growth opportunities that you see. Can give us an update on those strategic initiatives?

Steven W. Berglund - President and Chief Executive Officer

Yes, I take it you are referring to this concept of adjacency?

Paul Coster - JP Morgan

Yes.

Steven W. Berglund - President and Chief Executive Officer

Okay. Yes, so I think that being an applications-focused company, that is where we see most of the growth for the company coming from is from penetrating our existing market, but then looking for adjacencies. And I think that that continues. I am not sure I've got any good examples to use in the last quarter of anything new in that regard. But I'll use the... as an example, it may not be a perfect example, but the scanning Total Station that came out in the first quarter, that was introduced in the first quarter, which represents an instrument at a new price point, really seeking out a different market, satisfying a different need, somewhere between total laser scanning and conventional total station surveying. So the unit is targeted at roughly about a $70,000 price point, which is higher than a Total Station, but lower than, classic laser scanning. So I would call that a crude adjacency. I think we could come up with more elegant examples than that, but essentially an unmet need close by... to the market that we are already satisfying. And we took an existing platform, modified it and brought it to effectively a new application and really a new customer set. So that's the sort of thing that we hope to do on a daily basis.

Paul Coster - JP Morgan

As you do that, do you believe that you have the channels necessary to do that or are you going to have to buy your way or rent your way into new channels?

Steven W. Berglund - President and Chief Executive Officer

The attraction and the... the attraction of this particular view on adjacency is that effectively, you don't have to kind of reinvent yourselves in a big way. We don't have to create step functions; we can do things in a lot of relatively small steps. So in this case, the channels already existed. It was simply to take this new capability, put it into existing channels and do some training, do some market positioning, if you will. But it was all incremental, existing product platform, existing channel. So essentially at the increment, a relatively rich margin mix. Now the concept of adjacency could also be applied in a different context, which is we have an existing product capability and we go look for a new market, we go look for a new group of customers. That would require some new channel development, and that has happened. But generally, the attraction of the adjacency is you don't have to reinvent yourself on a major step, step functions to go looking for these new markets and you certainly don't have to at the company.

Paul Coster - JP Morgan

Okay, last question. The acquisitions that you have in mind in the next six months, are they technology tuck-ins or are you acquiring market? Can you just give us some sense of what we should expect?

Steven W. Berglund - President and Chief Executive Officer

I'll avoid that particular question and answer a safe question, which is what we've talked about in terms of our overall acquisition strategy is to meet specific needs. We do not make acquisitions to acquire revenues, we are not attempting to build or revenue by acquisitions. But what we are trying to do is accomplish a number of strategic objectives. For example, creating a beachhead in a new marketplace. So you look at Eleven and MobileTech acquisitions, those got us into a direct store delivery, you look at Advanced Public Safety and Visual Statement, and those got us into public safety. So there is that strategic rationale. And then another case is to make an acquisition to establish... to fill in a product or a technology gap. So when we acquired MEPSE [ph], that got us into laser scanning and there are other examples like that. So I would say whatever we do, we'll fall into those realm, you will not see us taking departures into new, totally new unexplored territory. And probably, most likely, the acquisitions will be in our traditional mode of being relatively small to medium-size, but largely to establish these beachheads or to fill in gaps.

Paul Coster - JP Morgan

Great. Thank you very much.

Steven W. Berglund - President and Chief Executive Officer

You bet.

Operator

Your next question comes from Benett Notman with Davenport.

Benett Notman - Davenport & Company, LLC

Yes, in your opening comments, you talked about sort of the growth of software and deferred revenue in the business model. I am just wondering if you could talk a little bit about where that's coming in and sort of how that fits into the strategy of coming here?

Steven W. Berglund - President and Chief Executive Officer

Well, let me talk to software and services in a general sense as probably the strategy, and maybe how Raj can talk about kind of deferred revenue as a piece in this whole thing. But certainly, if you look at our acquisitions over the last several years, they have been largely software-oriented operations. Sometimes discrete standalone software solutions, sometimes bundled with hardware, so... or have had a strong services component. Certainly @Road had a strong services component. So what we see is that we view... do not view ourselves as a product company; we view ourselves as a solutions company, increasingly to be a solutions company. To actually in an application set to provide a solution for a class of users, it's necessary to provide both hardware but also software and then increasingly services. And in pursuit of that solutions definition, we have viewed ourselves increasingly as more of a software and services company as well as being a hardware company. So it's something that we have been consciously doing. It is something we will continue to do. And from a financial standpoint, the fall off there is that a well run software company or well run services company is typically going to attract higher gross margins; and if it's well run will ultimately lead to higher operating margins. So we also viewed it from a financial standpoint as an opportunity to potentially expand our operating margins a bit more. Raj, why don't you talk deferred revenue?

Rajat Bahri - Chief Financial Officer

Sure. So if you look at our deferred revenue, Benett, end of this year, our deferred revenue balance was around $28 million, and between long term and short term. And if you look at our Q2 ending balance, we were at $51 million. So you have seen a significant increase in our deferred revenue on the balance sheet. There are three main reasons for it. One is the subscription model, the @Road acquisition we have done. As you sell hardware and the hardware is all installed, but you recognize revenue over the term of the contract. So it gets recognized for approximately three years. So the good news is that there is a stream of revenue that has to be recognized in the future and kind of an annuity kind of a phenomenon.

The second reason is, as Steve has mentioned, we are becoming... we have brought some software companies as well as the software content in our products has been increasing. And what happens is when you recognize revenue under the software rules, if there is some functionality, you may promised... you may deliver 80% of the functionality, but some of the functionality has not been delivered, you defer the revenue till all the functionality is delivered, even though you may have been actually paid for that revenue.

And the third reason for increase in the deferred revenue is that we have been wining some big contracts like the Marine contract of $8 million plus that we announced in E&C. And again since it is delivered over a multiple period of time and typically you have to, typically, not always, but typically you to wait till you deliver the final delivery and then you get to recognize that revenue. So we have... so the good news is that this revenue will be coming back to us in the future we have built a significant amount of deferred revenue. The only flip side of it is that it makes... depending upon how you recognize revenue, it some times may cause some fluctuations in some quarters depending upon if you can or you cannot recognize that revenue.

Benett Notman - Davenport & Company, LLC

Okay, great. And then could you talk a little bit about the Advanced Devices business and which end markets exactly are driving the growth in embedded components and sort of what we should be monitoring there for end markets?

Steven W. Berglund - President and Chief Executive Officer

Okay. So the embedded business, well, let me state that what's driving the growth is not automotive at this point in time; it's a much wider market. So it's what we are selling here is GPS functionality, typically board level, printed circuit board level functionality to anyone how needs GPS functionality. So it's actually a fairly diverse group widely based, but a lot of it asset tracking and that sort of thing, which is what's driving the growth at this point in time. But it used to be a more automotive; it's shifted, it's now mostly non-automotive that's the underlying driver here.

Benett Notman - Davenport & Company, LLC

And then given the success you've had with the Nokia relationship and how that's contributed to margin, is there any more technology licensing in the future for that business unit?

Steven W. Berglund - President and Chief Executive Officer

It's something we are interested in. I think it would... I would be misspeaking if I were to indicate that we expect any head turning sorts of deals coming up. But I think it's always operative in the background, but I wouldn't be projecting anything significant anytime soon.

Benett Notman - Davenport & Company, LLC

Right. And then last question from me, could you just talk about the Connected Construction Site concept and sort of where you are and are you productizing that?

Steven W. Berglund - President and Chief Executive Officer

Sure. So again, this is not a phenomenon that we are going to see happen on any given day. It's progressive. So again, I think that we are productizing at the place that is most evident is in our, what we are calling, our construction services division, which is bringing a product to market and upgrading all the time. But the product is called Trimble Construction Manager which is performing a number of things including asset management but also monitoring the condition of the site. So largely, at this point in time, the most visible reflection of a Connected Construction Site is in that product. As we get closer to the end of the year, I would expect that at our users conference in Dimensions in November is we'll have more specific things to say and to show about the Connected Construction Site. But again, it's a progressive thing, there is not going to be any given quarter where the world suddenly changes. But what we are doing is building more and more functionality into this software program, we are building more and more functionality into other Trimble hardware platforms to make them all work better together and connect them and come up with better solutions.

But ultimately, I think the relative vision here that may be closer than anyone understands is looking, for example, at the site foreman, the site superintendent, the person responsible for managing a large construction site. Today, that individual, find out what's going on, gets in a pick-up truck, drives around and does visual inspection and has conversations with people and then goes back to the trailer which is full of paper. The vision, if you will, for some point in future is for that individual to basically be able to sit in that trailer, look at a computer screen, be able to see where every piece of equipment and really every value add activity on that construction site, be able to see it on the computer screen, potentially click on a machine, understand the productivity of that machine to date, potentially be able to look at the deliveries that are supposed to be made that afternoon in terms of concrete trucks and stuff and make sure that they are on track, click on another screen and find out what the weather is going to be that afternoon in case there is a weather-sensitive operation that's going to occur. So that is the relative sort of vision we are talking about. A lot of those pieces where functionality exist and what we need to do now is to get those more effectively in the marketplace. So again, a progressive thing, but there is actually quite a bit that's already occuring.

Benett Notman - Davenport & Company, LLC

Great, thank you.

Steven W. Berglund - President and Chief Executive Officer

You bet.

Operator

Your next question comes from the line of Eli Lustgarten with Longbow.

Eli Lustgarten - Longbow Research

Good afternoon.

Steven W. Berglund - President and Chief Executive Officer

Hey Eli.

Eli Lustgarten - Longbow Research

A couple of just quick questions. On foreign currency, can you tell us about the impact on top line, bottom line sectors?

Rajat Bahri - Chief Financial Officer

Sure. So as you know, U.S. dollar weakened against most of the foreign currencies like the euro. So it definitely... it had an impact, favorable impact on our revenue. We have gained around 1 to 2 points of growth because of that. And on the bottom line, we are naturally hedged. So we do sell revenue, but we also have a lot of expenses in countries like Sweden, a lot of R&D expenses, countries like New Zealand. And it hurts us from an operating expense point of view. So we are naturally, will close to naturally hedged from a bottom line perspective. So we had a very minimal impact on the operating income line.

Eli Lustgarten - Longbow Research

Okay. Going forward, I guess you gave us $10.5 million intangibles and $4.5 million of stock expense. Is that the new run rate for the quarter for the next few quarters at least?

Rajat Bahri - Chief Financial Officer

Yes, that's really close.

Eli Lustgarten - Longbow Research

And actually one more, we should annualize that for 2008?

Rajat Bahri - Chief Financial Officer

That's correct.

Eli Lustgarten - Longbow Research

Okay. And then... interest, besides [ph] you are paying down interest, your debt, do you have any target level you would like to see get at the end of the year or what can we assume the charges will look like for the next couple of quarters?

Rajat Bahri - Chief Financial Officer

So, yes, so our debt right now is $120 million. And if you assume kind of the worst case scenario, at $120 million at 6% interest rate and just cut it by half, that would be a little bit of a conservative estimate for the back half of the year as far as interest rate is concerned, because we would certainly earn some interest income on our cash balance as well, so there will be some offset there.

Eli Lustgarten - Longbow Research

So I mean, that's assuming that the 120 stayed there, it will it be a --

Rajat Bahri - Chief Financial Officer

Yes. Depending on our acquisition strategy, it may or may not come down on that.

Eli Lustgarten - Longbow Research

Now as far as... as you look at various sector operations, is the Nokia income going to also disappear in the fourth quarter, I think as it did last year? I can't remember [ph], but --?

Rajat Bahri - Chief Financial Officer

So we started getting Nokia income in the third quarter of last year and it's a long-term, long, long-term contract and we get paid for it every quarter.

Eli Lustgarten - Longbow Research

So that would be every quarter. Should we expect a normal seasonality in the E&C business here in the second half as you would [ph] historically during the first half?

Steven W. Berglund - President and Chief Executive Officer

Yes, certainly, I think traditional seasonality more or less is going to be what you are going to see. So you should anticipate that from an E&C perspective, that the second quarter was the seasonally strong quarter of the year and that the third and fourth quarters should reflect the traditional pattern among the quarters. So nothing has changed there.

Eli Lustgarten - Longbow Research

Okay. And as far as the ag business being so strong, are we going to be able to see much stronger Field Solutions because that is going [ph] into at least the third quarter this year in the third quarter and higher margins than we normally have seen before in that sector?

Steven W. Berglund - President and Chief Executive Officer

Yes. So I think that you are going to see the... ag is going to continue to be strong in our view for the rest of the year. I think you have to be real careful there because that is a very seasonal business. And typically, we hit... probably hit stronger in the second quarter because of things like the rainfall than would have been natural. But I would say that with a certain amount of care and caution, you should expect to see stronger ag in not only the second half of the year, but very much seasonally challenged, if you will.

Eli Lustgarten - Longbow Research

So expect the margin... we had very strong margins in the first half in Field Solutions than we did last year. Should we expect them to seasonally weaken, but probably not as much as they weakened last year, that would be a fair comment?

Steven W. Berglund - President and Chief Executive Officer

Yes, I think that you have to do the arithmetic, but that would be a... you are going to see some scale effect because our cost structure in many respects is constant throughout the year. So yes, you will see some seasonal fall off probably.

Eli Lustgarten - Longbow Research

Well, thank you.

Steven W. Berglund - President and Chief Executive Officer

You bet. Thanks.

Operator

There are no more questions at this time. I would like to turn the call over to Mr. Steve Berglund.

Steven W. Berglund - President and Chief Executive Officer

Okay, thanks for attending. We'll talk to you next quarter. Bye.

Operator

This concludes today's second quarter 2007 earnings conference call. You may now disconnect.

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Source: Trimble Navigation Q2 2007 Earnings Call Transcript

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