Trimble Inc. (NASDAQ:TRMB) Q1 2024 Earnings Call Transcript

Trimble Inc. (NASDAQ:TRMB) Q1 2024 Earnings Call Transcript May 3, 2024

Trimble Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by. My name is Krista, and I will be your conference operator today. At this time, I would like to welcome everyone to the Trimble First Quarter 2024 results conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question and answer session. [Operator Instructions] Thank you. I would now like to turn the conference over to Rob Painter, President and Chief Executive Officer. Rob, you may begin your conference.

Rob Painter : Welcome, everyone. Before I get started, our presentation is available on our website, and we ask that you refer to the safe harbor at the back. Our financial commentary will reflect non-GAAP performance metrics, including organic growth comparisons, which refer to the corresponding period of last year unless otherwise noted. In addition, our P&L commentary will primarily emphasize our as-adjusted numbers, which exclude our agriculture business, better reflecting Trimble on a go forward basis. Starting on slide four, during the first quarter, we continued to advance our connect and scale strategy, which involves digitally connecting workflows within targeted industry segments and creating scale across Trimble through shared technology platforms.

Our strategy delivers outcomes in the form of unique value to our customers and sustainable value creation to our shareholders. We want to convey three key messages today, starting with the solid performance in the quarter, where all three segments performed ahead of expectations as detailed on slides five and six. $2.3 billion of ARR grew 13% organically, as-adjusted revenue grew 8% organically, as-adjusted gross margins were a record 67.5%, as-adjusted EBITDA margin expanded 290 basis points to 27.9% and free cash flow was strong at $227 million. We are confirming our previous total year guidance despite unfavorable currency moves and we will provide an update in our next call as we build confidence in the months ahead. Key message number two is a strategic portfolio highlight.

In the first quarter, we divested certain water monitoring assets, our 21st divestiture in the last four years. And on April 1st, we closed our PTx Trimble joint venture. I’m proud to have established this precision AG joint venture with Eric Hansotia and his team at AGCO. This is a high character team with a bold vision. These moves simplify and focus our organization and provide cash to strengthen our balance sheet and support our capital allocation strategy. Key message number three on slide seven is that our new reporting segments are in place which align to our new organizational structure. We provided historical data on the segments to our investors on April 12th. It takes an enormous amount of work to affect change on this scale and I’m grateful to our Trimble colleagues for their courage and dedication.

The sum of these actions will simplify and focus our business, thereby enabling us to reset to a new and better baseline as we aim to perform to our full potential. As evidence on an as-reported basis, our first quarter revenue was 73% software services and recurring and 58% recurring. While on an as-adjusted basis, our first quarter was 77% software services and recurring and 63% recurring. Turning to the segments, let’s start on slide eight with our AECO segment. Connect and scale is well in motion here and it is working. Connect is about connecting users, data, stakeholders and workflow across the industry lifecycle continuum. Our right to win starts with the breadth, depth and connectedness of our offerings, it bookends by delivering solutions that connect the physical and digital worlds.

Scale is about making Trimble easier to do business with and enabling efficient and effective growth. In the quarter, we moved our go-to-market team to an account based selling model. We expanded our pre-package to Trimble Construction One offerings and we released our next version of systems transformation, which is providing us new insights into our customers. Mark Schwartz and his team delivered record first quarter bookings and 18% increase in ARR and margin expansion of 430 basis points. This business is a multi-year overnight success and we trust the new reporting structure now gives enhanced visibility to the quality of the business we have been transforming over the last few years. To emphasize the point, this is a scaled $1.1 billion ARR segment operating as a rule of 40 plus business, in fact, a rule of 50 plus in the quarter.

Market conditions remain favorable at the moment with strengthened sub-segments such as reshoring and on-shoring of manufacturing, EV and battery plants, data centers and renewable energy projects. The physical side of our business is largely conveyed in our new field systems reporting segment with key highlights on slide nine. This business is predominantly hardware, but that discrete word underplays the importance of this business to our strategy. Think of this as industrial IOT, the data collection node in the physical world that provides us the ability to connect the physical and digital worlds. In this business, we are continuing to transform our selling models moving towards hybrid models where we increasingly monetize aspects of the solution as recurring revenue.

Thus the segment revenue splits approximately 50-50 as hardware and software. On an as-adjusted basis, which excludes our agriculture business. Ron Bisio and his team grew revenue by 1% while increasing operating margins by 250 basis points to 26.9%. Software services and recurring revenue are 48% of the business and ARR grew 14%, evidence of our connected scale strategy and motion in this segment. Market conditions remain mixed and overall slightly positive. We see strength in the same sub-segments as AECO including infrastructure spend. On the cautious side, we see economic weakness in pockets of Europe and Asia Pacific, most notably through lower OEM retail unit sales and continued weakness in residential construction. We are closely monitoring U.S. GDP growth along with global interest rate dynamics and how that will impact capital purchases.

Closing our segment commentary on slide 10, transportation and logistics began the year with a solid start. We closed the Transporeon acquisition last April. Thus it is excluded from the organic comparison in the first quarter. On the heels of record fourth quarter bookings, the Transporeon team delivered a record first quarter bookings. Chris Keating and his team reorganized their go-to-market strategy and recommitted to process excellence and organizational focus. They are also delivering innovation, most notably through AI-driven product releases and autonomous procurement and autonomous quotation, which have found product market fit. They predominantly deliver this bookings growth in a European region that continues to experience a freight recession, thus demonstrating that selling a winning value proposition and backing it up with innovation and process improvement can generate positive results, even in a tough market environment.

They also delivered a multi-hundred thousand dollar annualized contract value global cross-sell win, selling autonomous procurement to an existing enterprise software customer that is notably in North America. We’ve also begun cross-selling our map solutions into Transporeon’s European customer base. We remain confident this is an exciting Trimble business with a compelling right to win and an attractive business model that enables a series of land and expand product-led growth opportunities. In context of the bookings and ARR growth, we will continue to allocate capital to our go-to-market expansion. In the rest of the segment, the 4% organic revenue growth was driven by our enterprise and MAPS teams, which each grew double digit. Excluding Transporeon, we have delivered consistent margin expansion since the end of 2021, including Transporeon, the segment expanded margins by 480 basis points in the quarter.

Before I turn it over to Phil for his first call as our incoming CFO, let me once again express my gratitude to David Barnes for his service and partnership over these last few years. Phil, over to you.

Phil Sawarynski: Thank you, Rob. We believe shareholder value is ultimately a function of maximizing long-term free cash flow. Connect and scale is our engine, which in the mid to long-term aims to deliver cumulative recurring free cash flow. Slide 11 highlights balance sheet and cash flow dynamics in the quarter. Free cash flow was strong in the quarter, coming in at $227 million, or 1.4 times non-GAAP net income. We continue our asset-like model with capital expenditures less than 1% of revenue and negative working capital. Pro forma net debt to EBITDA after the close of the agriculture joint venture stands at about one. Post the close of the AGCO transaction at the beginning of the second quarter, we have just under $1 billion in cash even after paying down our term debt and the outstanding balances on our credit facilities.

Our strong cash balance puts us in good position to resume our share buyback activity after we issue the 10-Q. Now a few comments about capital allocation. Our priority remains the same, which is to invest back into our business where we see opportunities for the highest returns. For example, over the last few years, we have been investing in digital transformation, the fruits of which are being demonstrated in AECO. We continue to transform our processes and systems in AECO, and over time, we will expand this work throughout the rest of the company. As promised, we retired over $1 billion debt in early April. In January, we announced an $800 million share repurchase authorization, and in the first quarter, we executed $175 million of buybacks.

On the merger and acquisition front, we will opportunistically pursue tuck-in acquisitions with a bias toward the AECO segment where we can land and expand with capabilities that fit inside the Trimble Construction One offerings. As an example, we acquired a field human resources application in the third quarter of 2023 and doubled the customer account in the first few months under our ownership. This was enabled by our Connect and Scale strategy via bundled product offerings that we put in the hands of our sellers. We intend to run the same playbook as we think about our acquisition strategy going forward. Before I turn to guidance, an update on the expected timing of the release of our 10-Q filing, our auditor’s EY informed us several weeks ago that the 2023 audit of Trimble was selected as part of the PCAOB’s inspection of EY’s work.

During preparation for the PCAOB review, EY concluded that either EY nor Trimble had sufficient documentation related to certain IT and other controls for revenue related systems and processes. While EY had deemed Trimble’s controls over revenue effective at the time of the 10-K filing, EY’s subsequent internal review over the last few weeks has changed their conclusion. Unfortunately, the result is that our 10-Q filing will be delayed and we will need to amend our 10-K to revise the internal control disclosures after the completion of EY’s additional audit procedures. We’ve decided to delay our annual shareholders meeting until EY has completed their work. It is first and foremost important to note and emphasize that our auditors have not withdrawn their 2023 financial audit opinion.

We are committed to working with our auditors to close this out in an expeditious manner. With that, let’s turn to guidance for the second quarter and the remainder of the year. As Rob noted earlier, we are reaffirming all elements of our initial guidance for 2024, despite negative currency moves, with some puts and takes between quarters and with prudence, given that we are still early in the year and our global end market environments are dynamic. Several factors influence our outlook for the year. While we got off to a very strong start in the first quarter, some of our outperformance came from hardware and term license revenue in the first quarter that we previously anticipated would come in the second quarter or later in the year. With this dynamic in mind, we think the best way to understand our trends is by looking at the year through a lens of first half versus second half.

Overall, our outlook for the first half remains consistent with what we shared with you a quarter ago. We expect that as-adjusted organic revenue growth in the second half of the year will be consistent with the first half after adjusting for the impact of the extra week in the fourth quarter. Let’s now move to our detailed guidance on slide 12. I will focus again on our as-adjusted view, excluding agriculture. Please note that we’ve also included slides in the appendix to our presentation that provide more information on our segment and corporate assumptions. Our prior guidance, assumed that the agriculture joint venture would close on April 1st, which is exactly what happened. The as-adjusted view removes agriculture in the historical periods, which enables looking at the growth dynamics over current portfolio in a consistent way.

Our outlook for ARR growth remains strong with continued expectations for 11% to 13% organic growth for the year. This is driven primarily by the expectation of mid-to-high teens growth in AECO ARR. Our total company full year organic revenue growth outlook remains in the 4% to 7% range. This is driven by AECO growth in the high-teens to low twenties field systems growth flat to down in the low single digits and transportation revenue flat to up in the low single digits. As a reminder, our 2024 fiscal year includes 53 weeks, which increases full year and fourth quarter revenue by approximately $85 million, of which approximately $70 million is in the AECO segment. Excluding this extra week revenue growth an AECO is expected to be up in the low to mid teens.

Our margin outlook for the year is also unchanged with non-GAAP operating margin expected to be in the range of 24% to 25% and adjusted EBITDA margin in the range of 26.5% to 27.5%. This represents year-over-year improvement on both measures of between 100 and 200 basis points. AECO margins are expected to be up approximately 300 basis points for the year and by about 50 basis points excluding the extra week. This margin expansion reflects both the strong growth in our construction software businesses with high gross margins while continuing to invest in support of future growth opportunities. In field systems, margins are expected to be down approximately 100 basis points due to changes in customer and product mix. Finally, in transportation, we expect margins to continue to improve with margins up approximately 100 basis points for the year with continued margin expansion in our enterprise MAPS and Transporeon businesses.

Our EPS forecast of $2.60 to $2.80 is unchanged and continues to reflect the benefits of capital redeployment of the proceeds from the joint venture transaction. We’ve already paid down all of our prepayable debt and we continue to anticipate that we will execute on up to $800 million of share repurchases over the course of the year. Relatives to our prior guidance, EPS will benefit from lower net interest expense due to the increased cash on our balance sheet offset by lower equity income. From a cash flow perspective, we continue to expect full year free cash flow of approximately 0.85 times non-GAAP net income. This outlook does not assume a change as it relates to expensing of research and development for tax purposes. Excluding the impact of acquisition deal expenses and the 53rd week, our free cash flow forecast for the year is roughly one times non-GAAP net income.

Note that we expect free cash flow in the second quarter to be the lowest of the year. Second quarter cash flows normally seasonally low and in the second quarter, we will see high acquisition related expenses related to the closing and transition costs for the agriculture joint venture as well as higher cash taxes. I’ll finish by offering a few comments on how our guidance for 2024 breaks out by quarter. As we discussed, our guidance overall assumes that excluding the 53rd week, our as-adjusted organic growth is relatively consistent between the first half and second half of the year. For the second quarter, we expect revenue between $845 million and $875 million, which reflects as-adjusted organic revenue approximately flat year-over-year.

As-adjusted organic revenue growth year-over-year in all three segments is expected to be lower than the first quarter. In AECO, these dynamics reflect the timing of the term license sales, which although considered as part of our ARR calculation, are recognized upfront under the accounting rules and positively impacted the segment in the first quarter. To illustrate this point further, within AECO, we recognize approximately $85 million of term license revenue in the first quarter, and in both the second quarter and third quarter, we expect term license revenue in AECO to be approximately $30 million, due in large part to the normal timing of the term license renewals. Then in the fourth quarter, that term license revenue will increase again above first quarter levels due to the inclusion of the 53rd week in January 1st, 2025, in our 2024 fiscal year, which is when many of the term licenses renew.

Our ARR measure evens out the lumpy nature of term license revenue, and we believe it is the best measure of growth in AECO. It’s important to note that term license revenue is highly profitable. So the profitability in our AECO segment and at the company level will be highest in the first quarter and fourth quarter and lower in the second and third quarters. In the field system segment, we had strong sales of geospatial technology to government customers in both the second quarter of 2023 and in the first quarter of 2024, which we did not expect to repeat in the second quarter. Transportation revenues and organic growth will be modestly lower in the second quarter, primarily reflecting reduced low merchant hardware sales in our North American mobility business.

At this point, we expect that total company third quarter revenue will be similar to second quarter revenue. With fourth quarter revenue, the high point for the year assisted by $85 million in revenue from the 53rd week. Operating and EBITDA margins for the year are expected to follow these same trends. We look forward to providing you with more details on the drivers and economics of these segments at our investor day event in December. Rob, I’ll turn it back to you.

Rob Painter: Thanks Phil. When we think about a right to win a Trimble, we believe we can uniquely bring together users and connect workflow between the physical and digital worlds across industry continuance. Connect and Scale is our strategy. Our strategy is an industry platform strategy. Our platform strategy is in turn a data strategy. If we are successful in our pursuits, we will collect one of the most complete data sets in and across industries, creating a fly well of enhanced insights and data connectivity, thereby enabling our customers to transform how they work while building a competitive mode around our business. Thanks to all our Trimble colleagues for delivering a solid start to the year and for demonstrating resilience and conviction as we continue to transform how we work so that we can transform how the world works. Operator, we can now open the line to questions.

See also 30 Most Profitable Companies with Highest Margins in the World and 10 Most Tax-Friendly States for Retirees: Some with No Property Tax.

Q&A Session

Operator: Thank you. We will now begin the question and answer session. [Operator Instructions] Your first question comes from the line of Chad Dillard with Bernstein. Please go ahead.

Chad Dillard: Hi, good morning, guys.

Rob Painter: Hi, Chad.

Chad Dillard: So I guess my first question, just wanted to dig in more into the financial controls issue. So I hope you can give a little bit more detail on, just like what happened in terms of the IT and the impact on revenue recognition. And then, I guess like to what extent, at least right now, do you think this could potentially impact the income statement and just like, how you’re thinking about the timing of a resolution?

Rob Painter: Sure, good morning. I’m going to turn it to David Barnes. David is staying on with us to see this through to its conclusion, and so David why don’t you?

David Barnes: Hey, Chad. So the process is that our 10-K was filed, as you know, in February. And the PCOB selected EY’s audit of Trimble for their review. And as the EY team looked over their work papers on the internal control side of things, they concluded that the documentation that they and we had was not sufficient to meet the standards of the audit of internal controls. And Chad, the thing I’d point out is the EY support of our financials is unchanged. This is just about the internal controls. No issues with our numbers have been identified by EY or us. What’s happening is EY is going to go through, enhanced audit procedures to confirm the numbers. And then we will issue an amended 10-K, which will enable us to issue the Q as well.

We’ve looked at — companies have gone through this and it takes probably more than a month. Hard to predict the timing. It’s inconvenient, but we at this point have no reason to believe that our numbers will change and we’re working cooperatively with EY to get through it.

Chad Dillard: Great, that’s helpful. And just moving to AECO, can you give a little bit more detail on bookings for that business like during the quarter? And if you can just talk about what the take rate is on your bundles offering?

David Barnes: So bookings in the quarter continued to be strong. So put together really a couple of years now of the strong progression in the bookings, the bookings, the ACV bookings were over 20% growth in the quarter. So we’d like what we’re seeing in terms of the progression there. Within that, Trimble Construction One is clearly an offering that we’ve been talking a lot about over the last say year, year and a half. The bookings grew faster than that within Trimble Construction One. So Trimble Construction One were continuing to increase the level of adoption through that as we’ve transformed our selling organization and the processes and the systems to go along with that. So giving an example in North America, think about 80% of our bookings were Trimble Construction One bookings within the quarter and those grew at a level of almost 2X, the bookings level growth on a year-over-year basis, so, strong progression, Chad.

Operator: Please limit yourself to one question and one follow-up. Your next question comes from the line of Jason Celino from KeyBanc. Please go ahead.

Jason Celino: Hey, thanks for taking my question. Maybe double-clicking on that a little bit. When you think about the growth that you’re seeing in AECO, and maybe if you go a step deeper on PC-1, is there a way to think about it versus net new versus expansion?

Rob Painter: Jason, the breakdown on that is about two-thirds, one-third, two-thirds existing logos, one-third new logos. So if we take new logos, what we see is that the offering is expanding the addressable market. And in some cases, that’s allowing us to go, I’d say more in the small, mid-size end of the market with the offering. And then on the, let’s call it the mid to upper end of the market we continue to see customers wanting to buy into an ecosystem. We think that’s driving a good amount of the growth. Teams doing a great job executing.

Jason Celino: Yes, I mean, it seems that you’re executing quite well. I know the demand environment doesn’t make it easy, but maybe relative to 90 days ago, maybe can you just give us an update on how some of that end market or macro kind of sentiment is within that segment? Thanks.

David Barnes: Yes, good question. So on the macro side within AECO, what I would comment on is that we see good growth and on-shoring, reshoring of manufacturing. We see, and you see that in Europe and North America. Renewables, data centers, these are strong growers in North America and those bookings in the AR growth, supports that. Residential with industry environment is on the other side of that. Trade that aspect of the market is a bit more challenged. We actually also, Jason, have quite a bit of data within our own systems, as you know, we’re managing nearly a third of U.S. construction through our systems. And so we can see that hiring is up in the market here in North America and the non-residential space we can see geographically that there’s been the largest growth in the Midwest, followed by the Southeast with Florida’s, Carolinas and Georgia.

Operator: Your next question comes from a line of Jonathan Hull with William Blair. Please go ahead.

Jonathan Hull: Hi, good morning. Just wanted to start with a little bit more of a high-level question. As we look at Trimble moving forward, just given the model and mixed changes here, at what point should we expect ARR and total revenue growth to converge a little bit more?

Rob Painter: Hey, Jonathan, good morning. It’s Rob. Good question. We actually already see that in AECO, and so you can see the growth in the quarter, for example, is the 18% on the ARR, as well as 18% revenue. If you look in transportation and logistics, you have the same phenomenon, total revenue up for ARR, up for, so it correlates to the amount of recurring that’s in that. The one that will be disconnected and would remain so for, I think, a number of years would be at field systems, which is predominantly a hardware business. I think the recurring is, I call it in the 20% range on that. So those will remain separated and thus leave a separation at the total company level.

Jonathan Hull: Got it. And just as a follow-up, can you give us a little bit more detail on Transporean and what may be changed there to drive the much improved results? Thank you.

Rob Painter: Yes, good question as well. So another strong quarter of bookings growth, that’s two quarters in a row of records for the business, a record Q4, and then a record with the Q1 as well. What I would say is a few things to add onto that. So the team began successfully cross-selling Transporean solutions to existing Trimble transportation customers here in North America, which exemplifies go-to-market synergies, and we think we’re just getting started. Conversely, we’ve been selling some of our MAPS solutions into the European market. Those bookings growth, we’re both with the shippers and carrier customers, and that’s important because we continue, the team’s continuing to grow network participants on all sides of the transportation management platform, which effectively connects the buyers and the sellers of freight.

Dozens of new logos were added in the quarter. I like what we’re seeing from new product development as well with autonomous procurement and autonomous quotation. So I’d say a number of things coming together. The team’s executing quite well, and which is still a very difficult economic or difficult freight market economy, doubly so in Europe.

Operator: Your next question comes from the line of Jerry Revich with Goldman Sachs. Please go ahead.

Jerry Revich: Yes, hi. Good morning, everyone. I’m wondering if we could just talk about the 2Q margin outlook. So you both said an outstanding first quarter and I understand the comments about terms license sales, but historically you just don’t have that type of margin step down that you’re guiding to 2Q versus 1Q. And so I just want to make sure we understand how much of that is making sure that we can beat numbers like we did this quarter versus a meaningful slowdown in any part of the business because obviously the performance in the quarter was really strong.

Phil Sawarynski: Hey, Jerry. It’s Phil and thanks and good question because I know there’s a lot of moving parts in our outlook. So yes, if you think about Q1 as I talked about the term licenses are largely Q1 dynamic and that’s that $50 million drop from Q1 to Q2. So if you look at the margin basis, I think it’s around a 400, a little bit more than a 400 point drop. So the large part of that I’ll put into actually four buckets. Half of that or a little over half of that is because of the dynamic of the term license. If you remember, the term licenses actually get recognized all up front. So that’s high margin revenue. And then, as you move into Q2, the other two pieces are one, we have our merit raises that take effect in April.

And so that’s about a 100 basis points. And then another 100 basis points is some additional OpEx, primarily around the AECO business and the sales and marketing and R&D spend that we’ve talked about incremental spend there to continue to drive that growth engine. And then the remainder is the term license to bridge that 400.

Jerry Revich: Okay. And then, can I separately on the ARR, nice acceleration in performance in the quarter, really across the segments. As we think about what the Transporeon rolling into the mix will look like and it feels like you’re looking for an acceleration based on about looking side 15 [ph] across the segments, putting the pieces together across the total company. Could we see ARR accelerating on an organic basis in the mid to high teams from an exit rate standpoint, beyond the full year guide? Just think about what 4Q might look like given the cadence that you described in the slides?

Phil Sawarynski: Well, to the Transporeon will certainly help them at the company level in terms of bringing up the ARR growth potential. The other side of that is the mobility business. And so the net of that gets to the guide that we put forward, Jerry.

Jerry Revich: And Rob, is it fair to say that there’s an acceleration though 4Q above the full year ARR guide?

Rob Painter: At this point, no, no, we’re maintaining the maintaining the outlook on that. It has a bit, I mean, it would buy us more than above to the mid. But we’re going to leave that guide where we are right now.

Jerry Revich: Thank you.

A – Rob Painter: You are welcome.

Operator: Your next your next question comes from the line of Kristen Owen with Oppenheimer. Please go ahead.

Kristen Owen: Hi, good morning. Thank you for taking the question. Rob, you called out the rule of 40 balance for AECO. And I think it just in this previous question that about 100 basis points going to reinvestment in that business. Just wondering if you can talk about sort of balancing that lifetime customer value versus your customer acquisition cost? How you think about investment versus growth to build out the opportunities in that business?

Rob Painter: Hey, good morning, Kristin. Great question. Let me take that two-fold. First with the call it the 100 bps of investment, OpEx investment into the AECO segment that Phil referenced. More than half of that is at the sales and marketing level. So that’s putting feet on the street sellers to go get the business that we think is there. About a quarter of it is an R&D as we continue to drive connectivity and interoperability between the solutions driving workflow capabilities as well as AI investments we’re making into the products. And then the remainder is in G&A, which is really the systems investments and the systems investments, which are enabling a lot of this to happen. So then at the level when we think about the return on investment that we’re making to put into the business, we look at that lifetime value over the customer acquisition cost.

And the easy heuristic is when we’re at a ratio above three, that’s telling us to lean forward and invest into the business. We’re well above that as a floor of our thinking. And so when we do that math, this is actually its pretty straightforward exercise to say we should be leaning into investing in this business to go after the market, especially when we’re delivering well above the rule of 40, in fact, above rule of 50.

Kristen Owen: Okay. Thank you. That’s helpful. When I think about the overall size of that market opportunity, I mean, we obviously the business is going through a transformation at this point in time, TC1 really just starting to ramp. If we look at sort of the five-year model for Trimble, how do you think about your mix of market opportunity for continuing growth in AECO? Is it within your existing customer base? Is it new products? Is it new logos? Just help us understand what sustains this growth on a go forward basis?

Rob Painter: Yes, it’s a great question. So on a multi-year basis, I would frame this market as the largest available TAM that we have to service. We know the multi-trillion dollar size of global construction. We’re playing both in vertical structure construction, horizontal construction. We know it’s a market that’s large global underserved, under penetrated, has challenges with productivity, at the intersection of productivity and sustainability, which our solutions positively affect. We see more and more customers wanting to buy into ecosystems and our right to win, we think, begins with the breadth and depth of solutions we have across the continuum of the life cycle. Furthermore, if you subscribe to an ocean, the world’s becoming more data-centric, more data-driven, then you will like the touchpoints we have across this industry where we believe move from optimizing tasks to optimizing systems.

So I think we’re well and uniquely positioned to do so. With respect to how we then think about existing versus new logos, within the existing customer base we have, we think that there’s hundreds of millions of dollars of untapped ARR to mine through cross-sell and up-sell, given the breadth of that installed base that we have. With the systems investments that we’re making, it becomes more efficient to go to market. Some of those investments are starting to create the ability for customers to self-provision licenses, more e-commerce capabilities are starting to come to market. That, in turn, creates a more efficient go-to-market motion into the smaller end of the market. And so that, we think, would be another TAM that we can unlock through the nature of the business model and efficiency at which we go to market.

We for sure think that we can continue to win new logos along the way as customers and the market overall continues to adopt and continues to digitize. I would expect within that five years that the majority of that revenue would come through the existing base in this land and expand motion. So that’s the expectation I’d want to set there. So continue to feel very, very positive about the work in this business and the progress that we’re making. And we’d like to think that we’re just getting started.

Kristen Owen: Thanks so much.

Operator: Your next question comes from the line of Rob Wertheimer for Melius Research. Please go ahead.

Justin Pellegrino: Good morning, everybody. This is Justin Pellegrino on for Rob. I just wanted to look at the equipment side. And what is a typical downside in the equipment side look like versus where we’re at now? Are we most away into a normal downturn? Just any color there would be helpful. Thank you.

Rob Painter: Sure. Good morning and thanks for the question. Well, we certainly are following what the OEMs are reporting on their unit sales, both at a retail side and a wholesale demand level. And there’s for sure a correlation within field systems, field systems business we have and the OEM. So we have OEM exposure, let’s say, in field systems that we really don’t have nearly as much of in the other two segments of the business. What we would see through our own numbers is that the European economy is more challenged and we’ve seen some of the prints out there on units in, let’s say, Europe and construction. Interestingly enough, our Europe business and field systems performed quite well, relatively well in the first quarter.

So it’s not a perfect, let’s say, R-squared on that correlation. We’re also fundamentally architected to serve the aftermarket and to serve the mixed fleet within that. So there’s also another, I’d say, call it the mindset that we have is not to be driven by what are new unit sales. Although we do obviously sell onto new units as we see many, many hundreds of thousands of millions of machines that would benefit from having Trimble technology on it, machine types like excavators remain low single digit penetrated with technology. And so we think there is enormous opportunities to drive technology adoption into the base of machines that are out there. That’s just the civil construction side of the business. So in field systems, survey mapping is an important business.

For us, and I would say, we disconnect that from the unit sales coming out of the machinery manufacturers. And there, a surveyor fundamentally creates a digital model of the physical world that work could be an oil and gas workflow. It could be a cadastral survey. It could be in residential application. It could be in our national parks. There’s a wide variety of applications in that market, which would be independent of machine units. Hope that helps provide some color.

Justin Pellegrino: Thank you.

Operator: Your next question comes from the line of Rob Mason from Baird. Please go ahead.

Rob Mason: Yes, good morning. Rob, you noted the Transporeon business had a win in North America. And I’m just curious, if I think about when you bought the business, I’m not sure that was — the thesis there was heavily predicated on North America penetration. But now that you’ve owned it for about a year, I’m just curious how you’re sizing up the opportunity to bring Transporeon or at least parts of Transporeon to North America. And perhaps any comment on any commercial efforts you have around that as well?

Rob Painter: Good morning, Rob, and thanks for the question. You’re right about the original thesis of it is we didn’t, let’s say, create our model fundamentally around bringing the European applications into North America. We saw that as additive opportunities and we for sure saw that we could do it. We just didn’t predicate the deal on that being the fundamental thesis. So yes, hey, good news or that the example, the customer talked about in the prepared remarks. It’s a multi hundred thousand dollar ARR when that we have and it actually is of using the autonomous quotation product that we talked about earlier as well. So not even I’d say the — it’s called the older existing application capabilities we had in the business is actually a new one.

And so we find that very interesting to think about what’s most unique about what we have in special about the North America install base. It’s carrier centric. Its the nature of our customers. So when we look at capabilities to bring into North America on the carrier side that would look like autonomous quotation and it’s really creating automation around spot transactions. So that’s something that makes sense for our sellers to be able to introduce to the existing customer base. In addition, we’ve talked before about engage Lane in North America and the marketplace in Europe. We brought those organizations or those teams together into one team to create a global, what’s called global scale and global opportunity around that. So that’s another example.

And then the third example is real time visibility. We’re doing that as one business now, not separately in Europe and North America. And so those would be additional capabilities then we want to penetrate here into the North American.

Rob Mason: Yes. Okay. Just as a follow up, again, as we get through this year, I guess, we’ll get recalibrated to the new of these go forward segments and the business without ag. But I was just curious in particular on the hardware and perpetual software, gross margin trend. Its trended lower over the last 12 months, but my suspicion ag had something to do with that. At 44% in the first quarter, how does that look on a go forward basis without ag as we go through this year?

Rob Painter: Yes, it’s a good question. Rob and Phil can chime in after I set this up. And you’re right, the resident ag there in the numbers that you see. But in addition to that, we think about transitioning more of those hardware models into an element of recurring revenue. And that will naturally have a gross margin impact. So think about a system that might have sold for let’s call it $40,000 system. And that for us, from a call it accounting perspective as an element of hardware and software that’s in that. And let’s say that that traditionally was splitting, let’s call it $25,000 of hardware and $15,000 of software, so $40,000 sale. That might now convert to $25,000 and for the hardware upfront and a subscription of $5,000 a year.

And in that case, that will have near term headwinds to the gross margins. Now we’re not flipping a switch and going 100% that direction. Rob, but you can see from the ARR growth that was 13% ARR growth in the first quarter that it is a model that we are moving towards. So on a longer term basis that could be 200 to 300 basis points of a headwind. Phil, do you want to add anything to that?

Phil Sawarynski: No, I think that’s right, Rob.

Rob Mason: Okay. That’s very helpful. Thank you.

Operator: Your next question comes from the line of Joshua Tilton with Wolfe Research. Please go ahead.

Joshua Tilton: Hey, guys. Happy Friday. Can you hear me?

Rob Mason: Yes. Hi. Good morning.

Joshua Tilton: Good morning, guys. So just my first one kind of a clarification, I appreciate all the color around the term impact to AECO. I guess what I’m trying to understand is because of six to six accounting, will there always be a term components in the AECO revenue line item each quarter? Basically, every time you renew something or even sign a new deal. And then my follow-up, just for the clarification, is the reason why we have so much extra rev in the AECO segment because of the extra week, because there’s just a bunch of renewals that will have term licenses tied to those renewals that will land in the extra week of the year. Am I thinking about this correctly?

Rob Painter: Yes. Hey, Joshua. So your second question is an easy one. Yes, you are thinking about it correctly. Our 53rd week encompasses January 1 of 2025, and a large portion of our term licenses were new around that date. And so you are correct in thinking that the 53rd week, roughly $70 million of the $85 million there are the term licenses that were new. And your first question, yes, there is an element of term licenses within AECO that we’ve had and we continue, will continue to have. That’s largely in our structures business. And some of it has to do with the complexity and the horsepower around the offering itself where it’s challenging to move that more into the cloud. So you will see that dynamic going forward at least for the foreseeable future.

Joshua Tilton: So just to be clear, term is not tied to all contracts in AECO, just some of them?

Rob Painter: Correct. So it’s a limited subset of the total AECO offerings.

Joshua Tilton: Okay. Super helpful. And then I guess my follow up on is just very high level. We’ve definitely had a lot of positive inbound since you guys have given this new segmentation. But I guess when you guys are sitting around the table right there, did anything change in terms of how you guys think about the business and plan about thinking about the business going forward that like aligns with this segmentation? Or is it kind of just business as usual for you guys there? And this segmentation is more for us investors better understand what’s already been going on behind the scenes?

Rob Painter: Hey, Josh, it’s Rob. I’ll take this one. I think it’s a really good question. It’s not just business as usual. It really does change how we were thinking about the business, how we’re running it and some of value creation opportunities that this unlocks. This does simplify and focus the company and I think provides a great new baseline for us as we move forward and executing the strategy. If we look at the AECO assets in that segment as an example, this is a business that is now operating an over a billion dollars in ARR. It’s a scaled ARR software business. This mandate and the business enables the team to take, I’d say, the processes and the systems capabilities across a broader swath of the business than what we were doing previously.

If I look within field systems as an example there, this is the first time in decades that we’ve had our survey business and our civil construction business under one leadership. That is providing a sharper focus and frankly level of accountability to sharing R&D capabilities, being more thoughtful about our positioning technologies and how we’re using them across the business. It’s driving better outcomes in terms of attaching things like our positioning services business to the hardware that we sell and survey and civil construction. And then super importantly to go-to-market level, the similar competency within this is selling — simply put selling hardware through a global dealer channel. So we’re bringing more efficiency and how we go to market.

That is to say, we have one leader in Asia Pacific, one in the European region and one in the America, so three leaders from these regions overseeing the scope of what we do and survey and civil. Previously that would have been six people instead of three. So that for us providing better and more consistent management at the dealers and then it enables a different way to think about capital allocation where we can put some of those resources and to helping dealers plan their long term business health and their strategies to complement the work you’re doing in the short term, and to help them identify the market opportunities and make the number. Transportation arguably had the least amount of change and there would feel probably a bit more like businesses as usual.

Joshua Tilton: Super helpful. I guess just last one to kind of tie that all together. As investors, we see this change, we see the change in the segmentation. You told us, it’s definitely not business as usual. There are new and exciting things going on. Like what are we going to see in 12 months? Maybe 12 months or too soon. Over the three year timeframe, like what should investors be judging you on looking at you at to say, this metric was this much better because of all the changes we made? Like where are we going to see all the positivity that you talked to come through in the numbers?

Rob Painter: Yes. No, I like the question. And I use the words in the prepared marks about a multi-year overnight success. This journey is a thousand little steps. We launched Connect and Scale of January 2020. I think what we have now creates a new baseline. But let’s also look at the facts and the fact base, I should say. In 2018, we had $1.1 billion of ARR. We closed Q1 at $2.03 billion of ARR. In 2018, we were 31% recurring revenue as a business, as-adjusted, Q1 we’re 63% ARR. We had EBITDA of 22.6% in 2018. We closed Q1 at 27.9%. Structurally, our gross margins in 2018 were 58% and Q1 adjusted to 67.5%. Over the last five years, we produced 44% operating leverage. We haven’t just decided that this is the direction that we’re going.

We’ve been working on this for a number of years. So now as we take this as the baseline, I think one of the — probably one of the better things as an outcome of the resegmentation is that transparency and that visibility to the investment community, which is what you’re highlighting. It is very obvious to see in that AECO business now. This is a scaled ARR business operating well above rule of 40. Growing ARR in the high teens produced 37.4% operating income in the first quarter. I’m emphatically positive and proud of the team and what they’ve accomplished on that. So I look forward in a three-year time frame. We’re looking — we talk about ARR and free cash flow. To me, those are the big bookends, not the only bookends, but they’re two of the biggest bookends that we have to drive value.

So I’d say in the three-year time frame, you should be looking for continued ARR growth. We should be able to continue to progress the structural gross margins as software I would expect would outgrow hardware over that time frame. That structural gross margin improvement is an abler of an ability to drive operating leverage. We drive operating leverage. That means we’re driving increased levels of EBITDA. And then as Phil said in his prepared remarks, I think cumulative free cash flow is the game and the long-term game. And so we’d be looking to continue to progress the free cash flow and the business relative to the net income that we have. That’s the quantitative framework I’d have around that. I hope that helps.

Joshua Tilton: It definitely did. I am fired up. Thank you so much.

Operator: Your next question comes from the line of Tami Zakaria with JPMorgan. Please go ahead.

Tami Zakaria: Hi. Good morning, Rob, Phil and David. Thank you for taking my question. I have a follow-up on that Transporeon comment. The autonomous code solution you sold to a North American customer. Can the same salesperson currently selling the existing Trimble solution sell the new Transporeon solution to the customer? Basically, I’m trying to understand how does the back end of all of this work in terms of the customer rep for each of the two solutions, the billing, et cetera. And then how did the ACV go up after selling this versus what it was before?

Rob Painter: Hi, Tami. Good morning. This is Rob. I’ll take that one. So it’s a multi-hundred thousand dollar ARR, it’s over $400,000 ARR in that example that I used, so therefore the ACVs over the $400,000 — yes, $400,000 as well. In terms of the go-to-market motion, think of it as a named account seller who’s responsible for the account in North America bringing in a sales engineer, a sales specialist from Transporeon, who knows the depth of the functionality to be able to, I’d say, be conversant with the customer and the value proposition and how to use it. That’s actually very similar. Tami, to Trimble Construction One, when we’re selling a breadth of offerings, now we do have named account sellers, and then we can bring in the technical specialists to really know the depth of a given solution to make sure that customer can get the most value out of that. Did I answer your question?

Tami Zakaria: Yes, it does. Thank you. So the second question, after this formation of PTx Trimble, how do you view the organic growth algo [ph] potential of this new streamlined portfolio that you have? Basically, I’m curious to know whether you think it’s now the right time to refresh the 2027 target?

Rob Painter: Okay, so hey, on the 2020 multi-year targets, we’re going to have an Investor Day in December, and Phil mentioned that in his prepared remark. We had been saying second half of the year, but we’re narrowing that to December, so that’s the formal update. I appreciate that in the interim, there’ll be questions of how do we think about that progression of the business and the model. I think we can continue to provide color in the next couple of calls, but what we already know is the baseline, and I want to highlight that. We know we have a baseline from the quarter on, or you can actually say take the year, where we’re guiding for the level of EBITDA for the company between 26.5% and 27.5%, we’ve talked about the ARR growth, they’re guiding 11% to 13% organic, so if you take the EBITDA that we have and you continue to play forward the growth we expect and apply operating leverage on that, it’s not that hard to see that we could look at about 100 bps of gross margin improvement a year, and that that could look like 100 bps on the bottom line on a year-over-year basis.

And if that plays through, then you can get to a 2027 in a plus or minus frame, and then we’ll put the finer points and the details around that in December for 2027 or wherever we decide to set the next multi-year mark.

Tami Zakaria: Perfect. This is very helpful. Thank you.

Rob Painter: You’re welcome.

Operator: That concludes our question and answer session. And with that, that concludes today’s conference call. Thank you for your participation and you may now disconnect.