Trimble Inc (TRMB) — Q4 2023 Earnings Call Transcript

Welcome, everyone. Before we 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. Strategic progression takes place as a series of a thousand little steps, periodically punctuated by non-linear moves and events. Reflecting on the quarter and the year, 2023 represented a transformative year for Trimble. Within the portfolio, the Transporeon acquisition and the announcement of the agriculture joint venture with AGCO represent two of the larger moves in the history of our company. Reflecting on our Connect & Scale strategy over a five-year timeframe, the structural improvement in the business is self-evident and is the result of methodical work over the last few years by our colleagues and partners. Annualized recurring revenue finished 2023 at a record $1.98 billion, up 13% organically, and represents the single biggest lever we have to increase shareholder value. This compares with ARR of $1.1 billion five years ago. Recurring revenue was 49% of our total revenue in 2023 and 53% in the fourth quarter versus 31% in 2018. Remaining performance obligations closed the year at $1.8 billion. Gross margin closed at a record 64.7% in 2023, up 470 basis points over 2022. This compares to 58% five years ago. This is definitive structural improvement. EBITDA margin closed at a record 26.6% for the year. In dollars, we crossed the threshold of $1 billion of EBITDA. This compares to EBITDA of 22.6% five years ago. Operating leverage has been 44% over a five-year timeframe. We are running with negative working capital, and we closed with free cash flow of $555 million, up 60% over the prior year. Our ARR and low capital intensity punctuate the difference between industrial technology and industrial. While the evolution of our financial metrics during our transformation has been compelling, the bigger takeaway is how this positions the company today for success now and in the future. Trimble has never been in a better position to help our customers succeed with solutions that address the growing intersection of the physical and digital worlds. We are eager to leverage our strong market position and unique assets to drive continued profitable growth in software and technology-enabled services, to expand margins and to showcase our ability to increase the company's overall returns through smart capital allocation. We believe this framework is the winning formula for a world-class industrial technology company, and we believe executing against this plan will allow Trimble to unlock and sustainably compound value for shareholders. With that structural context, let's turn to Slide 3 and talk about our three-fold framework that guides our capital allocation priorities looking back on 2023 and forward into 2024. First, we remain committed to executing our Connect & Scale strategy. Over the last several years, our P&L investments have been heavily biased towards our software assets in architecture, engineering, construction, and owners, which we refer to as AECO. This focus is driven by the size and immediacy of the secular opportunity. Our transformation of AECO software represents the tip of the spear for the company and increasingly provides a template for how we will operate across all of Trimble. Looking at tactical proof points of progression, let's start with our product strategy. Trimble Construction One, or TC1, can be thought of as a commercial framework around pre-packaged bundled offerings. In the fourth quarter, we doubled the number of these pre-packaged offerings by serving more users across more vertical segments. Nearly half of our AECO bookings in the fourth quarter were TC1 bookings. We come into 2024 with a strong portfolio, and we will learn, adapt, and expand these offerings. As we connect more of our data and workflows, we will continue to expand these offerings, powered by the investments we have been making in our underlying systems and enhanced by our process transformation. After a couple of years of hard work, we can now see a 360-degree view of our customer set, which unlocks marketing and selling insights to enhance our go-to-market motion with more advanced marketing and selling strategies that are more efficient and cost-effective. We will continue to roll out functionality in 2024 and we will expand the capabilities across more geographies and more of the product portfolio. And it goes further, because product, systems, and process work have to link to an aligned go-to-market organization in order to turn possibility into a reality. As measured by cross-sell activity, more than 20% of 2023 annualized contract value, or ACV, bookings in AECO were cross-sell bookings. In the fourth quarter, this number accelerated to over 25%. This didn't happen by accident. The acceleration comes from a packaging of solutions across business lines and is enabled by our digital transformation. We are winning on the breadth of capability. To put this into further context, the AECO teams delivered over 30% ACV bookings growth in 2023 and had a record fourth quarter. Slide 4 shows a number of quotes from our customers, who've continued to give us positive feedback about our direction. We are delivering lifecycle value and uniquely connecting workflows, all while making ourselves easier to do business with. As we come into 2024, we are moving towards an account-based selling model, which will further align ourselves to sell TC1 and cross-sell offerings. This capital allocation is working, and is built on our strategy around the construction continuum that has been accelerated by successful M&A over the last 10 years. Back to Slide 3, the second of our three capital allocation priorities is to further simplify and focus our business. In the last four years, we have divested 21 businesses that did not meet the must-have threshold of a connect and scale business, namely the ability to further a connected industry solution while delivering compelling and sustainable financial results. In early 2024, we divested a small water metering business and a steeler business that we owned in Germany. We continue to look for areas where we can further simplify our portfolio, which goes beyond divestitures. We have reduced thousands of SKUs in the last couple of years and turned a number of standalone products into features within larger bundled solutions. In September, we announced our joint venture with AGCO, which naturally led us to rethink how we organize ourselves, which in turn unlocked an ability for us to further simplify and focus our teams. In the second half of 2023, we undertook $50 million of run rate cost reductions, $10 million ahead of our commitment in November, recognizing that we needed to say no to more things so that we could further focus on the organization. Given the pending AGCO JV and the new organizational structure that officially went into effect in January, we reorganized the business under three pillars: AECO, Field Systems, and Transportation and Logistics. This structure brings similar businesses together, enhancing our ability to achieve scale and growth. The new organization in place is already off to a good start, and hats off to the team for executing these changes seamlessly. Beginning with the first quarter, we will naturally re-segment our reporting results to reflect the way we view our business. And when we do this, we will simultaneously be able to deliver an increased level of clarity on our business models that many of you have been seeking. Slide 5 provides an overview of the direction we are going with these three segments, while providing a bit of color on the software and recurring revenue centricity of each segment. Returning again to Slide 3, let's talk about the third of our three capital allocation priorities, which is return the capital to shareholders. In September, when we announced the JV, we communicated our plan to pay down debt and return capital to shareholders via a buyback. In the fourth quarter, we executed $100 million of buyback. On January 30, our Board approved a new buyback authorization of $800 million, replacing the remaining authority under the prior plan. We reiterated our intention to pay down $1.1 billion of debt and communicated that our near-term intentions on M&A are to focus on tuck-in opportunities. These capital allocation priorities sit against the backdrop of our day-to-day execution. They also sit within a context of what we are seeing in our end markets across the global economy. Geographically speaking, North America has been overall healthy. Europe remains quite challenged. The agriculture and transportation markets face macro headwinds, a result of commodity prices and overcapacity in trucking. The engineering and construction markets have proved to be more resilient, with puts and takes across sub-segments. Control what we control is the operating theme in place. We deliver an enduring value proposition in the form of productivity, quality, safety, transparency, and environmental sustainability. Record bookings in parts of the business such as AECO software and Transporeon, demonstrate the durability of the business.

Thank you, Rob. Slides 6, 7, and 8 cover the financial highlights for the quarter and the year. Organic revenue growth in the fourth quarter was plus 3% and for the year was plus 1%. Excluding the agriculture business, growth was 6% in the fourth quarter and 4% for the year. Standout metrics for 2023 include a 470 basis point improvement in gross margin and $555 million in free cash flow, enabled by profit growth and the success of our efforts to bring inventory levels down. With net debt at $2.8 billion, we remain ahead of the deleverage plan we put in place at the time of the Transporeon acquisition. We have paid down $268 million of the debt incurred to finance the deal. We ended the year with net leverage of 2.8 times, only modestly above our long-range target of 2.5 times. The JV with AGCO is pending regulatory approval, and we continue to expect that the transaction will close in the first half of this year. For modeling purposes, we have assumed that the deal closes early in the second quarter. With debt paydown following the AGCO JV transaction close, our leverage will be below 2 times. Slide 9 covers revenue trends by geography and business model. $1.98 billion of ARR is the standout highlight, up 24% year-on-year and up 13% on an organic basis. Product revenues, which are non-recurring and predominantly our bundled hardware and perpetual software, were down 3% year-on-year. Excluding agriculture, product revenues were down less than 1%, reflecting the stabilization of these businesses now that dealer inventories have come well down from their peak in early 2022. Dealer inventories are now broadly in line with dealers' business outlook, and our sales trends going forward are expected to track underlying demand trends. By geography, growth in North America reflects the relative strength that Rob referenced earlier. APAC revenues were strong, driven by growth in Australia and India. Revenues were down organically in Europe, reflecting challenging macroeconomic conditions across many of the end markets we serve there. Slide 10 breaks down performance at the segment level. In Buildings and Infrastructure, the highlight in the quarter was the strong performance of our recurring revenue offerings. Bookings in our AECO software businesses increased over 30% year-on-year, driven in part by the strong cross-sell and TC1 performance, which Rob mentioned earlier. Aided by the bookings performance, segment ARR grew year-on-year by just under 20%, with net retention over 110%, and at the highest levels this business has seen. Segment revenues of non-recurring offerings, principally machine control for civil construction customers, were relatively flat year-on-year, resulting in total segment revenue up organically by 10%. Segment margins were up by 290 basis points year-on-year, driven both by fixed cost leverage and by the mix shift toward higher margin software offerings. In Geospatial, revenues grew organically by 1%. Our revenue in this segment breaks down across three broad categories: field sales to end users, government business, and OEM business. Sales of our core survey and mapping products to end users returned to meaningful growth in the quarter, reflecting a healthier state of dealer inventories and improving underlying market conditions. Offsetting the strong end user growth, component sales to OEMs were down as we lapped some unusually large shipments a year ago. Segment margins were up by 180 basis points, driven principally by lower component input costs versus year-ago levels. In Resources and Utilities, organic revenue for the quarter was down year-on-year by 4%. Excluding sales of products to agriculture customers, Resources and Utilities revenues were up by approximately 10%. Segment operating margins were lower year-on-year by 160 basis points, driven principally by lower revenue. In Transportation, revenue was up 1% organically. Segment organic ARR was up mid-single digit as growth in our transportation enterprise software and MAPS businesses offset the anticipated impact of churn in our North American mobility offerings. Transporeon remains an inorganic comparison, and the highlight in the quarter for Transporeon was achieving a record level of bookings, up over 20% versus prior year. We were encouraged by the sales performance of the team in light of the difficult macro dynamics in Transporeon's core European market. Segment margins increased year-on-year by 610 basis points, reflecting the higher margins of Transporeon and margin progression in the balance of the segment. Let's move now to 2024 guidance on Slide 11. I will focus on our performance, excluding our Agriculture business and including on a go-forward basis, our more limited exposure to Ag, as a 15% owner of the JV and a supplier of products to the JV. For the sake of completeness, we show on Page 11, two views: a reported view with the Ag business included through the first quarter of 2024; and an as-adjusted view without the agriculture business, which will ultimately be operated within the JV. The outlook for ARR growth remains strong, driven by momentum across our AECO software businesses. We expect full year organic growth rates in the 11% to 13% range, off our year-end 2023 levels of $1.98 billion. As-adjusted organic revenues are expected to grow for the year in the 4% to 7% range. Please note that our fiscal 2024 will include 53 weeks, and the extra week will increase full year and fourth quarter revenues by approximately $85 million. On an as-adjusted basis, we expect margins to improve, with EBITDA margins between 26.5% and 27.5%. This represents margin improvement year-on-year of between 100 basis points and 200 basis points. The margin improvement will come from a combination of improved software mix and the impact of the cost actions we took coming out of 2023. From a cash flow perspective, we expect full year cash flow of approximately 0.85 times non-GAAP net income. Excluding the costs relating to our AGCO JV transaction and the impact of the 53rd week, free cash flow is estimated to be approximately equal to non-GAAP net income. Our base cash flow forecast assumes no change in tax legislation. A bill moving through the U.S. Congress will, if enacted, restore the immediate expensing of R&D for tax purposes. If passed, this legislation would improve incrementally our cash outlook for 2024 by approximately $130 million. Our EPS forecast for the year reflects the beneficial impact of our planned deleveraging following the close of the AGCO JV and up to $800 million of share repurchase. We expect EPS for the year in the range of $2.60 to $2.80. I'll finish by offering a few comments on how our guidance for 2024 breaks out by quarter and by segment. We expect organic revenue growth to be strongest in Buildings and Infrastructure. Software businesses in Buildings and Infrastructure are expected to grow in the mid to high teens with product-related businesses up slightly, leading to organic revenue growth for the full year of between 11% and 13%. Buildings and Infrastructure organic growth includes approximately $70 million from the 53rd week. We plan to accelerate model conversions from perpetual to subscription software, tied with hardware in our civil construction business. Geospatial revenue is expected to be down slightly on an organic basis, with growth in field sales and survey offset by lower sales to U.S. federal customers where business tends to be lumpy from year-to-year. We will also accelerate model conversions from perpetual to subscription software in our survey and mapping business. Resources and Utilities as-adjusted organic growth will be up in the high-single digits, led primarily by continued growth in our positioning services business. Transportation revenues are expected to be up in the mid-single digits for the year and relatively flat on an organic basis, with growth in Transporeon offset by lower North American mobility revenue. We expect reduced hardware revenue in mobility, as we are intentionally pivoting that business away from lower-margin hardware sales to OEMs, instead focusing on the higher value-added data flows. From an operating margin perspective, we expect to grow margins year-over-year in the Buildings and Infrastructure and Resources and Utilities segments. Transportation margins will be up slightly, while Geospatial segment margins are expected to be down year-over-year due to changes in customer and product mix. For the first quarter, let's turn to Slide 12 for additional color. On an as-adjusted basis, we expect organic growth between 2% and 6%, and EBITDA margin between 26% and 27%. Buildings and Infrastructure is expected to drive most of the organic growth in the first quarter, with low-single digit growth in Geospatial. As-adjusted Resources and Utilities is expected to post high-single digit revenue growth in the first quarter. During the first quarter, we expect to see softness in Agriculture. Weakness in the global ag market is certainly a factor, but the bigger driver is the expected impact of the transition in our distribution strategy. Transportation revenues in the quarter are expected to be down modestly on an organic basis. Overall, we expect sequential improvement in Transportation segment organic growth rates as the year progresses, driven by gradually improving end market conditions and the inclusion of Transporeon in our organic trends, beginning in the second quarter. As Rob mentioned earlier, we are moving to implement a new segment reporting structure that reflects our updated organization and the way we will evaluate our businesses and allocate capital going forward. Our plan is to publish more details on our new segment reporting structure later in the first quarter, with financials going back two years and the perspective on how our 2024 annual guidance cascades to the new segments. We will have a separate conference call with investors to review that information when it is available. Rob, I'll turn it back over to you.

Thanks, David. We were busy in the fourth quarter preparing ourselves to come into 2024 with a running start. We were with over 10,000 customers at Trimble user conferences in September, October, and November. We recommitted to our capital allocation priorities, undertook cost reduction, prepared to reorganize the company and made our numbers for the quarter. We plan to host an Investor Day later in the year to discuss the evolution of the business and to provide investors with more financial detail, including updated targets. I will end by taking a moment to welcome Ron Nersesian and Kara Sprague to the Trimble Board, two fantastic additions. Operator, we can now open the line to questions.

Hi. Good morning. Thank you for taking the questions. I wanted to start with maybe the Q1 guides. It sounds like there's some moving pieces in there. And when I look at this outline that you provided on Slide 12, it looks like Agriculture is really the driver between the revenue growth numbers there and maybe what we would have expected. So, if you could help us just understand what the underlying growth in the JV assets looks like in Q1? And just any other moving parts that we should be considering for the 1Q guidance? Thank you.

Good morning, Kristen. This is Rob, and thanks for the question. So, coming into Q1 and thinking about the guide at the company level, what I would want you to hear is the momentum we have with the ARR and the overall business and the stabilization of the supply chains throughout most of the hardware businesses, which reflects in the total year guide. With respect to the first quarter specifically within the current Resources and Utilities segment, some of this is a quarterization topic, and then when we double click within that, within the Agriculture business specifically, there's two dynamics to consider: one is, at the overall market level, so call it market sentiment; and then the other is, within the transition of the relationship. So, at the overall Agriculture market level, you can see that from some of the market statistics from farmer sentiment in the U.S. and Europe, and what we've seen from some of the OEM posts on their numbers and unit expectations coming into the year. So that's part of the topic. And then, the other one is called more the aftermarket side. We're in the transition with the prior corporate relationship we've had and into the new JV relationship. And in that time of transition, there's a natural gap. And so, we never expected, as we've been making this distribution transition, that it was going to be a perfectly linear transition. So, we really think about it at the annual level, not at just a quarter-to-quarter comparison to really track the progress. So, the work is well underway from the integration planning between the teams, from signing up dealers in the aftermarket. So, before you get that revenue in the aftermarket, we've got to be signing up the dealers. And so, it's like comparative to looking at bookings and software business that you got to get the booking before you get the ARR. So, I hope that color helps you, Kristen.

Yeah, thanks for that, Rob. The other question that I have is a little bit longer term sort of post this AGCO JV. When we look at some of the momentum that you outlined, particularly around like the TC1 platform, how do you use that as a framework in some of the other areas of the business going forward? If you can outline any areas where maybe you're seeing growth with existing customers, how that's driving that cross-sell revenue? And as you go through these model transitions in some of the field services business, how you can use the success that you've seen in TC1 in those areas?

I'm glad you asked that question because the work we're doing around TC1, particularly in the B&I segment, will soon include discussions about AECO. The digital transformation efforts we've been pursuing over the last few years, focusing on people, processes, and systems, have significantly impacted our construction software business. We view this as a model for the rest of the company and as a leading initiative. A considerable amount of effort has gone into this, along with valuable insights gained along the way. The success reflected in those bookings is clear evidence that our strategy is effective. As we look to apply this approach to other areas of the business, particularly in field systems, we are currently seeing strong growth in ARR in those segments. We can already implement some of the concepts and frameworks from TC1 in different parts of the business, such as bundling our correction services with our hardware products. We're also transitioning some of our hardware businesses to separate value between the hardware and a subscription or term license on top of that. While these processes happen concurrently rather than sequentially, the AECO software side of the business serves as an excellent model for us and has been very successful thus far.

Thank you for the time.

Yes. Hi. Good morning, everyone.

Hi, Jerry.

Good morning.

Rob, why don't we just talk about, given the organizational change, obviously you laid out the restructuring savings and opportunities, can you comment on just beyond restructuring? How has the P&L responsibility shifted at all? It sounds like there are more changes beyond just cost savings. I'm wondering, if you could just expand on that. You alluded to cutting back, I think, on some lower ROI projects. Can you just talk more about the opportunities of the realignment beyond cost savings?

Sure, Jerry. Thanks for the question. I'll give you a couple of examples. At AECO, Mark Schwartz is now leading that segment for us, and at the field systems level, Ron Bisio is in charge. These are two instances of our leadership reorientation. Ron has a solid background with Trimble, particularly in our hardware businesses and dealer channel expertise, so we have consolidated all of that under his leadership across our hardware-centric operations. Mark has dedicated most of his Trimble career to the AECO software space and has been doing an outstanding job advancing the business. In fact, under his leadership, we have seen accelerating growth in that area. On the cost side, we looked at several aspects. One focus was on larger areas where we saw revenue potential shifting from the near- to mid-term to the mid- to long-term. For example, in Autonomy, we took a comprehensive view for realignment and reprioritized capital allocation. Additionally, we reassessed our cloud and platform investments at the corporate level, deciding to move them closer to the business. Since AECO is at the forefront of our transformation efforts, it made sense to align those investments nearer to the AECO leadership, where capital allocation trade-offs can be made more effectively. This should lead to greater organizational efficiency. These are some examples of how we are looking to simplify and sharpen our focus, ensuring that we execute more effectively. I think Q4 demonstrated that these changes are producing results, and as we approach Q1 and 2024, I'm confident that we have the right organization in place to work on the right initiatives.

Thank you, Rob. And separately, can I trouble you folks just to flesh out the performance of Transporeon for us? Exiting the fourth quarter, what was organic growth, logo growth, retention rates? You mentioned bookings were good. Can you just expand on some of the quantitative numbers on the performance entering '24?

Sure. I'm happy to provide that information. As a reminder, our business model primarily operates on a transaction and consumption basis. Overall, we are still mainly focused on the European market, where the economy has not shown improvement. This situation poses a challenge for some transactions, and there is a decrease in spot deals compared to contracts, which is not favorable for our business model. However, we aim to focus on what we can control. For some key figures, our gross retention rate is essentially 100%, excluding Russia, where we chose to withdraw from the market. Our annual recurring revenue is in the high single digits, and our operating margins are above 20%, indicating that our team is effectively managing costs. The fourth quarter marked record bookings for our company. Additionally, we have introduced new products, such as autonomous procurement, which have contributed to the growth in bookings, alongside the ongoing value we provide to our customers. On the product integration front, our global teams are collaborating to create a unified feature for real-time visibility, incorporating the MAPS technology from Trimble into the Transporeon business. These are some relevant statistics, both quantitative and qualitative for you, Jerry.

Thank you, Rob.

Hi. Good morning. Just wanted to get a little bit more color on your thoughts around, I guess, the macroenvironment as it relates to your guidance and the potential impact to, I guess, the organic growth outlook as you start to look to next year?

Hey, Jonathan. Good morning. It's Rob. Starting with the macro outlook, North America is currently the strongest region. Europe, on the other hand, continues to face challenges and I believe it will remain difficult throughout 2024. These two regions significantly influence the overall business. In contrast, Asia Pacific appears to be relatively stable. In terms of vertical markets, we're seeing strength in construction subsegments like infrastructure, renewables, data centers, reshoring, and onshoring, all of which are contributing positively to our bookings. However, the residential sector is facing challenges globally, particularly in Europe. The freight markets, which affect our Transportation business, are also struggling on a global scale. I have already mentioned that Agriculture faces similar global challenges. As we look towards 2024, it's essential to acknowledge how structurally different our business is compared to the past. It's useful to consider the $1.98 billion of ARR we finished the year with, which reflects our calculation averaging across the fourth quarter. If we considered only contracted ARR, the figure would be even higher. This gives us strong visibility and predictability into our business. The bookings we achieved in the fourth quarter will help drive growth moving forward. I believe it's crucial to evaluate our business model and overlay it with geographic and end-market segments to form a comprehensive view of the macro factors that support our guidance for the year.

Excellent. And just as a follow-up, can you maybe help us understand where we are in terms of the distribution partnership realignment? And what does the opportunity look like just given the divestiture coming up and just the changing nature of your positioning within the space? Thank you.

Jonathan, do you specifically mean Agriculture? Or do you mean distribution realignment across all of Trimble?

The Agriculture segment of it.

From the realignment of distribution, we are focusing on several key areas. One significant aspect is working with the C&H aftermarket dealers, and we are successfully bringing them on board as retail outlets that complement our full-line vantage dealers. The dealer sign-ups are proceeding as planned. Additionally, with the AGCO realignment, we are making progress in our integration planning with the team, and we now have a clear strategy for collaborating with these new partners. Overall, our planning efforts are well underway, and they are essential for starting the business on a strong note.

Great. Thank you.

Hi. Good morning. Thank you so much. So, at the last Investor Day, I think you had a slide; you expected about 20% of revenues transacted through the connected digital platform by 2023, and that would go up to 70% by 2024 and 90% by 2025. I know you're hosting another Analyst Day probably this year. So, where are you in that journey now in terms of getting revenues through that platform?

Hey, Tami, it's David Barnes. I want to provide some context regarding digital transformations and large process projects, which are quite challenging, and our experience aligns with that. We concluded 2023 with approximately 15% of our revenue processed through the new digital platform, mainly from the North American AECO software segments. We're reevaluating the scope and focus of the next phase of digital transformation. We anticipate increasing that percentage to around 35% by early 2024 by incorporating more of our businesses, including the e-Builder and Cityworks suites, and expanding the AECO initiative globally. Currently, we are reassessing how our digital platform integrates with our hardware businesses and transportation. Therefore, I won’t provide a forecast on how we will move from 35% to a larger share of the business. However, we now have a more informed and strategic approach, and we are reassessing our priorities.

And those priorities, if I can add to that to build on David's comment, is for sure to continue on the software businesses as the priority for the work.

Yeah, that's right. Rob said in his commentary earlier that the AECO business is the tip of the spear. It's where we see the highest, most direct early returns through the digital transformation and TC1 and selling bundles. So, that's where our focus is at the moment.

Got it. That's very helpful. Thanks, David and Rob. My second question is about understanding the operating margin guidance for this year better. Excluding the Ag JV, it appears you expect about 80 to 180 basis points of operating margin improvement this year. What are the key components that contribute to that? How do you plan to achieve it? Additionally, what impact, if any, does the 53rd week have on that margin guidance?

Tami, I'll begin by providing some perspective, and then I'll let David expand on that. At a structural level, we ended the year with a gross margin of 64.7%, compared to 58% five years ago. Over this five-year period, we've achieved an operating leverage of 44%. In the fourth quarter, we discussed the progress of our bookings, which contributes to the annual recurring revenue and the contracted annual recurring revenue we expected to have by the year's end. Structurally, the foundation of our business is set to enhance gross margins as we continue our growth. You can see in the web tables how gross margins differ between product sales and our subscription and software services, with the latter showing significantly higher margins. This product mix alone helps boost gross margins. I'm referring to that structural gross margin because it's a key factor that will enable us to increase our operating margin. We also discussed cost management in our prepared remarks, which is another important aspect. David, would you like to add to that?

As Rob mentioned, our recurring revenue businesses have a significantly higher gross margin, around 80%, compared to about 50% for our product streams. This shift in business mix contributes to a margin improvement of approximately 100 to 200 basis points. Regarding the 53rd week, we estimate it will generate about $85 million in revenue for the year, all occurring in the last quarter. However, this is not the only factor affecting our business. As I noted earlier, our work with large government clients, especially the U.S. federal government, experiences fluctuations from year to year. While we considered this a positive aspect earlier in 2023, it can also pose challenges. Additionally, we are focused on model conversions related to software bundled with hardware. When we consider the changes in federal business and the effects of model conversions alongside the 53rd week, they tend to balance each other out. Overall, I view the 53rd week as a positive element, but other factors neutralize that benefit.

Got it. Thank you so much.

Sure.

Great. Good morning, Rob. Good morning, David. This is actually Devin on for Jason today. Thanks for taking our questions. I want to start with the construction software business. Nice to hear bookings growth exiting at more than 30% over there. Really strong results. Maybe looking at 2024, seems like macro could be improving and TC1 really seeing strong traction there. How are you kind of thinking about bookings growth to trend for 2024 and any additional maybe puts and takes you can kind of give us on how the different sub-product group would kind of perform for the year?

Devin. Hey, good morning. This is Rob. Let me give you my perspective and thoughts on the bookings opportunity we have within the AECO software business. And this is a business now that comes into the year with, call it, in the range of $1 billion of ARR to start with, so of the company's, call it, $2 billion of ARR. So, we're talking some law of large numbers to continue to grow at that double-digit ARR clip, and we have to continue to be able to book at a healthy level. And all of 2023 was evidence of that, and accelerated even into the fourth quarter of 2023. So, we come in with some momentum and confidence around that. The color I'd like to put around that with Trimble Construction One is that it unlocks the cross-sell and up-sell by putting in place a framework that allows our customers to easily scale with us, that in turn unlocks our bundles and the offerings that meet the customers' needs. And so, that then creates an environment where inside the company, we're working together to help scale a customer's usage of our products with a lot less friction that they would have had in the past. And we're seeing faster times to close deals. We're seeing a greater share of wallet share captured when a new logo enters our ecosystem. And one of the things we said in the prepared remarks was that our TC1 agreements have now accelerated to make up 50% of the bookings that we had in the fourth quarter. And those agreements are the basis that powers that cross-sell penetration and that made up 25% of the fourth quarter bookings that we had. Coming into 2024, we'll continue to expand TC1 by rolling it out to more regions, for example, Asia-Pacific, and we'll roll it out into more of the portfolio. For example, that's the "O" and the AECO. So, we play those factors forward. We've got a belief set that we can continue to grow those bookings in the AECO space at a quite healthy double-digit level.

Got it. No, that's very helpful color. And then, just a quick follow-up on TC1. It seems like things are really picking up over there. I want to ask, are you still mainly seeing adoptions among existing customers that are opting for TC1? Or are you seeing more new customers kind of adopting that product? And then, in terms of kind of the ASP opportunity, are you still kind of seeing the 2 to 3 times uplift that you kind of highlighted at your Analyst Day from TC1?

There are both existing customers and new customers involved. For existing customers, particularly in the construction ERP space, we are driving conversions from on-prem to the cloud, which involves more than just a simple transition; it changes the nature of the offering. This isn't just about pricing; it's about providing more value, granting access to a wider range of our services. We continue to see a significant uplift in these conversions at a rate above 2x. For new customers, the distinction between existing and new is somewhat blurred. Our cross-sell data shows that customers who primarily purchase one or two solutions are increasingly adding third, fourth, or even fifth solutions to their purchases. Additionally, we are also securing wins with straight new customers, which contributes entirely as new revenue. So, in summary, both existing and new customers are contributing to this growth.

Great. Thanks for all the details.

Hi. Good morning, guys. So, I wanted to go back to your question about the adjusted operating margins, and I was hoping you could bridge from '23 to '24. Just trying to understand like the moving parts of cost savings mix, operating leverage and more specifically, the impact of the AG divestiture.

Okay. Let me start with the last point. So, when we announced the Ag deal, we said that the impact on a '23 pro forma basis of the divestiture of Ag was about 70 basis points negative to operating margins, so that's where we started, and you can see the '24 outlook in our as-adjusted table. The principal drivers from there, as I mentioned earlier, we're planning on an as-adjusted basis, i.e., without the Ag business in the base, 100 basis points to 200 basis points of margin improvement. One way to think of that, Chad, is essentially all of it is in the gross margin improvement, which is a natural impact of mix. If you drill down a little more, we do have the benefit of cost reduction, but we are adding resources where it's driving growth. In fact, all or slightly more than all of our year-on-year OpEx is in our AECO business, where we had over 30% bookings growth, and we have about 20% ARR growth, we are really allocating our operating capital to pour the coal on that on that business. So, you can think of it as taking the cost reductions we've taken and reallocating it to the highest-return, highest-growth business.

To expand on David's comment, he is spot on regarding our capital allocation strategy. We are focusing our go-to-market operating expenses in the AECO sector. I should have mentioned earlier in response to Devin's question that our net retention ratio in the AECO segment is approximately 110%, which is an outstanding achievement by our team. A key metric for us is the ratio of customer lifetime value to customer acquisition costs, and that currently stands well above three, indicating that this is an area where we should continue investing operating expenses. While we might not see a return on investment in the first year, we are making a long-term investment to support bookings growth, which will lead to sustainable annual recurring revenue growth and overall revenue growth.

That's helpful. And then, just on the segment reorg, can you talk about the impact on your distribution in go-to-market? Just trying to understand like the operational changes here. I guess like what you can do better now versus before under the old structure?

I'm glad you asked that question, Chad. Let's discuss what we're now referring to as field systems. This is similar to what we used to call the Geospatial businesses, with survey being the most recognizable segment. Alongside that, we handle machine control through our SITECH division, which was traditionally part of the B&I segment. Both segments are now united under Field Systems, managed by Ron Bisio. We’ve made a significant change by having one person responsible for sales for all Field Systems in each major region: one in APAC, one in the Americas, and one in Europe, the Middle East, and Africa. Previously, this would have required six people, so we've streamlined our approach. This consolidation not only provides efficiency but also allows us to reconsider how we allocate resources, enabling us to invest more time, effort, money, and personnel into ongoing dealer development. Beyond just short- to mid-term gains, this structure helps us support our dealers in building long-term businesses. Many of our dealers handle multiple Trimble sectors, such as civil and survey or agriculture and survey. With clear accountability, we can make more informed decisions on resource trade-offs across these portfolios. On the product side, this new structure enhances our efficiency in managing our hardware SKUs. We've recently reduced the SKUs by 10%, leading to simplification in our systems. We now have a unified perspective on our GNSS portfolio and can incorporate total stations and scanners across various segments. This sharpens our thinking regarding our product offerings. Combining our product perspective with our go-to-market strategy positions us well. It feels like the right time for these changes, and the announcement of the joint venture prompted us to rethink our approach and implement it quickly. The teams did detailed planning in the fourth quarter and have come out of the gate strong, aligned with clearly defined objectives and key results for each major business area.

Great. Thank you.

Hey, guys, thanks for taking my questions here. In the prepared remarks, you guys talked about being open to continuing to divest certain aspects of the business. When you look across your three new reporting segments, where do you see the most opportunity to maybe divest over the next 12 months and continue to simplify the portfolio?

Good morning, and thank you for the question. This is Rob, and I’ll share my perspective on this matter. I consider it in two parts. The first part is the financial profile of the business, which includes a short-term outlook and a long-term perspective. We assess whether it can meet our return expectations, whether regarding returns on invested capital, ARR growth, or EBITDA. The second part pertains to the strategic appeal, which involves evaluating the competitive landscape as well as how well a business or product contributes to enhancing the overall strength of our operations. If a segment operates in isolation and does not bolster our Transportation or Construction sectors, it falls on the less favorable side of my assessment grid. In considering our portfolio, I’ll use Field Systems as an example. During the financial crisis in 2008, we intervened to support some dealers by acquiring a few of them, but we are not ideally suited to own a distribution business long-term; that responsibility is better suited to local entrepreneurs. This perspective underpins our recent discussions about potential divestitures. We aim to identify parts of the business that we do not believe we can effectively manage. While I won’t delve into specifics for each segment, I believe we have shown the courage to reflect on our business strategy, as seen in the 21 divestitures we've made in recent years that have streamlined our operations and highlighted our focus, which we believe leads to greater efficiency and better results for the company.

Very helpful. And then, it also sounds like we're going to get a little more color around the '24 guidance in context of these new reporting segments when you give us that additional disclosure. But maybe if I just step back and take a little bit longer view, like how do you guys think or how should investors think about the different growth rates across those three segments over the next, call it, three to five years?

I'm going to keep my comments at a high level for now as it's more suitable to explore this further during our next Investor Day. In the presentation, specifically on Slide 5, we provided an estimate of the AECO Field Systems and Transportation and Logistics sectors for 2024. This includes revenue projections and a breakdown of software and recurring revenue within these segments. I want to emphasize that we believe we can maintain a double-digit growth rate for our annualized recurring revenue, which is a top priority for the company. Field Systems, which encompasses our hardware business, shows a growth trend similar to what we've discussed in previous Investor Days. Historically, from 2019 to 2023, this has been in the range of 4% to 6% annually, depending on the specific business area, with some parts performing better. While there are fluctuations quarter-to-quarter, looking at the long-term trend is more insightful. Additionally, our Transportation business now includes Transporeon, marking a significant change since our last analyst update. An interesting note is that during our last Investor Day, we projected that by 2027, 60% of our revenue would be recurring. Based on David's recent comments and our pro forma estimates, we now anticipate reaching that goal as early as 2024.

Super helpful. Thank you.

Yes. Hi. So, I wanted to ask two on the Transportation market, if I may, and you touched on this earlier, Rob, on Transporeon, where you had a good bookings quarter in the midst of, I assume, a pretty weak European market. So, any further commentary on what you changed there, or if anything changed to drive that growth? And given that business is levered to spot transactions and rates, any insight as to what the sustainable growth might be when that market comes back? And then just the second question will be simply on the idea of de-emphasizing hardware sales to OEMs in Transportation, and focusing on the flow of data. Is there any strategic link there? Do you get less flow of data if you don't have as much in the field on devices? And could you just talk around that issue? Thank you.

Thank you for the question, Rob. Let's address the bookings growth in the fourth quarter, particularly in this challenging market. This highlights the value our technology provides. At our customer conference in Barcelona in September, I noticed many major brands using our Transporeon technology, spanning various sectors like retail, consumer packaged goods, packaging, and construction materials. Despite a tough market, where companies may hesitate to spend or make changes, our technology still drives efficiencies and productivity for our customers. Our win rates are at an all-time high, which is crucial for our business outlook. While our bookings are not as high as we would prefer on an annual basis, they indicate we are maintaining or possibly gaining market share. I appreciate our team's daily efforts in achieving this. Regarding the mix of spot contracts, I recall Jamie Dimon's comment about recessions occurring every seven years. Markets naturally fluctuate, and we're seeing signs of stabilization, which is different from growth. Historically, our business has rebounded strongly after freight recessions. If the market turns for the better, though I won't predict it will in 2024, we could see significant revenue growth at a strong double-digit rate. Finally, concerning the OEM segment and the reduction in hardware focus, our Transportation hardware differs significantly from other Trimble products. The onboard compute devices have become less differentiated, resembling commercial off-the-shelf tablets rather than unique hardware. Years ago, developing our own hardware was a distinct advantage as it integrated smoothly into our software solutions. However, the current technology landscape makes that model less appealing. We refer to it as low-calorie revenue due to the unattractive margins associated with hardware sales. In the OEM space, if a manufacturer opts to produce the lowest-cost hardware, we may not excel in that area on a global scale. On the data integration front, OEMs prioritize machine health data, which is valuable for both them and their customers, though it often relates to customer service agreements. Customers manage mixed equipment fleets and aim to enhance productivity, efficiency, safety, and visibility within their existing technology. Thus, it's essential to provide a data feed for both OEMs and a gateway to enable customers to adopt comprehensive telematic solutions, whether from Trimble or other providers. I hope this clarifies things, Rob.

Thank you.