Trimble Inc (TRMB) — Q1 2024 Earnings Call Transcript

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 4. During the first quarter, we continued to advance our Connect & 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 3 key messages today, starting with a solid performance in the quarter, where all 3 segments performed ahead of expectations as detailed on Slides 5 and 6. $2.03 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 on our next call as we build confidence in the months ahead. Key message #2 is a strategic portfolio highlight. In the first quarter, we divested certain water monitoring assets, our 21st divestiture in the last 4 years. And on April 1, 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 #3 on Slide 7 is that our new reporting segments are in place, which align to our new organizational structure. We provided historical data on the segments to investors on April 12. 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 evidenced 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 8 with our AECO segment. Connect & Scale is well in motion here and it is working. Connect is about connecting users, data, stakeholders, and workflow across the industry life cycle 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 prepackage 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, an 18% increase in ARR and margin expansion of 430 basis points. This business is a multiyear 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 strength in subsegments such as reshoring and onshoring 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 9. 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 Connect & Scale strategy in motion in this segment. Market conditions remain mixed and overall slightly positive. We see strength in the same subsegments 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 in 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 digits. 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.

Thank you, Rob. We believe shareholder value is ultimately a function of maximizing long-term free cash flow. Connect & 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 1.4x non-GAAP net income. We continue our asset-light 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 1. 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 a 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 human resources application in the third quarter of 2023 and doubled the customer count in the first few months under our ownership. This was enabled by our Connect & 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 auditors, 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 neither 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 have 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 have also included slides in the appendix to our presentation that provide more information on our segment and corporate assumptions. Our prior guidance assumed the agriculture joint venture we closed on April 1, which is exactly what happened. The as-adjusted view removes agriculture in the historical periods, which enables looking at the growth dynamics of our current portfolio in a consistent way. Our outlook for ARR growth remained 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 20s, field systems growth flat to down in the low single digits 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 in 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. Relative 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 0.85x non-GAAP net income. This outlook does not assume a change as it relates to expensing 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 1x 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 flow is 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 3 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 recognized 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 1, 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 Systems 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 do 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-margin hardware sales in our North American mobility business. At this point, we expect the 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.

Thanks, Phil. When we think about our right to win at Trimble, we believe we can uniquely bring together users and connect workflow between the physical and digital worlds across industry continuums. Connect & Scale as our strategy, our strategy as 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 flywheel of enhanced insights and data connectivity, thereby enabling our customers to transform how they work while building a competitive moat 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.

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

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?

Chad, our 10-K was filed in February, and the PCAOB chose EY's audit of Trimble for review. Upon reviewing their work papers on internal controls, the EY team determined that the documentation we had was insufficient to meet the audit standards for internal controls. It's important to note that EY's support of our financials remains unchanged; this issue pertains solely to internal controls. No discrepancies with our numbers have been found by either EY or ourselves. EY will now conduct enhanced audit procedures to verify the numbers, after which we will issue an amended 10-K, allowing us to release the 10-Q as well. We've seen companies go through this process, which typically takes over a month, and predicting the exact timing is challenging. While it's inconvenient, we currently have no reason to suspect any changes to our numbers, and we are working collaboratively with EY to resolve this.

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 bundled offering?

Bookings in the quarter remained robust, marking a continued strong progression over the past couple of years. ACV bookings saw over 20% growth during the quarter, which is encouraging. Within this, Trimble Construction One has been a key focus for us over the past year or so, and its bookings grew even faster. We are seeing increased adoption of Trimble Construction One as we enhance our selling organization, processes, and systems. For instance, in North America, about 80% of our bookings for the quarter were from Trimble Construction One, and those grew at nearly double the year-over-year booking growth rate. Overall, we are witnessing strong progression.

Maybe double-clicking on that a little bit. When you think about the growth that you're seeing in AECO and maybe if you can go a step deeper on TC1? Is there a way to think about it versus net new versus expansion?

Jason, the breakdown on that is about 2/3, 1/3, 2/3 existing logos, 1/3 new logos. So if we take new logos, what we see is that the offering is expanding the addressable market. In some cases, that's allowing us to go, I'd say, more than the small, mid-sized 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. Team has done a great job executing.

Yes. I mean it seems like 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?

Yes, that's a great question. On the macro side within AECO, I would like to note that we are observing substantial growth in onshoring and reshoring of manufacturing, especially in Europe and North America. The renewables and data centers sectors are seeing strong growth in North America, which is reflected in the bookings and ARR growth. However, the residential sector is facing challenges due to the current interest rate environment. The trade aspect of the market is also slightly more difficult. Additionally, we have a significant amount of data from our own systems, as we manage nearly a third of U.S. construction. This data indicates that hiring in the nonresidential sector is increasing in North America. Geographically, we are seeing the most growth in the Midwest, followed by the Southeast, particularly in Florida, the Carolinas, and Georgia.

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 mix changes here, at what point should we expect ARR and total revenue growth to converge a little bit more?

It's Rob responding to your question, Jonathan. We've already observed this trend in AECO, where the growth for the quarter was 18% for both ARR and revenue. Similarly, in transportation and logistics, total revenue and ARR both grew by 4%. This suggests a correlation between recurring revenue and overall growth. However, field systems, which is primarily a hardware business, will likely remain disconnected for several years, with recurring revenue around 20%. Therefore, there will continue to be a distinction at the total company level.

Got it. And just as a follow-up, can you give us a little bit more detail on Transporeon and what maybe changed there to drive the much improved results?

We had another strong quarter of bookings growth, marking two consecutive quarters of record performance for the business, first in Q4 and now in Q1. It's worth noting that the team has successfully started cross-selling Transporeon solutions to our existing Trimble Transportation customers in North America, which showcases our go-to-market synergies, and we believe we are just beginning. Additionally, we have been selling some of our mapping solutions in the European market, achieving bookings growth with both shipping and carrier customers. This is significant as we continue to increase network participants on all sides of our transportation management platform, effectively linking freight buyers and sellers. In this quarter, we added dozens of new logos and are pleased with the progress in developing new products like autonomous procurement and autonomous quotation. Overall, various factors are aligning well, and the team is performing strongly despite the current challenging economic environment in the freight market, particularly in Europe.

Yes, I'm wondering if you could just talk about the 2Q margin outlook. So you folks had an outstanding first quarter, and I understand the comments about the term license sales, but historically, you just don't have the 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.

Jerry, it's Phil. Thank you for the great question because I know our outlook has many factors at play. Regarding Q1, as I mentioned, the term licenses primarily affect Q1, which accounts for the $50 million decrease from Q1 to Q2. When looking at margin, this translates to over a 400-point drop. A significant portion of this can be divided into four categories, with just over half of it attributed to the term license changes. Remember, term licenses are recognized fully upfront, which contributes to high-margin revenue. As we transition into Q2, two other influences come into play: first, we have merit raises effective in April that impact about 100 basis points; second, another 100 basis points comes from increased operating expenses, mainly related to the AECO business, as well as sales, marketing, and R&D expenditures aimed at sustaining our growth. The remaining portion explains the term license impact contributing to that 400-point shift.

Okay. And then can I ask 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 the outlook in Slide 15, across the segments, putting the pieces together across the whole company, could we see ARR accelerating on an organic basis in the mid- to high teens from an exit rate standpoint, beyond the full year guide. Just thinking about what 4Q might look like given the cadence that you described in the slides?

Well, so 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.

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

At this point, no. We are maintaining the outlook on that. It would provide us more than above the mid, but we're going to leave that guidance as it is right now.

Rob, you called out the Rule of 40 balance for AECO. And I think just in this previous question had 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 opportunity set in that business?

Kristen, that's a great question. Let me address it in two parts. First, regarding the 100 basis points of investment in the AECO segment that Phil mentioned, more than half of that is allocated to sales and marketing. This means we are focusing on bringing in more sellers to pursue the business opportunities we see. About a quarter of the investment is going towards R&D, where we're enhancing connectivity and interoperability among our solutions, along with AI initiatives for our products. The rest of the investment is in general and administrative costs, primarily for system improvements that support these efforts. When we evaluate the return on investment, we consider the lifetime value compared to customer acquisition cost. A helpful guideline is that a ratio above 3 indicates a strong case for investing further in the business. We are significantly above that mark, which gives us confidence to pursue more investments in this area, especially since we are performing well above the Rule of 40 and, in fact, exceeding the Rule of 50 in the first quarter.

That's helpful. Considering the overall size of the market opportunity, the business is currently undergoing a transformation, and TC1 is just beginning to ramp up. As we examine the 5-year model for Trimble, how do you view your market opportunity mix for sustained growth in AECO? Does it come from your existing customer base, new products, or attracting new clients? Please help us understand what will support this growth moving forward.

It's a great question. Over multiple years, I would describe this market as the largest total addressable market for us to service. We recognize the multitrillion dollar scale of global construction and our activity spans both vertical and horizontal construction. This market is vast, global, underserved, and underpenetrated, with productivity challenges at the intersection of productivity and sustainability, which our solutions positively impact. We observe an increasing number of customers looking to engage with ecosystems, and we believe our competitive edge lies in the extensive range of solutions we offer throughout the life cycle. Additionally, if you believe the world is becoming more data-centric, you will appreciate our numerous points of engagement within this industry, allowing us to evolve from optimizing tasks to optimizing systems. We are convinced that we are uniquely positioned to achieve this. Regarding existing and new customers, we see significant untapped annual recurring revenue potential within our current customer base through cross-selling and upselling, given the breadth of installed solutions. The systems investments we are making are enhancing our market approach, with improvements that enable customers to self-provision licenses and increase e-commerce functionality. This, in turn, streamlines our market approach, especially in reaching smaller market segments. We believe this presents another market opportunity we can unlock due to our business model and efficient market strategy. We are confident in our ability to secure new customers as the market continues to adopt digital solutions. I would anticipate that over the next five years, most of our revenue growth will stem from expanding within our existing customer base. I want to emphasize that we are very optimistic about our efforts in this business and the progress we are making, and we believe we are just beginning.

This is Justin Pellegrino on for Rob. I just wanted to look at the equipment side and what does a typical downside in the equipment side look like versus where we're at now? Are we most of the way into a normal downturn? Just any color there would be I think helpful.

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 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 2 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, in construction, although interestingly enough, our Europe business in 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 on to new units as we see many, many hundreds of thousands of millions of machines that would benefit from having Trimble technology on and machine types like excavators remain low single-digit penetrated with technology. And so we think there's 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, surveying and 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, could be a cadastral survey, 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. I hope that helps provide some color.

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 1 year, I'm just curious how you're sizing up the opportunity to bring Transporeon, at least parts of Transporeon to North America and perhaps any comment on any commercial efforts you have around that as well?

Rob, I appreciate your question. You’re correct that our initial strategy didn’t primarily focus on integrating the European applications into North America. We viewed that as an additional opportunity and were confident in our ability to pursue it, but it wasn’t the main focus of the deal. The positive news is the customer I mentioned earlier represents a significant annual recurring revenue win, using the autonomous quotation product we discussed. This is a new offering rather than something from our existing capabilities, which we find quite intriguing. What’s particularly unique about our North American installed base is its carrier-centric nature. When we consider bringing new capabilities to North America for carriers, we think about products like autonomous quotation aimed at automating spot transactions, making it easier for our sellers to present these to our existing customers. Additionally, we've previously mentioned Engage Lane in North America and the marketplace in Europe; we have unified these teams into one to enhance our global scale and opportunity. Another area of focus is real-time visibility, which we are now addressing as a single business rather than separately in Europe and North America. These are further capabilities we aim to introduce into the North American market.

Okay. As a follow-up, as we progress through this year, I expect we'll adjust to the new segments and the business without agriculture. I'm particularly interested in the trend of hardware and perpetual software gross margins, which have decreased over the last 12 months. I suspect agriculture may have influenced that. With a margin of 44% in the first quarter, what does the future look like without agriculture as we continue through this year?

Yes, it's a good question, Rob, and Phil can chime in after I set this up. And you're right, there was an impact 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 an accounting perspective, has an element of hardware and software that's in that. And let's say that, that traditionally was splitting, we'd 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?

No, I think that's right, Rob.

Can you hear me?

Yes.

So just my first one is 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 606 accounting, will there always be a term component in the AECO revenue line item each quarter, basically, every time you renew something or you can sign a new deal? And then my follow-up just as a 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?

Yes, Josh, it's Phil. I'll answer your second question first. Yes, you are thinking about it correctly. Our 53rd week includes January 1, 2025, and a large portion of our term licenses renew around that date. You are right that the 53rd week accounts for roughly $70 million of the $85 million in term licenses that renew. As for your first question, there is an element of choice in this within AECO that we've had and will continue to have, primarily in our structures business. Some of it relates to the complexity and capacity of the offering itself, which makes it challenging to shift more into the cloud. You will see this dynamic continue at least for the foreseeable future.

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

Correct. It's a limited subset of the total AECO offerings.

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 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 to better understand what's already been going on behind the scenes?

I appreciate the question. This is not simply business as usual; it fundamentally alters our approach to running the business and reveals new opportunities for value creation. It streamlines and sharpens our focus as a company, establishing an effective new baseline moving forward with our strategy. For instance, our AECO assets are now generating over $1 billion in annual recurring revenue. This larger framework allows our team to integrate processes and system capabilities across a wider range of the business than before. Within Field Systems, we’re now unifying our survey and civil construction businesses under one leadership for the first time in decades. This change enhances our focus and accountability regarding R&D capabilities, as well as our positioning technologies. It ultimately leads to better results in terms of linking our positioning services with the hardware we offer in survey and civil construction. Importantly, at the go-to-market level, we are streamlining sales by working through a global dealer network more efficiently. We now have one leader for the Asia Pacific region, one for Europe, and one for the Americas, reducing our leadership from six to three. This change allows for improved and more cohesive management of our dealers and rethinks capital allocation, enabling us to support dealers in planning for their long-term business health while addressing their immediate market opportunities.

This has been very helpful. To summarize, as investors, we notice the changes in segmentation. You mentioned that things are definitely not operating as usual. There are new and exciting developments taking place. What can we expect to see in the next 12 months? Perhaps that timeframe is too short; looking over three years, what metrics should we use to evaluate your performance and see the improvements from all the changes made? Where will we observe the positive outcomes you've mentioned reflected in the numbers?

I appreciate the question. In my prepared remarks, I mentioned the concept of a multiyear overnight success. Our journey consists of many small steps. We introduced Connect & Scale in January 2020, and I believe we've established a new baseline. To put this into perspective, in 2018, our annual recurring revenue (ARR) was $1.1 billion, and we closed Q1 with $2.03 billion of ARR. Back in 2018, 31% of our revenue was recurring, whereas in Q1, that figure rose to 63%. Our EBITDA in 2018 was 22.6%, and we finished Q1 at 27.9%. Additionally, our gross margins were 58% in 2018, adjusted to 67.5% in Q1. Over the past five years, we've achieved 44% operating leverage. This direction wasn't a sudden decision; we've been dedicated to this goal for several years. As we move forward with this baseline, one positive outcome of our resegmentation is the increased transparency and visibility for the investment community, which you've mentioned. This is clearly evident in the AECO business. It's now a well-scaled ARR business operating well above the Rule of 40, with ARR growth in the high teens and producing 37.4% operating income in the first quarter. I am extremely optimistic and proud of our team's achievements. Looking ahead over the next three years, focusing on ARR and free cash flow will be essential in driving value. Therefore, you can expect continued ARR growth and further improvements in structural gross margins during this period. I anticipate that software will outpace hardware in growth, leading to enhanced operating leverage and increased levels of EBITDA. As Phil noted in his remarks, cumulative free cash flow is critical for our long-term strategy. We aim to continue to improve free cash flow in relation to our net income. This is the framework I propose. I hope this information is helpful.

It definitely did. Sounds fired up.