Trimble Inc.

Good morning. My name is Audra and I will be your conference operator today. At this time, I would like to welcome everyone to the Trimble fourth quarter 2022 results conference call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press the star key followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. At this time, I would like to turn the conference over to Rob Painter, Chief Executive Officer. Please go ahead.

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. Financial commentary today will reflect non-GAAP performance metrics, including organic growth comparisons, which will relate to the corresponding period of last year, unless otherwise noted. The Trimble 343 operating model simultaneously balances a view on looking forward three months, four quarters, and three years. As I think about framing today's commentary on 2022, I think there is a parallel to look back three months at our fourth quarter, four quarters to look back at the year 2022, and three years back to 2020 when we began our connect and scale journey. COVID, supply chain disruptions, and net divestitures over these last three years has created a dynamic that makes it challenging to discern the signal from the noise in any given quarter, especially when looking at the year-over-year trends, whereas the long baseline reveals the definitive patterns of progression. As I reflect on the fourth quarter of 2022, let's begin on slide two with our key messages, which are consistent with the commentary from the prior quarter. Our key growth metric is annualized recurring revenue, which met Our expectations grew 16% to a record level of $1.6 billion. Congratulations to the team for delivering this record performance, which compares to $1.19 billion of ARR at the end of 2019. Total revenue for the year was a record $3.68 billion, up 7% over 2021, and up 6% compounded since 2019, growing through COVID and business model transitions. Total revenue in the quarter was $857 million, flat with last year, and towards the lower end of our guidance range. The delta between the ARR and the total revenue performance reflects a slowdown in hardware sales through our dealer partners, as dealers continue to sell through their inventory while processing mixed macroeconomic sentiment. For perspective, over the last three years, the sum of our civil, agriculture, and survey hardware and related software has grown at a 12% compound annual growth rate, with agriculture growing above and survey growing below this baseline. Gross margin finished at a record level of 61.8%, exceeding our expectations, reflecting software mix, the cumulative impact of model conversions, and abating supply chain disruptions. For the year, we achieved a 60% gross margin, a record annual level, up 170 basis points year over year, which compares to 57.7 percent gross margin in 2019. EBITDA margin of 24.3 percent met our expectations in the quarter and ended at 25 percent for the year, up 210 basis points as compared to 22.9 percent in 2019. Finally, earnings per share of 60 cents was exactly at the midpoint of our guidance for the quarter. Moving to slide three. Let's look at the progression of our Connect and Scale strategy through the lens of our reporting segments, beginning with buildings and infrastructure. The big event for the team was our Trimble Dimensions User Conference in November, where we had over 5,700 attendees from the global engineering and construction industry, which provided a great forum to reconnect with our customers and partners. We launched many new innovations, including the Trimble Construction Cloud, powered by Microsoft Azure, which is an industry cloud built to streamline construction projects by connecting users, data, and workflow. We also announced extensions of our machine control technology platform to new OEMs and new machine types, further expanding our reach to connect the physical and digital worlds. The highlight financial achievement in the quarter was delivering over 20% organic growth in ARR, in addition to record levels of ACV software bookings and record levels of cross-sell bookings. We also had a strong start for our newly acquired bid-to-win business, where we've had some early cross-sell wins. As we've previously discussed, we continue to allocate incremental capital towards our own digital transformation, as well as our go-to-market efforts, which are generating strong interest from our customers and partners and demonstrating encouraging signs of internal productivity and efficiency. The work we are doing in this business will be highly leveraged across the entirety of the company. In geospatial, Revenue is down further than expected as dealers moderated their inventory levels in the face of softening demand and macro uncertainty. Looking at the indicators, we see softness in residential, and while a portion of the expansion of infrastructure is getting consumed by inflation, underlying optimism remains in the market. For perspective, I look at the three-year CAGR that I talked about on slide two in order to calibrate the long baseline performance. Strategically speaking, in 2022, We continued to launch new innovations in GNSS, 3D laser scanning, and handheld data collectors. And we achieved a double-digit increase in ARR as our business model strategy takes hold. In transportation, we delivered revenue and ARR growth in line with expectations, in addition to delivering the fourth quarter in a row of operating margin expansion. Connect and scale progression also came in the form of continued development of connected workflows, such as connected maintenance, connected locations, and engaged lane. The big story, of course, in the fourth quarter was the announcement of the Transporian acquisition. To refresh memories, Transporian operates a leading cloud-based transportation management platform, powering a global network of 145,000 carriers and 1,400 shippers. The platform integrates with more than 3,000 systems and powered more than 25 million transactions in 2022. For me, This is the very definition of a connect and scale business. I had a chance to spend a few days in Europe with Stefan Siebert and the Transporian team in January, and my level of conviction of strategic and cultural fit has only increased. We are still working through regulatory approvals, and we expect to close the deal in the first half of this year. We're excited to get to work together. In resources and utilities, Revenue and ARR growth were led by our positioning services, utilities, and forestry businesses. Our definition of utilities covers our work with electrical and water utilities, but our positioning services business can also be thought of as a utility, in this case, precision GPS as a utility. In October, we announced that we crossed a hurdle of 34 million hands-free miles driven with General Motors and their Super Cruise program. Precise GPS technology enables a vehicle to maintain its lane position in various environments, and we are working on several other Tier 1 and OEM program opportunities. Moving to agriculture, revenue is flat year over year and up when excluding Russia and Ukraine. The three-year double-digit CAGR growth on slide two is instructive for calibrating the long baseline growth of the agriculture business. But the product lens on ConnectedScale We are now bundling our guidance hardware, software, and our positioning services, providing both easier access to the technology and a better value proposition for our customers. With a go-to-market lens on ConnectiveScale, users and customers are at the center of our strategy. In pursuit of this strategy, we announced this week that we are taking a different approach to our go-to-market relationship with C&H Industrial. Moving forward, our distribution to aftermarket customers After a 12-month transition period, it will be done entirely through independent dealer partners with the product bearing the Trimble brand. Less than 20% of our revenue in the resources and utilities segment goes through C&H to their dealer network today. We expect to maintain this revenue and address aftermarket demand and the needs of farmers through our direct relationships with our independent dealer network. This evolved approach to distribution will also enhance our ability to offer OEM brand agnostic solutions to customers to help them orchestrate their field operations with mixed fleets of equipment. Our new approach to aftermarket distribution will improve our ability to sell our full range of technology solutions to aftermarket customers, including guidance, selective spraying, variable rate application, water management, and our connected farm works center software solutions. Our evolving strategy will also enhance our ability to cooperate with LEMs across the industry for their needs for factory-fit equipment. Let me now turn the call over to David to take us through the numbers.

Thank you, Rob. Starting on slide four, I'd like to begin my financial commentary this quarter by discussing organic growth trends across the components of our business. As Rob mentioned earlier, our recurring revenue businesses grew strongly year on year in the fourth quarter, with ARR up 16%. The strength of our recurring revenue offerings in a weakening and uncertain macroeconomic environment validates our focus on the continued evolution of our business model. While our recurring revenue streams were strong in the fourth quarter, revenues of hardware and related software were down. Organic hardware revenue was down 13% versus prior year and came in below our expectations. The factors driving the slowdown in our hardware business in the fourth quarter were consistent with what we described in our third quarter call. During the fourth quarter, our dealers continued to reduce their inventory levels, reflecting both our improving supply chain execution and uncertainty in the future economic outlook. The drop in demand was most pronounced in our geospatial segment, as our surveying end customers ordered less than they did earlier in 2022. Hardware backlog reduced sequentially during the quarter, as expected. From a geographic perspective, revenues were up modestly on an organic basis in both North America and the rest of the world, with strong trends in Latin America, but were down in Europe and in Asia Pacific. Year-on-year, Europe trends were meaningfully impacted by the loss of business in Russia and Ukraine, and were up 1% organically, excluding that impact. With that as a backdrop, I'd like to turn now to our total financial performance for the fourth quarter and full year 2022. Starting on slide five, fourth quarter revenues of 857 million were flat on an organic basis and down 8% when including the impact of foreign currency and acquisitions and divestitures. Gross margin was up 400 basis points, reflecting both the accelerating mixed shift towards software and the positive net impact of our price increases and moderating cost inflation. EBITDA margin was up 20 basis points and operating margin was down 20 basis points, as increases in our gross margin largely offset higher spending against our connect and scale strategy, especially our digital transformation, and higher spending on travel and trade shows. Diluted earnings per share were 60 cents. Looking at cash flow, both cash flow from operations and free cash flow were as expected down here on year. with the single biggest factor being the amortization of R&D for tax purposes. We did not repurchase any shares during the quarter and do not plan to restart our repurchases until we are well on the way to delevering following the issuance of debt to fund the Transporean acquisition. Turning to slide six and results for the full year 2022, we achieved success across a number of critical dimensions. Organic revenue grew by 7%. Gross margin improved by 170 basis points, reflecting the positive impact of our ongoing next shift. EBITDA margin was 25%, even as we restored spending across a number of areas that had been constrained during the COVID pandemic, and as we accelerated investments against our strategy. Cash flow is down year on year, principally as a result of an increase in our inventories and a change in U.S. tax legislation, both of which we expect to normalize over time. As we move to complete the Transporean acquisition, we take this on with a strong balance sheet. Working capital remains negative. Our year-end net debt to EBITDA ratio stood at 1.4 times, and the ratings agencies maintained our bond ratings and stable outlooks following the announcement of the transaction. Turning now to our quarterly and annual results by segment on page seven. Speaking to the fourth quarter, buildings and infrastructure achieved organic ARR growth of over 20% and recurring bookings growth in the high teens. Sales of civil construction hardware were down year on year by just over 10%, leading to organic revenue growth for the segment of 2%. Dealers continued to reduce their inventory levels and end market demand moderated. Segment margins of 25% were down year on year, impacted by lower civil construction revenue or dimensions user conference, subscription transition, and connect and scale investments. Revenues in the hardware-centric geospatial segment were down 12% year-on-year on an organic basis, driven principally by declining dealer inventory levels and softer end-market demand across the surveying sector. Segment revenues were also pressured by lower shipments to U.S. federal customers, which vary meaningfully from quarter to quarter and can be difficult to predict. Segment margins remained over 25% despite these headwinds. Revenues in our resources and utilities segment were up 6% organically driven by growth from CityWorks and positioning services sold to agriculture customers. Our agriculture revenue was impacted by the loss of business in Russia and Ukraine, with an estimated year-on-year impact of minus 5% to the segment in the fourth quarter. Segment margins improved in the quarter sequentially in versus prior year, coming in just under 36%. Our fourth quarter results in the transportation segment reflect improvement across a number of dimensions. Organic revenue grew 5% driven by higher year-on-year sales of enterprise and map software solutions. ARR for the segment grew at a mid-single-digit rate in the quarter. Revenue trends in our mobility offerings improved sequentially from prior quarters, driven in part by higher sales to our largest OEM customers. Operating margins of 14.5% were the highest since 2019 and reflect strong performance by our team in managing costs. Let's turn next to our guidance for 2023 on slide eight. The projections I will share with you today exclude the impact of our pending acquisition of Transporian. Starting with ARR, we expect organic ARR growth at a mid-teens level in 2023. Our strong outlook for ARR growth is grounded in the solid bookings momentum we achieved in 2022, the potential for accelerated cross-sell as our digital transformation rolls out to a growing portion of our business, and the essential role that our software plays in our customers' operations. The outlook for revenue, excluding future acquisitions and divestitures, is $3.7 to $3.8 billion, reflecting an expectation of organic, growth in the range of 2% to 5%. As a reminder, divestitures of businesses in 2022 will impact total reported revenue growth trends with the biggest impact in the first half of the year. Our cautious outlook for 2023 organic revenue growth is rooted in an expectation of continued dealer inventory reductions over the next several quarters and softer end market demand in an environment of limited GDP growth. We expect revenue from hardware and related software will be down in the low single digits organically for the year, offset by strong recurring revenue growth. From a margin perspective, we expect that gross margins will improve by over 200 basis points as our business mix continues to shift in the direction of higher margin software. We expect a modest increase in operating margins as we invest against our strategy in an environment where organic revenue growth is harder to come by. I'll note here that our leadership teams have been working hard over the last several months to adapt our spending plans to the current economic climate. Allocating capital against our strategic priorities is always a major focus for us, and the need for sharp focus is never higher than in the time of weak economic growth. We are confident that we can continue to progress our strategy within the constraints of our operating plan. Income from equity investments is expected to be relatively flat with 2022, and net interest expense is forecast at approximately $70 million. Netting this out, we project to achieve earnings per share in the range of $2.66 to $2.86. We expect that cash flow will grow significantly in 2023, driven in part by reductions in inventory levels. We expect free cash flow for the year of approximately one times non-GAAP net income. Our cash flow forecast for this year now assumes that amortization of R&D costs under Section 174 of the U.S. Tax Code, will not be repealed within a timeframe that will allow us to recover the accelerated tax payments that we made in 2022. While we believe that there is bipartisan support for this change, we are less confident than we were a quarter ago that this legislation will pass soon enough to help us this year. By way of reminder, this issue impacts the timing of tax payments and has an immaterial impact on our tax rate. If Section 174 is repealed within the next several months, our free cash flow would benefit by approximately $150 million. Note that our cash flow guidance excludes the impact of transactional costs relating to the pending transport and acquisition. While we are not offering quarterly guidance, a few factors are likely to impact the sequential evolution of our financial results as the year progresses. We expect organic revenue to be down in the first quarter and flat in the first half of the year, reflecting the strong growth in hardware and related offerings that we saw in the first half of 2022. We expect organic revenue to be up in the mid to high single digits in the second half of the year. Influenced by these revenue growth patterns, we expect operating and EBITDA margins to be relatively flat in the first half of the year and up in the second half. While we expect mid-teens organic ARR growth for the year, growth in the first half is likely to be slightly lower driven by planned churn from a small number of customers. We expect ARR growth to improve sequentially through the year. From a segment perspective, we expect organic revenue growth for the year in buildings and infrastructure, resources and utilities, and transportation segments with the strongest growth in buildings and infrastructure. Revenues in the geospatial segment are expected to decline for the year with the highest levels of organic decline in the first quarter as we lap strong numbers from the first quarter of 2022. Geospatial trends through 2023 will continue to be impacted by reductions in dealer inventory levels and ongoing softness in demand in a number of the segments and markets. We expect margins to be stable in buildings and infrastructure and resources and utilities. We project growth in transportation margins, while geospatial margins will be down modestly for the year.

Back to you, Rob. Let me thank our colleagues, customers, and partners. for their support and their work in our strategic and financial progression. I'm proud to say that we continue to win culture and innovation awards. I'm proud to announce that we received approval of our emissions reduction targets by the Science-Based Targets Initiative. Our objective is a 50 percent reduction in scope one, two, and three emissions by 2030. In addition, we released our first task force on climate-related financial disclosures report. In 2022, Our highlight financial metrics were ARR growth and gross margin expansion. Our 2022 ACV bookings gives us confidence that we can continue to grow ARR at a double-digit rate in 2023. Hardware demand remains the hardest revenue stream to predict. While the signals are mixed and even a bit confusing in the short term, the long-term secular attractiveness remains. Our ability to uniquely connect the physical and digital worlds provides a guiding light for our business and remains the foundation of our right to win in our served market. We have surgically reduced our expense structure and moderated spending across the company to ensure discipline and focus in an uncertain environment. What remains certain is our conviction to grow our business by focusing on our customers and continuing to execute our connect and scale strategy. Operator, let's now open the line for questions.

Thank you. At this time, I would like to remind everyone in order to ask a question, press star then the number one on your telephone keypad. We'll go first to Jonathan Ho at William Blair.

Hi, good morning. I just wanted to maybe start out with the CNH aftermarket deal. Can you maybe give us a little bit more color on why it makes sense to do this now and what this could potentially do for the resources and utility segment, particularly as you engage more with the independent dealers?

Hey, good morning, Jonathan. It's Rob. Let me break it down in three respects, context, strategy, and next steps. For context, let's talk about connect and scale, and our strategy means to connect users, data, and workflow, and the users are at the center of our universe. And in that, we believe we need to be closer to the customers, that user, that farmer. So when we talk to the customers, and we work with, by the way, over 100 OEMs today, and obviously the farmers themselves, what they're asking us to do is to help them manage a mixed fleet. And I've personally visited farmers in the last six months in Mexico, Chile, Brazil, Japan, Australia, Germany, and here in the US. So the strategy is we go to market strategies. We sell through multiple avenues. today to reach our customers. We have a direct sales, particularly the enterprise farms. We sell through OEMs. We work with over 100 OEMs. And then we sell through a channel. And the channel breaks down into a Trimble channel that we already have today to reach the aftermarket as well as selling through CNH dealers in the aftermarket. So what we're moving from is where we sell to CNH today call it CNH from Trimble to CNH corporate to reach the CNH dealer. That's the from, the to. The 2B state will be going from Trimble straight to independent dealers. And those independent dealers will be capable of selling the full line of Trimble kit, which is more than guidance because we also do variable rate, we do selective spraying, we do water management, and we do software. So as we look forward, to this. As we work through the transition, we need to sign up the dealers to be independent dealers directly with Trimble. And we think it can expand the available set of products and capabilities they have to take to market. We think it'll help us be incrementally closer to the end users of the technology and in a context of customer success, which is part of Our strategy, we think we can help customers and those users become more successful with the technology because when we're out there in the field talking to them, they are asking for help to integrate and manage a mixed fleet of technology as well as mixed fleet of equipment.

Got it. And then just as a follow-up, I think you've also referenced some additional investments that you'd like to make. for that connected scale in the 2023 timeframe. Can you help us understand where those investments are going to go? And again, maybe why that makes sense to make those investments now given the macro environment. Thank you.

Sure. So we've been investing in this strategy incrementally really for the last couple of years. And demonstrable evidence of where we see The attractiveness of it and I'd say momentum for it is in the growth of the ARR. So the work we're doing up front really is touching more of our software businesses first and particularly the recurring revenue businesses that we have. So a post of 16% organic growth on ARR, the $1.6 billion, this is supporting growth, continued growth in that. And I think from a shareholder value perspective, this would be the most valuable revenue stream that we have at the company. The investments, they pick up systems, they pick up people, they pick up process. So from a systems perspective, think customer-facing, think internal-facing. That's the scale part of Connect and Scale, enabling us to efficiently and effectively grow. When we look at people and the work that we're doing, we look at customer success. Customer success is about net retention. That's the metric you look at for customer success. And the economics of net retention are very powerful. So I'm of a mind, we're of a mind, that we continue down this path, and if anything, we continue down this path with more conviction. And behind all of this is a strong balance sheet, 24.3% EBITDA, in the quarter, so we believe this is emphatically the right thing to do at this moment.

Thank you. Thanks, Jonathan.

We'll go next to Robert Heimer at Mellius Research.

Hey, good morning, everybody. It seems like there's a lot of structural progress in the quarter on margins and on ARR, which is, I guess, continuing. And the surprise, I guess, for us was just a bigger D-stock in the hardware than we would have thought. And so I had a couple questions around that. One is, were you able to see those elevated levels of inventory previously at dealers? And are they normal after what you look in your outlook? Or are they low? I mean, if there's any characterization of that. I guess there's been a debate in construction in North America anyway as to whether large projects will fill in as smaller projects go away, and that seems to be the case, but maybe the mix of your customers is more fragmented than the big ones. I'm just trying to look for context around why that decline happens and is continuing and how big it is.

Yeah. Hey, Rob. It's David Barnes. First point I'll make is that the supply chain the constraints and then the removed constraints has has really moved trends around in our shipments in our dealers inventory that were hard to predict and in some cases challenging to understand so just by way of reminder we had unsustainably and undesirably high hardware backlog early in 2022 our supply chain even today isn't fully freed up. But to the extent that it freed up, it happened very dramatically at the end of second quarter. So we shipped a lot of product. You'll recall that the hardware revenue was way up at that time frame. So dealer inventories did grow. And I'll say it took us a while to figure out how quickly the dealers were able to find customers for and deploy that inventory. And that happened exactly while some of the end markets that our dealers serve slow, you know, particularly in the geospatial side. There's probably the highest within Trimble level of exposure direct and indirect to residential home construction, which slowed. There's some anxiety about the general economic outlook. So these two things happened all together, freeing up our supply chain, very big backlog, lots of shipments. And that created the destocking that we talked about a quarter ago, and it has picked up. We're not through it yet. We think we have a pretty good sense of where our dealers want to be and where they will be over the sustained period of time. It's my guess that we'll have two more quarters, i.e., Q1 and Q2, of meaningful inventory reductions in our dealers, and anything after that will be smaller. But the guidance we've given reflects that expectation.

Any guess on if those two quarters happen? Would dealers be lower than normal at that point and maybe don't have perfect visibility into the channel? I understand.

Yeah, well, what I'll say is that we still do have isolated cases of supply challenges in our ag one of them. But I think at that point, there may be some reasons for dealers to have a little more inventory than they would have had pre-COVID. Not much, though. Our supply is really good. Hey, Rob, the thing I'd remind you on is we look at this noise of one quarter to another, big increases in the first half of 22, and the decline we just reported. Rob had a good chart in his presentation of the multi-year trend. We're still way above where we were. So we do think that a lot of this is the noise of the resetting of the supply chain. That's the bigger factor, really, than any fundamental change in demand.

That's perfect. Thank you.

We'll take our next question from Chad Dillard at Bernstein.

Hi. Good morning, guys. Hey. Hi, Chad.

I just wanted to go back to the C&H agreement and just to better understand the medium term organic growth potential. And maybe you can talk about what needs to be done to set up an independent channel and when you expect that to be in place and just how much of your product portfolio you'll be able to sell within that channel versus how much you're able to sell with C&H.

Hey Chad, so this is Rob. I'll start with the quantitative framework.

I had a chart on the second slide that showed over the last three years the CAGR of the hardware businesses has been 12%. Those three businesses are survey, civil construction, and ag. Ag's been above that 12% growth over the last three years. And ag grew this year. Ag's And it grew even more if you exclude Russia and Ukraine, which was we were selling quite a bit of kit into Russia. And so we'll start to lap that later this year, mid this year. So call that context in terms of the growth that we've had. And I'll give you some more context when we look at. We look at units, we look at pricing, we look at share of wallet, we look at market share, and we think we're holding our own on a global basis and probably growing in Europe, holding our own in North America, growing in Brazil. So if we now turn to the CNH part of your question, we're talking about the aftermarket business. that we have with CNH. And that business that we sell through CNH into the aftermarket today is primarily guidance. So an opportunity we have as we move to independent dealers. And remember, we have independent dealers today. They're full-line Trimble dealers today in agriculture. As we move the business that goes through CNH, that gives us an opportunity to expand the product portfolio to a set of independent dealers. Those independent dealers could very well be dealers we already work with today. It just will happen with a direct relationship with us at Trimble, or it may be a fully new dealer. We have a 12-month transition with C&H on this part of the arrangement, and it's a very positive conversation I want to say that we've been having with the C&H team. optimistic here. It's the right thing to do. It's what our customers are asking for, and it's time to get to work to set it up.

That's helpful. And then just my second question. I was hoping you'd give an update on the digital transformation. What percentage are you done magazine 23? Can you talk about some of the focus areas for this coming year, and if you could quantify just the incremental cost to execute you're expecting for 23?

So I'll start with the second part.

The incremental cost is about 100 bps to the bottom line, consistent with what we had this year as well. So that's the cost side of the equation. On the focus side of the equation, the digital transformation, there's a meta theme. It's more than a system. transformation for us. So, you know, I think about people, I think about process, I think about systems and the systems themselves, and then we think about the go-to-market aspects of the digital transformation. And it's primarily focused right now on supporting our software businesses, particularly software businesses within buildings and infrastructure. And that connects with the Trimble Construction One dialogue that we've had with you and others. And so first point of reference I look at is continuing to grow the ACB bookings, which is the leading indicator for the growth of the ARR. We look at net retention as a key metric as well with inside that go-to-market. We look at the organization of the sales team itself in the go-to-market. So in France Benelux, we put the construction sales team together software team as one organization. We've mostly done that in North America as well. And so it's getting the sales team aligned to sell a consolidated offering of Trimble Construction One. And then with Trimble Construction One, it started out as a targeted to general contractors. And then we will be releasing more persona-based bundles. Remember, we sell to owners in the public sector. We sell to architects and engineers. So we have targeted portfolios to sell to those personas with a go-to-market team, a sales team that comes more and more together as one organization to be enabled and equipped to sell everything that we do. On the system side, in the second quarter, we'll have the next, I'll say, big release of the systems. Those systems are meant to increase the efficiency and effectiveness of our own sellers and and it moves us closer and closer to having commerce capabilities, e-commerce capabilities with an external lens. On the people side, we continue to invest in customer success, and on the process side, we continue to invest in developing playbooks for how we go to market, starting with that software business, but then the next wave after that goes into software and other parts of Trimble, and then into the hardware that we sell through our dealer channels. And we got asked a question earlier in the call about visibility into dealers and their inventory. This is another reason that we think that these systems investments are a good thing for us to get increased levels of precision on that visibility. Hope that helps, Chad.

That's helpful. Thank you. We'll go next to Kristen Owen at Oppenheimer.

Great. Thank you for the question. So I wanted to ask about the eBuilder viewpoint SketchUp contingency. This business is obviously doing quite well and a pretty stark contrast to some of the more conservative macro view that you've expressed. And even just on an ARR growth basis, really strong compared to some of the peers in the software space. We've talked about the macro, but I'm just wondering from a portfolio basis, if you can speak to the playbook with these businesses, what's working in this environment, and just how you intend to port those lessons learned over once the transport and acquisition closes.

Sure. Good morning, Kristen. This is Rob. I'll answer the question. So you're correct. That contingent of businesses is doing very well, and it's even more than eBuilder Viewpoint SketchUp. It's from our Tekla structures. offering our mechanical electrical plumbing software as well, our project management software. Really, the whole contingent is performing. I'll say one thing that is nice on the software side and the recurring revenue is certainly you get a higher degree of predictability. There is not a wholesale in between the retail, and so you get a clear demand a clear view of the demand, which is why, by the way, on the hardware side, we're looking back at the three-year trend on the Keger so that we can see the signal through the noise. In terms of what's working with it, I would say it's the value proposition meets the digitization of the market. So call it the secular aspect of digitization, a chance to meet with a number of Construction companies during my travels over the last months was with one of the largest European contractors in the world yesterday here in Colorado. And digitization and data and sustainability are at the very top of the agenda of those customers, and they know they need to adopt technology in order to further their strategies. Most of these companies have solid technology. Backlog and many technology to to help them get the work done from a value proposition perspective We're hearing strong resonance With the I'd say both the integrated and connected offerings and Trimble construction one is certainly seems to have resonance With the customers that we're talking to even in its early form that it is that we see that and as an evidence of that and we had a record level of cross-sell ACV bookings and buildings infrastructure in the fourth quarter. So that tells me that there's – it's not just marketing resonance. It actually has resonance in terms of turning into business. So the value proposition, it's around the connected offering. So customers increasingly are looking to move from optimizing tasks to optimizing the system. And to do that, they need to have more connected data and more connected workflows. We're hearing customers say because this is where they want to go, they want to buy it from one company as opposed to having to stitch together multiple vendors on their own. They like the ease of dealing with the one company or even the one overall account representative. So there's an aspect of ease to doing business with us meets a level of connectivity, which is Ultimately, they're trying to get to do their work better, faster, safer, cheaper, greener, and it is resonating.

Thanks for that, Rob. And porting some of those lessons with Transporeon, how you see maybe some of that value proposition or combining the offerings, how you see that bleeding into the transportation business once that acquisition has closed?

Sorry, I forgot about that. Thanks for the question. So on Transporean, I think the great news of Transporean is they already have that through the 140,000 carriers, the 1,400 shippers in the network, 3,000 integrations with ERP and warehouse management systems, and already last year had 25 million transactions run through the system. It is definitively a platform company really in the mode of connect and scale. So they have a set of connected capabilities. They're selling it through a dedicated sales force. There's a land and expand play within that. There's strong net retention. There's strong gross retention in the business. So actually I see as much that we can take from Transporian to Trimble as much as I think that we could take aspects of Trimble into the Transporian business. So it's one of the many reasons I'm excited by that is because I think it will be DNA additive to us. As were, and I know you know this, as were eBuilder and Viewpoint acquisitions were additive to us at Trimble to take the best of and take it to other model transitions that we've that we've done, and I see the same thing in store with Transporean.

That's super helpful. I'll leave it there. Thank you.

Thank you.

As a reminder, if you would like to ask a question, please press star 1. We'd also like to ask you to limit yourself to one question and one follow-up to allow everyone an opportunity to ask a question. We'll move to our next question from Tammy Zacharia at JPMorgan.

Hi, good morning. Thanks so much. I hope everyone is doing well. So my first question is the gross margin grade expansion, 200 to 250 basis points. How much of that is price cost tailwind? And how much of that is software versus hardware exchange? And are there any other factors driving this leverage this year?

Hey, Tammy, it's David. The way to think about that is essentially all of the Gross margin improvement is the evolving mix of our business. We are continuing to take price, mostly in hardware, but at a lower rate. So that's not really the margin driver. What's driving our margins up is we're becoming more and more of a software business and those have higher gross margins.

Got it. So see, if prices keep coming down, input prices, could that be a source of upside to your gross margin rate?

You know, there's a number of puts and takes in our hardware gross margin. We've already seen a benefit. So in the third and fourth quarter of 22, we got to the point where for our hardware businesses, our price realization more than offset our cost improvements. So that's sort of baked into the run rate now. We are continuing to take pricing at a moderate level in our hardware businesses. So that ought to help our margins just a little bit on the hardware side, but the by far bigger story is the makeshift.

Got it. So one quick one. I wanted to go back to the destocking comment. Can you talk about what sales to end users look like in the fourth quarter against the dealer de-stocking you saw. Did sales to end users overall moderate in fourth quarter versus the third quarter?

Yeah, so let me frame it up this way. If we look at our dealer de-stocking, I would say it had a negative approximately 400 basis point impact on our organic revenue trend, so we reported flat. We would have been roughly up 4%. So if you look specifically at hardware, our hardware revenues organically were down 13. So I think you can infer, Tammy, that there was some end-market softness, particularly on the geospatial surveying market in Q4, which partly we think is temporal. You know, we had a lot of new products last year, and we had a lot of new products last year. as in many businesses when you have new products, you get a spike in orders and we had a clean supply chain to deliver those through. So we've got a bit of a pullback for that reason. Fundamentally, I would say the secular end market sales to retail trends feel up, maybe not up as much as they were earlier in 22, but the general direction is up. There's some soft areas including anything tied directly to residential construction that is clearly contracted. But on the balance with what's happening in infrastructure, we think the secular direction of demand is up. But with the dealer destocking and the customer ordering patterns earlier in 22, we're seeing a pullback for those reasons.

Got it. Very helpful. Thank you.

We'll go next to Jason Salino at KeyBank Capital Markets.

Hey, guys. Good morning. Just a couple quick ones. I think you mentioned churn in the first half impacting the ARR growth. What type of customers or what segment are you seeing these come from?

Yeah. Hey, Jason. It's David. We do expect churn from a handful of customers, principally in our transportation segment. These are customers that made a decision to come off our platform's many quarters ago and they're just now implementing them. So I see that as noise, not signal. Our customer satisfaction and retention in transportation is on a secular positive trend. We just expect to see a number of these probably in the first quarter pull off. So that will reduce our ARR growth rate a little bit lower in Q1 from what we expect to see for the full year. Okay.

And then maybe if I were to you know, really simplify it. Your construction software portfolio seems to be executing, you know, quite well. But it's, you know, completely different drivers than the hardware desoldering elements. So are you seeing any macro impact on this construction software portfolio? Thanks.

Short answer is no, not seeing an impact on the software portfolio.

Excellent. Thanks. You're welcome.

Our next question comes from Jerry Rovitch at Goldman Sachs.

Yes, hi. Good morning, everyone. Rob, I'm wondering if you could just talk about the progress on Trimble Construction 1. What proportion of new orders does it account for now? And when we last caught up, you were seeing triple the ASP versus base orders before. I'm wondering if that trend has continued.

Hey, Jerry. Good morning. On TC1, the Trimble Construction 1, the best evidence I can give you on the progress is that it comes in the form of the record level of cross-sell and up-sell that we had in the quarter from an ACV bookings perspective. And the reality is it's not all of that is the Trimble Construction 1 branded portfolio. So there's sub-aspects where we can just sell across the portfolio, which I'd say is a subset really of TC1. There's cross-sells. That cross-sell as a percent of the total ACV bookings and buildings and infrastructure software was nearly 30%. So for us, that was record dollars, record percentage level. And when we go through the business reviews, we look at almost every account to look at what they're buying and why they're buying it and looking at the competitiveness win ratios. What we're seeing is when we're selling the bundled offerings, whether it's less than the full TC1 offering or it's TC1, we're seeing the sales cycles reduce. We're seeing the size of the bookings go up. We're seeing the win ratios go up as well. And so in aggregate, it looks to be a winning formula. And I would add to that, Jerry, that it's still relatively early in in the game for us. And so with the sales kickoff meetings that we've been having in the last weeks, it is really a big emphasis to the team. So to get the offering out to the general contractors and then the next personas after that in architecture engineering, owners and public sector, and then geographically rolling that out as well and aligning the sales team behind that and then actually doing the sales enablement work underneath the covers, which is critical. to help the sellers with their effectiveness. So I'd say, Jerry, lots in aggregate or in sum, I think lots of good things happening on this front, and we'll keep updating you here every quarter.

We'll go next to Rob Mason at Baird.

Yes, good morning. First question, I just wanted to clarify a comment from earlier. I think around the cost for Connect and Scale, there was mention of 100 basis points. Is that what is built into the 23 guidance, or was that the cost for 22? And then maybe just as an extension to that question, just talk about the Where you've settled now on maybe the model that you plan to implement on the hardware-software bundles that are transitioning those conversions, I think there were several options presented at the Investor Day. I'm just curious to speak to maybe what year one, year two economics will look like on those.

Yeah. Hey, Rob. It's David Barnes. I'll try both. On the connect and scale discrete investments, Spending on that 22 versus 21 was about 100 basis points, around $40 million. Embedded in our guidance for 2023 is a deceleration in the rate of growth, so we'll spend somewhere in the order of another 20 or a little more than that million dollars incremental, 23 above 22. We still have more work to do, and we believe this is a high priority investment. With regard to the model options, I'll say the menu that we presented at the Investor Day is still out there. This topic is tied with digital transformation. Our ability to sell hardware and software bundles together in a recurring basis is heavily dependent on the rollout of our digital transformation. We're doing it in a somewhat koogee way now. But the bulk of that opportunity is ahead of us and all the options that we showed at the Investor Day are still options we're considering.

And Rob, I'm going to add just a bit of context too on top of the Connect and Scale investments because it's a capital allocation call. And so we've taken down spend in other parts of the company in part to help fund what we're doing here. So we've thought a lot about the cost management aspect of our model. If we look over the last three years, organically, ARR has grown double digit over 12%. Total revenue has grown 6%. The gross margin dollars have grown faster than that as the mix shifts more software-centric. And our total headcount organically has grown 2%. over that timeframe. So a third of total revenue growth, a sixth of the ARR growth. And so it's very much in context of how we're thinking about allocating capital at Trimble and where we're putting it to work.

Well, maybe as a follow-on to that, Rob, you know, Transporean, you know, following that completion of that, you will be in somewhat of a deleverage mode. But how much flexibility are you giving yourself or, you know, to be able to do a transaction like, I guess, a rivet or, you know, something along those lines, I guess, you know, on the capital allocation side to supplement, connect, and scale.

Let's say from a flexibility, if we're talking acquisition and deployment of the balance sheet, I would say here in the next 12 to 18 months, not a lot of flexibility because, you know, our primary commitment is to deleverage. So certainly anything at scale would I would say we've limited some flexibility of the balance sheet. Now, if it's not at scale, whether it's a rivet size acquisition or it's Trimble Ventures where we've put single digit millions to work in that aspect, I would say we do retain some flexibility with caution to stay close to making sure we understand um, our, our model and that we're taking a relatively conservative view of the, of the balance sheet. Um, now map to the P and L let's not forget that, um, you know, in 2022, 38% of our total revenue is now recurring 1.6 billion. That's grown. We believe we'll grow double digit again next year. So our, our P and L has, um, more visibility than it's ever had. And therefore the business model has got more resilience. And, and so, uh, and we maintain the investment grade. So I look at those factors all together, and I'd say there's flexibility on a smaller size of capital deployment, not a lot of flexibility on transformative size deals for the next couple of years.

Sure. Very good. Thank you. You're welcome.

We'll go next to Arseneji Madovic at Wolf Research.

Hi, this is Arsene on for gal. Thanks for taking my question. Just wanted to follow up on a prior question regarding digital transformation. How is the progress for revenue being transacted through the connected digital platform tracking versus your expectations? And where does that shake out as a portion of revenue for FY 22? At the investor day, I believe 2% of revenue had or had been expected to be the target as communicated. So was that met or exceeded, and do the projections shared at your investor base still stand for the portion of revenues expected to transact through the digital platform in the future? And then just one brief follow-up. Thanks.

So our answer is yes.

Yeah, with 2% of our business in Europe, and that's live and working, and we're just about to roll out the next phase to our North American, principally to our North American software businesses. and with further rollouts from there.

But we're moving forward. Got it. That's helpful. Thank you. And just one follow-up. Has anything changed from the time Transparency was announced that would maybe alter the expectations for revenue and EBITDA initially communicate at the announcement of the acquisition or everything all good there still?

Yeah, look, we communicated the financial parameters there. We still don't own the business. Obviously, we're talking to them, but we have no updates. to our outlook, and we'll update that outlook once the transaction closes at some point in the first half of this year.

Got it. Thank you, guys. Sure.

And that does conclude our question and answer session. I'd like to turn the conference back to Michael Labo for closing remarks.

Thank you, everyone, for joining us on the call. We look forward to talking to you next quarter.

And this concludes today's conference call. You may now disconnect.