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{
"speaker": "Operator",
"content": "Good afternoon. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Agilent Technologies Inc. Fourth Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to withdraw your question, again, press star one. Thank you. Parmeet Ahuja, you may begin your conference."
},
{
"speaker": "Parmeet Ahuja",
"content": "Thank you, and welcome everyone to Agilent's conference call for the fourth quarter of fiscal year 2024. I am sure you have seen our press release earlier today regarding our new market-focused organizational structure, which we will talk about in more detail. These changes have no impact on our company's consolidated financial statements. All financial metrics and guidance during this call will be shared under our historical structure. We will provide recast historical segment information to reflect these changes ahead of our upcoming investor day. Now onto our quarterly results. With me are Padraig McDonnell, Agilent President and CEO, and Bob McMahon, Agilent Senior Vice President and CFO. Joining in the Q&A will be Phil Binns, President of the former Life Sciences and Applied Markets Group, Simon May, President of the newly formed Life Sciences and Diagnostic Markets Group, and Angelica Riemann, President of the expanded Agilent CrossLab Group. Also joining the call is Mike Zhang, President of the newly formed Applied Markets Group. This presentation is being webcast live. The news release for our fourth quarter financial results, investor presentation, and information to supplement today's discussion, along with the recording of this webcast, are available on our website at investors.agilent.com. Today's comments will refer to non-GAAP financial measures. You will find the most directly comparable GAAP financial metrics and reconciliations on our website. Unless otherwise noted, all references to increases or decreases in financial metrics are year-over-year, and references to revenue growth are on a core basis. Core revenue growth excludes the impact of currency and any acquisitions and divestitures completed within the past twelve months. Guidance is based on forecasted exchange rates. During this call, we will also make forward-looking statements about the financial performance of the company. These statements are subject to risks and uncertainties and are only valid as of today. The company assumes no obligation to update them. Please look at the company's recent SEC filings for a more complete picture of our risk and other factors. And now I would like to turn the call over to Padraig."
},
{
"speaker": "Padraig McDonnell",
"content": "Great. Thank you, Parmeet. Hello, everyone, and thank you for joining today's call. Before I begin, I would like to welcome new AMG President, Mike Zhang. While Mike is new to this role, he is not new to Agilent. Mike joined Agilent more than twenty years ago as a manufacturing engineer in China and most recently was Vice President and General Manager of the GC and GCMS business. Within our former Life Sciences and Applied Markets Group, with his broad experience in both manufacturing and into the business, Mike will be an incredible asset in this role. Very much looking forward to him moving AMG and Agilent forward. I also want to take a moment to wish Phil Binns a wonderful retirement in advance of him leaving Agilent. Phil joined Agilent with the Varian acquisition in 2010. All told, Phil is celebrating just over forty years of service with Agilent and Varian. Although Phil is retiring from the business president role, he has graciously agreed to serve as a special adviser through April 2025. All of us at Agilent wish Phil the very best and look forward to working with him during the last five months at Agilent. Now onto our high-level Q4 results. I am happy to share not only our solid fourth quarter results that point to continued steady market recovery, but also our outlook and drivers for the 2025 fiscal year. I am especially excited to talk about Agilent's customer-first strategy evolution and our aggressive transformation ambition that led to the news you read ahead of the call. The new market-focused organizational structure to become a nimbler, even more customer-centric company to accelerate our performance. In the fourth quarter, the Agilent team delivered revenue of $1.701 billion, roughly one percent reported growth with a flat core growth. This represents a sequential improvement of over four hundred basis points from Q3. In addition, our total company book-to-bill was greater than one. This points to a steady market improvement we are seeing and we expect it to continue in 2025. We also gained share in all our geographies. Evidence that even in challenging CapEx environment, customers trust Agilent. As we evolve, we are confident this will only accelerate. Bob will provide deeper details on our Q4 results and our outlook for Q1 and FY 2025. Now I would like to spend some time talking about our new organization structure we announced earlier today. Our new market-focused organization structure is a result of our customer-centric market force strategy and an important step in our organizational transformation work, which we have named Ignite. This is a product of our enterprise focus strategy that drives our evolution to become a nimbler, even more customer-centric company to accelerate our performance. The new market-focused organization structure is one of the most significant changes Agilent has seen in a decade and continues the work we did creating our commercial organization three years ago. The commercial organization doubled down on our customer-first approach in the field and it's a critical competitive advantage in supporting our customers. At that time, we started by creating a singular commercial leadership structure. We then created a foundational infrastructure and intensified our focus on digital capabilities, accelerated and end-to-end customer experience, and ensured sales channels were customer and market-centric. So changes you see today are part of the successful journey we started three years ago. With the new structure, we are aligning business units to our markets facilitating close collaboration among the businesses like never before and enabling better execution and cross-division customer-first priorities. We are combining the strength of our three businesses as well as our portfolios so that we can offer end-to-end solutions and workflows revolve around our customers and markets. The Life Sciences and Diagnostics Markets Group's or LDG represents $2.5 billion in annual revenue and is primarily focused on our pharma, biopharma, and clinical diagnostic end markets. LDG provides a comprehensive portfolio of leading technology platforms and solutions to serve Agilent's customers' value chain, including research and discovery, development and scale-up, production of therapeutics, and development of critical cancer diagnostics. LDG includes LC and LCMS, cell analysis as well as CDMO capabilities which include NESD and BioVectra. The business also includes pathology, companion diagnostics, and genomics. Simon May will serve as president of LDG prior to joining Agilent earlier this year at Bio-Rad Laboratories. Simon was Executive Vice President and President of Life Science Group. The Applied Markets Group or AMG represents $1.3 billion in annual revenue and is focused on food, environmental, forensics, chemicals, and advanced materials markets. AMG includes GC and GCMS spectroscopy, vacuum technology platforms, and certified pre-owned business. AMG will focus on growing its agile and strong leadership in these markets and accelerating growth in new areas of the market. Mike Zhang, a twenty-two-year veteran of Agilent, has been promoted to president of AMG. Most recently, Mike was Vice President and General Manager of our GC and GCMS product lines. The Agilent CrossLab Group or ACG represents $2.7 billion in annual revenue and is focused on supporting our customers in all our end markets. The group is uniquely positioned to leverage its comprehensive portfolio and capabilities to further enhance the installed base of instruments with targeted workflows and applications that drive critical outcomes and productivity in labs. ACG includes services, software and informatics, automation, and consumables. This business will accelerate and strengthen customer relationships across all end markets. Angelica Riemann, a twenty-five-year veteran of Agilent, will continue to serve as president of ACG. Prior to her current role, she served as Vice President and General Manager of the ACG services business. This change is one of the many that demonstrate how we are becoming nimbler and accelerating the pace of innovation. And you can see that with the Q4 launch of the exciting Agilent Infinity 3 LC series that harnesses our fifty years of LC expertise and leadership. The Infinity 3 series has advanced automation that simplifies our customers' daily routines and is compatible with previous generation, which allows for seamless upgrades and technology refreshes. And Agilent Infinity Lab LC solutions are certified by MyGreenLab. These instruments optimize lab space, and they reduce water, solvent, and energy consumption while also minimizing waste. While just launched in October, early traction from customers has been very positive. Also in Q4, we closed our acquisition of BioVectra, demonstrating our commitment to providing customers the most advanced capabilities to accelerate our therapeutic programs. With BioVectra now being part of Agilent, we expand our portfolio of CDMO services beyond our market-leading oligonucleotide production at NASD. Adding more rapidly growing therapeutic modalities like peptide synthesis, a market expected to continue to expand rapidly over the coming years. And bringing world-class capability to support gene editing therapies. Just last month, my leadership team and I visited BioVectra to welcome our new team members to Agilent, and we became even more accelerated by the capabilities we would be able to harness. Plus both Agilent and BioVectra's focus on putting customer first and accelerating the pace of innovation so we can add to and capitalize on opportunities was abundantly clear as I spoke to dozens of BioVectra employees. Separately, during the quarter, we hit another important milestone. For the full year, we passed the $1 billion mark in digital orders, for the first time across the company. This is a result of our investment in our digital ecosystem to ensure our customers can do business with us in ways that meet their needs. To reinforce what I have stated in previous calls, we are sharply focused on key growth factors such as BioPharma, PFAS, and advanced materials. And the Agilent team has mobilized to accelerate value creation through our Ignite transformation program. The objective of Ignite is to drive revenue growth and margin expansion by increasing our execution capabilities."
},
{
"speaker": "Operator",
"content": "The world is moving faster than ever,"
},
{
"speaker": "Padraig McDonnell",
"content": "and so are we. That is exactly why we introduced our new market-focused organization structure. We are laser-focused on winning in the marketplace and adding value to our customers and shareholders. We will dive more deeply into these details including our evolved strategy and the Ignite transformation, that will help us execute on that strategy. At our investor day on December seventeenth in New York."
},
{
"speaker": "Bob McMahon",
"content": "We"
},
{
"speaker": "Padraig McDonnell",
"content": "Bob would now provide the details of the results as well as our outlook for the fiscal year of 2025 and the first quarter. After Bob delivers his comments, I will be back for some closing remarks. Over to you, Bob."
},
{
"speaker": "Bob McMahon",
"content": "Thank you, Padraig, and good afternoon, everyone. In my remarks today, I will provide some additional details on fourth quarter revenue and take you through the income statement and other key financial metrics. I will then cover our guidance for fiscal year 2025 and the first quarter of 2025. Unless otherwise noted, my remarks will focus on non-GAAP results. As Padraig said, we are pleased with our Q4 results. Agilent finished the fourth quarter, with core growth in line with our expectations while EPS exceeded our expectations as we executed well against a challenging albeit improving market. Q4 revenue was $1.701 billion, a decline of 0.3% core but a sequential improvement of over four hundred basis points. On a reported basis, our revenues were up 0.8% as we benefited from fifty basis points of currency and BioVectra contributed sixty basis points. Looking at our Q4 performance by business unit, the Life Sciences and Applied Markets Group reported $833 million in revenue. That represents a 1% decline as instrument volumes continue to be constrained, by conservative customer CapEx spending while consumables grew mid-single digits. Having said that, for our instruments business, our orders grew year on year and for the third consecutive quarter, our book-to-bill was once again greater than one. We see this as positive evidence of an ongoing steady instrument recovery. Moving on to Agilent CrossLab Group, the business delivered revenue of $426 million for the quarter, 5%. ACG grew in every market and in every region except China, where it was flat year over year but up sequentially. The contracts business including our fast-growing enterprise services business, double digits again in Q4 as it has every quarter this year. Our largest customers continue to maximize utilization of their assets, right-size their operations, and leverage OpEx budgets to deliver on their productivity goals and outcomes. We recently received a top supplier award from one of our largest strategic customers in the applied markets as a recognition of our long-standing and beneficial partnership throughout the years. The Diagnostics and Genomics Group posted $442 million in revenue, representing a 3% decline that was slightly above expectations. Pathology saw solid growth globally, and was offset by expected softness in NESD and cell analysis instruments. Now looking at our end markets and geographies, our largest end market, pharma, declined 1%, slightly better than what we expected. Within pharma, biopharma declined mid-single digits while small molecule grew low single digits. Encouragingly, all regions except for the Americas, grew in the quarter. The Americas region was pressured by the expected decline of NASD. We expect both the Americas region and NASD to return to growth in fiscal year 2025. In chemicals and advanced materials, revenue grew 1% with our advanced materials submarket growing mid-single digits driven by our business in the semiconductor market. Our business in the diagnostics and clinical end market performed strongly growing 7% driven by pathology, and improved performance in genomics."
},
{
"speaker": "Operator",
"content": "In environmental and forensics,"
},
{
"speaker": "Bob McMahon",
"content": "we declined 6% although dollars were roughly flat sequentially. All regions grew except for the US, related to timing of orders. That being said, we continue to see very strong growth in PFAS solutions. With our business growing more than 40% in Q4 across multiple end markets. Now wrapping up our end markets, food was down 3% versus last year. While our academia and government market was down 1%. Geographically, Asia ex-China high single digits and Europe grew low single digits in the quarter while the Americas and China declined as expected. China was down only 3% and exceeded our expectations. We also booked our first China stimulus orders in October and anticipate much more in fiscal year 2025. Now let's move to the rest of the P&L. Gross margin was 55.1% in the quarter, down seventy basis points versus last year driven by lower volume and mix. Our operating margin was 27.4% as our productivity initiatives and the cost actions we took earlier in the year were fully recognized this quarter. The annualization of these savings coupled with the market recovery and the initial returns from the Ignite transformation, give us confidence in driving EPS growth in fiscal year 2025. In addition, we continue to look for ways to drive EPS growth below the line. Our net interest income was in line while we benefited from a lower tax rate in the quarter and our share count was 287 million diluted shares outstanding. Now putting it all together, Q4 earnings per share was $1.46, that was ahead of our expectations and up 6% from a year ago. Now let me turn to cash flow and the balance sheet. We continue to enjoy a very strong balance sheet and healthy cash flows. Operating cash flow was $481 million in the quarter, and we invested $93 million in capital expenditures. For the year, we well exceeded our operating cash flow expectations. With operating cash flow of $1.75 billion during the quarter, we returned over $400 million to shareholders, consisting of $335 million in share repurchases, and $68 million in dividends. For the year, we returned over $1.4 billion to shareholders, through repurchasing shares and dividends. Looking forward, you may have also seen recently we announced a 5% increase in our quarterly dividend. Marking another year of increases advancing our industry-leading dividend. We ended the quarter with a net leverage ratio of 1.1, a very strong number even as we acquired BioVectra in the quarter. Our strong cash flow and healthy balance sheet provide us with plenty of opportunity to invest in the business going forward. In summary, we performed well and saw steady market improvement in the quarter. We are executing well, staying disciplined, and investing in high-growth opportunities. Now let's move on to our outlook for the upcoming fiscal year and first quarter. We expect the recovery that we have seen the past few quarters to continue throughout fiscal 2025. While we expect the market to grow slower than historical rates for the full year, we expect improvement throughout the year with the second half of the year returning to more traditional levels of growth. We expect our results to mirror that cadence of improvement on a core basis. As Padraig noted earlier, we exited Q4 with a book-to-bill ratio over one for the company, and greater than one for instruments. In addition, Q4 was the first quarter in 2024 that instrument orders grew year on year. While one quarter does not a trend make, it is certainly encouraging. For the full year guide, we expect revenue in the range of $6.79 to $6.87 billion. This represents a reported growth range of 4.3% to 5.5%. Currency is a slight headwind of 0.2 points while M&A related to BioVectra contributes 2% at the low end and 2.2% at the high end. This translates to a core growth of 2.5% to 3.5%. To start the year, we think this is a prudent way to plan given the near-term dynamics in the US. From a geographic perspective, we expect modest growth in the Americas and Europe. While we see funnel activity increasing in China, we are taking a conservative approach on the timing of revenue associated with the stimulus. We expect to see recovery over the course of the year in China, resulting in slightly positive growth for the full year. From a business group perspective, we expect to return to growth in all three groups led by ACG. As a note, this statement is true under the new structure as well. As Parmeet mentioned earlier, we will provide recast historical segment information to reflect these changes ahead of our upcoming investor day. In terms of phasing, we expect improvement throughout the year with more normalized growth expected in the second half of the year. We are projecting roughly fifty to seventy basis points of operating margin expansion for the year. Below the line, we expect net interest expense of $25 million due to the financing of BioVectra versus the net interest income this year. In addition, we expect a tax rate of 13% and 286 million shares outstanding. Fiscal 2025 non-GAAP EPS is expected to be in the range of $5.54 to $5.61 and incorporates the planned five cents year one dilution from BioVectra. This range represents a 5% to 6% growth rate if excluding the BioVectra dilution, a growth rate of 6% to 7% year on year. We expect cash flow to remain strong in fiscal year 2025. We are expecting roughly $1.65 billion in operating cash flow and $450 million in CapEx as 2025 is the peak spending year for the NASD expansion. Looking to Q1, we expect revenue in the range of $1.65 billion to $1.68 billion. Our forecast assumes no significant budget flush during the end of this calendar year. This represents a reported decline of 0.5% to growth of 1.3%. Currency is a thirty basis point headwind while M&A is expected to contribute 1.8 points of growth. We are expecting core growth between a decline of 2% to flat at the upper end. It's important to note that we estimate our projected Q1 year-over-year results will be negatively impacted this year by roughly two percentage points due to timing of the Lunar New Year which occurs in late January, versus February of last year. This includes the additional $15 million in revenue pull forward we communicated in Q1 of last year. Adjusting for the Lunar New Year impact, we are expecting continued sequential growth improvement. First quarter 2025 non-GAAP earnings per share are expected to be between $1.25 and $1.28. Lower than the full year growth rate due to the Lunar New Year timing. Looking into 2025 and beyond, we remain incredibly optimistic about the future of our markets and our long-term prospects. We are confident in our new market-focused approach and the Ignite transformation will propel us to accelerated growth and we will become a stronger company. With that, I'll turn it back over to Padraig for some closing comments."
},
{
"speaker": "Padraig McDonnell",
"content": "I've said it before and I want to say it again. These are exciting times at Agilent. Over the last several months, we've been focused on evolving our strategy, transforming our processes, and empowering our people while continuing to win in the marketplace. Already we've made bold moves that have created momentum. We've developed our future strategy, we've kicked off our Ignite transformation to help execute on that strategy. And along the way, we've made moves to create new growth vectors. We are making acquisitions that will contribute to our growth and we are strengthening our capability to efficiently and effectively integrate those acquisitions that will lay the foundation for future M&A. These initial actions position us well for the journey ahead."
},
{
"speaker": "Bob McMahon",
"content": "They ensure we are building the capability"
},
{
"speaker": "Padraig McDonnell",
"content": "strength, and speed to reinvigorate our culture and enable us to thrive while delivering outstanding results for our customers and for our shareholders. And amid all this change, Fortune magazine this month named Agilent number eleven among the world's best workplaces 2024, a list that only includes twenty-five companies. This is yet another recognition of what we already know internally. The Agilent team is the best in the industry. This is not only a recognition of our outstanding company culture, of the talented professionals we have."
},
{
"speaker": "Bob McMahon",
"content": "Ones who are ambitious,"
},
{
"speaker": "Padraig McDonnell",
"content": "resilient, and high performing. This is exactly the team we need to evolve Agilent. To build an enduring company that sets the standard for excellence with our customers, and creates value for our shareholders. Thank you again for joining today's call. I couldn't be more energized by the momentum we have, the opportunities we will seize, and the history we will make. Now I look forward to answering your questions. Parmeet?"
},
{
"speaker": "Parmeet Ahuja",
"content": "Thanks, Padraig. Operator, if you could please provide instructions for Q&A now."
},
{
"speaker": "Operator",
"content": "And your first question today comes from the line of Patrick Donnelly from Citi. Your line is open."
},
{
"speaker": "Patrick Donnelly",
"content": "Hey, guys. Thanks so much for taking the questions. Padraig, maybe one for you. Just on the instrument side, and I know you guys touched on the book-to-bill over one for three quarters now, a little bit of improved growth on the order side year over year. Can you talk about where we are in the cycle, what your expectations are? As you guys know, there's a debate in the market about what the cycle looks like. Does it overcorrect to the upside as we work our way through the next year or so? Are you guys framing that up? What's the right way to think about this replacement cycle, where we are, and the size of it as we go forward here?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. Thanks, Patrick. Great question. So, you know, clearly, we're seeing a steady recovery in instruments and, you know, our book-to-bill was greater than one, which is really great to see. In terms of replacement cycle, what you would see across the industry is that it's not uniform. It's across different vendors at different speeds and, of course, at different times. But what we do see is that we have we're probably midway through the expected timing on where we expect that replacement cycle to be. We see competitors are probably benefiting from refresh of their own install base with some new systems. But what you would see from our side is our Infinity 3 that we announced last month. We expect to start seeing an increased demand for our solutions, and we're seeing a lot of excitement with our customer base. And we've already seen tens of millions of dollars in orders there. So what we expect in that replacement cycle is to be slow and steady, but really kicking off in Q1."
},
{
"speaker": "Patrick Donnelly",
"content": "Okay. And that's helpful. And then maybe on China, you know, always a focus with you guys. It sounds like slight growth for 2025 is the right way to think about it. Can you just talk about what you guys are seeing there and hearing there? You know, Bob, helpful to hear that you guys got your first orders there in October. What's the expectation as we move forward here? It sounds like a steady recovery. Are you still seeing I know you guys were kinda hovering around that $300 million revenue a quarter stability. It sounds like continued and maybe a little bit of improvements as we work our way through the year. Are there different segments that are maybe picking up a little bit? Would be helpful to talk through. Thank you, guys."
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. Thanks, Patrick. So performance was a bit better than expected, and it was also really encouraging to see lab activity to continue to improve across our services and consumables. So we actually have seen quite dramatic share gains within China, which is also a really good point. So what I would say is it's steadily improving. You know, talking to the teams. And I would say on the stimulus side, you know, we talked in the call about we've already have some stimulus orders in. We expect much more in Q1. That will, of course, translate to revenue. And this is a really, really good sign as we see momentum both from the direct input of more confidence in the market and, of course, getting the dollars in. So steadily improving, and we expect that through the year, Patrick. We expect as we go through the stimulus orders and we go forward, expect that to improve. One area that was really standout for us was PFAS in China. It was the fastest-growing business for us across the globe or region across the globe, and that just goes to show the durable nature of some of these growth factors that are happening where you have the emergent pollutants act moving. And what we've seen in China is that our great technical expertise coupled with our great solutions are already there to pick up the business. So that was one real clear standout."
},
{
"speaker": "Bob McMahon",
"content": "Yeah. Hey, Patrick. Just want to add on to what Padraig is saying. Yeah. You're absolutely right. We ended the quarter with roughly $310 million, $312 to be precise, in China. Which was a nice sequential increase from Q3 and, you know, it was down 3% as I mentioned. In addition to the PFAS, both chemical and advanced materials actually grew in the quarter. We're, you know, we have a leadership position and pharma was flat, which was actually a very nice thing. And we're taking a kind of a conservative approach, as I mentioned, in terms of the stimulus orders, but we've seen quite active funnel from the standpoint of bidding activity here in the first half of this quarter as well as and expect that to continue throughout the course of 2025."
},
{
"speaker": "Patrick Donnelly",
"content": "Okay. That's helpful. Thanks, Bob and Padraig. I appreciate it."
},
{
"speaker": "Padraig McDonnell",
"content": "Thanks, Patrick."
},
{
"speaker": "Operator",
"content": "Next question comes from the line of Matt Sykes from Goldman Sachs. Your line is open."
},
{
"speaker": "Matt Sykes",
"content": "Hi, good afternoon. Thanks for taking my questions. Maybe the first one just on DGG, which has been sort of weighing on growth over the course of the year, but noticeably strong quarter. You had called out CancerDx as well as genomics. Could you just provide a little bit more color on what's driving that growth? And how sustainable do you think that growth is, particularly in genomics as we move through 2025?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. I just said start off, and I'll kick it over to Simon. You know, as we really are seeing nice growth in our pathology business, which grew high single digits in Q4 and is slightly ahead of expectations. A highly durable business in any markets. What we're seeing in genomics, while it's a still challenging market, we posted low single-digit growth, which was also ahead of expectations. But, Simon, I don't know if you want to add some color."
},
{
"speaker": "Simon May",
"content": "Yeah. Just a quick couple of quick points to add. As Padraig mentioned, we were pretty pleased with the high single-digit growth that we saw in pathology in the quarter. And in particular, the blend and the mix between instruments and consumables there, we continue to be really healthy. With our instrument placements, and we think that sees us quite nicely going into 2025. On the genomic side, it was really notable because it's the first time that we've seen growth in genomics for quite a while now. I'd say we've had a bit of a pivot in our strategy there to really double down on the growth drivers that we see in genomics, where we've got clearly differentiated value propositions and in particular, our Magnus automated NGS library prep continues to see fantastic traction. We're also very encouraged by the pipeline that we're seeing for our Aveda NGS chemistry. And, again, this gives us a lot of hope going into FY 2025. And as I think about pathology and genomics and these growth factors that we see here, we do believe that they're durable given the macro conditions and the competitive position that we enjoy."
},
{
"speaker": "Matt Sykes",
"content": "Great. Thanks. And maybe just for my follow-up, a high-level question for you, Padraig. On the resegmentation, it makes sense from a go-to-market strategy for some of these segments to put them together. I'm wondering from an R&D development and new product innovation, how this might help. I mean, you referenced the LC replacement cycle accelerating faster for competitors as they refresh their installed base. Should we start to see a faster cycle of new product introductions due to the resegmentation, or is it gonna be similar to the pace that we've seen in the past and resegmentation really doesn't necessarily inform R&D direction?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. Well, look, I think we're refocusing the groups really for a few reasons. We want to be closer to customers, but also understanding where do we want to make our biggest investment or most asymmetric that are going to accelerate innovation in key areas. And when I talk about focus, it's really three things. You know, it's the energy to time, but also the capital allocation. And what you will see from this refocusing of our segments, we're gonna be able to do that. You're gonna see programs accelerate. But also, we don't want to be two inches deep across the company. We want to be focused on our key growth factors and making sure we accelerate. We have a huge amount of product lines and, of course, we can have incremental additions to product lines across the board. But from this new structure, you're gonna see an acceleration of R&D. No doubt about it."
},
{
"speaker": "Matt Sykes",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Rachael Raycroft with Your line is open."
},
{
"speaker": "Rachael Raycroft",
"content": "Perfect. Thank you for taking the questions, you guys, and good afternoon. So I wanted to follow-up on Patrick's question on China. Appreciate that it's early days, but how are you guys thinking about the risk of potential tariffs on Agilent's business at this point in China and in the rest of the world? Is there anything embedded in guidance currently from a tariff standpoint? And then can you remind us what was the tariff impact on Agilent in the first Trump administration?"
},
{
"speaker": "Bob McMahon",
"content": "Yeah. Hey, Rachael. This is Bob. I'll take that question. As you can imagine, there's been a fair amount of work that we've been doing on this exact question. What I would take it if I took it into two chunks, actually, we've been working on diversifying our supply chain particularly within China, you know, China, back in eighteen, nineteen when the first tariffs came and then, obviously, double down on that resiliency with COVID. And so it is ten to fifteen million dollars existing today. And we think that the future potential magnitude of this is certainly manageable with us with additional mitigation activities. Obviously, with something that would be more broad-based than that, it would be more material. But to just give you a frame of reference, roughly two-thirds of our business in the US comes from product that's sourced in the US."
},
{
"speaker": "Rachael Raycroft",
"content": "Great. That's helpful. And then just for my follow-up, you mentioned that chemical and advanced materials grew 1% this quarter. Was wondering, could you just break down some of the trends that you saw within? You mentioned that semiconductors drove some of the performance that you saw on the advanced materials side. We actually had one of your peers call out some weakness in semi this quarter. So just talk to us about what you're seeing from an underlying perspective on that side. And then again, just tell me business as well. Thanks."
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. So in the chemical advance materials, we grew 1% and we sold 4% of materials, and that's driven, you know, a lot by our battery business that we have and, of course, semiconductor. We saw a slight decline in chemical and energy. But overall, we're very happy with the growth that we've seen in Asia ex-China, by the way, was driven and also low single digits in China. So the one thing that I would note about this industry is that we've got the broadest platform and solutions around it. And it's the CAM is returning to positive year on year growth for the first time since Q2 in 2023, so that really bodes well for the future."
},
{
"speaker": "Bob McMahon",
"content": "Yeah. Hey, Rachael. And maybe just for the benefit of you and the rest of the folks on the call, I talked about guidance. If you look at it by end market, just to kinda give everyone a frame, you know, for the full year FY 2025, we're expecting pharma to return to growth. So low to mid-single-digit growth there. Academia government roughly flat. Actually, expect the diagnosis and clinical that Simon just talked about to continue and be the highest growth end market, at least to start off the year here in FY 2025 at mid-single digits. CAM also low to mid, given the work and the discussion that Padraig just gave. And then food and environmental, both low single digits with pockets of very strong growth. And really, you know, food, there was a potential where the actually could accelerate throughout the course of the year given some of the potential changes in the administration coming up."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Vijay Kumar from Evercore ISI. Your line is open."
},
{
"speaker": "Vijay Kumar",
"content": "Hey, guys. Thanks for taking my question. Maybe building off of the last question here on the drivers of fiscal 2025. When you look at the first half versus second half, it does assume a back half step up. We're just curious. Is that being driven by end markets normalizing? Maybe if you could just walk us through from first half versus back half dynamics in fiscal 2025?"
},
{
"speaker": "Bob McMahon",
"content": "Yeah, Vijay. That's exactly right. So, you know, obviously, our first quarter is what I would call artificially depressed just because of the way of the nature of our timing of our fiscal year relative to Lunar New Year. But if you looked at first half versus second half, we're expecting this continued recovery throughout the course of the year. And with a more normalized growth in the back half of the year. And so where does that show up? It shows up in a couple of areas. Obviously, with the potential for China getting better throughout the course of the year. As Padraig mentioned, certainly, stimulus can help that. We've taken a conservative approach on that and not fully baked in with all the activity that we talked about. We'll see how that plays out, but certainly early days are very positive from that standpoint. And then also from a pharma perspective, we're also expecting to see that recovery particularly on the back of Infinity 3 as Padraig just mentioned, and that replacement cycle accelerating. So you're actually seeing those that would be the two biggest and then, you know, continued biotech recovery on the small biotech side as well throughout the course of next year."
},
{
"speaker": "Vijay Kumar",
"content": "Understood. And then one on that maybe margins, we cash. Pretty impressive free cash execution in fiscal 2024. Just wanna make sure I have the numbers right. Is the guide assuming free cash flow down above it, there's a timing element and on the margin sort of similar cadence question, what is Q1 assuming and what drives the back half step up in margins? Thank you."
},
{
"speaker": "Bob McMahon",
"content": "Yeah. So Q1, so let me answer your question around free cash flow. Yeah. We are expecting a slight slip down really a result of a step up in CapEx spending this year versus last year. As we, you know, finished the heavy levels of spending for the NASD expansion for Trane CND. I don't expect that to continue into 2026 and 2027, so you would see that then step back down. So that free cash flow is really a timing issue. In terms of Q1, profitability with the lower revenue, we typically have higher expenses in Q1 as some of the merit resets. We've got our sales meetings and kickoffs meetings there, and then you've got, you know, some January typically is a very light month, but we have a full amount of expenses in there. And then you then also look at the Ignite transformation that Padraig talked about, many of those activities that we've been kicking off will come into play in the second half of the year, which will generate incremental savings both on the top line and the bottom line. And what you'll hear more about that, some of those details at the Investor Day in mid-December."
},
{
"speaker": "Vijay Kumar",
"content": "And so thank you."
},
{
"speaker": "Operator",
"content": "Next question comes from the line of Jack Meehan from Nephron Research. Your line is open."
},
{
"speaker": "Jack Meehan",
"content": "Thank you. Good afternoon. I was wondering if you could just walk us through for the 2025 guide what this assumes for each of the segments. Not sure if you can provide it under the old method or just the new method, but any color would be great."
},
{
"speaker": "Bob McMahon",
"content": "Yeah. I could do that. So if you think about this at, I'll call it legacy number. So LSAG kinda low single digits with the consumables business being kind of mid-single-digit and slower on the instrument throughout the course of the year. That's probably our area where we've taken a prudent approach as we go through the course of the year. It could be more than that, depending on the uptake of the replacement cycle INFINITY 3, but low single digits there. ACG continued to be very strong with mid to high single digits as the instrumentation recovery and then continued double-digit on the services business. Just continues to be a real stalwart of growth, and we still have a lot of opportunity there around rate. And then for DGG, kind of low to mid-single-digit growth. Going forward, which is a recovery, you know, the continued performance of pathology in the genomics businesses, as Simon mentioned, and then a return to growth really for NESD."
},
{
"speaker": "Jack Meehan",
"content": "Right. Okay. And then wondering if you could just talk a little bit more just what your expectations are for LC, LCMS. I think everybody's trying to benchmark expectations for next year and one of your peers sounds a little bit more bullish as it pertains to the cycle. So I don't know if you have any thoughts as we try and compare and contrast some of these results. Any color would be great. And maybe just off of that, any comments you can share around GLP one contribution I think that might be a factor, but any color would be great. Thank you."
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. So, you know, there's a lot of dynamism in terms of replacement cycle. You know, it doesn't happen at any time, as I said before, any one time, but it's across the board in different industries and different times. From our perspective, you know, our LC and LCMS orders are improving. There's no doubt about that. And we have a huge amount of excitement around our Infinity 3. We have a lot of focus programs with our customers around that. So what you will see next year is I think it's a steady increase in cadence of that replacement cycle. You know, it's a little bit too early to call. Will that be gradual over a number of quarters or a bolus in one quarter or maybe then a slowdown and again on the next quarter? But we're really watching that as we go forward. I think we're being very conservative around what we're seeing on that because of a lot of turbulences everybody has seen in the last few years in the market. But I would say customer sentiment is steadily improving. And on the GLP One side, you know, we had a really fantastic year. We grew 30% in GLP one this year. We're involved in a lot of new site build-outs in QAQC departments and actual getting closer to production as well with systems. So a very, very strong year. And actually one thing that's really interesting is through the acquisition of BioVectra, we, of course, have a healthy pipeline of GLP-one and synthetic peptides within their CDMO capability. We're seeing a lot of requests from both sides of the business about how we can help customers both on the analytical side and on the CDMO side. So we're seeing a huge amount of synergies there. So this is a market that's going to continue very strongly and we're going to be really there to take the business."
},
{
"speaker": "Bob McMahon",
"content": "Hey, Jack. Just to build on what Padraig is saying on the LC replacement cycle, I think one of the things is, you know, we're taking a more conservative approach as Padraig mentioned. And I think if that happens, we will get that business rest assured. I would also say, if we look at the age of our installed base, it is continuing to get old. It is well beyond the median now. And throughout the course of next year. So we would expect that to continue to be able to be replaced. Because when we look at the instrumentation through our consumables business and our services business, the activity continues to be high. So these instruments are being used, and so it's only a matter of time to be able to do that replacement."
},
{
"speaker": "Jack Meehan",
"content": "Awesome. Thank you, guys."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Dan Leonard from UBS. Hi. Thank you. Just to clarify on instruments one last time, is your expectation that instrument growth is flat in 2025?"
},
{
"speaker": "Bob McMahon",
"content": "In aggregate across all platforms, our expectation is that it will grow. Low single digits."
},
{
"speaker": "Dan Leonard",
"content": "Okay. And then my follow-up. You mentioned, I think, something about the administration and changes in your food forecast. Are there any other areas where you think the change in US administration could impact your business? Any other areas that you were sensitive to putting together your forecast for 2025?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. Look, there's a lot of changes that can happen at this time. You know, there's a lot of people expecting a lot of change. We have yet to see what those changes will be. Of course, you can see maybe some changes in the NIH funding, which is very low for us as a percentage of the business. We actually expect the PFAS spending will actually increase as it goes forward on it. The area to watch, I would say, is, of course, tariffs, which Bob talked about. We're ready for that. Ready for any scenario on that side. But also on biopharma, I think, is the IRA is also continues to move forward, the International Pricing Index seeing what happens on biopharma is gonna be really important. So that's why we're taking a kind of conservative and prudent approach. So lots going on. But what I would say is from the strategy work, I would imagine, we're ready for all outcomes."
},
{
"speaker": "Dan Leonard",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Puneet Souda from Leerink Partners. Your line is open."
},
{
"speaker": "Puneet Souda",
"content": "Yeah. Hi, Padraig, Bob, thanks for taking my questions. First one, just wanted to clarify on the tariff side. I mean, if there were any retaliatory tariffs could you elaborate on your manufacturing and final assembly positions just globally so we can understand sort of how much of the product is sort of China for China, made in China versus made in other Asian countries and not coming from the US."
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. Maybe I can start off by talking about our, you know, our US supply chain in there. About 60%, as Bob said, is produced in the United States. About 35% is the rest of the world. So it's actually a small percentage that's produced in China. But, of course, we have mitigations and steps there. We have many supply chain areas across the globe that we can move around, and we've done that before since 2018. We expect the impact probably in the quarter of $4 million to $5 million we can probably mitigate that within a few months. So I would say we're waiting to see how that all plays out. But we're already taking steps across potential tariffs. The big question for everybody is that will it be on will it be beyond China? I think everybody's waiting to see what that is, but even in that case, we're ready with mitigations."
},
{
"speaker": "Bob McMahon",
"content": "Yeah. Hey, Puneet. To build on what Padraig is saying, particularly for retaliatory tariffs in China, very little of our revenue now is produced in the US that goes into China. We spent a lot of time and effort building in China for China, and we have a full portfolio of capabilities there. Which is actually really important for us to be able to take full advantage of the stimulus products today. So, and, you know, I think that number will be relatively small. From the standpoint of retaliatory impact from China exports from the US."
},
{
"speaker": "Puneet Souda",
"content": "That's helpful. Thanks. And then, I have a question on Infinity 3 series. Just wondering, given the launch timing, was there any pause that you saw in on the instrumentation? And what is the order book telling you? Do you think this is what's driving, you know, is it a major driver of instrumentation orders in the quarter being positive as you pointed out?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. You know, we had a minimal effect to be honest. We really planned around that and of course, we are very careful with our customers to make sure we bring them through the cycle of replacement. So minimal impact. You know, we're very extremely excited about it. You know, it's a system that not only will be best in class in terms of performance, but also in terms of productivity. And that's what we're hearing loud and clear from our customers. It's about productivity and how it lends their labs to be more productive going forward. We're extremely pleased with the order book that we've seen so far. And we expect that that will continue to ramp and, you know, customers are really voting with their orders on that. So we're excited about that ramp for next year."
},
{
"speaker": "Puneet Souda",
"content": "Okay. Thank you. Look forward to the investor day."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Tycho Peterson from Jefferies. Your line is open."
},
{
"speaker": "Tycho Peterson",
"content": "Hey, thanks. Wanted to probe in a little bit. Are you able to delineate what LC did and what mass spec did in the quarter? And then just thinking a little bit about the new administration, I know you're not guiding for any budget flush here, but is there any risk of kind of pause in spending given all the moving pieces around pharma? What are you hearing from customers at this point?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. Maybe I can start with the second part, Tycho. We're not seeing a pause from pharma validating. We're actually seeing a little bit more activity. So we're not seeing that across the board, and that's about the US and globally. And, of course, that's something we really want to watch with the new administration coming in. And what transpires over the next few weeks. But in terms of the LC and LCMS, Bob, I don't know if you got any color on those."
},
{
"speaker": "Bob McMahon",
"content": "Yeah. Hey, Tycho. Just to give you a couple of different pieces of data. If I look at our pharma business overall, it was down low single digits. Pharma, small molecule was actually up 3% overall with biotech or biopharma being down. If we look at specifically LC, LCMS, within pharma, it was up low single digits."
},
{
"speaker": "Tycho Peterson",
"content": "Okay. That's helpful. And then the follow-up on NASD, I know I think you're talking back to growth in 2025. Can you maybe just talk a little bit about your ability to cross-sell with BioVectra and then how are you thinking about clinical versus commercial customers?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. I'll start off, Tycho, and I'll hand it over to Simon. You know, first of all, we are extremely pleased on the cross-selling ability between the two businesses. It was one of the key sources of value about why we did the BioVectra acquisition that customers were asking us for this capability, a broader range of capability, and we've seen that actually accelerate from both sides. Simon, I don't know if you want to add more color on NESD."
},
{
"speaker": "Simon May",
"content": "Yeah. Just to build on what Padraig said with BioVectra and the NASD cross-pollination, there's been really strong engagement between the teams. In fact, they spent several days together in our Boulder facility last week, and I'd say they came away really energized that the portfolio complementarity fit between businesses is exactly as we expected. In fact, maybe a little bit more so. Then as we think about NASD going into FY 2025, I think as Bob mentioned earlier, we're projecting high single-digit growth for the business. The order book looks really strong in NASD, but it's important to understand the nuances of the mix in that order book. We've got a number of commercialization qualifications going on right now. So in terms of FY 2025 revenue, there's a lot of energy going into that with relatively limited revenue upside, and a lot of that's gonna actually hit towards FY 2026. But, again, the order book overall is very healthy. And as we think about twelve, eighteen, twenty-four months view, we're really bullish about what we're seeing. But once again, high single-digit growth, maybe we'll nudge double-digit in NASD in FY 2025?"
},
{
"speaker": "Tycho Peterson",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Brandon Couillard from Wells Fargo. Your line is open."
},
{
"speaker": "Brandon Couillard",
"content": "Hey, thanks. Good afternoon. Just on the Infinity 3 launch, can you remind us, you know, when the Infinity 2 I think it's the 1290 system rolled out. And what's the is there an ASP premium? Is there an ASP kicker to this replacement cycle this time as well to the three versus the legacy two system. Thanks."
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. We don't talk about a difference in pricing on it, you know, but I think we've had a number of years, of course, very, very successful years with the Infinity 2 and this builds on success. I will say that the installed base for Agilent is way broader than the Infinity 2. You know, we have 1100s that are very, very prominent out there. We have a lot of labs with 1100s and those are the labs for us, I think, that are gonna be talking about replacement. But we also have seen significant interest from Infinity 2 customers because the CDXTR productivity capability is really going to help them in the lab. So I would say it's not just, you know, one series to the next. It's a broad install base replenishment we're gonna see."
},
{
"speaker": "Bob McMahon",
"content": "Yeah. All I would say is pricing has held up very nicely. Early days."
},
{
"speaker": "Brandon Couillard",
"content": "Okay. And then Bob, how much of the CapEx is in Nexter is tied to the train B and build out for NASD, we expect those to come online, and what does maintenance CapEx look like? In fiscal 2026? Thanks."
},
{
"speaker": "Bob McMahon",
"content": "Yeah. That's a great question. So roughly half is NASD between the continued build-out and the validation activities of that $450 million. If I look at, kinda maintenance CapEx, think about it in, you know, kinda two and a half to three times sales. Range on a go-forward basis."
},
{
"speaker": "Brandon Couillard",
"content": "That's total cover. Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Doug Schenkel from Wolfe Research. Your line is open."
},
{
"speaker": "Doug Schenkel",
"content": "Good afternoon, guys. Thanks for taking my questions. Just want to start first with a question on guidance philosophy. Just to be clear, it sounds like you're trying to factor in a degree of conservatism on China stimulus, the impact of uncertainty as it relates to the new administration, and conservatism on a potential LC replacement cycle. Hopefully, I'm not missing anything there. But is it fair to say that the error bar around your assumptions are wider than normal heading into a new fiscal year and your intent across the board was to make assumptions that were consistently on the lower end of those error bars?"
},
{
"speaker": "Padraig McDonnell",
"content": "I think you said it well. You know, we were very conservative in that because of those reasons, you know, what is the expected LC replacement cycle recovery? Is it faster? Is it, you know, is it a little bit less than that? The China stimulus, you know, which is very early days, you know, I think we want to make sure that we continue to monitor that. And, of course, whether we see improved conditions or not in terms of sentiment in the US. So all of these things are factoring into this. So it is conservative in what we're guiding, but also I'd say here, the bars are wider than normal."
},
{
"speaker": "Doug Schenkel",
"content": "Okay. Thank you for that. And just as always, correct me if I'm wrong, but I believe in your prepared remarks, you indicated that small molecule was up low single digits while biopharma was down mid-singles. If I have that right, is that comp effect, or are you seeing more of a recovery in demand amongst, you know, small versus large molecule applications, and I guess, finally, if so, why? That seems to be a little contradicting just curious if you could give us a little more there."
},
{
"speaker": "Bob McMahon",
"content": "Yeah, Doug. You know, you heard it right. Our small molecule business was up low single digits across both instruments. You know, it was the combination of instruments and services. And our biotech, our large molecule was down mid-singles. Now if you took out NASD, which shows up in the large molecule, it was down low single digits. So better recovery than the mid-single digits. And it actually speaks to, I think, that continuation of volume in small molecule. You know, if you look at pill count, it continues to go up. And these are, you know, well-capitalized companies. They have probably the older fleet you just think about kind of the replacement versus kind of the biotechs of the world, and so we're expecting that to continue and, it was the first to kind of go down. And so we're, you know, in the cycle, and I think we're expecting it to be the first, you know, moving positive. Now we think there's more upside in biotech than there is in small molecule, but it certainly is a nice leading indicator around the idea around this replacement cycle."
},
{
"speaker": "Doug Schenkel",
"content": "Okay. Thanks very much."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Michael Ryskin from Bank of America. Line is open."
},
{
"speaker": "Michael Ryskin",
"content": "Great. Thanks for taking the question, guys. First, I want to ask a quick follow-up on China stimulus. I know you kinda touched on them in a couple of different questions. But early in the prepared remarks, you did make some comments of, you know, seeing some initial China stimulus orders come in. I think China in the quarter exceeded your expectations. I know there's not a lot embedded directly into the guide. But could you just walk us through sort of, like, how China's stimulus could play out next year? And I'm asking this from a perspective of, you know, gradual ramp as you go through the year. Is it gonna be a trickle? Is it could it be very back-end loaded? It's just trying to think through the various scenarios and what you're looking for there. Once the initial order is clear."
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. Look. I think what we've seen is that it's much broader. The stimulus in terms of range. We spoke about that before. We see it, you know, both on commercial and government accounts. Our first orders have actually come in from government accounts. We've been highly successful in those overall tenders, and we're in the low millions range, low single-digit millions range of orders to bring. We're expecting to close much more this quarter. And one thing that's really playing into our favor is our broad platform capabilities. Including the technical capabilities of our teams up and running. And you couple that with our Made in China initiatives that we really invested over the last year, it puts us in a very, very strong position to capitalize, but it'll be interesting to see how that's launched. Past the first quarter, we don't have great visibility yet, but, of course, a lot of deal activity. But the first quarter is looking very strong in terms of orders."
},
{
"speaker": "Bob McMahon",
"content": "Yeah. Hey, Mike. And just to kind of frame it, kind of how we're thinking about China to your point. If we took Q4 and just divide it by or multiply it by four, that would get you to that low single-digit growth. Now we're expecting a recovery throughout the course of the year, but that kind of gives you a sense for what we put in the initial guide and we'll know a lot more about those timing of the stimulus revenues going forward. You know, once we actually get those awarded and then the delivery dates and so forth. But we do think that that'll occur throughout the course of the year."
},
{
"speaker": "Michael Ryskin",
"content": "Okay. That's helpful. And then, Bob, maybe for you, just on the margin guide for next year, fifty to seventy bps. So really impressive starting point honestly better than I think a lot expected. Especially given, you know, still a little bit of a subdued top-line environment. How much of that can you attribute to Ignite and sort of, you know, maybe some of the transformation or one-time cost savings, how much is just the underlying strength of the business, maybe beside the price or some mix shift next year? Just a little bit of what's going into that margin expansion for next year?"
},
{
"speaker": "Bob McMahon",
"content": "Yeah. What I would say, Mike, is it's a little of all those things. So maybe stay tuned, and we'll give you a little more meat on the bones here come mid-December. But we certainly have some incremental opportunities both in price and, you know, cost efficiencies associated with the Ignite transformation. And those things will start to feather into the second half of this year, as I mentioned before. If you recall, the first half of this year also has the annualization of the savings of the actions that we had to take in the June, July time frame as well. So we're benefiting and then you also have the merit increases and so forth that gets reset. And so you'll actually see this throughout the course of the year through a series of initiatives that have already been kicked off."
},
{
"speaker": "Padraig McDonnell",
"content": "And I would say just following up on that, Bob, we're very excited to meet everybody in December in New York to talk about it. It's an extremely well-thought-out program. It's across the board. It's ultimately gonna help us to invest for growth in key areas as well as margin expansion."
},
{
"speaker": "Michael Ryskin",
"content": "Okay. Thanks a lot, guys."
},
{
"speaker": "Operator",
"content": "And your final question comes from the line of Dan Brennan from TD Cowen. Your line is open."
},
{
"speaker": "Dan Brennan",
"content": "Great. Thanks for taking the questions here. Maybe the first one just on pharma. In the Americas. I think you called that in the prepared remarks Americas Pharma XMASD was kind of maybe a weaker spot. You just unpack a little bit what's happening in, you know, US versus, say, Europe, rest of the world and kind of, you know, what's kind of assumed from what happened in 4Q in 2025?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yeah. I mean, look, we saw a lot of strength in Europe in terms of pharma. I wouldn't read too much into the American numbers. You know, I think there is, of course, companies wondering about their CapEx budgets and that comes at different phases. But we expect, we expect Pharma to continue."
},
{
"speaker": "Dan Brennan",
"content": "Okay. That's helpful. And then maybe just one on if I can just go into the broader market. I know you talked about the period in Mark's, Bob, and a few times it came up like you're expecting a below-trend market. At least it sounds like for the first half of the year, can you just remind us in terms of your kind of growth algorithm maybe, like, what would what is your assumptions based upon for a market growth typically? Kinda what are you assuming? And kind of specifically, is it just pharma that's weaker? Or are there other spots that you're pointing to that are below trend? And, you know, any color on that would be helpful. Thank you."
},
{
"speaker": "Bob McMahon",
"content": "Yeah, Dan, if we looked at the long-term growth rates of our markets, we believe those are mid-single digits, you know, four to when you look at the aggregate across. We're obviously not expecting that for the full year here. We are expecting that we're doing better than the market. If you look at kinda how we exited here roughly flat on a core basis, you know, if you adjust for the timing of Lunar New Year, you know, you had the midpoint one percent, you know, and expect that kind of performance to continue that cadence. And so you would have the second half of the year a more normalized kind of growth rates. And so it's really across the board. We're seeing, you know, some of the industrial or applied markets things like CAM being a little ahead of the curve and certainly our diagnostics and clinical business continues to be strong. It has been throughout the course of this year. Exiting at a very healthy rate, and I would expect that to continue. The big ones are pharma coming in and then, you know, some of the other applied markets as well."
},
{
"speaker": "Operator",
"content": "And this concludes the question and answer session. Mr. Ahuja, I turn the call back over to you."
},
{
"speaker": "Parmeet Ahuja",
"content": "Thanks, Rob, and thanks everyone for joining the call today. Before we sign off, I'd like to wish everyone a happy Thanksgiving. Have a good rest of the day and week everyone."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. You may now disconnect."
}
] |
a | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Ladies and gentlemen, welcome to the Agilent Technologies Q3 2024 Earnings Call. My name is Regina and I will be coordinating your call today. [Operator Instructions] I will now hand you over to your host, Parmeet Ahuja, to begin. Please go ahead."
},
{
"speaker": "Parmeet Ahuja",
"content": "Thank you and welcome, everyone, to Agilent's conference call for the Third Quarter of Fiscal Year 2024. With me are Padraig McDonnell, Agilent President and CEO; and Bob McMahon, Agilent Senior Vice President and CFO. Joining in the Q&A will be Phil Binns, President of the Agilent Life Sciences and Applied Markets Group; Simon May, President of the Agilent Diagnostics and Genomics Group; and Angelica Riemann, President of the Agilent CrossLab Group. This presentation is being webcast live. The news release for our third quarter financial results, investor presentation and information to supplement today's discussion, along with a recording of this webcast are available on our website at www.investor.agilent.com. Today's comments will refer to non-GAAP financial measures. You will find the most directly comparable GAAP financial metrics and reconciliations on our website. Unless otherwise noted, all references to increases or decreases in financial metrics are year-over-year and references to revenue growth are on a core basis. Core revenue growth excludes the impact of currency and any acquisitions and divestitures completed within the past 12 months. Guidance is based on forecasted exchange rate. As a reminder, beginning in the first quarter of fiscal 2024, we implemented certain changes to our segment reporting structure related to the move of our Cell Analysis business from LSAG into DGG. We have recast our historical segment information to reflect these changes. These changes have no impact on our company's consolidated financial statements. During this call, we will also make forward-looking statements about the financial performance of the company. These statements are subject to risk and uncertainties and are only valid as of today. The company assumes no obligation to update them. Please look at the company's recent SEC filings for a more complete picture of our risk and other factors. And now, I'd like to turn the call over to Padraig."
},
{
"speaker": "Padraig McDonnell",
"content": "Thanks, Parmeet. Good afternoon, everyone and thank you for joining today's call. The Agilent team executed well in the third quarter and posted solid results, delivering better-than-expected revenue and earnings. Revenue of $1.578 billion, declined 4.4%, an improvement of 300 basis points from Q2, reflecting the steady improvement in the market. Operating margin of 27.4% improved sequentially, as the actions we announced last quarter start to deliver. And we remain on-track to deliver the incremental annualized savings of $100 million by the end of the fiscal year. Earnings per share of $1.32 is $0.04 above the high end of guidance. As a result of our strong Q3 performance, we are raising our guidance at the midpoint for both revenue and EPS and we continue to make investments in our most promising growth opportunities that I referenced in our Q2 call. We are investing in our digital ecosystem to further enhance our differentiated customer experience, plus we are mobilizing the organization to accelerate value creation through strategic transformation initiatives, driving margin expansion and growth and increasing our execution capabilities. Separately in the quarter, we were excited to announce two acquisitions that demonstrate our focus on biopharma and our digital ecosystem, which I'll talk about in a moment. As you know well, the pace of change is faster than ever. Our markets, customers and competitors are not standing still, neither are we. We are accelerating our pace of innovation and execution, so we can add to and capitalize on opportunities in front of us. We are sharply focused on key growth vectors, including biopharma, PFAS and Advanced Materials. I continue to meet and connect with employees, customers and shareholders around the globe to listen to their perspectives on how we should build on our strengths and move Agilent forward. The entire Agilent team is clear on what is vital to the company's future, becoming even more customer focused and even more nimble to continue to win in the marketplace and add value to customers and shareholders. We are evolving our strategy, adapting quickly to market trends and changes, while accelerating our pace of innovation in areas of greatest return for long-term growth. We're excited to announce that you'll hear more about these topics and our transformation at our Investor Day we have planned in New York on December 17th. Now, let's talk further about our Q3 results. All our end markets except academia and government, which is our smallest, ended the quarter better-than-expected. Our largest market pharma declined high-single-digits, slightly better than our expectations and while biopharma continues to be pressured, we are seeing relatively better performance in small molecule. Our leadership in providing workflow solutions for PFAS continued to show strong performance in the environmental markets. Geographically, Europe exceeded expectations led by small-molecule pharma, as well as continued strength in environmental. Our other regions performed roughly in-line with expectations. While capital equipment budgets remain constrained, we continue to see good lab activity in Q3 with services plus consumables growing mid-single digits. When looking at our performance by business unit, the Life Sciences and Applied Markets Group reported $782 million in revenue, down 7%, while the instrument side of the business remains constrained, it was encouraging that our instrument book-to-bill was again greater than one. The group saw a decline across all regions and most end-markets with low single-digit growth in Environmental & Forensics. The Consumables continue to be a bright spot, growing by mid-single digit. The LSAG team also was busy innovating with the introduction of the 8850 GC that helps customers reach their sustainability goals by delivering answers efficiently, while using up to 30% less power than other GC's and has a much smaller footprint. Moving on to the Agilent CrossLab Group, the business delivered revenue of $411 million for the quarter, up mid-single digit. ACG grew in every region except China, where we were down modestly year-on-year, but showed meaningful improvement versus last quarter. Once again, we drove double-digit growth in service contracts, which represented nearly 70% of the total business. And beyond another quarter of solid revenue growth, ACG also delivered a record operating margin of 34%, demonstrating that the resiliency and strength of the recurring revenue business continues despite the constrained capital equipment environment. The continued strength of our business is a testament to our strategy of increasing the connect rates on our instruments and the ongoing value we are providing to our customers in helping them reach their productivity goals. The Diagnostics and Genomics Group posted $385 million in revenue, representing an 8% decline. Pathology grew mid-single digits globally and was offset by declines in Cell Analysis, NASD and genomics. NASD stepped down sequentially in Q3 as expected and we are on track for NASD's revenues to step-up sequentially in Q4. In the face of a constrained CapEx environment, the Agilent team has remained consistent in putting our customers first and fostering deeper relationships with them. We continue to execute well and be disciplined, while investing in high-growth opportunities. As I mentioned earlier, we were thrilled to announce two acquisitions, that speak to our focus on biopharma and increasing recurring revenue, as well as on strengthening the digital ecosystem for Agilent customers. In late July, we signed a definitive agreement to acquire BIOVECTRA, a leading specialized contract development and manufacturing organization. The Canada-based company builds on Agilent's capabilities in oligonucleotides and CRISPR therapeutics by expanding our portfolio of services. BIOVECTRA adds rapidly growing modalities in microbial fermentation, antibody-drug conjugates and high-potency active pharmaceutical ingredients. It also brings world-class capabilities that when combined with NASD enables us to deliver customers a complete gene editing solution. The company delivered more than $110 million in revenue during the calendar year 2023 and expects double-digit revenue growth this year. The BIOVECTRA acquisition remains on-track to be closed by the end of the year and we're looking-forward to welcoming the BIOVECTRA team to Agilent. At the end of the quarter, we also announced the acquisition of California-based Sigsense, a start-up that uses artificial intelligence and power monitoring to help customers optimize their lab operations. Sigsense Technology already is available to our customers through CrossLab Connect, a suite of digital applications that improve lab performance. A hearty welcome to the Sigsense team who already is part of Agilent. During the quarter, we released our annual ESG report, which showcases a large and growing portfolio of products that help our customers reach their sustainability goals. Instruments certified with the My GreenLab ACT label now accounts for 40% of all instrument revenue and we continue to regularly release products like the new 8850 GC with environmental benefits. We are also proud that we have recently ranked in the top 20 of Time Magazine's 500 Most Sustainable companies in the world. Bob will now provide the details on our results, as well as our outlook for the remainder of the year. After Bob delivers his comments, I will be back for some closing remarks. Over to you, Bob."
},
{
"speaker": "Bob McMahon",
"content": "Thanks, Padraig and good afternoon, everyone. In my remarks today, I'll provide some additional details on revenue in the quarter, as well as take you through the income statement and other key financial metrics. I'll then cover our updated full-year and fourth quarter guidance. Q3 revenue was $1.578 billion, a decline of 4.4% core, but a 300 basis-point sequential improvement as Padraig noted. Excluding China, revenue declined low-single digits in the quarter. On a reported basis, currency had a negative impact of 1.1 percentage points, while M&A had a negative impact of 10 basis points, resulting in a reported decline of 5.6%. Our largest end market pharma declined 8%. Biopharma was down low double-digits or down mid-single digits, excluding NASD. Small molecule performed better, down mid-single digits and was led by growth in Europe. Services and pharma continues to perform well, growing high single-digit. In Chemical & Advanced Materials, revenue declined 5%, with growth in Americas offset by softness in China. Our Advanced Materials sub-segment performed better, driven by our business in the semiconductor market. Academia and government, our smallest market, can be lumpy from quarter-to-quarter. We saw a decline of 11% as Europe and China both saw double-digit declines, partially offset by better performance in the Americas region. Our business in the diagnostics and clinical end-market grew 2%, including continued mid-single digit growth in pathology, offset by ongoing softness in genomics. In Environmental & Forensics, we grew 4%, another great quarter for our PFAS testing business. We saw robust business in Europe, led by the new EU Water Directive and in China due to the nationwide emerging pollutants program. Now wrapping up our end-markets, food was down 3% versus last year, but grew sequentially and was led by Asia, ex-China. Moving on to our regional performance, Europe was flat overall, beating our expectations, while we declined 6% in the Americas and declined 1% in Asia, ex-China. China revenue declined 11% with quarterly revenue improving sequentially, driven by growth in services and consumables. This speaks to some increase in lab activity, which is encouraging. Now, let's move on to the rest of the P&L. Gross margin was 56.0% in the quarter, down slightly versus a year-ago, but up 40 basis points sequentially. Our operating margin of 27.4% improved sequentially and was better-than-expected. Despite the dampened demand, we continue to make good progress in driving our productivity initiatives and continuing to manage the cost structure very well, while investing for growth. As Padraig mentioned, we are on track to deliver the $100 million in incremental annualized cost-savings by the end of the fiscal year. Below the line, our net interest income was in line as was our tax rate of 13% and we had $291 million diluted shares outstanding in the quarter. Putting it all together, Q3 earnings per share were $1.32. That was ahead of our expectations, but down 7.7% from a year ago as we went up against a difficult compare due to the variable pay reset in Q3 of last year. Now, let me turn to cash flow and the balance sheet. We continue to enjoy a very strong balance sheet and healthy cash flows. Operating cash flow was $452 million in the quarter and we invested $92 million in capital expenditures. As we committed in Q2, we ramped-up our share repurchases starting here in Q3. We purchased $585 million in shares and paid out $68 million through dividends, for a total of $653 million returned to shareholders in the quarter. This includes $500 million of the previously announced $750 million opportunistic share repurchase and we expect to complete the additional $250 million repurchase in Q4. We ended the quarter with a net leverage ratio of $0.6 and even with the upcoming BIOVECTRA acquisition, our balance sheet and leverage ratios will still be in a very strong position. In summary, we performed well and continue to see a steady improvement in the market and expect that to continue into FY 2025. Because of our Q3 results, we are increasing the midpoint of our revenue and earnings per share guidance for the year. We now expect full-year revenue to be in the range of $6.450 billion to $6.500 billion. This represents a decline of 5.6% to 4.9% on a reported basis and a decline of 5.0% to 4.3% on a core basis. Currency and M&A combined are a headwind of 60 basis points. Full-year non-GAAP earnings per share are now expected to be between $5.21 and $5.25, representing a decline of 4.2% to 3.5%. This assumes net interest income of $38 million, a 13% tax rate and $292 million fully diluted shares outstanding. We have not included any impact of the BIOVECTRA acquisition in our updated guidance and $0.06 does not have a material financial impact to the year or Q4. This full-year guidance translates into Q4 revenue in the range of $1.641 billion to $1.691 billion. This represents a decline of 1.9% to 1.1% growth on a core basis and a decline of 2.8% to 0.2% growth on a reported basis. Currency and M&A are a combined headwind of 90 basis-points. Fourth quarter non-GAAP earnings per share are expected to be between $1.38 and $1.42, marking a return to growth at the midpoint. We expect a 13% tax rate, a decrease in net interest income to $5 million due to the lower cash balance and $287 million diluted shares outstanding for the quarter. Now, I'd like to turn the call back to Padraig for some closing comments. Padraig?"
},
{
"speaker": "Padraig McDonnell",
"content": "These are exciting times at Agilent, with a team that is second to known, we are doubling down on our customer force culture and deepening our relationships to further enhance our market leading customer experience that is already the best in the industry. We are evolving our strategy to aggressively pursue our ambition to grow in markets where we have a right to win through both organic and inorganic growth and we will continue to accelerate value creation through strategic transformation initiatives. We remain a leader across key platforms and we're in great long-term growth markets that are beginning to show evidence of recovery. And best of all, our team is engaged, leading to Newsweek including Agilent on its America's Greatest Workplaces 2024 list. Again, thank you for joining today's call. I'm energized by how we are evolving Agilent. Each data team gains momentum in building an enduring company that sets the standard for excellence with our customers and creates value for our shareholders. We are fueled by the future possibilities and I look forward to continuing to share our progress. Parmeet, over to you for Q&A."
},
{
"speaker": "Parmeet Ahuja",
"content": "Thanks, Padraig. Regina, if you could please provide instructions for Q&A now?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question will come from the line of Matt Sykes with Goldman Sachs. Please go ahead."
},
{
"speaker": "Matt Sykes",
"content": "Hi, good afternoon. Thanks for taking my questions. Maybe the first one, just digging in a little bit on the LSAG where you had a pretty solid beat. It looks like that was driven primarily by consumables and services. So, I'm curious if you can give any more color on what instruments did? I know you had a book-to-bill above one, but just how does that inform your view as we go into 2025 on the replacement cycle, specifically large biopharma demand and how that might impact your view on when that replacement cycle starts kicking-in?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Thanks a lot, Matt, maybe I'll kick it off and give it to Bob. I think, first of all, you're correct, we saw very, very promising growth in both Consumables & Services, which shows lab activity is actually improving or is very stable. We're still very challenged on the instrument side, but what we're seeing is, we're seeing a lot of activity around conversations with lab managers. Our funnel is extremely stable. We haven't seen any -- any cancellations. But what I would say is that, deal closure times are still elevated. So we're not at this point seeing any budget towards the end of the year and which of course for us ends at the end of October, but we're watching that closely. I don't know if you want to add anything, Bob?"
},
{
"speaker": "Bob McMahon",
"content": "Yes. Thanks, Matt, for that question and maybe just to fill in and add some additional commentary to what Padraig was saying. When we looked at the quarter, we were very pleased actually both our Consumables business, as well as our Instrument business performed better-than-expected in the quarter. We were down 7% in total. Our Consumables business was actually up mid-single digits towards the high-end there. And our Instruments business was down low-double-digits, but that was better than what we expected. And as Padraig mentioned, we had a book-to-bill that was greater than one on the instrument side again this quarter, which was very encouraging."
},
{
"speaker": "Matt Sykes",
"content": "Got it. Thanks for that. Very helpful. And then just on Academic & Government, I know you've talked about it and you've talked about it for a while, how volatile that can be, but just given sort of the two quarters in a row of sort of negative performance there and you called out Europe and China specifically. Are there any kind of durable trends you're seeing either in funding or in demand that you think might be more persistent in that specific end-market as we go through Q4 and then as we look into 2025?"
},
{
"speaker": "Padraig McDonnell",
"content": "No, I think, look, we saw a decline of about 11% and that was really against the comparative feature, the stimulus in EMEA and strong results in APAC and China. And so it was a really tough compare. And I think what we're seeing is funding remains stable in most regions and except I would say Europe where we're seeing a reallocation of funding towards defense, but I would say no major changes in that market."
},
{
"speaker": "Matt Sykes",
"content": "Got it. Thank you very much."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Rachel Vatnsdal with JP Morgan. Please go ahead."
},
{
"speaker": "Rachel Vatnsdal",
"content": "Perfect. Good afternoon. Thanks for taking the questions you guys. I wanted to dig into NASD a little bit. Obviously, we had some positive announcements intra quarter with the Helios-B readout. You mentioned that NASD stepped down sequentially as expected and then you said you're expecting that to then step up into fiscal 4Q. So could you unpack all that for us a little bit? How should we think about the magnitude of the step-up into 4Q? And then given some of the updated data readouts that we got intra quarter, how does that underpin your assumptions on NASD next year and then also long-term?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Look, I'll start off and maybe I'll hand it over to Simon, who is on the call here as well. We've seen, with clinical batches, of course, there can be changes with customers progress in those batches. We're not seeing any changes in what we're saying for Q4, so we're fairly certain of Q4 on that. What we're seeing as well is that we've grown our clinical business over 50% this year, which is very promising. The long range view of the market is very strong with the drugs and the modalities that are being used. But I think what you're seeing is a normal kind of up and down between quarters with that business. But I don't know if you want to add any more color, Simon?"
},
{
"speaker": "Simon May",
"content": "Yes, I'd just echo what Padraig said, I think the Q3 performance that we saw in NASD was largely in line with expectations. And in that business, we always see a natural lag between order booking activity and revenue recognition because of the length of time that these programs take. And towards the end of last year, we were really seeing the effects of the IRA impacts and that's still not completely waned, but what we saw in Q3 was pretty strong bookings activity. So as we look to Q4 and into 2025, I think we're cautiously optimistic about seeing a return to growth there. So I'd really just characterize Q3 as in line with expectations and part and parcel of the lumpiness you see in this business. You also mentioned Helios, I think it's just worth mentioning that we were very happy to see that development, but still very early days in terms of how that's going to ramp up and play out and too soon to say where that's concerned. There's certainly no impact in the remainder of 2024 and unlikely in 2025 as well."
},
{
"speaker": "Bob McMahon",
"content": "Yes. Hey, Rachel, this is Bob. Just to add-on a little more to answer your last part of your question in terms of the sequential step-up where we had talked -- as Simon and Padraig had said, we've done a little better actually in Q3 than we expected and we're expecting a roughly $20 million step-up from Q3 to Q4. Those orders are all in-house and we're still on-track for the long -- the full-year estimate for NASD and that's incorporated into our guidance."
},
{
"speaker": "Rachel Vatnsdal",
"content": "Great. That's helpful. Then for my follow-up, I just wanted to dig a little bit more into 4Q guidance and what that means in terms of an exit-rate into 2025. So appreciate some of your comments earlier, you highlighted in Matt's question that you're not really assuming a budget flush for your fiscal year end in October. But I guess, how should investors look at this 4Q number on an organic growth basis of that down 2% to up 1% on the range. And how do we look at that translating into 2025? If I look at consensus right now, consensus is just shy of 5% organic on 2025, Street is also nearing that double digit EPS growth. So I appreciate it's still a little bit early for you guys to formally give us 2025 expectation, but what do you think about exit rate and where sell-side numbers are right now?"
},
{
"speaker": "Bob McMahon",
"content": "Yes, you were reading my mind, Rachel. This is Bob and it is a little too early to talk about FY 2025. But I think what it does show is our expectation of this continued steady improvement. We improved here in Q3, 300 basis-points sequentially. We're expecting another improvement here going into Q4. And I would expect that improvement to continue into FY 2025. So -- and we do expect -- while it's too early to give you a specific number, we do expect to grow next year. These markets will return and we've been below the long-term trend, but there's nothing to suggest that the or the long-term growth rates of these markets, there's nothing to suggest that these markets have changed and so we're optimistic about continued recovery going into FY 2025."
},
{
"speaker": "Rachel Vatnsdal",
"content": "Understood. Thanks, guys."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Patrick Donnelly with Citi. Please go ahead."
},
{
"speaker": "Patrick Donnelly",
"content": "Hey, guys. Thank you for taking the questions. Bob, maybe one for me, just on China, how you guys are thinking about the region there? It sounds like it was down 11%, that got a little bit better on the revenue side sequentially. It sounds like again, lab activity maybe look a little bit better. Could you just talk about expectations into year-end? Some of your peers have suggested you could see a bit of a pause on the capital side into calendar year-end as we wait for a little clarity on the stimulus. Just how you guys are thinking about China, again, not only into your fiscal year, but just into the year-end on the calendar side and what's your view in terms of do we see a little bit of an air pocket here until the good news dollars get firmed up?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes, Patrick. It's a great question and we had actually seen a little of that in our Q2 of last -- just a quarter ago here really on the bid activity, primarily for instrumentation. We are optimistic about the mid-term here in terms of the stimulus. That's probably more FY 2025 event probably. But what we are seeing is more activity there and I think what's encouraging and maybe I can turn it over to Angelica as well, our services business has seen an increase in a pickup in activity and certainly we saw consumables as well. So it still dampened demand and we did see that impact in Academia & Government, that was the biggest impact in China, but we are seeing some pockets of green shoot in terms of recovery."
},
{
"speaker": "Angelica Riemann",
"content": "Yes, Bob, I'll just add. In China, we are encouraged from a services perspective on the nice sequential growth that we saw from Q2 to Q3, which is indicative of continued and somewhat increasing lab activity in China."
},
{
"speaker": "Patrick Donnelly",
"content": "Okay. That sounds encouraging. And then maybe another one for you, Bob. Just as we think about the margin construct as we work our way into year end and into 2025, maybe just remind us some of the moving pieces to think about high-level as we look ahead to next year, obviously, the cost out program seems to be progressing well to your point, the margins came in nicely here in 3Q. But yeah, maybe just the moving pieces as we go ahead to next year without talking too much about the top line, obviously, the volume matters there. But just kind of down the P&L, how to think about some of the margin algo for next year would be helpful."
},
{
"speaker": "Bob McMahon",
"content": "Yes, I think as we talked about, Patrick, it's a great question and we're committed to continuing to drive efficiencies across all of the P&L line items and I think you've seen that across the actions that we've taken. We're on track to delivering that $100 million of incremental annualized savings by the end of 2024. So there will still be a tailwind, obviously going into 2025 for that benefit. Offsetting that will be some resets of our variable pay and activities like that, but we are committed to covering that. If I think about it at the highest level, what I would expect us to continue to be able to do is drive leveraged earnings next year. And I think you're seeing that the scale benefit that we're seeing in certainly our ACG business here this last quarter, just phenomenal profit contribution and I think with volume coming back into the instrument business as well, that will set us up nicely for next year. So think about a nice incremental tailwind associated with the continued actions or the annualization of that actions that come in FY 2025, partially offset by merit in some of the activities and then we'll have our ongoing productivity measures and some -- we'll actually share some of the more detail around this probably in our Analyst Day in December. So stay-tuned on that as well."
},
{
"speaker": "Patrick Donnelly",
"content": "Thanks. Okay. That's great. Thank you, guys."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Jack Meehan with Nephron Research. Please go ahead."
},
{
"speaker": "Jack Meehan",
"content": "Thank you. Good afternoon. I wanted to dig into some of these instrument trends a little bit more. I was wondering, if you could talk about just what you're seeing across some of the big categories like LC, LCMS, GC, spectroscopy, any color on how those performed?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes, I mean in general terms, Jack, I think you know the customers are very, very cautious. But what I will say is that lab manager remain very engaged with our sales teams about future projects, that is true. We see a lot of stability in that. So it's still very challenged and I would say that, you know our deal close rate is still elevated, but our funnels are very stable with low cancellations. So I think that goes across most of the markets. And as you see going-forward, you know our results in CST and services growing mid-single digits and bodes very, very well in terms of lab activity increasing. So we're seeing slow, but steady improvement."
},
{
"speaker": "Bob McMahon",
"content": "Yes. Hey, Jack, just to follow-on to that. I think one of the things as we mentioned in the call, the book-to-bill being at one for instruments is a positive sign. It was slightly better than what we expected. Overall, LSAG instruments were down low-double-digit."
},
{
"speaker": "Jack Meehan",
"content": "Yes. Yeah. Were all the categories kind of right around there?"
},
{
"speaker": "Padraig McDonnell",
"content": "I would say if you looked at the LC and LCMS business, they were in the mid-teens, our spectroscopy business better than that."
},
{
"speaker": "Jack Meehan",
"content": "Okay. And then just as one end-market follow-up, I was curious in CAM in the third quarter, so it was down 5%, it was a little bit below what I was thinking. Is there anything just within the different categories within that end-market that softened a little bit relative to what you were thinking a few months ago?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. So, you're correct, it was declined by 5% and it was really due to the impact of overproduction in China, which negatively impacted market investments globally. But we did see increases in service and consumables, both combined at 7% increase, but there was a decrease of about 14% in instruments and I think CapEx spending remains slightly challenged there."
},
{
"speaker": "Jack Meehan",
"content": "Yes. That makes sense. Thank you, guys."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Vijay Kumar with Evercore ISI. Please go ahead."
},
{
"speaker": "Vijay Kumar",
"content": "Hey, guys. Thanks for taking my question. One, I guess, Padraig or Bob, if you look at the guidance change over the last three months, NASD, China, biopharma, those have been the big categories, right? I think the guide assumes NASD doubled -- down double digits in fiscal 2024, China down high singles, double-digits, biopharma down, which of these is expected to get better next year? What is getting better or worse? And is there a first-half versus second-half dynamic that we should be aware of?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes, Vijay, thanks for the question. I think in terms of what we expect getting better, we expect all of them to improve next year. We raised the midpoint of guidance, $15 million on revenue and $0.03 in EPS and we see across all those areas, markets improving slowly and that's reflected in the sequential increase that we're guiding in Q4. So while we had a kind of a solid Q3, the end market environment for capital remains constrained and visibility while improving is still difficult."
},
{
"speaker": "Vijay Kumar",
"content": "Understood. And maybe on that Q4 commentary for guidance implies I think up 6% or 7%, which seems generally in line with your historical sequential step-up from 3Q. And is the bookings trends that we saw and NASE trends we saw, does it support that historical, I guess, seasonality because I think where the Street is debating upon is that historical seasonality, does it bake in some year-end budget flush or what is baked into that sequential step-up?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. So I think what we're seeing is that it's -- we normally see the step-up, that's what we're expecting this time. We're not including the budget flush in that. If we see a budget flush, it's on top and that will be in our Q1 numbers as we go forward."
},
{
"speaker": "Bob McMahon",
"content": "Yes. Hey, Vijay, this is Bob and just to build-on what Padraig is saying, I mean you're absolutely right. When we look at the sequential, it is in-line with our historical in our order book based on what we've seen today. Obviously, we have to book orders in Q4, but our order book trends would support that."
},
{
"speaker": "Vijay Kumar",
"content": "Fantastic. Thank you, guys."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Tycho Peterson with Jefferies. Please go ahead."
},
{
"speaker": "Tycho Peterson",
"content": "Hey, guys. Question on BIOVECTRA and maybe just synergies with the rest of the NASD business. How do you think about -- does that change views on capacity? And maybe just talk a little bit about how much of their BIOVECTRA business is clinical versus commercial and any kind of emerging modalities that you're adding here?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. I'll start, Tycho and I'll bring in Simon in a minute. So we are absolutely delighted with BIOVECTRA. We think it's a great asset that enhances our offerings and it really allows us to deepen our relationships with our key pharma customers. And what we're really excited about is that it builds on our capabilities on the current NASD modalities around anti-sense and particularly gene editing with microbial fermentation and ADC capability. And so we're very happy with that. So there's a lot of synergies as we bring that forward. So I'll hand over to Simon to talk maybe about capacity in the main business."
},
{
"speaker": "Simon May",
"content": "Yes, I think Padraig hit many of the high notes already in terms of the synergies. We already mentioned the complete solution offering in gene editing, which we see as a really significant competitive advantage going forward. Sterile fill finish is another synergy that we're excited about. We've had a lot of request from our customers over the past few years for that capability. And from the diligence we've done with BIOVECTRA, we think they've got truly world-class capabilities there. And as Padraig also mentioned with microbial fermentation, high potency APIs, there's an existing footprint there in GLP-1 manufacturing. So I think we've got a slightly higher clinical mix in BIOVECTRA than we have in NASD. So I think we're just killing several birds with one stone with this acquisition. From a capacity perspective, I'd say BIOVECTRA has been ahead of the curve with capacity CapEx and we've got some skin to grow into there over the next few years"
},
{
"speaker": "Tycho Peterson",
"content": "Okay. That's helpful. And then a follow-up on China. You had the pull-forward dynamic in the first quarter, $15 million. If that were back in 2Q, I think you were effectively flat, maybe down a little bit. First, is that the right assumption? What are you actually embedding in 4Q for China in guidance? And then how do you think about the return to growth in 2025? Could you see that in the first half of the year?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Hey, Tycho, that's -- your recollection is correct. And as we think about implied fourth quarter down mid-single digits in China, we're going up quite honestly against some easier compares in-full disclosure. And we would expect a slight sequential step-up from a revenue perspective as well. And so that reflects this steady improvement. We do expect, again, not a lot of that stimulus to come in our Q4, basically none, but more into Q5, but the bidding activity that we're seeing has ramped-up. And then I think the activity that we're seeing in services and consumables, we're expecting that to continue. It's probably too early to tell next year for China, but I would expect it to continue to improve and not be down the way it is. We're expecting a low double-digit decline this year, we would expect to improve from that and it will probably be improvement throughout the year as opposed to an immediate improvement. Certainly, the stimulus will help us with that. But again, that will be in our first and second quarters most likely, but we're not expecting a huge step-up right there. It will be overtime because this stimulus is over a three-year period."
},
{
"speaker": "Tycho Peterson",
"content": "Understood. Thanks."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Puneet Souda with Leerink Partners. Please go ahead."
},
{
"speaker": "Puneet Souda",
"content": "Yes. Hi, guys. Thanks for the questions here. Instrumentation growth, obviously, an important question. You know, last quarter, you lowered expectations meaningfully, but again, book-to-bill was a strong more than one. Again, this quarter it is more than one and I think you said that, that last quarter was the first time you saw growth in the market after seven quarters. So that looks like it's continued again into the quarter. So just maybe help us understand instrument where we sit on instrumentation and what sort of recovery are you seeing here in August and what gives you sort of confidence that the instrumentation should bounce -- continue to bounce back into 2025 as well?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes, look at the indications from the team, we have a strategic account team that does a lot of citations with our major accounts. There's -- we're seeing that more positive than negative in terms of customer sentiment, which is a very good sign. We see a lot of activity in our testing labs, as well as focusing on PFAS and so on. So there is drivers within the markets that are positive. But overall, I would say it's slow and steady and we're trading it as that. And the teams have really good visibility. Our commercial teams, which we've transformed in the last few years are really, really close to our customers. We have really good visibility into that. So it's slow, but steady. I don't know if you want to add anything, Bob, to that?"
},
{
"speaker": "Bob McMahon",
"content": "Yes. No, I think you're spot-on and we're not building any budget flush into our Q4, Puneet. So if that does in fact happen, that would be a benefit to our current estimate."
},
{
"speaker": "Puneet Souda",
"content": "Okay. Thanks. And then recent drug pricing negotiation with Medicare on the first drugs are out. Obviously, IRA is having an impact, but over the next three years annually, 15 drugs will be negotiated and that probably leads to another set of impacts. So what are you hearing from your large pharma customers and overall, how are they thinking about the R&D spend and the spend that they're -- that they currently have on Agilent?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Look, I think in general, they're very cautious, of course, with some of the impacts, the macro impacts that are facing. They're not -- there's a lot of M&A activity going on within pharma, a lot of consolidation, which of course takes time and energy for these companies to focus on. And I think what you're going to see overtime is it probably even out in terms of impact. What isn't going down, by the way, is the number of R&D programs. We see that increasing in a number of key modality areas, particularly around GLP-1, etc. So we need to wait and see, but having said that, people kind of forget in the last few years the enormous amount of spend that has happened and we're seeing that normalize now, of course in the installed-base and coming out of that in 2025."
},
{
"speaker": "Puneet Souda",
"content": "Okay, fair. Okay. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Michael Ryskin with Bank of America. Please go ahead."
},
{
"speaker": "Michael Ryskin",
"content": "Hey, guys. Thanks for taking the questions. I want to follow-up on maybe this is what Puneet was just getting at, but you called out in your prepared remarks a couple of times that with biopharma, small molecule held up a little bit better or small molecule did a little bit better than large molecule, I assume. Just wondering if you could delve into that a little bit more, was that a particular instrument class or modality that drove that? Was that -- does that have to do with budget cycles, just what you're seeing there and why there's such a difference in molecule type?"
},
{
"speaker": "Bob McMahon",
"content": "Yes. Hey, Mike, this is Bob. You're right, I mean, our small molecule business was down mid-single digits in the quarter, which was better-than-expected actually. And then in Europe, it grew, which was a very positive sign. And this does speak to -- you can only hold-on to your old instruments for so long before the replacements need to happen. We're not calling replacement cycle inflection just yet, but every quarter these instruments get older. And one of the things that I think is important here is, pill counts and volumes continue to grow. And back to the question around the IRA and the pricing, I think it was generally, you know, not the worst case scenario, maybe a little better than people expected. And where our strength is, is in the development moving into production and that continues to be long-term positive trend. So that would be our core LC franchise and then the biopharma, some of that was impacted by our NASD business, which was kind of the air pocket. Actually, if you take our biopharma business, which was down double digits and you take NASD out, we are at mid-single digits as well. Not as -- it was down a little more than small molecule, but generally still in that same range. So both of them are actually when you take out the kind of the one-time unique aspect of NASD performing better quarter-on-quarter, which is a positive sign."
},
{
"speaker": "Padraig McDonnell",
"content": "So I would say, just adding to that, Bob, we saw services growing double-digits in biopharma and mid-single digits in small molecules. So that's a big component of what we see in those different modalities."
},
{
"speaker": "Michael Ryskin",
"content": "Okay. Both of those answers really helpful. And then for my follow-up, I want to lean in a little bit more on BIOVECTRA. I mean, everything you kind of laid out there for the rationale and the financials of the deal certainly makes sense. But I'm just curious, you know, you've had a presence in some CDMO type capabilities in the past. Just wondering how hard are you going to lean into this? And what I'm alluding to is obviously, one of your large traditional tools vendors has a CDMO business has been in that business for a number of years now and there's a lot of talk of the benefits of having both the instrument, the consumables and the services business on the tail-end. Is this something you're going to continue to grow overtime? Is it BIOVECTRA like a beachhead acquisition? I mean we should expect more investment down the road?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes, I'll start and then maybe hand it over to Simon. When we look at our M&A ambition, first of all, we're -- it's going to be -- it's going to be really centered around where our strategy is, what's the strategic fit in faster-growing markets and of course, value creation. BIOVECTRA takes all of those boxes and it's an area of where we're building out more capabilities for customers. So we see that continuing. And so we're really excited about it, but we do see that this business has a lot of runway. It's a business that's growing well, very well-run, of course and has had a lot of capital investment over a number of years. And I think this is only the start of our ambition in continuing to grow BIOVECTRA and NASD. But Simon?"
},
{
"speaker": "Simon May",
"content": "Not much to add really, only beyond that, we've got a very strong existing position in the RNA modality. I'd say up until this point, it's been a relatively narrow capability position and BIOVECTRA builds on that quite nicely as we look at future optionality around complementary capabilities and modalities, we think it's a rich space and that's probably all we can say at this point."
},
{
"speaker": "Michael Ryskin",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Dan Brennan with TD Cowen. Please go ahead."
},
{
"speaker": "Dan Brennan",
"content": "Great. Thanks. Thanks for taking the questions. Maybe just back to China, the down 11% was a bit better than we were looking for. Can you just unpack what specifically got better in the quarter given the guidance cut that you made last quarter, maybe either by customer type or by product type? And then just to clear up, like so your guidance for China, I know it was down double digit. Has that changed at all? Have you improved that? So that's my first question."
},
{
"speaker": "Bob McMahon",
"content": "Yes. Hey, Dan. Thanks for the question. China is still in line with our full-year end guidance down low-double-digits. If I look at where we actually performed slightly better than what we anticipated, it was actually in pharma and it gets back to what we were talking about before, the activity both on the services side performing sequentially better, as well as our consumables business actually growing. And so we were down you know close to 30% in Q2 of last year, we were down low double-digits in pharma year-on-year. And so that was the big sequential improvement in Q3 and I would expect that to continue into Q4."
},
{
"speaker": "Dan Brennan",
"content": "Okay. Thanks, Bob. And then sorry to go back to NASD, but there's just been a lot of questions from investors after the turn of events year-to-date in terms of that business really slowing a lot. Can you -- did you say what it did actually in the quarter? I didn't hear the number kind of year-over-year, what did NSD do in the quarter and then kind of if we take your guidance full-year, I know you said step-up, could you just give us some clarity on the quarter? And then any additional color on clinical versus commercial? It sounds like your bookings are improving, so that portends well for the outlook, but just trying to unpack like what's going on right now in the quarter? Thank you."
},
{
"speaker": "Bob McMahon",
"content": "Yes. Hey, Dan. What I would say is, we typically don't give a specific number for NASD, but it actually performed in line or slightly better than what we expected. So we had been signaling a step down in Q3 and we actually did better than what we were expecting there. The full-year is still in line with where we were, which is roughly a $300 million business. As Simon was saying, the bookings continue to be positive in terms of activity and we're starting to see some of our customers, the readouts of some of the activities, which is more a harbinger of long-term opportunity versus short-term. But you know, if anything, it was a little better than we expected. So I don't want anyone to takeaway that it wasn't -- even though it was down in the quarter, we expected that and communicated that as part of our guidance and we're still on-track for the full-year estimate that we had coming into the quarter."
},
{
"speaker": "Dan Brennan",
"content": "Got it. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Catherine Schulte with Baird. Please go ahead."
},
{
"speaker": "Catherine Schulte",
"content": "Hey, guys, thanks for the questions. Maybe first, just could you talk about growth rates by segment for the fiscal fourth quarter and maybe your assumptions for instrumentation versus consumables and services in the fourth quarter?"
},
{
"speaker": "Padraig McDonnell",
"content": "Bob?"
},
{
"speaker": "Bob McMahon",
"content": "Yes, I'll -- hey, Catherine, it's Bob. What I would say is, if I look at our Q4, all groups, we would expect to do better and if I went by group, LSAG would be -- we're expecting kind of low single digits off of a down 7% this year. Consumables being better than that overall and with the instrument side, still probably down slightly or would be down slightly. DGD down mid-single digits and ACG up mid-single digits towards the high-end. That's what we've embedded in our guidance. So all three of those actually performing better than where we were in Q3."
},
{
"speaker": "Catherine Schulte",
"content": "Yes, perfect. And then maybe going back to Small Molecule, nice to see the improvement there. I think what was just Small Molecule performance excluding China? I know you said Europe grew, but just curious to get more color on what you're seeing elsewhere?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes, I think what we're seeing is Europe was a standout in Small Molecule, a lot of activity there, but probably stable across the different markets on us. And what we did see from the Small Molecule side, we did see pretty good growth in services that as well as has had that number, but I think overall Europe ahead, but everywhere else stable."
},
{
"speaker": "Bob McMahon",
"content": "Yes. What -- and so we were down mid-single digits and as Padraig said, if you took China out, we were down low-single digits everywhere else."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Josh Waldman with Cleveland Research. Please go ahead."
},
{
"speaker": "Josh Waldman",
"content": "Hey, good afternoon. Thanks for taking my questions. A couple for you. Padraig or Bob, maybe first a follow-up. On your assumption for no budget flushing impact on pharma instrumentation, is that just a function of the timing of your quarter relative to calendar year-end buying from these customers? Or are there other things you're seeing that are leaving you on the sidelines as it relates to end of your pharma spending? And then a related question was, curious any high-level thoughts you had on 2025 based on planning conversations you're having with pharma accounts, are you thinking next year should be a return to normal growth type year in pharma instrument budget as budgets are reset or is it more of a gradual recovery or return to normal over a couple of year period. Any feedback you're getting from accounts on that?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes, I'll take the first one and maybe hand-off to Bob for the second one. I think it's a year ago and we were -- people were talking about budget flushes. We didn't expect it and we didn't see it. We saw a little bit, but not much. We're expecting the same this time, of course, our year-end at the end of October. So if we do see any activity will be in Q1 2025. Why do we see this is because we're very close to our customers. We know exactly when, where the funnel is, where the deals are and where installed base, we have a lot of installed base information. So we're not expecting it anything substantial at the end-of-the year. But what we are seeing is a lot more conversations about next year, slow, steady recovery and we're hearing that across the board. I don't know if you want to take the second question, Bob?"
},
{
"speaker": "Bob McMahon",
"content": "Yes. Josh, on 2025 as we were saying, it's probably too early to say. But what I -- our current indication is that it's not going to snap back November 1st to be back to normal. I do think that you'll continue to see a recovery throughout FY 2025 and get back to that long-term growth rate sometime in 2025, that's the way we kind of think about it. But I don't think it's another two to three year estimate either or based on our conversations with our customers right now. So it's probably in between."
},
{
"speaker": "Josh Waldman",
"content": "Got it. Okay. And then just had a follow-up on ACG. I was curious if you could provide a bit more context on the dynamics you're seeing there, especially interested in what you're seeing from an RFP and win rate dynamic in the contracted business? And then you mentioned, I think in the slide decks, benefiting from mix. I was wondering if you could flush that out a bit?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes, I'll take the first part of that question and hand it over to Angelica. Extremely pleased with ACG's performance and that's years of investment in a broad product offerings in key markets, that are really being received by customers in this environment where they want to get more productivity out of their systems, they want to use their assets in different ways. And we've seen the flow through to our results in spite of the CapEx challenges all year. So the business performs extremely well and the margins are extremely good. So I'll ask Angelica to provide more color on the contract business. But I think what's really interesting is our enterprise service business as well. Angelica?"
},
{
"speaker": "Angelica Riemann",
"content": "Yes, so to really dive in on the contracts, right? It's nearly 70% of our business in Q3 and it's continuing to grow double-digit. As we continue to see that strong demand in our enterprise service offerings, which are in the high -- the mid-teens, it's really about being there to help customers optimize their lab operations, improve their productivity and our offers really facilitate our customers improving the lab operations, the efficiencies and the waste reduction. So we're continuing to see some very strong and sticky behavior within our contracts franchise."
},
{
"speaker": "Bob McMahon",
"content": "Yes. And Josh, just on the comment on mix is, when we have business on-contract, that generally is good for us and good for our customers as well."
},
{
"speaker": "Josh Waldman",
"content": "Got it. Okay. Appreciate all the detail."
},
{
"speaker": "Operator",
"content": "Our final question will come from the line of Doug Schenkel with Wolfe Research. Please go ahead."
},
{
"speaker": "Doug Schenkel",
"content": "Hey, guys. Thanks for fitting me in. I know it's late in the call, that being said, I got three lightning round questions, which I'm going to rattle through and then listen to the answers. The first is on math. If recurring revenue growth was up mid-single digits in the quarter, it seems like instruments has to be down around 20%, maybe more based on the numbers you reported in the 10-Q in Q3 of last year. Bob, I think you said in response to Matt Sykes' question, it was down low-double digits. What are we missing? Just not trying to be too picky here, but it just seems important in the context of assessing trends and what way to put on your book-to-bill commentary. So that's the first question. The second is on China stimulus. Any change in dynamics regarding stalling either in terms of conversions or even cancellations? There's some skeletal that that there's been some recent changes as the shape of stimulus becomes a bit more clear? And then the third question is on 2025. If you exit 2024 with flattish core growth in Q4, that would obviously be a positive trend relative to what we've seen over the last few quarters. That said, it would seem like if you draw a straight line that you'd be on track to exit 2025 at around, call it 5%, maybe 6% growth rather than growing mid-single digits for the year. So I think you need a fundamental improvement in overall market conditions and/or a real impact from China stimulus to get to mid-singles for the year. I just want to see if any of my logic is flawed there? Thank you and have a good night."
},
{
"speaker": "Padraig McDonnell",
"content": "That's certainly a lightning round, Doug, but we'll try and we'll answer it. I think, Bob, you can take the first and the last one, I'll take China."
},
{
"speaker": "Bob McMahon",
"content": "Yes. The comment that I had on Instruments was specifically related to LSAG instruments and they were down low double-digit. Consumables was up mid-single digits for the total being down minus 7%. So that is. We do have some instrumentation in DGG as well that was down roughly the same as where LSAG was. So down 20% is way too negative. I'll turn it over to Padraig for the second one and then I can jump back into last one."
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Look, I think, we're very close to our China team and the local team has seen an increased activity. We're seeing that improve from last quarter and for clarity, of course, we're not building any benefit from the stimulus into our Q4 guide. But what we're seeing is, we're seeing in early days, what we're hearing that the stimulus is broader in terms of its reach over a three-year period. Having said that, we are hearing that the first tranche will likely be focused on Academic & Government accounts. But again, it's early days, as it trickles down through provinces, as the mechanism of the funding goes, we'll be sure to update as we know that."
},
{
"speaker": "Bob McMahon",
"content": "Yes. And I think just the last one real quick. It's too early. We're not going to get into what we're looking at for FY 2025 other than to say that we expect improvement throughout the year."
},
{
"speaker": "Operator",
"content": "And I'll now turn the call back over to Parmeet Ahuja for any closing remarks."
},
{
"speaker": "Parmeet Ahuja",
"content": "Thanks, Regina and thanks everyone for joining the call today. With that, we'd like to end the call. Have a good rest of the day, everyone."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this concludes today’s call. Thank you for joining. You may now disconnect."
}
] |
a | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Ladies and gentlemen, welcome to the Agilent Technologies Q2 2024 Earnings Call. My name is Regina, and I will be coordinating your call today. [Operator Instructions]. I will now hand you over to your host, Parmeet Ahuja, to begin. Please go ahead."
},
{
"speaker": "Parmeet Ahuja",
"content": "Thank you, and welcome, everyone, to Agilent's conference call for the second quarter of fiscal year 2024. With me are Padraig McDonnell, Agilent President and CEO; and Bob McMahon, Agilent's Senior Vice President and CFO. Joining in the Q&A will be Phil Binns, President of the Agilent Life Sciences and Applied Markets Group; Simon May, our newly named President of the Agilent Diagnostics and Genomics Group; and Angelica Riemann, President of the Agilent CrossLab Group. This presentation is being webcast live. The news release for our second quarter financial results, investor presentation and information to supplement today's discussion along with the recording of this webcast are available on our website at www.investor.agilent.com. Today's comments will refer to non-GAAP financial measures. You will find the most directly comparable GAAP financial metrics and reconciliations on our website. Unless otherwise noted, all references to increases or decreases in financial metrics are year-over-year and references to revenue growth are on a core basis. Core revenue growth excludes the impact of currency and any acquisitions and divestitures completed within the past 12 months. Guidance is based on forecasted exchange rates. As previously announced, beginning in the first quarter of fiscal 2024, we implemented certain changes to our segment reporting structure related to the move of our cell analysis business from LSAG into DGG. We have recast our historical segment information to reflect these changes. These changes have no impact on our company's consolidated financial statements. During this call, we will also make forward-looking statements about the financial performance of the Company. These statements are subject to risks and uncertainties and are only valid as of today. The Company assumes no obligation to update them. Please look at the Company's recent SEC filings for a more complete picture of our risks and other factors. And now, I'd like to turn the call over to Padraig."
},
{
"speaker": "Padraig McDonnell",
"content": "Thanks, Parmeet. Good afternoon, everyone, and thank you for joining today's call. I want to begin by saying I'm incredibly honored to serve as CEO of this great company, and I'm thankful for the opportunity to lead such a talented team. I truly believe the Agilent team is second to none, and I'm energized about the future possibilities that lie ahead of us. I also want to take this time to welcome our new DGG President, Simon May to the Agilent team. Simon's diversified experience, strong technical skills and growth mindset will be a key asset in this role. Since starting earlier this month, Simon has hit the ground running, and I am really looking forward to him helping move DGG and Agilent forward. Before I talk about the quarterly results, I'd like to tell you how I spent my time since the announcement in February that I will become Agilent's CEO. I've been meeting and connecting with employees, customers and shareholders around the world to listen to their perspectives and how we should build on our strengths and evolve Agilent. What they have told me is clear, Agilent must become even more customer focused and even more nimble to continue to win in the marketplace and add value to customers and shareholders. This has really resonated with our employees and customers. As an energized Agilent team, we will evolve our strategy, adapting quickly to market trends and changes while accelerating our pace of innovation in areas of greatest return for long-term growth. We will double down on our customer first culture, deepening our relationship to further enhance our market-leading customer experience that is already the best in the industry. Now let's talk about the Q2 results and outlook moving forward. In a challenging market environment, the Agilent team delivered on expectations. In the second quarter, we reported revenue of $1.573 billion, a 7.4% decline. This was against a tough compare of 9.5% growth in Q2 of last year. While revenues declined in the quarter, our book-to-bill was greater than one, and orders grew year-over-year for the first time in seven quarters. Earnings per share of $1.22 beat our expectations and represented a 4% decline from the second quarter of 2023. Now looking forward, the market environment continues to be challenging, but we are seeing early signs of recovery. However, as we announced in our press release, this market recovery is not at the pace we anticipated when we provided guidance earlier in the year. As a result, we are reducing our market growth expectations and revising our full year core revenue to be in the range of $6.42 billion to $6.5 billion and growth to decline between 4.3% and 5.4%. We now expect earnings per share to be between $5.15 and $5.25 for the year. We have responded quickly to the lower market growth expectations and are taking difficult, but necessary actions to streamline our cost structure. These actions will allow us to invest in our most promising growth opportunities while also delivering incremental annualized savings of $100 million by the end of the fiscal year. We are sharpening our focus on key growth vectors such as Biopharma, PFAS and Advanced Materials, while also investing in our digital ecosystem, and accelerating our innovation to drive even faster execution. And we are leveraging our strong balance sheet and plan to repurchase $750 million of our common stock across the third and four quarters, over and above our normal anti-dilutive repurchases. Bob will provide more details on our results and latest outlook in his remarks. Getting back to Q2 results. As expected, all end markets saw a declining revenue in Q2. Geographically, the Americas and Europe came in slightly ahead of expectations, while China lagged. Despite the challenging market conditions, our Agilent team stay close to our customers and continue to leverage our strong relationships with them to execute remarkably well while maintaining strong cost discipline. When we look at our performance by business unit, the Life Sciences and Applied Markets Group reported $754 million in revenue, down 13%. The group saw a decline across all end markets and regions, with consumables being a bright spot. Consumables grew in the low single digits, driven by Chemical and Advanced Materials, Food, and Environmental and Forensics. Also, while relatively small, we continue to see strong growth in our pre-owned instrument business. The LSAG team continues to innovate, introducing two new instruments this quarter that extend our applied markets leadership. First, our 7010D GC/Triple Quad instrument delivers exceptional sensitivity for customers in the environmental PFAS and Advanced Materials markets. Designed for analysis that demand the lowest limit of detection. And second is our 8850 GC, a distinguished new member of our market-leading GC portfolio. The 8850 is ultrafast in separation and colon speeds with design innovations that enable customers to run tests up to twice as fast as regular benchtop GC. And it's the smallest high-performance benchtop GC on the market. Plus, it's sustainable, using up to 30% less electricity power compared with a traditional benchtop GC. Now moving on to the Agilent CrossLab Group, which delivered revenue of $402 million for the quarter, up 5%. ACG grew across all end markets in every region except China. The business delivered double-digit growth in services contracts which now represent almost 70% of the total business, offset by declines in new instrument installation revenues. The ongoing strength in our contracted business speaks to our strategy of increasing the connect rates on our instruments and the ongoing value we are providing to our customers. The Diagnostics and Genomics Group posted $417 million in revenue, representing an 8% decline. Pathology was up mid-single digits globally and was more than offset by declines in the mid-20s in cell analysis due to the constrained capital environment for instrumentation. NASD declined low teens as expected, driven by more clinical products being produced this year versus Q2 of last year. Europe was a bright spot for DGG, growing low single digits in the quarter, while Americas and China declined. Despite the subdued market environment, we continue to innovate in our cell analysis business. We recently introduced the Agilent Spectrum Flow Cytometer, which allows our customers to perform sophisticated experiments that expand the range of the research on the same easy-to-use NovoCyte platform. Bob will now provide details on our results as well as our outlook for the remainder of the year. After Bob delivers his comments, I will be back for some closing remarks. Over to you, Bob."
},
{
"speaker": "Bob McMahon",
"content": "Thanks, Padraig, and good afternoon, everyone. In my remarks today, I will provide some additional details on revenue in the quarter as well as take you through the income statement and other key financial metrics. I'll then cover our updated full year and third quarter guidance. Q2 revenue was $1.573 billion. a decline of 7.4% core. On a reported basis, currency had a negative impact of 0.8 percentage points, while M&A had a negative impact of 0.2%, resulting in a reported decline of 8.4%. As Padraig mentioned, Pharma, our largest end market, declined 11%, with both Biopharma and Small Molecule declining roughly the same percentage. Instrument demand continues to be constrained, while services delivered mid-single-digit growth. Looking forward, while we have seen sentiment improve, instrument purchases are still constrained and we are expecting that to continue for the rest of the year. In addition, we have reduced our expectations for NASD as several clinical programs have pushed out into next year and some commercial products have not ramped at the pace as expected. As a result, we have reduced our full year growth outlook for the Pharma end market from roughly flat to down low double digits, similar to our Q2 performance. Our revised expectation for the Pharma end market is the largest change in our outlook. The Chemical and Advanced Materials market was better than expected, declining 3% after coming off a very tough comparison of 16% growth last year. The academia and government market declined 12% against a tough compare of 11% growth last year. While soft globally, the decline was driven by China, which was down mid-30s. Our business in the Diagnostics and Clinical market declined 2%. Our pathology business continues to show resilience in this market, growing mid-single digits, while our NGS QC instrumentation business also grew slightly. These were offset by softness in our NGS chemistries business. The Environmental and Forensics market declined 2%. The business grew mid-single digits ex China, highlighted by continued strength in serving the rapidly expanding PFAS opportunity. The Food market declined 13% on a very tough compare of 21% growth last year, heavily impacted by the low 30s decline in China. On a geographic basis, all regions declined. The Americas region was down 5%. Europe was down 3%, while Asia Pacific ex China was down slightly. China was down 21%, missing our expectations of a mid-teens decline. We saw demand weakness expand beyond Pharma. As a result, we have revised our full year expectations for China for a mid-single-digit decline to a double-digit decline. We have seen funnel activity increase because of the recently announced stimulus program, but we are not assuming any revenue impact in our fiscal year. Moving down to P&L. Our second quarter gross margin was 55.6%, up 30 basis points from a year ago as productivity and cost savings were offset by lower demand and mix. Our operating margin of 25.1% was down year-over-year as expected. Below the line, we benefited from greater-than-expected interest income and a lower tax rate. Our tax rate was 12.5%, and we had 293 million diluted shares outstanding. Putting it all together, Q2 earnings per share were $1.22, down 4% from a year ago, less than the decline in revenue and ahead of our expectations. Now let me turn to cash flow and the balance sheet. Operating cash flow was $333 million in the quarter and we invested $103 million in capital expenditures as we continue our planned NASD expansion. We returned $299 million to shareholders in the quarter, $69 million through dividends and $230 million through repurchase shares, catching up on our anti-dilutive buying year-to-date. In summary, we met our expectations for the quarter our markets are recovering but at a slower pace than we anticipated. We are directing our energy towards high-growth opportunities and are committed to delivering value to our customers and our shareholders. Now on to our revised outlook for the year and our third quarter guidance. We now expect full year revenue to be in the range of $6.42 billion to $6.50 billion. This represents a decline of 6.0% to 4.9% on a reported basis and a decline of 5.4% to 4.3% on a core basis. Currency and M&A combined are a headwind of 60 basis points. This is a $300 million reduction at the midpoint and is primarily related to changes in two areas: China overall in the Pharma end market outside of China. For China, we have reduced our expectations to a double-digit decline from mid-single digits with all end markets being reduced. This represents roughly $70 million of the guidance reduction. The remainder of the change in the Pharma end market globally outside of China is due to two factors. The first and largest factor is continued caution in budget releases and extended approval times for instrumentation purchases in both Small and Large Molecules. This is roughly $175 million of the change. The second factor is related to NASD due to the reasons I mentioned earlier, and represents the remaining $55 million reduction. While down from our previous guidance, we are expecting growth in the second half of the year to be roughly 400 basis points better than the first half of the year and plan to exit the year roughly flat year-on-year at the midpoint of the new guidance. Full year non-GAAP earnings per share are now expected to be between $5.15 and $5.25, representing a decline of 5.3% to 3.5%. This incorporates a roughly $35 million expense reduction due to the actions Padraig mentioned. The majority hit in Q4 in order to help mitigate the bottom-line impact of the change to our revenue guidance. It also assumes a 13% tax rate and 292 million fully diluted shares outstanding. We will leverage our strong balance sheet and plan to repurchase $750 million of our shares in the second half of the year in addition to our anti-dilutive repurchases. We expect these repurchases to be weighted towards Q3. All told, we expect to return roughly $1.4 billion to shareholders this year between dividends and share repurchases. In addition, the Board authorized a new $2 billion share repurchase program that will go into effect August 1 and replace the existing authorization. Now for our Q3 guidance, we expect revenue will be in the range of $1.535 billion to $1.575 billion. This represents a decline of 8.2% to 5.8% on a reported basis and a decline of 6.9% to 4.5% on a core basis. Currency and M&A combined were a headwind of 130 basis points. Third quarter non-GAAP earnings per share are expected to be between $1.25 and $1.28, representing a decline of 12.6% to 10.5%. Looking forward, we remain disciplined. We're focusing on what we can control and driving strong execution in a challenging market, and we are optimistic about the long-term future. Now back to Padraig."
},
{
"speaker": "Padraig McDonnell",
"content": "When I joined you last quarter as CEO-elect, I said Agilent has a compelling story to tell, and I was excited by the possibilities that lie before us as we help our customers bring great science to life. That excitement has only grown. I spent 26 years at Agilent, first starting as a field employee before moving to sales and then leading some of our businesses. I know Agilent's strengths and its opportunities very well. We are in great long-term growth markets. And while the markets are recovering slower than anticipated, they are recovering. This company is a leader across key platforms, making us uniquely qualified to support our customers and their missions to solve some of the world's most important problems. And our customers value their relationships with us because we offer them an unparalleled experience. And as I said earlier, that is a competitive differentiator in the market. The actions we are now taking, while difficult, will enable us to quickly capitalize on growth opportunities as the markets fully recover. I know the future is bright, and we will forge an enduring company that sets the standard for excellence with our customers and create value for our shareholders. Thank you again for joining today's call. I look forward to continued dialogue with all of you. Parmeet, over to you for Q&A."
},
{
"speaker": "Parmeet Ahuja",
"content": "Thanks, Padraig. Regina, if you could please provide instructions for the Q&A now."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question will come from the line of Matt Sykes with Goldman Sachs. Please go ahead."
},
{
"speaker": "Matt Sykes",
"content": "Maybe just the first one is more of a timing question on China. I mean we've been through a lot of quarterly results this season and the stabilization theme in China has been pretty consistent and you guys have talked about sequential stabilization over the last number of quarters. So, was this really an April impact that you saw in China? And if so, what was sort of the deceleration that you saw there? And what were some of the causes of it?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Thanks, Matt. I think while Q2 was relatively soft to guidance, we adjusted the H2 outlook, what we're seeing in China is we saw a -- stability over a number of quarters. What we really believe is that this is not a material deterioration from that. But what we've seen is that we've seen the stimulus have some effect and the stimulus has been much larger than previous stimulus. It's over multi-years. And of course, customers are looking about what are the components of that and they're looking at some of the areas and where it's going to help them. So that has had a material effect. We don't see the stimulus having an impact in H2, but we do think it's going to have an impact in '25. I think there's kind of a direct and indirect side of the stimulus. I think on the direct side, you see this delay, which is normal, but you see also the indirect side where, the government is investing in technology and sciences going forward, which creates a lot of, I would say, future momentum."
},
{
"speaker": "Matt Sykes",
"content": "Got it. And then just for my follow-up, you guys have often talked about sort of 18- to 24-month down cycle in the LC replacement cycle. And I'm just wondering just given some of the comments you made around Biopharma, given that's an important customer segment for that, have you kind of changed those views in terms of what the LC replacement cycle will look like and what the potential recovery in the replacement cycle will look like? I think some were thinking sort of towards the end of this year, but is this more now into 2025, is that replacement cycle been extended in terms of recovery?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes, we don't see any material change. But Bob, I don't know if you want to add some color on that."
},
{
"speaker": "Bob McMahon",
"content": "Yes. I think, Matt, as you said, we're still expecting improvement in the back half of this year, just not at the pace that we had expected. And so, we're not seeing any material extension of kind of the use case for LC or an LC/MS in the marketplace and are still expecting recovery in '25."
},
{
"speaker": "Operator",
"content": "Our next question will from the line of Jack Meehan with Nephron Research. Please go ahead."
},
{
"speaker": "Jack Meehan",
"content": "I was wondering if you could share what's the new sales outlook for an ASP this year? And can you talk about like bridging from kind of the second half to some of the longer-term targets you've had previously. Like what are you assuming in terms of kind of progression after this year?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. I mean the NASD business, we talked before about the business being about 50% commercial and 50% clinical that's changed a bit to be more like 75% clinical and 25% commercial. We've seen the IRA inflation Reduction Act having an impact on the price provisioning. So, what you see with Pharma partners, they are looking for larger indications instead of smaller indications. So, what we've seen is, I would call it, an air pocket in Q3. And our clinical business is actually growing. Orders are growing about 50%. So, we're -- we have a good order book on that side. So, it's a readjustment and we see that readjustment go through H2 and beyond. I don't know if you want to add anything to that, Bob."
},
{
"speaker": "Bob McMahon",
"content": "Yes, I think Jack to add some numbers to what Padraig was saying here. Originally, we were expecting it to be roughly flat, which would have said roughly a $350 million business. We're now seeing roughly $300 million this year. As Padraig is mentioning, we're expecting to build back from there as these clinical programs move through the clinical pathway and are expecting to have more volume in '25. And I would say our long-term perspective on NASD remains unchanged. We're still very excited about that opportunity and are still building out the capacity in our Colorado site."
},
{
"speaker": "Padraig McDonnell",
"content": "Second question, I think the second part of the question was about '25. We'll grow next year. And as you can see in our guidance that we really are anticipating improving conditions across the second half, but it's too early to talk about specific ranges for next year. We want to wait to see how pacing an improvement plans out in the second half."
},
{
"speaker": "Jack Meehan",
"content": "And then on the cost savings program, I think I heard talk about $100 million. I just wanted to clarify, is that incremental to the $175 million you previously talked about? And where are those -- any color on where the savings is coming from?"
},
{
"speaker": "Bob McMahon",
"content": "Yes, it is incremental to the savings that we've already built into the plan, and we're expecting to get that annualized savings by the end of the year. It's primarily headcount-related, Jack."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Patrick Donnelly with Citi. Please go ahead."
},
{
"speaker": "Patrick Donnelly",
"content": "Maybe one on the instrument side, I guess it will be China and then just broadly, I know a few quarters ago, you guys felt like orders were picking up, the funnel looked okay, but it was really that I think, Bob, you said it was the velocity of conversion of those orders in that funnel to revenue. Is that what you're seeing is just that continues to stretch out the visibility into that normalizing. It's just proving to be a little trickier. I just want to talk through, I guess, that instrument piece because again, you sound okay on the orders in the funnel and the conversation, but that converting over rim, I guess that I just want to talk through again, the conversion piece and the velocity of the conversion."
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Yes. No, I think at an at level, as we talked about, our book-to-bill was greater than one, which is a positive sign and where orders grew year-over-year. On the instrument side, the orders grew low single digits, excluding China, but declined low single digits overall. So, what we're really seeing is that our funnel is really stable, but we're seeing those extended purchasing decisions being continuing to extend out through the second half."
},
{
"speaker": "Bob McMahon",
"content": "Yes. I think, Patrick, to build on what Padraig is saying at the beginning of the year, we were expecting when we were talking primarily to our Pharma customers, budgets weren't being materially cut outside of a specific number of well-publicized customers. And we were expecting to see by our second quarter, some of these budgets being released. And what we're seeing now is still a very cautious environment. And so, the funnel is still there. We are seeing our book-to-bill as Padraig mentioned, to be greater than one. We just haven't seen that inflection, which we would have expected to see at least in our order book. One of the things that we do see and it primarily happened late in the quarter is our teams are paid on first half versus second half quota. And so, our April numbers are usually quite large, which prepares us for the -- for Q3 and we just didn't see that inflection in late April, which we normally would see."
},
{
"speaker": "Patrick Donnelly",
"content": "Okay. That's helpful color. And then maybe to follow up on Jack's question on NASD there. You understand the revenue change. How are you guys thinking about the capital investment on that front? Obviously, it's been sizable in the past years, you've often talked about the continued expansion of the trains. How do you think about the CapEx devoted to this over the next few years? Has there been any change in terms of push out of that capital? Or how you're thinking about the potential investment and the expansion on this front just given the shift in revenue here."
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. No, absolutely not. I think despite some near-term headwinds that we have, the medium, long-term story for NSAD is really holds firm. And as I said before, we're seeing our clinical business grow more than 50% this year, and we really remain excited about the expansion of customers. And getting back to the therapeutic class that we're involved in with siRNAs drugs, we're seeing those approvals for drugs increase substantially in 2023. And being an integral part of the manufacturers of several of these on market therapeutics, the future is extremely bright in this area. So, no change in our capital investment."
},
{
"speaker": "Bob McMahon",
"content": "Yes. Patrick, just one other thing to add on to that as I'm sure you're aware, as part of that expansion, not only are we expanding capacity, we're also expanding our therapeutic options. So, not only siRNA but also anti-sense and also CRISPR opportunity. So, it also provides us with more capabilities to support our existing and new client base."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Vijay Kumar with Evercore ISI. Please go ahead."
},
{
"speaker": "Vijay Kumar",
"content": "I guess Padraig or Bob, thanks for laying out the changes in the guidance assumptions here, right. I think part of it was China, part of it was NASD. But more than half, I think, it's coming from Pharma cautiousness that's outside of China, ex-NASD, which I think that the market. I thought we were expecting stabilization. Is this a funding environment kind of question or is elections or what changed because second quarter, it feels like revenues were roughly in line -- was it the exit rate? Can you just talk about what the exit rate trends were and what customers are telling you?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. I mean on the Pharma instrumentation side, in terms of guidance, we see an impact of about $175 million and it really simply Pharma's willingness to spend in capital equipment remains challenged over time. And again, customers are focusing on lab efficiency and productivity. But based on what we're hearing from customers, these trends will continue to impact the second half. And that's why we're lowering our expectations around that instrument piece. What I will say that the formulas are holding very strong. The conversations are very robust with customers, so we do expect it to improve going into next year."
},
{
"speaker": "Bob McMahon",
"content": "Vijay, to build on what Padraig is saying, the guidance that we're building out right now is based on what we're seeing today. It doesn't assume any meaningful inflection. That certainly -- I'd characterize this as a prudent guide given what we know today. Certainly, we're not assuming any of that inflection. You bring up a number of variables, which are hard to quantify around the upcoming election and so forth. But we don't think it's a funding issue. We do feel like we are seeing biotech funding coming up. Obviously, on the Small Molecule side, those are they're well-capitalized companies. It's just a very -- it's still cautious in terms of them getting through their approval processes."
},
{
"speaker": "Vijay Kumar",
"content": "And just maybe related to that Padraig, Bob. I think is this just a few handful of customers or across the Board? Because obviously, the next question is, is this a share loss? Or is this more of -- what gives you the confidence that this is just a pushout and not a share shift on the savings or cost savings, Bob, that 35 is in Q4. So the expectations is the incremental 65 is for fiscal '25."
},
{
"speaker": "Bob McMahon",
"content": "Let me answer the last question first. So that is a cumulative number for the second half of the year. We'll see some of that happen here in Q3 and roughly be at that $100 million run rate in Q4. So roughly about a $25 million run rate and then we'll get the full incremental 65, obviously, next year as we go into the business. Do you want to comment?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Yes, look, when we look across our Pharma customers, we see generally, it's across the board. We do have some customers that are a little bit more positive than negative this year. But overall, I would say it's a market effect. What I would say -- on the other question, this is definitely a macro story, not a market share story. And in fact, when we look at our objective market share data, we're holding or even gaining in some areas. And I will remind you not to comment on our peers in this area, but we have a month ahead in what we're seeing on it, but we're seeing very robust market share numbers coming in."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Dan Brennan with TD Cowen. Please go ahead."
},
{
"speaker": "Dan Brennan",
"content": "Maybe first one, just on China. You talked about in response to an earlier question about the stimulus is delaying demand this year. Could you just speak through that a little bit? Like what's your visibility on that? Any way to get a sense of how much of what you should be seeing in China's customers waiting to see the final details of the stimulus. And I know you also alluded to like this could be a big impact in '25. Can you just speak through that a little bit?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Look, I think having worked with China for many years. It's a multiyear program as opposed to the last one, which I think was a year program in the shorter term. So, it's very encouraging to see it. We've seen some proposals from customers, but they're still, quite frankly, trying to work out what are the mechanisms for the funding as we go forward. So, we're seeing a lot of activity around that. And I would say in terms of the confidence boost, we do really see that in '25, we're going to get some benefit from this, but really too early to tell on it. So, we're taking down our guidance in the second half primarily related to this."
},
{
"speaker": "Bob McMahon",
"content": "Dan, this is Bob. To build on that, I had mentioned in our prepared remarks that bid activity has actually improved. And so, we're seeing a number of proposals working with our customers to actually get a piece of the stimulus. What's not yet clear is the timing of the release of that budget comes from the provincial -- or from the state down to the provincial and then to the local government. And so, we've taken a, what I would say, is a conservative approach to assuming none of that stimulus money will actually -- we'll see any of that in the second half of the year. But it will come, it will come. And so -- if it comes earlier, that would be a benefit to what we're forecasting right now. But we're -- what we did see, particularly in April is a little slowing down of normal bid process waiting to get access to that money. And so, we think that, that's just a transitory change, not a structural change."
},
{
"speaker": "Dan Brennan",
"content": "Got it. And then -- and maybe just one more on Pharma, if you don't mind. So, the instrument growth was so powerful for yourselves and some of your peers coming out of COVID. Is there any chance that like the slowdown you're seeing now maybe just some miscalculation, maybe there was such instrument demand and purchase is done in the last couple of years that customers at work just kind of working through that all those purchases versus like an exceptional slowdown right now given the macro? Just maybe speak a little bit to that, if you could about the overhang for maybe the strength in the past couple of years versus what you're seeing real time now?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes, no doubt about it. We've -- tremendous growth rates during the post-COVID period. But we don't see anything fundamentally changing with the cycle on instrument replacement cycles. We don't see it's a kind of a rundown of available instruments or anything like that because lab activity is very, very high. We see that across the board. We actually see activity on the sales side, but also on the support side, very, very high. So we think it's primarily actually on the macro situation."
},
{
"speaker": "Bob McMahon",
"content": "Yes. And Dan, just to kind of build on what Padraig had said. We looked at ACG and our CSD or our consumables business outside of China, both of those grew mid- to high single digits in the quarter. So, it does speak to lab activity. They're not having instruments just sitting idle. And in ACG, our contracted services business continues to perform extraordinarily well, up double digits. So, the demand is there outside of China right now."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Rachel Vatnsdal with JPMorgan. Please go ahead."
},
{
"speaker": "Rachel Vatnsdal",
"content": "So first up, I just wanted to ask on China. We've seen some of the headlines from BIOSECURE Act. So, I was wondering if you could break down your exposure to large CDMOs in the region? And if that contributed to any of the weakness there just given me some of the commentary from an RFP standpoint? And then just on China stimulus and some of the dynamics there, how should we think about local competition competing for some of these dollars on the stimulus dynamic and you talked about some of these proposals that you're working on. So, can you detail what sectors, what types of customers are you really seeing that proposal work be done right now?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Look, I think on the BIOSECURE Act, we see normal -- people are looking at their supply chains, and that's positives and negatives around the globe. As you see that one of the areas that we've seen from that is actually we see a benefit on our service business as we relocate laboratories in some cases and get them up and running quickly with our services on that one. So, definitely some exposure to CDMO, but I would say not the overall macro side on it. And then I think the second part, Bob, I don't know if you want to take that one?"
},
{
"speaker": "Bob McMahon",
"content": "Yes. I would say just a building on that point on our questions around CDMO, most of our business in China is local. So, it's not multinational and so wouldn't necessarily fall under the BIOSECURE Act. There are certain large companies that are on that list that are customers of ours, but that is that business has been pretty muted for a while, and that's not the cause of the incremental weakness here. I would say on the bid activity, it's about -- it's across the board. It's not in one region of the country or one end market or customers and obviously, Chinese local competitors are going to be buying for that business like we are. But I think we've shown time and time again our ability to provide very strong and robust instrumentation, coupled with very good service. And so, I don't think that we're in any disadvantage from a local perspective from that standpoint."
},
{
"speaker": "Padraig McDonnell",
"content": "In fact, Bob, I would say our scale and service there really makes it a differentiator where we can scale with customers and get them up and running very, very quickly. We take the competition very seriously. But we've always had competition in China, and we continue to keep a focus on that."
},
{
"speaker": "Rachel Vatnsdal",
"content": "Great. And then for my follow-up, just given some of the moving pieces on this fiscal 3Q guide, could you walk us through your expectations by segment for 3Q?"
},
{
"speaker": "Bob McMahon",
"content": "Sure. I'll take that real quick. By business group, we're expecting LSAG to be down double-digits DGG down mid-single and ACG growing at mid-single digits. If we looked at by end market, Pharma, as I mentioned in the prepared remarks, would be down very similar to Q2, so down low double digits. And with academia and diagnostics markets being roughly flat, Chemical and Advanced Materials being very similar to Q2 results. And then Food being down roughly the same, maybe a little better than where we saw Q2 as well. And then Environmental and Forensics similar performance as Q2."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Doug Schenkel with Wolfe Research. Please go ahead."
},
{
"speaker": "Doug Schenkel",
"content": "I guess, I have too high level, but I think important questions. One is Yes. Simply put, I want to get your thoughts as we sit here today about the Company's long-term growth outlook. And essentially, to what top line growth rate are you managing the business as you think about the next few years? In Pharma and Biotech, you have less exposure as a percentage of sales to some of the higher growth areas of that end market and the outlook for one of your higher growth areas, NASD within Biopharma it's certainly in question amongst investors given how things have been going recently. And while there is hope that China stimulus will help across many end markets, as we kind of think past that, ultimately, many believe the durable growth rate in China where you're overexposed will be materially lower than what we've seen in years past. And then as we think of other discrete differentiating growth drivers for the Company, when we look at CrossLabs and DGG, the growth rates have moderated there in part because of the market, but also in part because you did have above-average concentration with one high-growth diagnostic companies as an example. So, there's a lot of bad guys here right now. Obviously, in the long term, there's a lot of belief in Agilent in how you run the business. But I think there are a lot of questions when you kind of pull all this together about what is the inherent growth rate of this business. Can you share any thoughts on that?"
},
{
"speaker": "Padraig McDonnell",
"content": "Maybe I'll kick it off a bit at a high level. I think, first of all, we participate in excellent markets with multiple long-term growth drivers. You look at the characterization that's going to be needed in biotherapeutics in time, improving human health. Quality of our Food is really going to be a continued growth driver for the Company. I would say there's a lot of growth factors within the business that in adjacent markets where we continue to invest in those opportunities. You've seen part of Biopharma, PFAS. And I do believe NASD long term is going to continue to grow. In our service business, we expect that to grow high single digits over the long term as we increase our attach rate, which is not a small point because every percentage increase in attach rate is about $30 million incremental on that side. So overall, I think we're in extremely durable long-term markets. On the China story, we're going to see probably getting down to more mature level growth rates in China, but I would remind everybody that there are secular drivers in China that continue to come up and the government continues to invest in science and technology, but also the scale of the country being so large, we benefit tremendously from the aftermarket element consumable and service around that and being able to kind of drive attachment to some of the emerging workflows. So, Bob, I don't know if you have anything to add on that?"
},
{
"speaker": "Bob McMahon",
"content": "Yes, I would just say, as we think about kind of our long-term algorithm that we've been talking about, that 5% to 7%, we're not ready to walk away from that. I think we still feel good about that. And I think while you talked about some of the bad guys, we still believe in Biopharma and are continuing to invest there. In addition, Padraig mentioned a few things on the applied side where we are the undisputed leader. So, things like PFAS, the electrification, semiconductors, those things weren't there five years ago to the extent that they're going to be there in the next five years. So certainly, the markets are a bit challenging right now, but we are seeing them recover, and we would expect to be able to get back to those rates in the near term."
},
{
"speaker": "Doug Schenkel",
"content": "Okay. And Bob, maybe sticking with you. If we go back to the beginning of the year when you set guidance for the fiscal year. Yes, I think it's fair to say there were a number of questions from the investment community about how you were setting guidance for the year. Specifically, there was concern about the plausibility of what you assumed for the second half. In hindsight, obviously, these questions and concern to be well-founded. What went wrong? Does this tell you something about your visibility for the business? If so, is it a transitory issue? And if that's the case, can you help us explain why? And if it's not visibility, what do you need to do in terms of changing your guidance philosophy moving forward?"
},
{
"speaker": "Bob McMahon",
"content": "Yes. Thanks, Doug. And I think it is visibility. I think if you looked across the last seven years, the two most volatile years have been the last two. And so, I think we were expecting based on the feedback that we got from our customers that they would be releasing budgets much more quickly than what they have or at least what we're seeing and while we did have an expectation that we were going to see an inflection in the back half of this year, when we're talking to our customers, it just hasn't happened. And so, I think the visibility is something that I think will we will get back, particularly as we have more recurring revenue and continue to have the connect rate on to the services business. And we're disappointed as everyone else is, but you can rest assured that we're going to come out of this stronger going forward."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Dan Leonard with UBS. Please go ahead. Dan, your line might be on mute. Our next question will come from the line of Michael Ryskin with Bank of America. Please go ahead."
},
{
"speaker": "Michael Ryskin",
"content": "I want to pick things up exactly where you just ended on the last answer with Doug on visibility. So, I mean you kind of talked about how you had a certain set of expectations going into the year based on conversations with customers that didn't play out. I mean, is that -- is there any reason to think that visibility is better now, I guess, is my question, if we look at the guide change and specifically focusing on Pharma with or without an NASD, if you want to just talk about Pharma, the CapEx of Pharma and NASD, it seems like visibility there is still really, really challenged. So, on the one hand, a lot of your prepared remarks are markets are improving. But on the other hand, you're not expecting in 3Q because you just talked about low double digits. It doesn't seem that you're expecting for the rest of the year. So just exiting the year, entering next year, how do we know we're not going to be having the same conversation again about another push out and then another push out? Just talk about that visibility going forward."
},
{
"speaker": "Bob McMahon",
"content": "Yes. I think if we look at just first half, second half and look at where our core guidance is, it's not assuming any inflection in the back half. I mean you could make an argument that typically, we have a higher weighting towards the back half of the year, just part of normal seasonality, and we're not assuming that in our guide. And so, if you look at also Pharma, we're assuming it's down roughly the same as it's been in the first half of the year, but we'll get easier compares. And so, we're not expecting \"a big inflection in the back half of the year.\" I would say also on NASD, which we are assuming a reduction in the second half of the year relative to the first half of the year, we have all those orders in-house. And so, we've got a plan, a production plan and both for Q3 and Q4. And while something could happen, it's not like we're looking for orders to guide us on those. And those are the two big areas that made the biggest change when I think about where we were back in November, giving guidance to where we are today."
},
{
"speaker": "Michael Ryskin",
"content": "Okay. And Bob, since you touched on 3Q, 4Q ramp, I'm going to follow up on that as well, actually. I mean, you normally do see some seasonality third quarter, the fourth quarter, depending on the year, depending on the comp, let's call it about $100 million, maybe $100 million plus. You're something that your guide for 3Q and fiscal year implies about $120 million repeat to 4Q for this year. So again, not excessive, but still some step-up and it seems like 2Q and 3Q certainly are below trend. So, is there any risk to that 4Q number? I mean is there anything else we should be thinking about in terms of what makes that achievable besides just comp and seasonality?"
},
{
"speaker": "Bob McMahon",
"content": "Yes. The biggest change there is our NASD business, which we will see a low water point here in Q3 if we -- what we ended up seeing is some of these clinical programs getting pushed out. They've got pushed out from Q3 into Q4. And so, there's a $30 million incremental step-up from Q3 to Q4. So, if you took that out, we did get back to a more historical kind of level."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Dan Arias with Stifel. Please go ahead."
},
{
"speaker": "Dan Arias",
"content": "Bob or Padraig, on the capital equipment portfolio and the order book and the sales funnel that you have there, maybe just in simplistic terms, how would you describe the average time to deal close that it feels like you're going to be working with in the back half of the year versus what you've seen as a historical average? And embedded in that is just this question on instrument demand that you have a line of sight on via the sales funnel, but that just hasn't been booked yet versus what's not materialized at all yet? And then how the outlook change reflects those two things."
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Look at it, I think it's hard to put a number on the extended deal time. It depends actually on the platform and portfolio. So, there's quite a big difference between, for example, GC and LCMS on that. But what I would say, in general, the deal time is prolonged. The win rates, of course, haven't changed. They're still very, very strong, but that deal time is prolonged. And I think if you look at it in the second half when we're looking at the visibility of what we're seeing in the funnel, the best thing and we're doing is staying close to customers on this one, making sure we're there to help them, of course, with their decisions and help them get up and running when they make the decision to purchase on it. So, we're going to see this continued extended deal time, I think, through the end -- through the second half."
},
{
"speaker": "Bob McMahon",
"content": "Yes. Dan, I wish I could say we have all the orders in-house for the second half for instruments. It just doesn't work that way. So, we have much better visibility into Q3, but we will need continued performance in Q3. Now we've had several quarters here of book-to-bills being greater than one in our instrumentation portfolio, which is a positive thing. I would say, hey, we're building some backlog. And as Padraig mentioned earlier in the call, particularly in LSAG. LSAG orders grew ex-China. And that is the first time that's happened in several quarters. So, we are seeing some positives and if you look at the second half of the year, our performance relative to last year should improve just because of the benefit of easier compares. And so -- we're not, again, looking for that huge inflection. And we're not expecting also as Padraig was saying, a constriction, so to speak, or an acceleration of those deal funnels. We're expecting them to stay very similar to the way they are right now."
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. I think just to close off, Bob, I think the deal closure time lines remain at an elevated but very stable level. They're not deteriorating further, which I think is a really good sign. And in terms of the funnel is stable, no cancellations within that, which, of course, is very important to see."
},
{
"speaker": "Dan Arias",
"content": "Okay. And then maybe on -- as a follow-up on Biopharma. I'm just curious about the extent to which the IRA is part of the conversation there these days. It sounded like last year, the industry kind of contemplated an adjustment as the idea was coming into the picture. So, do you think spending expectations got rightsized for a period of time? Are you finding that that's sort of a continual evolving conversation?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes, I would say it's a continuing evolving conversation. Clearly, on the NASD side, we've seen an impact from the IRA something we're watching closely, but I think this will evolve over time. What we're seeing in terms of programs-based around pricing provisions, there definitely has been an impact on that side."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Josh Waldman with Cleeland Research. Please go ahead."
},
{
"speaker": "Josh Waldman",
"content": "A couple for you. Padraig or Bob, I wondered if you could talk a bit more on how instrument orders progressed sequentially. I mean did orders deteriorate over the last 90 days or really just a function of orders not improving as you expected? And then I wondered if you could comment on what you're seeing from new orders, new order perspective across the key product categories within LSAG categories like LC/MS, GC, ICP. I guess is it fair to assume LC/MS is driving the majority of the softness just given the comments on Pharma."
},
{
"speaker": "Padraig McDonnell",
"content": "I don't know if you want to take that one, Bob."
},
{
"speaker": "Bob McMahon",
"content": "Yes, I'll take it. So, I wouldn't characterize it, Josh, is a deterioration. It actually just wasn't the inflection or the acceleration that we were expecting. We did -- as we were saying here, we did have a positive book-to-bill and ex China orders grew. They just didn't grow to the extent that we expected them to, particularly in April, which we would typically have higher acceleration just kind of given the end of the quarter. In terms of the platform, what you're seeing is the platforms that are more focused on Pharma being the areas that are the weakest. So, LC and LC/MS are weaker than the applied markets. And you can kind of see that in our end markets as well. And so, we were expecting those to kind of perform better this year, and we're just still seeing that, I'd say, lower-than-expected performance from the standpoint of order velocity."
},
{
"speaker": "Josh Waldman",
"content": "Got it. Okay. Then a follow-up on China. I wondered if you could comment a bit more on where we’re seeing…"
},
{
"speaker": "Bob McMahon",
"content": "I would say -- sorry, just one quick -- so one thing I would say, though, is if I looked at the performance, the revenue performance versus the order performance, the order performance was significantly better in Q2 on those two main platforms than the revenue. So again, these are points that says we are getting out of it, maybe not at the pace that we were expecting. So -- and so those are some positive points that would suggest that we're going to continue to -- it's not going to deteriorate coming out in Q2 -- or excuse me, in second half. Sorry."
},
{
"speaker": "Josh Waldman",
"content": "Is it -- what were the two platforms?"
},
{
"speaker": "Bob McMahon",
"content": "LC and LC/MS. So yes. Yes."
},
{
"speaker": "Josh Waldman",
"content": "Okay. Okay. Got it. Got it. And then a follow-up on China. I just wondered if you could comment a bit more on where all you're seeing demand coming softer than expected from a new booking’s perspective and then a bit more detail on how you're contemplating the stimulus. I mean, it sounds like you saw improved bidding and funnel activity on the prospects of stimulus, but just wondered if you could provide what's giving you the confidence that, that stimulus related funnel ends up converting to orders and sales at some point in the future?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Maybe starting on the stimulus. This is an extremely large program, a multiyear program. It's very real. We've seen some of the customers with activity is asking us to bid and some of the things, even though they're not sure exactly yet how the mechanisms would work. So that gives us great confidence for '25 just from that. But I said earlier, also the indirect impact of confidence in science and technology in China. It's a real photo confidence by the government in making sure we -- making sure to get the market going again. So, I think in -- we saw meaningful softness extend to all markets because remember, the stimulus is not only academia and government, it's across all markets. And that has really come at once. And we did see at the end of the quarter, we also started to see customers postpone purchasing decisions have told us, right, sort of said we're going to postpone and they try to gauge if there's any benefit of the stimulus-related funding, and that's normal. I think that's expected. If you didn't see that, then the stimulus would have different questions. And why we believe that a stimulus program will ultimately be long-term positive, we really don't see any benefit in H2, and that's why we're roughly reducing by $70 million."
},
{
"speaker": "Josh Waldman",
"content": "Got it. Did you see stimulus-related postponing and Pharma and CDMO as well or more just government accounts?"
},
{
"speaker": "Bob McMahon",
"content": "Yes, it was both government and non-government accounts across the board. So, I would say it was pretty broad beyond Pharma."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Catherine Schulte with Baird. Please go ahead."
},
{
"speaker": "Catherine Schulte",
"content": "Maybe just sticking on China stimulus to start off. Is there any way to quantify the increase in the funnel activity that you've seen there just as we try to think about potential opportunity in future years?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. What we're seeing is a postponement, and I think it's really too early to tell on the funnel side on -- if the customers are still working out the mechanisms about how it works, we're still waiting to see on the impact on the panel, particularly for '25, it's too early to tell."
},
{
"speaker": "Catherine Schulte",
"content": "Okay. And then on LSAG, what was performance in the quarter, excluding China? And then any commentary on the Pharma end market specifically for that business outside of China in the quarter?"
},
{
"speaker": "Padraig McDonnell",
"content": "Bob, do you want to take this one?"
},
{
"speaker": "Bob McMahon",
"content": "Yes. So, our LSAG business declined 13% globally, ex-China, it was down 8%."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Paul Knight with KeyBanc. Please go ahead."
},
{
"speaker": "Paul Knight",
"content": "Within the 34% of business that's Pharma, what portion is Biopharma or Large Molecule, Bob?"
},
{
"speaker": "Bob McMahon",
"content": "It's roughly 45%."
},
{
"speaker": "Paul Knight",
"content": "And what's the overall growth rate of that piece, do you think?"
},
{
"speaker": "Bob McMahon",
"content": "Long term or in the quarter?"
},
{
"speaker": "Paul Knight",
"content": "In the quarter and long term."
},
{
"speaker": "Bob McMahon",
"content": "Yes. So, if we looked at our Biopharma business, it was down roughly 12%, Small Molecule was down roughly 10%. Total Pharma was down 11%. So, it kind of gives you a sense. I think."
},
{
"speaker": "Padraig McDonnell",
"content": "Yes, I would say before we get on to the long term, Bob, for Biopharma, really tough compare was mid-teens, plus mid-teens last year on that side. But what we're seeing is the long-term prospect for this market is very strong."
},
{
"speaker": "Paul Knight",
"content": "Yes. And then I know that you've got -- you have always been very aggressive and innovative on your M&A for biologics. Are you seeing that market open up on the M&A side of that marketplace?"
},
{
"speaker": "Padraig McDonnell",
"content": "You mean in the space itself."
},
{
"speaker": "Paul Knight",
"content": "Is pricing becoming more realistic as you think about your acquisition strategy?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Well, I think there's long memories. So, people don't forget the elevated pricing for assets, but we're going to remain very disciplined. It's going to become an increasingly bigger part of the puzzle for us M&A, but we're going to make sure that we do it in a very disciplined way, link to strategy and of course, looking at areas of where we can double down and growth factors. So we're very focused on that going forward. But I would say, while pricing maybe has come down in little areas across the board, people have long memories."
},
{
"speaker": "Operator",
"content": "I will now turn the call back over to Parmeet Ahuja for closing remarks."
},
{
"speaker": "Parmeet Ahuja",
"content": "Thanks, Regina, and thanks, everyone, for joining the call today. With that, we would like to end the call. Have a good rest of the day, everyone."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect."
}
] |
a | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Ladies and gentlemen, welcome to the Agilent Technologies Q1 2024 Earnings Call. My name is Regina and I will be coordinating your call today. [Operator Instructions] I will now hand you over to your host, Parmeet Ahuja, to begin. Please go ahead."
},
{
"speaker": "Parmeet Ahuja",
"content": "Thank you, Regina and welcome, everyone, to Agilent's conference call for the first quarter of fiscal year 2024. With me are Mike McMullen, Agilent's President and CEO; Padraig McDonnell, Agilent Chief Operating Officer and CEO-elect; and Bob McMahon, Agilent's Senior Vice President and CFO and acting President of the Diagnostics and Genomics Group. Joining in the Q&A will be Phil Binns, President of the Agilent Life Science and Applied Markets Group; and Angelica Riemann, our newly named President of the Agilent CrossLab Group. This presentation is being webcast live. The news release for our first quarter financial results, investor presentation and information to supplement today's discussion along with the recording of this webcast are available on our website at www.investor.agilent.com. Today's comments will refer to non-GAAP financial measures. You will find the most directly comparable GAAP financial metrics and reconciliations on our website. Unless otherwise noted, all references to increases or decreases in financial metrics are year-over-year and references to revenue growth are on a core basis. Core revenue growth excludes the impact of currency and any acquisitions and divestitures completed within the past 12 months. Guidance is based on forecasted exchange rates. As previously announced, beginning in the first quarter of fiscal 2024, we implemented certain changes to our segment reporting structure related to the move of our cell analysis business from LSAG into DGG. We have recast our historical segment information to reflect these changes. These changes have no impact on our company's consolidated financial statements. During this call, we will also make forward-looking statements about the financial performance of the company. These statements are subject to risks and uncertainties and are only valid as of today. The company assumes no obligation to update them. Please look at the company's recent SEC filings for a more complete picture of our risks and other factors. And now, I'd like to turn the call over to Mike."
},
{
"speaker": "Mike McMullen",
"content": "Thanks, Parmeet and thanks, everyone, for joining our call. Before I review our first quarter results, I want to first acknowledge our news last week that I will be retiring at the end of the fiscal year and that Padraig McDonnell is Agilent's new Chief Operating Officer and will become CEO on May 1. It was a difficult decision to retire after almost 40 great years with this special company and in the role that I love, I will miss working with the One Agilent team. However, I must say it's a great feeling and quite gratifying to be handing over the CEO reins to a tremendously capable successor in Padraig. With Agilent operating from a position of strength and with a very promising long-term outlook. I have known Padraig for more than 20 years. I've worked closely with him during that time. He has always been completely committed to our customers and Agilent's success. He is a product of our culture, knows our company, team and markets and those have developed compelling business strategies, build winning teams and deliver exceptional results. Padraig has a strong track record result at every position he has held during his 26-year career at Agilent. I know he has the knowledge, leadership skills and customer focus that will be key to Agilent's success moving forward. I look forward to all of you seeing first-hand what a capable result driven leader we have in Padraig. Padraig would you like to say a few words?"
},
{
"speaker": "Padraig McDonnell",
"content": "Thank you, Mike. I'm honored to be able to follow you as Agilent's next CEO and I'm grateful for your support throughout my career and during this transition. You have made a significant impact on Agilent, our customers and our team. I'd also like to welcome Angelica Riemann to this call. After leading our services division for the last 2.5 years, I can tell you she has the experience and the skill set to continue evolving ACG to align with the growing opportunities that the business has demonstrated in supporting the broad installed base and our enterprise customers. Expect to see continued great things ahead from Angelica and ACG. I've had the pleasure of meeting some of you on this call and I look forward to meeting and working with you all in the future. Agilent has a compelling story to tell and I'm excited by the possibilities that lie in front of us as we help our customers bring great signs to life."
},
{
"speaker": "Mike McMullen",
"content": "Thanks, Padraig. For today's call, I will take lead, covering the overview of our financial results, while next quarter, Padraig will take on these duties as the new CEO. Now, on to the Q1 results. We are pleased with the start of the year. The Agilent team continues its strong execution in a challenging market environment. The first quarter provided further evidence of our team's capabilities with revenue coming in better than expected at $1.66 billion. This represents a decline of 6.4% against a tough compare of 10% growth in Q1 of last year. The better-than-expected top line results and disciplined cost management drove higher-than-expected earnings per share of $1.29 down 6% from Q1 last year. Given the solid Q1 results and our continued view is slow but steady recovery throughout the year, we are maintaining our full year outlook that we shared with you in November. Key to our Q1 performance was the ongoing sequential stabilization we experienced in China and secular growth drivers in applied markets globally. From an end market perspective, our total pharma business is down 12% which was in line with our expectations. This falls 11% increase in the first quarter last year. While declining overall against a very strong Q1 of last year, our applied end markets were more resilient than expected and show sequential growth from the fourth quarter. In these markets, PFAS Solutions and Advanced Materials, including batteries and semiconductors were high bits for us. Geographically, both China and Europe finished Q1 better than expected, while revenue for the Americas was in line with expectations. Looking at performance by business unit, the Life Sciences and Applied Markets Group delivered revenues of $846 million and down 11%. This is against a difficult compare of 10% growth last year. While still too early to call an overall market recovery, results were better than expected. Our diversified portfolio and broad end market coverage helped drive the performance. We continue to experience a conservative environment for capital spending. But are better than expected, Q1 results were driven by consumables which grew mid-single digits, China and a better-than-expected performance in applied markets. During the quarter, we also completed the expansion of our Shanghai manufacturing facility as we continue to take steps to ensure our long-term leadership in China. We also made our first customer shipments for Agilent's newly released LC/MS offerings. Our latest highest sensitivity triple quad, the 6495D enables expanded and enhanced workflows, including for PFAS. This, in addition to Revident, the first of a new generation of LC/Q-TOF systems that combine a new architecture with enhanced instrument intelligence for maximize operation time and productivity. The Agilent CrossLab Group posted revenue of $405 million. This is up 5% with growth across all regions except China. Our contracts business led the way with double-digit growth overall, led by strength in enterprise service contracts. This performance highlights the continued strength and resiliency of our business. Connect rates for both services and consumables continue to improve. This is a result of our focused strategy to deliver end-to-end customer value while also building a larger recurring revenue business. The Diagnostics and Genomics Group delivered revenue of $407 million, down 6% core. Our pathology-related businesses and our NGS QC portfolio grew mid-single digits which was more than offset by declines in NGS chemistries and NASD. NASD declined low double digits as expected. This is because a very tough compare of 22% growth driven by significant volume last year from a single commercial program. We continue to be encouraged with our long-term prospects due to the increasing number of programs across a range of indications many of them target large patient populations. The DGG team continues to innovate and deliver differentiated solutions for our customers. In the quarter, we induced a new ProteoAnalyzer system. The new platform simplifies and improves the efficiency of analyzing complex protein mixtures. And processes that are central to analytical workflows across the pharma, biotech, food analysis and academia sectors. From an overall Agilent perspective, we recently achieved World Economic Forum recognition for operations of Waldbronn, Germany. This site was named a Global Lighthouse for implementing innovation that boost productivity, output and quality. This marks the second Global Lighthouse award for us after seeing the recognition for our Singapore facility two years ago. Agilent is the only life science tools company to be recognized as a Global Lighthouse. Agilent recently achieved a top 5 ranking in the Barron's list of 100 most sustainable companies. In addition, we are included in the Dow Jones Sustainability Index globally and in North America for the ninth year in a row. Looking ahead, we expect the current market environment to persist through the first half, we expect a slow and steady improvement in the second half of the year. We will continue taking actions that will make us stronger and position us well for the future. We will maintain our approach to prioritize investing for growth with a focus on execution and driving productivity. Our better-than-expected Q1 results and my confidence the Agilent team reinforced our view for the full year. Bob will now provide the details on our results as well as our outlook for Q2. After Bob's comments, I will rejoin for some closing remarks. And now, Bob, over to you."
},
{
"speaker": "Robert McMahon",
"content": "Thanks, Mike and good afternoon, everyone. In my remarks today, I'll provide some additional details on revenue in the quarter, as well as take you through the income statement and other key financial metrics. I'll then finish up with our second quarter guidance. Q1 revenue was $1.66 billion, a decline of 6.4% core. On a reported basis, currency added 0.9 percentage points, while M&A had a negative impact of 0.1%, resulting in a reported decline of 5.6%. And overall, orders were greater than revenue in Q1 as expected. As Mike mentioned, pharma, our largest end market declined 12%. Within pharma, biopharma declined low single digits but grew low single digits outside China, bolstered by strength in services and consumables. Small molecule was down high teens in the quarter with softness globally. The chemical and advanced materials market was down 4% off a very tough comparison of 14% growth last year. We saw broad resilience in advanced materials with a low single-digit increase year-on-year as well as growth sequentially. Given the extremely tough compare of high 20s growth last year, these are impressive results. As expected, the chemical side saw a decline. The academia and government market was up 2%. The growth in this market reflects the stability of academic funding and lab activity. Our business in the diagnostics and clinical market declined 5%, mid-single-digit growth in pathology was more than offset by continued headwinds in genomics, cell analysis and LC and LC/MS. The environmental and forensics market declined 1% after growing 12% in Q1 of last year. We continue to see new regulations around the world driving PFAS testing. Europe grew mid-single digits, while China and the Americas were down low single digits. Americas faced a difficult compare of low 30s growth last year. The food market declined 3% but was up low single digits, excluding China. On a geographic basis, as Mike mentioned, both China and Europe exceeded our expectations while the Americas were in line with our expectations. China was down 9% and showed a sequential increase over last quarter which was much better than expectations. China benefited from continued stabilization and a bigger-than-expected Lunar New Year impact as some customers pulled forward incremental demand from Q2. We estimate the pull-forward impact to be roughly $15 million or 5% of China's revenue in the quarter. Even adjusting for this impact, China outperformed. Europe was down 4% year-on-year after growing 10% last year and was up mid-single digits sequentially. This was driven by continued strong demand for our ACG services, offset by muted demand in pharma and expected softness in chemicals. In the Americas, revenue was down 8% due to declines in pharma and the softness in NASD and NGS chemistries. Moving down the P&L. First quarter gross margin was 56.0% down 50 basis points from a year ago as productivity and cost savings were offset by lower demand and mix. Our operating margin of 25.8% was down year-over-year as expected. Our ongoing cost savings initiatives are delivering as planned. Below the line, we benefited from greater-than-expected interest income in the quarter, driven by nice work from our treasury team, coupled with very strong cash flow. Our tax rate was 13.5% and we had 294 million diluted shares outstanding. Putting it all together, Q1 earnings per share were $1.29, down 6% from a year ago and ahead of our expectations. Now, let me turn to cash flow and the balance sheet. I continue to be very pleased with our cash flow generation. Operating cash flow was $485 million in the quarter, significantly above last year. In Q1, we invested $90 million in capital expenditures as we continue our planned NASD expansion. And during the quarter, we returned $69 million to shareholders through dividends. Although no shares were repurchased during the quarter, we expect to catch up on our anti-dilutive share repurchasing for the remainder of the year. In Q2, we expect a minimum of $180 million to be repurchased. All in all, we had a good start to the year. And as Mike mentioned, it reinforces our confidence in the full year guide we provided in November. Now, to our guidance for the second quarter. We expect Q2 revenue will be in the range of $1.56 billion to $1.59 billion. This represents a decline of 9.1% to 7.4% on a reported basis and a decline of 8.4% to 6.7% on a core basis against 9% growth last year. Currency and M&A combined are a headwind of 70 basis points. Our Q2 guidance also reflects the $15 million impact of the Q1 pull forward in China I mentioned earlier. Second quarter non-GAAP earnings per share expected to be between $1.17 and $1.20. Before turning back over to Mike, I just want to express my thanks to Mike and to congratulate Padraig. Mike, it has been a real pleasure to work with you. While there have been many ups and downs in the markets these past few years, one thing I knew I could always count on is your steady leadership and strong partnership. And Padraig, congratulations again. I'm really looking forward to working with you. And now, I'll turn things back over to Mike. Mike?"
},
{
"speaker": "Mike McMullen",
"content": "Thanks, Bob. Today marks my 37th and final earnings call with all of you. Time does truly fly by. I want to first thank you for your support and engagement over the years. I have to say it has been a tremendous honor serving as Agilent's CEO and represent the achievements of the One Agilent team to all of you and the broader investor community. In 2015, we launched the then new Agilent with a goal to transform Agilent into a leading life science and diagnostics company. We had ambitious goals to drive long-term shareholder value creation with significantly stepped up financial results delivered by an unmatched One Agilent team working together in a truly differentiated and compelling company culture. I couldn't be proud of the Agilent team and what we've accomplished together over the last 9 years. While current market conditions remain challenging, the long-term promise of growth remains with end markets power buying investments to improve the human condition. On the Agilent front, we've never been in a stronger position to continue to capitalize on opportunities to serve our customers within the market and deliver differentiated financial results. It's been a pleasure to work with all of you over the years. I will miss it. While at the same time, I know that you will enjoy working with Padraig in the years ahead. Like me, I know you'll be impressed with Padraig's knowledge of our industry and our business. As I noted earlier, he knows how to develop compelling business strategies, build winning teams and deliver exceptional results. His track record of success during his Agilent leadership journey speaks for itself and have no doubt, it will continue in his new role. While this is my last earnings call with you, I'm certain that the best is yet to come for Agilent. Thank you. And now over to you, Parmeet for the Q&A."
},
{
"speaker": "Parmeet Ahuja",
"content": "Thanks, Mike. Regina, if you could please provide instructions for Q&A now."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Derik De Bruin with Bank of America."
},
{
"speaker": "Derik De Bruin",
"content": "Congratulations, Mike. And good luck. So first question, we've been getting a lot of incomings on the NASD business. And just because the growth trajectory is not doing what I think what people had thought it was going to do this year. I assume there's a couple of questions. It's like, look, there's been some pushouts in some clinical readouts from Alnylam with their HELIOS-B trial, there's been some other sort of like developments in the market. I guess the question is like, are you still confident that, that segment can grow this year, NASD can grow this year? And I just -- is there any risk at all that there's like an overcapacity situation because as the market -- is it just taking longer for things to catch up? Just sort of your thoughts on that, please?"
},
{
"speaker": "Mike McMullen",
"content": "I'll tag team with Bob on this. So as you saw in our prepared remarks, Q1 came in as expected for the NASD business. And we are in a situation where we've had, I think, the broadest number of clinical programs and such. So we're very active. The volume is less commercial this year as we pointed out in the script as well versus clinical. And Bob, I know we've been talking a lot with the team about the outlook for the year, particularly with some of our customers who are resequencing some of the clinical programs into '25."
},
{
"speaker": "Robert McMahon",
"content": "Yes. Derik. And as you're talking about, we remain very optimistic about the future of NASD, our forecast for Train C and D remains intact in terms of building out the expansion. I would say that as we're talking about things, you mentioned one of the clinical trials. That's an important element of one of our customers. We are seeing some potential pushouts into FY '25. And as they are looking at revisiting the clinical trial programs and time lines and it's probably closer to flat this year based on that, although we're not giving up hope but that's built into kind of keeping our guide the way it is. But I think if you look at the number of commercial programs -- or excuse me, clinical programs that we have, we're very excited about the future."
},
{
"speaker": "Mike McMullen",
"content": "And Bob, I think it's also fair to say that this is not a byproduct of overcapacity in the industry or a significant change in in-sourcing. It's really how some of our customers are reacting to really the IRAC."
},
{
"speaker": "Robert McMahon",
"content": "That's right."
},
{
"speaker": "Derik De Bruin",
"content": "Well, that takes me -- that's a great segue into my next question which is what's sort of the latest on pharma? It doesn't sound like you're ready to call an inflection point but it does sound like things sounded a little bit better. Can you just sort of give your thoughts on what budget releases are sort of timing around that? Any sort of like notable developments? I mean, when do you -- are you seeing any sort of like signs of life that -- or the signs of budgets could start to be released in the second quarter?"
},
{
"speaker": "Mike McMullen",
"content": "Yes. Great question, Derik. Obviously, top of mind, within Agilent, as we mentioned, Q1 came in where we thought it would. But what's the outlook? And Padraig, I know you've just spending a lot of time with your team and customers talking about this exact question."
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. Thanks, Mike. And I think customers continue to be cautious globally. I think as we're stable -- what we're seeing a stability but no material improvement versus what we saw in the last half of last year. And in terms of the capital budget cycle in '24, this is the time we see it. It's pretty early in that cycle. But we've heard move in both directions, positive and negative but fewer customers expecting negative budgets. So we're watching and seeing how that goes."
},
{
"speaker": "Mike McMullen",
"content": "Yes. I think what you shared with me earlier, Padraig, was the tone was more negative at this time last year. It's still not super positive yet and still a lot of caution but we're not seeing anything to cause us to change our outlook for the year. I think Bob -- thank you very much. I think, Bob, you had one."
},
{
"speaker": "Robert McMahon",
"content": "Yes, I was just going to say one of the things that we see is very strong performance in our services and our consumables business in the pharma sector which actually speaks to lab activity. And so while we've seen a depressed capital cycle here and we're optimistic about that turning around in the second half of the year."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Matt Sykes with Goldman Sachs."
},
{
"speaker": "Matt Sykes",
"content": "Maybe just to start out, maybe bigger picture in China. It sounded like you made some comments about sequential improvement. It sounds like it's informing some of your confidence for back half. What are the risks that China just simply doesn't get worse and just kind of bounce along the bottom. And what kind of catalysts are you looking for in China for the back half for some level of improvement? I know it's not necessarily baked in your guide but you did make some comments about some sort of nascent optimism there potentially?"
},
{
"speaker": "Mike McMullen",
"content": "Yes, sure. Thanks for the question, Matt. And as we had a really, I think, a nice print to start off the year. A big part of that was the performance in China. Yes, we had a bit of a pull-in from Q2 from Lunar New Year but the business overall was better than expected. And to answer your question, we now have several quarters real orders, real revenue and the sequential growth, the numbers are real. So we're not seeing anything on the macro world that would also dramatically change what has continued to be a very challenging economic market in China. So what gives us confidence is the fact that we've had a number of quarters now, our predictability in the business. The numbers are coming in slightly better than we had anticipated. But again, I think it's more just the fact that there's ongoing run rate of business that gives us confidence on the outlook. And Bob, I know that you want to jump in on this one Padraig?"
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. And I think if, Matt, as you just mentioned, we aren't assuming any inflection in our guide. That's been consistent. Actually, Q1 ended up being a little better than we anticipated. We kind of putting that money in the bank, so to speak. And if you look at it, we'll have now quarters of numbers that are relatively stable which is a very positive sign. And I think when we look at our funnel, it's also stable as well as the order funnel -- order forecast is what Mike just talked about as well."
},
{
"speaker": "Matt Sykes",
"content": "And then maybe just on ACG which had a good quarter. You talked about the contract revenue and specifically enterprise services. With that growth, maybe could you just help kind of size that contract business within ACG? And then maybe talk about what is driving that growth? And what kind of contribution can that make to the ACG segment over the course of this year?"
},
{
"speaker": "Mike McMullen",
"content": "Matt, thanks for your support of the ACG business over the years. And I want to use this opportunity to introduce our new ACG Group President. But first, I'd like to maybe have a two-part response probably and Bob, I think it's roughly about 65% just to make sure. So roughly about 65% of our total services business is in the contracts arena. And Angelica, maybe you could share your thoughts on really what's been driving the growth we're seeing in that contract business."
},
{
"speaker": "Angelica Riemann",
"content": "Yes. Thanks, Mike. As you mentioned, it's about 65% of the total business. And a part of that demand has really been driven by the lab-wide enterprise services offerings, where we're able to help customers as they're navigating their own economic situation really helping them optimize their entire lab operation. And our portfolio offerings in this stage have allowed us to really facilitate that improvement in lab operations, lab efficiency and that's particularly important to those enterprise customers."
},
{
"speaker": "Mike McMullen",
"content": "And in times of tough economic times, the market times, the productivity help and driving productivity in the labs as a well-received offering we have."
},
{
"speaker": "Robert McMahon",
"content": "Matt, just one other quick thing on that. One of the great things that Angelica and team have been doing and you heard us talk about this a lot is about the increasing of the attach rate and that continues to grow at roughly 1 point again year-on-year this year. And that kind of locks in that resiliency of that stability in that business. And if you think about a 2/3 of that business growing double digits, it really helped power the business and when we see the inevitable turnaround of the instrument business, that will be a nice tailwind as well."
},
{
"speaker": "Mike McMullen",
"content": "So, absolutely, Bob."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Brandon Couillard with Jefferies."
},
{
"speaker": "Brandon Couillard",
"content": "So the chemical and advanced materials business, we actually performed a little better than we were expecting. Obviously, you're still seeing some headwinds in the chemical side. Just give us your state of the union there, what you're seeing from a macro's perspective and kind of outlook for that business moving into the second half look like?"
},
{
"speaker": "Mike McMullen",
"content": "Yes. So I'll do a tag team on this with Padraig. So as you may recall, we've talked earlier this year about these secular growth drivers in the applied markets. And we saw that pretty much across the globe. And I think what we're seeing again is the investments being made in advanced materials relative to the semiconductor supply chain and also the fab is driving productivity. We're seeing continued investment relative to battery, battery development, QA/QC. And I think we continue to see some real nice growth in the PFAS side of our environmental business. Started in the U.S., I think all those applied market secular drivers that we've been pointing to for, for some time, delivered in Q1. And I think our outlook remains the same that we're expecting there'll be a source of positivity for us in the overall CAM [ph] market space, albeit the chemical market is expected to remain subdued."
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. That's right, Mike. I think it's really a tale of two submarkets. We saw broad resilience in the advanced materials with sequential growth. And given the extremely tough compare and high 20s we had last year, it was truly a very impressive result from the teams. The chemical and energy side was -- we saw a decline but on a very tough compare of 10% but we did see a sequential improvement versus Q4 '23. Overall, I think our portfolio is extremely strong in this area. We have ability to cross and upsell across that. And of course, our strong services offerings have that value proposition."
},
{
"speaker": "Brandon Couillard",
"content": "And then, Bob, in terms of the guide for the year, I mean, you're sticking with the organic growth range for the year, you beat the first quarter. This China pull forward, then explain all of the upside in the first quarter what the NASD outlook is lower, what other moving parts by end market or geography kind of gets you to the same midpoint?"
},
{
"speaker": "Robert McMahon",
"content": "Yes. That's a great question, Brandon. And you talked about a couple of them. We feel really good about where we started the year. It's still at the beginning of the year, though, so we're kind of banking some of that. What I would say is if you looked across the moving pieces, with the NASD being slightly lower, that would be offset by a little better results in the LSAG side of the business. And really, that chemical and advanced materials and academia are two areas that are probably slightly better than what we had forecasted. But overall, we're maintaining the guide and as we are looking here felt good about really at the start to the year."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Puneet Souda with Leerink Partners."
},
{
"speaker": "Puneet Souda",
"content": "So my first question is really around maybe, I think Bob, you talked a little bit about the book-to-bill orders growing faster than revenue. But maybe could you elaborate a bit on more on the instrumentation side, what you're seeing and what you're seeing with the respect to book-to-bill in China? And a quick question, a clarifying question on the 2Q guide. It does look a slight step down versus Q1. And I just want to make sure beyond the Lunar New Year? What else are you baking in there?"
},
{
"speaker": "Robert McMahon",
"content": "Yes. I'll take that. There are a lot of questions in that one question. But so true to form, Puneet and one of the things -- I'll start with the last one. I mean, we typically do have seasonality. There is that $15 million that gets pushed from one quarter to another; that's strictly timing in China because of the Lunar New Year. But Q2 is typically a lower revenue number. So we're building in that normal seasonality. In terms of book-to-bill in China, actually book-to-bill was greater than 1 in China; so continued stabilization. And in terms of book-to-bill for our instruments, it was below 1, are kind of expected. Now some of that was a result of the China pull forward where the orders came in and we were expecting that revenue to be shipped in Q2; so there's some element of timing there. But all in all, a positive start to the year."
},
{
"speaker": "Mike McMullen",
"content": "Bob, if I cover headline on that, too, I'd just say that Q2 seasonality is as normal and the Q1 book-to-bill results are as our normal pattern. So again, we've been talking a lot about normalization of business flow. And I think we're seeing it in terms of the seasonal patterns and book-to-revenue situations."
},
{
"speaker": "Puneet Souda",
"content": "And then just a high-level question, or a simple question. Could you maybe elaborate a bit on the pharma side, where you're seeing more traction, more growth? Is it the large pharma, small biotechs, CROs, CDMOs. Maybe just talk a little bit about that."
},
{
"speaker": "Robert McMahon",
"content": "Yes, I'll take that, Puneet. If we look at across our business, the relative strength was actually in our biopharma. So a large molecule. And our business is skewed to the larger midsize and large cap companies. The standout has been the ACG business and our consumables on that. So it actually speaks to activity in the labs. We are starting to see -- I don't want to call it a trend but certainly a stabilization on the emerging biotech side of it. The instruments were still down but that is where we're starting to see the relative strength in the pharma business. And that speaks to kind of the long-term growth drivers, I think, in that market. And I would expect that to continue throughout the course of the year as our business gets stronger and the markets get stronger. And quite honestly, we have more favorable comps."
},
{
"speaker": "Mike McMullen",
"content": "Bob, I think I recall correctly, outside of China, our biopharma business actually grew in the quarter."
},
{
"speaker": "Robert McMahon",
"content": "That's right."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Rachel Vatnsdal with JPMorgan."
},
{
"speaker": "Rachel Vatnsdal",
"content": "So first up, I just want to follow up there on a comments around book-to-bill. So you mentioned the book-to-bill for instrumentation was below 1 for the quarter and some of that was really timing related. So I guess, can you just break that down for us a little bit further. What trends are you seeing in liquid chromatography versus mass spectro for example? And then is there any dynamics or trends to call out from geography on the instrumentation business as well?"
},
{
"speaker": "Mike McMullen",
"content": "I don't think there's any new trends here. I think without going into the details of our product line, the small molecule side has really been in an area where we've talked about the year-on-year challenges there from the LC side. But Phil, I don't know if you want to jump in with any thoughts here but I don't think there's any real outstanding new trends here with perhaps the better-than-expected trends we saw in applied markets, particularly on advanced materials but maybe you have something else you want to add?"
},
{
"speaker": "Phil Binns",
"content": "Yes, sure, Mike. I think that's pretty much the case similar to Q1 around how the markets are performing. We're seeing some bright spots around some of the secular areas in the applied markets, in the instrumentation which is driving the business forward but just support your comments there."
},
{
"speaker": "Robert McMahon",
"content": "Rachel, just one other thing to build on what Mike and Phil were just talking about. When we look at our LSAG business, it was down 11% which was better than what we expected. The piece that's really been driving that down is the pharma market which is what we've been expecting. If we looked at the rest of the markets, they were much better than the down 11% with the exception of the diagnostics and clinical which is a small number."
},
{
"speaker": "Mike McMullen",
"content": "Right. And to your question, Rachel, that dynamic in the pharma really speaks to pressure on the LC business."
},
{
"speaker": "Rachel Vatnsdal",
"content": "And then I just wanted to ask about monthly trends. Some of your peers have talked about how spending a bit, a little bit slow out of the gate in January and then into early February. So I guess, since you guys have a few more weeks of visibility here. Can you walk us through where you seeing similar trends on just slower spending to start the year? And has any of that started to come back? Any color there as we enter fiscal 2Q would be helpful."
},
{
"speaker": "Mike McMullen",
"content": "Well, I've been in this business for a while and it's always slow in January. And that's why we have the seasonality we talked about relative to Q2. So I don't think we're seeing any significantly different trends that we've seen historically. Padraig, I know that you're closer than I am but [indiscernible]."
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. No, I think that's right, Mike. I think on the ACG side, we see a number of service -- our service contract business comes in strong under the ACG side but on the capital side, we're not seeing much."
},
{
"speaker": "Robert McMahon",
"content": "Yes. And Bill, just a final -- put a finer point on that, January came in as we expected."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Vijay Kumar with Evercore ISI."
},
{
"speaker": "Unidentified Analyst",
"content": "This is Jordan [ph] on for Vijay. Maybe one follow-up on the China side. Have you seen any hints of stimulus to start the year? And if we do see a stimulus, do you have any foresight to what implications that will have on Agilent?"
},
{
"speaker": "Mike McMullen",
"content": "Both Padraig and I are in the conference and we're shaking our head, no. We've not heard anything about any potential stimulus. And what I can tell you is if it does happen, it's upside to our outlook."
},
{
"speaker": "Unidentified Analyst",
"content": "Understood. And then maybe one more for me. Can you talk about how pricing has trended in the quarter? And any updates to your expectations for the remainder of the year?"
},
{
"speaker": "Mike McMullen",
"content": "Bob, do you want to take that one?"
},
{
"speaker": "Robert McMahon",
"content": "Yes. We were pleased with the results. It was between 1% and 2%. So but in line with kind of the seasonality and the mix that we saw, we would expect to see in Q1. So right now, it's on track. As we've talked about, our consumables business and ACG business have the greatest price realization followed by generally speaking, actually, we had a very good result in diagnostics and genomics in the quarter. And then we did see some mix but not anything out of the ordinary instrumentation side. So all in, we're on track for what we expected for the full year."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Patrick Donnelly with Citi."
},
{
"speaker": "Patrick Donnelly",
"content": "Bob, maybe one for you first. Just in terms of the EPS guide. It looks like you guys got an additional $20 million on the kind of net interest other income. Can you just kind of flag if that's rolling through, did that core earnings number move a little lower? Is any moving pieces there? And then secondarily, just on the margin piece, you guys have that cost savings plan. Can you just talk about how that paces as the year goes, would be helpful."
},
{
"speaker": "Robert McMahon",
"content": "Yes. Thanks, Patrick. Great question. And what I would say is a couple of things. We are on track to have more interest income than what we anticipated at the beginning of the year that $20 million and some of that in the first quarter as well and that's really a result of actually having better-than-expected cash flow in the first quarter and great work by the treasury team. I would say that the savings -- we're on track for the savings targets for the full year. And as I think about the year, it's still very early in the year and this provides us what I would say is more confidence in the guide."
},
{
"speaker": "Patrick Donnelly",
"content": "And then, maybe just on kind of the book-to-bill. How are you guys thinking about -- I think last quarter, you said the book-to-bill for the year would be above 1 but you'd have quarters kind of in and out on the instrument side which obviously we're seeing this quarter. How are you thinking about just the order trends and the book-to-bill trends on the instrument side as we work our way through the year given what you're seeing today?"
},
{
"speaker": "Robert McMahon",
"content": "Yes, no change to what we said back in November. Q1 is a proof point for what we said."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Dan Brennan with TD Cowen."
},
{
"speaker": "Daniel Brennan",
"content": "Maybe just going to beat the dead horse but just for the instruments, did you guys say -- I know in the Q, you usually put out what the instrument number actually was. So what did actually instruments do in the quarter? And then given how much easier comps go as we get through the year? Can you just kind of give us a sense of pacing like what should we expect on Q2 in instruments and then we can kind of have at the back half of the year?"
},
{
"speaker": "Mike McMullen",
"content": "I know the team did a calculation on that because LSAG was down 11% but that includes our consumables business which was up."
},
{
"speaker": "Robert McMahon",
"content": "Yes, I would say we typically don't give all that information but it was down -- we were down 11%. It was down, puts 20%, in the quarter but that was better than expected, offset by 6% growth in our consumables business. If we look at the LSAG thinking for Q2, it's down low teens. So -- and a lot of that has to do with some of the timing associated with that $15 million shift. That's almost all capital equipment from Q1 -- from Q2 back into Q1. So if you look at it, it is in line with where we expect it to be."
},
{
"speaker": "Mike McMullen",
"content": "And then, we go into more favorable compares in Q3 and Q4."
},
{
"speaker": "Robert McMahon",
"content": "Correct, correct."
},
{
"speaker": "Daniel Brennan",
"content": "Got it. Okay. And then I know there's been a handful of questions running on China. But can you just -- would you mind spending a bit more color on kind of what maybe by segment, pharma, applied? Any color you can give us kind of what you're seeing within the different businesses in China? And is down mid-single still the expectation for China for the full year? Or is there a chance you can kind of see some upside for that number."
},
{
"speaker": "Mike McMullen",
"content": "I think we've have raised it up a bit. It's still down..."
},
{
"speaker": "Robert McMahon",
"content": "Yes, yes. I think we're cautiously optimistic there. I'd say it's still within a range that we had before, so I don't want to call an inflection. But if you looked at the markets we were down that 9% was roughly down 20%-ish [ph] in pharma. So that continues to be the area of really around the globe but China is no different. The great thing is many of the other markets performed much better. So even when you think about like academia and government, that grew, so did our chem and advanced material business now grew very low single digits. And then our forensics in environmental was down low single digits. So you're actually starting to see the continued stabilization and then you'll get into very much easier compares in the back half of the year in China because that down 22% was down compared to up 12% last year. We had another strong compare in Q2 and then we actually started seeing the pretty significant declines year-on-year. And so there's reasons to be optimistic about that continued stabilization that Mike talked about but we're not ready yet to call an inflection. But when it happens, we'll take it."
},
{
"speaker": "Mike McMullen",
"content": "And Padraig, I know you want to jump in this as well."
},
{
"speaker": "Padraig McDonnell",
"content": "Yes. And I think what we see is as also consumables and services continue to outperform expectations in China, so that's kind of we expect that to continue."
},
{
"speaker": "Mike McMullen",
"content": "Yes, I think the story is a great. I think the story really was in pharma, Q1, the instrument and the CapEx side of things. But we're pleased with the start there."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Catherine Schulte with Baird."
},
{
"speaker": "Catherine Schulte",
"content": "Maybe first, when pharma was down 12% in the quarter. I think you said biopharma was up 2% ex China. What was small molecule performance ex China. And maybe the outlook for biopharma versus a small molecule for the rest of the year?"
},
{
"speaker": "Robert McMahon",
"content": "So small molecule on a global basis was down roughly 18%. And it was ex China, it was down 20% and down roughly 14% for China. So pretty consistent across the globe. I would say, in China, the big area in China that has been impacted is on the small molecule side, where we'll start to see better comps going forward after Q2."
},
{
"speaker": "Catherine Schulte",
"content": "Okay. And then maybe on consumables, it's great to see a return to growth there this quarter. Can you talk through what you saw outside of China on the consumables side?"
},
{
"speaker": "Robert McMahon",
"content": "Our consumables business was pretty consistent across the globe in terms of growth."
},
{
"speaker": "Mike McMullen",
"content": "So I don't know if you have anything you want to add to that on the -- or we've seen the consumables, I think we're really pleased to see that because it really speaks to the lab activity being robust. So anything else you want to jump in on with?"
},
{
"speaker": "Phil Binns",
"content": "Yes. Probably just one item there, Mike. I think we are seeing really good traction around our workflow development. So end-to-end solutions which obviously is also drives our services business as well. But around the consumables, the -- in most of our end markets, we've been pretty heavily focused on developing workflows and making our customers' lives easier and more integrated in our labs and that's showing some really good traction and that's reflected in solid connected attach rates in the consumable space."
},
{
"speaker": "Mike McMullen",
"content": "Thanks, Phil. I'm really glad you close with the comments about connect rates. We talked about that relative to our services business, we're also seeing a very strong positive trend on consumables as well which bodes well to our future in terms of recurring revenue business growth."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Jack Meehan with Nephron Research."
},
{
"speaker": "Jack Meehan",
"content": "Just had a couple of follow-ups. The first one was, could you just talk about what you're seeing in the genomics business within DGG. I know it's still been a bit of a drag. Just when do you think that's going to start to turn?"
},
{
"speaker": "Mike McMullen",
"content": "I think I'll invite Bob in on this one but I think it's been sort of a tale of two cities. When we talk about our genomics business, there's really two pieces to it. The half of it's in QA/QC activities for NGS workflows and we're seeing really solid growth in the consumables on that side of things as well as you're starting to see signs of life on the CapEx, not the current because the call churn there yet but that's in a reasonably good shape. I think we've seen really in our U.S.-based genomics business, some really market challenges have been hitting us. And Bob, maybe you can elaborate on that?"
},
{
"speaker": "Robert McMahon",
"content": "That's right. Thanks, Mike. And as you said, our NGS QC portfolio from an instrument and consumable side actually grew mid-single digits in the quarter which was very nice. The genomics chemistry side that we referenced in the prepared remarks was down. We faced some very difficult comps. We had a couple of companies that reorganized and exited some businesses. They had some lifetime buys at the end of Q1. I would expect that the performance of that to improve starting in the second half of the year."
},
{
"speaker": "Jack Meehan",
"content": "Great. And I also wanted to ask about the academic end market. I know that's been very stable for you guys. But just what you're seeing in the U.S. here with the continuing resolution for the NIH, just thoughts on the durability moving forward."
},
{
"speaker": "Mike McMullen",
"content": "Yes, Jack, thanks for noticing that. That was a real bright spot for us. We actually grew, I think, 2% in the quarter. And this is -- we've been working on this thing for some time to really build out our portfolio and really change our market position in academia research and I think it's starting to show up in the numbers. I think stabilization really is what we're seeing which is the funding is there. And NIH is a relatively really small part of Agilent's business, so really is immaterial. But we're seeing universities have increasingly been funded through private sector. So the money is there. And even so, we saw money in China as well. So it was really a nice global story for us and we're fairly optimistic that, that kind of stabilization can be there for us for the rest of the year."
},
{
"speaker": "Operator",
"content": "Your next question will come from the line of Doug Schenkel with Wolfe Research."
},
{
"speaker": "Doug Schenkel",
"content": "I want to ask a question on guidance and then a question on capital deployment."
},
{
"speaker": "Mike McMullen",
"content": "Surely, absolutely. Go ahead, Doug."
},
{
"speaker": "Doug Schenkel",
"content": "So for the year, on one hand, around 48% of sales is in the first half, at least that's how you've guided, I believe. Yes, that's lower than last year but it's not outside the norm for the last several years. On the other hand, just given some math, your guidance for the first half embeds the assumption that revenue declines around 7% organically and then improves 7% to 9% positive organic in the second half. Can you could do that just as a function of the comps? Or do you actually really need to see improvement in certain geographies or certain end markets or categories? And then again, just a math question. Does guidance assume Q4 revenue kind of exiting around like $1.8 billion?"
},
{
"speaker": "Robert McMahon",
"content": "Doug, this is Bob. I'll take that last one. We'll tell you when we get to Q4 and what I would say but your math is -- in all seriousness, your math is spot on as usual. I think one of the things that we look at is, we look at it a couple of different ways. I think the way to look at it is that first half, second half kind of looking at seasonality, that's probably more instructive given kind of the changes in the growth rates. And when you look at it, as you noticed -- as you mentioned, it is in line with our historical seasonality. And when you look at the growth rates, you're right, we are expecting growth in the back half of the year. A lot of that is, in fact, the easier the compares. And when we actually look at -- what I would ask you to take a look at also is a 2-year stack basis relative to implied Q1 and first half and second half. And what you would see there is a much more smooth number that we also looked at as well. So as usual, you're spot on there."
},
{
"speaker": "Mike McMullen",
"content": "And Bob, I think that's why we really emphasized in the script, the word stabilization because as things, as we have kind of a stabilization, we're going to get a lift in the growth rate just by the comps as they go."
},
{
"speaker": "Doug Schenkel",
"content": "Yes, I know there's a lot of focus on how much improvement is necessary to get there. So if a lot of this is stability is just math that I think obviously makes people more comfortable. I know I've taken up a lot of air time already. Real quick. Capital deployment, the cash flow remains robust. The balance sheet is super clean. Can you just talk about your thinking right now on capital deployment and what the environment looks like right now?"
},
{
"speaker": "Mike McMullen",
"content": "Yes. I think we remain very interested in deploying capital in a balanced way which is inclusive of investing for in the business. And that speaks directly to we are interested in M&A. It's our build and buy growth strategy. I just have to say that the funnel pipeline is more robust than I've seen in a number of years and nothing to obviously announce but we're very much engaged."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Josh Waldman with Cleveland Research."
},
{
"speaker": "Josh Waldman",
"content": "Yes. Just a couple on my end and maybe Bob, starting with you first, a follow-up on the guide. Can you comment a bit more on how Q2 guide moved versus the framework and the initial outlook? I assume core outlook came down a bit but just wanted to confirm the moving pieces there. And then, does the core guide reflect any changes in Q3 or Q4? Or is it really just reflecting an update on H1?"
},
{
"speaker": "Robert McMahon",
"content": "Yes, that's a good question. It's a little of both, Josh. So Q2 is relatively intact for what we had originally thought with the exception of that small movement of the China business, that's roughly a point of core growth from Q1 and Q2 switching. What I would say is Q1 also had a beat into it and what we're taking is some of that out of the second half of the year. And so the takeaway is Q2 is spot on from where we expected it to be, absent that kind of shifting the timing shift of China and then the Q2 or the rest of Q1 kind of the beat really helps us in the second half of the year."
},
{
"speaker": "Josh Waldman",
"content": "And then, Mike, can you talk about how visibility in the business as you've covered the last three months? Has there been any improvement in the ability of the funnel to predict near-term sales or still seeing an elongation of kind of opportunity and quoting, flipping to orders. Curious, total company and then also what you're seeing in pharma specifically."
},
{
"speaker": "Mike McMullen",
"content": "Yes. No, I'll have Padraig jump in as well. I think the business remains the same. I don't think it's any better or any worse. And so I think it's the normal kind of cadence of business. And that's why, as Bob just mentioned, when we're talking about the second half, we bank some of the beat to put again the second half because we've yet to see the second half materialize in terms of the order book which is typical at this time of the year."
},
{
"speaker": "Padraig McDonnell",
"content": "I think that's right, Mike. And I think as far as the quality of orders remains -- that remain in our backlog, nothing has changed. We've not seen any increase in cancellations and ex China the funnel continues to grow and that's led by the aftermarket business. I will say as a continuing theme, the deal closure times remain at an elevated levels but it's definitely stable and deal win rates have been consistent."
},
{
"speaker": "Mike McMullen",
"content": "Yes. I think there's been an important point made here, elevated but we're not seeing the elongation. So they're stable but they're longer than they have been in the past."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Dan Leonard with UBS."
},
{
"speaker": "Dan Leonard",
"content": "My first question, just a bit more on China. Are you expecting sequential growth in Q2 in China similar to Q1?"
},
{
"speaker": "Robert McMahon",
"content": "No, if you looked at the sequential number, it's going to be roughly the same as what we had in Q1."
},
{
"speaker": "Dan Leonard",
"content": "And Mike, congrats on your retirement. I was wondering if you could elaborate on timing. I was surprised, others were surprised. I've gotten the question a number of times and we would just love to hear your thoughts."
},
{
"speaker": "Mike McMullen",
"content": "Yes. Thanks for that. So while it's maybe a surprise to many on the call and it was a surprise when I shared the news across the company because the Agilent team just knows how much I love working for this company and work with them. And it really was a hard-wall, really difficult decision for me but not been contemplating this for a while. And I pulled the Board into the discussion sort of communicating with them because we really wanted to make sure that they had enough time to really run a thorough and thoughtful selection process in which they were able to do. And in my mind, they came out with the best possible choice in selecting Padraig. But yes but this is something that I've been contemplating for a while and then try to engage in the Board about my timing and then I really want to make sure they had enough time to really pick the right successor and that's what they did."
},
{
"speaker": "Dan Leonard",
"content": "You always seem to be having a lot of fun. So congrats again it's been good."
},
{
"speaker": "Mike McMullen",
"content": "Thank you. It's going to be hard to step away. But I have to say, the [indiscernible] family was just too strong. We have a 6-month old -- 18-month old grandson and he will soon have a brother and sister so there's a lot going on, on the family side. And there's only one way I could make more time. So again, it's been a real pleasure to work with all of you on the call."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Luke Sergott with Barclays."
},
{
"speaker": "Luke Sergott",
"content": "I just want to talk about the margins on the quarter and kind of the step down in DGG and LSAG and I assume, obviously, it's probably driven by the volume declines there on the instrument side. But how do you guys view the recovery in the margins between DGG and LSAG throughout the year to hit your guide?"
},
{
"speaker": "Robert McMahon",
"content": "Luke, this is Bob. Just real quick. You're right. If I look at DGG, it actually was improvement year-over-year but it was down and it was really a result of that margin or the volume. I would say also there was an element of mix in LSAG and I would expect that to continue to improve. The cost actions that we took weren't fully actualized all and as expected in Q1. So we'll have the full impact of those as well in Q2 throughout. So I would expect an improvement over the course of the year as volumes grow up in both LSAG and DGG."
},
{
"speaker": "Luke Sergott",
"content": "And then, just a follow-up here from the 2Q guide. Can you just help frame what you guys are embedded there by the different segments?"
},
{
"speaker": "Robert McMahon",
"content": "Yes, if I look at Q2 guide, we're still expecting, if I looked at the end market pharma down double-digits academia and government down low single digits really as a result of some of that timing shift, diagnostics and clinical down mid-singles and chemical and advanced materials, down high single digits and food about the same. Both of those are, as a result of some of the shift also in the China business from Q2 back into Q1 and then environmental and forensics kind of mid-single-digit decline."
},
{
"speaker": "Operator",
"content": "Our final question will come from the line of Paul Knight with KeyBanc."
},
{
"speaker": "Paul Knight",
"content": "Mike, really super to see you love doing what you're doing and I knew you, I don't know, 15 years before you became CEO. So I guess, concluding question I would have, at least professionally, would be what do you see in terms of two things. Number one, why do you think the kind of market growth rate is for the markets that Agilent participates in? And then geographically, where do you see the surprise over the next 5 years? Like will Japan reinvigorate its growth? Will Europe see more in-sourcing? I would love to have your perspective on those things."
},
{
"speaker": "Mike McMullen",
"content": "Thanks, Paul. Yes, we do go way back to don't we and it's been great to work with you over those years, going way back to the CAG days in my prior role, I think we think this is a 4% to 6% kind of growth market, mid-singles. So we think that the kind of market growth that we're not experienced in the industry right now is the anomalies and this will be back to that 4% to 6% kind of long-term growth rate. Obviously, certain segments within that overall macro number, that big TAM will be growing faster than that and that's always a challenge to make sure that you pick those segments so you can actually beat that number. I think there's going to be some geographic mix. I mean, we've evolved our view of long-term growth into China because we actually expect some of the supply chain moves and other things that have been going on that you'll see a growth, more growth in Europe which has been more of a slower grower for us geographically. But we've been -- continue to be surprised how well we do. Our team does in Europe. I think you're going to expect to see Japan rejuvenate it, particularly, I think you can make the case of the semi industry which is going to return to some strength in Japan. But that's the beauty of this business is just the diversified nature of both the end markets and geographies. So that would be my last -- I guess, my final projection of long-term growth for the market in this role. But thanks, Paul. I appreciate the comments and looking forward to staying in touch."
},
{
"speaker": "Operator",
"content": "I will now turn the call back over to Parmeet Ahuja for closing remarks."
},
{
"speaker": "Parmeet Ahuja",
"content": "Thank you, Regina and thanks everyone for being on the call today. With that, we'd like to close the call. Have a good day, everyone."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this concludes today's call. Thank you all for joining."
}
] |
aapl | 2,024 | 4 | [
{
"speaker": "Suhasini Chandramouli",
"content": "Good afternoon, and welcome to the Apple Q4 Fiscal Year 2024 Earnings Conference Call. My name is Suhasini Chandramouli, Director of Investor Relations. Today's call is being recorded. Speaking first today are Apple CEO, Tim Cook, and CFO, Luca Maestri, and they'll be joined by Kevan Parekh, Vice President of Financial Planning and Analysis. After that, we'll open the call to questions from analysts. Please note that some of the information you'll hear during our discussion today will consist of forward-looking statements, including, without limitation, those regarding revenue, gross margin, operating expenses, other income and expense, taxes, capital allocation, and future business outlook, including the potential impact of macroeconomic conditions on the company's business and results of operations. These statements involve risks and uncertainties that may cause actual results or trends to differ materially from our forecast. For more information, please refer to the risk factors discussed in Apple's most recently filed annual report on Form 10-K and the Form 8-K filed with the SEC today along with the associated press release. Apple assumes no obligation to update any forward-looking statements, which speak only as of the date they are made. Additionally, today's discussion will refer to certain non-GAAP financial measures. You can find a reconciliation of these measures in our fourth quarter and full year 2024 earnings release, which is available on our Investor Relations website. I'd now like to turn the call over to Tim for introductory remarks."
},
{
"speaker": "Tim Cook",
"content": "Thank you, Suhasini. Good afternoon, everyone, and thanks for joining the call. Today, Apple is reporting revenue of $94.9 billion, a September quarter record and up 6% from a year ago. iPhone grew in every geographic segment, marking a new September quarter revenue record for the category, and Services set an all-time revenue record, up 12% year-over-year. We also set September quarter segment revenue records in the Americas, Europe, and the Rest of Asia Pacific, as well as in a large number of countries, including the United States, Brazil, Mexico, France, the UK, Korea, Malaysia, Thailand, Saudi Arabia, and the UAE. And we continue to be excited by the enthusiasm we're seeing in India, where we set an all-time revenue record. This has been an extraordinary year of innovation at Apple. We brought the revolutionary Apple Vision Pro to customers in February, which brings users tomorrow's technology today. And in June, we announced Apple Intelligence, a remarkable personal intelligence system that combines the power of generative models with personal context to deliver intelligence that is incredibly useful and relevant. Apple Intelligence marks the beginning of a new chapter for Apple innovation and redefines privacy and AI by extending our groundbreaking approach to privacy into the cloud with Private Cloud Compute. Earlier this week, we made the first set of Apple Intelligence features available in US English for iPhone, iPad, and Mac users, with systemwide Writing Tools that help you refine your writing, a more natural and conversational Siri, a more intelligent Photos app, including the ability to create movies simply by typing a description, and new ways to prioritize and stay in the moment with notification summaries and priority messages. And we look forward to additional intelligence features in December, with even more powerful Writing Tools, a new visual intelligence experience that builds on Apple Intelligence, and ChatGPT integration, as well as localized English in several countries, including the UK, Australia, and Canada. These features have already been provided to developers and we're getting great feedback. More features will be rolling out in the coming months, as well as support for more languages, and this is just the beginning. Now, I'll turn to our results for the quarter, beginning with iPhone. iPhone revenues set a September quarter record of $46.2 billion, up 6% from a year ago, with growth in every geographic segment. With the introduction of Apple Intelligence, we're beginning a new era for iPhone. iPhone 16, powered by A18, is equipped with an incredible new 48-megapixel Fusion camera, fantastic photo experiences, and the addition of the action button and camera control. An iPhone 16 Pro is the most advanced iPhone we've ever made, powered by A18 Pro and featuring even larger displays, an industry-leading pro camera system with camera control, and studio quality mics, all with a huge leap in battery life. Turning to Mac, revenue was $7.7 billion, up 2% from a year ago. Just this week, we brought a new generation of Apple Silicon to Mac, M4, M4 Pro, and M4 Max. From blazing fast performance to Apple's most advanced neural engine yet, our latest chips can easily tackle incredibly complex workflows, and they ensure our newest Macs will be the best personal computers for AI the instant they hit stores. With the newest additions to our Mac lineup, customers can choose the Mac that's just right for them, whether that's iMac, the world's best and most beautiful all-in-one; MacBook Air, the world's most popular laptop now with double the starting memory; MacBook Pro, the best Pro notebook anywhere; or the incredible, mighty new Mac mini, our first-ever carbon-neutral Mac. iPad revenue was $7 billion, 8% higher year-over-year. iPad is unlike any other product on the market today, and it's become an essential device in homes, schools, and businesses of all sizes. Recently, we were thrilled to introduce the newest iPad mini, featuring an ultra-compact design built for Apple Intelligence with support for Apple Pencil Pro. It's been a big year for iPad. iPad Air was popular with students and teachers as they got back to school this year, while creators are pushing the boundaries of what's possible with the M4-powered iPad Pro. In Wearables, Home and Accessories, revenue was $9 billion, down 3% from a year ago. During the quarter, we launched the all-new Apple Watch Series 10, bringing a beautiful new design and new capabilities to the world's most popular watch that make it even more powerful, intelligent, and sophisticated. It's the thinnest Apple Watch yet, making it more comfortable than ever, while offering the biggest, most advanced display. watchOS 11 brings some huge new health and fitness insights to users, including sleep apnea notifications, which help to alert people with a potentially serious but often undiagnosed condition. We're proud of the impact we make through our health innovations on watch, and I'm grateful for every note I receive about the importance of watch in people's lives. With AirPods 4, we broke a new ground in comfort and design with our best-ever open-ear headphones available for the first time with active noise cancellation. And we were especially pleased to unveil revolutionary end-to-end hearing health capabilities for AirPods Pro 2 with hearing protection, hearing test, and hearing aid features. These just became available in a software update this week, and we believe this will make a meaningful difference in our users' lives. I've already started getting notes from customers calling the experience life changing. And Apple Vision Pro continues to deliver spatial experiences that weren't possible before, including immersive entertainment like the new short film, Submerged, which gives people a view into the unique storytelling power made possible by spatial computing. Vision Pro has more than 2,500 native spatial apps and 1.5 million compatible apps for visionOS 2, as well as applications companies are building to reimagine how they work. Vision Pro continues to inspire awe in its users, and we're just scratching the surface of what's possible. And just yesterday, we announced we're bringing Vision Pro to Korea and the UAE. As I mentioned earlier, Services achieved an all-time revenue record of $25 billion, up 12% from a year ago, and with all-time revenue records across most of our categories. With Apple TV+, we love celebrating the craft of great storytellers who know how to put on a show. Audiences love to discover new movies like Wolfs, explore acclaimed new series like Disclaimer, and dive back into returning favorites like Slow Horses and Shrinking. Apple TV+ productions have become fixtures at award shows, earning more than 2,300 nominations and more than 500 wins today. Apple also offers a live sports experience in a league of its own with MLS Season Pass, and subscribers have been cheering on their favorite teams in the MLS Cup playoffs. This month, we also marked 10 years of Apple Pay. There's always something magical about being able to buy groceries or pay for movie tickets seamlessly with your Apple device. Today, users choose Apple Pay for purchases across tens of millions of retailers worldwide. And we're excited to make the Apple Pay experience even better, with the option to redeem rewards and access loans from credit cards, debit cards, and other lenders right at checkout. Whenever we celebrate big moments, Apple Stores are the best places to share them with customers. I had an incredible time during launch day in September alongside our team at Apple Fifth Avenue, where energy and enthusiasm filled the air. And in stores all over the world, customers are eager to get a closer look at our latest innovations. We also opened two new stores during the quarter and we can't wait to bring four new stores to customers in India. We're passionate about education and believe technology has a vital role to play in both helping teachers to inspire their students and students to learn about the world around them. In honor of World Teachers' Day, Apple was proud to share new resources for teachers to engage their students in ways that aim to make learning easy and fun. Additionally, we've expanded our education grant program into 100 new schools and communities, helping with everything from access to technology, to educator resources, to scholarships and financial support. As we near the end of the year, we're proud of the progress we've made in our efforts to be carbon-neutral across our entire footprint by the end of the decade. As I mentioned earlier, we were thrilled to introduce our first-ever carbon-neutral Mac with the latest Mac mini. And in another milestone, customers can choose a carbon-neutral option of any Apple Watch. These achievements are amazing for all of us at Apple, and we are determined to reach our 2030 goal. At Apple, across everything we do, we manage for the long term, because we're always thinking about what comes next, the next great challenge, the next innovative idea, the next big breakthrough. As we close out the year, we have the best lineup we've ever had going into the holiday season, including Apple Intelligence, which marks the start of a new chapter for our products. This is just the beginning of what we believe generative AI can do, and I couldn't be more excited for what's to come. Before I hand it over to Luca, with Luca transitioning to a new role with Apple, this will be the final time he's joining our call. So, I just wanted to take a moment to recognize his extraordinary service as Apple's CFO and to thank him for his partnership. I am deeply grateful. In his 10 years in the role, Luca has done truly exceptional work in shaping Apple as we know it today. He has helped manage Apple for the long term, thoughtfully and deliberately. He has helped us enrich the lives of so many around the world, and he has been a leader that people look up to and have learned so much from. I have incredible confidence in our incoming CFO, Kevan Parekh, and we look forward to more of you meeting and working with him going forward. With that, I'll turn it over to Luca."
},
{
"speaker": "Luca Maestri",
"content": "Good afternoon, everyone. And thank you, Tim, for the very kind words. Serving as Apple's CFO has been a real privilege and an amazing journey, and I've greatly appreciated the support from our investors and the analyst community over the years. Kevan is exceptional, and I know you will enjoy interacting with him going forward. Let me now turn to the results for the fourth quarter of our fiscal year. We're very pleased to report a new September quarter revenue record of $94.9 billion, up 6% year-over-year. We grew in the vast majority of the markets we track and achieved September quarter revenue records in the Americas, Europe and Rest of Asia Pacific. Products revenue was $70 billion, up 4% year-over-year, driven by growth in iPhone, iPad and Mac. Our installed base of active devices reached an all-time high across all products and geographic segments, thanks to very high levels of customer satisfaction and loyalty and a large number of customers who are new to our products. Services revenue reached an all-time record of $25 billion, up 12% year-over-year. We saw broad-based strength around the world, reaching all-time records in both developed and emerging markets with double-digit growth and record results across most services categories. Company gross margin was 46.2%, near the high end of our guidance range. Products gross margin was 36.3%, up 100 basis points sequentially, primarily driven by favorable mix. Services gross margin was 74%, unchanged from the prior quarter. Operating expenses of $14.3 billion were at the midpoint of the guidance range we provided at the beginning of the quarter and up 6% year-over-year. During the quarter, we recorded a one-time income tax charge of $10.2 billion, which relates to the impact of the reversal of the European General Court's State Aid decision. When we exclude this one-time charge, net income was $25 billion and diluted earnings per share were a $1.64, up 12% year-over-year, and a September quarter record. Operating cash flow was very strong at $26.8 billion, a new September quarter record. Let me now get into more detail for each of our revenue categories. iPhone revenue was $46.2 billion, up 6% year-over-year, and a September quarter record in total and across several markets, including the US, the Middle East, Korea, and South Asia. The iPhone active installed base grew to a new all-time high in total and in every geographic segment. During the September quarter, many iPhone models were among the top-selling smartphones around the world. In fact, according to a survey from Kantar, iPhone was the top-selling model in the US, Urban China, the UK, Australia, and Japan. We continue to see high levels of customer satisfaction for the iPhone 15 family, with 451 Research recently measuring it at 98% in the US. Mac revenue was $7.7 billion, up 2% year-over-year, driven by the strength in MacBook Air. Customers have been loving the performance of Apple Silicon on Mac and we are very excited to bring the latest M4 family of chips to the lineup. The Mac installed base reached an all-time high with about half of customers in the quarter being new to Mac. And in the latest reports from 451 Research, customer satisfaction was 95% in the US. iPad generated $7 billion in revenue, up 8% year-over-year. In addition to growth in developed markets, we also saw strong performance in many emerging markets, with double-digit growth in Mexico, Brazil, the Middle East, India and South Asia. The iPad installed base reached another all-time high, and over half of the customers who purchased iPads during the quarter were new to the product. Also, customer satisfaction was recently measured at 97% in the US. Wearables, Home and Accessories revenue was $9 billion, down 3% year-over-year. The Apple Watch installed base reached a new all-time high, with over half of customers purchasing an Apple Watch during the quarter being new to the product. And the latest reports from 451 Research indicated customer satisfaction of 96% for watch in the US. Our Services revenue reached an all-time record of $25 billion, growing 12% year-over-year. Services continue to see strong momentum with the growth of our installed base of active devices setting a solid foundation for the future expansion of our ecosystem. And we see increased customer engagement with our services offerings. Both transacting accounts and paid accounts reached a new all-time high, with paid accounts growing double-digits year-over-year. Paid subscriptions also grew double-digits. We have well over 1 billion paid subscriptions across the services on our platform, more than double the number we had only four years ago. And as always, we remain focused on improving the breadth and quality of our services from new games on Apple Arcade to new features like Tap to Cash and pay with installments using Apple Pay to many successful new and returning shows on Apple TV+. This past quarter, we celebrated the five-year anniversary of Apple Card, which was ranked #1 in customer satisfaction among co-branded credit cards by J.D. Power for the fourth year in a row. Turning to enterprise, we continue to see strong demand across our products and services. NVIDIA launched its Mac as a choice program supported by AppleCare for Enterprise and Apple Professional Services with over 10,000 Macs deployed worldwide. And Novartis, a leading global pharmaceutical company, recently chose iPhone 16 as the standard mobile device for all employees. We also see continued momentum with Apple Vision Pro in the enterprise space. UC San Diego Health is the first hospital in the world to test spatial computing apps on Apple Vision Pro in clinical trials for patient surgery in the operating room. Let me now turn to our cash position and capital return program. We ended the quarter with $157 billion in cash and marketable securities. We repaid $2.6 billion in maturing debt and increased commercial paper by $7 billion, leaving us with total debt of $107 billion. As a result, net cash was $50 billion at the end of the quarter. During the quarter, we returned over $29 billion to shareholders, including $3.8 billion in dividends and equivalents and $25 billion through open market repurchases of 112 million Apple shares. As we move ahead into the December quarter, I'd like to review our outlook, which includes the types of forward-looking information that Suhasini referred to at the beginning of the call. The color we're providing today assumes that the macroeconomic outlook doesn't worsen from what we are projecting today for the current quarter. We expect our December quarter total company revenue to grow low- to mid-single digits year-over-year. We expect Services revenue to grow double-digits at a rate similar to what we reported in the fiscal year 2024. We expect gross margin to be between 46% and 47%. We expect OpEx to be between $15.3 billion and $15.5 billion. We expect OI&E to be around negative $250 million, excluding any potential impact from the mark to market of minority investments. And our tax rate to be around 16%. Finally, today, our Board of Directors has declared a cash dividend of $0.25 per share of common stock payable on November 14, 2024 to shareholders of record as of November 11, 2024. With that, let us open the call to questions."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Luca. We ask that you limit yourself to two questions. Operator, may we have the first question, please?"
},
{
"speaker": "Operator",
"content": "Certainly. We will go ahead and take our first question from Michael Ng with Goldman Sachs. Please go ahead."
},
{
"speaker": "Michael Ng",
"content": "Hey, good afternoon. I just have two. The first one is for Tim on Apple Intelligence. I was wondering if you could just expand a little bit on some of the early feedback to Apple Intelligence both for iOS 18.1, but also the developer beta so far, and whether you would attribute Apple Intelligence to any of the strong iPhone performance that we've seen to date. Thanks."
},
{
"speaker": "Tim Cook",
"content": "Thanks, Michael. As I noted in my comments, just this week on Monday, we made the first set of Apple Intelligence features available in US English for iPhone, iPad, and Mac. This includes things like systemwide Writing Tools that help you refine your writing, a more natural conversational Siri, more intelligent Photos app, including the ability to create movies, simply by typing a description, which is really cool, and new ways to prioritize and stay in the moment with notification summaries and priority messages. There's also email summaries and email priority. We're getting a lot of positive feedback from developers and customers. And in fact, if you just look at the first three days, which is all we have obviously from Monday, the 18.1 adoption is twice as fast as the 17.1 adoption was in the year-ago quarter. And so, there's definitely interest out there for Apple Intelligence. Carrying on in the quarter, we are looking forward to bringing even more features in December, and this will include even more powerful Writing Tools and visual intelligence experience that builds on Apple Intelligence, and ChatGPT integration in addition to other features, as well as we'll bring localized English to several countries that include the UK, Australia, and Canada. So, it's going to be quite a software quarter between the release on Monday and the release in December. And then, as we turn the corner to '25, we'll have more languages rolling out, starting in April as well and more features as well. And so, it's a very strong drumbeat, and we couldn't be more excited about it."
},
{
"speaker": "Michael Ng",
"content": "Great. Thank you very much. And my second one just for Luca. First, congratulations again, Luca, on the new role and it's been a real privilege being able to spend some time with you. A question that I think will overlap with your new role as well. Could you just talk a little bit about the CapEx outlook and whether investments in things like Private Cloud Compute could change the historical CapEx range of roughly $10 billion a year? Thank you very much."
},
{
"speaker": "Luca Maestri",
"content": "Thank you, Michael. On the CapEx front, I've mentioned before a number of times, we have a bit of a hybrid model in the way we run our data centers. In some cases, we use our own data centers. In some cases, we use, third-party providers. So, our CapEx numbers may not be fully comparable with others. But, obviously, we are rolling out these features, Apple Intelligence features already now, and so we are making all the capacity that is needed available for these features. You will see in our 10-K the amount of CapEx that we've incurred during the course of fiscal '24, and we will -- in fiscal '25, we will continue to make all the investments that are necessary, and of course, the investments in AI-related CapEx will be made."
},
{
"speaker": "Michael Ng",
"content": "Great. Thank you, Tim. Thank you, Luca."
},
{
"speaker": "Suhasini Chandramouli",
"content": "All right. Thanks, Mike. Can we have the next question, please?"
},
{
"speaker": "Operator",
"content": "Our next question is from Erik Woodring with Morgan Stanley. Please go ahead."
},
{
"speaker": "Erik Woodring",
"content": "Great. Thanks so much for taking my questions. I have two as well. Tim, maybe if we start with you, I think each of the last four years you've exited the December quarter with iPhone demand outpacing supply. As we look to this quarter in the iPhone 16 cycle, lead times are relatively short. There are no known supply shortages. And I'm just curious whether you've been able to maybe get a better read on early cycle iPhone demand this year relative to past years. And if so, what you've learned about upgrade rates, switching rates, trade-ups versus trading down and being more price sensitive? And overall, any impact that Apple Intelligence may have on iPhone 16 sales? And then, I have a follow-up. Thank you."
},
{
"speaker": "Tim Cook",
"content": "There's a lot there. On Apple Intelligence, we believe it's a compelling upgrade reason. And we'll -- but we just launched it three days ago and so what we've got now from a data point point of view is the number I just referenced that 18.1 has twice the adoption rate of 17.1. So, that clearly shows a level of interest out there. In terms of exiting the December quarter with demand greater than supply, that's not my recollection that, that happened for all four of the years. We clearly had cases during COVID where there were disruptions and that's the some spilled over, but in a more regular environment where we're not having something, a 100-year flood kind of thing, we would -- our desire is to get into balance as quickly as possible. We don't want customers having to wait for products. And so, if you look at how we've done this year, we did that very quickly on the 16, on the 16 Pro family, the Pro and the Pro Max, we've been constrained in October, but we believe that soon we'll be out of constraint. And so, that's a good sign from our point of view. Keep in mind that, that's a function of supply and demand, not one side or the other. And we've been preparing for the quarter for a while. So that's what I would say there."
},
{
"speaker": "Erik Woodring",
"content": "Okay. That's really helpful. Thank you, Tim."
},
{
"speaker": "Tim Cook",
"content": "Yeah, thank you."
},
{
"speaker": "Erik Woodring",
"content": "And then, Luca, if I just turn to you, obviously, it's been a pleasure working with you, and we wish you all the best in the next role. There's plenty of debate in the market right now about input costs and commodity prices, and the impact that will have on gross margins. Historically, you do guide gross margins up 50 basis points sequentially, which you just told us about for the December quarter. So, can you maybe just help us understand your view of component prices and broadly whether you still see those as tailwinds to gross margins and how sustainable that tailwind might be, or whether that should become a headwind as we look forward? Thanks so much."
},
{
"speaker": "Luca Maestri",
"content": "Yes, Erik. As you know, our gross margins are a factor of many, many variables. Commodities, of course, are important. They're not the only factor. But specifically on commodities, I can tell you that both for the September quarter and what we expect for the December quarter, most commodities are going to move down in price, while NAND and DRAM increased during the course of the September quarter and we expect them to increase during the December quarter. We are very pleased with the level of gross margins that we've reported during the course of the year. The entire fiscal year of '24, they're really, for our company, record levels of gross margin, and obviously guiding to 46% to 47% for the December quarter with all the new technologies that we've included in the products, with all the new features that Tim has talked about, a lot of new products across the board, I think it's a very good sign."
},
{
"speaker": "Erik Woodring",
"content": "Great. Thanks so much, Luca."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Erik. Can we have the next question, please?"
},
{
"speaker": "Operator",
"content": "Our next question is from Ben Reitzes from Melius. Please go ahead."
},
{
"speaker": "Ben Reitzes",
"content": "Hey, thanks a lot. And I'll echo those comments about Luca. Miss you, and good luck. And my question is with regard to iPhone again, and with regard to the fourth quarter, is my first question -- or sorry, the fourth calendar quarter, your first quarter. When you look at mid- to low-single-digit revenue growth, do you expect the iPhone to grow faster? And what are you thinking about in the answer to that question with regard to China, which keeps improving each quarter? Thanks very much. And then, I have just a follow-up. Thanks."
},
{
"speaker": "Luca Maestri",
"content": "Ben, we are not providing that level of color today. Yes, we've said that we expect total company revenue to grow low- to mid-single digits. Keep in mind, Apple Intelligence, as Tim said, is rolling out over time, both features and languages. And we just had a number of exciting launches just this week from the Apple Intelligence feature to the new Mac. So, we leave it at that. We've given you the total for the company and some pretty good direction on Services, which we expect to continue to grow at a similar rate than what we've seen in fiscal '24."
},
{
"speaker": "Ben Reitzes",
"content": "Great. Thanks, Luca. Hey, Tim, I wanted to ask you, I mean, you guys are well aware a lot of the noise out there, people chattering about builds, lead times, and you guys are guiding for mid- to low-single-digit growth. That certainly doesn't sound like alarm bells here, vis-a-vis what you guys must be hearing. And I know you guys are just running your business and doing the best you can, but you have a lot of perspective now, Tim. What are people missing here? And it certainly just sounds like -- you guys are typically conservative. That guide for revenue is certainly sounds like [this guy is certainly not falling] (ph), and you have a pretty good product cycle. So, what do you think people are missing and what are you excited about? Thanks so much, Tim."
},
{
"speaker": "Tim Cook",
"content": "Ben, I could not be more excited about Apple Intelligence and the rollout that we've got in front of us. I'm on the -- I'm obviously on future releases as well, working on it and it's changing my daily life. I'm super excited about the health features that we're rolling out. If the number of emails I'm already getting from customers that have taken a hearing test and are using their AirPods Pro 2 as a hearing aid, are just -- are staggering and heartwarming to read. I'm also thrilled about sleep apnea and the notification there that we'll have through the watch. This week is a very exciting week for us because we just rolled out three days -- three launches of different, Macs and desktops and laptops. And so, we have a lot of things on the docket and it's definitely the strongest lineup we've ever had going into the holiday season. In terms of the noise, I tune it out, because if not, it would just be, deafening. And so that that's what I do, I can't speak for everybody else, but that's what I do."
},
{
"speaker": "Ben Reitzes",
"content": "Thanks a lot, Tim. Appreciate it."
},
{
"speaker": "Tim Cook",
"content": "Thanks, Ben."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Ben. Can we have the next question, please?"
},
{
"speaker": "Operator",
"content": "Our next question is from Amit Daryanani with Evercore. Please go ahead."
},
{
"speaker": "Amit Daryanani",
"content": "Good afternoon. Thanks for taking my questions. I have two as well. And Luca, best of luck in the future. It's been a pleasure working with you. I guess the first one I have is, away from iPhones, on the Services side, you're adding $100 billion run rate with Services today, which is a phenomenal achievement by itself. As you look at the Services portfolio today, can you just talk about how much of this business do you think is reoccurring versus transactional? And are the growth rates different between the subscription portfolio over here versus transactional portfolio?"
},
{
"speaker": "Luca Maestri",
"content": "Yes, Amit, I'll take this one. Yes, we are, first of all, very, very happy with -- it's an important milestone. Of course, we've got to a run rate of $100 billion. You look back just a few years ago, and the growth has been phenomenal. We're very pleased. We've got a very diversified portfolio of services. And over the years, the amount that is recurring in nature has grown and is growing faster than the transactional piece. We have well over 1 billion paid subscriptions on our platform right now between our own services and third-party services. That continues to grow strong double-digits. So, we feel very, very good. And, essentially, to your question, yes, the recurring portion is growing faster than the transactional one."
},
{
"speaker": "Amit Daryanani",
"content": "Got it. If I can just follow-up, if I look at the growth rates across the different geographies, there's always concern around China when it comes to iPhone demand, I feel, but the performance in September looks fairly good. I wonder if you just touch on, what are you seeing from a demand perspective in China? If the recent stimulus plan in China could essentially be a catalyst for iPhone? And then, EMEA really stood out with double-digit growth. Maybe you can just flush that out as well for us. Thank you."
},
{
"speaker": "Tim Cook",
"content": "Yeah, I'll take the China question. If you look at how we did for the quarter, we were relatively flat year-over-year. And a key component of that improvement relative to the year-over-year performance that we had been achieving is that there was a sequential improvement in foreign exchange. And so that helped us out. As you know, it's been a headwind that we've been reporting for a period of time. And -- but the other parts that are -- what else is going on there is that our installed base of the active devices reached an all-time high. We had the top two selling, smartphones in Urban China according to Kantar. The level of new customers that we have buying the products like Mac and iPad are well over 50%. Watch is over three quarters that are new to the product. And so, there's several positive signs there. In terms of the stimulus, it's a clear focus of the team there, but I'm not an economist and don't want to ad lib on the effect of it."
},
{
"speaker": "Luca Maestri",
"content": "On the Europe side, Amit, a number of things. As you see from our results during the quarter, Europe grew double-digits, 11%, and really, it was really good growth across the board, the different segments. They all did well. Keep in mind, our definition of Europe in our segment reporting includes a number of emerging markets, like Turkey, where we've grown very strongly, the Middle East. Tim mentioned a number of records in Saudi, in UAE, and we also include India where we set an all-time revenue record during the September quarter. But I have to say also Western Europe grew nicely. So, we've seen very good results for us in the entire segment."
},
{
"speaker": "Amit Daryanani",
"content": "Great. Thank you very much."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thanks, Amit. Can we have the next question, please?"
},
{
"speaker": "Operator",
"content": "Our next question is from David Vogt with UBS. Please go ahead."
},
{
"speaker": "David Vogt",
"content": "Great. Thanks everyone for taking my question, and congratulations, Luca. I know Luca, and I know Tim, you don't want to give a lot of granularity, but if I just try to pull together your comments about what the demand environment looks like, are we to assume based on sort of the commentary that there is a risk that maybe the product revenue portfolio could be down in the December quarter if I take your numbers at face value? And if that's the risk, is that more iPhone-related, Mac-related, given the strength that you've seen in iPad related? Just trying to get a handle on kind of what potentially is giving you that degree of, I don't want to say caution, but maybe balanced for you going into the December quarter. And then, I have a follow-up."
},
{
"speaker": "Luca Maestri",
"content": "As I said, David, we're not providing that level of color. We're giving you some data on services. I would repeat what I said earlier. We're very early in the cycle, very early in the cycle with a lot of new products and features that that we are launching. And we're very excited about them, but it's early. And the Apple Intelligence rollout is going to happen over time, not across the world as normally we do with software releases."
},
{
"speaker": "David Vogt",
"content": "Right. Okay. So maybe a follow-up for, Tim. When you think about to Luca's point about the rollout being staged over the next several quarters across the world, do you think that has any impact on sort of the normal historical demand cadence across different regions? So, should we see something different, let's say, in the December quarter, the March quarter, the June quarter, et cetera, relative to history, given the timing of the rollout and where customers are probably waiting for the devices to be enabled to have the operating system? Would just love to kind of get your perspective on how we think about the demand cadence, how it might be different than maybe historically? Thank you."
},
{
"speaker": "Tim Cook",
"content": "Yeah, David. It's clearly, as you point out, a different cadence, if you will, than we would normally do. As we talked about at WWDC, we wanted to give a comprehensive vision of Apple Intelligence, and we said then that it would rollout over time. And we're right on the, what we said, at WWDC, and so we're executing well. In terms of the demand curve, I would just say that what we believe here is that it's a compelling reason for upgrading. And, it's -- that's both my personal experience and feedback that I'm getting and so we'll see. We're not projecting, beyond the current quarter obviously. We just don't do that."
},
{
"speaker": "David Vogt",
"content": "Great. Thanks, Tim, and best of luck, Luca."
},
{
"speaker": "Luca Maestri",
"content": "Thank you very much."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, David. We'll take the next question, please."
},
{
"speaker": "Operator",
"content": "Our next question is from Wamsi Mohan with Bank of America. Please go ahead."
},
{
"speaker": "Wamsi Mohan",
"content": "Yes, thank you so much. Luca, we will miss you on these calls. Tim, maybe for you, as you think about this staggered rollout of Apple Intelligence, can you help us think through potentially how much of the global installed base of phones will have access to Apple Intelligence in their native language, in their region within the next year or maybe in the next two years? And what are some of the gating factors in the rollout? And I have a follow-up."
},
{
"speaker": "Tim Cook",
"content": "If you look at our schedule, we started in the -- with US English, that started on Monday. There's another release coming that adds additional features that I had referenced in December in not only US English but also localized for UK, Australia, Canada, Ireland, and New Zealand. And then, we will add more languages in April. We haven't set the specifics yet in terms of the languages, but we'll add more in April and then more as we step through the year. And so, we're moving just as fast as possible while ensuring quality. That's what we're doing."
},
{
"speaker": "Wamsi Mohan",
"content": "Okay. Thanks, Tim."
},
{
"speaker": "Tim Cook",
"content": "Yeah."
},
{
"speaker": "Wamsi Mohan",
"content": "And then, as a follow-up, maybe this is a little premature, but how is Apple at a high level prepared to potentially deal with any tariffs that might come post the selection cycle? And if not exactly how, perhaps you can just help investors think about some of the things Apple has done already to try to insulate from some of these impacts, potential impacts?"
},
{
"speaker": "Tim Cook",
"content": "I wouldn't want to speculate about those sorts of things. And so, I'm going to punt on that one."
},
{
"speaker": "Wamsi Mohan",
"content": "Okay. Thank you, Tim."
},
{
"speaker": "Tim Cook",
"content": "Yeah. Thank you."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Wamsi. May we have the next question, please?"
},
{
"speaker": "Operator",
"content": "Our next question is from Krish Sankar from TD Cowen. Please go ahead."
},
{
"speaker": "Krish Sankar",
"content": "Yeah. Hi, thanks for taking my question. And again, thanks Luca for all your help with analyts and investors. My first question is on R&D. Given how much your tech peers are spending on AI, does this new era of Apple Intelligence actually require Apple to invest more in R&D beyond your current 7% to 8% of sales to capture this opportunity? And then, I had a follow-up."
},
{
"speaker": "Luca Maestri",
"content": "Krish, as you know, we've been investing heavily in R&D over the last several years. Our R&D growth has been significant during the last several years. And obviously, as we move through the course of fiscal '24, we've also reallocated some of the existing resources to this new technology to AI. And so, the level of intensity that we're putting into AI has increased a lot, and you maybe don't see the full extent of it because we've also had some internal reallocation of the base of engineering resources that we have within the company."
},
{
"speaker": "Krish Sankar",
"content": "Got it. Thanks for that, Luca. And then, another quick follow-up. I understand Apple Intelligence is a feature on the phone today, but do you think that, in the future, it could potentially have or benefit the services growth business, or is that too -- are these too bifurcated to even make a call on the [indiscernible]? Thank you."
},
{
"speaker": "Tim Cook",
"content": "I think, just to keep it in mind, Apple Intelligence is also available on the Mac for the M-series products and on certain models of iPad, and in addition to the phone. And so, it's on all three. You're quite -- what was your follow-on question?"
},
{
"speaker": "Krish Sankar",
"content": "Tim, it does on -- can the Apple Intelligence actually help the Services growth rate?"
},
{
"speaker": "Tim Cook",
"content": "Keep in mind that we were have released a lot of APIs and developers will be taking advantage of those APIs. That release has occurred as well and of course more are coming. And so I, definitely believe that a lot of developers will be taking advantage of Apple Intelligence in a big way. And what that does to Services, I'll not forecast, but I would say that from an ecosystem point of view, I think it will be great for the user and the user experience."
},
{
"speaker": "Krish Sankar",
"content": "Got it. Thanks, Tim."
},
{
"speaker": "Tim Cook",
"content": "Yeah."
},
{
"speaker": "Suhasini Chandramouli",
"content": "All right. Thank you, Krish. Can we have the next question, please?"
},
{
"speaker": "Operator",
"content": "Our next question comes from Samik Chatterjee with JPMorgan. Please go ahead."
},
{
"speaker": "Samik Chatterjee",
"content": "Great. Thank you. Thanks for taking my questions. And Luca, congrats on the new role and pleasure working with you these years. I guess, if I could, for my first one, start with mix on the iPhone side? And what I'm really curious about if you have any thoughts given that Apple Intelligence is now going to be a consistent feature set across all the four sort of iPhones on the iPhone 16 series that you launched and going back to iPhone 15 Pro and Pro Max. Are you seeing any change in behavior from a consumer perspective in terms of which sort of on the mix front within the iPhone series where consumer adoption is given that there's more consistency of the features when it comes to Apple Intelligence across the board? And I have a follow-up. Thank you."
},
{
"speaker": "Tim Cook",
"content": "It's tough to answer your question, because we've been constrained in October on the Pro and the Pro Max. And so, it's really too early in the curve to call the precise mix on the consumer versus the Pro. So, we'll see."
},
{
"speaker": "Samik Chatterjee",
"content": "Okay. And for my follow-up, Tim, during the quarter I think over the last 90 days, we had the quotes come out in relation to the DOJ relative to the Google sort of revenue sharing agreement that you have with them. How do you sort of look at it going forward in terms of emphasizing the role that Apple has in that ecosystem with Safari and sort of the potential outcomes that you're looking at? Thank you."
},
{
"speaker": "Tim Cook",
"content": "I don't want to speculate on that from a legal point of view. It's an ongoing case, and I will save that for another day."
},
{
"speaker": "Samik Chatterjee",
"content": "Okay. Thank you. I'll leave it there. Thank you."
},
{
"speaker": "Suhasini Chandramouli",
"content": "All right. Thank you, Samik. Operator, may we have the next question, please?"
},
{
"speaker": "Operator",
"content": "Our next question comes from Richard Kramer with Arete Research. Please go ahead."
},
{
"speaker": "Richard Kramer",
"content": "Thanks very much. My first one, Tim, I'd like to ask about some of the components in Services where despite your installed base, some parts of the Apple One bundle, like Music and News and Arcade and Fitness, are not obviously the market-leading offerings. And maybe what might change that and what other services could you call out as growing faster, having wider -- widening addressable markets like we've seen in pay or advertising?"
},
{
"speaker": "Tim Cook",
"content": "The way that I view it is that we have lots of opportunity in all of those. And so, there's lots of customers to try to convince to take advantage of it, and we're going to continue investing in the Services and adding new features and -- whether it's News+ or Music or Arcade, that's what we're going to do. Keep in mind that for us, we're more focused on being best than being most. And so, in some cases, not in every case, some of the services that you -- the majority of the services that you mentioned are not cross platform. We make them for our customers only and so that in some cases changes the person who's going to sell the most perhaps, but that's -- our objective is to make the best."
},
{
"speaker": "Richard Kramer",
"content": "Okay, thanks. And then, Luca, one piece of unfinished business was your pledge to get to a net-neutral cash position. And over the last two years, you stayed around $50 billion of net cash. We've clearly seen instances in the past where elevated marketing spend or other programs brought increases in market share. I guess my question looking back on your tenure is, at your scale now of $57 billion of OpEx, do you still see incremental ways to put that cash to work in the business? Or will we just continue to see increased shareholder returns?"
},
{
"speaker": "Luca Maestri",
"content": "Well, obviously, as you've seen, our OpEx has gone up over the years. We've also seen at the same time a significant expansion in gross margin, maybe to a level that I would have not expected a few years ago, but we've done a very good job on a number of fronts. And so, I would say we -- when we plan -- every time we plan for the upcoming year, we think about all the different areas where we can deploy our resources and we make them available to grow the business. I think we've done very well over the long term and -- but our fundamental philosophy is to look after the business first. And then, if we have excess cash, we will continue to return it to our shareholders and the plan has worked quite well so far."
},
{
"speaker": "Richard Kramer",
"content": "Okay. Thank you very much."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Richard. We'll take our last question, please, operator?"
},
{
"speaker": "Operator",
"content": "Our last question comes from Atif Malik with Citi. Please go ahead."
},
{
"speaker": "Atif Malik",
"content": "Thank you for squeezing me in. It seems to us that the spec differentiation between iPhone 16 Pro and base model isn't as big as prior years. All iPhones have new A18, A18 Pro chips and there wasn't an increase in ASPs versus last year. Can you share with us if there is a shift in your strategy in terms of..."
},
{
"speaker": "Operator",
"content": "Unfortunately, Mr. Malik's line has dropped."
},
{
"speaker": "Suhasini Chandramouli",
"content": "All right. Sorry, Atif. We'll connect offline. Thank you, everybody. A replay of today's call will be available for two weeks on Apple Podcasts as a webcast on apple.com/investor and via telephone. The number for the telephone replay is 866-583-1035. Please enter confirmation code 0331536 followed by the pound sign. These replays will be available by approximately 5 pm Pacific today. Members of the press with additional questions can contact Josh Rosenstock at 408-862-1142. And financial analysts can contact me, Suhasini Chandramouli, with additional questions at 408-974-3123 Thank you again for joining us."
},
{
"speaker": "Operator",
"content": "Once again, this does conclude today's conference. We do appreciate your participation."
}
] |
aapl | 2,024 | 3 | [
{
"speaker": "Suhasini Chandramouli",
"content": "Good afternoon and welcome to the Apple Q3 Fiscal Year 2024 Earnings Conference Call. My name is Suhasini Chandramouli, Director of Investor Relations. Today's call is being recorded. Speaking first today is Apple’s CEO, Tim Cook, and he'll be followed by CFO, Luca Maestri. After that, we'll open the call to questions from analysts. Please note that some of the information you'll hear during our discussion today will consist of forward-looking statements, including, without limitation, those regarding revenue, gross margin, operating expenses, other income and expense, taxes, capital allocation, and future business outlook including the potential impact of macroeconomic conditions on the company's business and results of operations. These statements involve risks and uncertainties that may cause actual results or trends to differ materially from our forecast. For more information, please refer to the risk factors discussed in Apple's most recently filed Annual Report on Form 10-K and the Form 8-K filed with the SEC today along with the associated press release. Apple assumes no obligation to update any forward-looking statements which speak only as of the date they are made. I'd now like to turn the call over to Tim for introductory remarks."
},
{
"speaker": "Tim Cook",
"content": "Thank you Suhasini. Good afternoon everyone and thanks for joining the call. Today, Apple is reporting a new June quarter revenue record of $85.8 billion, up 5% from a year ago and better than we had expected. EPS grew double digits to $1.40 and achieved a record for the June quarter. We also set quarterly revenue records in more than two dozen countries and regions, including Canada, Mexico, France, Germany, the UK, India, Indonesia, the Philippines, and Thailand. And we set an all-time revenue record in services which grew 14%. At our Worldwide Developers Conference, we were thrilled to unveil game-changing updates across our platforms, including Apple Intelligence. Apple Intelligence builds on years of innovation and investment in AI and Machine Learning. It will transform how users interact with technology, from writing tools to help you express yourself, to image playground, which gives you the ability to create fun images and communicate in new ways, to powerful tools for summarizing and prioritizing notifications. Siri also becomes more natural, more useful, and more personal than ever. Apple Intelligence is built on a foundation of privacy, both through on-device processing that does not collect users' data and through private cloud compute, a groundbreaking new approach to using the cloud, while protecting users' information powered by Apple silicon. We are also integrating ChatGPT into experiences within iPhone, Mac, and iPad, enabling users to draw on a broad base of world knowledge. We are very excited about Apple Intelligence and we remain incredibly optimistic about the extraordinary possibilities of AI and its ability to enrich customers' lives. We will continue to make significant investments in this technology and dedicate ourselves to the innovation that will unlock its full potential. Recently, we've also been excited to bring Apple Vision Pro to more countries, giving customers the chance to discover the remarkable capabilities of this magical device. Vision Pro users are customizing their own workspaces, watching movies on 100-foot screens, and exploring entire worlds with just a pinch of their fingertips. With more than 2,500 native spatial apps and 1.5 million compatible apps for Vision OS, the developer community continues to pioneer stunning spatial experiences that are only possible with Vision Pro. Last month, we announced that we're bringing some amazing new immersive content to Vision Pro, including new series, concerts, films, and more. And we've seen great interest for Vision Pro in the enterprise, where it can empower companies large and small to pursue their best ideas like never before. With each innovation, we're unlocking new ways of working, new ways of learning, and new ways of tapping into the unlimited promise of human potential. We are doing that across every product and every service. Now let me share more detail in our June quarter results, beginning with iPhone. iPhone revenue was $39.3 billion, down 1% year-over-year. On a constant currency basis, we grew compared to last year. Customers continue to praise the iPhone 15 lineup for its incredible battery life, exceptional cameras, and unmatched power and performance. And we are excited to bring incredible new features to the iPhone with iOS 18, making it more personal, capable, and intelligent than ever before. This update includes the biggest redesign of the Photos app, new customization options for the home screen, messages over satellite, and the introduction of Apple Intelligence. Apple Intelligence utilizes the power of our most advanced iPhones, the iPhone 15 Pro and Pro Max, offering a transformative set of capabilities. Mac revenue was $7 billion, up 2% from a year ago. Customers are loving the latest M3-powered 13 and 15 inch MacBook Air. With back-to-school season upon us, MacBook Air is the perfect companion for students on campus and small business owners, developers, and creatives of all kinds depend on Mac to do more than they ever could before. Powered by Apple silicon with its neural engine and privacy built in at the chip level, Macs are simply the best personal computers for AI. And every Mac we've shipped with Apple silicon since 2020, is capable of taking advantage of Apple Intelligence with Mac OS Sequoia. We also know the importance of security for our users and enterprises so we continue to advance protections across our products. Turning to iPad, revenue was $7.2 billion, 24% higher year-over-year. During the quarter, we had an incredible launch where we unveiled the all-new 11 and 13 inch iPad Air, the perfect device for education, entertainment, and so much more. And With the new iPad Pro, we pushed the boundaries of power-efficient performance with the remarkable M4 chip, the engine behind this incredibly thin device. By leveraging the latest in Apple silicon, Video Editors and Musicians can take advantage of the cutting edge AI features in Final Cut Pro and Logic Pro. And we're very excited that iPad Pro and iPad Air models powered by the M series of Apple silicon will be able to utilize the powerful capabilities of Apple Intelligence. In wearables, home, and accessories, revenue was $8.1 billion, down 2% from a year ago. Apple Watch is empowering users to live a healthier day with a range of tools to take charge of their wellness journeys. At the core of Apple Watch, are powerful AI features that are helping users get help when they need it most, from irregular heart rhythm notifications to walking steadiness to crash detection and fall detection. I've heard time and again how meaningful these features are for users and their loved ones, and their stories motivate us to keep pushing forward on this vital work. As I mentioned earlier, in services, we set an all-time revenue record of $24.2 billion with paid subscriptions climbing to an all-time high. We achieve revenue records in the majority of the services categories with all-time revenue records in advertising, cloud, and payment services. Apple TV+ productions are delighting audiences on screens large and small. We're sharing powerful works of imagination with series and movies like Presumed Innocent, the Upcoming Disclaimer, and The Instigators starring Matt Damon. And we can't wait for returning fan favorites with new seasons of The Morning Show, Slow Horses, and Severance. Apple TV+ productions also continue to earn accolades with nearly 2,300 nominations and 500 wins to-date. That includes 72 Emmy Award nominations across 16 programs our best ever showing for the upcoming awards event. During the quarter, we also expanded Tap to Pay on iPhone to more markets including Japan, Canada, Italy, and Germany, enabling more businesses to use the power of iPhone to accept contactless payments. And we announced new updates to our services coming this fall, including US national park hikes and custom walk routes and Apple Maps, the ability to pay with rewards using Apple Pay, collaborative listening with Apple Music, and a redesigned Apple Fitness+ experience to help users make the most of our library of workouts and meditations. Turning to retail, we continue to expand in emerging markets with our first ever location in Malaysia. Customers from all over the country came together with our team members to celebrate this special moment. Elsewhere in the world, our teams have been sharing the magic of Apple Vision Pro and demos that delight, inspire, and deeply move customers exploring the wonders of spatial computing for the first time. At the heart of all of our innovations are the values that guide everything we do. We believe fundamentally that the best technology is technology that works for everyone. And in honor of Global Accessibility Awareness Day, we introduced all new capabilities to give users more ways to take advantage of all our products can do. These include eye tracking for users to control iPhone or iPad visually, music haptics to give those who are deaf or hard of hearing a tangible way to experience music, and vocal shortcuts that tie task to a user's voice. And we are committed as ever to shipping products that offer the highest standards of privacy for our users. With everything we do, whether it's offering a browser like Safari that prevents third-parties from tracking you across the internet or providing new features like the ability to lock and hide apps, we are determined to keep our users in control of their own data. And we are just as dedicated to ensuring the security of our users' data. That's why we work to minimize the amount of data we collect and work to maximize how much is processed directly on people's devices, a foundational principle that is at the core of all we build, including Apple Intelligence. And we continue to make significant progress on the environment. We are proud to say that all of our data centers, including those that will run private cloud compute, operate on 100% renewable energy. At Apple, we're constantly accelerating our pace of innovation. We are a company in relentless pursuit of big ideas. Time and again, we've seen how a spark of creativity can reach breakthrough velocity, reach across previously unexplored dimensions, and ultimately take flight in ways that can change the world. It's why we're going to keep investing in the meaningful innovation that enriches the lives of all of our customers. We have a busy time ahead of us, and I couldn't be more excited for all the amazing things yet to come. With that, I'll turn it over to Luca."
},
{
"speaker": "Luca Maestri",
"content": "Thank you, Tim, and good afternoon, everyone. We are very pleased to report a new June quarter revenue record of $85.8 billion, up 5% year-over-year, despite 230 basis points of negative foreign exchange impact. We achieved growth in the vast majority of our markets, with June quarter revenue records in the Americas, Europe, and rest of Asia Pacific. Products revenue was $61.6 billion, up 2% year-over-year, driven by the launch of the new iPad Pro and iPad Air. Our installed base of active devices reach an all-time high across all products and geographic segments, thanks to our unmatched levels of customer satisfaction and loyalty and a large number of customers who are new to our products. Services revenue reached an all-time record of $24.2 billion, up 14% year-over-year, with an all-time record in developed markets and a June quarter record in emerging markets. Company gross margin was 46.3% near the high end of our guidance range and down 30 basis points sequentially driven by a different mix within products which was partially offset by a favorable mix shift towards services and cost savings. Products gross margin was 35.3%, down 130 basis points sequentially, primarily driven by mix, partially offset by favorable costs. Services gross margin was 74% down 60 basis points from last quarter. Operating expenses of $14.3 billion were at the low end of the guidance range we provided and up 7% year-over-year. Net income was $21.4 billion, diluted EPS of $1.40 was up 11% year-over-year and set a June quarter record. And operating cash flow was very strong at $28.9 billion, also a June quarter record. Let me get into more detail for each of our revenue categories. iPhone revenue was $39.3 billion, down 1% year-over-year, but grew on a constant currency basis. We set June quarter records across several countries, including the UK, Spain, Poland, Mexico, Indonesia, and the Philippines. And the iPhone Active installed base grew to a new all-time high in total and in every geographic segment. During the June quarter, many iPhone models were among the top selling smartphones around the world. In fact, according to a survey from Kantar, iPhone was the top selling model in the US, urban China, the UK, Germany, Australia, and Japan. Customer satisfaction on the iPhone 15 family continues to be extremely high, with 451 Research measuring it at 98% in the US in their latest reports. Mac generated $7 billion in revenue, up 2% year-over-year, driven by the MacBook Air powered by the M3 chip. We saw particularly strong performance in our emerging markets, with June quarter records for Mac in Latin America, India, and South Asia. The Mac installed base reached an all-time high with half of MacBook Air customers in the quarter being new to Mac. And customer satisfaction for Mac was recently reported at 96% in the US. iPad revenue was $7.2 billion, up 24% year-over-year, driven by the launch of the new iPad Pro and iPad Air. Customers are loving the latest iPad lineup for its new design and display, unparalleled performance, AI capabilities and much more. The iPad install base has continued to grow and is an all-time high, as half of the customers who purchased iPads during the quarter were new to the product. Also, customer satisfaction was recently measured at 97% in the US. Wearables, home and accessories revenue was $8.1 billion, down 2% year-over-year, a sequential acceleration from the March quarter. Watch and AirPods continue to face a difficult compare against prior year launches of the AirPods Pro second generation, the Watch SE and the first Watch Ultra. Apple Watch continues to attract new customers, with almost two-thirds of customers purchasing an Apple Watch during the quarter being new to the product, sending the Apple Watch install base to a new all-time high. And the latest reports from 451 Research indicate a customer satisfaction of 97% for watch in the US. In services, total revenue reached an all-time record of $24.2 billion, growing 14% year-over-year. We continue to have great momentum in services, as the growth of our installed base of active devices, sets a strong foundation for the future expansion of our ecosystem. And we see increased customer engagement with our services offerings. Both transacting accounts and paid accounts reach a new all-time high with paid accounts growing double digits year-over-year. Also, paid subscriptions showed strong double digit growth. We have well over 1 billion paid subscriptions across the services on our platform, more than double the number that we had only four years ago. And we are constantly focused on improving the breadth and quality of our services. From critically acclaimed new content on Apple TV+ to new games on Apple Arcade and the many latest features we previewed during WWDC for iCloud, Apple Pay, Apple Cash, Apple Music, and more. Turning to enterprise, we continue to see businesses, leveraging our entire suite of products to drive productivity and creativity for their teams and customers. USAA, a leading insurance and financial services company, recently expanded beyond their existing iPhone and iPad deployments to provide their employees with the latest MacBook Air. And American Express has continued to add to their fleet of over 10,000 Macs to enhance their employees' productivity, security, and collaboration. We're also excited to see leading organizations such as Boston Children's Hospital and Lufthansa using Apple Vision Pro to build innovative spatial computing experiences to transform the training of their workforces. Let me now turn to our cash position and capital return program. We ended the quarter with $153 billion in cash and marketable securities. We repaid $4.3 billion in maturing debt and increased commercial paper by $1 billion, leaving us with total debt of $101 billion. As a result, net cash was $52 billion at the end of the quarter. During the quarter, we returned over $32 billion to shareholders, including $3.9 billion in dividends and equivalents and $26 billion through open market repurchases of 139 million Apple shares. As we move ahead into the September quarter, I'd like to review our outlook, which includes the types of forward-looking information that Suhasini referred to at the beginning of the call. The color we are providing today assumes that the macroeconomic outlook doesn't worsen from what we are projecting today for the current quarter. We expect foreign exchange to continue to be a headwind and to have a negative impact on revenue of about 1.5 percentage points on a year-over-year basis. We expect our September quarter total company revenue to grow year-over-year at a rate similar to the June quarter. We expect services revenue to grow double digits at a rate similar to what we reported in the first three quarters of this fiscal year. We expect gross margin to be between 45.5% and 46.5%. We expect OpEx to be between $14.2 billion and $14.4 billion. We expect OI&E to be around negative $50 million, excluding any potential impact from the mark to market of minority investments, and our tax rate to be around 16.5%. Finally, today our Board of Directors has declared a cash dividend of $0.25 per share of common stock payable on August 15, 2024, to shareholders of record as of August 12, 2024. With that, let's open the call to questions."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you Luca. We ask that you limit yourself to two questions. Operator, may we have the first question, please?"
},
{
"speaker": "Operator",
"content": "Certainly. We will go ahead and take our first question from Erik Woodring with Morgan Stanley. Please go ahead."
},
{
"speaker": "Erik Woodring",
"content": "Great. Thank you very much for taking my question. Maybe Tim, if we start with you, you know, I thought some of the color you provided before the call about iPhone 15 performing better than the iPhone 14 was interesting. So just with that context, can you maybe help us understand where you see iPhone replacement cycles today, where you think the size of the base of iPhones that are aged and likely to upgrade are, and what that translates to in potential pent-up demand, as we enter a new iPhone cycle. And I have a follow-up, thank you."
},
{
"speaker": "Tim Cook",
"content": "Yes, hi Eric. The installed base hit an all-time high during the quarter and so we were very happy about that. iPhone in general grew in constant currency. And the 15, as you point out, if you look at the same number of weeks of the 15 from launch and compare that to the 14, the 15 is doing better than the 14. And so that's kind of a state of where we currently are. In terms of upgrade rates, it's very difficult mid-cycle to call upgrade rates. I would just say that with Apple Intelligence, we are very excited about the level of value that we're going to provide to users. And we believe that -- that presents another reason for a compelling upgrade."
},
{
"speaker": "Erik Woodring",
"content": "Okay, that's very helpful. Thanks, Tim. And then second, can you maybe dig into the China dynamics a bit? Sales down 6% this quarter, 3% in constant currency, an improvement from last quarter on a tougher compare that came on the back of some iPhone discounting. So can you maybe just share color on the China market as a whole how much you believe promotions helped in the quarter, how sustainable this improvement is, and if this performance really changes any of your approach to the China market as we look forward. Thanks so much."
},
{
"speaker": "Tim Cook",
"content": "Yeah, Erik, as you point out, we decreased by 6.5% year-over-year for the whole of Greater China. And if you look at it on a constant currency basis, we declined by less than 3%. So over 50% of the decline year-over-year is currency related. That is an improvement from the first half of the fiscal year, and so we're happy to see the acceleration. If you look at iPhone in particular for Greater China, the installed base set a record. We also in Mainland China set a June quarter record for upgraders and so that's a very strong signal and in fact from Kantar -- the survey from Kantar this quarter showed that iPhones were the top three models in urban China. Also, if you look at -- one of the things we look at is the 15 family compared to the 14 family for the same number of weeks from launch. So this goes all the way back to the September of 2023. If you look at that, the 15 is outperforming the 14. And so those are some of the color I would provide. In addition, one of the things that we're very focused on is the level of new customers buying our products. And so if you look at this on the Mac and iPad, in Mainland China, the majority of customers buying or buying for the first time, buying that product for the first time and the watch, the vast, vast majority of people are buying a product for the first time. And during the quarter, I should say also that iPad returned to growth in Greater China, as it did around the world. And so we continue to be confident in the long-term opportunity in China. I don't know how every chapter of the book reads, but we're very confident in the long-term."
},
{
"speaker": "Erik Woodring",
"content": "Great. Thanks so much."
},
{
"speaker": "Tim Cook",
"content": "Yeah."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Erik. Operator, may we have the next question, please?"
},
{
"speaker": "Operator",
"content": "Our next question is from Ben Reitzes with Melius. Please go ahead."
},
{
"speaker": "Ben Reitzes",
"content": "Hey, thanks a lot. Appreciate it. Hey, Tim, you know, now that you've launched or announced Apple intelligence, do you have any ideas on how it may impact services. Would it – do you feel like it'll accelerate your Services business augmented? And maybe folks will need to buy more storage and some other things. How are you thinking about it as a catalyst for Services into next year? And I have a follow-up. Thanks."
},
{
"speaker": "Tim Cook",
"content": "We started the rollout of Apple Intelligence this week with developers, so some of the features are out there as of Monday. And we couldn't be more excited about getting them out there. Obviously, this will enable developers to take their apps to the next level. And so we are taking the first step in getting the beta out there, and we can't wait to see what kind of amazing things they do with it."
},
{
"speaker": "Ben Reitzes",
"content": "Okay. Thanks. And then Luca, with regard to gross margin, it's been -- there's been some component price inflation and mix. Do you mind just giving us a little more color on how you are managing that sequentially and how you feel about the current component environment as an impact on margins? Thanks."
},
{
"speaker": "Luca Maestri",
"content": "Sure, Ben. I think I'll give you a bit of the walk for the June quarter and then get into the outlook that we provided for the September quarter. At the total company level, we've reported 46.3%. It is down 30 basis points sequentially, and it was really driven by a different mix. Within products, of course, we launched very important products like the iPad during the course of the quarter. But we had an offset from a shift in mix towards Services, and we got some good cost savings. And so when you look at it on a year-over-year basis, we are up significantly on the margin front. And keep in mind that foreign exchange continues to be a bit of a headwind for us. As we go into the September quarter, we are guiding 45.5% to 46.5%, which is kind of within the guidance that we provided last quarter. Again similar dynamics, we expect a slightly different mix. We expect foreign exchange to have a minimal impact sequentially, although a more significant impact on a year-over-year basis. On the commodity side, I think that is what you are referring to, yes we have seen some increases on the memory front, but the rest of the commodities, we see a continuous decline. So in general, we feel -- we're well positioned. And as you know well, these are very high levels of gross margin for us and we are pleased where we are."
},
{
"speaker": "Ben Reitzes",
"content": "Okay. Thanks a lot."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you Ben. Operator may we have the next question please."
},
{
"speaker": "Operator",
"content": "Our next question is from Mike Ng with Goldman Sachs. Please go ahead."
},
{
"speaker": "Mike Ng",
"content": "Hi, good afternoon. I just have two questions. First, I was wondering if you could talk about whether or not you've seen a shift in demand for iPhone 15 Pro, Pro Max models since WWDC that could potentially foreshadow consumer demand for Apple Intelligence enabled phones?"
},
{
"speaker": "Tim Cook",
"content": "We just announced the sort of the requirements at the system and the silicon level in June. And so we had very limited time during the quarter. So it's really too early to tell."
},
{
"speaker": "Mike Ng",
"content": "That's fair. And then with the focus on upgrader potential over the next several years, I was just wondering if you could talk about what you are expecting from the US promotional environment from your channel partners, whether that's US wireless carriers, given the importance of device sales for those partners during an upgrade cycle. Or any retail support on what could be a very strong smartphone upgrade period? Thank you."
},
{
"speaker": "Tim Cook",
"content": "We are very excited about Apple Intelligence and what it brings, and it is another compelling reason for an upgrade. I'd leave the promotional question for the sort of the carriers themselves to answer. But I believe it will be a very key time for -- and a compelling upgrade cycle."
},
{
"speaker": "Mike Ng",
"content": "Great. Thank you Tim."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thanks Mike. Operator, can we have the next question please."
},
{
"speaker": "Operator",
"content": "Our next question is from Amit Daryanani with Evercore. Please go ahead."
},
{
"speaker": "Amit Daryanani",
"content": "Good afternoon everyone. And I have two as well. I guess, Tim, maybe back to the Apple Intelligence dynamic. There's clearly a lot of excitement from consumers around what Apple Intelligence could mean for them. Can you just touch on your -- do you think the intent is to launch all the Apple Intelligence features at the same time to consumers, or do you think they end up getting staggered a bit? And if they are staggered, do you think it impacts how consumers come out and buy the next-generation iPhone?"
},
{
"speaker": "Tim Cook",
"content": "The rollout, as we mentioned in June, sort of -- we've actually started with developers this week. We started with some features of Apple Intelligence, not the complete suite. There are other features like languages beyond US English that will happen over the course of the year, and there are other features that will happen over the course of the year. And ChatGPT is integrated by the end of the calendar year. And so yes, so it’s a staggered launch."
},
{
"speaker": "Amit Daryanani",
"content": "Got it. And then I guess your Services growth rates have been extremely impressive for several quarters and it seems like it is accelerated recently. Can you just touch -- talk about when you look at this double-digit growth, how much of that do you think is coming from the installed base growth versus better ARPU or better monetization of the installed base? And how do you kind of see that mix changing as you go forward?"
},
{
"speaker": "Luca Maestri",
"content": "Yes, Amit, it is Luca. It's a combination of a number of factors. The installed base growth is very important of course, because we have a larger pool of customers that uses the ecosystem and uses our Services. We are seeing and we've seen this consistently for many, many quarters now. We see continued growth in the level of engagement that our customers have with our ecosystem. We have more transacting accounts every quarter, so more people using the ecosystem both the free elements of the ecosystem and the paid elements. We see paid accounts growing double digits, and we've seen that for many, many quarters. Now we look at our paid subscriptions on our platform, and they are growing strong double digits as well. So obviously, the growing level of engagement helps us both from an ARPU standpoint and just a volume standpoint. Obviously, as you've seen over the last several years, we launched new services over time, and we've launched many new services, fairly recently. Obviously, our payments business is relatively new, Apple TV+, Apple Arcade, Fitness+, so many other services we've added. And so we are providing more and more opportunities for our customers to interact with the ecosystem. And we believe we are doing also a very good job at improving the quality of these services and improving the amount of content that we make available. We continue to make significant investments on TV+, on Apple Arcade. We are launching new shows, new games all the time. And I think you will continue to see that as we go forward. We are very, very happy with the 14% growth that we had this quarter because, particularly if you look at the performance that we had in Services a year ago, the compares for us tend to get a bit more challenging in the second half of our fiscal year. But in spite of that, we delivered a level of growth that was better than what we were expecting at the beginning of the quarter."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thanks Amit. Operator we will take the next question please."
},
{
"speaker": "Operator",
"content": "Our next question is from Wamsi Mohan with Bank of America. Please go ahead."
},
{
"speaker": "Wamsi Mohan",
"content": "Yes. Thank you so much. Tim, you announced Apple Intelligence, but you also announced partnerships with OpenAI and presumably more coming down the road. How should investors think about the monetization models around these partnerships where the CapEx investments are clearly being made by these potential partners. But you're obviously -- they're leveraging your distribution to your very attractive installed base. So in the long-term, do you see the Apple Intelligence part -- the Services growth from Apple Intelligence being the larger contributor over time? Or do you see these partnerships becoming a larger contributor over time? And I have a follow-up."
},
{
"speaker": "Tim Cook",
"content": "I think the way that I look at it is that Apple Intelligence is the on-device processing and the Private Cloud Compute. And a lot of that will be things with a personal context. And then for world knowledge, we are integrating with ChatGPT initially, and that will be focused on world knowledge as I said. And so the monetization model, I don't want to get into the terms of the commercial agreements because they are confidential between the parties. But I see both aspects as being very important. People want both."
},
{
"speaker": "Wamsi Mohan",
"content": "Okay. Thanks. As a follow-up maybe for Luca. Just stepping back to the gross margin discussion again. If I look at calendar 2023, you had on average 150 basis points increase in product gross margins on a year-on-year basis. In 2024 so far, it had been more flat year-on-year. When we think about that, is the incremental headwind, I mean there was FX headwinds throughout the last several years. So ex-FX, are there other incremental headwinds that are either temporary or structural in nature that are perhaps limiting further upside to what are obviously very strong gross margins? Thank you."
},
{
"speaker": "Luca Maestri",
"content": "Yes. Of course, as you said, the foreign exchange continues to be -- this is incremental on a year-over-year basis. And it is one of those things that is outside of our control. We try to hedge our exposures. But it is what it is. We know that when the dollar is strong, our gross margins are affected. The other element that I think it's always important to keep in mind is that within the Products business, our products have different margin profiles. And depending on the relative success in the marketplace, our products' gross margin tends to move. And so the mix of our products has an impact on gross margins, right? And so we need to pay attention to that. Of course, we just launched an iPad and that is one of the factors. But we want all our products to be very successful in the marketplace. And that's why we always look at gross margin dollars as the first order of priority, and gross margin percentage tends to follow from that. The other factor that obviously has an impact, a significant impact is the state of the commodity markets, and they tend to go in cycles. And so we will see how that plays out over time. But in general, we feel good about the level of gross margins that we have for our products business, and we think we are in a good position there."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thanks Wamsi. Operator, can we have the next question please."
},
{
"speaker": "Operator",
"content": "Our next question is from Krish Sankar with TD Cowen. Please go ahead."
},
{
"speaker": "Krish Sankar",
"content": "Hi, thanks for taking my question. And congrats on the strong results. The first one for Luca or Tim. We keep hearing about these increasing silicon content for AI edge devices. And also, I think, Luca you spoke about increasing commodity costs. So I'm curious how to think about margins for these new AI devices. And Tim, do any of these Apple Intelligence features need more hardware updates than what we have today? And then I have a quick follow-up."
},
{
"speaker": "Tim Cook",
"content": "Maybe I'll take the second one first and then pass it over to Luca. In terms of the requirements to run Apple Intelligence, there are system requirements and there are silicon requirements. And so from an iPhone point of view, the iPhone 15 Pro and Pro Max will run Apple Intelligence and the successor products obviously. If you look at the Mac, it starts with the M series of silicon that started in 2020. And the iPad is the same, and so it starts with the M series of silicon. And so there are system requirements and silicon requirements that go with each of those."
},
{
"speaker": "Luca Maestri",
"content": "And from a gross margin standpoint, as you know, we don't provide any color past the current quarter, and we just provided guidance for the quarter 45.5% to 46.5%. It is essentially broadly in line with what we reported for the June quarter. So we'll take it quarter by quarter and we will report as the time goes by."
},
{
"speaker": "Krish Sankar",
"content": "Got it. Very helpful. And then a quick follow-up for Tim. Thanks for the color on China. We also see many other consumer discretionary and luxury brands talk about a weak China. And I think Tim, you said half the details was FX related. I'm curious, the other half of the weakness, was that more China macro related or do you think it is kind of like specific to Apple with domestic competitors? Any other color you could give would be very helpful. Thank you very much."
},
{
"speaker": "Tim Cook",
"content": "Well, certainly, the competitive environment there is the most competitive in the world. I've said that before and that remains to be the case. The macroeconomic factors have been in the press too, and I'm not an expert on those. I can only tell you what we're seeing. And we were pleased that the business showed improvement from the first half of the year."
},
{
"speaker": "Krish Sankar",
"content": "Thanks Tim."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you Krish. Operator, can we have the next question please."
},
{
"speaker": "Operator",
"content": "Our next question is from David Vogt with UBS. Please go ahead."
},
{
"speaker": "David Vogt",
"content": "Great. Two, if I may also. Tim, first one for you. I know it is early days, and you talked about the developers just getting their hands on Apple Intelligence. But when you think about the categories that are currently in the App Store and kind of what you think app developers could do with this new technology, what's your instinct say in terms of -- are these going to be iterative applications to currently available applications? Is there any sort of category that you think lends itself more naturally to Apple Intelligence? Is it games? Is it more creative? I'm just trying to get a sense of how you're thinking about it. And then I have a follow-up for Luca. Thanks."
},
{
"speaker": "Tim Cook",
"content": "If you look at how we've deployed Apple Intelligence or are deploying Apple Intelligence, we've really thought about it at pretty much all of the apps that you use every day. And so we've thought about it from Notes to Mail to Messages and all the rest. And so there is been a deep level of thinking about how it affects those apps. And that's going to surface Apple Intelligence in a way that is natural to the user, in a way that will I think, get them very excited about it and get usage. Similarly, I think the developers will do that on a broad basis with their apps as well. And so I think, it is profound and we'll see what the developers do. But we're very excited to get the initial seed out there this week and see what they do. I think it will be amazing, yes."
},
{
"speaker": "David Vogt",
"content": "Yes. No, that's helpful. I appreciate it. And Luca, just maybe -- I know you didn't give a full rundown of product categories in your prepared remarks. But if I kind of take your comments at face value, I guess what I'm trying to think about is for the next quarter, it sounds like with Services being relatively strong and FX easing a little bit. You are effectively saying that product revenue in the September quarter is going to basically be flat with the September quarter last year ahead of a product launch. And so I'm just trying to get a sense for, what are the puts and takes in that sort of outlook particularly as you have Apple Intelligence hopefully stoking the fire for demand going forward? Thanks."
},
{
"speaker": "Luca Maestri",
"content": "Well, we have provided -- let me repeat what we provided. We think that we are going to be growing total company revenue at a rate that is similar to what we reported, so the plus 5%, right? In spite of the fact that we are going to have some foreign exchange headwinds, and we said about 150 basis points in the December quarter. And we said that we will grow Services double digits at a rate that is similar to what we've reported for the first three quarters of the fiscal year. We are not going into the other categories. I think there is a lot of good math that you can do from what we've given you here. Keep in mind on the Mac that we will have a challenging compare from a year ago, given the fact that we launched and we had the full quarter impact of the launch of the MacBook Air 15-inch a year ago. And also on the iPad, we reported 24% growth in the June quarter. Clearly we had the benefit from the launch in the June quarter of the new products, the iPad Air and the iPad Pro. So important to keep that in mind on a sequential basis."
},
{
"speaker": "David Vogt",
"content": "Great. Thank you very much."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you David. Operator may we have the next question please."
},
{
"speaker": "Operator",
"content": "Our next question is from Atif Malik with Citi. Please go ahead."
},
{
"speaker": "Atif Malik",
"content": "Hi, thank you for taking my question. The first one is for Tim. I know it's early days. The feedback on Apple Intelligence software features like notification summary and reduced interruption focus from the developers who have tried the iOS 18.1 beta version this week is very positive. My question is in response to an earlier question, you talked about a staggered launch on some of these software features. So are you expecting most of the features that you announced at WWDC to be part of iOS 18? Or we should be thinking that some of these features could potentially be part of iOS 19 next year?"
},
{
"speaker": "Tim Cook",
"content": "Our objective that we said in June is to roll out US English starting in the fall and that is to users, and then proceed with more functionality, more features, if you will, and more languages and regions coverage as we proceed across the next year. And so we sort of gave a time frame that -- and we're tracking to that."
},
{
"speaker": "Atif Malik",
"content": "Understand. And the next one for Luca. Luca the Services growth momentum seems very strong. Are you seeing any impact from changes made to comply with the DMA rules?"
},
{
"speaker": "Luca Maestri",
"content": "Well, as you know we have introduced some changes to the way we run the App Store in Europe already in March. And we are seeing a good level of adoption from developers on those changes. We are on an ongoing basis, discussing with the European Commission how to ensure full compliance with the DMA. It is obviously early stage, but in general, our results for the Services business and for the App Store have been pretty good until now. Again to just provide you a frame of reference, the percentage of revenue that we generate from the European Union on the App Store is about 7% of the total."
},
{
"speaker": "Atif Malik",
"content": "Very helpful. Thank you."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you Atif. Operator may we have the next question please."
},
{
"speaker": "Operator",
"content": "Our next question is from Samik Chatterjee with JPMorgan. Please go ahead."
},
{
"speaker": "Samik Chatterjee",
"content": "Yes. Hi. Thanks for taking my question. I guess, Tim, if I can just ask you about Apple Intelligence as well. There is a regulatory aspect as well in certain geographies. You mentioned the staggered launch that you are aiming for and the timelines you're thinking. How are you thinking about the complexity of the regulatory process, in particular like EU and maybe China? And does -- in terms of your timelines of the rollout, are you sort of embedding in the regulatory aspect here? And how should we think about timing then including that? And I have a follow-up. Thank you."
},
{
"speaker": "Tim Cook",
"content": "We are engaged as you would guess, with both regulatory bodies that you mentioned. And our objective is to move as fast as we can, obviously because our objective is always to get features out there for everyone. We have to understand the regulatory requirements before we can commit to doing that and commit a schedule to doing that. But we're very constructively engaged with both."
},
{
"speaker": "Samik Chatterjee",
"content": "Okay, got it. And a quick one on the Wearables category, Luca. I know you mentioned the acceleration there on a sequential basis. Maybe you can just sort of parse that out in terms of what -- which categories drove the acceleration because that's been a category that has been lagging a bit in terms of revenue trends for the past couple of quarters. So just curious what is starting to sort of drive it to accelerate on a sequential basis? Thank you."
},
{
"speaker": "Tim Cook",
"content": "Yes, I'll take that one. I think the important thing to remember when you look at the Wearables, Home and Accessories categories is that we have a difficult launch compare. And we've been running that for a few quarters and we still have that because last year had the continued benefit from the AirPods Pro second generation, the Watch SE and the very first Watch Ultra. And so it is important to keep that in mind. If you sort of take a step back, however and look at the business across the trailing 12 months, it is grown -- the Wearables, Home and Accessories business has grown to almost $40 billion, which is double what it was five years ago."
},
{
"speaker": "Samik Chatterjee",
"content": "Thank you."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you Samik. Operator, may we have the last question please."
},
{
"speaker": "Operator",
"content": "Our last question is from Richard Kramer with Arete Research. Please go ahead."
},
{
"speaker": "Richard Kramer",
"content": "Thanks. Thanks very much. Tim, you referenced the investment in innovation, and your R&D sales ratio reached what I think was a June quarter record even before launching Apple Intelligence. Do you see the rollout of these features requiring further increases in R&D or increases in OpEx or CapEx for cloud compute capacity? And is it even possible to forecast the Services usage as they roll out, given that they are so new for consumers? Thanks."
},
{
"speaker": "Tim Cook",
"content": "Clearly, we have increased R&D over time. We have been investing in AI and ML for years. And in addition to investing more, we've also redeployed certain skills onto AI and ML. And so the growth in sort of embedded in our numbers that we've shared here, it is increasing year-over-year. On the CapEx part, it is important to remember that we employ a hybrid kind of approach, where we do things internally and we have certain partners that we do business with externally where the CapEx would appear in their respective businesses. But yes, I mean you can expect that there is -- we will continue to invest and increase it year-on-year."
},
{
"speaker": "Richard Kramer",
"content": "Okay. And maybe a quick follow-up for Luca. When we look at the free cash flow margins for the first nine months, they are up materially. And given this year's product mix, can you describe to us what exactly in the Services mix or cost control is driving what seems to be structurally higher free cash flow margins across the business?"
},
{
"speaker": "Luca Maestri",
"content": "Yes, I'm glad you noticed that. We are pretty pleased with that fact. And I think you probably also noticed that we've increased our return of capital to shareholders this quarter. This one was a record quarter for us. Well, it's a combination of a number of things. Of course, an improvement in the top-line helps the margin expansion that we've had over the last several years and several quarters obviously has helped. And so that is driving better operating cash flow. On the CapEx front as Tim said, we employ a hybrid model. Some of the investments show up on our balance sheet and some other investments show up somewhere else and we pay, as we go. But in general, we try to run the company efficiently. We continue to think that capital efficiency is a good thing. And therefore, we are pleased with the fact that our free cash flow is doing well this year."
},
{
"speaker": "Richard Kramer",
"content": "Okay. Thanks."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Richard. A replay of today's call will be available for two weeks on Apple Podcasts, as a webcast on apple.com/investor, and via telephone. The number for the telephone replay is (866)-583-1035. Please enter confirmation code 1969407 followed by the pound sign. These replays will be available by approximately 5 p.m. Pacific Time today. Members of the press with additional questions can contact Josh Rosenstock at (408)-862-1142. And financial analysts can contact me, Suhasini Chandramouli with additional questions at (408)-974-3123. Thank you again for joining us today."
},
{
"speaker": "Operator",
"content": "Once again this does conclude today's conference. We do appreciate your participation."
}
] |
aapl | 2,024 | 2 | [
{
"speaker": "Suhasini Chandramouli",
"content": "Good Afternoon, and welcome to the Apple Q2 Fiscal Year 2024 Earnings Conference Call. My name is Suhasini Chandramouli, Director of Investor Relations. Today's call is being recorded. Speaking first today is Apple's CEO, Tim Cook, and he'll be followed by CFO, Luca Maestri. After that, we'll open the call to questions from analysts. Please note that some of the information you'll hear during our discussion today will consist of forward-looking statements, including, without limitation, those regarding revenue, gross margin, operating expenses, other income and expense, taxes, capital allocation and future business outlook, including the potential impact of macroeconomic conditions on the company's business and results of operations. These statements involve risks and uncertainties that may cause actual results or trends to differ materially from our forecast. For more information, please refer to the risk factors discussed in Apple's most recently filed Annual Report on Form 10-K and the Form 8-K filed with the SEC today, along with the associated press release. Apple assumes no obligation to update any forward-looking statements, which speak only as of the date they are made. I'd now like to turn the call over to Tim for introductory remarks."
},
{
"speaker": "Tim Cook",
"content": "Thank you, Suhasini. Good afternoon, everyone, and thanks for joining the call. Today, Apple is reporting revenue of $90.8 billion and an EPS record of $1.53 for the March quarter. We set revenue records in more than a dozen countries and regions. These include, among others, March quarter records in Latin-America and the Middle East, as well as Canada, India, Spain and Turkey. We also achieved an all-time revenue record in Indonesia, one of the many markets where we continue to see so much potential. In services, we set an all-time revenue record, up 14% over the past year. Keep in mind, as we described on the last call, in the March quarter a year-ago, we were able to replenish iPhone channel inventory and fulfill significant pent-up demand from the December quarter COVID-related supply disruptions on the iPhone 14 Pro and 14 Pro Max. We estimate this one-time impact added close to $5 billion to the March quarter revenue last year. If we remove this from last year's results, our March quarter total company revenue this year would have grown. Despite this impact, we were still able to deliver the records I described. Of course, this past quarter, we were thrilled to launch Apple Vision Pro and it has been so wonderful to hear from people who now get to experience the magic of spatial computing. They describe the impossible becoming possible right before their eyes and they share their amazement and their emotions about what they can do now, whether it's reliving their most treasured memories or having a movie theater experience right in their living room. It's also great to see the enthusiasm from the enterprise market. For example, more than half of the Fortune 100 companies have already bought Apple Vision Pro units and are exploring innovative ways to use it to do things that weren't possible before, and this is just the beginning. Looking ahead, we're getting ready for an exciting product announcement next week that we think our customers will love. And next month, we have our Worldwide Developers Conference, which has generated enormous enthusiasm from our developers. We can't wait to reveal what we have in-store. We continue to feel very bullish about our opportunity in Generative AI. We are making significant investments, and we're looking forward to sharing some very exciting things with our customers soon. We believe in the transformative power and promise of AI, and we believe we have advantages that will differentiate us in this new era, including Apple's unique combination of seamless hardware, software and services integration, groundbreaking Apple's silicon, with our industry-leading neural engines and our unwavering focus on privacy, which underpins everything we create. As we push innovation forward, we continue to manage thoughtfully and deliberately through an uneven macroeconomic environment and remain focused on putting our users at the center of everything we do. Now let's turn to our results for the March quarter across each product category, beginning with iPhone. iPhone revenue for the March quarter was $46 billion, down 10% year-over-year. We faced a difficult compare over the previous year due to the $5 billion impact that I mentioned earlier. However, we still saw growth on iPhone in some markets, including Mainland China, and according to Kantar during the quarter, the two best-selling smartphones in Urban China were the iPhone 15 and iPhone 15 Pro Max. I was in China recently where I had the chance to meet with developers and creators who are doing remarkable things with iPhone. And just a couple of weeks ago, I visited Vietnam, Indonesia and Singapore, where it was incredible to see all the ways customers and communities are using our products and services to do amazing things. Everywhere I travel, people have such a great affinity for Apple, and it's one of the many reasons I'm so optimistic about the future. Turning to Mac. March quarter revenue was $7.5 billion, up 4% from a year ago. We had an amazing launch in early March with the new 13-inch and 15-inch MacBook Air. The world's most popular laptop is the best consumer laptop for AI with breakthrough performance of the M3 chip and it’s even more powerful neural engine. Whether it's an entrepreneur starting a new business or a college student finishing their degree, users depend on the power and portability of MacBook Air to take them places they couldn't have gone without it. In iPad, revenue for the March quarter was $5.6 billion, 17% lower year-over-year, due to a difficult compare with the momentum following the launch of M2 iPad Pro and the 10th Generation iPad last fiscal year. iPad continues to stand apart for its versatility, power and performance. For video editors, music makers and creatives of all kinds, iPad is empowering users to do more than they ever could with a tablet. Across Wearables, Home and Accessories, March quarter revenue was $7.9 billion, down 10% from a year-ago due to a difficult launch compare on Watch and AirPods. Apple Watch is helping runners go the extra mile on their wellness journeys, keeping hikers on course with the latest navigation capabilities in watchOS 10, and enabling users of all fitness levels to live a healthier day. Across our watch lineup, we're harnessing AI and machine-learning to power lifesaving features like a regular rhythm notifications and fall detection. I often hear about how much these features mean to users and their loved ones and I'm thankful that so many people are able to get help in their time of greatest need. As I shared earlier, we set an all-time revenue record in services with $23.9 billion, up 14% year-over-year. We also achieved all-time revenue records across several categories and geographic segments. Audiences are tuning in on screens large, small and spatial and are enjoying Apple TV+ Originals like Palm Royale and Sugar. And we have some incredible theatrical releases coming this year, including Wolves, which reunites George Clooney and Brad Pitt. Apple TV+ productions continue to be celebrated as major awards contenders. Since launch, Apple TV+ productions have earned more than 2,100 award nominations and 480 wins. Meanwhile, we're enhancing the live sports experience with a new iPhone app, Apple Sports. This free app allows fans to follow their favorite teams and leagues with real-time scores, stats and more. Apple Sports is the perfect companion for MLS Season Pass subscribers. Turning to retail, our stores continued to be vital spaces for connection and innovation. I was delighted to be in Shanghai for the opening of our latest flagship store. The energy and enthusiasm from our customers was truly something to behold. And across the United States, our incredible retail teams have been sharing Vision Pro demos with customers, delighting them with a profound and emotional experience of using it for the very first time. Everywhere we operate and everything we do, we're guided by our mission to enrich users' lives and lead the world better than we found it, whether we're making Apple podcasts more accessible with a new transcripts feature or helping to safeguard iMessage users' privacy with new protections that can defend against advances in quantum computing. Our environmental work is another great example of how innovation and our values come together. As we work toward our goal of being carbon-neutral across all of our products by 2030, we are proud of how we've been able to innovate and do more for our customers while taking less from the planet. Since 2015, Apple has cut our overall emissions by more than half, while revenue grew nearly 65% during that same time period. And we're now using more recycled materials in our products than ever before. Earlier this spring, we launched our first-ever product to use 50% recycled materials with a new M3-powered MacBook Air. We're also investing in new solar and wind power in the U.S. and Europe, both to power our growing operations and our users' devices. And we're working with partners in India and the U.S. to replenish 100% of the water we use in places that need it most with the goal of delivering billions of gallons of water benefits over the next two decades. Through our Restore Fund, Apple has committed $200 million to nature-based carbon removal projects. And last month, we welcomed two supplier partners as new investors, who will together invest up to an additional $80 million in the fund. Whether we're enriching lives of users across the globe or doing our part to be a force for good in the world, we do everything with a deep sense of purpose at Apple. And I'm proud of the impact we've already made at the halfway point in a year of unprecedented innovation. I couldn't be more excited for the future we have ahead of us, driven by the imagination and innovation of our teams and the enduring importance of our products and services in people's lives. With that, I'll turn it over to Luca."
},
{
"speaker": "Luca Maestri",
"content": "Thank you, Tim, and good afternoon, everyone. Revenue for the March quarter was $90.8 billion, down 4% from last year. Foreign exchange had a negative year-over-year impact of 140 basis points on our results. Products revenue was $66.9 billion, down 10% year-over-year due to the challenging compare on iPhone that Tim described earlier, which was partially offset by strength from Mac. And thanks to our unparalleled customer satisfaction and loyalty and a high number of customers who are new to our products, our installed base of active devices reached an all-time high across all products and all geographic segments. Services revenue set an all-time record of $23.9 billion, up 14% year-over-year with record performance in both developed and emerging markets. Company gross margin was 46.6%, up 70 basis points sequentially, driven by cost savings and favorable mix to services, partially offset by leverage. Products gross margin was 36.6%, down 280 basis points sequentially, primarily driven by seasonal loss of leverage and mix, partially offset by favorable costs. Services gross margin was 74.6%, up 180 basis points from last quarter due to a more favorable mix. Operating expenses of $14.4 billion were at the midpoint of the guidance range we provided and up 5% year-over-year. Net income was $23.6 billion, diluted EPS was $1.53 and a March quarter record, and operating cash flow was strong at $22.7 billion. Let me now provide more detail for each of our revenue categories. iPhone revenue was $46 billion, down 10% year-over-year, due to the almost $5 billion impact from a year ago that Tim described earlier. Adjusting for this one-time impact, iPhone revenue would be roughly flat to last year. Our iPhone active installed base grew to a new all-time high in total and in every geographic segment. And during the March quarter, we saw many iPhone models as the top-selling smartphones around the world. In fact, according to a survey from Kantar, an iPhone was the top-selling model in the U.S., Urban China, Australia, the U.K., France, Germany and Japan. And the iPhone 15 family continues to be very popular with customers. 451 Research recently measured customer satisfaction at 99% in the U.S. Mac revenue was $7.5 billion, up 4% year-over-year, driven by the strength of our new MacBook Air, powered by the M3 chip. Customers are loving the incredible AI performance of the latest MacBook Air and MacBook Pro models. And our Mac installed base reached an all-time high with half of our MacBook Air buyers during the quarter being new to Mac. Also customer satisfaction for Mac was recently reported at 96% in the U.S. iPad generated $5.6 billion in revenue, down 17% year-over-year. iPad continued to face a challenging compare against the launch of the M2 iPad Pro and iPad 10th Generation from last year. At the same time, the iPad installed base has continued to grow and is at an all-time high as over half of the customers who purchased iPads during the quarter were new to the product. In addition, the latest reports from 451 Research indicated customer satisfaction of 96% for iPad in the US. Wearables, Home and Accessories revenue was $7.9 billion, down 10% year-over-year due to a difficult launch compare. Last year, we had the continued benefit from the launches of the AirPods Pro second-generation, the Watch SE and the first Watch Ultra. Apple Watch continues to attract new customers, with almost two-thirds of customers purchasing an Apple Watch during the quarter being new to the product, sending the Apple Watch installed base to a new all-time high and customer satisfaction was recently measured at 95% in the U.S. In services, as I mentioned, total revenue reached an all-time record of $23.9 billion, growing 14% year-over-year with our installed-base of active devices continuing to grow at a nice pace. This provides a strong foundation for the future growth of the services business as we continued to see increased customer engagement with our ecosystem. Both transacting accounts and paid accounts reached a new all-time high with paid accounts growing double-digits year-over-year. And paid subscriptions showed strong double-digit growth. We have well over $1 billion paid subscriptions across the services on our platform, more than double the number that we had only four years ago. We continued to improve the breadth and quality of our current services from creating new games on Arcade and great new shows on TV+ to launching additional countries and partners for Apple Pay. Turning to enterprise, our customers continued to invest in Apple products to drive productivity and innovation. We see more and more enterprise customers embracing the Mac. In Healthcare, Epic Systems, the world's largest electronic medical record provider, recently launched its native app for the Mac, making it easier for healthcare organizations like Emory Health to transition thousands of PCs to the Mac for clinical use. And since the launch of Vision Pro last quarter, many leading enterprise customers have been investing in this amazing new product to bring spatial computing apps and experiences to life. We are seeing so many compelling use cases from aircraft engine maintenance training at KLM Airlines to real-time team collaboration for racing at Porsche to immersive kitchen design at Lowe's. We couldn't be more excited about the spatial computing opportunity in enterprise. Taking a quick step back, when we look at our performance during the first-half of our fiscal year, total company revenue was roughly flat to the prior year in spite of having one less week of sales during the period and some foreign exchange headwinds. We were particularly pleased with our strong momentum in emerging markets, as we set first-half revenue records in several countries and regions, including Latin-America, the Middle East, India, Indonesia, the Philippines and Turkey. These results, coupled with double-digit growth in services and strong levels of gross margin, drove a first half diluted EPS record of $3.71, up 9% from last year. Let me now turn to our cash position and capital return program. We ended the quarter with $162 billion in cash and marketable securities. We repaid $3.2 billion in maturing debt and commercial paper was unchanged sequentially, leaving us with total debt of $105 billion. As a result, net cash was $58 billion at the end of the quarter. During the quarter, we returned over $27 billion to shareholders, including $3.7 billion in dividends and equivalents and $23.5 billion through open-market repurchases of $130 million Apple's shares. Given the continued confidence we have in our business now and into the future, our Board has authorized today an additional $110 billion for share repurchases, as we maintain our goal of getting to net cash-neutral over time. We are also raising our dividend by 4% to $0.25 per share of common stock, and we continued to plan for annual increases in the dividend going forward as we've done for the last 12 years. This cash dividend will be payable on May 16, 2024 to shareholders of record as of May 13, 2024. As we move ahead into the June quarter, I'd like to review our outlook, which includes the types of forward-looking information that Suhasini referred to at the beginning of the call. The color we are providing today assumes that the macroeconomic outlook doesn't worsen from what we are projecting today for the current quarter. We expect our June quarter total company revenue to grow low-single-digits year-over-year in spite of a foreign exchange headwind of about 2.5 percentage points. We expect our services business to grow double-digits at a rate similar to the growth we reported for the first-half of the fiscal year. And we expect iPad revenue to grow double-digits. We expect gross margin to be between 45.5% to -- and 46.5%. We expect OpEx to be between $14.3 billion and $14.5 billion. We expect OI&E to be around $50 million, excluding any potential impact from the mark-to-market of minority investments and our tax rate to be around 16%. With that, let's open the call to questions."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Luca. We ask that you limit yourself to two questions. Operator, may we have the first question, please?"
},
{
"speaker": "Operator",
"content": "Certainly. We will go ahead and take our first question from Mike Ng with Goldman Sachs. Please go ahead."
},
{
"speaker": "Mike Ng",
"content": "Hey, good afternoon. Thank you very much for the question. I have two, first, I'll ask about the June quarter guidance. The revenue outlook for low-single digits growth, I was wondering if you could run through some of the product assumptions, iPhone, like what kind of gives you confidence around that? And then on the service momentum, what was better than expected in the quarter? And then I just have a quick follow-up."
},
{
"speaker": "Luca Maestri",
"content": "Hey, Mike. It's Luca. On the outlook, what we said is we expect to grow low-single-digits in total for the company. We expect services to grow double-digits at a rate that is similar to what we've done in the first-half of our fiscal year. And we've also mentioned that iPad should grow double-digits. This is the color that we're providing for the June quarter. In services, we've seen a very strong performance across the board. We've mentioned, we've had records in several categories, in several geographic segments. It's very broad based, our subscription business is going well. Transacting accounts and paid accounts are growing double-digits. And also we've seen a really strong performance both in developed and emerging markets. So very pleased with the way the services business is going."
},
{
"speaker": "Mike Ng",
"content": "Great. Thank you. And I wanted to ask about, as Apple leans more into AI and Generative AI, should we expect any changes to the historical CapEx cadence that we've seen in the last few years of about $10 billion to $11 billion per year or any changes to, you know, how we may have historically thought about the split between tooling, data center and facilities? Thank you very much."
},
{
"speaker": "Luca Maestri",
"content": "Yes. We are obviously very excited about the opportunity with Gen AI. We obviously are pushing very hard on innovation on every front and we've been doing that for many, many years. Just during the last five years, we spent more than a $100 billion in research and development. As you know, on the CapEx front, we have a bit of a hybrid model where we make some of the investments ourselves. In other cases, we share them with our suppliers and partners on the manufacturing side, we purchased some of the tools and manufacturing equipment. In some of the cases, our suppliers make the investment. On the -- and we do something similar on the data center side. We have our own data center capacity and then we use capacity from third parties. It's a model that has worked well for us historically and we plan to continue along the same lines going forward."
},
{
"speaker": "Mike Ng",
"content": "Excellent. Thank you very much."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Awesome. Thank you, Mike. Operator, can we have the next question, please?"
},
{
"speaker": "Operator",
"content": "Our next question is from Wamsi Mohan with Bank of America. Please go ahead."
},
{
"speaker": "Wamsi Mohan",
"content": "Yes, thank you so much. Tim, can you talk about the implications to Apple from the changes driven by EU DMA? You've had to open up third-party app stores, clearly disposes some security risks on the one-hand, which can dilute the experience, but also lower payments from developers to Apple. What are you seeing developers choose in these early days and consumers choose in terms of these third-party app stores? And I have a follow-up."
},
{
"speaker": "Tim Cook",
"content": "It's really too early to answer the question. We just implemented in March, as you probably know, in the European Union, the alternate app stores and alternate billing, et cetera. So we're focused on complying while mitigating the impacts to user privacy and security that you mentioned. And so that's our focus."
},
{
"speaker": "Wamsi Mohan",
"content": "Okay. Thank you, Tim. And Luca, I was wondering if you could comment a bit on the product gross margins, the sequential step down. You noted both mix and leverage. Any more color on the mix, if you could share if customers are at all starting to mix down across product lines or is this more a mix across product lines? Just trying to get some color on customer behavior given some of the broader inflationary pressures. Thank you so much."
},
{
"speaker": "Luca Maestri",
"content": "On a sequential basis, yes, we were down. It's primarily the fact that we had a slightly different mix of products than the previous one. Obviously, leverage plays a big role as we move from the holiday quarter into the -- into, you know, a more typical quarter. So I would say primarily leverage in a different mix of products. I mean, we haven't seen anything different in terms within the product categories, we haven't seen anything particular."
},
{
"speaker": "Wamsi Mohan",
"content": "Thank you so much."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thanks, Wamsi. We'll take the next question, please."
},
{
"speaker": "Operator",
"content": "Our next question is from Erik Woodring with Morgan Stanley. Please go ahead."
},
{
"speaker": "Erik Woodring",
"content": "Great. Thanks so much for taking my questions. Maybe my first one, Tim, you've obviously mentioned your excitement around Generative AI multiple times. I'm just curious how Apple is thinking about the different ways in which you can monetize this technology because historically software upgrades haven't been a big factor in driving product cycles. And so could AI be potentially different? And how could that impact replacement cycles? Is there any services angle you'd be thinking? Any early color that you can share on that? And then I have a follow up, please. Thanks."
},
{
"speaker": "Tim Cook",
"content": "I don't want to get in front of our announcements, obviously. I would just say that we see Generative AI as a very key opportunity across our products. And we believe that we have advantages that set us apart there. And we'll be talking more about it in as we go through the weeks ahead."
},
{
"speaker": "Erik Woodring",
"content": "Okay. Very fair. Thank you. And then Luca, maybe to just follow up on Wamsi's comments or question. There's a broad concern about the headwind that rising commodity costs have on your product gross margins. Wondering if you could just clarify for us if we take a step back and look at all of the components and commodities that go into your products kind of collectively, are we -- are you seeing these costs rising? Are they falling? What tools do you have to try to help and mitigate some rising costs if at all, rising input costs if at all? Thank you so much."
},
{
"speaker": "Luca Maestri",
"content": "Yes. I mean during the last quarter, commodity costs, and in general, component costs have behaved favorably to us. On the memory front, prices are starting to go up. They've gone up slightly during the March quarter. But in general, I think it's been a period not only this quarter, but the last several quarters where, you know, commodities have behaved well for us. Commodities going cycles and so there's obviously always that possibility. Keep in mind that we are starting from a very high level of gross margins. We reported 46.6%, which is something that we haven't seen in our company in decades. And so we're starting from a good point. As you know, we try to buy ahead when the cycles are favorable to us. And so we will try to mitigate if there are headwinds. But in general, we feel particularly for this cycle, we are in good shape."
},
{
"speaker": "Erik Woodring",
"content": "Thank you so much."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Great. Thank you, Erik. Operator, we'll take the next question, please."
},
{
"speaker": "Operator",
"content": "Our next question is from Ben Reitzes with Melius. Please go ahead."
},
{
"speaker": "Ben Reitzes",
"content": "Hey, thanks for the question. And hey, Tim, I was wondering if I could ask the China question again. Is there any more color from your visit there that gives you confidence that you've reached a bottom there and that it's turning? And I know you've been -- you've continued to be confident there in the long-term. Just wondering if there was any color as to when you think that the tide turns there? Thanks a lot. And I have a follow-up."
},
{
"speaker": "Tim Cook",
"content": "Yes, Ben, if you look at our results in Q2 for Greater China, we were down 8%. That's an acceleration from the previous quarter in Q1. And the primary driver of the acceleration was iPhone. And if you then look at iPhone within Mainland China, we grew on a reported basis. That's before any kind of normalization for the supply disruption that we mentioned earlier. And if you look at the top-selling smartphones, the Top 2 in Urban China are iPhones. And while I was there, it was a great visit and we opened a new store in Shanghai and the reception was very warm and highly energetic, and so I left there having a fantastic trip and enjoyed being there. And so I maintain a great view of China in the long-term. I don't know how each and every quarter goes and each and every week. But over the long haul, I have a very positive viewpoint."
},
{
"speaker": "Ben Reitzes",
"content": "Okay. Hey, thanks, Tim. And then my follow-up, I want to ask this carefully though. It's a -- there's a fear out there that, you may lose some traffic acquisition revenue. And I was wondering if you thought AI from big picture and it doesn't have to be on a long-term basis, I mean from a big picture, if AI is an opportunity for you to continue to monetize your mobile real estate, just how you -- how maybe investors can think about that from a big picture, just given that's been one of the concerns that's potentially been an overhang, of course, due to, you know, a lot of the news and the media around some of the legal cases? And I was wondering if there's just a big-picture color you could give that makes us kind of think about it better and your ability to sort of continue to monetize that real estate? Thanks a lot."
},
{
"speaker": "Tim Cook",
"content": "I think AI, Generative AI and AI, both are big opportunities for us across our products. And we'll talk more about it in the coming weeks. I think there are numerous ways there that are great for us. And we think that we're well-positioned."
},
{
"speaker": "Ben Reitzes",
"content": "Thanks, Tim."
},
{
"speaker": "Tim Cook",
"content": "Yes."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thanks, Ben. Can we have the next question, please?"
},
{
"speaker": "Operator",
"content": "Thank you. Our next question is from Krish Sankar with TD Cowen. Please go ahead."
},
{
"speaker": "Krish Sankar",
"content": "Yes, hi. Thanks for taking my question. Again, sorry to beat the AI haul. But Tim, I know you don't want to like reveal a lot. But I'm just kind of curious, because last quarter you spoke about how you're getting traction in enterprise. Is the AI strategy going to be both consumer and enterprise or is it going to be one after the other? Any color would be helpful? And then, I have a follow-up for Luca."
},
{
"speaker": "Tim Cook",
"content": "Our focus on enterprise has been and you know through the quarter and the quarters that preceded it on selling iPhones and iPads and Macs and we recently added Vision Pro to that. And we're thrilled with what we see there in terms of interest from big companies buying some to explore ways they can use it. And so I see enormous opportunity in the enterprise. I wouldn't want to cabin that to AI only. I think there's a great opportunity for us around the world in the enterprise."
},
{
"speaker": "Krish Sankar",
"content": "Got it. Very helpful. And then for Luca, you know, I'm kind of curious on -- given the macro-environment, on the hardware side, are you seeing a bias towards like standard iPhone versus the Pro model? The reason I'm asking the question is that there's a weaker consumer spending environment, yet your services business is still growing and has amazing gross margins. So I'm just trying to like square the circle over there. Thank you."
},
{
"speaker": "Luca Maestri",
"content": "I'm not sure I fully understand the question, but in general, what we are seeing on the product side, we continued to see a lot of interest at the top of the range of our products. And I think it's a combination of consumers wanting to purchase the best product that we offer in the different categories and our ability to make those purchases more affordable over time. We've introduced several financing solutions from installment plans to trading programs that reduce the affordability threshold and therefore, customers tend to buy -- want to buy at the top of the range that is very valuable for us in developed markets, but particularly in emerging markets where the affordability issues are more pronounced. But in general, over the last several years and that is also reflected in our gross margins, over the last several years, we've seen this trend, which we think is pretty sustainable."
},
{
"speaker": "Krish Sankar",
"content": "Got it. Thank you very much, Luca, and thanks, Tim."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Krish. Operator, we'll have the next question, please."
},
{
"speaker": "Operator",
"content": "Our next question is from Amit Daryanani with Evercore. Please go ahead."
},
{
"speaker": "Amit Daryanani",
"content": "Thanks for taking my question. I have two as well. You know, I guess, first off on capital allocation, you folks have about $58 billion of net cash right now. As you think about eventually getting to this net cash-neutral target, do you think at some point, Apple would be open to taking on leverage on the balance sheet and continuing the buyback program? Or is it more like once you get to this neutral position, it's going to be about returning free cash flow back to shareholders? I'm just wondering, how do you think about leverage on your balance sheet over time and what sort of leverage do you think you'd be comfortable taking on?"
},
{
"speaker": "Luca Maestri",
"content": "Hey, Amit. This is Luca. I would say one step at a time, we have put out this target of getting to net cash-neutral several years ago and we're working very hard to get there. Our free cash flow generation has been very strong over the years, particularly in the last few years. And so as you've seen this year, we've increased the amount that we're allocating to the buyback. For the last couple of years, we were doing $90 billion, now we're doing $110 billion. So let's get there first. It's going to take a while still. And then when we are there, we're going to reassess and see what is the optimal capital structure for the company at that point in time. Obviously, there's going to be a number of considerations that we will need to look at when we get there."
},
{
"speaker": "Amit Daryanani",
"content": "Fair enough. I figure it's worth trying anyway. If I go back to this China discussion a bit and, you know, Tim, I think your comments around growth in iPhones in Mainland China is really notable. Could you step back, I mean, these numbers are still declining at least Greater China on a year-over-year basis in aggregate. Maybe just talk about what are you seeing from a macro basis in China and then at least annual decline -- or year-over-year declines that we're seeing. Do you think it's more macro driven or more competitive driven over there? That would be helpful."
},
{
"speaker": "Tim Cook",
"content": "Yes, I can only tell you what we're seeing. And so I don't want to present myself as a economist. So I'll steer clear of that. From what we saw was an acceleration from Q1, and it was driven by iPhone and iPhone in Mainland China before we adjust for this $5 billion impact that we talked about earlier did grow. That means the other products didn't fare as well. And so we clearly have work there to do. I think it has been and is through last quarter, the most competitive market in the world. And I -- so I, you know, wouldn't say anything other than that. I've said that before, and I believe that it was last quarter as well. And -- but if you step back from the 90-day cycle, what I see is a lot of people moving into the middle class, a -- we try to serve customers very well there and have a lot of happy customers and you can kind of see that in the latest store opening over there. And so I continue to feel very optimistic."
},
{
"speaker": "Amit Daryanani",
"content": "Great. Thank you."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thanks, Amit. Operator, we'll take the next question, please."
},
{
"speaker": "Operator",
"content": "Our next question is from David Vogt with UBS. Please go ahead."
},
{
"speaker": "David Vogt",
"content": "Great. Thanks guys for taking my question. I'm going to roll the two together, so you guys have them both. So Luca obviously, I'm trying to parse through the outlook for the June quarter. And just based on the quick math, it looks like all things being equal, given what you said, the iPhone business is going to be down mid-single-digits again in the June quarter. And if that's the case and maybe this is for Tim obviously, how are you thinking about the competitive landscape in the context of what you just said maybe outside of China and what changes sort of, the consumer demand or receptivity to new devices because we've been in this malaise for a while. Is it really this AI initiative that a lot of companies are pursuing? And do you think that changes sort of the demand drivers going forward? Or is it just really more of a timing issue in terms of the replacement cycle is a little bit long in the tooth, and we see a bit of an upgrade cycle at some point, maybe later this year into next year? Thanks."
},
{
"speaker": "Tim Cook",
"content": "I do see a key opportunity, as I've mentioned before with Generative AI with all of our devices or the vast majority of our devices. And so I think that if you look out that that's not within the next quarter or so and we don't guide at the product level, but I'm extremely optimistic. And so that -- that's kind of how I view it. In terms of the -- I'll let Luca comment on the outlook portion of it. I think if you step back on iPhone though and you make this adjustment from the previous year, our Q2 results would be flattish on iPhone. And so that's how we performed in Q2."
},
{
"speaker": "Luca Maestri",
"content": "Yes, David, on the outlook, I'll only repeat what we said before, and this is the color that we're providing for the quarter. We do expect to grow in total, low-single-digits. And we do expect services to grow double-digits, and we expect iPad to grow double-digits for the rest. I'll let you make assumptions and then we will report three months from now."
},
{
"speaker": "David Vogt",
"content": "Great. Thanks guys. I'll get back in the queue."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thanks, David. Operator, we'll take the next question, please."
},
{
"speaker": "Operator",
"content": "Our next question is from Samik Chatterjee with JPMorgan. Please go ahead."
},
{
"speaker": "Samik Chatterjee",
"content": "Hi, thanks for taking my question, and I have a couple as well. Maybe for the first one, your services growth accelerated from 11% growth to 14%. If you can sort of dig into the drivers of where or which parts of services did you really see that acceleration? And why it isn't a bit more sustainable as we think about the next quarter? Because I believe you're guiding more to sort of averaging out the first half of the year for the next quarter. So just curious what were the drivers and why not have it a bit more sustainably sort of improve as we go through the remainder of the year? And I have a quick follow-up. Thank you."
},
{
"speaker": "Luca Maestri",
"content": "So a number of things on services. First of all, the overall performance was very strong. As I said earlier, all-time records in both developed and emerging markets. So we see our services do well across the world. Records in many of our services categories. There are some categories that are growing very fast also because they are relatively smaller in the scheme of our services business like cloud, video, payment services. You know, those all set all-time revenue records. And so we feel very good about the progress that we're making in services. As we go forward, I'll just point out that if you look at our growth rates a year ago, they improved during the course of the fiscal year last year. So the comps for the services business become a bit more challenging as we go through the year. But in general, as I mentioned, we still expect to grow double-digits in the June quarter at a rate that is very similar to what we've done in the first half."
},
{
"speaker": "Samik Chatterjee",
"content": "Got it. Got it. And for my follow up, if I can ask you more specifically about the India market. Obviously, you continue to make new records in terms of revenue in that market. How much of the momentum you're seeing would you associate with your sort of retail strategy in that market, retail expansion relative to maybe some of the supply change or the sort of manufacturing changes or strategy you've undergone or taken in that market itself. Any thoughts around that would be helpful?"
},
{
"speaker": "Tim Cook",
"content": "Sure. We did grow strong double-digit. And so we were very, very pleased about it. It was a new March quarter revenue record for us. As you know, as I've said before, I see it as an incredibly exciting market and it's a major focus for us. In terms of the operational side or supply chain side, we are producing there, from a pragmatic point of view, you need to produce there to be competitive. And so yes, there the two things are linked from that point of view. But we have both operational things going on and we have go-to-market, and initiatives going on. We just opened a couple of stores as last year, as you know, and we see enormous opportunity there. We're continuing to expand our channels, and also working on the developer ecosystem as well. And we've been very pleased that there is a rapidly-growing base of developers there. And so, we're working all of the entire ecosystem from developer to the market to operations, the whole thing. And I just -- I could not be more excited and enthusiastic about it."
},
{
"speaker": "Samik Chatterjee",
"content": "Got it. Thank you. Thanks for that."
},
{
"speaker": "Tim Cook",
"content": "Yes."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Samik. Operator, we'll have the next question, please."
},
{
"speaker": "Operator",
"content": "Our next question is from. Please go ahead."
},
{
"speaker": "Aaron Rakers",
"content": "Yes, thanks for taking the questions, and I think I have to have two as well like everybody else. I guess, I'm going to go back to the China question. I guess, at a high level, the simple question is, when we look at the data points that have been repeatedly reported throughout the course of this quarter, I'm curious, Tim, you know, what are we missing? Like where do you think people are missing, Apple's iPhone traction within the China market, just at a high level, you know, given the data points that were reported throughout this course of the last quarter?"
},
{
"speaker": "Tim Cook",
"content": "I can't address the data points. I can only address what our results are. And we did accelerate last quarter, and the iPhone grew in Mainland China. So that's what the results were. I can't bridge to numbers we didn't come up with."
},
{
"speaker": "Aaron Rakers",
"content": "Okay. And then as a quick follow-up, I know you guys haven't talked about this, you know, quantified it in quite some time. But I'm curious how we would characterize the channel inventory dynamics for iPhone?"
},
{
"speaker": "Tim Cook",
"content": "Sure. The -- for the March quarter, we decreased channel inventory during the quarter. We usually decreased channel inventory during the Q2 timeframe. So that's not unusual. And we're very comfortable with the overall channel inventory."
},
{
"speaker": "Aaron Rakers",
"content": "Thank you."
},
{
"speaker": "Tim Cook",
"content": "Yes."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Aaron. Operator, we'll take the next question, please."
},
{
"speaker": "Operator",
"content": "Our next question is from Richard Kramer with Arete Research. Please go ahead."
},
{
"speaker": "Richard Kramer",
"content": "Thanks very much. I'm not going to ask about China, but you regularly call out all the rapid growth in many other emerging markets. So is Apple approaching a point where all of those other emerging markets in aggregate might crossover to become larger than your current $70 billion Greater China segments, and maybe investors could look at that for driving growth for the wider business? And then I have a follow-up for Luca. Thanks."
},
{
"speaker": "Luca Maestri",
"content": "I think, Richard, you're asking a really interesting question. We were looking at something similar recently. Obviously, China is by far the largest emerging market that we have. But when we started looking at places like India, like Saudi, like Mexico, Turkey, of course, Brazil and Mexico and Indonesia, the numbers are getting large, and we're very happy because these are markets where our market share is low, the populations are large and growing. And our products are really making a lot of progress with the -- in those markets. The level of excitement for the brand is very high. Tim was in Southeast Asia recently, and the level of excitement is incredibly high. So it is very good for us. And then -- and certainly, the numbers are getting larger all the time. And so the gap as you compare it to the numbers in China is reducing, and hopefully, that trajectory continues for a long time."
},
{
"speaker": "Richard Kramer",
"content": "Okay. And then as a follow-up, maybe for either of you, I mean, you're coming up on four years from what was incredibly popular iPhone 12 cycle. And, you know, given you're struggling to reduce your net -- your -- reach your net neutral cash position and your margins are sort of near highs, do you see ways to deploy capital more to spur replacement demand in your installed base either with greater device financing, more investment in marketing, more promotions. I mean, do you feel like you needed to produce those sort of margins or is it a more important to spur growth with replacement? Thanks."
},
{
"speaker": "Tim Cook",
"content": "I think innovation spurs the upgrade cycle, and as one thing, of course, there's economic factors as well that play in there. And what kind of offerings there are from our carrier partners and so forth. And so there's a number of variables in there. But we work all of those, and you know, we price our products for the value that we're delivering. And so that's how we look at it."
},
{
"speaker": "Luca Maestri",
"content": "And if I can add to Tim's comments, Richard, one of the things that when you look over the long arc of time that maybe is not fully understood is that we've gone through a long period of very strong dollar. And what that means given that our company sells more than 60% of our revenue is outside the United States. The demand for our products in those markets is stronger than the results that we report just because of the translation of those local currencies into dollars, right? And so that is something to keep in mind as you look at our results, right? And so we are making all the investments that are needed and Tim has talked about innovation. Obviously, we made a lot of progress with financing solutions, with trading programs and so on, and we will continue to make all those investments."
},
{
"speaker": "Richard Kramer",
"content": "Okay. Super. Thanks, guys."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Richard. Operator, can we take our last question, please."
},
{
"speaker": "Operator",
"content": "Our next question is from Atif Malik with Citi. Please go ahead."
},
{
"speaker": "Atif Malik",
"content": "Hi. Thank you for taking my questions, and I have two questions as well. First for Tim, for enterprise, specifically, what are some of the top two or three use cases on Vision Pro you're hearing most excitement? And then I have a follow-up for Luca."
},
{
"speaker": "Tim Cook",
"content": "Yes, the great thing is, I'm hearing about so many of them. I wouldn't say that one has emerged as the top, right now. The most impressive thing is that similar to the way people use a Mac, you use it for everything. People are using it for many different things in enterprise, and that varies from field service to training to healthcare related things like preparing a doctor for pre-op surgery or advanced imaging. And so the -- it commands control centers. And so it's an enormous number of different verticals. And you know our focus is on -- is growing that ecosystem and getting more apps and more and more enterprises engaged. And the event that we had recently, I can't overstate the enthusiasm in the room. It was extraordinary. And so we're off to a good start, I think, with the enterprise."
},
{
"speaker": "Atif Malik",
"content": "Great. And then Luca, I believe you mentioned that for the March quarter, the commodity pricing environment was favorable. Can you talk about what you're assuming for commodity pricing on memory and et cetera for the June quarter and maybe for the full-year?"
},
{
"speaker": "Luca Maestri",
"content": "Yes, we provide guidance just for the current quarter. So I'll tell you about the, you know, the guidance. We're guiding to again to a very high level of gross margins, 45.5% to 46.5%. Within that guidance, we expect memory to be a slight headwind, not a very large one, but a slight headwind. And the same applies for foreign exchange. Foreign exchange will have a negative impact sequentially of about 30 basis points."
},
{
"speaker": "Atif Malik",
"content": "Thank you."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Atif. A replay of today's call will be available for two weeks on Apple podcasts as a webcast on apple.com/investor and via telephone. The number for the telephone replay is 866-583-1035. Please enter confirmation code 0467138 followed by the pound sign. These replays will be available by approximately 5:00 P.M. Pacific Time today. Members of the press with additional questions can contact Josh Rosenstock at 408-862-1142, and financial analysts can contact me, Suhasini Chandramouli, with additional questions at 408-974-3123. Thank you again for joining us."
}
] |
aapl | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Apple Q1 Fiscal Year 2024 Earnings Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions. I would like to turn the call over to Suhasini Chandramouli, Director of Investor Relations. Please go ahead."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you for joining us. Speaking first today is Apple's CEO, Tim Cook; and he'll be followed by CFO, Luca Maestri. After that, we'll open the call to questions from analysts. Before turning the call over to Tim, I would like to remind everyone that the quarter we're reporting today included 13 weeks, whereas the quarter we reported a year ago included 14 weeks. Please note that some of the information you'll hear during our discussion today will consist of forward-looking statements, including, without limitation, those regarding revenue, gross margin, operating expenses, other income and expense, taxes, capital allocation and future business outlook, including the potential impact of macroeconomic conditions on the company's business and results of operations. These statements involve risks and uncertainties that may cause actual results or trends to differ materially from our forecast. For more information, please refer to the risk factors discussed in Apple's most recently filed annual report on Form 10-K and the form 8-K filed with the SEC today along with the associated press release. Apple assumes no obligation to update any forward-looking statements, which speak only as of the date they are made. I'd now like to turn the call over to Tim for introductory remarks."
},
{
"speaker": "Tim Cook",
"content": "Thank you. Suhasini. Good afternoon, everyone, and thanks for joining the call. Today, Apple is reporting revenue of $119.6 billion for the December quarter, up 2% from a year ago despite having one less week in the quarter. EPS was $2.18, up 16% from a year ago and an all-time record. We achieved revenue records across more than two dozen countries and regions including all-time records in Europe and rest of Asia-Pacific. We also continue to see strong double-digit growth in many emerging markets with all-time records in Malaysia, Mexico, The Philippines, Poland, and Turkey, as well as December quarter records in India, Indonesia, Saudi Arabia, and Chile. In Services, we set an all-time revenue record with paid subscriptions growing double-digits year-over-year. And I'm pleased to announce today that we have set a new record for our installed base, which has now surpassed 2.2 billion active devices. We are announcing these results on the eve of what is sure to be a historic day as we enter the era of spatial computing. Starting tomorrow, Apple Vision Pro, the most advanced personal electronics device ever, will be available in Apple stores for customers in the U.S. with expansion to other countries later this year. Apple Vision Pro is a revolutionary device built on decades of Apple innovation and it's years ahead of anything else. Apple Vision Pro has a groundbreaking new input system and thousands of innovations, and it will unlock incredible experiences for users and developers that are simply not possible on any other device. There is already so much excitement behind this product from reviewers, customers, and developers. They are praising everything from the incredible experience of watching a movie on a 100-foot screen to remarkable new machine learning capabilities like hand tracking and room mapping. We can't wait for people to experience the magic for themselves. Moments like these are what we live for at Apple. They're why we do what we do. They're why we're so unflinchingly dedicated to groundbreaking innovation and why we're so focused on pushing technology to its limits as we work to enrich the lives of our users. As we look ahead, we will continue to invest in these and other technologies that will shape the future. That includes artificial intelligence where we continue to spend a tremendous amount of time and effort, and we're excited to share the details of our ongoing work in that space later this year. Now, let's turn to the results for the December quarter, beginning with iPhone. We are proud to report that revenue came in at $69.7 billion, 6% higher than a year ago. The iPhone 15 lineup has earned glowing reviews and been embraced by customers. The iPhone 15 and iPhone 15 Plus feature a gorgeous new design with color-infused back glass and contoured edges, Dynamic Island, A16 Bionic, and a new 48 megapixel camera system. And the iPhone 15 Pro and iPhone 15 Pro Max set the gold standard for smartphones with a beautiful and lighter titanium design, industry-leading performance with A17 Pro and our most advanced camera system with the equivalent of seven pro lenses and the ability to record spatial video. Features like Emergency SoS and roadside assistance via satellite bring peace of mind to users when they travel, and I'm grateful for every note I've received about their lifesaving impact. Turning to Mac. Revenue came in at $7.8 billion, up 1% year-over-year, driven by the strength of our latest M3-powered MacBook Pro models in spite of having one less week of sales. Just last week, we got to wish Mac a happy 40th birthday. When it was introduced 40 years ago, Mac changed everything, and through the years, it has done so again and again. Recently, we have been on a tremendous pace of innovation. Since the introduction of Apple silicon in 2020, we've been proud to offer our users unmatched performance and power along with a remarkable Neural Engine for artificial intelligence and machine learning. This past fall, we had an amazing launch of the latest generation of Apple silicon for Mac, M3, M3 Pro, and M3 Max. These chips break new ground in power and performance empowering users to do more than they ever could before, whether they're making a musical masterpiece using the latest features in Logic Pro, or beating their high score in a graphics intensive game. A favorite amongst students, business owners, artists, and video editors, our MacBook Pro lineup is the world's best pro notebook family. And iMac, the world's most capable and best-selling all-in one, is now faster than ever, thanks to M3. In iPad, revenue for the December quarter was $7 billion, down 25% year-over-year due to a difficult compare with the launch of the M2 iPad Pro and the 10th generation iPad during the December quarter last year and one less week of sales. iPad remains the most versatile, capable, and elegant tablet on the market today. It continues to be the go-to-device for students, creators, and more with customers loving iPad's incredible combination of portability and performance. Powerful apps like Final Cut Pro and Logic Pro for iPad allow video and music creators to unleash their creativity in new ways that are only possible on iPad. iPad continues to push the boundaries of what's possible on a tablet. In Wearables, Home and Accessories, revenue came in at $12 billion, down 11% from a year ago due to a difficult compare with the launch timing of several products in this category and the impact of the 14th week last year. Across our latest Apple Watch lineup, we're enabling and encouraging our users to live a healthier day, while making Apple Watch even more intuitive to use. The new double tap gesture on Apple Watch Series 9 and Apple Watch Ultra 2 make it easier to answer calls, play and pause music or take a photo with iPhone. I've been deeply moved by the many touching stories about how features like a regular rhythm notification and fall detection helped Apple Watch users when they needed it most. And for the first time ever, users can choose a carbon-neutral option of any new Apple Watch. Meanwhile, our AirPods lineup continue to be a holiday favorite. In Services, we set an all-time revenue record of $23.1 billion and an 11% year-over-year increase. Because we had one less week this quarter, this growth represents an acceleration from the September quarter, and we achieved all-time revenue records across advertising, cloud services, payment services and video, as well as December quarter records in App Store and AppleCare. Across our services, we're constantly growing our offerings to give users even more to love. With the redesigned Apple TV app, we've made it easier for subscribers to enjoy all their favorite shows, movies and sports, including Apple TV+ hits like Masters of the Air, Monarch, and Slow Horses. We're proud to be a part of Martin Scorsese's Killers of the Flower Moon, a film that has moved audiences and earned more than 200 accolades including Best Film of the Year from the New York Film Critics Circle, nine BAFTA nominations, a Golden Globe win, and 10 Oscar nominations, including Best Picture. Across all Apple TV+ productions, we've now earned 2050 award nominations and 450 wins since we've introduced the service. We're also excited to have a new season of Major League Soccer kicking off this month. We're looking forward to seeing Lionel Messi return to the field and to following all of our favorite teams in what is sure to be an incredible season. And we're counting down to the Apple Music Super Bowl halftime show, featuring Usher. Turning to Retail. In recent months, we opened three stores, including our 100th store in Asia-Pacific. Throughout the holidays, our team members pulled out all the stops to help customers find the perfect gift. And I know our U.S. team members are especially excited to begin demoing Apple Vision Pro for our customers tomorrow. At Apple, we live and breathe innovation. We are driven to pioneer new technology that can enrich our customers' lives, and we're just as intentional about showing up with our values and being a force for good in the world. February is Black History Month, and to honor it, we've launched our new Black Unity Collection, which includes the Black Unity Sport Loop band. This year's designs reflect a lasting commitment to working toward a more equitable world. We also continue to do a central work through our Racial Equity and Justice Initiative, and we're proud to continue providing grants to organizations that are making a real impact in the world. In recent months, we've also taken significant strides in our environmental work. We're partnering with suppliers to bring more clean energy online for Apple production. We're using more recycled materials than ever before and more energy-efficient transportation than ever before. And each day, we are taking more and more steps toward becoming 100% carbon-neutral across all of our products by 2030. Apple is a company that has never shied away from big challenges. That's because we are grounded by a deep sense of purpose and guided by core belief in the transformative power of innovation. And so, we are optimistic about the future, confident in the long-term, and as excited as we've ever been to deliver for our users like only Apple can. With that, I'll turn it over to Luca."
},
{
"speaker": "Luca Maestri",
"content": "Thank you, Tim, and good afternoon, everyone. Revenue for the December quarter was $119.6 billion, up 2% from last year. During the December quarter a year ago, two unique factors affected our results. First, we had an additional week in the quarter. And second, we had COVID-related factory shutdowns that limited iPhone supply. We estimate that the net impact of these two factors resulted in a 2 percentage point headwind to our revenue performance this quarter. We set all-time revenue records in Europe and rest of Asia-Pacific, and continue to see strong performance across our emerging markets with double-digit growth in the majority of the emerging markets we track. Products revenue was $96.5 billion, flat compared to last year, driven by strength in iPhone, offset by challenging compares for iPad and Wearables, Home and Accessories and one less week of sales this year across the entire portfolio. Thanks to our unparalleled customer loyalty and very strong levels of customer satisfaction, our total installed base of active devices set a new record across all products and all geographic segments, and is now over 2.2 billion active devices. Services revenue set an all-time record of $23.1 billion, up 11% year-over-year. When we take into account the extra week last year, this represents a sequential acceleration of growth from the September quarter. We are very pleased with our Services performance in both developed and emerging markets with all-time revenue records in the Americas, Europe, and rest of Asia-Pacific. Company gross margin was 45.9%, up 70 basis points sequentially, driven by leverage and favorable mix, partially offset by foreign exchange. Products gross margin was 39.4%, up 280 basis points sequentially, also driven by leverage and mix, partially offset by foreign exchange. Services gross margin was 72.8%, up 190 basis points from last quarter, due to a more favorable mix. Operating expenses of $14.5 billion were at the midpoint of the guidance range we provided and up 1% year-over-year. Net income was $33.9 billion, up $3.9 billion from last year. Diluted EPS was $2.18, up 16% versus last year and an all-time record. And operating cash flow was very strong at $39.9 billion. Let me now provide more detail for each of our revenue categories. iPhone revenue was $69.7 billion, up 6% year-over-year. We set all-time records in several countries and regions, including Latin America, Western Europe, the Middle East, and Korea, as well as December quarter records in India and Indonesia. Our iPhone active installed base grew to a new all-time high, and we had an all-time record number of iPhone upgraders during the quarter. Customers are loving their new iPhone 15 family, with the latest reports from 451 Research indicating customer satisfaction of 99% in the U.S. In fact, many iPhone models were among the top-selling smartphones around the world during the quarter. According to a survey from Kantar, iPhones were four out of the top five models in the U.S. and Japan, four out of the top six models in urban China and the UK, and all top five models in Australia. Mac generated revenue of $7.8 billion and return to growth, despite one less week of sales this year. This represents a significant acceleration from the September quarter when we faced a challenging compare due to the supply disruptions and subsequent demand recapture we experienced a year ago. Customer response to our latest iMac and MacBook Pro models powered by the M3 chips has been great. And our Mac installed base reached an all-time high with almost half of Mac buyers during the quarter being new to the product. Also, 451 Research recently reported customer satisfaction of 97% for Mac in the U.S. iPad was $7 billion in revenue, down 25% year-over-year. iPad faced a difficult compare because during the December quarter last year, we launched the new iPad Pro and iPad 10 generation, and we had an extra week of sales. However, the iPad installed base continues to grow and is an all-time high with over half of the customers who purchased iPads during the quarter being new to the product, and customer satisfaction for iPad was recently measured at 98% in the U.S. Wearables, Home and Accessories revenue was $12 billion, down 11% year-over-year due to a challenging launch compare and the extra week a year ago. This time last year, we had the full quarter benefit from the launches of the AirPods Pro 2nd generation, the Watch SE, and the first Watch Ultra. We continue to attract new customers to Apple Watch. Nearly two-thirds of customers purchasing an Apple Watch during the quarter were new to the product, and the latest reports from 451 Research indicate customer satisfaction of 96% in the U.S. And in Services, we were very pleased with our double-digit growth, which was driven by the strength of our ecosystem. Our installed base is now over 2.2 billion active devices and continues to grow nicely, establishing a solid foundation for the future expansion of our Services business. And we continue to see increased customer engagement with our services. Both transacting accounts and paid accounts reached a new all-time high, with paid accounts growing double-digits year-over-year. Also, our paid subscriptions showed strong double-digit growth. We have well over 1 billion paid subscriptions across the services on our platform, more than double the number that we had only four years ago. Finally, we continue to build on the breadth and the quality of our current services. From Oscar-nominated theatrical releases with Apple TV+ to more publications or News+ like The Atlantic and exciting new games on Arcade. Turning to Enterprise, we continue to see many business customers leverage Apple products to improve productivity and drive innovation. Target recently added the latest M3 MacBook Pro to their existing deployment of thousands of Mac’s, enabling employees across various departments to do their best work. In emerging markets, Zoho, a leading technology company headquartered in India, offers its 15,000 plus global employees a choice of devices, with 80% of their workforce using iPhone for work and nearly two-thirds of them choosing Mac as their primary computer. With the upcoming launch of Apple Vision Pro, we are seeing strong excitement in Enterprise. Leading organizations across many industries such as Walmart, Nike, Vanguard, Stryker, Bloomberg, and SAP have started leveraging and investing in Apple Vision Pro as their new platform to bring innovative spatial computing experiences to their customers and employees. From everyday productivity to collaborative product design to immersive training, we cannot wait to see the amazing things our enterprise customers will create in the months and years to come. Let me now turn to our cash position and capital return program. We ended the quarter with $173 billion in cash and marketable securities. We decreased commercial paper by $4 billion, leaving us with total debt of $108 billion. As a result, net cash was $65 billion at the end of the quarter, and our goal of becoming net cash-neutral over time remains unchanged. During the quarter, we returned nearly $27 billion to shareholders, including $3.8 billion in dividends and equivalents and $20.5 billion through open market repurchases of 112 million Apple shares. We also retired an additional 6 million shares in the final settlement of our 19th ASR. As usual, we will provide an update to our capital return program when we report results at the end of this quarter. As we move ahead into the March quarter, I'd like to review our outlook, which includes the types of forward-looking information that Suhasini referred to at the beginning of the call. The color we are providing today assumes that the macroeconomic outlook doesn't worsen from what we are projecting today for the current quarter. And we expect foreign exchange to be a revenue headwind of about 2 percentage points on a year-over-year basis. As a reminder, in the December quarter a year ago, we faced significant supply constraints on the iPhone 14 Pro and 14 Pro Max due to COVID-19 factory shutdowns. And in the March quarter a year ago, we were able to replenish channel inventory and fulfill significant pent-up demand from the constraints. We estimate that this impact added close to $5 billion to the March quarter's total revenue last year. When we remove this impact from last year's revenue, we expect both our March quarter total company revenue and iPhone revenue to be similar to a year ago. For our Services business, we expect a similar double-digit growth rate to what we reported in the December quarter. We expect gross margin to be between 46% and 47%. We expect OpEx to be between $14.3 billion and $14.5 billion. We expect OI&E to be around $50 million, excluding any potential impact from the mark-to-market of minority investments and our tax rate to be around 16%. Finally, today our Board of Directors has declared a cash dividend of $0.24 per share of common stock payable on February 15, 2024, to shareholders of record as of February 12, 2024. With that, let's open the call to questions."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Luca. We ask that you limit yourself to two questions. Operator, may we have the first question please?"
},
{
"speaker": "Operator",
"content": "Certainly. We'll go ahead and take our first question from Erik Woodring with Morgan Stanley. Please go ahead."
},
{
"speaker": "Erik Woodring",
"content": "Hey guys, good evening. Thank you for taking my questions. I have two. And congrats on the nice quarter here. Luca, maybe if we start with you. Can you unpackage some of the Services drivers a bit for us. Obviously, really nice outperformance in the December quarter versus your expectations. A record gross margin implies your higher margin businesses were likely the sources of outperformance. But can you maybe just clarify a bit how we should think about Services growth for the March quarter? And then, speak to some of those underlying drivers in the December quarter and then in the March quarter, what the different puts and takes would be? And then, I have a follow-up please. Thank you."
},
{
"speaker": "Luca Maestri",
"content": "Thanks, Erik, for the question. Let's start with the December quarter. As we said, up 11%, $23.1 billion is an all-time record for us, with all-time records in The Americas, in Europe, and the rest of Asia Pac. So it was pretty broad-based geographically, and very strong across all the Services categories, because we had all-time revenue records for cloud, for payments, for video, and for advertising and December quarter records for the App Store and for AppleCare. Obviously, last year, we had an extra week, so the 11% is stronger than -- the underlying performance is stronger than the 11% that we have reported. I think the entire ecosystem is doing well because we continue to see growth and new all-time highs in both transacting accounts and paid accounts, which is obviously very important. And paid subscriptions continue to grow strong double-digits. Just as a reference, we have more than a billion paid subscriptions across all the services on our platform. This is more than double the number of paid subscriptions that we had only four years ago. So, obviously, very significant growth there. What I said during the prepared remarks around the March quarter, I mentioned that we will continue to grow double-digits at a percentage that is similar to what we reported for the December quarter. We don't provide guidance around the different services categories. So, we will provide more color when we report in three months."
},
{
"speaker": "Erik Woodring",
"content": "Okay. Thank you, Luca. And then, Tim, really nice to see your installed base reach a record high, again, against all products and geos. I'm wondering if you could share a bit more detail about the new users you were able to on-board over the last 12 months. Meaning, how might this new cohort look different from past cohorts, either in terms of geographic representation or SKU to certain products or even how their monetization trends might differ from past cohorts. And that's it from me. Thanks so much."
},
{
"speaker": "Tim Cook",
"content": "Yes. Hi, Erik. I would say emerging markets are -- have been a very key area of strength for us. If you look at it, India grew -- in revenue terms grew strong double-digits in the December quarter and hit a quarter revenue record. The other emerging markets like Indonesia also hit a quarterly record. And we had several regions, with records from Latin America to the Middle East. And that theme has been pretty consistent across the other quarters that -- of the year as well. And so, emerging markets, very, very important. And I feel like we are doing a great job there."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thanks, Erik. Operator, can we have the next question please?"
},
{
"speaker": "Operator",
"content": "Our next question is from Mike Ng with Goldman Sachs. Please go ahead."
},
{
"speaker": "Mike Ng",
"content": "Hey, good afternoon. I just have two questions as well. First, on Services. Just on the outlook for the March quarter for a similar double-digit growth rate as of December quarter. I'm just wondering why not -- why won't it be potentially faster, given that the December quarter obviously had a headwind from the extra week comp, and I'd also think that some of the pricing uplifts on select Apple One services that were implemented last winter should help in the March quarter? Any additional thoughts there would be great in terms of what some of your assumptions are. And then, I have a quick follow-up."
},
{
"speaker": "Luca Maestri",
"content": "Yes. We'll see how the quarter develops. I would point to two things. One is the fact that we mentioned that we expect a couple of points of negative foreign exchange in the March quarter, and foreign exchange was essentially flat for us in the December quarter. So, you've got a bit of a headwind there. And then, when you look at our other progression of our Services business over the last few quarters, the compares for March are slightly more difficult than the compares for December."
},
{
"speaker": "Mike Ng",
"content": "Great. Thank you, Luca. And then, my second question. It was very interesting to hear about some of the enterprise customer investments into Vision Pro. Could you maybe just talk about some of the efforts to support Vision Pro developer ecosystem. And it was also good to hear about the potential upcoming announcements on AI. So any thoughts there would also be helpful. Thank you."
},
{
"speaker": "Tim Cook",
"content": "Yeah. Hi. It's -- we are incredibly excited about the Enterprise opportunities with Vision Pro. I've seen several demos from different companies. Luca mentioned several in his opening remarks, but Walmart has a very cool merchandising app. There are firms that are doing collaboration -- design collaboration apps. There are field service applications. Really all over the map, there are applications that are for control center, command center kind of things. SAP has really gotten behind it and, of course, SAP is in so many of companies. I think there will be a great opportunity for us in Enterprise, and we couldn't be more excited about where things are right now. We are obviously looking forward to tomorrow. This has been multiple years of efforts from so many people across Apple. And really, it took a whole of company effort to bring it to this far. In terms of generative AI, which, I'd guess, is your focus, we have a lot of work going on internally as I've alluded to before. Our MO, if you will, has always been to do work and then talk about work and not to get out in front of ourselves. And so, we're going to hold that to this as well. But we've got some things that we are incredibly excited about that we'll be talking about later this year."
},
{
"speaker": "Mike Ng",
"content": "Wonderful. Thank you, Tim."
},
{
"speaker": "Tim Cook",
"content": "Yes."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Mike. Operator, can we have the next question please?"
},
{
"speaker": "Operator",
"content": "Our next question is from Wamsi Mohan with Bank of America. Please go ahead."
},
{
"speaker": "Wamsi Mohan",
"content": "Yes, thank you so much. I have two questions as well. First on iPhone. There have been concerns around replacement cycles lengthening, China competition intensifying, and you still beat iPhone revenues despite the weaker performance in China. Curious how you're thinking about the 15 cycle overall, given what you saw in the December quarter. And I've a follow-up."
},
{
"speaker": "Tim Cook",
"content": "Hi, it's Tim. The -- we were up 6%, as we mentioned in the opening remarks. We are happy with that performance. Underneath there, we had really strong performance in several parts of the world with all-time records in Europe and rest of Asia-Pacific. As I mentioned earlier, we did particularly well in several emerging markets from Latin America to the Middle East. And we set December quarter records in India and Indonesia. And so, really some spectacular broad-based reactions to iPhone. We also importantly set an all-time record worldwide for iPhone upgraders. And the installed base hit a new all-time high consistent with the -- our overall devices. And so, there's lot of good things. Luca mentioned in his opening comments that iPhones were four out of the top five smartphone models in the U.S. and Japan and four out of the top six in urban China and the UK, and all top five in Australia, and the customer satisfaction level for iPhone 15 hit 99%. If you look at iPhone 15 since the announcement of it and shipment in September, so this is including some of Q4 and you compare that to iPhone 14 over the same period of time, iPhone 15 is outselling iPhone 14. And so, we feel very good about that, and the upgraders hitting a record is particularly exciting for us."
},
{
"speaker": "Wamsi Mohan",
"content": "Great. Thank you, Tim. And as a follow-up, obviously, you're just launching the Vision Pro and it's an entirely new category. It's a price point that's a much higher starting price point relative to most of your other, probably over the last decade, product introductions, but just wondering how would you measure the success of Vision Pro over time and which Apple products adoption curve would you look at as potentially the most similar? And is there a way in which we could think Vision Pro could eclipse maybe something like the iPad in revenue over time. Thank you."
},
{
"speaker": "Tim Cook",
"content": "You know, each product has its own journey. And so, I wouldn't want to compare it to any one in particular. I would just say we couldn't be more excited. Internally, we've got an incredible amount of excitement from developers and from customers that can't wait till tomorrow to pick up their units. And we are incredibly proud to be able to demo the unit in so many of our stores in the U.S. starting tomorrow for people that are -- that want to check it out. And so, we'll see and report the results of it in the Wearables category that you're familiar with. I think that if you look at it from a price point of view, there's an incredible amount of technology that's packed into the product. There's 5,000 patents in the product and it's, of course, built on many innovations that Apple has spent multiple years on, from silicon to displays and significant AI and machine learning. All the hand tracking, the room mapping, all of this stuff is driven by AI. And so, we're incredibly excited about it. I can't wait to be in the store for tomorrow and see the reaction myself."
},
{
"speaker": "Wamsi Mohan",
"content": "Thank you so much, Tim."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thanks, Wamsi. Operator, we'll take the next question please."
},
{
"speaker": "Operator",
"content": "Our next question is from Amit Daryanani with Evercore. Please go ahead."
},
{
"speaker": "Amit Daryanani",
"content": "Good afternoon. I have two as well. I guess, first off, I was hoping you could talk a little bit about what you're seeing in China right now. I think from a geographic basis, one of the few places that was down double-digits, while everything else was growing. So, I'm hoping you spend a bit of time discussing what are you seeing there from a competitive perspective and more importantly, from a demand perspective in China?"
},
{
"speaker": "Tim Cook",
"content": "Yeah. If you look at iPhone in China Mainland, which I think has been the focus of a lot of interest, and you look at it in constant currency, so more of an operational view, we were down mid-single digits on iPhone. And so, it was the other things that drove the larger contraction year-over-year. On the good news side, we had solid growth on upgraders year-over-year in Mainland China and we had four of the top six smartphone models in urban China. Also, IDC just put out a note, that you may have seen, that we were the top brand in -- for the full year and for the December quarter. And so, there's some good news along with – obviously, we'd prefer not to [contract] (ph)."
},
{
"speaker": "Amit Daryanani",
"content": "Fair enough. And then, as a follow-up, you folks have implemented a fair bit of changes around the App Store in Europe post the DMA implementation there. Can you just touch on what are some of the key updates? And then, Luca, as a net of it all, do you see it having any significant impact financially to your services or a broader Apple P&L statement? Thank you."
},
{
"speaker": "Tim Cook",
"content": "Yes. You know, the -- let me try to answer a little bit of both and then Luca can add some comments to it. We announced a number of changes last week in Europe that would be in effect beginning in March. So, the last month of the first calendar quarter, the second fiscal quarter. Those are -- some of the things that we announced include alternate billing opportunities, alternate app stores, our marketplaces, if you will. We're also opening NFC for new capabilities for banking and wallet apps. And so, these are some of the things we announced. The -- if you think about what we've done over the years is, we've really majored on privacy, security, and usability. And we've tried our best to get as close to the past in terms of the things that are -- that people love about our ecosystem as we can, but we are going to fall short of providing the maximum amount that we could supply, because we need to comply with the regulation. And so, in terms of predicting the choices that developers and users will make, it's very difficult to do that with precision. And so, I will see what happens in March."
},
{
"speaker": "Luca Maestri",
"content": "Yes, Amit. As Tim said, these are changes that we're going to be implementing in March. A lot will depend on the choices that will be made. Just to keep it in context, the changes applied to the EU market, which represents roughly 7% of our global app store revenue."
},
{
"speaker": "Amit Daryanani",
"content": "Perfect. That's a really good perspective to have. Thank you very much."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Amit. Operator, can we have the next question please?"
},
{
"speaker": "Operator",
"content": "Our next question is from Aaron Rakers with Wells Fargo. Please go ahead."
},
{
"speaker": "Aaron Rakers",
"content": "Yes. Thanks for taking the question. I have two as well as you would imagine. I guess, the first question I wanted to just ask maybe unpack a little bit more, just remarkable trends that we're seeing in your product gross margin specifically. So, I'm curious as we look forward, I guess on this last quarter, where there any kind of benefits you're seeing from like just the purchase component, obligations that you've put in place, let's say, a year ago, and that flowing through. And how are you thinking about the component pricing environment as we think about that gross margin into the March quarter and looking-forward?"
},
{
"speaker": "Luca Maestri",
"content": "Yes. On the product side and then maybe I'll make a comment in total for the company. On the product side, our gross margins increased sequentially 280 basis points. So, obviously, a very significant increase. I would say the two primary components of the increase are a favorable mix. Of course, iPhone did very well. We did very well with our high-end models. And leverage, of course, it's the biggest quarter of the year for us and so we get the leverage effect. We had a partial offset, negative impact from foreign exchange. But net-net, obviously, very significant improvement. And we had very similar dynamics on the Services side where we increased sequentially 190 basis points, also, in this case, due to a more favorable mix. And so, the combined effect of the two businesses gave us the 45.9% at the total company level, which is up 70% sequentially. You've heard from my prepared remarks that we are guiding total company gross margin to 46% to 47%, which is an additional expansion of margins compared to the already very strong results of the December quarter."
},
{
"speaker": "Aaron Rakers",
"content": "Okay. And then, the second question I was just going to ask. Tim, you alluded to kind of your excitement around generative AI and some announcements that we should think about maybe later this year. One of the things that stands out for me is that, your capital expenditures has actually come down this last year. I'm curious as you look to lean in more to generative AI, is there something we should consider about the CapEx intensity at Apple to make investments to really set the table for generative AI, kind of platform as we move forward? Just given some of the things that we've seen from some other large tech companies."
},
{
"speaker": "Luca Maestri",
"content": "I'll take the question, Aaron. We've always said, we will never underinvest in the business. So, we are making all the investments that are necessary throughout our product development, software development, services development. And so, we will continue to invest in every area of the business and at the appropriate level. And we're very excited about what's in store for us for the rest of the year."
},
{
"speaker": "Aaron Rakers",
"content": "Thank you."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thanks, Aaron. Operator, can we have the next question please?"
},
{
"speaker": "Operator",
"content": "Our next question is from Krish Sankar with TD Cowen. Please go ahead."
},
{
"speaker": "Krish Sankar",
"content": "Yes. Hi. Thanks for taking my question. I have two of them. First one for Luca, a clarification on a question. The $5 billion impact in March quarter, is that for product revenue or is that total company revenue. And along the same part, you highlighted the strong gross margins. And I understand last year, some of the commodity costs were deflationary, buy looks like it’s going to be inflationary right now. And also you've done some of the Mac conversions that -- the silicon conversions. So I'm just trying to figure out how much juice is there more to squeeze on the gross margin side? And then I'll follow up for Tim."
},
{
"speaker": "Luca Maestri",
"content": "Yes. The -- so the first part of the question was around -- oh, the $5 billion. The $5 billion, as I mentioned, a year ago we had this disruption of supply on iPhone 14 Pro and Pro Max because of the factory shutdown due to the COVID-19 situation. And so, essentially there was pent up demand as we exited December quarter, they got fulfilled and we also did the channel fill associated with it during the March quarter. So close to $5 billion that I mentioned is entirely related to iPhone. On the gross margin side, obviously, we are at very high levels of gross margin. And I'll repeat what I said before, we've had good expansion over the last few quarters and now we are guiding to 46% to 47% and that takes into account everything that is going on, which is, the commodity environment, which is the foreign exchange situation, and obviously the product and services mix. And the outcome of this is the guidance, which obviously is very strong and we're very happy with it."
},
{
"speaker": "Krish Sankar",
"content": "Thanks a lot, Luca. And then I have a follow-up for Tim. Tim, it was very interesting to hear your comments on enterprise. And historically, Apple has been a consumer centric company. And now with Vision Pro, Mac, it's sort of penetrating more into the enterprise. I'm kind of curious how to think about Apple of the future? Would it still be consumer centric or do you think it's going to be more enterprise focused also as we get into the future? Thank you very much."
},
{
"speaker": "Tim Cook",
"content": "We've really concluded that we can do both. That if you look at it, what has happened over the last several years is that, employees are in a position in many companies to choose their own technology that is the best for them. And so, it sort of took some of the central command from the traditional company and decentralized the decision-making. That is a huge advantage for Apple, because there's a lot of people out there that want to use a Mac. They're using a Mac at home. They'd like to use one in the office as well. iPad has also benefited from that. Vision Pro, it's -- when you look at the ton of use cases, I mean, we're starting with a million apps and 600 plus that are -- have been designed particularly for Vision Pro. When I look at what is coming out of Enterprise, it's some of the most innovative things I've seen come out of Enterprise in a long time. And so, I think there's a like there is for the Mac and iPad, and of course, iPhone has been in enterprise since the early days of iPhone. I think there's a nice opportunity there for Vision Pro as well."
},
{
"speaker": "Krish Sankar",
"content": "Great. Thanks a lot Tim. Very interesting to hear. Thank you."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, Krish. Operator, can we have the next question, please?"
},
{
"speaker": "Operator",
"content": "Our next question is from David Vogt with UBS. Please go ahead."
},
{
"speaker": "David Vogt",
"content": "Great. Thanks guys. And I have two questions as well. So, Tim and Luke, I appreciate the strength in the emerging markets like India and the other names that you kind of listed on the call, but can you maybe spend some time on the Americas? Obviously, that was relatively flat, you touched on China, but what are you seeing in that market from the carriers here in the States? And is the sales cycle elongating or the replacement cycle elongating? And in your view what has to change to kind of maybe re-accelerate that business in the America's, particular in the iPhone business? And then on sort of -- I just want to make sure I understand sort of the guide. So when I think about the $5 billion pull forward last year in the March quarter from a channel fill perspective, even if I back it out last quarter or I back it up this quarter, the March quarter, this would be sort of the softest quarter since the COVID pandemic. Obviously, I know the Americas as I just touched on is a little bit softer than China, which you cleared up earlier. But how do you think about the differences in sort of the macro conditions by region? And again, do you have a sense for are we nearing a trough from a macro demand perspective or how long do you think this particular weakness persists? Thanks."
},
{
"speaker": "Tim Cook",
"content": "Let me take the first part of your question about America. If you look at the U.S., which obviously drives the vast, vast majority of the revenue in America, we grew in the December quarter from an iPhone business point of view and the install base hit an all-time high. If you look at the replacement cycle, it's very difficult to measure the replacement cycle at any given point. And so, what we focus on internally a lot is the active install base and the -- obviously, the sales over usually a cycle and we feel better about those things. If you look at the -- who's selling what in the U.S., the iPhone is four out of the top five selling smartphones in the US. And of course, the customer satisfaction in the U.S. as we alluded to earlier is 99%. So we feel very, very good about what our position is in the U.S."
},
{
"speaker": "Luca Maestri",
"content": "And I would add to that, keep in mind, obviously, the extra week that we had a year ago that obviously makes the compare more -- a bit distorted. On the March quarter guide, I would point to you that, obviously, the COVID years had a lot of, let's say, turmoil in it, a lot of volatility that typically you wouldn't see. If you look at our sequential progression from December to March this year versus pre-COVID versus like a more normal environment, it's actually stronger than those years."
},
{
"speaker": "David Vogt",
"content": "Got it. Thanks, guys."
},
{
"speaker": "Suhasini Chandramouli",
"content": "Thank you, David. Operator, can we have the last question, please?"
},
{
"speaker": "Operator",
"content": "Thank you. Our last question is from Ben Reitzes with Melius Research. Please go ahead."
},
{
"speaker": "Ben Reitzes",
"content": "Yes. Hi. Thanks. Appreciate it. Two questions, if I can sneak them in. Just wanted to clarify on China. Tim, I think last quarter you still thought it was a growth market. Obviously, there's some concerns with the -- recently and given what we saw in the quarter, is there something that we can kind of point to where you feel that that market can resume growth in the future? And I'm wondering if you're still upbeat about that prospect. And then I just have a quick follow up."
},
{
"speaker": "Tim Cook",
"content": "Ben, we've been in China for 30 years. And I remain very optimistic about China over the long term. And I feel good about hitting a new install base number, high watermark and very good about the growth in upgraders year-over-year during the quarter."
},
{
"speaker": "Ben Reitzes",
"content": "Great. Thanks Tim. And just in terms of AI, I know you're not going to talk about your plans, but do you believe -- are you a believer in the edge thesis that AI and processing on smartphones and devices like yours is going to have a huge role in AI and AI apps and that it's something you guys can take advantage of."
},
{
"speaker": "Tim Cook",
"content": "Let me just say that, I think there's a huge opportunity for Apple with GenAI and AI. And without getting into to more details and getting out in front of myself."
},
{
"speaker": "Ben Reitzes",
"content": "Thanks Tim."
},
{
"speaker": "Tim Cook",
"content": "Yes, Thanks, Ben."
},
{
"speaker": "Suhasini Chandramouli",
"content": "All right. Thank you Ben. A replay of today's call will be available for two weeks on Apple Podcasts, as a webcast on apple.com/investor and via telephone. The number for the telephone replay is 866-583-1035. Please enter confirmation code 0106234 followed by the pound sign. These replays will be available by approximately 5 p.m. Pacific time today. Members of the press with additional questions can contact Josh Rosenstock at 408-862-1142 and financial analysts can contact me, Suhasini Chandramouli, with additional questions at 408-974-3123. Thanks again for joining us."
},
{
"speaker": "Operator",
"content": "Once again, this does conclude today's conference. We do appreciate your participation."
}
] |
abbv | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good morning and thank you for standing by. Welcome to the AbbVie Fourth Quarter 2024 Earnings Conference Call. All participants will be in a listen-only until the question-and-answer portion of this call. [Operator Instructions] Today's call is also being recorded. If you have any objections, you may disconnect at this time. I would now like to introduce Ms. Liz Shea, Senior Vice President of Investor Relations. Ma'am, you may begin."
},
{
"speaker": "Liz Shea",
"content": "Thank you. Good morning, and thanks for joining us. Also on the call with me today are Rob Michael, Chief Executive Officer; Jeff Stewart, Executive Vice President, Chief Commercial Officer; Roopal Thakkar, Executive Vice President, Research & Development, Chief Scientific Officer; Scott Reents, Executive Vice President, Chief Financial Officer; and Carrie Strom, Senior Vice President, AbbVie, and President, Global Allergan Aesthetics. Before we get started, I'll note that some statements we make today may be considered forward-looking statements based on our current expectations. AbbVie cautions that these forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those indicated in our forward-looking statements. Additional information about these risks and uncertainties is included in our SEC filings. AbbVie undertakes no obligation to update these forward-looking statements, except as required by law. On today's conference call, non-GAAP financial measures will be used to help investors understand AbbVie's business performance. These non-GAAP financial measures are reconciled with comparable GAAP financial measures in our earnings release and regulatory filings from today, which can be found on our website. Following our prepared remarks, we'll take your questions. So, with that, I'll turn the call over to Rob."
},
{
"speaker": "Rob Michael",
"content": "Thank you, Liz. Good morning, everyone, and thank you for joining us. Our fourth quarter performance closes out another excellent year for AbbVie, and I'm very pleased with the significant progress we made in 2024. We executed on our top commercial priorities, advanced our pipeline with key regulatory approvals and promising data, and further strengthened our business through strategic transactions. Turning to our results, we delivered full-year adjusted earnings per share of $10.12, which is $0.49 above our initial guidance midpoint. Excluding the impact of IPR&D expense, total net revenues were $56.3 billion, exceeding our initial guidance by more than $2 billion. Our results demonstrate a rapid return to sales growth, with full-year revenue up 4.6% on an operational basis, despite $5 billion of U.S. Humira erosion in 2024. This outstanding execution is driven by our ex-Humira platform, which continues to outperform expectations, delivering full-year sales growth of more than 18% with revenue growth accelerating to 22% in the fourth quarter. As I look to 2025 and beyond, we are well-positioned with our ex-Humira platform. It will allow AbbVie to deliver robust mid-single-digit revenue growth in 2025 and exceed our previous peak revenue in just the second year following the U.S. Humira LOE. And given that we have no significant LOE events for the rest of this decade, we have a clear runway to growth for at least the next eight years, including a high single-digit revenue CAGR through 2029. We anticipate a substantial portion of this growth will be driven by robust performance from Skyrizi and Rinvoq to assets are expected to collectively generate nearly $24 billion of revenue in 2025, reflecting growth of more than $6 billion. Based on this strong momentum, we now expect Skyrizi and Rinvoq to exceed more than $31 billion of combined sales in 2027, which is $4 billion above the guidance we provided last year. We are seeing strong performance across all of their approved indications, especially in IBD. And we see several tailwinds that will support growth into the next decade, including healthy immunology market growth, strong share capture given best-in-class profiles, continued robust market access, and momentum from new indications, such as the recent launch of Skyrizi in UC, as well as the potential for five new indications for Rinvoq over the next few years. In neuroscience, our second largest therapeutic area, we are seeing very robust performance, with sales of $10 billion expected in 2025, reflecting growth of $1 billion across psychiatry, migraine, and Parkinson's. In oncology, I am very encouraged by our long-term growth prospects. This includes our BCL-2 inhibitor, Venclexta; our FRα ADC for ovarian cancer, Elahere; our two novel c-MET ADCs for solid tumors, Teliso-V and 400, and our BCMA-CD3 bispecific for multiple myeloma 383. Lastly, while the recent performance in aesthetics has been impacted by challenging market conditions in the U.S. and China, the category remains very attractive given low penetration rates for facial injectables. When the market returns to more normalized growth, our leading commercial portfolio and forthcoming pipeline will help drive improved performance. Based on the market trends over the last few years, and our assumption for a gradual recovery in the near term, we now expect aesthetics to deliver a high single-digit revenue CAGR through 2029. Turning now to R&D, we have made excellent progress with our late-stage programs. These advancements include recent approvals for Skyrizi in UC, Epkinly in later lines of follicular lymphoma, Elahere for FRα-positive platinum-resistant ovarian cancer, Vyalev for advanced Parkinson's, and new indications for Botox and Juvéderm. In 2025, we anticipate approvals for Rinvoq in GCA, and Teliso-V for non-squamous, non-small cell lung cancer, as well as regulatory submissions for Tavapadon in Parkinson's, Venclexta in higher-risk MDS, and BoNT/E for aesthetics. We have also added depth to our pipeline by signing more than 20 early-stage deals since the beginning of 2024, including promising technologies and innovative mechanisms that can elevate the standard of care in immunology, oncology, and neuroscience. We have significant capacity to continue pursuing external innovation with a focus on differentiated opportunities that can drive growth in the next decade. In summary, I am very pleased with AbbVie's execution in 2024. And expect our diverse portfolio to drive strong growth in 2025 and beyond. With that, I'll turn the call over to Jeff for additional comments on our commercial highlights. Jeff?"
},
{
"speaker": "Jeff Stewart",
"content": "Thank you, Rob. I'll start with the quarterly results for immunology, which delivered total revenues of approximately $7.3 billion, exceeding our expectations. Skyrizi total sales were nearly $3.8 billion, reflecting operational growth of 57.9%. Rinvoq total sales were more than $1.8 billion, reflecting operational growth of 47.1%. On a full-year basis, Skyrizi and Rinvoq delivered approximately $17.7 billion in total combined revenue, an impressive increase of nearly $6 billion year-over-year, exceeding our expectations. These results reflect strong performance across all approved indications. I'll share some highlights in the U.S. Skyrizi total prescription share in the biologic psoriasis market is now approximately 40%, reflecting a very significant lead relative to all major competitors, with in-play capture rates remaining very strong. Over the course of 2025, we anticipate new data for Skyrizi on hard-to-treat areas of the body, including scalp and genital psoriasis. In addition, we expect the readout of our fifth head-to-head study in psoriasis comparing Skyrizi to Sotyktu, which will continue to differentiate the brand versus oral competitors. Rinvoq is now capturing more than 20% in-place share in atopic dermatitis, as our communication around our level-up study versus Dupixen continues to ramp. Recall that in level-up, we showed strong comparative results on stringent endpoints of skin resolution and itch reduction. In RA, Rinvoq is achieving the leading in-place share in the second line plus market, consistent with the brand's label. We see that U.S. physicians are increasingly utilizing only one TNF prior to initiating Rinvoq treatment in RA. In psoriatic arthritis, Skyrizi and Rinvoq together are capturing a leading in-place share in the room category, highlighting the effective co-positioning of both agents in this important segment. Across IBD, Skyrizi and Rinvoq are also capturing substantial portfolio share, given their respective efficacy, safety, and dosing profiles. In Crohn's disease, which is roughly two-thirds of the overall IBD market, these two treatments together are capturing approximately half of the in-place share with total prescription volumes ramping very rapidly. In ulcerative colitis, we are seeing a very strong inflection following the Skyrizi launch in the second-half of last year. Both Skyrizi and Rinvoq together are already capturing roughly a third of the UC in-play market, which supports robust momentum going forward for both AbbVie brands. We see similar performance internationally as well, where Skyrizi and Rinvoq are also achieving leadership positions across our major countries. So, I'm very pleased with this momentum and continue to see a significant opportunity for share gains across our existing indications, in addition to the typical market growth we see across room, derm, and gastro in 2025 and beyond. Turning now to Humira, which delivered global sales of more than $1.6 billion, down 48.7% on an operational basis, primarily due to biosimilar competition, we continue to see molecule compression in the U.S. with volume moving to other novel mechanisms, which has resulted in a benefit to both Skyrizi and Rinvoq. We anticipate Humira access will decrease throughout 2025 as more plans move to exclusive biosimilar contracts. It's reasonable to assume that roughly half of U.S. covered lives will continue to have parity access to Humira on a full-year basis, with select exclusionary contracts for existing patients expected to begin around the middle of the year. Moving now to oncology, where total revenues were approximately $1.7 billion. Imbruvica global revenues were $848 million, down 6.2%, reflecting continued competitive dynamics in CLL. Venclexta global sales were $655 million, up 13% on an operational basis, reflecting strong demand for both CLL and AML across our key countries. Lastly, Elahere continues to demonstrate a strong launch trajectory for FR-alpha positive platinum-resistant ovarian cancer, with global sales of $148 million. Sales in the U.S. are annualizing at more than $600 million and commercialization is now underway in key international markets where we are accelerating regulatory and reimbursement timelines. Moving to neuroscience, where total full-year revenues were $9 billion, reflecting impressive absolute sales growth of nearly $1.3 billion. In the quarter, total revenues were $2.5 billion, up 19.9% on an operational basis. This robust performance is driven by continued double-digit growth of Vraylar with global sales of $924 million, Botox Therapeutic with global revenues of $873 million, Ubrelvy with global sales of $303 million, and Qulipta with global revenues of $201 million. Beyond these leading therapies for psychiatry and migraine, we are very excited for an emerging portfolio in Parkinson's disease. We recently launched Vyalev, the only subcutaneous 24-hour continuous infusion of levodopa-based therapy for the treatment of advanced Parkinson's disease. As a less invasive, non-surgical delivery system that can provide meaningful improvements in on-time and off-time, we are seeing very high interest from both physicians and patient communities. Parkinson's experts report significant benefit from the continuous 24-hour delivery and the control of symptoms morning, day, and through the night. While sales in the U.S. are expected to ramp gradually over the next several quarters as we work to establish the appropriate Medicare coverage and benefit determination, uptake internationally is exceeding our expectations. Finally, I'm very encouraged by the data we are seeing for tavapadon for potential use as a monotherapy for early Parkinson's disease, as well as an adjunct to optimize oral therapy for more advanced patients. Tavapadon represents a very complimentary addition to our Parkinson's disease portfolio with Vyalev and Duopa. So, overall, I'm extremely pleased with the commercial execution across our therapeutic portfolio, which is demonstrating very strong momentum as we head into 2025. With that, I'll turn the call over to Carrie for additional comments on aesthetics. Carrie?"
},
{
"speaker": "Carrie Strom",
"content": "Thank you, Jeff. Fourth quarter global aesthetic sales were approximately $1.3 billion, reflecting an operational decrease of 4.4%. In the U.S., aesthetic sales of $839 million declined 5% as challenging market conditions and promotional dynamics impacted key assets. Consistent with recent quarters, the U.S. facial injectable market continues to be affected by suppressed consumer spending that is related to the cumulative impact of high inflation over several years. As a higher price procedure relative to toxins, current conditions are most notably impacting the filler market, which declined by approximately 10% in the quarter. The toxin market remains more resilient, demonstrating low single-digit% growth. Although we continue to be the clear market leader in toxins and fillers, in Q4, our facial injectable share declined by a few points. In October, we launched an updated version of our Alle consumer loyalty program, which was designed to benefit providers by increasing treatment frequency, patient retention, and cross-selling. While some providers embraced the new loyalty program, many felt the new contract was too complex to integrate into their practices, therefore negatively impacting market share and inventory levels. Based on this market reaction, we reinstated our original Alle consumer loyalty program earlier this month. This action has been met with a rapid and favorable response from our providers with encouraging early indicators for sales and market share recovery. Internationally, aesthetic sales were $459 million. This represented an operational decline of 3.2% that was primarily due to lower Juvéderm sales as Botox cosmetic sales were roughly flat on an operational basis. Our international results were impacted by our second largest global market, China, where lower consumer spending related to economic headwinds continues to affect performance. Looking to 2025, we've planned prudently with our outlook for modest aesthetic sales growth. In the U.S., this reflects a gradual improvement in market growth rates and share for both toxins and fillers. Additionally, based on our Alle loyalty program changes, we expect a one-time price adjustment to negatively impact our first quarter U.S. results. Internationally, we are focused on retaining a strong competitive position as we launch multiple new products in China while we closely monitor market conditions and consumer sentiment. In summary, while economic headwinds and key geographies have created a near-term impact on market conditions, we continue to see significant long-term growth potential, given high consumer interest and low penetration rate. Allergan Aesthetics is uniquely positioned to benefit based on our customer relationships, commercial investments, and innovative pipeline. With that, I'll turn the call over to Roopal."
},
{
"speaker": "Roopal Thakkar",
"content": "Thank you, Carrie. We continue to make significant progress with our R&D efforts to advance novel clinical programs across all stages of our diversified pipeline. In 2025, we expect a strong cadence of important data readouts, regulatory submissions, and new approvals, as well as many clinical trial starts for key programs. Starting with immunology, regulatory applications are under review for Rinvoq and GCA, with approval decisions anticipated in the second quarter. Data for two Phase 3 Rinvoq programs will be available this year, alopecia areata and vitiligo, and for our HS and lupus programs in 2026. Moving to Skyrizi, data from the head-to-head in psoriasis versus Sotyktu will be available this year. Also this year, to further support differentiation in IBD, a study comparing Skyrizi to Entyvio in ulcerative colitis will be initiated. Additional mid-stage monotherapy and combination studies are planned in 2025, including a Phase 2 study evaluating lutikizumab in atopic dermatitis, a Phase 2 study evaluating Skyrizi and lutikizumab in psoriatic arthritis, and advancement of our anti-TREM1 antibody, ABBV-8736 with the eventual goal to add it to the Crohn's Disease Platform Study as a monotherapy and in combination with Skyrizi. Moving to oncology, where multiple regulatory and clinical milestones as well as phase transitions for key programs are planned. One area that we are particularly excited about is our ADC pipeline, where several assets are aimed at multiple tumor types. Our regulatory application is under review for accelerated approval of Teliso-V as a monotherapy in patients with previously treated c-Met overexpressing EGFR wild type non-squamous non-small cell lung cancer. The target for an approval decision is in the first-half of this year. This represents a segment of lung cancer with high unmet need where patients have limited options and tend to have a very poor prognosis. If approved, Teliso-V would be the first c-Met-directed ADC for the treatment of non-small cell lung cancer. We are also rapidly advancing our next-gen c-Met asset. A Phase 3 study evaluating ABBV-400, also known as Temab-A, was recently initiated in patients with c-Met overexpressed refractory metastatic colorectal cancer. Temab-A, as a monotherapy, is being compared against chemotherapy plus bevacizumab. This year, data from a Phase 1 CRC study evaluating Temab-A in combination with bevacizumab could enable a Phase 3 study in an all-comers population. Temab-A is also progressing well across lung programs. A Phase 2 study in EGFR wild-type non-small cell lung cancer is being planned, where Temab-A will be evaluated with a PD-1 inhibitor as a frontline combination therapy. In the EGFR mutant segment, results from the ongoing Phase 1 study could enable Temab-A dose optimization studies as a monotherapy in the second line setting and in combination with osimertinib in the first line setting. In gastroesophageal cancer, a Phase 2 trial was recently started evaluating Temab-A in combination with chemotherapy and a PD-1 inhibitor in frontline patients. We are also excited about ABBV-706, an ADC that utilizes the same Topo warhead and linker technology as Temab-A, but with an antibody that targets SEZ6. Encouraging data in small lung cancer, small cell lung cancer, were presented at ASCO last year. And this year, dose optimization and longer term duration data will be available. This readout could lead to the initiation of a registrational study in second line and dose optimization in combination with standard of care in the frontline. Moving to FRα ADC, Elahere is now approved for platinum resistant ovarian cancer in the U.S. and Europe and is currently in Phase 3 development for the platinum sensitive ovarian cancer segment, also, a next generation ADC targeting FRα, IMGN-151 is currently in Phase 1. This year, Elahere will be tested in combination with bevacizumab and a PARP inhibitor. 151 is being advanced into dose optimization as well as in studies with standard of care agents such as bevacizumab, carboplatin and a PARP inhibitor. These mid-stage studies for Elahere and 151 will be used to inform our Phase 3 approach in various settings for ovarian cancer, including induction and maintenance in platinum sensitive patients and in combination for frontline maintenance. Another ADC from ImmunoGen known as PIVAC targets a rare hematologic malignancy called Blastic Plasmacytoid Dendritic Cell Neoplasm. Based on positive data from the pivotal Phase 2 study, a regulatory application is planned for later this year. If approved, this would be an important new treatment option for patients with this aggressive blood cancer. Also in the area of hematologic oncology, the Phase 3 Venclexta MDS study is nearing completion with an overall survival data readout later this year. Now moving to neuroscience, following the Emraclidine EMPOWER-1 and 2 study readouts, a thorough analysis of the data was conducted to better understand the placebo effect observed in the two trials. Our findings point to a lack of uniformity of placebo effect across sites. When assessing sites beyond those with high placebo response, a clear efficacy signal was observed, albeit more modest than reported in Phase 1b. Therefore, we see a path forward as an adjunct to atypicals and schizophrenia and as a monotherapy in psychosis related to Alzheimer's and Parkinson's. These are diseases where there is a high unmet need for safe and tolerable treatments that can provide even a modest benefit. Additionally, our intention is to explore higher doses of Emraclidine. This is based on the degree of variability observed in the PK data from the EMPOWER studies. If higher doses are found to be safe and well tolerated, there is a potential opportunity to evaluate Emraclidine as a monotherapy in schizophrenia, as higher doses may result in greater efficacy. A multiple ascending dose study will be conducted this year and data will be available in the early part of 2026. Following this dosing work, Phase 2 studies in adjunctive schizophrenia and potentially monotherapy schizophrenia will be initiated. Dose ranging in elderly patients is ongoing with Phase 2 studies planned in 2026 in patients with psychosis related to Alzheimer's and Parkinson's Disease. Staying on the topic of Parkinson's Disease, positive top line results from the third Phase 3 trial for Tavapadon were recently announced. In the TEMPO-2 trial, Tavapadon met the primary endpoint, demonstrating a significant reduction in the severity of Parkinson's Disease symptoms compared with placebo at week 26. Key secondary endpoints were also achieved. We are very pleased with the emerging profile for Tavapadon, which shows strong efficacy as a monotherapy and as an add-on to Levo, Carbidopa. The six-month data from the Phase 3 studies show Tavapadon to be generally safe and well tolerated with low rates of adverse events of special interest, such as sedation and impulse control disorder. Longer term safety data will be available this year and regulatory submissions will then follow. Moving to aesthetics, we met with the FDA late last year regarding our BoNT/E submission for the treatment of glabellar lines. We are in the process of generating additional CMC data requested by the agency, which should be completed in the next few months. The regulatory submission will likely occur around the middle of the year. To summarize, there have been significant advancements across all stages of our pipeline. In 2025, we anticipate numerous important regulatory and clinical milestones, including many trial starts for key programs. With that, I'll turn the call over to Scott."
},
{
"speaker": "Scott Reents",
"content": "Thank you, Roopal. Starting with our fourth quarter results, we reported adjusted earnings per share of $2.16 which is $0.08 above our guidance midpoint. These results include an $0.88 unfavorable impact from acquired IPR&D expense. Total net revenues were $15.1 billion reflecting robust growth of 6.1% on an operational basis, excluding a 0.5% unfavorable impact from foreign exchange. Our ex-Humira platform delivered reported growth of 22%, once again exceeding our expectations. Adjusted gross margin was 83.8% of sales, adjusted R&D expense was 15.1% of sales and adjusted SG&A expense was 23.6% of sales. The adjusted operating margin ratio was 34.7% of sales, which includes a 10.4% unfavorable impact from acquired IPR&D expense. Net interest expense was $610 million. The adjusted tax rate was 20.2%. Turning to our financial outlook for 2025, our full-year adjusted earnings per share guidance is between $12.12 and $12.32. Please note that this guidance does not include an estimate for acquired IPR&D expense that may be incurred throughout the year. We expect total net revenues of approximately $59 billion reflecting robust operational growth of 5.7% despite a roughly 4% net unfavorable impact across our portfolio from the Medicare Part D benefit redesign. At current rates, we expect foreign exchange to have a 1% unfavorable impact on full-year sales growth. This revenue forecast contemplates the following approximate assumptions for select key products and therapeutic areas. We expect global immunology sales of $29.4 billion, including Skyrizi revenue of $15.9 billion reflecting growth of more than $4.1 billion driven by continued strong performance in psoriasis as well as robust uptake in IBD; Rinvoq sales of $7.9 billion reflecting growth of nearly $2 billion with continued market growth and share momentum across all approved indications. And Humira total revenue of $5.6 billion, including U.S. sales of $4 billion as more plans exclude branded Humira around the middle of the year. This forecast includes a $600 million net unfavorable impact from the Medicare Part D benefit redesign. In oncology, we expect global sales of $6.3 billion including IMBRUVICA revenue of $2.7 billion which reflects a $400 million net unfavorable impact from the Medicare Part D benefit redesign; Venclexta sales of $2.6 billion, reflecting continued strong demand, partially offset by a $100 million net unfavorable impact from Medicare Part D benefit redesign and Elahere revenue of $750 million. For Aesthetics, we expect global sales of $5.3 billion reflecting gradual improvement in market conditions across global markets as well as market share recovery in the U.S. This includes Botox Cosmetic revenue of $2.8 billion and relatively flat sales for Juvéderm. For neuroscience, we expect global sales of $10 billion reflecting continued double-digit growth. This includes Vraylar revenue of $3.5 billion reflecting continued strong prescription demand, partially offset by a $200 million net unfavorable impact from the Medicare Part D benefit redesign; Botox Therapeutics sales of $3.5 billion, total oral CGRP revenue of $2.1 billion and Vraylar sales of $300 million. For eye care, we expect global sales of $2.2 billion. Moving to the P&L for 2025, we are forecasting full-year adjusted gross margin of approximately 84% of sales, adjusted R&D investment of approximately 14.5%, adjusted SG&A expense of approximately $13.2 billion and an adjusted operating margin ratio of roughly 47% of sales. We expect adjusted net interest expense of approximately $2.6 billion which primarily reflects the annualized financing cost for the ImmunoGen and Cerevel transactions. We forecast our non-GAAP tax rate to be approximately 15.6%. Finally, we expect our share count to be roughly flat to 2024. Turning to the first quarter, we anticipate net revenues of approximately $12.8 billion. At current rates, we expect foreign exchange to have a 1.6% unfavorable impact on sales growth. This revenue forecast comprehends the following approximate assumptions for our key therapeutic areas. Immunology sales of $6.1 billion including Skyrizi sales of $3.2 billion and Rinvoq revenue of $1.6 billion, we expect U.S. Humira sales of $900 million. We also anticipate oncology revenue of $1.5 billion, aesthetic sales of $1.1 billion which includes an unfavorable one-time price adjustment due to the reimplementation of the original program, neuroscience revenue of $2.1 billion and eye care sales of $550 million. We are forecasting an operating margin ratio of roughly 44.5% of sales and model a non-GAAP tax rate of approximately 13.8%. We expect adjusted earnings per share between $2.47 and $2.51. This guidance does not include acquired IPR&D expense that may be incurred in the quarter. Finally, AbbVie's robust business performance continues to support our capital allocation priorities. Our cash balance at the end of December was approximately $5.5 billion and we expect to generate free cash flow approaching $17 billion in 2025, which includes roughly $2.7 billion of Skyrizi royalty payments. This free cash flow will support a strong and growing quarterly dividend, which we have increased by 310% since inception, as well as debt repayment, where we expect to pay down nearly $3 billion of total debt this year and remain on track to achieve a net leverage ratio of 2x by the end of 2026. Our strong cash flow also provides capacity for continued business development to further augment our portfolio. In closing, we are pleased with AbbVie's results in 2024 and our financial outlook remains very strong. We have considerable momentum across our diverse portfolio and we continue to be well positioned to deliver robust growth in 2025 and beyond. With that, I'll turn the call back over to Liz."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Scott. We will now open the call for questions. In the interest of hearing from as many analysts as possible over the remainder of the call, we ask you please limit your questions to one or two. Operator, first question please."
},
{
"speaker": "Operator",
"content": "Our first question comes from Vamil Divan with Guggenheim Securities. Your line is open."
},
{
"speaker": "Vamil Divan",
"content": "Great. Thanks for taking the question. So, maybe just to dive a little deeper on the Skyrizi, it is a great performance and guidance. Can you just comment a little more on pricing dynamics that you're seeing there as to how you've factored in pricing both for this year and maybe over the next several years? And then, just a quick follow-up on the comments that were given around aesthetics, especially on the share side, I think you lost a few points when maybe getting it back. Can you just give a sense of where you think the share is now for Botox and Juvéderm sort of this point in time? Thank you."
},
{
"speaker": "Jeff Stewart",
"content": "Yes, thanks, Vamil. It's Jeff. And I'll comment on Skyrizi and Rinvoq. And I think, we've been very consistent that over the near-term and over time, this is a volume-based business, so we're going to see price declines year-over-year. But I would say modest, right? We've sort of highlighted that as we negotiate the formularies, we've started to consistently see sort of these low single-digit price concessions. Now, obviously, what Scott highlighted was unique for the 25-year with the Part D redesign that he outlined. So, overall, consistent low single-digit price declines from the rebating side with a one-time Part D. And we would anticipate once we left the Part D, we would see that sort of trend going forward."
},
{
"speaker": "Rob Michael",
"content": "And Vamil, this is Rob. I'll just add that if you think about Skyrizi and Rinvoq, our strategy here was to elevate the standard of care for patients and ultimately would drive a rapid return to growth for the company beyond Humira. And that's exactly what we've been able to execute. That strategy has played out. You see the differentiation in the marketplace. We have nine head-to-head studies. We're launching a few more. We've upgraded our guidance now by an additional $4 billion in 2027. We've been very consistent in our language around the pricing dynamics. We said when you think about rebates, think about it as negative low single-digits going forward, but given the robust performance of these assets, it's volume that's dominating the growth, and we would expect that to continue."
},
{
"speaker": "Carrie Strom",
"content": "And hi, this is Carrie. I'll answer your question around Botox and Juvéderm share. So, in the U.S., we remain the clear market leader for both toxins and fillers. In Q4, a few points of share erosion, bringing Botox to around the low to mid-60s, Juvéderm to around the low to mid-40s. As I said, the reversion of the loyalty program back to the original one, which we announced in December. And then, put into action January 21st, was greeted with very positive response from our customers. And encouraging signs for us to recapture that share for both Botox and Juvéderm throughout the year. And just to note that the share did not go to one competitor. Rather, it was more distributed amongst the entire competitive set."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Vamil. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Yes. Our next question comes from Chris Schott with J.P. Morgan. Your line is open."
},
{
"speaker": "Chris Schott",
"content": "Great. Thanks so much. Just a two-parter on the Skyrizi Rinvoq dynamics, maybe just first on the 2027 guidance, can you just elaborate on what were the biggest drivers of upside to those targets, as you think about the various indications for the drugs? I guess, is it fair to think most of this coming from IBD, or is it across the board? And then, probably a longer-term question on those brands, can you just elaborate a little bit more on how we should think about the growth rate beyond 2027? So basically, how mature will these franchises be by then? And what type of growth rates can we think about over time? Thank you."
},
{
"speaker": "Jeff Stewart",
"content": "Yes. Maybe -- thanks, Chris. This is Jeff. I'll start on that. So, the primary driver of the change is, in fact, share capture. So, the pricing assumptions have been consistent. We can call the markets pretty well. We see the actuals and the long-term trends there. So, it's been really share capture. And I would say that we see it across the board. Certainly, we've been super encouraged with Skyrizi in psoriasis. We continue to see very, very robust TRx share trends. And there's no question that the ramps in IBD have been very, very significant. So, that's a big piece of it. But I would say it's across the board. So, predominantly share capture. I don't know if, Scott, you have anything to add. But that's the big dynamic there on the $4 billion."
},
{
"speaker": "Scott Reents",
"content": "Yes, Jeff. Maybe, Chris, if it would help, I can give you the breakdown by indication between the two on the 2027 guide, so, we talk about $31 billion combined in 2027. That's our new long-term guidance. That is $11 billion for Rinvoq and $20 billion for Skyrizi. Rinvoq is broken down. Rheum is about $4.8 billion; dermatology, $2.5 billion; IBD, $3.7. And then, on the Skyrizi side, $12.5 billion of that $20 billion guide is from psoriatic. And the remaining $7.5 billion is coming from IBD. So, that might help you kind of see those where the growth is coming from as well."
},
{
"speaker": "Rob Michael",
"content": "And if we speak to it in terms of the $4 billion, just to give you a sense then, to add to what just Scott mentioned. So, Skyrizi is up $3 billion. A billion of that is psoriatic and $2 billion is IBD. We're just seeing tremendous ramps early days with IBD. And then, for Rinvoq, it's up a billion from the previous guidance. And that's a mix of roughly $300 million rheum, $200 million derm, and $500 million IBD. So, again, across the board, we're seeing tremendous performance, particularly in IBD. And then, your question on how to think about the growth, we have obviously given guidance beyond '27. But as I look at the sell side consensus, clearly the growth that's in sell side consensus beyond '27 is below our expectations. We would expect to see these markets continue to grow. We would also expect to see continued share gains, albeit as you start getting close to that in place share level, the share curve bends, but you still expect to see some level of share growth. And then, keep in mind, we will have the five, we expect the five new indications for Rinvoq, collectively adding about $2 billion in peak sales and so that will also contribute. So, as I think about the rate of growth for Skyrizi and Rinvoq beyond '27, Rinvoq will likely grow faster than Skyrizi because of those new indications, but you'll still see a robust performance from both assets, at least through '32."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Chris. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Our next question comes from Geoff Meacham with Citigroup. Your line is open."
},
{
"speaker": "Geoff Meacham",
"content": "Hey, guys. Good morning. Thanks so much for the question. Just had a couple, first one on Cerevel, you guys called out the partial impairment today in the press release. Just want to get your perspective as to what the drivers are for the remaining value, assuming Tavapadon is mostly it, but wasn't sure what you'd assume for Emraclidine or backup compounds? And then, just on aesthetics, with the new guidance to 2029, is it fair to say that you think '25 could be the trough or have already seen a trough in terms of the growth rate? I'm just trying to think of the longer term picture. And then, just on BoNT/E, I wanted to get your perspective about the potential success there adding new patients to the paradigm, just given the potential there. Thank you."
},
{
"speaker": "Rob Michael",
"content": "Geoff, on your first question regarding -- this is Rob. On your first question regarding Cerevel, so keep in mind, the accounting rules do not allow you to write up an intangible. So, even though we are more optimistic about Tavapadon now than we were at the time of the deal, we can't write that value up. So, that would be the same as what we originally ascribed. We still obviously, as Roopal walked you through the development programs for Emraclidine, still see opportunity in adjunctive schizophrenia as well as neuro degenerative psychosis. And we haven't completely given up on the monotherapy opportunity either, but that's a more heavily risk adjusted opportunity now. So, when you think about the value you have to take into account, the timing, so there's some level of time delay as well as a different probability of success for monotherapy. That's all baked into because you're essentially valuing risk adjusted revenues. You have to take that into account. That said, we're still optimistic about the asset. We're pursuing it in these indications. And again, as I mentioned, we haven't completely given up on monotherapy that will depend on dose ranging. But that is the way we constructed the revaluation of the intangible. But overall, we still see a very nice opportunity particularly for Tavapadon and we still see potential for Emraclidine as well."
},
{
"speaker": "Jeff Stewart",
"content": "Geoff, I'll take your question regarding the aesthetics trough. So, we've not specifically guided that, but the way that we have modeled it and think about it is we do see recovery. And I think the big headwind here has been over the last two years has been the economic condition. So, we do see continued improvement. Carrie spoke about some of the market growth rates that we're seeing coming back in the U.S. for both fillers and toxins. So, we would -- if you model, you would anticipate '25 to be the trough. And then, our long-term guidance is that high-single-digit compound annual growth using '25 as the base year through '29. And if you model that, that's going to put you somewhere north of $7 billion. Certainly, this is a business we continue to be excited about. We think that there are continuing to be low market penetration rates globally, frankly, and we've got some innovation to continue to drive market growth. That market has grown low-double-digits historically, but I think as we model, we're thinking a high-single-digit growth in the markets. But we do see some growth accelerators with BoNT/E, and maybe I'll let the team talk about BoNT/E."
},
{
"speaker": "Rob Michael",
"content": "Maybe I'll just mention here just more broadly, this is Rob, on the business. I think as we reflect on the aesthetics performance and we are just going through a period of macroeconomic pressure on that business. But we do continue to see an attractive long-term setup again given low penetration rates, high consumer interest and our leading portfolio, including some exciting pipeline programs in toxins and fillers. When you think about it, as part of AbbVie, the aesthetics business has been able to continue investing despite the macroeconomic challenges and that will allow us to maximize opportunities when the market does recover. We have set up this business to be a global fully integrated unit with dedicated support from R&D and business development, and I'm confident that focused approach will pay off in the long run. It's just been difficult for us to call the market recovery, but we still have a lot of confidence in the long-term outlook."
},
{
"speaker": "Carrie Strom",
"content": "And this is Carrie. I'll comment on BoNT/E. So, as you said, BoNT/E will be an important catalyst for new patient activation into the category. Consideration continues to be very high for aesthetics and for toxins. And like we said, it continues to be underpenetrated. And that's because there continue to be barriers for these people who are interested in the category, but not acting around cost and concerns of an unnatural look. And that's really where BoNT/E will play an important role based on its unique profile that is suited to address these concerns. It's fast-acting. It has short duration. So, it's going to be a nice option to position for these considerers to try BoNT/E. And then, our commercial strategy will be to convert them from BoNT/E to Botox. So, this is going to be an important pipeline catalyst to help us to activate that consumer market and drive more consumers into the toxin category for Botox."
},
{
"speaker": "Roopal Thakkar",
"content": "And it's Roopal. Maybe one comment to add to Carrie's. On the R&D side, even thinking past that, this year we'll initiate a study with BoNT/E plus Botox to cover people immediately and get that long-term benefit. So, that, those studies will start this year."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Geoff. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Our next question comes from Terence Flynn with Morgan Stanley. Your line is open."
},
{
"speaker": "Terence Flynn",
"content": "Hi. Thanks for taking the questions. You mentioned the net impact of the Part D redesign. Can you tell us what the volume impacts you guys are assuming, if any, in that calculation? And then the second question I had is, on the pipeline slide, you noted you could have some Phase 2 UC data for 113, which I believe is your oral NLRX1 agonist. Just maybe speak to conviction level there and how you think about that on the forward and if that would be something that you could move into Phase 3. Thank you."
},
{
"speaker": "Scott Reents",
"content": "Terence and Scott, I'll take your question on the volume. So, we have guided a 4% of a net impact across the business for headwind to growth for Part D redesign. Now, when we think about that volume offset, we've not quantified that in the guidance, but that is part of the 4%. It's a, I would say, in the grand scheme, it's a fairly modest offset overall. And I think part of what you need to do when you think about that volume, recognize that when you look at the patient segments that exist, there's roughly three patient segments and they each take about a third of the business. But this is really something that will impact the standard eligible, and we're working very hard to ensure that people are electing cap and smooth. And so, we really see that volume offset coming from that one-third of the patient segment to drive that. So, that's why I think it's a little bit more of a modest offset, but we've not quantified it."
},
{
"speaker": "Rob Michael",
"content": "And it's logical when you think about it, because the other two-thirds, I mean, you have the LIS population, which is one-third, so they don't have an out-of-pocket burden like the standard eligible do, and the other third are covered by employer plans, where, again, they don't have the same out-of-pocket burden. So, when we analyzed it, we looked at the market and saw that about a third, as Scott mentioned, of the population would benefit from the lower out-of-pocket. But keep in mind, the cost share applies to the entire book of Medicare business. That's why the volume doesn't offset the price impact."
},
{
"speaker": "Roopal Thakkar",
"content": "And this is Roopal. I'll cover the NLRX question. This is our asset from Landos. We had observed very early data, I would say Phase 1b, in ulcerative colitis, and that looked good, but it was a very small sample size, I would say. So, this will be a robust Phase 2 with a placebo comparator, and we'll get objective data from centralized review of endoscopic data. So, it will be a good data set to look at, and if it looks good, definitely would be a Phase 3 asset for us. And the other consideration we would have, similar to what I highlighted about other biologics that we'd be combining with Skyrizi, if this looks good, this could be a combination agent with Rinvoq as well."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Terence. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Yes, our next question comes from Mohit Bansal with Wells Fargo. Your line is open."
},
{
"speaker": "Mohit Bansal",
"content": "Great. Thank you very much for taking my question, and congrats on all the progress, I have a question regarding IMI. So, I know you talked in the past about Skyrizi and Rinvoq benefiting from some of the Humira prescriptions going to these agents as well. So, taking that aside, it still seems like the volume or IRA space is growing rapidly. Can you talk a little bit about the underlying dynamics as well here, why this market continues to grow, and how should we think about longer term for the overall market growth itself? Thank you."
},
{
"speaker": "Jeff Stewart",
"content": "Yes. So, thanks, Mohit. It's Jeff. And like we talked about before, particularly around the acute event, in this case, this was the CDF exclusion in April, we could clearly start to measure the fact that not all of the switching from Humira was going to the biosimilar. We saw about 20% of it was slipping away into new mechanisms or more advanced mechanisms like Skyrizi and Rinvoq. Now, we've continued to see the molecule compress. And it's just physicians are using just less and less sequentially Humira and the biosimilars over time. I would say it's becoming harder to measure because you're also seeing a lot of dynamics around new head-to-head trials, new indications, new other approaches. So, I would say overall, it's there, but it's relatively modest in the scheme of the volume that is basically accruing from basically the promotion and the profile of the medication. So, it should continue. The more that we see sort of disruption in the market, you'll probably continue to see the molecule on trend continue to compress. Now albeit modest, your other point's very important. These markets are still very, very buoyant and significant. And one of the dynamics that we see over time, and I think we'll begin to see it quite dramatically around the world, particularly in IBD, is that the lines of therapy start to expand. So, it used to be like primarily what was fueling the markets was primarily the new patients coming in off of older traditional medications. But now you're seeing the emergence in atopic dermatitis of the second and third line markets, which are growing quite substantially. You're going to see that significantly emerge in IBD, whereas before physicians were really, really afraid to move people along. So, they did dose intensification, they added more steroids. But now that there's drugs like Skyrizi and Rinvoq and other agents, you're seeing those market lines of therapy expand. And so, that should continue. And we've contemplated that in our long-term projections. But that gives you some sense of why you're observing what you're seeing."
},
{
"speaker": "Rob Michael",
"content": "Now, as we look across, it's Rob, as we look across the specialty areas, in psoriasis and IBD we're projecting high single-digit market growth. Atopic dermatitis in the mid-teens, it's growing very -- I mean, you're seeing still fairly low penetration rates for atopic dermatitis. So, there's tremendous room for growth. So, we would anticipate mid-teens market growth there. And then, in rheumatoid arthritis, that's probably more like low to mid-single digits. But you can see across the board, very nice market growth, which then will be complemented by the market share gains."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Mohit. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Yes. The next question comes from Dave Risinger with Leerink Partners. Your line is open."
},
{
"speaker": "David Risinger",
"content": "Yes. Thanks very much. So, I have two questions, please. First, regarding ABBV-400 or Temab-A, could you please frame your long-term commercial vision for this candidate, including what some may underappreciate about how broadly it could potentially be adopted in the early 2030s? And then, second, on external transactions, emraclidine was a setback, but AbbVie's overall M&A track record has been very successful. Could you please discuss your agenda for M&A, including the potential to leverage your franchise strength in related product categories? Thanks so much."
},
{
"speaker": "Jeff Stewart",
"content": "Yes. Hi. It's Jeff. So, I will give some thoughts on that. It's a very, very attractive asset. I think it's underappreciated. And part of it is the first category it will compete in, which is colorectal cancer. I mean, if you look at the response rate that we've seen, let's say, in a smaller or mid-size cancer type, which is ovarian cancer with Elahere, it's quite striking. I mean, Elahere has been the most rapidly adopted ADC in the entire U.S. oncology market. And it's because it entered this market that was basically almost all chemo-based with unmet need where there had been no innovation. And when we look at the entry with 400 or Temab-A into colorectal cancer, it's a substantially larger tumor type, as it's quite evident. And we've already seen very, very nice monotherapy results in later lines, much, much better than we've seen with the old chemo standard of care. And really, it's whether or not they have c-Met or not. Now, the thing that will really cause a big inflection that Roopal can talk about in a moment is that it's the combinability as you go up into the lines of therapies, okay? And that's really going to make this thing inflect and become a very, very significant product for patients in colorectal cancer over time. Now, the studies will have to bear that out. And as well, we're seeing very, very significant early results in lung cancer as well. So, it is, I think it's an underappreciated asset. We'll have a chance with Teliso-V to sort of set the market around this whole c-Met, the modern c-Met area. But it's quite striking. So, first, we establish in later lines, very big cancer directly against older chemotherapy. And then, we move combination as we move forward. So, thanks for the question."
},
{
"speaker": "Roopal Thakkar",
"content": "Hey, it's Roopal, maybe just a comment there on our strategy around ADCs. And I think 400 is a good highlight of that. So, we think about what's a good target, meaning high expression on the tumor, low expression in healthy tissue. And then, we are continuing to focus on patient selection, individualization of care, utilizing robust biomarkers, as Jeff mentioned, c-Met. That is the opportunity to optimize benefit-risk and particularly tolerability. With our Topo Warhead platform, we've seen low rates, for example, of alopecia, stomatitis, diarrhea, which others, I think, continue to struggle with. And safety and tolerability, as Jeff has mentioned, are critical. So, we're also very focused on proper dose optimization to get this right, so we're able to combine in earlier lines. And that's the same approach that we have with the other one I mentioned, 706 in small cell lung cancer and others in the pipeline."
},
{
"speaker": "Rob Michael",
"content": "And then, David, this is Rob. I'll take your question on M&A. And thank you for acknowledging the strong track record we've had as a company. I would agree with that when you think about the transaction with BI that brought us Skyrizi, with Pharmacyclics that brought us Imbruvica, really gave us the critical mass to be a leader in blood cancers, and then the transaction with Allergan, which gave us three verticals that can really drive long-term growth for the company in neuroscience, aesthetics, and eye care. And then, more recently, the transaction with Immunogen, which really bolstered our ADC pipeline, as Roopal has highlighted. In terms of our go-forward strategy on BD, we continue to pursue assets that can add depth to our pipeline and really drive growth in the next decade. And we have a clear line of sight to growth for at least the next eight years within the company today. And so, my focus is really about bringing in assets that can help drive that growth in the next decade. And since the beginning of 2024, as I mentioned in my prepared remarks, we've signed more than 20 early-stage deals across immunology, oncology, and neuroscience. In immunology, we've added novel mechanisms that have the potential to raise standard care either as a monotherapy or in combination with Skyrizi and Rinvoq. You should expect that strategy to continue. In oncology, we've added new platforms, including multispecifics, trispecifics, T-cell engagers, and in situ CAR-T approaches. And then within neuroscience, it's not always appreciated the work we've been doing in neuroscience above and beyond cerebral. We expanded our discovery collaboration in psychiatry with Gedeon Richter, who discovered Vraylar. We also invested in a novel mechanism for mood disorders with Gilgamesh. And we recently acquired a next-generation A-beta antibody for Alzheimer's from Aliada. Again that is our area of focus. We have these five areas that can drive long-term growth. I mentioned neuroscientist aesthetics and eye care, and of course, immunology and oncology. I mean, these are all large markets with high unmet need. And so, our BD efforts are focused on building pipeline depth in those areas. Now, I should say if we see an opportunity for differentiation in another large market with high unmet need we would consider pursuing it, especially if it can help drive growth in the next decade. And the company has the financial wherewithal to pursue those opportunities as well."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Dave. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Yes. Our next question comes from Steve Scala with TD Cowen. And your line is open."
},
{
"speaker": "Steve Scala",
"content": "Thank you so much. I have an observation and two questions. The observation is splitting hairs, but on Part D redesign, the guidance had been a three percentage point headwind. It was just set on the call four percentage points. A year ago, it was two percentage points. If there is a change, please, can you identify that? Related to that is my first question. Are you seeing any evidence that IRA Medicare pricing is spilling over to the commercial market? And if yes, to what degree, or is there absolutely none? And then, my second question, the company has provided a lot of helpful perspective on the aesthetics market, but can you distill it to a number? The guidance for aesthetics was previously greater than $9 billion in 2030. What is that number now? Thank you."
},
{
"speaker": "Scott Reents",
"content": "Steve, this is Scott. I'll go ahead and start with your Part D observation and question. With Part D, we really -- we saw that as something that the analysts and maybe the marketplace hadn't fully understood the impact. I think we were one of the first companies to come out and talk with any sort of specificity and granularity around what we saw that Part D impact, mechanics of how it would work, and the impact to it. So, we came out with a guidance number, and I think that has probably, as you noted, the numbers, but it's evolved a little bit over time. I would say it's evolved not necessarily from our understanding of Part D, but because really the mix of the business. So, when we talk about it in the second quarter, I believe I came out and said we saw it would see an approximately 3% headwind to growth from the Part D redesign. We've distilled that number and made a precise number of 4%, roughly 4% today. And really, when you think about when I came out with that 3%, we've seen momentum in the business, and we've seen momentum in the business in areas, immunology and oncology in particular, where we reached some guidance, where we saw have high Part D channel mix. And so, that's really been a business mix change that has led to that 4% change, and that's really kind of what it's amounted to."
},
{
"speaker": "Rob Michael",
"content": "And Steve, I'll just add, I mean, when you think about the setup for the company, in '25, we said we would return to robust growth, and we're delivering in absolute terms in our guidance a little bit more than $2.5 billion of growth, and that's with headwinds from U.S. Humira erosion around $3 billion, the Part D benefit redesign of approximately $2 billion when you do the math on the roughly 4%, and then a $500 million headwind from the stronger U.S. dollar. So, the underlying growth platform is going to drive $8 billion of growth when you think about Skyrizi and Rinvoq, as well as neuroscience. So, the change you're seeing from, as Scott mentioned, is really more of a function of mix, but we're very pleased with the underlying growth that the business has allowed us to absorb these impacts and still deliver robust growth in 2025."
},
{
"speaker": "Jeff Stewart",
"content": "Steve, it's Jeff. I'll take your second question. So, as we've negotiated across the commercial books and the Medicare books, we have not seen any spillover or slippage in our actual negotiations over the last cycles. And one thing I would add is that we have seen in '24 some more consumption on the benefit redesign, particularly in our oncology agents. So, for Imbruvica and Venclexta, we actually see lower discontinuations and some more consumption. And so, that's encouraging, because if you remember that Part D sort of had the lead in where the cap moved down to roughly $33,000, $34,000, it'll sequentially move down more to $2,000 with the smoothing next year, which is a good policy, because it's encouraging to see that the change in benefit design makes people stay on their cancer medication a bit longer. Again, the volume will be more modest than the price hit, as Rob and Scott described it. But that's the dynamics that we're seeing in the channels."
},
{
"speaker": "Scott Reents",
"content": "And to answer your question regarding the aesthetics guidance, I'll reinforce maybe what I said earlier and Rob as well. So, when we look at that guidance, that long-term guidance is calling for high single-digit CAGR '25 through '29, so using '25 as the base here. If you do the math on that range, that is something above $7 billion, a little bit north of $7 billion, depending on where it falls within that high single-digit range. So, that's why we've specifically given the range on the high single-digit. The market growth that we've seen historically has been low double-digits, but we're seeing that market we're modeling for now, high single-digit growth during the time period that we've given this long-term guidance. And so, I think that answers your specific questions."
},
{
"speaker": "Steve Scala",
"content": "Thank you very much."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Steve. Operator, next question please."
},
{
"speaker": "Operator",
"content": "The next question comes from Tim Anderson with Bank of America. Your line is open."
},
{
"speaker": "Tim Anderson",
"content": "Thank you. A couple of questions, please. On aesthetics, a question I've asked before, what are your expectations for how obesity drugs are going to impact this business? You could argue that the surge in use of products, the GRIP ones, could be either a tailwind or a headwind to the use of products like toxins and fillers. It could be a headwind if patients are having to pick and choose between which products to put their out-of-pocket dollars towards. And then, a second question unrelated to the first. PBM reform still being debated in Washington. If AbbVie had its way, what would change about the current relationship between PBMs and drug companies, and what would you argue should be left alone?"
},
{
"speaker": "Carrie Strom",
"content": "Hi, this is Carrie. I'll answer your first question around the obesity market and the aesthetics opportunity. And you're exactly right. It continues to be both a headwind and a tailwind, a headwind in terms of share of wallet as these consumers are making decisions on what they're going to spend for. We see that more for the higher-priced products like fillers. And then, also a tailwind as this gets a new group of consumers or patients interested in aesthetics, and many of our aesthetic providers are administering these products. And so, they see this as an opportunity for lead generation and bringing new patients into the category. So, we do see it as both a tailwind, a headwind in the short term, but a tailwind in the long term. And the question is not if injectables work. We know that these products work well in these patients. It's really about how we can partner with our customers to build it and integrate it into their treatment practice. And that's what we're doing with our customers now in helping them position Botox and Juvederm in our product line for these new patients that are entering their practice."
},
{
"speaker": "Rob Michael",
"content": "And Tim, this is Rob. I'll take your question on PBM reform. Look, if there are changes to the rebate system, we don't have a strong preference between rebates or discounts. And that's because we've always competed on the attributes of our products, both the clinical benefit they provide and the value they return to health systems. So, we're confident in our ability to compete in either world. I would just point to our share performance in international markets that do not have a rebate-based system. And we see similar market shares in those countries as well. So, we can compete effectively in either system. We don't have a preference."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Tim. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Our next question comes from Chris Raymond with Piper Sandler. Your line is open."
},
{
"speaker": "Chris Raymond",
"content": "Yes, thanks. Just a question on atopic derm as a target indication, just from some of our work, it looks like the upside we're seeing in Rinvoq is largely in room and gastro. And I know you guys have sort of mentioned this, and it's fairly well known. But in atopic derm, at least from our data, it looks like things are starting to flatten out a little bit. And I heard your comments on the derm share of Rinvoq revenue in 2027. But that would seem to infer maybe some kind of inflection. So, maybe a two-part question here; first, talk about the current maybe atopic derm growth dynamic, and is there an inflection sort of anticipated? And then the second part of that is, should we be paying more attention maybe to lutikizumab as a contributor here? I know, Jeff, you've talked about atopic derm as a very important indication that you guys are targeting. Or is there some other sort of area, like external innovation, that you think will augment maybe your position in this indication? Thanks."
},
{
"speaker": "Jeff Stewart",
"content": "Yes, it's a very good question. It's an important segment. And to give you some sense of what we see in terms of the inflection. So, we have seen a significant inflection in our new patient capture. And this is despite the launch of other interleukin products over the last year. So, we've ramped to the highest in-place shares that we've had. And it was largely flat in the teens for mid-teens for many, many quarters. And it's ramping up now above 20%. And a lot of that is we've been able to start to distinguish Rinvoq on these stringent endpoints. Basically, like really minimal disease activity where you're taking itch down to a very, very low level. And you're almost completely clearing the skin. And those are the endpoints where we significantly outperform DUPI. Now, having said that, DUPI's still got the vast majority there, but we are seeing, we will see that in-place shares start to build into the TRXs over time, because our TRX share is quite below 20% at that point. I think the other thing that I'd note is that in many, or if not most, of the outside the U.S. markets, our shares are much higher and building even a little bit faster. So, in several large markets, we actually are ahead of Dupixent. And some of that has to do with the way that the label worked during our initial launch, et cetera. But we're quite bullish over time in terms of Rinvoq as this is the best agent in terms of getting to the complete control. Now, having said that, we would and we will continue to look for more assets. Some are in our pipeline as described. But this is a very, very attractive space that we want to continue to invest in. I don't know, Roopal, if you've got any comments on ludi or some of the other concepts."
},
{
"speaker": "Roopal Thakkar",
"content": "That's right. I mean, with the 5% penetration rate, there's still many patients that are untreated. So, lutikizumab will be our next one. And Jeff mentioned, there's other pipeline assets that we're working on. And key being skin clearance along with that itch. And if you can get them both and have a safe and tolerable profile, I think that'll continue to be competitive."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Chris."
},
{
"speaker": "Chris Raymond",
"content": "Thank you."
},
{
"speaker": "Liz Shea",
"content": "Operator, next question please."
},
{
"speaker": "Operator",
"content": "Thanks. Our next question comes from Trung Huynh with UBS. Your line is open."
},
{
"speaker": "Trung Huynh",
"content": "Great. Thanks for taking my questions. Just two for me, so, firstly, your sales in 4Q, did you see any notable difference in trends in stocking or gross-to-net patterns across the portfolio ahead of the changes in Part D versus previous years? Specifically, I'm interested if you had any meaningful one-offs for Skyrizi and Rinvoq for the quarter. And then, circling back on aesthetics, thanks for that updated long-term guide, can you give us a bit more color geographically how we should think about the split between ex-U.S.? China versus the U.S. as you return to growth? Is there an expectation on one coming back quicker than the other? Thanks."
},
{
"speaker": "Scott Reents",
"content": "This is Scott. I'll talk about the stocking. So, we did not see -- in the past, we've talked about it a couple years ago in particular. But the stocking was relatively minimal from in terms of the impact. So, we did not see anything with respect to Skyrizi and Rinvoq on the stocking in the fourth quarter that'll be impacted in the first quarter."
},
{
"speaker": "Trung Huynh",
"content": "And no real dynamics around gross to net either?"
},
{
"speaker": "Scott Reents",
"content": "No, that's right. For Skyrizi and Rinvoq, I'm sorry, no dynamics around gross to net for Skyrizi and Rinvoq. And with respect to aesthetics, I don't know Carrie if you want?"
},
{
"speaker": "Carrie Strom",
"content": "Sure. For aesthetics, if we think about the long-term, we see, like we said, we're planning prudently for the economic recovery around key markets like U.S. and China, where it's been challenging for the past few years. Both those markets will continue to be important moving forward as will the rest of the world. We see Japan as posting nice growth as being an underdeveloped market that we're able to invest in. And then, the pipeline catalysts will be important in both U.S. and the rest of the world. Notably, in China, in the past year, we've had multiple new pipeline catalysts, which are going to -- which continue to help drive share for both toxins and fillers last year and this year. And we expect the international business to continue to increase as a percent of the revenue for overall global Allergan aesthetics."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Trung. Operator, we have time for one final question, please."
},
{
"speaker": "Operator",
"content": "Sure. And our last question comes from Chris Shibutani with Goldman Sachs. Your line is open."
},
{
"speaker": "Chris Shibutani",
"content": "Great. Thank you very much. When you think about going beyond 2030 with your strategy across the portfolio, can you comment about the potential impact of some of these combination approaches in immunology? Do you expect these to be IP extending? Will there be co-formulation based approaches, just trying to understand the potential revenue implications, noting that clearly there could be some clinical benefit that could certainly make sense. And then, just a question about a business segment that has been around that you never talk about, which is eye care, how and why does this fit going forward? I understand there's a legacy with the Allergan deal. But just trying to think about the overall portfolio in areas where you clearly have strengths, but this seems to be one which is less than 5% of revenues. But what is the role for that on the board? How are you thinking about it? Thank you."
},
{
"speaker": "Roopal Thakkar",
"content": "Hey, Chris, it's Roopal. Maybe I'll start the ball rolling here on how we think about combos into '23 -- sorry in the 2030. So, the first thing is we have a very strong foundational asset in particularly IBD with Skyrizi. And you've heard me mention other combo studies in the psoriatic arthritis today as well. Now, that we would combine with the multiple assets that we've mentioned over time; TL1A, TREM-1, alpha 4 beta 7, IL-1 alpha beta, lutikizumab that we already have, that we would be able to look at as monotherapies and combo therapies. If they look good as monotherapies, they could also move forward by themselves. For all of these assets, we're also looking at biomarker approaches. Particularly with lutikizumab, but we would apply that same strategy to all of these assets. And as combinations, the goal would be co-formulations. So, as we enter into the clinical study, we're also doing CMC work in parallel to facilitate combination, co-formulation approaches. So, that would also be a convenience factor. And we would want to match with longer acting agents. So, for example, the TL1A we believe to be a longer acting agent. For TREM-1 we're seeing a long pharmacodynamic effect as an example. But then, the next way that we think about this, these combo strategies, is if we start seeing utility there, obviously moving forward with the co-formulation, but we are very competent in making bi-specifics. Lutikizumab is one of those. So, then in parallel we're making bi-specifics that could then also stand alone as single assets. And then, as you've heard recently with our Nimble transaction, we would also be looking at different mechanisms as an oral peptide. The lead one being IL-23, but we're also working on a TL1A. And what's unique and what we like about that platform is the potency, potentially being able to reduce the amount of peptide that's required and these assets having long half-lives. So, if that holds, then you could imagine combinations as a pill with these peptides with that type of profile that we hope to see. So, multiple steps as we think about immunology."
},
{
"speaker": "Rob Michael",
"content": "This is Rob. Your question on eye care, I mean our focus on eye care is in glaucoma, retinal disease, and prescription dry eye. We like that business. It precipitates in a large market with high unmet need, meets that criteria. It has very much a scientific focus. It's a data-driven business. It's a very efficient business as well. And obviously, we're excited about the REGENXBIO Gene Therapy Program focused on wet AMD and diabetic retinopathy. Depending on how that plays out, I think you could see that as becoming a stronger growth driver. We obviously have four of the five, as you think about, you get a lot of questions there. But we don't get as many questions on eye care, but we do believe as you start to get more visibility to this REGENXBIO Program, you'll likely spend more time focusing on it. We think of it as a potential to be a long-term growth driver for the company. And we like the fit it has for AbbVie."
},
{
"speaker": "Liz Shea",
"content": "Thank you, Chris. And that concludes today's conference call. If you'd like to listen to a replay of the call, please visit our website at investors.abbvie.com. Thanks again for joining us."
},
{
"speaker": "Operator",
"content": "Thank you. That concludes today's conference. You may all disconnect at this time."
}
] |
abbv | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning, and thank you for standing by. Welcome to the AbbVie Third Quarter 2024 Earnings Conference Call. All participants will be in a listen-only until the question-and-answer portion of this call. [Operator Instructions] Today’s call is being recorded. I would now like to introduce Ms. Liz Shea, Senior Vice President, Investor Relations."
},
{
"speaker": "Liz Shea",
"content": "Good morning and thanks for joining us. Also on the call with me today are Rob Michael, Chief Executive Officer; Jeff Stewart, Executive Vice President, Chief Commercial Officer; Roopal Thakkar, Executive Vice President, Research and Development, Chief Scientific Officer; Scott Reents, Executive Vice President, Chief Financial Officer; and Carrie Strom, Senior Vice President, AbbVie and President, Global Allergan Aesthetics. Before we get started, I’ll note that some statements we make today may be considered forward-looking statements based on our current expectations. AbbVie cautions that these forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those indicated in our forward-looking statements. Additional information about these risks and uncertainties is included in our SEC filings. AbbVie undertakes no obligation to update these forward-looking statements, except as required by law. On today’s conference call, non-GAAP financial measures will be used to help investors understand AbbVie’s business performance. These non-GAAP financial measures are reconciled with comparable GAAP financial measures in our earnings release and regulatory filings from today, which can be found on our website. Following our prepared remarks, we’ll take your questions. So with that, I’ll turn the call over to Rob."
},
{
"speaker": "Robert A. Michael",
"content": "Thank you, Liz. Good morning, everyone, and thank you for joining us. AbbVie is performing exceptionally well, and I’m extremely pleased with the execution against our strategic priorities, including continued double-digit sales growth from our ex-Humira platform, the closing and integration of Cerevel Therapeutics and the progress we are making to build and advance a compelling pipeline of innovative medicines. Turning to our results, AbbVie’s diversified portfolio delivered sales that were $260 million above our expectations and reflect robust mid-single-digit operational sales growth. Our ex-Humira platform drove this over achievement, including growth of nearly 18%. The momentum of Skyrizi and Rinvoq is especially impressive with combined sales expected to exceed $17 billion this year, which is $1.3 billion above our initial expectations. And, we see substantial opportunity for continued strong growth well into the next decade. Several other key products also delivered double-digit sales growth, including Venclexta, Vraylar, Ubrelvy and Qulipta. This broad-based performance further demonstrates the strength of our commercial portfolio. For the third time this year, we are raising our full-year revenue and adjusted EPS guidance. We are increasing our full-year revenue guidance by $500 million and have now raised total revenue by $1.8 billion since our initial guidance in February. We are also raising our full-year adjusted earnings per share guidance by $0.15 and now expect adjusted EPS between $10.90 and $10.94. In addition to achieving strong quarterly results, we have been very focused on investing in the business to generate sustainable long-term performance in the 2030s and beyond. During the quarter, we successfully completed the acquisition of Cerevel Therapeutics, strengthening our neuroscience pipeline. Cerevel enhances our ability to help patients suffering from devastating conditions such as Parkinson’s and schizophrenia. The integration has been seamless and we are excited to have the talented Cerevel team join our organization. Within the Cerevel pipeline, we are very pleased with the positive Phase 3 results and emerging profile of tavapadon in Parkinson’s. And, we remain on-track to read out both pivotal studies for emraclidine in schizophrenia in the fourth quarter. More broadly on the pipeline, we have been advancing key R&D programs across all stages of development. Some notable highlights include the U.S. approvals of Vyalev for advanced Parkinson’s and Botox for platysma bands. The U.S. regulatory submission of Teliso-V for non-squamous, non-small cell lung cancer, and the start of our Phase 2 Crohn’s platform study, which is evaluating Skyrizi in combination with several novel biologics. In summary, AbbVie continues to demonstrate strong commercial, operational and R&D execution. The robust performance of our growth platform once again exceeded our expectations and we see numerous opportunities to drive long-term growth. Further underscoring our confidence in that growth, today we announced a 5.8% increase in our quarterly cash dividend, beginning with the dividend payable in February 2025. Since inception, we have increased our quarterly dividend by more than 300%. With that, I’ll turn the call over to Jeff, for additional comments on our commercial highlights. Jeff?"
},
{
"speaker": "Jeffrey R. Stewart",
"content": "Thank you, Rob. I’m extremely pleased with the continued strong momentum across the therapeutic portfolio. I’ll start with the quarterly results for immunology, which delivered total revenues of more than $7 billion up 4.8% on an operational basis. Skyrizi global sales were $3.2 billion up 51.5% on an operational basis, exceeding our expectations. We are seeing robust prescription growth across psoriatic disease, with Skyrizi achieving in-play biologic share leadership in approximately now 30 key countries. In the U.S, we continue to capture nearly one out of every two in-play psoriatic disease patients on biologic therapy and we see substantial room for further total share growth. We believe that Skyrizi’s best-in-class profile with nearly complete skin clearance, high durability of response, easy onboarding and quarterly dosing for maintenance therapy sets a very high bar relative to other therapies on market or in development. Skyrizi has also demonstrated a compelling clinical profile in IBD, including strong endoscopic data paired with convenient dosing. This differentiated profile as well as our compelling head-to-head sequence data versus Stelara is supporting very rapid uptake in Crohn’s disease, where Skyrizi continues to gain market share globally, achieving in-play patient leadership across all lines of therapy in the U.S, Japan and Canada. Skyrizi’s U.S. in-play patient share is now approximately 32%, more than double the share of the second biologic treatment. And with Skyrizi’s total prescription share of approximately 8%, we see significant opportunity for revenue inflection in Crohn’s going forward. While we are still very early in our launch in the U.S. and Europe, we also anticipate robust uptake for Skyrizi in ulcerative colitis the new indication. Initial prescription trends as well as feedback from gastroenterologists have been overwhelmingly positive. Physicians are particularly impressed with the data that has been demonstrated for naive UC patients, who have not been exposed yet to biologics, where Skyrizi achieved very high results for clinical remission and endoscopic response. We have now secured broad formulary access for Skyrizi in UC, with sales in this indication expected to ramp meaningfully over the next several quarters. So, given the momentum we are seeing across all of these indications, we will be raising our full-year sales guidance once again for Skyrizi. Turning now to Rinvoq, which is also demonstrating robust growth. Global sales were $1.6 billion up 47.4% on an operational basis. We continue to see strong prescription growth across all seven of Rinvoq’s approved indications. I’m especially pleased with our performance in IBD, where Rinvoq’s uptake is exceeding our expectations. Rinvoq is now capturing double-digit in-play patient share in the U.S. for ulcerative colitis as well as Crohn’s disease. Both indications are now available in more than 75 countries with reimbursement and share continuing to increase. I also wanted to highlight our recent performance in atopic dermatitis, where Rinvoq is seeing an acceleration of in-play share following recent positive data from our second head-to-head study versus Dupixent. As an oral option that provides rapid skin clearance and itch relief, we believe Rinvoq’s strong differentiated profile will continue to compete well in this highly underpenetrated AD market. As a result of this continued strong performance, we will also be increasing the full-year sales guidance once again for Rinvoq. Looking forward, we see substantial momentum for both Skyrizi and Rinvoq, including continued share gains across existing indications on top of the typical underlying market growth across room, derm and gastro. Additionally, we are making excellent progress with several new indications for Rinvoq across sizable markets that will have the potential to provide another significant revenue inflection in the second half of this decade and into the 2030s. From a competitive perspective, a key element of Skyrizi and Rinvoq’s success has been their strong differentiation with compelling head-to-head data against several novel therapies. This includes Skyrizi superiority versus Humira, Cosentyx, Otezla and Stelara in psoriasis as well as Stelara in Crohn’s disease and Rinvoq superiority versus Humira and Orencia in rheumatoid arthritis as well as Dupixent in atopic dermatitis. To further support our differentiation, we have another head-to-head study ongoing for Skyrizi versus Sotyktu in psoriasis with plans also underway now for a study comparing Skyrizi versus Entyvio in ulcerative colitis. So given all of these factors, we feel very confident about the long-term growth prospects for both Skyrizi and Rinvoq. Turning now to Humira, which delivered global sales of $2.2 billion down 36.5% on an operational basis due to biosimilar competition. While Humira share erosion to biosimilars in the U.S. is largely in-line with our expectations, we are now seeing more Humira molecule volume moving to other novel mechanisms than previously anticipated. So, while this has an unfavorable impact to Humira sales, we are seeing a benefit to Skyrizi and Rinvoq, which is a very favorable dynamic for immunology portfolio now and certainly over the long-term. Moving now to Oncology, where total revenues were approximately $1.7 billion Imbruvica global revenues were $828 million down 8.8%, reflecting continued competitive dynamics in CLL, partially offset by higher persistency rates for existing patients. Venclexta is performing extremely well. Global sales were $677 million up 18.2% on an operational basis. This reflects strong momentum in CLL, especially in Europe, where recent guideline changes recommend combination use of Venclexta Plus BTK inhibitors as a preferred fixed duration treatment versus continuous BTK treatment alone. Growth is also supported by our very strong share position in frontline AML, where Venclexta is the leading treatment for patients who are ineligible for intensive induction chemotherapy. We are also seeing nice sequential revenue growth from Elahere and Epkinly, which are both demonstrating strong launch trajectories. Turning now to neuroscience, where total revenues were more than $2.3 billion up 16% on an operational basis. Vraylar is demonstrating robust performance. Sales were $875 million up 16.6% on an operational basis, reflecting continued new prescription growth in both bipolar disorder and adjunctive MDD. Within migraine, our leading oral CGRP therapies contributed $445 million in combined revenue this quarter, reflecting growth of approximately 22%, as we continue to see increasing prescription demand for both Ubrelvy and Qulipta. Global Botox Therapeutic sales were $848 million reflecting strong performance in chronic migraine as well as the other approved indications. Finally, we are very excited for the recent U.S. approval of Vyalev, a transformative therapy for patients with advanced Parkinson’s disease, who are uncontrolled on oral therapy alone. As a less invasive, non-surgical delivery system that can provide meaningful improvements in on-time and off-time, we believe Vyalev has the potential to significantly expand use beyond current device aided therapies. Sales in the U.S. for Vyalev are expected to ramp gradually over the next several quarters as we work to establish the appropriate Medicare coverage and benefit determination. At the same time, we are very encouraged by the interest in uptake internationally, where we have approval now in 35 countries with several thousand patients already on treatment. Longer-term, we anticipate peak sales of Vyalev to exceed $1 billion. So overall, I’m very pleased with the continued commercial execution and performance across the therapeutic portfolio. And with that, I’ll turn the call over to Carrie, for additional comments on aesthetics. Carrie?"
},
{
"speaker": "Carrie Strom",
"content": "Thank you, Jeff. Third quarter global aesthetics sales were more than $1.2 billion representing growth of 1.8% on an operational basis. In the U.S, aesthetic sales of $791 million increased by 3.9%, driven by growth from Botox Cosmetic as well as other brands across our broad portfolio. U.S. Botox Cosmetic sales were $414 million an increase of 6.5% versus the prior year. Favorable pricing dynamics and facial toxin market growth more than offset modest share erosion. Botox Cosmetics remains the clear market leader. U.S. Juvederm sales were $105 million. Juvederm’s market-leading share was consistent with last year and the overall filler market was roughly flat to the prior year. While the U.S. facial injectable market remains largely stable, growth is below historical rates. As a result, there is a reluctance from customers to maintain traditional toxin and filler inventory levels. Based upon the relatively higher price point of filler procedures in a still challenging U.S. economic environment, Juvederm is more impacted by this dynamic, which can be seen in third quarter results. Internationally, aesthetic sales were $448 million reflecting a decline of 1.6% on an operational basis. Within China, the economic dynamics that weighed on our results during the first half of the year have continued to impact consumer spending. This has created challenging aesthetic market conditions that have been particularly impactful to Juvederm’s performance. Primarily due to this circumstance, we are moderating our Juvederm sales outlook for the year. We are encouraged by the recently announced government stimulus in China. We will continue to monitor for any further developments and how it could positively impact consumer discretionary spending and aesthetic market growth. Although the current dynamics in China are challenging, its potential remains attractive and we are committed to bring innovation to this market that will drive long-term growth. Along those lines, in China, we recently received approval for the Botox Cosmetic indication in masseter muscle prominence, marking the first toxin in the world to have this indication. This approval enables us to market and train to this important treatment option that addresses a top aesthetic concern among many Asian patients. In the U.S., we are pleased that we received FDA approval for the use of Botox Cosmetic to treat platysma bands. This approval positions Botox as the only cosmetic toxin with four distinct indications and enables us to market and train beyond the face for the improvement of neck and jawline appearance. We also remain excited about the opportunity for BoNT/E. Based upon its rapid onset and short acting profile, BoNT/E has the potential to activate new patients that are hesitant to try facial toxins, driving long-term market expansion. Looking to the future, we continue to see significant growth potential for our aesthetics portfolio based upon low market penetration rates, our commitment to introduce novel treatments, our strong customer relationships and our position as the global aesthetics leader. With that, I’ll turn the call over to Roopal."
},
{
"speaker": "Roopal Thakkar",
"content": "Thank you, Carrie. Starting with immunology, where we recently began our Phase 2 Crohn’s disease platform study, which will evaluate Skyrizi in combination with several other novel biologics. This study will initially look at combinations of Skyrizi with our anti-IL-1α/β bispecific lutikizumab and our novel anti-α4β7 antibody ABBV-382. We are planning to include additional novel biologics in the future. Our approach in immunology has been to pursue therapies that are well differentiated and have the potential to elevate standard of care. We have clearly achieved this with Rinvoq and Skyrizi across multiple indications, including Crohn’s disease and ulcerative colitis. As we think about how the IBD market will evolve, we view dual mechanism approaches as having the greatest potential to achieve levels of efficacy that are above current standard of care. We are very excited about the potential for these combination therapies in IBD and we look forward to sharing updates as the data mature. In Oncology, we continue to make very good progress across all stages of our hem and solid tumor pipeline. In the area of solid tumors, we recently submitted our application to the FDA for accelerated approval of Teliso-V as a monotherapy in patients with previously treated c-Met overexpressing EGFR wild type non-squamous non-small cell lung cancer. Once approved, Teliso-V will become the first c-Met targeted ADC to enter non-small cell lung cancer, a segment with limited options and where patients tend to have a very poor prognosis, especially if their tumors express c-Met. We anticipate an approval decision in the first half of 2025. In the quarter, we also received a positive CHMP opinion recommending Elahere for the treatment of platinum resistant ovarian cancer in patients with high expression of FRα and treated with up to three prior therapies. This decision was based on the positive Phase 3 MIRASOL trial where Elahere demonstrated an overall survival benefit and significantly reduce the risk of cancer progression. We anticipate an approval decision in Europe in the fourth quarter. At the recent ESMO Congress we presented new Phase 1 data for ABBV-400 in advanced non-small cell lung cancer and gastroesophageal cancer. Early efficacy data from the lung cohort are promising with an objective response rate of 48% across all patients in the study and response rates ranging from 60% to 78% in patients with overexpressed c-Met. We are very pleased with the level of activity we’re seeing from our next generation c-Met ADC, which compares favorably to Teliso-V, where we’ve seen objective response rates ranging from 23% in medium c-Met expressors to 35% in patients with high c-Met expression. 400 has the potential to expand our c-Met portfolio into earlier lines of therapy and lower levels of c-Met expression in lung cancer. Similarly, in patients with advanced gastroesophageal cancer, 400 demonstrated promising activity with an objective response rate of 29% across all patients. This compares well against combination and single agent chemotherapy, which are the standards of care for patients in second line and third line of therapy respectively. Based on these encouraging preliminary data, we plan to begin Phase 2 studies for 400 in both non-small cell lung cancer and gastroesophageal cancer. Recall, we’ve also advanced 400 in late line colorectal cancer and we remain on-track to begin a Phase 3 study later this year. In the area of hematologic oncology, we received approval in Europe for Tepkinly as a monotherapy treatment for patients with relapsed refractory follicular lymphoma after two or more lines of therapy. Epcoritamab is now the only T-cell engaging bispecific approved in the U.S. and Europe to treat both follicular lymphoma and diffuse large B-cell lymphoma. Moving to neuroscience, we recently received FDA approval for Vyalev as the first subcutaneous 24 hour infusion of levodopa based therapy for the treatment of motor fluctuations in adults with advanced Parkinson’s disease. Our novel subcutaneous levodopa, carbidopa delivery offers meaningful benefits over current treatment options and others that are in development. Vyalev delivers significant improvements in on-time and off-time with a non-surgical 24 hour delivery system. It can deliver high levodopa doses similar to the amount provided by Duopa and it doesn’t require combination with oral drugs to achieve efficacy. We’re extremely excited to bring this transformative therapeutic option to patients in the U.S. We also recently announced positive topline results from the Phase 3 TEMPO-1 trial, which evaluated fixed doses of monotherapy tavapadon in early Parkinson’s disease. In the study, both doses of tavapadon met the primary endpoint demonstrating a significant reduction in the severity of Parkinson’s disease symptoms compared with placebo at week 26, as measured by decreases in the combined scores for Parts 2 and 3 of the Unified Parkinson’s Disease Rating Scale. Key secondary endpoints were also met in this study. We are very pleased with the emerging profile for tavapadon, which shows it is generally safe and well tolerated and it can drive strong efficacy as a monotherapy in early Parkinson’s and as an adjunctive treatment in patients with more advanced disease. Results from the two Phase 3 studies thus far look favorable compared to other dopamine agonists on the market. And, we believe tavapadon has the potential to become an important new treatment option as a monotherapy for Parkinson’s patients as well as an adjunct to oral levo/carbidopa. We expect to see results from TEMPO-2 later this year, which is our Phase 3 monotherapy study evaluating a flexible dose of tavapadon. Results from our long-term safety study, TEMPO-4 are expected next year. As Rob mentioned, we remain on track to share data from the two emraclidine pivotal studies in the fourth quarter. We also continue to invest in external innovation to strengthen our neuroscience pipeline. We recently announced two deals in this area, including an expanded collaboration with Gedeon Richter to develop novel targets for neuropsychiatric conditions and the acquisition of Aliada brings an anti-pyroglutamate Aβ antibody, which uses a unique blood brain barrier crossing and amyloid aggregate clearing technology. Aliada’s lead antibody has been able to achieve encouraging levels in cerebrospinal fluid with an extended half-life and the potential to be delivered subcutaneously. This molecule could become a best-in-class treatment for Alzheimer’s disease. Aliada’s novel technologies for enabling therapeutics to access the central nervous system also have the potential to be used with other programs across our neuroscience pipeline. In aesthetics, we recently received approval for Botox in the U.S. for moderate to severe platysma bands, marking the first global approval in this indication for any neurotoxin. There is currently a lack of non-surgical treatments available to improve the appearance of prominent platysma bands. And, we believe Botox will represent an important new treatment option for patients who are looking to reduce the appearance of vertical neck bands and improve jawline definition. In our novel toxin portfolio, we remain on-track to submit our regulatory application for BoNT/E around the end of this year. Our rapid onset short acting toxin has a highly differentiated clinical profile and once approved will offer patients a novel option compared to currently available neurotoxins. So in summary, this has been a very productive year thus far for our R&D organization and we are pleased with the progress we’ve made advancing our broad pipeline. With that, I’ll turn the call over to, Scott."
},
{
"speaker": "Scott T. Reents",
"content": "Thank you, Roopal. Starting with our third quarter results, we reported adjusted earnings per share of $3 which is $0.10 above our guidance midpoint. These results include a $0.04 unfavorable impact from acquired IPR&D expense. Total net revenues were nearly $14.5 billion reflecting robust growth of 4.9% on an operational basis, excluding a 1.1% unfavorable impact from foreign exchange. Our ex-Humira growth platform, which covers more than 80% of AbbVie’s total sales, delivered reported growth of nearly 18%, once again exceeding our expectations. The adjusted operating margin ratio was 46.7% of sales. This includes adjusted gross margin of 84.4%, adjusted R&D expense of 14.2%, acquired IPR&D expense of 0.6% and adjusted SG&A expense of 23%. Net interest expense was $591 million. The adjusted tax rate was 16.2%. Turning to our financial outlook. We are raising the midpoint of our full-year adjusted earnings per share guidance by $0.15 and now expect adjusted earnings per share between $10.90 and $10.94. Please note that this guidance does not include an estimate for acquired IPR&D expense that may be incurred beyond the third quarter. We now expect total net revenues of approximately $56 billion, an increase of $500 million. At current rates, we expect foreign exchange to have a 0.7% unfavorable impact on full-year sales growth. This revenue forecast includes the following updates to select key products and therapeutic areas. We now approximate Skyrizi global sales of $11.5 billion, an increase of $500 million due to continued strong performance across all approved indications. Rinvoq total revenue of $5.8 billion an increase of $100 million reflecting robust uptake in IBD. U.S. Humira total sales of $7.4 billion a decrease of $400 million reflecting more Humira molecule volume moving to other novel mechanisms, including Skyrizi and Rinvoq. Imbruvica totaled revenue of $3.3 billion an increase of $200 million reflecting higher persistency rates for existing patients. Venclexta total sales of $2.6 billion an increase of $100 million reflecting momentum in both U.S. and international markets. Aesthetics global revenue of $5.3 billion a decrease of $200 million almost entirely due to lower Juvederm volume which continues to be impacted by challenging economic conditions in key markets. Vraylar total sales of $3.3 billion a decrease of $100 million reflecting continued strong prescription demand partially offset by modestly unfavorable channel mix. And for Botox, we now expect global revenue in the therapeutic space of $3.3 billion an increase of $100 million reflecting robust demand across all indications. Moving to the P&L for 2024. We continue to forecast a full-year adjusted gross margin of approximately 84% of sales, adjusted R&D investment of 14%, adjusted SG&A expense of 23.5% as well as an adjusted operating margin ratio of roughly 44.5% of sales, which includes a 2.1% unfavorable impact from acquired IPR&D expense. Turning to the fourth quarter. We anticipate net revenues approaching $14.8 billion. At current rates, we expect foreign exchange to have a neutral impact on sales growth. We expect adjusted earnings per share between $2.94 and $2.98. This guidance does not include acquired IPR&D expense that may be incurred in the quarter and excludes any potential impact from the recently announced acquisition of Aliada Therapeutics. Finally, AbbVie’s robust business performance continues to support our capital allocation priorities. Our cash balance at the end of September was nearly $7.3 billion and we generated more than $11 billion of free cash flow, which includes approximately $1.5 billion of Skyrizi royalty payments in the first nine-months of the year. This free cash flow fully supports a strong and growing quarterly dividend, which we are increasing 5.8% to $1.64 per share, beginning with the dividend payable in 2025, as well as debt repayment, where we remain on-track to pay down the roughly $7 billion of maturities this year and anticipate achieving a net leverage ratio of two times by the end of 2026. Our strong cash flow also provides capacity for additional business development. We have executed more than a dozen early stage deals so far this year, and we continue to assess external innovation across all of our key growth areas. In closing, AbbVie has once again delivered strong top and bottom line results. I’m very pleased with the momentum of our ex-Humira growth platform, including continued robust performance from Skyrizi and Rinvoq, which further supports AbbVie’s long-term outlook. With that, I’ll turn the call back over to Liz."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Scott. We will now open the call for questions. We are aware of a peer earnings call that begins at 9:00 A.M. Central, so we will do our best to wrap up our Q&A right around the top of the hour. So, in the interest of hearing from as many analysts as possible, please limit yourself to just one question. Operator, first question please."
},
{
"speaker": "Operator",
"content": "Thank you. Our first question comes from Chris Schott with J.P. Morgan. You may ask your question."
},
{
"speaker": "Chris Schott",
"content": "Great. Thanks so much for the question, and congrats on the results. My question was really just centered around 2025 and just some preliminary outlook there. I guess a specific question, you mentioned Humira volumes are maybe shifting over to newer drugs. You comment at all about just in terms of where the street sits currently with Humira. I think consensus number is about $6.8 billion. Is that a reasonable forecast, or is that something you could see higher erosion given what’s happening with Humira? And, then bigger picture kind of tied to that, the mid-single-digit topline growth, it sounds like the trends you’re seeing here may be a net positive where maybe Humira volumes are declining, but that’s largely moving over to Skyrizi and Rinvoq. I just want to get some context of is that mid-single-digit target still a reasonable one to think about for AbbVie next year? Thank you."
},
{
"speaker": "Robert A. Michael",
"content": "Thanks for the question, Chris. This is Rob. I’ll start and then I’ll have Jeff supplement. So yes, we are very confident in that robust mid-single-digit growth, both topline, bottom line for 2025. I think you’ve interpreted correctly that the trends we’re seeing are net positive and that we’re seeing over performance from Skyrizi and Rinvoq more than offsetting the dynamics with Humira. And so, as we look at consensus, that’s probably not reflected. So, I think it’s fair to say, there’s a shift that’s required there, but we’re very pleased with the strong uptake for Skyrizi and Rinvoq. As I mentioned in my remarks, we have now delivered guidance increases of $1.3 billion for Skyrizi and Rinvoq in total. We’re seeing tremendous momentum, particularly with the IBD indications across really all indications, but particularly in IBD. And, we are starting to see the dynamic with the overall Humira molecule, where there is the switching that we’re seeing now to other mechanisms, including Skyrizi and Rinvoq, which is a long-term very positive benefit. So, as we look at the business, we’re very well-positioned. Essentially two years after the U.S. Humira LOE, we’ll be returning to robust top line and bottom line growth, and really performance across many parts of the business, not just Skyrizi and Rinvoq. You’ve seen us perform very nicely in oncology. We’ve obviously over performed our expectations in oncology, very pleased with the earlier returns on Elahere. Venclexta is performing exceptionally well. The guidelines changes in Europe are positive as we think about combination opportunities with BTK inhibitors. So, Venclexta is going to be strong, Epkinly is performing very nicely as well. And, then when I look across the neuroscience franchise, Vraylar is a strong grower. We’re very pleased with the migraine portfolio. Obviously, very excited about Cerevel and doing a number of deals now on the early pipeline both with Gedeon Richter and Aliada that really fortifies the long-term view for neuroscience as well. And, then with aesthetics, while it’s below our expectations for this year, obviously the economic conditions have dictated that. We still have tremendous confidence in the long-term outlook for that business. But, as we look at 2025, we’re very confident in our ability to return to that robust mid-single-digit growth."
},
{
"speaker": "Jeffrey R. Stewart",
"content": "Yes. Thanks, Rob. And, I’ll just add a little bit more flavor. It’s Jeff. So, we saw this trend start to emerge in terms of this compression of the, let’s say, the ADAM molecule or the ADAM market, the Humira plus biosimilars, just prior to the CVS event and then it accelerated over Q2. And again, we saw it throughout Q3. So, that’s why we’ve adapted our approach here. Other than this dynamic, the biosimilar dynamics are playing out really exactly as we anticipated. And you can see this compression in the IQVIA data. So, really the shrinking of the Humira or the ADAM market is something that’s quite clear. It’s a little difficult quantify over time with full precision, but we can see that the molecule continues to decline sequentially and we continue to see strong share gains as I highlighted for Skyrizi and Rinvoq. So, this incremental flow from the molecule compression, it’s clearly a contributing factor to some of the over performance that we saw in Q2 and Q3, but it’s really only one of several. We’ve also had significant incremental investments in the consumer space, the sales force approaches we’ve taken, Chris, the integration of the head-to-head data I talked about. And, certainly now we’re starting to see the impact of the UC launch. So, when we put all that together, we think that the dynamics are net-net quite positive overall. And, as Rob said, we’re still looking good for 25%."
},
{
"speaker": "Liz Shea",
"content": "Thank you, Chris. Operator, next question please.,"
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Mohit Bansal. Your line is open. You may ask your question."
},
{
"speaker": "Mohit Bansal",
"content": "Awesome. Thank you very much for taking my question. Just wanted to touch upon the trial you are running head-to-head against Entyvio. Could you help us understand based on pre-clinical or early data, what gives you confidence there? And, are you looking at non-inferiority or potential superiority over Entyvio there? Thank you."
},
{
"speaker": "Roopal Thakkar",
"content": "Mohit, it’s Roopal. I’ll take that one. So, when we look at the data, in particular, I think Jeff highlighted this, in ulcerative colitis with Skyrizi in this naive patient population, this is a patient population that hasn’t seen biologics or other advanced therapies like JAK inhibitors. The endoscopic improvement and this is in label was 76% in the maintenance portion of this. So, it was quite high, in fact, higher than what we’ve observed even with Rinvoq. So that gave us a good amount of confidence that we have the potential to differentiate with all other assets. You heard about the Skyrizi versus, ustekinumab head to head in Crohn’s disease, but this one gives us a unique opportunity there to go head to head with vedolizumab, especially looking at endoscopic improvement. So, for that particular endpoint, you asked about the type of endpoint. There we would think about superiority, because of it being an objective endpoint. Sometimes with symptoms like clinical remission, these could bounce around. That may be one where we consider as non-inferiority. But I would say endoscopic improvements in the field are now believed to be highly predictive of long-term outcomes. So, that would be how we’re looking at this, Mohit."
},
{
"speaker": "Mohit Bansal",
"content": "Thank you very much. Appreciate it."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Mohit. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Thank you. And this question comes from Vamil Divan with Guggenheim Securities. You may ask your question."
},
{
"speaker": "Vamil Divan",
"content": "Great. Thanks for taking the question. So, yes, I’ll give you just one on emraclidine. Just getting a lot of questions from investors kind of leading up to that data release. So, maybe you can just the level set expectations on what you’re hoping to see from the data, especially obviously now we have the approval from Bristol with [Coventry] (ph). Just kind of what are you thinking in terms of efficacy safety profile relative to that competitor? And also on the liver testing requirement that they had at initiation, is that something you’d expect as well based on your data? And then finally just tying to that just in terms of the data release, do you expect to get one press release or do you think you’re combining both studies? Or should we still expect the two separate releases? Thank you."
},
{
"speaker": "Roopal Thakkar",
"content": "Yes, Vamil, it’s Roopal. I’ll take that one. So, a couple of things. Maybe starting with what we’ve observed with the approval. So, we were encouraged by the lack of a boxed warning, meaning there’s a recognition that this is a unique mechanism of action looking specifically at the muscarinic class. So, we were pleased to see that. I think what was notable for us was the GI adverse events, including how that would play out in terms of longer-term tolerability. Also anticholinergic effects, bladder retention that was something I guess we did not anticipate. You mentioned hepatic monitoring that was something that we didn’t anticipate. The other thing that was notable is along with the BID dosing, there is a food effect. So, you have to wait a certain period amount of time when you eat and after you eat when you can take the pill. So, when we think about our profile, we continue to be encouraged with emraclidine being a single agent, once a day, no food effect. We don’t see the extent of GI effects. We don’t and we have not observed in the Phase 1b data any bladder issues. And when we had looked at that 1b data, we didn’t see any hepatic issues, so we don’t anticipate any type of laboratory monitoring. We were also thinking about neurodegeneration associated psychosis and these patients are typically older and likely more sensitive to anticholinergic effects. So, we continue to see an opportunity in that patient population as well. So, we’ve stated that the data will read out here in the next couple of months in the quarter. The same team is working on wrapping up these two studies. So, depending on how far apart the data are, we’ll probably determine as you stated, is it 1 or 2 press releases. It’s a little early right now for us to tell you is it going to be 1 or 2. But if they’re going to be close together, it’s potentially going to be 1."
},
{
"speaker": "Liz Shea",
"content": "Thank you, Vamil. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Terence Flynn with Morgan Stanley. You may ask your question."
},
{
"speaker": "Terence Flynn",
"content": "Hi, thanks for taking the question. Maybe a two part for me. Just wondering if you can I’m assuming contracting is now wrapped up, if you can comment at all on how to think about Skyrizi and Rinvoq, formulary positioning and pricing just high level for 2025. Thank you."
},
{
"speaker": "Jeffrey R. Stewart",
"content": "Yes. Hi, it’s Jeff. So yes, contracting is very, very close to wrapping up. We have a few more nuances and so typically that may take another month or so. Overall, we’re making very good progress on contracting next year. So, in terms of what we’ve highlighted in the past is we do not anticipate any material change for Skyrizi and Rinvoq in terms of the access for next year across Medicare or the commercial plans. We have quite high, very broad access and we assume that will continue. In terms of what we’ve highlighted to anticipate, we’ve said that we do have over our near-term in LRP sort of a negative pricing environment, but it’s modest. It’s nothing like we saw many quarters ago where we had seven indications. So, we said from a rebate perspective, low single digit changes is a reasonable assumption that we feel confident in despite we’re not fully complete, I think that’s a fair assessment at this point."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Terence. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Chris Shibutani with Goldman Sachs. You may ask your question. Chris Shibutani, your line is open. You may ask your question."
},
{
"speaker": "Chris Shibutani",
"content": "Apologies, I was on mute. Thanks for the question. All the comments you’ve made about Skyrizi or Rinvoq and the molecule switching are very helpful. Just curious as we think on the forward about other potential mechanisms and modalities in particular. I think we have competitor oral data that’s coming up. Interested to hear your thoughts in terms of that modality difference as well as, how you might rank your optimism for some of the new mechanisms of action? I believe you have a TL1A as well in your pipeline though earlier stage. Thank you."
},
{
"speaker": "Roopal Thakkar",
"content": "Hi, Chris. It’s Roopal. I’ll take that one. With respect to the oral, I’ll take us back to the Skyrizi head-to-head that occurred with apremilast, which is also an oral. The data were substantially higher from an efficacy standpoint for Skyrizi as was the tolerability along with when we asked patients what did they prefer, they actually preferred quarterly subcutaneous dosing. So, I would think about it that way as well. Now the question would be, it’s a similar mechanism, could the efficacy be better than what has been observed with a apremilast in psoriasis? Well, what we saw in the Phase 2 data, my recollection still is that Skyrizi is a full 50% higher when it comes to full skin clearance at a PASI 100. And that’s where the bar is now at PASI 90 and PASI 100. So, we still see an efficacy advantage. Also the data I’m sharing are Phase 3 Skyrizi data. The data that we saw for the oral 23 was from Phase 2. So, there is a reasonable potential that the efficacy data tend to settle down when you go to a broader patient population, especially those that have had longer standing disease or have seen other therapies like other biologics. So, we continue to feel very good and optimistic about our profile versus any emerging competition. Also, we think about our assets from a global standpoint. And when you think about majority of the countries, they are very driven by efficacy to gain access. And in the oral space, we don’t really see it across the globe. Maybe there’s a couple of countries. I think Jeff has mentioned the U.S., but that space may be referred to as a pre biologic space. So maybe more of an influence on the TIK2 or on a apremilast is how we see it. In terms of other mechanisms that we like, as I mentioned, we like anti L23 the way it’s delivered with Skyrizi, the depth of response, the high durability and the convenience with quarterly dosing. If we can couple that with other assets as part of our combination approach, we think that’s going to be extremely competitive in the future. Mechanisms like TL1a, we think are going to be important, especially from a combination approach, which we have one internally. We think the ulcerative colitis data are encouraging, but from a monotherapy standpoint, not differentiated, especially when you look at the Skyrizi data that I mentioned earlier and Rinvoq. And then in Crohn’s, something like TL1a, we think it really does need a combo. So that’ll be part of our platform along with our novel alpha 4 beta 7, we think that’s also a good combo. And then we’ve also provided very strong data in hidradenitis suppurativa with our IL-1 alpha beta lutikizumab. And we’ve seen some preclinical signals that IL-1 beta could be a driver of disease and resistance to other biologics. So, lutikizumab will also be part of the combo in our IBD platform. So, that’s just some of the mechanisms that we’re excited about. There are several others that are early in the pipeline and we will give you more information about those as the data mature."
},
{
"speaker": "Chris Shibutani",
"content": "Thanks very helpful."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Craig. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Trung Huynh with UBS. You may ask your question."
},
{
"speaker": "Trung Huynh",
"content": "Hi, guys. Thanks for taking my question. Just on the aesthetics business, in the Q&A you did mention that you still have a tremendous amount of confidence hitting that longer term guide here. I’m curious on how dependent this is on the economic environment getting better and getting better quickly. So, you’ve moderated your Juvederm outlook this year because it’s not being good. If next year is another challenging economic year, could we see that $9 billion in 2029 being moderated or even pulled? Just what’s giving you confidence? Thank you."
},
{
"speaker": "Robert A. Michael",
"content": "Thanks for the question. This is Rob. I’ll take that one. So, as we think about the long-term guide, which is greater than $9 billion by 2029, you need to believe that you can have essentially a compound growth around 11% to get there. If we look at the historical growth of this market, it’s been, let’s say, call it low double digits, low teens. As we look at it going forward, we think probably a more prudent assumption is when we see the recovery, something more in the high single digits, right? So, you need something beyond just the market recovery to get there. And when we look at our the innovation that we’re bringing particularly with the short onset, short acting or fast onset short acting BoNT/E that we expect to launch in ‘26. That could really transform the market, because if you think about the number one barrier for patients is fear of an unnatural look. That could really unlock a part of the market that’s dormant right now, plus it could also lead to share gains. And so I think we need to see, 1, how the market recovers, I would say, 2025 and 26 and then ultimately see how the BoNT/E launch ramps in ‘26. At that point, we’ll have a better sense of the $9 billion as we sit here today. If you believe that the market will recover to high single digits and we have a lot of confidence in BoNT/E, we still believe we can get there, which is why we’re not updating that guidance. But I would expect us to reflect more on that more likely in the ‘26 timeframe than in ‘25."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Trung. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Geoff Meacham with Citi. You may ask your question."
},
{
"speaker": "Geoff Meacham",
"content": "Good morning, everyone. Thanks for the question. I had a bigger picture one for Rob. So, when I look at your therapeutic areas, eye care stands out as one that’s pretty modest contributor today and also down the road. How would you rank that business strategically? And then related when you look at BD going forward, are there other TAs that you’re looking at that could be additive, just thinking specifically maybe metabolic or cardio? Thank you."
},
{
"speaker": "Robert A. Michael",
"content": "Thanks for the question, Geoff. So, this is Rob. So yes, I mean, our main focus is our five key growth areas, which includes eye care, includes immunology, oncology, neuroscience, aesthetics and eye care. And we participate in large markets with high unmet need that have great growth potential. And within those five verticals, we’re building depth across 24 core areas that does include eye care as well. When you think about diabetic retinopathy, wet AMD, prescription dry eye medications. And so eye care does play an important role, albeit it’s not as high of a growth driver as the other four verticals, but it is part of our five. And that ultimately guides both our internal R&D investments as well as our BD efforts, which as you know, continue to be very active. So, far this year, we’ve executed 15 deals along those lines, really focused more on early stage opportunities to drive growth in the next decade. So that’s our primary focus. Now if we see an opportunity for differentiation in a large market with high unmet need like metabolics, we would consider pursuing it, especially if we can help drive growth in the next decade. But again, it would be more opportunistic. We have to see differentiation and right now it’s not our primary focus. But again, we’re open to more sources of growth for the next decade if we see differentiation that we can create value. And we certainly have the financial wherewithal to pursue those opportunities."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Geoff. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from James Shin with Deutsche Bank. You may ask your question."
},
{
"speaker": "James Shin",
"content": "Good morning, guys. Thanks for taking our question. For emraclidine’s readout, I think there’s a question on how much erosion could be anticipated. I know you mentioned that the team the same team that was originally working on the Phase 1b is wrapping up studies and so forth. But there’s been some other data that has copied some of Cerevel strategies such as high baseline pans and so forth and placebo effect was still kind of surprisingly higher than it should be. Is there any insight on managing this placebo effect? Thank you."
},
{
"speaker": "Roopal Thakkar",
"content": "Thanks, James. It’s Roopal. When we did our thorough diligence, that was a major question that we and the broader team had. So, you bring up a good point. Some things that we observed in those two studies that will be the pivotal readouts were what Cerevel was strategically doing. One thing was limiting the number of countries, limiting the number of sites, central review for eligibility criteria, training of raters, certifying those raters, recertifying raters, monitoring blinded data with respect to site activity. So, I think those are important factors that could drive placebo in either direction. So, what we observed was, we would say a good control or at least the best one could do to manage placebo responses. So, it’s hard to know what if there’s any erosion until we see the data. But the effect size that we did see in the Phase 1b was a little over 12 points. So, we think that was a strong separation. And even if that were to go down a little bit, we still feel that based on the safety profile and tolerability profile, this could still be very, very competitive even if we saw a droppage in some point on the efficacy side."
},
{
"speaker": "Liz Shea",
"content": "Thanks, James. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Carter Gould with Barclays. Your line is open. You may ask your question."
},
{
"speaker": "Carter Gould",
"content": "Great. Good morning. Thanks for taking the questions. I was hoping to follow-up a little bit on the Aliada acquisition, sort of what differentiation you saw over some of the other enhanced brain delivery kind of approaches there that gave you confidence. And maybe we’ve seen AbbVie take a number of shots on goal across Alzheimer’s here, just seems pretty central to your longer term neuroscience portfolio. Can you maybe just again put that in some broader context as you think about the TA strategy longer term? Thank you."
},
{
"speaker": "Roopal Thakkar",
"content": "Sure. It’s Roopal. I’ll take that. Yes, we’ve been investing for a number of years in the space. And in addition to the recent deal, we’ll have an option readout with Alector and TREM2 coming up. We have SV2A molecule that would look at cognition and other symptoms. Emraclidine could participate in that space from an Alzheimer’s psychosis standpoint. We have other pipeline assets that are looking at tau, intracellular and even an approach looking at extracellular tau. We did have our own A beta monotherapeutic antibody, which we did read out. It did look good, but it wasn’t fully differentiated. And moving on to the Aliada deal, what we see there is the ability to access the CSF at what we would say at this stage at higher concentrations than maybe other competitors. So, we think that’s a good thing. The other aspect that we like is an extended half-life. So that could lead to convenient dosing. And if this approach plays out than one could consider having subcutaneous dosing even getting out to monthly. And if the efficacy is high because of deeper brain penetration that could result in lower levels, faster and a better able to see cognition benefit in a year or 18 months. So, those are some of the benefits that we would see. The other benefit would be getting to the parenchymal tissue more broadly and that could have a reduction in ARIA, which is probably what is disallowing this to really take off. It’s very challenging to take an elderly family member to get multiple scans and worry about them having stroke like symptoms. So, that would be something else we believe we can address with this asset of having a strong safety profile, tolerability, ease of onboarding and high efficacy and ultimately strong benefits on cognition."
},
{
"speaker": "Robert A. Michael",
"content": "And this is Rob. I’ll just add on here as we think about strategically about the neuroscience franchise. I mean, I think about it as having really four main segments, psychiatry, migraine, Parkinson’s and then neurodegeneration. And if you look at what we’ve done to build out the long-term growth outlook for this franchise, obviously, in psychiatry between Cereval, Gedeon Richter, we also had the early stage opportunity with Gilgamesh, really investing in longer term growth in psychiatry. We have actually a very strong franchise in migraine with the oral CGRPs as well as Botox Therapeutic. In Parkinson’s, now the launch of Vyalev, which is performing very nicely outside the U.S., and we expect will also perform nicely in the U.S. The early Phase 3 data we’ve seen so far for davapidone, the mitokinin disease modifying approach, it’s early and Parkinson’s is another investment we’ve made. And then in Alzheimer’s now with Aliada is another I’d say, long-term investment we’re making to grow the neuroscience franchise. There’s also adjacencies like ALS, MS that we’re interested in that we have some partnerships that we’ll continue to pursue. So, we see neuroscience as an important long-term growth driver for the company. We’re obviously investing heavily across a number of areas. But we think about really in those four categories, and so it’s one that we’re obviously very excited about the future prospects for."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Carter. Operator, next question please."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Steve Scala with Cowen. You may ask your question."
},
{
"speaker": "Steve Scala",
"content": "Thank you so much. I’m a bit surprised that how Cerevel was such a focus in the prepared remarks given the pending emraclidine data, which very much will color views of the Cerevel acquisition. Should we conclude you have increased confidence and or insight into the pending data? And related to that, KOLs seem to be looking for an effect size of 0.6. But based on what was just said, that doesn’t even seem to be a possibility. So, any thoughts would be appreciated. Thank you."
},
{
"speaker": "Robert A. Michael",
"content": "This is Rob and Roopal can take the second part. I’ll take the first part of the question. So, Steve, in the prepared remarks, we were talking about the quarter. We obviously closed the Cerevel transaction in the quarter. That’s a significant event. We also did see the Phase 3 trial results for tavapadon, so that was important to comment as well. As we’ve mentioned, we expect the two pivotals from emraclidine to read out in the fourth quarter. So, I wouldn’t read too much into it other than it was an important event to highlight in the quarter."
},
{
"speaker": "Roopal Thakkar",
"content": "Yes. And it’s Roopal. I agree. We have two positive Phase III studies with tavapadon. And in the oral space, I don’t know if we’ve seen a new mechanism that could have this type of approach in a very long time. So, it is important to discuss that because the unmet need continues to be very high and Parkinson’s is a place where we believe we can meaningfully participate in. On the effect size question, when we look at the 1b data, it was more than a 12 point differential. So we have observed sometimes a decrement and the question was around if placebo responses move up a little bit. So that being said, we still think we can maintain a very strong effect size coupled with the safety profile. Remember that the issue here in therapy isn’t just about efficacy, it’s about maintaining these patients on a drug that they can tolerate. And the majority of these patients don’t last very long and cycle through these assets and even stop these, especially atypicals without even letting their physicians know and then go on to have a flare and end up in the hospital. So, we think about this as a benefit, risk and tolerability profile and from a weight, metabolic, motor symptoms, sedation, these are major problems with atypicals. And with something like emraclidine, we feel that we can still fully differentiate. So, I don’t know if I’d read into any concerns other than maybe seeing an effect that’s slightly different than what we saw in Phase 1b. But beyond that, we think this could still be very competitive."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Steve. Operator, we have time for one final question."
},
{
"speaker": "Operator",
"content": "Thank you. Our final question comes from Luisa Hector with Berenberg. You may ask your question."
},
{
"speaker": "Luisa Hector",
"content": "Hello. Thanks for taking my question. Just on Vraylar, could you expand a little on the comments of the channel mix pressure in Q3 and how that will play out as we move forward? And perhaps just a quick comment on the extension of the collaboration with Gedeon Richter and why you went down that route? Thank you."
},
{
"speaker": "Scott T. Reents",
"content": "Luisa, this is Scott. I’ll take the question regarding Vraylar. So, essentially it was a channel mix change. It was slight. I would tell you that really kind of had accumulated over the course of the year. And that’s why we made, we decided it made sense to make the adjustment. So, as that channel mix change, we saw a little bit of negative price as a result of that. So, we took down the regular guidance by $100 million. Now, I would note in neuroscience in totality that was offset by the raise in Botox Therapeutics. So, neuroscience in our therapeutic or growth area guide is stable. So, maybe the second question will go to Roopal."
},
{
"speaker": "Roopal Thakkar",
"content": "Yes. It’s Roopal. We expanded further. We’ve had strong partnership. They’re a terrific organization. We have a follow on to Vraylar that’s more D3 meaning that will start entering the clinic quite soon in Phase II looking at bipolar depression and MDD as well as generalized anxiety disorder. As Rob described as part of our neuroscience strategy, psychiatry is a big part of that and having a deeper relationship with Gedeon Richter will allow us to have potentially even more assets in depression, in bipolar disorder, in schizophrenia and anxiety and potentially other adjacent indications that we continue to be interested in because the unmet need continues to be very high."
},
{
"speaker": "Liz Shea",
"content": "Well, thank you, and thanks, Shirley. That concludes our conference call today. If you’d like to listen to a replay of the call, please visit our website at investors.abbvie.com. Thanks again for joining us."
},
{
"speaker": "Operator",
"content": "Thank you. And this concludes today’s call. We thank you for your participation. And at this time, you may disconnect your lines."
}
] |
abbv | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning and thank you for standing by. Welcome to the AbbVie Second Quarter 2024 Earnings Conference Call. All participants will be in a listen-only mode until the question-and-answer portion of this call. [Operator Instructions] I would now like to introduce Ms. Liz Shea, Senior Vice President, Investor Relations."
},
{
"speaker": "Liz Shea",
"content": "Good morning and thanks for joining us. Also on the call with me today are Rob Michael, Chief Executive Officer; Jeff Stewart, Executive Vice President, Chief Commercial Officer; Roopal Thakkar, Executive Vice President, Research and Development, Chief Scientific Officer; Scott Reents, Executive Vice President, Chief Financial Officer; and Carrie Strom, Senior Vice President, AbbVie and President, Global Allergan Aesthetics. Before we get started, I’ll note that some statements we make today may be considered forward-looking statements based on our current expectations. AbbVie cautions that these forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those indicated in our forward-looking statements. Additional information about these risks and uncertainties is included in our SEC filings. AbbVie undertakes no obligation to update these forward-looking statements except as required by law. On today’s conference call, non-GAAP financial measures will be used to help investors understand AbbVie’s business performance. These non-GAAP financial measures are reconciled with comparable GAAP financial measures in our earnings release and regulatory filings from today, which can be found on our website. Following our prepared remarks, we’ll take your questions. So, with that, I’ll turn the call over to Rob."
},
{
"speaker": "Rob Michael",
"content": "Thank you, Liz. Good morning, everyone, and thank you for joining us. It’s a pleasure to speak with you today as AbbVie’s new CEO. I look forward to building on our track record of success and delivering on AbbVie’s promise to our patients, employees, shareholders and communities. As we begin this new chapter, nearly every aspect of AbbVie’s business is performing at or above our expectations. We are demonstrating a rapid return to revenue growth, with operational sales up nearly 4% through the first half of this year, including robust mid-single-digit growth in the second quarter. Our ex-Humira growth platform, which covers more than 80% of AbbVie’s total sales, will outperform our initial full year sales guidance by more than $1 billion, driven by strong performance in immunology and oncology. In addition, U.S. Humira performance continues to meet our expectations, having achieved or exceeded our guidance in all six quarters with biosimilar competition. The strong performance across our diversified portfolio will drive top-tier high single-digit compound growth through the end of this decade, which will support continued investment to drive growth in the next decade. Turning to our results, I’m especially pleased with immunology, where our leading portfolio is delivering performance well above our expectations. Skyrizi continues to demonstrate strong momentum in psoriasis and Crohn’s disease, where we have substantial headroom for additional share gains and the recent approval in UC will add another source of long-term growth. Rinvoq is also delivering robust growth across all approved indications. We are making excellent progress with late-stage development in five additional indications that we anticipate will launch in the second half of this decade. In oncology, Elahere has accelerated our on-market presence in solid tumors. We also have several exciting pipeline programs, including two novel c-Met ADCs for solid tumors, Teliso-V and 400, as well as 383, our BCMA CD3 bispecific for multiple myeloma. In neuroscience, our leading therapies for migraine and mood disorders continue to gain share and are competitively well-positioned. The pending acquisition of Cerevel will further augment our neuroscience pipeline and we’re excited about what our two companies can achieve together to make a difference for patients with neuropsych disorders. We have certified substantial compliance to the FTC second request and anticipate the Cerevel transaction will close soon. Lastly, we’ve been very active with business development, investing in exciting opportunities that can drive growth in the next decade. Through the first half of this year, we have executed nearly a dozen early-stage deals. These include promising technologies and innovative mechanisms that can elevate the standard-of-care in immunology, oncology and neuroscience. In summary, I’m very pleased with the strong momentum of our business. AbbVie’s results once again exceed our expectations and we are raising guidance for the second time this year, underscoring our confidence in the business. The robust performance of our growth platform and the advancement of our pipeline supports AbbVie’s top-tier long-term outlook. With that, I’ll turn the call over to Jeff for additional comments on our commercial highlights. Jeff?"
},
{
"speaker": "Jeff Stewart",
"content": "Thank you, Rob. We continue to demonstrate strong commercial execution across our therapeutic portfolio. I’ll start with the quarterly results for immunology, which delivered total revenues of approximately $7 billion. Skyrizi and Rinvoq are performing exceptionally well, contributing more than $4.1 billion in combined sales this quarter, reflecting operational growth of 50% in their fifth full year on the market. These assets are approved across a broad set of indications and are collectively supported by nine compelling head-to-head studies that demonstrate clear differentiation across multiple novel therapies, which has resulted in strong share capture. For Skyrizi, we continue to advance our clear leadership position in psoriasis, where total prescription share of the U.S. biologic market has increased to approximately 38%. Share is also ramping nicely in PSA, especially in the dermatology segment, where Skyrizi has achieved roughly 15% total prescription share in the U.S. biologic market. And for Rinvoq, we are seeing increasing share across each of the rheum indications, as well as additional momentum in atopic dermatitis, including total prescription share of 10% in the U.S. We are very excited about the growth potential in gastroenterology, where Skyrizi and Rinvoq are on pace to double their respective sales in IBD this year. The adoption in Crohn’s disease has been impressive, with Skyrizi and Rinvoq now achieving a combined in-place share in the U.S. of more than 40%. Skyrizi has achieved overall in-place share leadership in Crohn’s, with in-place share approximately now 13 points ahead of Stelara, following our compelling head-to-head sequence data published last year. This positive trial, which demonstrated Skyrizi’s high efficacy versus Stelara, including a more than doubling of effect in endoscopic remission has driven a significant inflection in performance and we anticipate continued share momentum. Commercialization for Skyrizi and ulcerative colitis is now underway in the U.S., with broad formulary access anticipated to ramp quickly over the next several months. Early feedback from gastroenterologists has been very encouraging, with Skyrizi’s UC data viewed as impressive, particularly for naïve patients who have not been exposed to biologics. We also expect the European launch in the coming months. We also see very robust adoption of Rinvoq in UC, where the brand is now achieving a leading in-place share in the U.S. Internationally, Rinvoq UC is now approved in 75 countries, with reimbursement and share gaining momentum. Having two novel therapies that each deliver differentiated levels of efficacy to treat both of these IBD conditions demonstrates our commitment to transforming the treatment landscape for physicians and patients in this area of high unmet need. Turning now to Humira, which delivered global sales of $2.8 billion, down 28.9% on an operational basis due to biosimilar competition. Erosion in the U.S. was in line with our expectations in the quarter and our guidance complicates -- contemplates the impact of additional formulary changes over the course of the year. Importantly, we continue to anticipate that Humira will maintain parity access to biosimilars for a significant majority of patient lives this year. Moving now to oncology, where total revenues were more than $1.6 billion. Imbruvica global revenues were $833 million, down 8.2, reflecting continued competitive dynamics in CLL. Venclexta global sales were $637 million, up 15.8 on an operational basis, with strong momentum across CLL and AML. Elahere is also performing very well, with sales of $128 million and our compelling overall survival data, recent positive updates in the NCCN guidelines and the expansion of commercial resources will continue to drive rapid uptake. Lastly, we continue to be pleased with the prescription trends for Epkinly in DLBCL. Commercialization is now underway for Epkinly’s second indication, follicular lymphoma, in the U.S., with European approval expected later this year. Neuroscience total revenues were nearly $2.2 billion, up 15.2% on an operational basis. This robust performance is driven by continued double-digit growth of Vraylar, with global sales of $774 million, Ubrelvy with total revenue of $231 million and Qulipta with global sales of $150 million. Each of these leading assets continue to gain share and remain competitively well-positioned. Botox Therapeutic is also performing well, especially in chronic migraine. Total global sales were $814 million, up 9.6% on an operational basis. Finally, we are pleased with the early launch trends for 951 in Japan and Europe, and look forward to bringing this innovative therapy for advanced Parkinson’s to the U.S. soon. Overall, I’m extremely pleased with the momentum across the therapeutic portfolio. And with that, I’ll turn the call over to Carrie for additional comments on aesthetics. Carrie?"
},
{
"speaker": "Carrie Strom",
"content": "Thank you, Jeff. Second quarter global aesthetic sales were approximately $1.4 billion, representing growth of 2.8% on an operational basis. In the U.S., aesthetic sales of $863 million increased by 4.4%, driven by Botox Cosmetic and Juvederm growth of 7.1% and 10.4%, respectively. This toxin and filler performance is supported by a consistent recovery in the facial injectable market, as the number of procedures in both categories increased by a mid-single-digit percentage versus the prior year. However, this level of market growth was lower than previously anticipated. Sales for Botox Cosmetic and Juvederm also benefited from a partial reversal of the prior quarter’s inventory destock, which was related to the timing of certain promotional activities. From a competitive perspective, our U.S. facial injectable portfolio remains the clear market leader, with strong and stable market share. Internationally, second quarter aesthetic sales were $527 million, roughly flat versus the prior year on an operational basis, as declines in China were balanced by growth in other international markets. In China, our largest international market, sales growth continued to be impacted by sustained economic headwinds, as well as a challenging comparison to the second quarter of last year, which benefited from a strong post-COVID recovery. Consistent with what we experienced in the U.S., economic challenges have impacted Juvederm sales growth more than other areas of our portfolio, based upon Juvederm’s relatively higher price point. Looking to the rest of the year, we expect our market-leading aesthetics portfolio to continue to perform well from a competitive perspective across the globe. As we evaluate market dynamics and leading economic indicators, particularly in the U.S. and China, market growth trends are below our prior expectations. Based upon this, we have moderated our outlook for the remainder of the year. Despite this near-term dynamic, we remain confident in the long-term growth outlook of our aesthetics portfolio. Global market penetration rates are extremely low and we expect long-term market growth to accelerate from current levels as economic conditions improve. As the market leader, we are also committed to driving growth by activating new patients and launching innovative treatment options. For example, in China, launch activities are underway for the Botox Cosmetic masseter muscle prominence indication. And in the U.S., we will soon launch Juvederm VOLUMA XC for the treatment of temple hollowing and we expect an approval for Botox Cosmetic in the platysma prominence indication by the end of the year. Pipeline catalysts like these in the key U.S. and China markets, along with our significant investment in consumer activation, injector training and practice support, will enable us to grow the aesthetics market and maintain our clear leadership position over the long-term. With that, I’ll turn the call over to Roopal."
},
{
"speaker": "Roopal Thakkar",
"content": "Thank you, Carrie. We continue to make very good progress advancing our pipeline with several regulatory and clinical milestones since our last earnings call. I will start with immunology. We received FDA approval for Skyrizi in ulcerative colitis, which marks its second inflammatory bowel disease indication. Skyrizi is now the only IL-23 specific inhibitor approved for both ulcerative colitis and Crohn’s disease. Skyrizi has proven to be a highly effective, durable, safe and well-tolerated treatment option for patients with moderate to severe inflammatory bowel disease. And this recent approval further strengthens AbbVie’s leadership position in this market. We also received a positive CHMP opinion recommending Skyrizi for the treatment of moderate to severe ulcerative colitis in Europe, with an approval decision anticipated soon. Earlier this month, we submitted our regulatory applications in the U.S. and Europe for Rinvoq and giant cell arteritis. Our submissions are based on the previously announced Phase 3 results from our SELECT-GCA trial, where Rinvoq demonstrated superiority compared to placebo on sustained remission from week 12 through week 52 on disease flare and showed a reduction in total steroid exposure at week 52. We expect approval decisions for this indication next year. We also recently began a Phase 3 study for lutikizumab, our anti-IL-1-alpha-beta-bispecific in hidradenitis suppurativa. HS is a skin disease that can be debilitating and there are limited treatment options. In our Phase 2 study, lutikizumab demonstrated strong clinical response rates and improvement in skin pain in a very refractory patient population. Based on these results, we believe lutikizumab has the potential to become an important new treatment option for patients with moderate to severe HS. We look forward to providing updates on the Phase 3 program as the data become available. In the second quarter, we announced two additional immunology transactions as we continue to invest in external innovation to expand our pipeline. These include the acquisition of Celsius Therapeutics, which brings a Phase 2 ready anti-TREM1 antibody for IBD and a license agreement with FutureGen to develop a next-generation anti-TL1A antibody for IBD that is designed to have less frequent dosing compared to other TL1As in development and will be evaluated in combination with Skyrizi. This follows the four immunology deals we announced earlier this year, which, as a reminder, included the acquisition of Landos and their oral NLRX1 agonist in Phase 2 for UC, a partnership with OSE to develop a novel ChemR23 agonist for IBD and RA, a collaboration with Parvus to utilize their immune tolerization platform for novel IBD therapies and a collaboration with Tentarix to develop conditionally active multi-specific biologics in immunology and oncology. Moving to oncology, where we continue to make very good progress across all stages of our heme and solid tumor pipeline. In the area of solid tumors, we recently announced positive topline results from our Phase 2 PICCOLO study evaluating Elahere as a monotherapy in ER alpha positive third-line plus platinum-sensitive ovarian cancer for those not eligible for retreatment with platinum-based therapies. Elahere met the primary and key secondary endpoints in the study, demonstrating an objective response rate of 52% and median duration of response of 8.25 month. Detailed results will be presented at an upcoming medical congress. Following discussions with the FDA, we will be submitting to Teliso-V for accelerated approval as a monotherapy in patients with previously treated c-Met overexpressing EGFR wild-type non-squamous, non-small-cell lung cancer. This submission will be reviewed under FDA’s real-time oncology review program. Teliso-V has also received breakthrough therapy designation from the FDA. Our submission will be based on the results of our Phase 2 LUMINOSITY study, where Teliso-V demonstrated strong clinical benefits across key endpoints, including overall response rate, duration of response and overall survival, with a tolerable safety profile. Submission is expected in the third quarter, with an approval decision anticipated in 2025. The confirmatory Phase 3 study for this potential accelerated approval is currently ongoing. We continue to see encouraging data for ABBV-400, our next generation c-Met ADC, which uses a topo payload. Recall that we’ve advanced 400 in late-line colorectal cancer based on the deep responses and prolonged durability observed as a monotherapy in our Phase 1 trial. And we remain on track to begin a Phase 3 study later this year in third-line CRC. We’re also seeing encouraging signals of activity for this next-gen ADC in the non-small-cell lung cancer cohort from our Phase 1 study. The preliminary data will be presented at an upcoming medical meeting. And based on the emerging Phase 1 results, we plan to begin a Phase 2 program for 400 in lung cancer. In the area of hematologic oncology, we received accelerated approval in the U.S. for Epkinly as a monotherapy treatment for patients with relapsed refractory follicular lymphoma after two or more lines of prior therapy. Epkinly is now the only T-cell engaging bispecific approved in the U.S. to treat both follicular lymphoma and diffuse large B-cell lymphoma. We’re extremely excited to bring this new subcutaneous treatment option to patients suffering from follicular lymphoma. We also recently received positive CHMP opinion with an approval decision in Europe expected later this year. In the quarter, we initiated a Phase 3 monotherapy study for ABBV-383 in third-line multiple myeloma. 383 is designed for high affinity binding to BCMA on malignant cells and low affinity binding to a unique CD3 epitope on T-cells, which has the potential to mitigate some of the adverse events associated with other T-cell engaging BCMA-based therapies while preserving high levels of efficacy. We remain excited about this asset’s potential to become a best-in-class BCMA CD3 bispecific by providing deep, durable responses and low incidence and severity of CRS, with the potential for outpatient administration, limited or no step-up dosing and monthly administration from the beginning of treatment. In addition to our Phase 3 monotherapy program, we have an ongoing Phase 1 study in later lines of multiple myeloma to evaluate 383 in various combinations, including with Pomalyst, Revlimid and Darzalex. Based on this work, we will begin Phase 2 combination studies in earlier lines of therapy next year. Moving to neuroscience, where in the quarter we announced that we received a complete response letter for our 951 regulatory application in the U.S. The CRL is based on observations identified during an inspection at a third-party manufacturing site that was unrelated to 951. The CRL did not identify any issues related to the safety, efficacy or labeling of 951, nor has the FDA requested any additional clinical data or device-related testing. We’re working closely with the site and the FDA to get clarity on timelines and we’ll provide updates as soon as information becomes available. Moving to an update on one of our Alzheimer’s disease programs. We recently completed an interim analysis of a Phase 2 study evaluating ABBV-916, our A-beta antibody. The emerging efficacy and safety profile in this study is similar to what has been demonstrated by approved agents. However, given the evolving landscape, we do not believe 916 as a monotherapy treatment will be sufficiently differentiated from other emerging therapies. As a result, we are discontinuing further development for 916 as a standalone antibody. As Rob mentioned, we remain on track to close the Cerevel transaction soon and we look forward to welcoming the team into our R&D organization. The emraclidine pivotal studies in schizophrenia remain on track to begin reading out near the end of this year. We’ll also see data from two additional Phase 3 studies for davapidon in Parkinson’s disease later this year. We look forward to providing updates on these programs once the transaction has closed and data are available. In aesthetics, we recently received approval for Botox in China for masseter muscle prominence, marking the first global approval in this indication for any neurotoxin. Masseter prominence is common in Asian populations and there is significant unmet need for minimally invasive treatment options. We anticipate high demand for Botox in this novel indication in China, which will help to further build our portfolio in the face-shaping segment. A regulatory application is under review in the U.S. for Botox and platysma prominence, which is another novel indication that will help build our position in the lower face and neck segment. We continue to expect an FDA approval decision later this year. And we remain on track to submit a regulatory application for BoNT/E near the end of this year. A rapid-onset, short-acting toxin has a highly differentiated clinical profile and once approved would offer patients a novel option compared to currently available toxins. So, in summary, we’ve made great progress across all of our therapeutic areas in the first half of the year and we look forward to additional data readouts, regulatory submissions and approvals throughout the remainder of 2024. With that, I’ll turn the call over to Scott."
},
{
"speaker": "Scott Reents",
"content": "Thank you, Roopal. Starting with our second-quarter results, we reported adjusted earnings per share of $2.65, which is $0.10 above our guidance midpoint. These results include a $0.52 unfavorable impact from acquired IPR&D expense. Total net revenues were nearly $14.5 billion, $450 million ahead of our guidance and reflecting robust growth of 5.6% on an operational basis, excluding a 1.3% unfavorable impact from foreign exchange. Importantly, these results reflect more than 18% sales growth from our ex-Humira growth platform. Adjusted gross margin was 85.2% of sales. Adjusted R&D expense was 13.3% of sales and adjusted SG&A expense was 22.9% of sales. The adjusted operating margin ratio was 42.6% of sales, which includes a 6.5% unfavorable impact from acquired IPR&D expense. Net interest expense was $506 million. The adjusted tax rate was 18.8%. Turning to our financial outlook, we are raising our full year adjusted earnings per share guidance by $0.10 to between $10.71 and $10.91. This EPS guidance continues to contemplate approximately $0.19 of dilution for the pending acquisition of Cerevel, which is expected to close soon. Please also note that this guidance does not include an estimate for acquired IPR&D expense that may be incurred beyond the second quarter. We now expect total net revenues of approximately $55.5 billion, an increase of $500 million. At current rates, we expect foreign exchange to have a 1% unfavorable impact on full year sales growth. This revenue forecast includes the following updated assumptions with the entire sales increase, once again, driven by our ex-Humira growth platform, which is now on pace to deliver nearly $6 billion of sales growth in 2024. We now expect Skyrizi global sales of approximately $11 billion, an increase of $300 million due to strong performance across all approved indications. Rinvoq, total revenue of approximately $5.7 billion, an increase of $100 million reflecting continued robust uptake in IBD. Venclexta total sales of approximately $2.5 billion, an increase of $100 million reflecting momentum in both U.S. and international markets. And for aesthetics, we now expect global revenue of approximately $5.5 billion. Given slower-than-expected near-term market growth, particularly in the U.S. and China, as a result, our total sales guidance for Botox and Juvederm will each be lower by roughly $100 million. Moving to the P&L for 2024, we continue to forecast a full year adjusted gross margin of approximately 84% of sales, adjusted R&D investment of 14% and adjusted SG&A expense of 23.5%. We now anticipate an adjusted operating margin ratio of roughly 44.5% of sales, in line with our previous expectations after including the approximately 2% impact of acquired IPR&D expense incurred through the second quarter. And we forecast our non-GAAP tax rate to be approximately 16.3%, also reflecting the impact of IPR&D. Turning to the third quarter, we anticipate net revenues of approximately $14.2 billion. At current rates, we expect foreign exchange to have a 1.3% unfavorable impact on sales growth. We expect adjusted earnings per share between $2.92 and $2.96. This guidance does not include acquired IPR&D expense that may be incurred in the quarter. In closing, AbbVie has once again delivered outstanding performance and I’m very pleased with the strong momentum across the portfolio heading into the second half of the year. With that, I’ll turn the call back over to Liz."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Scott. We’ll now open the call for questions. In the interest of hearing from as many analysts as possible over the remainder of the call, we ask that you please limit your questions to one or two. Operator, first question, please."
},
{
"speaker": "Operator",
"content": "Our first question comes from the line of Terence Flynn from Morgan Stanley. Please go ahead."
},
{
"speaker": "Terence Flynn",
"content": "Great. Thanks for taking the question and congrats, Rob, on the CEO position. Looking forward to the forward here. The question I had is, last quarter you guys gave some early commentary on how to think about 2025, looking at the business, obviously, momentum in immunology, some headwinds in aesthetics. So any update on how you’re thinking about the 2025 outlook, particularly, growth for revenue relative to EPS? Thanks."
},
{
"speaker": "Scott Reents",
"content": "Thanks, Terence. This is Scott. I’ll handle the question. So, with respect to 2025, as you know, we haven’t given guidance yet and we’ll provide that at a later time. But we have communicated a few top-level, high-level items to put in context of several dynamics at play next year. We have indicated that we’ll be returning to robust revenue growth, despite the headwinds from Medicare Part D redesign and continued Humira erosion. And when you think about robust growth, we characterize robust growth to be above industry average growth, which we see in the low-single digits. So when you think about the drivers, I mentioned in my remarks that we have $6 billion of growth from the growth platform in 2024 that we’re expecting. $5 billion of that is coming from Skyrizi and Rinvoq alone, our neuros franchise is growing by more than $1 billion and aesthetics has begun to recover from the economic headwinds. In 2025, we see incremental contributions from Skyrizi UC, which was recently approved, as well as 951. All these factors demonstrate strong momentum in the business. And then when you think about the offset of Humira, that erosion that we have expected this year at $4.5 billion. Last year that erosion was $6.5 billion and we do expect another step down in absolute dollar terms in 2025 for that erosion as well. So that will be less of a headwind to growth in 2025 than it was in 2024. So we feel very, very strong about that. And I think from a Part D perspective, we’ve talked about the several points of growth headwinds that we see there. And I think when you model that, you can think about those several points as approximately a 3% headwind to growth. So, overall, very strong momentum from the business with some headwinds, but we feel very confident in our ability to return to robust growth at the topline. Regarding EPS, the bottomline, we see EPS growing in line with that revenue growth that we’ve talked about. So, EPS will benefit from operating margin expansion. We’ve talked about that operating margin expansion will be on the SG&A line as we leverage the revenue growth and drive efficiencies and we have a good history of doing that. So, that operating margin will expand. However, that expansion will be roughly offset by the fact that in 2025, we’ll have a full year of interest expense associated with the financing for Cerevel and ImmunoGen. So robust growth at the topline and in-line growth from an EPS perspective."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Terence. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Next, we’ll go to the line of Chris Schott from JPMorgan. Please go ahead."
},
{
"speaker": "Chris Schott",
"content": "Great. Thanks so much. Just two questions for me. Maybe first on Rinvoq and Skyrizi, great results in the quarter. Can you elaborate a little bit more on the price versus volume dynamics this quarter? It seemed like results were maybe a little bit stronger than the RX trends would have implied, and I just was wondering if there was anything notable there. My second question was on the immunology portfolio, and as we think about 2025, I know we’re probably in the middle of contracting season right now, but just directionally, what are you anticipating for Humira, and should we be thinking about any incremental pressures on Rinvoq and Skyrizi just given biosimilar Humira dynamics going forward? Thanks."
},
{
"speaker": "Jeff Stewart",
"content": "Yeah. Hi, Chris. It’s Jeff. I’ll take that question. So, as noted, we’re very, very pleased with the fundamental momentum on Rinvoq and Skyrizi. So all of the indications are really hitting their stride. So we can see the impact of, obviously, consumer investments we’ve made. We’ve adjusted some of the sales forces. We’ve started to anticipate the ulcerative colitis that’s helped us basically increase our share of voice. And I think the other dynamic in terms of some of the incremental strength has come from this dynamic that we started to see earlier in the quarter where some of the Humira switching that takes place actually starts to accrue towards Skyrizi and Rinvoq because the physicians, when there’s this disruption in the market, will sometimes bring in those patients and start to assess them, and we saw about 20% would move to other mechanisms. So while it’s a component, there are certainly multifactorial approaches why we see this very, very strong volume dynamic and share capture for both of those agents. If I move to the contracting for 2025, obviously, the contract season is in progress and it’s progressing, and the negotiations are well underway. I think it’s important, if you’ll recall, that we already have some multiyear contracts in place that cover 2025, so that’s a positive dynamic. The remaining payer negotiations, as I mentioned, are underway and we anticipate that those will close out during the normal cycle. I would say that, at a macro level, we do expect to maintain parity access next year for Humira for a meaningful portion of lives across all of the channels. Now, that said, our Humira access will certainly be lower than this year as we continue to anticipate and watch certain segments of the market move to adopt biosimilars. And we’ve understood and planned for this, obviously, as we enter that third year of the biosimilars and so we’re well aware of dynamically evaluating how this is going to work out. So, certainly, things are progressing. We already have some in place from those multiyear contracts and we’ll be in a better position to provide some more information, obviously, later in the year as those negotiations or the remaining negotiations fully close out."
},
{
"speaker": "Rob Michael",
"content": "And Chris, this is Rob. Just to reiterate an important point that Jeff made, I mean, one trend that we are watching very closely is the switching from the Humira molecule to new mechanisms. I mean, we are starting to see an inflection that is accruing to new mechanisms like Skyrizi and Rinvoq, as Jeff mentioned. And it makes sense, doctors that are reevaluating the patients in their practice are likely looking at more than just the patients that are covered by CVS. What we have factored in is the CVS impact. What we didn’t factor in necessarily is an impact beyond just the CVS-wise. And to the extent that trend continues, it would represent a downside for Humira and an upside for Skyrizi and Rinvoq, which is a very good long-term tradeoff for us. That’s an important point. We want to make sure that was captured."
},
{
"speaker": "Jeff Stewart",
"content": "Thank you, Rob. And maybe, Chris, one more point that I didn’t address was the Skyrizi and Rinvoq contracting. So we are anticipating very robust and consistent access for Skyrizi and Rinvoq. And our former comments around sort of low single-digit price erosion should be quite consistent with what we said before. Obviously, the Medicare Part D is a separate dynamic. So things are stable and we’re anticipating ongoing very strong access for both of those brands."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Chris. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Next, we’ll go to the line of Carter Gould from Barclays. Please go ahead."
},
{
"speaker": "Carter Gould",
"content": "Good morning. Thanks for taking the question and congrats on the results. I guess first, just a housekeeping point. I guess, one -- I guess, on the last call, you had talked about earnings growth not being quite at the rate of revenue growth and it sounds like today you see those more in line. Any, I guess, further color on kind of what’s driving that? I would assume it’s sort of the key I&I drivers, but any other color there would be appreciated. And I guess the more pertinent question, maybe on the commentary on Cerevel, should there be any expectation for divestments or other concessions as we contemplate that deal closing? Thank you."
},
{
"speaker": "Scott Reents",
"content": "Yeah. This is Scott. I’ll take the question regarding EPS growth or earnings growth in line with the revenue growth. So when we look at this, as I mentioned, we’re looking at a couple of things. The SG&A that we’re driving some operating margin expansion, we spent a lot of time focusing on that and we do see some efficiencies that we can drive, and we do have the ability to leverage that. So there will be expansion operating margin, which you would expect to then let earnings outpace the revenue growth. However, there is this offset and we had a very successful bond offering when we set the financing in place for Cerevel and ImmunoGen. So, but that will be an offset to the operating margin expansion. So you can think of those two as essentially netting one another and then driving that earnings growth in line with the topline."
},
{
"speaker": "Rob Michael",
"content": "Hey, Carter. This is Rob. I’ll take your question on Cerevel. Look, we’ve made very good progress with the FTC and have certified substantial compliance to their second request. No divestments are expected. I would expect the transaction to close soon, potentially as early as next week. We’re obviously very excited about the potential best-in-class therapies in Cerevel’s pipeline, especially emraclidine for schizophrenia, davapidon for early Parkinson’s and their core antagonist for major depression. I mean, these assets clearly will be great additions to our neuroscience franchise."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Carter. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Next, we’ll go to the line of Vamil Divan. Please go ahead."
},
{
"speaker": "Vamil Divan",
"content": "Yeah. Hi. Thanks for taking my question. So, maybe one if I could just, I guess, for Rob, just around sort of your business development priorities now. You obviously did a sort of larger deal last year with Cerevel, ImmunoGen, you’ve done a number of these smaller acquisitions. And I guess I’m trying to get a sense of the kind of balance between investing for the long-term and then sort of balancing the near-term earnings growth outlook. So there’s a lot of focus on that $11 floor for a long time, obviously, with all the IPR&D. You sort of dipped a little bit below that for this year, which makes sense. But I’m just trying to think now that we’re sort of halfway through the year, how are you thinking about sort of where your priorities are and the need to kind of balance the near-term numbers versus investing for the long-term? Thanks."
},
{
"speaker": "Rob Michael",
"content": "Yeah. Vamil, thanks for the question. So, the $11 floor, again, was on an ex-IPR&D basis, where obviously with this guidance, ex-IPR&D, I think, we’re just a little bit over $11.40 and we’re certainly positioned to return to robust growth. I mean, we’re delivering robust revenue growth this quarter. When you look at the outlook for 2025, it’s very strong and so we should be beyond the conversations on the floor at this point. As we think about the tradeoffs for the long-term and the short-term, clearly we have an on-market portfolio today that can drive the growth that we need to deliver on that high single-digit, top-tier outlook in this decade. So our BD efforts continue to be focused on early-stage assets that can drive growth in the next decade, and you’ve seen us execute nearly a dozen deals this year along those lines. These include new mechanisms in immunology that can combine with Skyrizi or Rinvoq or be pursued as model therapies. We’ve also added new platforms, including multi-specifics, that have applicability in immunology and oncology. Our deal targeting in situ CAR-T therapy is another example of a platform investment in oncology. And we added a novel mechanism for psychiatric disorders, given our focus in neuroscience. So we intend to continue adding more depth to our pipeline in our core areas, particularly think about early-stage deals, because what we’re really trying to set up for is that growth in the next decade. We have a clear line of sight to top-tier growth this decade and we want to position the company to deliver strong growth in the next decade as well."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Vamil. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Next, we’ll go to the line of Chris Shibutani from Goldman Sachs. Please go ahead."
},
{
"speaker": "Chris Shibutani",
"content": "Thank you. Good morning. On the aesthetics business, today has been a day of reporting across the industry. There’s some commentary that aligns with what you said. However, some additional questions I have are on granularity about procedure volumes and pricing. Now, in the first quarter, you talked about promotional activities that you pushed towards a seasonally strong second quarter. One, should we think about the pricing backdrop as being a component of some of the sluggishness as opposed to purely thinking about or primarily thinking about volume of procedures? And if you could sort of respond in the neurotoxin neuromodulator versus the filler segment, that’d be helpful. Thank you."
},
{
"speaker": "Carrie Strom",
"content": "Hi. This is Carrie. I’ll address the questions. So, first let’s talk about the market dynamics for market growth in the U.S. for facial injectables. So, late last year, we started to see a recovery and a return to growth of the toxin market and we’ve seen that market growth recovery continue this year in that mid-single-digit range. And that’s volume, that is traffic into our customers’ offices and that’s really been consistent for the past few quarters. So, the market dynamics for our business are really driven by patient demand and volume. Although, when we think about price, price is a factor that we’ll be looking for the second half of the year, which will give us some favorable pricing dynamics. We did take a price action at the beginning of the year for toxins and then we’ll have some more efficiency when it comes to our strategic shifts in our pricing promotions for the second half of the year. So, one example of that would be promotions we did last year, for example, around competitive launches that we won’t need to do this year based on the success of our competitive strategy last year. So really our performance is driven by market growth and we also had some nice stability in our market share. Anything you’d like to add?"
},
{
"speaker": "Jeff Stewart",
"content": "Maybe because it’s worth mentioning, so some of that shift in promotional activity that you mentioned, we did talk about in the first quarter that that was a destocking that occurred of inventory levels. And when Carrie made her remarks and we spoke about it last quarter, we said that would reverse over time. We did see that reversing in the second quarter on a partial basis. And when you think about the reversal of that Q1 destock, you can think about from the U.S. market that really would reduce by 50% or cut in half the growth rates we published for the actual results for both Botox and Juvederm. So we saw that partial reversal of that destocking event and then we will see that continue to unwind throughout the course of the year, especially as we have some of our larger promotional activities and the back half of the year with Botox Day and Juvederm Day, we do see typically an inventory, a stocking uplift from those activities."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Chris. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Next, we’ll go to the line of Mohit Bansal from Wells Fargo. Please go ahead."
},
{
"speaker": "Mohit Bansal",
"content": "Great. Thanks for taking my question. I just wanted to talk a little bit about the pipeline in IBD space as well. I mean, you have done a bunch of these and then there has been some movement, especially in the oral IBD drugs as well. I mean, given your expertise, I would love to understand, how do you think about a pipeline moving beyond the likes of Skyrizi, IL-17s and all, because these drugs are pretty good. But when you think about an oral, what is the ideal profile of the drug that could be a first-line drug and then when you think about combinations, I mean, what are you exactly looking for? Thank you."
},
{
"speaker": "Roopal Thakkar",
"content": "Hey, Mohit. It’s Roopal. I can talk about that. With respect to orals, we did do this deal with Landos and this is our NX-13asset, which we’ll anticipate a readout end of this year, beginning of next year. Early data point to good outcomes in ulcerative colitis and this asset works through NF-kappa-beta, so you’ll see what we’ve observed in preclinical models is reductions in IL-6, IL-1, TNF, interferon gamma. And it’s potentially a monotherapy and one that wouldn’t have a boxed warning. So far, the safety data has looked good. But there’s also opportunities, we believe, as you mentioned, combinations, that you could still combine with Rinvoq. And as I mentioned the boxed warning and in certain geographies, Rinvoq is utilized post-anti-TNF. Even with a combo there, there’s still opportunity. The second and third line segments in IBD and across immunology continue to grow, and they’re getting larger and larger as patients cycle through biosimilar anti-TNFs. We’ll see them cycle through, for example, in IBD with IL-1223, like Stelara. So in the future, there’s multiple opportunities. And the way we think about these is do we see an asset that is novel and can address mechanisms that haven’t been addressed yet, and can they complement something like Rinvoq? So if you see a little bit less efficacy, that may be okay if it’s complementary. It may not work necessarily as a monotherapy, but we still see opportunities for a combo. And given the other assets that we’ve talked about that could be IV or sub-cue, we still see a lot of opportunity with Skyrizi. In a platform study in IBD we’ll kick off later this year, looking at various combinations, many of the assets that I mentioned in the prepared remarks, including a TL1A, including our own internal alpha-4 beta-7, could be added on to Skyrizi to drive that efficacy even higher because there’s still a bit of a ceiling effect. And I would say the unmet need in IBD in particular continues to be quite high."
},
{
"speaker": "Mohit Bansal",
"content": "Okay. Thank you."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Mohit. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Next, we’ll go to the line of Chris Raymond from Piper Sandler. Please go ahead."
},
{
"speaker": "Chris Raymond",
"content": "Thanks. Hey. Just another follow-up on Humira. So, Jeff and Rob, just hearing your commentary about how when patients discontinue Humira, a number of them are switching to newer biologics. I think you gave the 20% number going to newer biologics like Skyrizi and then also Rinvoq. But we saw some of this happening in the gastro space with one of the checks we did recently, but I wonder if you could provide maybe a little more color on this phenomenon. Is there a particular therapeutic silo where this is maybe happening more extensively? And can you give us a sense as to how this has been influenced or accelerated by biosimilar availability and just any more color there? Thanks."
},
{
"speaker": "Jeff Stewart",
"content": "Yeah. Thanks for the question. It’s almost like a bimodal phenomenon. So, the 20% I highlighted, so if you just look from our data, when we just look at the CVS template, so we can see the degradation of Humira that goes down pretty steeply because, remember, it’s an exclusion. So, Humira is no longer widely available at all. So, most of it happens within the first two weeks or three weeks. And in that one segment, we see that the biosimilar doesn’t take up all the Humira loss and we can see it moving to other mechanisms, particularly Skyrizi and Rinvoq. So that’s within, let’s say, the acute biosimilar event. Now, to Rob’s point, what he highlighted is, if you take a step back and you look at the macro market, we’ve started to see in the first quarter and second quarter that the overall molecule, so that’s the adalimumab molecule, inclusive of biosimilars, has started to compress faster than it did before there was the availability of this action that was taken by CVS. So, it’s a doubling of effect, acutely in the segment that takes place with the exclusion and then the wider market. Now, we’re watching this pretty carefully because we haven’t -- obviously haven’t seen something like this before in terms of the compression of a molecule. So, that’s basically the dynamics that we’re seeing. And we do think it’s because some physicians or segments of physicians are, they realize that these biosimilars where there’s an acute interruption, they want to check how the patients are doing. And if they’re not fully in remission when they come in for their appointment, let’s say before the switch, sometimes they’re transitioned at the rates that I described. So that’s sort of the prescriber behavior. Now, where is it coming from? Like, well, we actually see that it is accruing across all of the indications, particularly Humira has quite robust, let’s say, base dynamics in the rheumatology indications. But we can see it in rheum. We can see it in derm. Derm to Skyrizi in particular, which is probably not a surprise given the position. I highlighted a 38% share and a 60% in-place share for Skyrizi and derm. And we also do see it to some degree in gastroenterology. So, to Rob’s point, we’re going to continue to monitor that. If the overall molecule would continue to compress, obviously, there would be some mitigation of some of it accruing over to Skyrizi and Rinvoq, and so we’ll have to continue to see how these weeks and months play out here over the third quarter."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Chris. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Next, we’ll go to the line of Gary Nachman from Raymond James. Please go ahead."
},
{
"speaker": "Gary Nachman",
"content": "All right. Great. Thanks. Can you talk more about how you’re managing the growth for Skyrizi and Rinvoq in IBD across both UC and Crohn’s, which have both been really strong? And with the Skyrizi UC launch, is there any cannibalization there with Rinvoq? And I guess, generally, how do you see those products working synergistically both in terms of sales force and reimbursement, if you see any sort of issues or conflicts there? Thanks."
},
{
"speaker": "Jeff Stewart",
"content": "Yeah. Thank you for the question. A very important question in terms of how we commercialize these. Roopal highlighted it. Obviously, you have the two big indications with two assets within those indications. And so we have constructed, not just in the U.S., but around the world, a very sophisticated approach in terms of multiple sleeves of representatives and medical experts that are representing both drugs across both indications. And it really is, let’s say, for example, in our largest market, the U.S., it’s relatively easy to execute, because what we see is that our representatives can highlight Skyrizi’s data and potential as the obvious frontline agent, which is obviously tremendous data. I mentioned the sequence data. I mentioned our core data. The naive to biologic data in UC is absolutely fantastic for the Skyrizi data. And then, really ironically, because of the label changes that took place a few years ago, Rinvoq is positioned in later lines. So, really, that sort of approach is highly synergistic in terms of we recommend that physicians consider starting with Skyrizi and the efficacy will be fantastic. But to Roopal’s point, there’s still pressure on that disease and then you have a backstop with tremendous, tremendous data on Rinvoq in later lines. And so that’s how we position it. We look and we monitor the cannibalization. It’s quite modest, and overall, when you look at the dynamic of share capture, it’s quite encouraging to see how the infield teams and the commercial teams are managing all of those assets. So, we’re very encouraged about how we’ve approached the market in terms of our execution and I think the results are speaking for themselves."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Gary. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Next, we’ll go to the line of Steve Scala from TD Cowen. Please go ahead."
},
{
"speaker": "Steve Scala",
"content": "Thank you. Regarding the 2024 sales guidance, which I realize is about $55 billion, but it implies similar growth in the second half as in the first half, if not a slight deceleration. Why won’t total sales do better and what were your reservations about raising sales guidance today? It seems that across the business, strengths are exceeding challenges, so it would seem not unreasonable to have higher sights now. Second question is, I’m wondering if you can elaborate on the comment, a portion of Humira lives is a portion of Humira lives closest to a quarter, a half or three-quarters of lives. Thank you."
},
{
"speaker": "Scott Reents",
"content": "Steve, this is Scott. I will talk regarding the revenue. So, just to clarify, we did raise the revenue guidance in total from $55 billion to $55.5 billion, a $500 million raise and that included a $300 million raise for Skyrizi, a $100 million raise for Rinvoq, a $100 million raise for Venclexta, a $200 million spread across other products and then a $200 million reduction in the guidance for aesthetics. So, we do see very strong momentum in the business and we did raise our sales guidance from $55 billion to $55.5 billion."
},
{
"speaker": "Rob Michael",
"content": "And Steve, this is Rob. If you just look at, as I mentioned in my remarks, the first half of the year, we talked operational growth around 4%. If you -- the implied operational growth in the second half, based on our guidance, would be slightly above that and really driven by the ex-Humira growth platform, which on a reported basis, grew more than 18% this quarter. And so we’re very pleased with the performance of the business, and I think, when you look at the guidance and you do the math, you’ll see that the actual implied second half operational growth is slightly higher than the first half."
},
{
"speaker": "Jeff Stewart",
"content": "And Steve and Jeff, so to give some sense, so we’re looking at coming up on the third year of biosimilar. So, the first way to think about it, in the first year 2023, we had very strong parity access across all the channels and we really exited the year around, I think, 97% or something like that. This year, I think, when we look at all the ins and outs, I think, the three-quarter approach is quite reasonable, and as I mentioned in my remarks to early one of the questions, it will certainly be lower next year and I would think that that range would be around that 0.5 point, but again, we’re not fully complete with all the dynamics. So, that gives you some broad spectrum over three years, maybe around the halfway point, plus or minus, as we go into 2025."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Steve. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Next, we’ll go to the line of Trung Huynh from UBS. Please go ahead."
},
{
"speaker": "Trung Huynh",
"content": "Hi, guys. Trung Huynh from UBS. Thanks for taking my questions. Just two from me. On the aesthetic, thanks for your comments this year and you’ve also moderated your short-term guide accordingly, but you’ve noted that the long-term 2029 guide remains intact. So, with growth around 4% this year in line with that new guide, I imagine next year will be slightly higher, but then it does imply that growth is well into the double digits for 2027, 2028 and 2029 on our calculations. Just what here makes you confident about that level of growth later in the decade? And then secondly, just following up on some of your thoughts on the immunology pipeline, you noted the potential of the utility of multispecifics in immunology. You’ve got a pretty strong bispecific platform. Just what are your thoughts on the data that you’re seeing here? Is there anything in development that we should be looking at? Thank you."
},
{
"speaker": "Scott Reents",
"content": "Trung, this is Scott. I’ll start with your question regarding the long-term guidance on aesthetics. So you’re right. We’ve guided to a long-term $9 billion in 2029 and we’re not changing that guidance. The guidance changed, as you noted, that I mentioned today is just a short-term guidance change for 2024. We remain very confident in our ability to hit that $9 billion in 2029. When you think about these markets, there’s very low penetration in the markets globally. There’s a lot of excitement in the space and we expect the market to recover and grow at historical rates. I would say when we look at the market growth, we do see that rebounding and growing well. And then you also should think about there’s additional innovation coming that will drive that. So, we have some of the additional indications in Botox that Roopal walked through, as well as the quick onset short-acting toxin BoNT/E that will also drive additional market growth. And so we continue to feel very comfortable with our ability to achieve that on a long-term basis in 2029."
},
{
"speaker": "Roopal Thakkar",
"content": "Trung, it’s Roopal. I’ll take the next question on the pipeline. So, we continue to be excited about bispecifics, in particular lutikizumab. And it’s an IL-1 alpha, and importantly, also 1-beta. And this, we believe, distinguishes it from earlier generation assets that were singular, and let’s say, only took out IL-1 alpha. We see, I would say, very, very strong benefits in hidradenitis suppurativa and I don’t think that was observed as a pure monoclonal. And the efficacy that we’re seeing is in a 100% anti-TNF failure population and very sick, early Stage 3, 70%. It is one of the most severe, probably the most severe ever studied. So we think there continues to be potential in the bispecific space as you take out multiple cytokines. The way to address it is through engineering of the assets. The other way is combination, so we can get to that bispecific approach through combos. And then, thirdly, I would say earlier in the pipeline is the multispecific approach, which the advantage that could provide is you maintain your bispecific approach, but then a third arm, let’s say, can target specific cells and that could further enhance efficacy, and in particular, safety. And we’re looking at that approach in immunology and as well in oncology, and that was reflected in our partnership with Tentarix."
},
{
"speaker": "Liz Shea",
"content": "Thank you, Trung. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Next, we’ll go to the line of Evan Seigerman from BMO Capital Markets. Please go ahead."
},
{
"speaker": "Evan Seigerman",
"content": "Hi, guys. Thank you so much for taking my question and it was really, really helpful to update today. So, just looking at kind of the expected growth for…"
},
{
"speaker": "Liz Shea",
"content": "Can you just -- can you speak up just a little bit? Sorry."
},
{
"speaker": "Evan Seigerman",
"content": "All right. Can you guys hear me all right? Does that work?"
},
{
"speaker": "Rob Michael",
"content": "Yeah."
},
{
"speaker": "Liz Shea",
"content": "It’s still faint, but we’ll do our best."
},
{
"speaker": "Evan Seigerman",
"content": "All right. Sorry about that. I’ll speak very loudly. So when looking at expected growth for Vraylar over the next few quarters, can you comment on what type of impact you think new competitors to the MBD market might have and what you can do to help maintain a growth position going forward?"
},
{
"speaker": "Jeff Stewart",
"content": "Yeah. Hi. It’s Jeff. We’re very pleased with how both of the indications are performing and we monitor them very carefully, certainly with bipolar and aMDD. So when we look at our quarterly surveys of our target physicians and really our whole call cycle, we can see now that Vraylar is the most preferred agent overall for bipolar disease based on its indication set, its tolerability, its efficacy, et cetera. And we’ve really gone to the very top of the lead table for aMDD as well. So, if we look overall on our demand, we’re tracking above 20% in terms of the push. We continue to focus our team and where necessary add share a voice in terms of our sales force. So, we’re quite comfortable that we can continue to grow our share, which has been growing very, very nicely, particularly on the MBRX side, and certainly, face the competitive dynamics and navigate those as we go forward."
},
{
"speaker": "Roopal Thakkar",
"content": "Jeff, maybe to add. it’s Roopal here. There is going to be competition, but what we see as a benefit clinically for Vraylar is that full spectrum coverage in bipolar and when you’re able to take mania, you don’t need an adjunctive therapy for that. So that’s a big advantage. The other thing that we continue to hear and probably reflected in our data is the really limited impact on fatigue and sedation. And so what we’re hearing is with Vraylar, patients really don’t have to sacrifice their daytime productivity in order to gain that benefit. And then the other benefit, I would say, with Vraylar is flexible, adjustable dosing. So these things together, I think, underlie what Jeff was speaking about."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Evan. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Next, we’ll go to the line of James Shin from Deutsche Bank. Please go ahead."
},
{
"speaker": "James Shin",
"content": "Hi. Good morning. Thanks for taking our question. You mentioned some of the Humira contracts going to 2025. Does that also apply to Skyrizi and Rinvoq, and that’s what gives you visibility on the low single-digit price erosion? And secondly, has the introduction of co-branded Humira and now that PBMs are more intertwined with biosimilars, changed the negotiation dynamics at all? Thank you."
},
{
"speaker": "Rob Michael",
"content": "Yeah. So, typically, again, in some cases we are able to secure multiyear contracts. And as you can imagine that we would do that for the portfolio, basically, the way that our products work. So, that does help with the visibility in terms of what our access would look like for 2025, as well as the pricing dynamics. Again, I want to clarify that the negotiating season is not fully complete, but the dynamics are progressing, as I highlighted there. So, yes, to your first question. The other dynamic in terms of Cordavis, I’m not sure that that’s actually changing the dynamics in terms of the negotiations overall. That was obviously a volume-related deal with CVS that we announced over a year ago or almost a year ago now. So it doesn’t necessarily play into other negotiations. Each of these payers and pharmacy benefit managers, they have their own ideas in terms of how they want to approach the I&I category and certainly the Humira -- the emergence of the Humira biosimilars. So it’s a CVS-unique dynamic."
},
{
"speaker": "Liz Shea",
"content": "Thanks, James. We have time for one final question, Operator."
},
{
"speaker": "Operator",
"content": "For our last question, we’ll go to the line of Louise Chen from Cantor Fitzgerald. Please go ahead."
},
{
"speaker": "Louise Chen",
"content": "Hi. Thanks for taking my questions here. So I wanted to first ask you, do you still feel that your aesthetics business is a good strategic asset for you, and if so, where do you see the synergies within your organization? And second question I wanted to ask you is, how do you think pharma will fare under a Democratic versus a Republican presidency and how are you going to navigate through that uncertainty in the near term? Thank you."
},
{
"speaker": "Rob Michael",
"content": "So, Louise, this is Rob. I’ll take your question. Look, we like the aesthetics business. When you think about the growth profile, the profitability, we have set it up as a fully integrated standalone unit, because it behaves differently than the therapeutics business. We think we’ve actually seen, since we announced the transaction, really strong performance. We’ve exceeded our deal model expectations since we announced the deal. So we think it’s operating very well. Obviously, we’re working through some macroeconomic headwinds. But when you look at, for example, share performance, we had the entry of DAXXIFY last year and we did not lose any share. I think a lot of investors were concerned that we’d see considerable share loss. And so I think the team has done a remarkable job of competing in this marketplace, going through a period with economic headwinds. We’re still very confident given low penetration rates, given our relationship in the field, the potential innovations that we plan to bring forward. It has a very nice fit. And you think about just from a profitability and a growth standpoint, it fits the profile we’re looking for. So I certainly feel it’s a nice fit for the company. As it relates to the election, look, it’s hard to handicap it, whether Democrat or Republican. If you think about we’ve obviously contemplated the Inflation Reduction Act. We’ve come out and said that even with modeling that impact in, that we still expect to deliver on our long-term outlook. Now, I will say our view on the IRA from a policy perspective is we’re certainly in favor of the Part D benefit redesign because it helps address patient out-of-pocket burn. But the price-setting provisions in the IRA will certainly harm long-term innovation in our industry. So, we are hopeful that if it’s a new administration or the current administration, that they’ll reassess those provisions that ultimately are harmful for long-term patient care in the U.S. I mean, it clearly takes away the incentive to launch in later lines of smaller patient populations, which is really a very unfortunate negative outcome for the legislation. So, the way I view it is addressing patient out-of-pocket burden is good policy, but taking away the incentive for innovation is not, and my hope is under either administration, that will be reconsidered."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Louise. That concludes today’s conference call. If you’d like to listen to a replay of the call, please visit our website at investors.abbvie.com. Thanks again for joining us."
},
{
"speaker": "Operator",
"content": "Thank you all for joining the AbbVie second quarter 2024 earnings conference call. That concludes today’s conference. Please disconnect at this time and have a wonderful rest of your day."
}
] |
abbv | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning and thank you for standing by. Welcome to the AbbVie First Quarter 2024 Earnings Conference Call. All participants will be able to listen-only until the question-and-answer portion of this call. [Operator Instructions] Today's call is also being recorded. If you have any objections, you may disconnect at this time. I would now like to introduce Ms. Liz Shea, Senior Vice President of Investor Relations. Ma'am, you may begin."
},
{
"speaker": "Liz Shea",
"content": "Good morning, and thanks for joining us. Also on the call with me today are Rick Gonzalez, Chairman of the Board and Chief Executive Officer; Rob Michael, President and Chief Operating Officer; Jeff Stewart, Executive Vice President, Chief Commercial Officer; Scott Reents, Executive Vice President, Chief Financial Officer; Carrie Strom, Senior Vice President, AbbVie and President, Global Allergan Aesthetics; and Roopal Thakkar, Senior Vice President, Chief Medical Officer, Global Therapeutics. Joining us for the Q&A portion of the call is Tom Hudson, Senior Vice President, Chief Scientific Officer, Global Research. Before we get started, I'll note that some statements we make today may be considered forward-looking statements based on our current expectations. AbbVie cautions that these forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those indicated in our forward-looking statements. Additional information about these risks and uncertainties is included in our SEC filings. AbbVie undertakes no obligation to update these forward-looking statements except as required by law. On today's conference call, non-GAAP financial measures will be used to help investors understand AbbVie's business performance. These non-GAAP financial measures are reconciled with comparable GAAP financial measures in our earnings release and regulatory filings from today, which can be found on our website. Following our prepared remarks, we'll take your questions. So with that, I'll turn the call over to Rick."
},
{
"speaker": "Rick Gonzalez",
"content": "Thank you, Liz. Good morning, everyone, and thank you for joining us today. I'm extremely pleased with our start to 2024 with first quarter results exceeding our expectations. Before we discuss our performance in more detail, I'd like to share my perspective on the planned CEO transition that was announced earlier this year. After serving more than 11 years as AbbVie's first CEO, I have decided to retire from the role effective July 1, of this year and will continue to serve AbbVie as Executive Chairman of the Board. As you heard me say before, it is important that we choose the right time to make this critical leadership transition. The Board and I have been long planning for my eventual succession and now is the opportune time to move forward with the transition. As our business is performing very well and is in a strong position for the long-term. We are successfully navigating the Humira U.S. loss of exclusivity. We have built an outstanding company culture, an important priority and competitive advantage. And our productive R&D engine, which has yielded numerous innovative new medicines for patients will continue to fuel our robust pipeline for years to come. After a multi-year process, our board has unanimously selected Rob Michael, our current President and Chief Operating Officer as AbbVie's next CEO. I have known and worked with Rob for many, many years and he is an excellent choice as my successor. He brings the experience, the leadership and the strategic vision to build on AbbVie's past successes, advance our strategy and enhance shareholder value. Since our inception, Rob has held several important leadership positions that have collectively had a tremendous impact on AbbVie from establishing our financial planning organization to navigating the end of exclusivity for Humira in the U.S., to driving key business development opportunities that have been critical to diversify our business and support long-term growth, including the acquisitions of Allergan and ImmunoGen and the pending Cerevel transaction. Looking back, AbbVie has evolved tremendously as an independent company and our performance has truly been exceptional. Since our inception, we've grown our revenue from $18 billion to $55 billion. Our market capitalization has increased substantially from $54 billion to roughly $300 billion today. We have achieved a total shareholder return of more than 675%, which is top tier relative to our peers. And importantly, we’ve substantially increased our investments in R&D to discover and develop new medicines that have the potential to improve the lives of patients. As I look ahead, our company has never been stronger and our future has never been brighter. We are executing well across all aspects of our business and our long-term growth prospects remain very strong. In summary, it has been a privilege and immensely gratifying to serve with all of my AbbVie colleagues for the past 11 years, growing AbbVie into what it is today. And I look forward to continuing to work with Rob and the leadership team to create meaningful value for our shareholders and all of our stakeholders. And I'd also like to take this opportunity to thank all of our shareholders for the trust and confidence you put in me as AbbVie's CEO. With that, I will turn the call over to Rob for comments on our recent business performance. Rob?"
},
{
"speaker": "Rob Michael",
"content": "Thank you, Rick. Before I comment on our first quarter performance, I want to congratulate Rick on his exceptional leadership of AbbVie over the past 11 years. During his tenure, Rick made several strategic moves that have positioned AbbVie to have a bright future beyond Humira, consistently drove the organization to deliver very strong performance and demonstrated the genuine care for our employees, patients, shareholders and communities that has defined who we are as a company today. It has been my privilege to work closely with Rick over many years, and I look forward to working with him in his role as Executive Chairman. AbbVie's outlook is very strong and I am excited about the remarkable impact that we the remarkable impact that we will continue to have on patients' lives. Turning to first quarter performance, we're off to an excellent start to the year with strong top and bottom-line results. We reported adjusted earnings per share of $2.31, which is $0.11 above our guidance midpoint. Total net revenues were $12.3 billion approximately $400 million ahead of our expectations. This overachievement was driven by our ex-Humira growth platform, which delivered revenue growth of more than 15% this quarter and includes continued robust sales from Skyrizi and Rinvoq, with combined growth above 50% in their fifth full year on the market, as well as double-digit revenue growth from several other key products including Venclexta, Vraylar, Ubrelvy and Qulipta. This broad based sales momentum clearly demonstrates the strength of our diversified portfolio with multiple growth drivers to support our long-term outlook. We are also making excellent progress with several of our near-term priorities. We recently completed the acquisition of ImmunoGen, which accelerates our entry into the solid tumor market and strengthens our oncology pipeline. The integration has been seamless and we are impressed by the caliber of talent we have welcomed into AbbVie. We also remain on track with the pending acquisition of Cerevel, which we anticipate will close in the middle of the year. Cerevel's pipeline of differentiated assets will further augment our neuroscience portfolio. In addition, we continue to advance our R&D pipeline and invest for long-term growth. This progress includes the FDA's full approval of Elahere for FR alpha positive platinum resistant ovarian cancer, a meaningful first in class treatment for patients and a significant long-term growth opportunity for AbbVie in solid tumors. We also gained U.S. approval of Juvederm Voluma XC for temple hollows, further strengthening our leadership in aesthetic fillers, and we executed several business development opportunities adding novel early stage programs and partnerships in oncology and immunology. Given the strong results this quarter, we are raising our full year adjusted earnings per share guidance by $0.16 and now expect adjusted EPS between $11.13 and $11.33. In summary, this is an exciting time for AbbVie and I am extremely pleased with the momentum of our diverse portfolio. We're off to an excellent start to the year and we are well positioned to deliver a high-single-digit revenue CAGR through the end of the decade. With that, I'll turn the call over to Jeff for additional comments on our commercial highlights. Jeff?"
},
{
"speaker": "Jeff Stewart",
"content": "Thank you, Rob. I'll start with the quarterly results for immunology, which delivered total revenues of approximately $5.4 billion exceeding our expectations. Skyrizi global sales were $2 billion reflecting operational growth of 48%. We continue to see exceptional momentum across all of the approved indications. In psoriasis, Skyrizi is the clear market leader in the U.S. biologic psoriasis market with a total prescription share now above 35%. That's more than double the share of the next closest biologic therapy. Share is also ramping nicely in PsA, especially in the dermatology segment, where we are now capturing one out of every four new or switching in play biologic patients. Globally, Skyrizi has achieved psoriatic in play share leadership in nearly 30 key countries. In IBD, Skyrizi is on track to add more than $1 billion of incremental sales growth this year. We are seeing tremendous performance in Crohn's disease, where our compelling head-to-head data versus Stelara is driving a meaningful inflection of patient share. As a result, we have now achieved in play share leadership in Crohn's across all lines of therapy in both the U.S. and Japan as well as other key markets around the world. And finally, we are preparing for the launch of Skyrizi in ulcerative colitis, which represents another substantial long-term growth driver. We expect approval decisions in the middle of this year and anticipate rapid access in the U.S. following our launch. Given the robust frontline capture for Skyrizi in Crohn's and the exceptional bio-naive data we have generated in UC, we anticipate a strong launch. Turning now to Rinvoq with global sales of approximately $1.1 billion, reflecting operational growth of 61.9%. In rheum, we continue to see strong prescription growth across each of the four approved indications, and I'm especially pleased with our performance in rheumatoid arthritis, where Rinvoq has achieved in play share leadership in nearly 20 key international markets. Atopic dermatitis is tracking in line with our expectations with continued market share momentum globally. Importantly, we recently announced positive results from LEVEL UP, our second head-to-head study in AD. LEVEL UP demonstrated Rinvoq superiority for patients starting therapy on the 15 milligram dose versus Dupixent across key efficacy parameters, including the high levels of skin clearance and itch reduction. We anticipate these strong head-to-head results will support additional share capture, especially given Rinvoq label use in the U.S., which requires that initiation with a 15 milligram dose. And in IBD, Rinvoq's uptake continues to be very strong. Rinvoq is capturing high teens in play patient share in ulcerative colitis as well as mid-teens in play patient share in Crohn's disease. This performance is especially encouraging recognizing that we're still relatively early in the launch phase for both the UC and CD indications, and the lines of therapy are also expanding, with second line plus growing even faster as patients cycle to newer, higher efficacy agents like Rinvoq and IBD. Turning now to Humira, which delivered global sales of approximately $2.3 billion, down 35.2% on an operational basis due to biosimilar competition. Erosion in the U.S. played out slightly better than our expectations in the quarter with the vast majority of the impact this quarter driven by price. As previously communicated, the recent changes to the CVS template formularies were anticipated in our full year outlook for U.S. Humira and the volume impact is tracking in line with our expectations. Our guidance has also contemplated the impact of additional formulary changes that are expected to go into effect over the course of the year. We continue to anticipate that Humira will maintain parity access to biosimilars for a significant majority of patient lives this year. Moving now to oncology, where total revenues were more than $1.5 billion exceeding our expectations. Imbruvica global revenues were $838 million, down 4.5%, reflecting continued competitive pressure in CLL. Venclexta global sales were $614 million, up 16.3% on an operational basis and we are seeing robust momentum internationally with strong performance for both CLL and AML. Elahere generated $64 million of sales to AbbVie, reflecting a partial quarter of revenue following the February close of the ImmunoGen acquisition. The Elahere sales and marketing team is executing very well and I'm pleased with the smooth integration into our commercial organization. We anticipate that the recent positive updates in the NCCN guidelines for both platinum sensitive and platinum resistant ovarian cancer patients as well as the full label approval, which of course, includes the compelling overall survival data that has never been achieved before in these platinum resistant patients will continue to drive strong Elahere uptake. Lastly, the global launch of Epkinly in third line plus DLBCL is also performing well and we remain on track for the potential label expansion for follicular lymphoma later this year. Neuroscience total revenues were nearly $2 billion, up 16% on an operational basis, again, ahead of our expectations. This robust performance is driven by continued double-digit growth of Vraylar with global sales of $694 million, Ubrelvy with total revenue of $203 million and Qulipta with global sales of $131 million. Each of these leading assets continue to gain share and remain competitively well positioned. Botox Therapeutic is also performing well, especially in chronic migraine. Total global sales were $748 million, up 4.5% on an operational basis. And finally, we are very excited about 951, which will be commercialized as Vyalev in the U.S. and represents a potentially transformative next generation therapy for advanced Parkinson's disease. Feedback from the launches in Japan and Europe have been very encouraging and we remain on track for commercial approval in the U.S. later this year. So overall, I'm extremely pleased with the strong and balanced growth across our therapeutic portfolio this quarter, a testament to our differentiated product profiles and commercial execution. And with that, I'll turn the call over to Carrie for additional comments on aesthetics. Carrie?"
},
{
"speaker": "Carrie Strom",
"content": "Thank you, Jeff. First quarter global aesthetic sales were over $1.2 billion, reflecting a modest decline on an operational basis. In the U.S., aesthetic sales of $776 million were roughly flat versus the prior year. We continue to see sustained momentum in the facial injectable market recovery that emerged in the back half of last year. Consistent with the past few quarters, the toxin market grew by a mid-single-digit percentage. We saw similar year-over-year increases in the number of facial filler procedures, representing a return to quarterly market growth for the first time since early 2022. From a competitive perspective, our U.S. aesthetics portfolio continues to perform well. Market share for both Botox Cosmetic and Juvederm was stable in the first quarter as these assets remain the clear market leaders. While we're pleased that the market and share trends across U.S. facial injectables are aligned with our previous expectations, our first quarter results were impacted by customers holding lower than normal inventory levels at quarter end. This dynamic relates to a decision made during the quarter to shift the timing of certain promotional activities into the second quarter. We therefore expect inventory levels to normalize in the second quarter and remain on track to deliver full year aesthetics sales growth in the U.S. Internationally, first quarter aesthetic sales were $473 million reflecting an operational decline of 5.5%. Consistent with our expectations, growth in China was impacted by persistent economic headwinds as well as a challenging comparison versus the first quarter of last year, which benefited from a robust recovery post-COVID. We are monitoring the economic developments across China and continue to anticipate a recovery in the second half of this year. Our pipeline continues to generate important new assets. Uptake of our recently launched Volux and SkinVive products remain strong, underscoring the importance of innovation within aesthetics. Given this context, we are excited for the upcoming launch of Juvederm Voluma XC for the treatment of temple hollows. As the only dermal filler approved for use in the upper face, we anticipate the Voluma XC introduction will activate more consumers and support the long-term growth of our filler portfolio. And within our toxin pipeline, we continue to expect FDA approval of the platysma prominence indication for Botox near the end of this year, enhancing Botox growth potential as a noninvasive treatment to reduce the appearance of vertical neck bands and improve jawline definition. We also remain on track to submit a new drug application for our short acting toxin, BoNT/E, before the end of this year. This novel toxin has demonstrated a rapid onset of action as well as a short duration of effect, meaningfully lowering the barrier for toxin adoption across consumers who have been considering but hesitant to try Botox. Given this profile, BoNT/E has significant market expansion potential as satisfied patients would naturally convert to Botox. Overall, the underlying trends across our aesthetics portfolio align well with our previous expectations and we remain on track to deliver high-single-digit global aesthetics growth this year. With that, I'll turn the call over to Roopal."
},
{
"speaker": "Roopal Thakkar",
"content": "Thank you, Carrie. I'll start with immunology. We recently announced positive top-line results from 2 Phase III studies for Rinvoq in dermatology and rheumatology. In the LEVEL UP study, which evaluated Rinvoq against dupilumab in atopic dermatitis, Rinvoq demonstrated superiority on the primary endpoint at week 16, which was a composite endpoint measuring skin clearance and itch reduction. Twice as many Rinvoq patients achieved this very stringent endpoint compared to dupilumab. Rinvoq also demonstrated superiority on all rank secondary endpoints in this trial. LEVEL UP was a study in which patients started on Rinvoq 15 milligrams and could escalate to 30 milligrams if they did not achieve treatment goals, which is how Rinvoq is prescribed for atopic dermatitis in the U.S. We also saw very rapid responses with Rinvoq demonstrating superiority on itch as early as week two and on skin lesions as early as week four. Rinvoq's safety profile in the LEVEL UP trial was consistent with what has been observed in previous studies. There were no serious infections in patients treated with Rinvoq and one in the dupilumab group. The rate of serious adverse events was similar across treatment arms. There were no malignancies, MACE events or VTEs reported in either treatment group. Based on these data as well as results from previous Phase III studies, we remain very confident in Rinvoq's profile in atopic dermatitis, and we believe it offers meaningful advantages over other products on the market today. We also announced positive top-line results from our Phase III select giant cell arthritis trial, which evaluated Rinvoq in combination with a 26-week steroid taper regimen compared to patients receiving placebo in combination with a 52-week steroid taper. In the study, Rinvoq 15 milligrams met the primary and key secondary endpoints, demonstrating superiority on sustained remission from week 12 through week 52, as well as on disease flare and reduction in cumulative steroid exposure at week 52. Importantly, Rinvoq's safety profile was consistent with what has been observed in more than 15,000 patients previously studied across controlled trials. The mean age in this population was 71, which is the oldest population studied to date with Rinvoq. And the average prednisone equivalent dose at baseline was almost 35 milligram. Rates of serious adverse events and VTEs were similar across treatment groups. There were no MACE events in the Rinvoq arm, while there were two in the placebo group. Based on the results from the select GCA trial, we believe Rinvoq has the potential to be a safe and tolerable oral treatment option. We plan to submit our regulatory applications for this indication later this year. We continue to make very good progress with our inflammatory bowel disease programs. We anticipate several advancements this year, including the initiation of a Phase II study for lutikizumab in ulcerative colitis. The start of our Phase II Crohn's disease platform study, which will evaluate combinations of Skyrizi with lutikizumab and other novel biologics. And we remain on track for approval decisions for Skyrizi in ulcerative colitis, with the U.S. expected in the second quarter and Europe in the second half of the year. We also continue to invest in external innovation to expand our immunology pipeline, as evidenced by four deals that we announced in the first quarter. These include the acquisition of Landos Biopharma, which brings an oral NLRX1 agonist currently in Phase II for ulcerative colitis, a partnership with OSE immunotherapeutics to develop a novel ChemR23 agonist antibody for inflammatory conditions, such as IBD and RA. A collaboration with Parvus Therapeutics to utilize their immune tolerization platform to develop novel therapies for IBD, and a collaboration with Tentarix Biotherapeutics to develop conditionally active, multi-specific biologics in immunology and oncology. We are excited to partner with these companies who are all pursuing very innovative approaches to developing transformative therapies. Moving to oncology, where in the quarter, we closed the ImmunoGen transaction, which brings exciting programs in both solid and blood cancers. Last month, Elahere received full approval from the FDA for FR alpha positive platinum resistant ovarian cancer in patients treated with up to three prior therapies. This conversion to full approval was based on data from the confirmatory Phase III MIRASOL trial, where Elahere demonstrated an overall survival benefit and significantly reduced the risk of cancer progression. We expect to see results from additional ImmunoGen programs this year, including data from the Phase II PICCOLO study evaluating Elahere as a monotherapy in FR alpha positive third line plus platinum-sensitive ovarian cancer patients who are not eligible for retreatment with platinum-based therapies. And we expect to see data in the second half of the year from a potentially registration-enabling Phase II trial for our CD123 targeting ADC, Pivek in a rare blood cancer called blastic plasmacytoid dendritic cell neoplasm. Now moving to program updates in hematologic oncology. Based on the totality of the data from our TRANSFORM-1 trial and following recent feedback from regulators, we will not be submitting navitoclax for approval in myelofibrosis, and we will wind down the TRANSFORM-2 study, in the relapsed refractory setting. In other areas of [EMAC], we remain on track for several regulatory and clinical milestones this year, including regulatory approvals in the U.S. and Europe for a Epinkly in relapsed/refractory follicular lymphoma. The Phase III readout from the Venclexta VERONA trial, in treatment-naive, higher-risk MDS and initiation of a Phase III monotherapy study for ABBV-383 in third-line multiple myeloma. We remain very excited about this asset's potential to become a best-in-class BCMA CD3 bispecific by providing deep, durable responses and low incidence and severity of CRS and with the potential for outpatient administration, limited or no step-up dosing and monthly administration from the beginning of treatment. Moving to other areas of our pipeline. In aesthetics, we remain on track to submit our regulatory application for BoNT/E in the second half of the year. Our rapid onset short-acting toxin as a highly differentiated clinical profile compared to currently available neurotoxins. BoNT/E is designed for patients that are considering using facial toxins for the first time or for a special event and will allow them to experience results over a very short period of time. This novel toxin will complement our existing business as patients would naturally transition to BOTOX following experience with this trial toxin. And in neuroscience, we continue to make good progress with 951, where we have received regulatory approvals in 33 countries thus far and anticipate an approval decision in the U.S. in the second quarter. As Rob mentioned, we remain on track to close the Cerevel transaction in the middle of this year. Cerevel recently announced positive top line results from their Phase III TEMPO-3 trial evaluating Tavapadon as adjunctive therapy to levodopa in patients with Parkinson's disease. In study, Tavapadon met the primary endpoint, demonstrating a 1.1 hour increase in total on time without troublesome dyskinesia compared to patients treated with levodopa and placebo. Tavapadon also met the key secondary endpoint in the trial, providing a significant reduction in off time compared to levodopa and placebo. Two additional Phase III studies for Tavapadon in Parkinson's disease are expected to read out later this year. The emracladine pivotal studies in schizophrenia remain on track to begin reading out later this year as well. We look forward to providing updates on these programs once the transaction has closed. With that, I'll turn the call over to Scott."
},
{
"speaker": "Scott Reents",
"content": "Thank you, Roopal. Starting with our first quarter results. We reported adjusted earnings per share of $2.31, which is $0.11 above our guidance midpoint. These results include an $0.08 unfavorable impact from acquired IP R&D expense. Total net revenues were $12.3 billion, $400 million ahead of our guidance and reflecting a return to growth of 1.6% on an operational basis, excluding a 0.9% unfavorable impact from foreign exchange. Importantly, these results reflect more than 15% sales growth from our ex-Humira growth platform. The adjusted operating margin ratio was 42.2% of sales. This includes adjusted gross margin of 82.9%, adjusted R&D expense of 14.7%, acquired IP R&D expense of 1.3% and adjusted SG&A expense of 24.6%. Adjusted net interest expense was $429 million. The adjusted tax rate was 14.8%. Turning to our financial outlook. We are raising our full year adjusted earnings per share guidance to between $11.13 and $11.33. This increase of $0.16 at the midpoint includes $0.26 of operating overperformance partially offset by $0.10 of higher dilution due to the earlier close of ImmunoGen. As previously communicated, this earnings per share guidance includes $0.42 of dilution related to the recently closed acquisition of ImmunoGen and the pending acquisition of Cerevel. Please also note that this guidance does not include an estimate for acquired IP R&D expense that may be incurred beyond the first quarter. We now expect total net revenues of approximately $55 billion, an increase of $800 million. At current rates, we expect foreign exchange to have a 0.9% unfavorable impact on full year sales growth. This revenue forecast includes the following updated assumptions with the entire sales increase driven by our ex-Humira growth platform. We now expect Skyrizi global revenue of $10.7 billion, an increase of $200 million due to strong momentum across all approved indications. Rinvoq total sales of $5.6 billion, an increase of $100 million, reflecting robust uptake in IBD. Imbruvica total revenue of $3.1 billion, an increase of $200 million, reflecting lower erosion and Elahere total sales to AbbVie of $450 million, an increase of roughly $200 million, reflecting a partial year of revenue following the February close of the ImmunoGen acquisition. Moving to the P&L for 2024. We continue to forecast adjusted gross margin of approximately 84% of sales, adjusted R&D investment of 14%, adjusted SG&A expense of 23.5% and an adjusted operating margin ratio of roughly 46.5%. We now expect adjusted net interest expense of $2.2 billion, which includes the partial year cost in 2024 to finance the ImmunoGen and Caravel transactions. Turning to the second quarter, we anticipate net revenues of approximately $14 billion, which includes U.S. Humira erosion of approximately 32%, reflecting a step-up in volume erosion and with the recent CVS formulary change, partially offset by a onetime price benefit also associated with that change. At current rates, we expect foreign exchange to have a 1.3% unfavorable impact on sales growth. We are forecasting adjusted operating margin ratio of approximately 49.5% of sales, and we are also modeling a non-GAAP tax rate of 16.4%. We expect adjusted earnings per share between $3.05 and $3.09. This guidance does not include acquired IP R&D expense that may be incurred in the quarter. In closing, I'm very pleased with the excellent start to the year. We are demonstrating strong momentum across the portfolio and our financial outlook remains very strong. With that, I'll turn the call back over to Liz."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Scott. We will now open the call for questions. In the interest of hearing from as many analysts as possible over the remainder of the call, we ask that you please limit your questions to one or two. Operator, first question, please."
},
{
"speaker": "Operator",
"content": "First question comes from Mohit Bansal with Wells Fargo."
},
{
"speaker": "Mohit Bansal",
"content": "Congrats on the progress and congrats Rob as well. So maybe let's just start with 2024. I mean so thanks for this guidance. But when we look from 2024 to '25, there are a couple of headwinds that you have highlighted in the past. So obviously, IRA Part D redesign will be there and Humira may have another leg down. And given the volume erosion here, people are a little bit concerned there. Can you help us understand that what is your current thinking on the trough, '24 versus '25? And could you give us some confidence that you can continue to grow in '25 despite these headwinds from IRA and Humira?"
},
{
"speaker": "Robert Michael",
"content": "This is Rob. I'll take that question. So if you think about ’24, ‘25. I mean, clearly, the ex-Humira growth platform is demonstrating great momentum. If you just think about Skyrizi and Rinvoq alone are growing by more than $4 billion per year. Aesthetics will recover to high single-digit growth. Our neuroscience franchise will grow by over $1 billion this year on the heels of strong momentum for Vraylar and our migraine portfolio and we will have incremental contributions from Vyalev and Elahere in '25. So we have several drivers that will offset Humira erosion next year as well as the Part D benefit redesign impact and allow us to still deliver robust revenue growth. When you think about that redesign impact, it will really spread across our business, most concentrated in immunology and oncology. And we would estimate that total revenue impact could be worth several points of growth, while we'll still deliver robust revenue growth, we will have that headwind in '25. But keep in mind, for us, the IRA impact really hits us in '25 and isn't a significant headwind in the years that follow as products that are subject to negotiation will not have that Part D cost share impact. So the way to think about it is despite that headwind in '25, we will still deliver robust growth, with that growth rate accelerating in the years that follow. And then if you think about on a margin perspective, we're going to continue to expand operating margins. So that will be a tailwind. You should be, though modeling annualization of interest expense from these transactions. And keep in mind that we essentially would have -- think of it as a roughly half year for Cereval and 10.5 months this year for ImmunoGen. So that should be something that you do model for '25. So we'll have robust revenue growth we'll have earnings growth, not quite at the rate of the revenue growth because of that annualization impact. But then when you get to ‘26 and beyond, you have even faster revenue growth and very robust earnings growth. So that's probably the best way to think about the profile of the company. But when you look at that ex-Humira growth platform, there's a lot of momentum there and we are very well positioned to deliver very robust growth."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Mohit. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "The next question is from Vamil Divan with Guggenheim."
},
{
"speaker": "Vamil Divan",
"content": "So maybe I could just ask a couple on the aesthetics side. It sounds like your commentary is pretty generally in line with Liz said before, but obviously, the number was a little lighter this quarter than even to your guidance that what people are expecting so. Can you maybe just talk a little bit more about that you mentioned some shift in promotional efforts to the second quarter and maybe inventory levels then as a result being lower and maybe I don't know if you can quantify that a little bit? And was this sort of planned when you gave your guidance back in February or is this something that's sort of evolved over the quarter? Maybe just kind of why the decision maybe would be helpful to give us some comfort on the outlook there?"
},
{
"speaker": "Carrie Strom",
"content": "This is Carrie. So first, I'll give a little bit of context to the fundamentals in terms of market growth and market share, which were in line with our expectations. So our market share continues to be strong and stable. For Botox Cosmetic, despite a new competitor, strong stable share at high levels. And then for our Juvederm line continued share strength, even some share pickup in in the past few quarters, as we launch our new products. So like you said, those fundamentals are in line with our expectations. As we were going through the quarter, we really realized that the aesthetics market is quite sensitive to seasonality with Q2 and Q4 typically having the highest volume. And after a few years of COVID and economic disruption, we're now anticipating a return to that typical seasonality. So we shifted investment in some of our sales and marketing efforts into Q2, which impacted customer and sales promotional timing and activities, which then resulted in lower inventory held by our customers in Q1. And we do expect that to come back in Q2 and the rest year. And I'll let Scott address the rest of that question."
},
{
"speaker": "Scott Reents",
"content": "Sure. Thanks, Carrie. So Vamil to quantify the inventory impact in the first quarter, it was a little bit more than $50 million between Juvederm and Botox and you can think of that as being split roughly 2/3 to about and 1/3 to Juvederm. And I think as Carrie mentioned in her remarks that impact of that inventory will -- we expect that to turn in the second quarter."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Vamil. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Next question comes from Chris Shibutani with Goldman Sachs."
},
{
"speaker": "Chris Shibutani",
"content": "When we think about the 2024 upcoming contracting season, which obviously has been quite dynamic for Humira over the past year plus. Can you provide us with any insights in terms of structural aspects within your contracts that you build in that may help provide offsets. We often have limited visibility. We're looking at the prescription volume trends. And it feels as if our calculus is sometimes incomplete. But what can you reassure us in terms of the dynamics as we're seeing this year two play out and how you're approaching contracting for the forward?"
},
{
"speaker": "Jeff Stewart",
"content": "Chris, it's Jeff. So the contracting season typically starts April or May. And frankly, as we've highlighted before can run in the immunology category really through the end of the year. So we have a few philosophies that we look towards, which are -- we want to continue to basically make sure that patients if possible, based on our pricing concessions aren't disrupted because when you start to disrupt patients, they do struggle with the change. It's a change in their treatment course. And so as we look to that, we've historically highlighted that we are negotiating for parity contracts with Humira. And we do put some controls in place in some cases, but not all, we seek multi-year contracts with our payers to try to establish the relationship, the pricing, et cetera and we will think of ways to make sure that those contracts can hold. So they have some teeth in them. They can't just be willy-nilly discarded. And so it is a long-term, in some cases, partnership over a couple of years with these payers. I can't go into the details over exactly how those controls work. But suffice it to say that there's terms and timing and limits in terms of when contracts can be changed even maybe some clawbacks in some cases. So because we want these more sustained relationships because of our position in the category with these great brands, we typically use those sort of techniques and that's how we go for it. So again, it's hard to look forward too much because it is dynamic as we look to '25. But we've been quite successful in maintaining good access for our brands and certainly, Humira is tracking in line with our expectations."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Chris. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Our next question comes from Chris Schott with JPMorgan."
},
{
"speaker": "Chris Schott",
"content": "Just a couple more on the Humira front. I think Humira you had mentioned that in 2024, you expected most of the impact would be price versus volume. I think the street has been concerned that we're seeing more volume erosion, particularly with the CVS book of business. I'm just interested in your latest thinking as we think about price versus volume for the remainder of this year as we consider CVS [Signa], et cetera. How should we think about that balance just so there's kind of surprises, I guess we watch these volume trends playing out? And then maybe just on a related topic, can you talk at all about the tail for Humira sales in the U.S.? I guess the part of the question, do you expect that you'll see most players or payers eventually switch out Humira like we're seeing at CVS? And if so, is it still reasonable to think about there being a kind of a decent tale of revenue, I guess, for this product in the U.S. over time?"
},
{
"speaker": "Jeff Ryan",
"content": "There's a lot in there. Let me go through it in a systematic fashion. So I think, first, to directly answer your question. We still as we look forward, believe that the significant majority of our lives will be at parity. So that means our guidance around the majority being price is still holding in our go-forward look. Let me give you some perspective. I had some in my opening remarks over what's happening with CVS. So the first is that, as I mentioned, the step down in volume was really anticipated and based on our analysis of the data, which I'll highlight, it's really right in line with our expectations. Now one of the things in my remarks, I often talk about new to brand or our in-play share capture, and that's a really good way to look at performance, particularly early in launch cycles when you're looking at capture rate or competitive dynamics. I think it's important that investors and analysts need to be very mindful when you have a dislocation or disruption or switching, you can get very, very full at looking at NRx or NBRx because it sort of overinflates what you might be looking at. So I think that's important. The other fact base that we look at is in terms of the step down is we look at other analogs and we look at the Cosentyx Taltz analog or Taltz was advantage in ESI for Cosentyx back in 2019. And we see that typically in this category, almost 90% of the erosion tracks within the first two to three weeks. And that's actually what we're starting to see, we believe with the CVS template following that similar pattern. So if you can't really look at NRx or NBRx, you really have to look at TRx in this case, Chris. And this is very interesting. And we would make sure to guide folks to look at what's happening with the TRx data in the market. And what we see is that not all of the Humira prescriptions are moving to a biosimilar. And if you look at the first two weeks, it's pretty meaningful. Over 20% of the Humira prescriptions are moving to other mechanisms of actions, including Skyrizi and Rinvoq. And in fact, while we haven't studied this week as much, it actually seems to have accelerated a bit from there. And that actually makes some sense because if you think it from the physician's perspective, when patients are being switched, they often take a break in a pause to say, are these patients really under control, should I consider an alternative. And that's actually what we see playing out in the market. So the pure degradation or step-down from Humira is in line with what we see, but we are seeing a fairly significant move to other mechanisms, as I mentioned, including our own Skyrizi and Rinvoq. And that could be very, very good for patients who are probably getting better care for control of their disease. Now having said that as well, if we look through the rest of '24, we have very solid contracts with our payers through 2024. And remember that these payers can add biosimilars at parity whenever they choose. We saw that last year in the middle of the year, and that's really not different now. So when we look at the structure and controls of our existing agreements, we do not see widespread exclusions for the rest of the year, as we go forward. And so I think we've been pretty consistent with that that select clients will move towards biosimilars over the course of the year. Last year, we saw that with Kaiser and Medicaid plans. We talked about the CVS exclusion for the template business. And we do see that some select plans may take another approach, which we've contemplated as the year goes on, which is they may move new patients to the biosimilar, but maintain the large existing base. And that's quite manageable because really only about 14% or 15% of the patients are new patients that cycle into Humira. So overall, that's our perspective. We're confident things are tracking in line. We're quite interested in this shift to other mechanisms, which is frankly somewhat anticipated, but maybe operating a little higher than we thought, and we still believe that a significant majority of Humira will see it at parity lives in '24. Okay. So the tail we're going to be negotiating '25. And what we've highlighted is we are going to watch exactly how the interchangeables play out. We think we've got a good understanding of that. And so it will probably become more apparent as we move through '25 where that tail may sit. And we've highlighted that it may start to emerge in '25 and probably be much more visible by '26. And that's going to ultimately depend on how over the course of '25, the price volume fully plays out in the marketplace."
},
{
"speaker": "Robert Michael",
"content": "And Chris, this is Rob. On your question regarding the guidance for this year. I think it's important to note yes, we've said that the vast majority of the erosion is price. We've talked about that dynamic. If you think about first half, second half, we have the annualization impact given the mid-year step-up in rebates last year. So the annualization impact comes through in the first half, you'd expect price erosion to be greater in the first half or the second half. But at the same time, we did contemplate volume erosion because we were very well aware of the CVS contract. We gave you that guidance. And so we have contemplated that volume erosion, but that's more of a second half versus first half as well as the potential for we knew with an interchangeable coming in, there could be some marginal amount of volume pickup there. So we did put in volume erosion in our guidance, but the vast majority of it is price, but I don't want investors to think that we didn't put any volume into our guidance. We were very well aware of the CVS contract. And I think we made some prudent assumptions on potentially other impacts. But overall, we're still tracking in line with that guidance."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Chris. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Our next question comes from Terence Flynn with Morgan Stanley."
},
{
"speaker": "Terence Flynn",
"content": "Congrats to Rick and best of luck to Rob in a new role. Just wondering if you could maybe frame a little bit for us the opportunity for Skyrizi in UC versus Crohn's disease. I think last time we heard from J&J, Crohn's represented about $7 billion of Stelara sales. Obviously, you guys have made decent inroads there based on your comments. But just wondering think about the dollar opportunity in ulcerative colitis. And then when you were talking through some of the latest Rinvoq data, I was just wondering if there's an opportunity down the road as you generate more clinical data, but also commercial data to potentially revisit the restrictions on line of therapy on the label at some point, or if we shouldn't think about that as a possibility."
},
{
"speaker": "Jeff Stewart",
"content": "It's Jeff. I'll take the first question. So Crohn's is larger than you see. I mean, if you look at the overall market or revenue, I think it's 65%, 70%. So it's -- Crohn's is very, very significant. Having said that, ulcerative colitis is a multibillion-dollar opportunity for us. It's still a very, very underpenetrated and substantial indication. So it's weighted about 65 -- 35 --70-30, but still, I wouldn't underestimate what ulcerative colitis means. And I think I would add in concert with my prepared remarks, we've seen very, very significant acceleration into frontline Crohn's disease with Skyrizi. And what's remarkable, we studied a very, very difficult population in ulcerative colitis, but we still had substantial amount of naive patients. And the performance in that naive population is exceptional. I mean, it is at the very, very top of the league table terms of overall ability to get to endoscopic clearance and symptom control. And so we like that setup because, obviously, we have exactly the same representatives who are establishing the Crohn's indication in frontline, and we know that we can bring UC very fast afterwards when we get the approval this year. So it's a substantial global opportunity, not the size that we'll see over the LRP with Crohn's, but still one of our largest opportunities that we have in the category. And I'll ask Roopal based on the safety data he highlighted to comment on the second question."
},
{
"speaker": "Roopal Thakkar",
"content": "Yes, thank you. So the data we keep generating continues to at least drive confidence for sure that the original Phase III that came out with their safety profile, and what we continue to learn even with longer-term data, even in more high-risk patients confirms what we've always seen. And that will continue to drive confidence, I think with our clinicians. Now from a health authority standpoint, I think the position there is that you have this oral surveillance study with upadacitinib, and they're going to apply those findings to the other assets in a similar class probably until there's another outcome study to sort of argue against that -- that's kind of how we see it, now that's in the U.S. I would say globally, there's still an opportunity for many jurisdictions where JAK inhibitors can be at parity. So you might start seeing some more movement there in earlier lines. But as Jeff stated in his prepared remarks, the second line and even third line of many of these indications continues to grow as people now have options where in the past, if all you had was a TNF, maybe you were cycling. But now that you know that there's other therapies you're starting to see people break sooner. So I think that second and third line is still a huge opportunity, and we'll continue to grow with this emerging data."
},
{
"speaker": "Jeff Stewart",
"content": "And Terence, it's Jeff again. One more comment. I mentioned how we're excited about the naive position for both Skyrizi, CD and UC coming. But what's also nice is those same representatives are in the office and are able to highlight basically a one-two punch, where you use Skyrizi first in earlier lines based on this exquisite data. And then obviously, for later lines, you can use Rinvoq. And so we actually see in the marketplace that, that combination and that positioning is allowing us right now in real time, capturing almost towards 40% of all in-play share with Skyrizi first and Rinvoq second. So it's an encouraging position as we fill out that portfolio."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Terence. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "The next question comes from Carter Gould with Barclays."
},
{
"speaker": "Carter Gould",
"content": "I wanted to circle back on the prior commentary around some of the TRx data. And I guess the overarching question is that, I guess, appropriately kind of capturing all the volume you're really seeing? And there's clearly with your part of your agreement with CVS and the Cordavis there, there is the potential for some Humira volume to potentially be shifting there. Is that being captured by TRx. So I guess, any commentary there on sort of the accuracy of that data that we're all seeing. And then maybe if you just go back and I wanted to circle back on the EPS commentary on '25 sort of the way you framed that growth. Is that sort of x-IPR&D? Any color there would be appreciated."
},
{
"speaker": "Jeff Stewart",
"content": "Yes, it's a great question. So it's early, but we believe the data is accurate. I mean, if you look at the first two weeks to give you some sense, and this is inclusive of the Cordavis Humira. There was a downdraft of about 13,000 prescriptions for Humira from baseline. And the biosimilars captured about -- which was primarily the Cordavis Humira, captured about 10. So there's 3,000 prescriptions or over 20% that we can see in our data moving to other mechanisms of action, including our Skyrizi and Rinvoq. And again, it's very logical because this is just not a one-to-one type of switch like these physicians are interviewing and discussing with patients, their care path forward. And so we think that clearly, some are moving to other mechanisms, and we've seen that in other analogs as well. So we believe the data is accurate. Again, it's early. We're going to continue to monitor it. Where that ultimately lands, we'll have to see. Again, I want to reiterate the pure Humira downdraft is within line with what we assumed and we are seeing this other market behavior that's taking place."
},
{
"speaker": "Robert Michael",
"content": "And Carter, this is Rob. Just to clarify my earlier comments. Yes, it is ex-IP R&D. We always guide to ex-IP R&D. What I was trying to highlight is you should expect robust revenue growth in '25 and that growth accelerating in 2016 and beyond given that Part D benefit redesign impact in '25. And given that operating margin will expand, you typically would expect our earnings to grow faster than our revenue. And that is generally true with 1 exception in '25 being that we will have an annualization impact from net interest expense. We'll still deliver a very solid earnings growth. But as you model it, just keep in mind that while you expect typically earnings to outpace revenue growth given expanding operating margin, you do have that dynamic in '25, that's important for your modeling."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Carter. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Our next question comes from Simon Baker with Redburn Atlantic."
},
{
"speaker": "Simon Baker",
"content": "Two quick ones, if I may. Just going back to Humira, but in a slightly broader sense. There's been a degree of political noise around the role of PBMs in blocking or rather than assisting biosimilar uptake. I just wondered if you expect that to come to anything in terms of structural changes within the market? And then secondly, on Rinvoq and the Level Up deal -- Level Up data. I wonder how you see the competitive dynamics evolving in that space? Is this about switches? Or is this about market expectation expansion. I asked because this morning Sanofi said that they welcome competition as a way of expanding the number of people treated in an area that's still relatively unpenetrated. So I just wonder how you see the opportunity commercially?"
},
{
"speaker": "Jeff Stewart",
"content": "It's Jeff again. I would say that we're not anticipating like a wholesale restructure of the PBM industry, for example. I mean, we certainly think that there's very reasonable chance of sort of transparency reform, exactly how some of the economics are working, maybe transparencies to the government or downstream to the clients, that's very possible. But a major wholesale change, we don't see that happening in the near-term. Obviously, we are continuing to monitor that and would make adjustments as we might need to. Regarding your atopic dermatitis question, I think the answer is really a bit of both. I think as we've highlighted before, the market here is exceptional in terms of the low bio penetration or oral and bio penetration. It's really only about 4% or 5%. And so I think Sanofi's comments are very well timed. I mean this marketplace is going to grow significantly as this innovation is able to be delivered to the global population with this very serious disease. But we also think this Level Up study is good for our market share penetration, and I'll give you some perspective. Our U.S. market share is lower. It's around 9%. So typically, where our countries have been able to highlight more direct comparisons. We couldn't do that because of the starting dose, I highlighted. We see that most of our international affiliates have market shares in the mid-teens in some cases in the low 20s. And so the ability to bring a comparative study that's directly linked to the U.S. label and show the physicians how you can get to higher levels of control and really patients want -- they want no disease on their skin and they really don't want itch if they can get there. And that's what we studied in Level Up. So we think it's certainly going to help with both market expansion and in particular, around the world with our ability to capture some more share. So I hope that helps."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Simon. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "Next question comes from Tim Anderson with Wolfe Research."
},
{
"speaker": "Tim Anderson",
"content": "I have questions on contracting for Skyrizi in '25. How many lives do you already have locked up through your general multi-year contracting? And then do you continue to think that the availability of cheap versions of Humira, either brand or biosimilar won't lead to any increase in step edits on Skyrizi under the idea that while Skyrizi is better, something like Humira or biosimilar Stelara might be just fine. That same arrangement can be made in the statin category, for example, Crestor is the best Zocor might do just fine."
},
{
"speaker": "Jeff Stewart",
"content": "Yes. I think we'll probably pass on the number of lives locked up. I mean we are confident, given the market position TAM of Skyrizi and Rinvoq, I think, in particular around the momentum that we have across the Skyrizi indication that we're going to have very favorable access in 2025 and beyond. I think the other thing that we've highlighted is I'm very pleased with how the adoption of Skyrizi is going in IBD. I mean it's very, very clear that we're taking significant share from Stelara and the doctors are voting with their pen, or they're basically electronic prescribing because the ability to get these very sensitive patients under significant control, the world's really never seen anything like the sequence trial in terms of the ability to control the most difficult aspect of this challenging disease. So as time goes by, we think that differentiation is going to aid us significantly as we think about the formulary positions relative to not only Humira, but also to Stelara."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Tim. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "The next question comes from Luisa Hector with Berenberg."
},
{
"speaker": "Luisa Hector",
"content": "It's on Elahere. I wonder whether you might be able to tell us the full quarter of sales. And then any commentary around penetration rate of Elahere and how much off-label use you think may be happening with the guideline inclusion?"
},
{
"speaker": "Scott Reents",
"content": "Sure. It's Scott. With respect to the Elahere full quarter of sales, we closed mid-year in February. Prior to that there were -- according to what we've seen approximately, just let me just double check here, $70 million -- I'm sorry, $110 million in the full quarter, $113 million in the full quarter."
},
{
"speaker": "Jeff Stewart",
"content": "And it's Jeff. What we also see in the marketplace, a big catalyst that we saw in the first quarter was the movement from the accelerated approval to the full approval that Roopal highlighted with the MIRASOL data. So we were rapidly able to basically integrate that into all the material of the medical liaisons and certainly account managers and sales folks. And having that definitive table in the label and the ability to go deeper into our call plan is going to be very positive to continue the growth rates through the rest of the year. In terms of off-label, that's difficult to say. We think that the majority of the sales thus far are in that platinum-resistant population. However, the guidelines do allow for reimbursement with different levels of FRA alpha some of the updates that I mentioned in my prepared remarks. So we'll continue to monitor it, but there's certainly a significant headroom in terms of the populations that are coming in terms of the ovarian cancer marketplace."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Luisa. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "The next question comes from Gary Nachman with Raymond James."
},
{
"speaker": "Gary Nachman",
"content": "When looking at the strong performance of the neuro franchise of Vraylar and migraine in particular, talk about the competitive dynamics there in those markets. And how did the gross connects impact you in 1Q versus what you expected? And how should that trend for the rest of the year? And then with respect to Cerevel, just your confidence that it will still close by mid-year, and how FTC is viewing the schizophrenia market and how much overlap there might be between emraclidine and Vraylar? Just the latest thinking on that based on your conversations with FTC."
},
{
"speaker": "Jeff Stewart",
"content": "It's Jeff. I'll take the competitiveness comment in terms of what we're looking at. We're very pleased with the competitive -- our ability to gain market share in these segments. I'll start off with migraine. We continue to be the new to brand share leader in Botox for chronic migraine, and we see that Qulipta is accelerating significantly. So Qulipta is now the leading preventative agent. And what's nice is there's very little interaction with Botox because if you're an injector, you use Botox, if you're not an injector, you have access to a fantastic drug with Qulipta. So Qulipta is really clearly taking over the market leadership position among the injectable and the oral CGRPs. Ubrelvy continues to have a very meaningful and substantial lead over the main competitor, Nurtec and we are seeing some increased penetration into the larger triptan segment, which is key to our long-term growth. Vraylar continues to perform very well, ongoing market growth. And it's really because we have -- if we look at our perceptions, Gary, of our key prescribers, you're at the very, very top of the table, the league table in terms of perceptions around the efficacy around adjunctive major depression, which is our most recent indication and we have probably the best scope of indications for bipolar 1. And so both of those are allowing us to continue to gain share. So we're in a pretty good position. We also feel that the gross to net our vouchers, our co-pay, which sometimes can get a little funky in the first quarter. We have strong controls there and we're seeing a lot of stability. So overall, those businesses are performing very well"
},
{
"speaker": "Robert Michael",
"content": "Gary, I'll take your question. This is Rob. I'll take your question on the FTC. We are working closely with the agency on their additional requests I mean, keep in mind that we do not have any overlapping MOAs with Cereval and Vraylar share in schizophrenia is very low. The vast majority of Vraylar sales comes from the bipolar and AMBD indications. In the case of davapidon, it will serve the early Parkinson's segment, which Duodopa and Vyalev do not participate in. So we don't have any concerns with the merits of the transaction and continue to expect closing it in the middle of the year."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Garry. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "The next question comes from Steve Scala with TD Cowen."
},
{
"speaker": "Steve Scala",
"content": "And I apologize in advance for asking you to clarify on Humira. But you mentioned several times that things are playing out as planned. But in the prepared remarks, you said U.S. erosion played out slightly better than you thought in Q1. So is the conclusion that whatever was better is temporary. You also mentioned volume pressure, but price -- offset by price benefit. Can you quantify that? But when you sum it all up, it sounds like you expect volumes to underperform the expectations you set three months ago? And is that in part maybe due to the Accredo news from yesterday. So that's a big -- that's a long question, but that's only one question. And the second question is curious if the FDA has contacted at the about the potential safety issues with Emlacridine post the competitor issue with convulsions in rabbits. And have you seen this with your agent?"
},
{
"speaker": "Jeff Stewart",
"content": "Yes. So it's Jeff. So I'll try to take that. So the first part was the first quarter. I mean, it was marginally better in terms of overall performance because we didn't see -- obviously, we didn't see any volume disruption until 401. Now when you look at 401 and we look after three weeks, we look at our model in terms of the expectation around retention of Humira with the CVS template, that's largely tracking in line with what our expectations were with a bit of the surprise that some of that Humira is not going to the biosimilar, as I mentioned, is going to other mechanisms including Skyrizi and Rinvoq. So overall, as we look to the balance of the -- really the first quarter, what we're seeing play out in the second quarter and look to the full year, our commentary, and I'll ask Rob to highlight if he has anything to add is very much in line with what we've guided at the beginning of the year. So no material change in what we're seeing in the marketplace."
},
{
"speaker": "Robert Michael",
"content": "Yes, this is Rob. I'll confirm that, what Jeff is saying. I mean it's tracking in line with our expectations. We are not saying that volume is worse than we originally guided. We're saying this is tracking in line with our expectations. We try to characterize for you the price versus volume dynamics? Obviously, saying it's the price erosion is the vast majority of the decline, but there is volume, and it's tracking exactly as we anticipated. So there isn't an additional downside here. As Jeff mentioned, we did have slightly better performance in the first quarter. But again, it was -- I mean, I think, to the tune of $30 million to $40 million on this book of business, not overly material, but ahead of the initial expectation."
},
{
"speaker": "Roopal Thakkar",
"content": "Steve, it's Roopal. I can take the next question. We did a thorough diligence. And when we look at data sets that offer clinical data, obviously, we do a deep dive there, also look at blinded data, but we also do a deep dive looking at toxicology, animal tox in particular. And we didn't observe anything that was consistent with what has been described thus far. And as I mentioned, when we look at blinded safety data either from the 1B or the current pivotals that are running, we don't see an adverse event like this that would be related. And as far as we know, no health authority has reached out to ask any further questions about this."
},
{
"speaker": "Robert Michael",
"content": "Steve, this is Rob. I'm going to come back to your previous question and maybe I understand where the confusion could be. That one-time price benefit is a year-over-year dynamic. It was contemplated in our guidance. When you have a formulary change you essentially have those rebates go away and you recognize that. That was part of our guidance. That was not a benefit versus our guidance. That's a benefit in the year-over-year. So if you look at Scott guided to I think it was 32%."
},
{
"speaker": "Scott Reents",
"content": "That's right."
},
{
"speaker": "Robert Michael",
"content": "Erosion in the second quarter, which is lower than -- it was around 40% in the first quarter. So naturally, you'd wonder why would you have less erosion. Well, there's that year-over-year dynamic but that was how we planned the year. We anticipated it because we knew about the change that was coming in April 1. So I don't want to interpret that as a benefit versus our guidance, that's a benefit in the year-over-year calculation."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Steve. Operator, next question, please."
},
{
"speaker": "Operator",
"content": "The next question comes from Trung Huynh with UBS."
},
{
"speaker": "Trung Huynh",
"content": "Congratulations, Rick, on the next chapter of the life and Rob for moving AbbVie forward. Again, on biosimilar Humira. In your remarks, you mentioned post the expected CVS contract, there was a step-up in price for Humira. Is that simply because you're giving away more price to CVS at the contract at the time. And you mentioned additional contracts moving to biosimilar like CVS this year. Are there any meaningful contracts here that you can flag so we're not surprised? And is it possible we could see a actually a pricing increase by year-end because of this?"
},
{
"speaker": "Scott Reents",
"content": "Trung, this is Scott. I'll start with your question regarding the price benefit. So in my remarks, I indicated that with the formulary change in CVS and the volume step-down we saw there that there's a onetime price benefit associated with that. And you can think of this as we have the volume declines, that volume had been associated with price that we would have been paying in terms of rebate that those rebates will no longer be paid. Therefore, there's a one-time price benefit associated with that initial step down in the quarter. So that's what that relates to."
},
{
"speaker": "Jeff Stewart",
"content": "Yes. And in terms of what we see going forward, as I highlighted, we don't see a significant exclusionary action where Humira would be removed from a formulary going forward. We did plan for, obviously, that smaller plans may make some adjustments to their formularies. That's all within the volume degradation and the pricing dynamics that we put into our guidance. And as I mentioned in one of the comments, some of the payers, not super large would maybe consider this idea of starting new patients on the biosimilars versus maintaining all the existing patients on Humira. So if you were to see that, you shouldn't be surprised about that and that would be within the contemplated approaches that we're taking as we look across '24 with our knowledge of what's happening in the marketplace."
},
{
"speaker": "Liz Shea",
"content": "Thanks, Trung. Operator, we have time for one final question."
},
{
"speaker": "Operator",
"content": "And our final question comes from Evan Seigerman with BMO Capital Markets."
},
{
"speaker": "Evan Seigerman",
"content": "On the aesthetics business, maybe talk to me about some of the dynamics you're seeing in China. I know that there's a lot of macro headwinds and this is a pretty big part of your business. And then a bit of housekeeping on Skyrizi, where the last quarter you disclosed the $1.9 billion cash payment for royalties. Can you provide us any color on what this quarter's royalty was? And I believe that was for the full year last year but maybe just for the quarter."
},
{
"speaker": "Carrie Strom",
"content": "This is Carrie. I'll address your question on aesthetics in China. And we do expect economic headwinds that we're seeing in China to persist over the near-term with the China aesthetics market flat overall for 2024. So the way to think about it is to expect negative market until the recovery starts to begin in the second half of 2024. China does remain a very important market for our aesthetics business. And as the market there starts to recover, we will continue to invest in consumer activation, injector training and continue to launch new products in the support market."
},
{
"speaker": "Scott Reents",
"content": "It's Scott. So you're right. With respect to the schedule relative payments. So you have to remember that these are on a bit of a lag, so they don't track each quarter sales. But the $400 million was the amount in the first quarter that we paid in cash payment."
},
{
"speaker": "Liz Shea",
"content": "Well, thanks, Evan. That concludes today's conference call. If you'd like to listen to a replay of the call, please visit our website at investors.abbvie.com. Thanks again for joining us."
},
{
"speaker": "Operator",
"content": "Thank you. That concludes today's conference. You may all disconnect at this time."
}
] |
abnb | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good afternoon, and thank you for joining Airbnb, Inc.'s earnings conference call for the fourth quarter of 2024. As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Airbnb, Inc.'s website following this call. I will now hand the call over to Angela Yang, Director of Investor Relations. Please go ahead."
},
{
"speaker": "Angela Yang",
"content": "Good afternoon, and welcome to Airbnb, Inc.'s fourth quarter of 2024 earnings call. Thank you for joining us today. On the call today, we have Airbnb, Inc.'s co-founder and CEO, Brian Chesky, and our Chief Financial Officer, Ellie Mertz. Earlier today, we issued a shareholder letter with our financial results and commentary for our fourth quarter of 2024. These items were also posted on the Investor Relations section of Airbnb, Inc.'s website. During the call, we will make brief opening remarks and then spend the remainder of time on Q&A. Before I turn it over to Brian, I would like to remind everyone that we will be making forward-looking statements on this call that involve a number of risks and uncertainties. Actual results may differ materially from those expressed or implied in the forward-looking statements due to a variety of factors. These factors are described under forward-looking statements in our shareholder letter and in our most recent filings with the Securities and Exchange Commission. We urge you to consider these factors and remind you that we undertake no obligation to update information contained on this call to reflect subsequent events or circumstances. You should be aware that these statements should be considered estimates only and are not a guarantee of performance. Also during the call, we will discuss some non-GAAP financial measures. We provide a reconciliation to the most directly comparable GAAP financial measures in the shareholder letter posted to our investor relations website. These non-GAAP measures are not intended to be a substitute for our GAAP results. With that, I'll pass the call to Brian."
},
{
"speaker": "Brian Chesky",
"content": "Alright. Well, thank you very much. And hey, everyone. Thanks for joining me today. 2024 Airbnb, Inc. outpaced the travel industry's growth. We ended the year with Q4 revenue. Now before we get into the results, nights booked, and GBV all accelerating from Q3. I want to just quickly touch on some of the work that got us here. You know, over the past several years, we've been preparing for Airbnb, Inc.'s next chapter and we wanted to make sure that guests and hosts love our core service before we introduce something new. So we listened to their feedback and we rolled out more than 535 features and upgrades to improve the experience. These upgrades include major reliability efforts, like guest favorites. Guest favorites make it easier for guests to find the best listings in Airbnb, Inc. We've also made it easier to host by launching the Toast network. It's a really simple way to find the best local host to manage your Airbnb. Now in just four months, the cohost network has grown to almost 100,000 listings. At the same time, we've been driving growth in a number of product optimizations. We made it easier for guests to find the perfect stay with enhanced search functionality and better merchandising. And this includes things like suggested destinations, more detailed maps, and a new welcome guide for guests. We also introduced flexible payment options in local payment methods in nearly two dozen countries, making it easier for people around the world to use Airbnb, Inc. And we're in the process of rolling out a completely redesigned checkout experience that makes it even simpler to book at Airbnb, Inc. As a result, we've seen a higher conversion rate, and we expect these improvements to continue delivering growth in 2025. By optimizing key parts of our product, like search, merchandising, and payments, we're seeing strong near-term results, and we're building a foundation to support the introduction of new offerings. Finally, we've rebuilt our platform from the ground up with a new technology stack. This includes new listing management tools for hosts, and these tools make it easier for hosts to list and manage their homes while giving them the ability to eventually offer more services. We've also upgraded our messaging system into a single unified platform, making communication between guests and hosts smoother and more reliable. Now with this new tech platform, we are able to innovate faster and expand beyond short-term rentals into becoming an extensible platform with a range of new offerings, and 2025 marks the start of Airbnb, Inc.'s next chapter. No. Today, our service is better than ever, and our platform is ready for the support with next. In 2025, we will continue building on this momentum. We're executing on a multiyear growth strategy to perfect our core service, accelerate growth in global markets, and launch and scale new offerings. Now we've talked a lot on previous calls about how we're preparing to expand beyond our core business. In this year, you'll see the beginning of a new Airbnb, Inc. So now I'm gonna turn it over to Ellie to give you a financial update. Ellie?"
},
{
"speaker": "Ellie Mertz",
"content": "Thank you, Brian, and good afternoon. I'll start with a review of our financial results and then provide our current outlook for Q1 2025. As Brian mentioned, we ended last year on a strong note. Nights and experiences booked accelerated in Q4 to 12%, making it the highest year-over-year growth quarter of 2024. Revenue also grew 12% year-over-year to $2.5 billion in Q4. Net income was $461 million and adjusted EBITDA was $765 million. For the full year, adjusted EBITDA totaled $4 billion, representing an adjusted EBITDA margin of 36%. Since 2020, we've delivered over 4,000 basis points of EBITDA margin expansion. Next, I'll turn to the balance sheet and cash flow. During Q4, we generated $458 million of free cash flow. And for the full year, we generated $4.5 billion, representing a free cash flow margin of 40%. At the end of the year, we had $10.6 billion of corporate cash and investments, as well as $5.9 billion of funds held on behalf of our guests. Our strong balance sheet allowed us to repurchase $838 million of our Class A common stock during Q4 and $3.4 billion for the full year. At the end of Q4, we had $3.3 billion remaining on our repurchase authorization. Now let's shift to our Q1 2025 outlook. After closing out 2024 with our highest quarter of nights and bookings growth, we're excited about the strong demand we continue to see early in 2025. For Q1, we expect to deliver revenue between $2.23 billion and $2.27 billion, representing 4% to 6% year-over-year growth, or 7% to 9% when excluding FX headwinds. As we mentioned last quarter, revenue in Q1 2024 benefited from both the timing of Easter and the extra day from leap year, creating a hard year-over-year comparison. Without these calendar impacts and FX headwinds, our revenue growth would be about 6 percentage points higher, or 10% to 12%, which is relatively stable compared to Q4. For nights and experiences booked, we expect year-over-year growth in Q1 2025 to be relatively in line with Q1 2024 once you exclude leap day, which contributed about one percentage point of growth last year. On profitability, we expect adjusted EBITDA and adjusted EBITDA margin to decline compared to Q1 2024, driven by the same factors impacting revenue. That said, if you exclude the calendar and FX headwinds, adjusted EBITDA margin in Q1 would remain relatively flat year-over-year. As we look ahead to 2025, we're focused on executing our multiyear growth strategy. Our strategy is designed to drive long-term growth and deliver market share gains through three levers: one, perfecting our core service; two, accelerating growth in global markets; and three, launching and scaling new offerings. We're focused on strengthening the economics of our core business and generating strong free cash flow while also investing in growth opportunities. This year, we plan to invest $200 million to $250 million towards launching and scaling new businesses, which we'll introduce in May. Even with these investments, we expect to maintain strong profitability, delivering a full-year adjusted EBITDA margin of at least 34.5%. Because these investments will roll out throughout the year, their impact on our quarterly adjusted EBITDA margin will be the most pronounced in the first nine months of 2025. As these new businesses scale over the coming years, we expect them to make a significant contribution to revenue growth. And so each year, we'll layer in new offerings where we see long-term revenue growth opportunities. And at the same time, we'll focus on delivering strong profitability and world-class free cash flow for our core business. And now with that, I'll open it up to Q&A."
},
{
"speaker": "Operator",
"content": "We will now begin the question and answer session."
},
{
"speaker": "Stephen Ju",
"content": "Thank you. So I think in the past, in terms of the global sort of localization effort, you've talked about Brazil and I think in the shareholder letter, you were showing your localization effort for Japan. So just wondering how long it typically takes for one of these efforts to localize in any given country you know, it takes to come together. If you have you guys have mentioned Argentina, Germany, South Korea, and other places. Ellie, I guess, the $200 to $250 million of investment that you're planning to incur I guess, in the, you know, the front half of this year for the most part. What is that primarily gonna be geared to? Is it gonna be marketing? Is gonna be engineering, staff up, or any color there would be helpful. Thank you."
},
{
"speaker": "Ellie Mertz",
"content": "Great. Thank you, Stephen. Let me start just giving a little bit of color in terms of our global market strategy. As backdrop in terms of context on this strategy, we've shared over the last year that Airbnb, Inc. is a very global brand. However, our business is concentrated in our top five core markets. So that's the US, UK, Canada, France, and Australia. Those five markets comprise about 70% of our gross booking value. And so as a growth lever that we've been investing in, we've been targeting markets outside of that top five. Where we think that there's a sizable opportunity for us to invest and both gain penetration in the markets and also provide a tailwind to our global growth rates. I think what you've seen over the last not just the Q4 results, but over 2024 as well is that those investments and that targeting of new geos has had a meaningful impact on our growth. In particular, what we shared in Q4 was that those markets that we've targeted are growing about double the rate of our core markets. And to your question in terms of, you know, how long does it take, I would say it depends on the specific market. I think Brazil is a huge success case, and that's a market that we've been focused on in particular with adding brand marketing over the last two years, and we've been able to materially increase the scale of our business in that country in particular. I think there's other markets that maybe the duration for building scale will take longer. A country that I would put in that category would be Japan, which is a market that we just commenced our brand marketing in Q4. And we're starting at a lower base of domestic awareness. So each of our targeted markets, you know, we have to factor in where the market is, the level of awareness and consideration we have among local travelers and the level of product optimizations we need to make to make sure that we are appropriately addressing the local audience. So your second question is around our investments in scaling launching and scaling the new businesses. As the letter details, we're planning to spend approximately $200 to $250 million this year. And you should see the bulk of that investment hit both our marketing line and our product development line items. Just to give a little bit more color here. In terms of marketing, we will obviously be spending to build out the teams to drive the supply operations around those new offerings. We will also be investing behind awareness of the new products and demand generation. And then on the product side, we will be slightly increasing our pace of count growth across our development organization. So that we can move more quickly across our road map and support these new businesses."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Richard Clarke with Bernstein. Please go ahead."
},
{
"speaker": "Richard Clarke",
"content": "Hi. Thanks for taking my questions. I just want to ask about the launch we've seen of AI. I think Airbnb, Inc. avoided some of the volatility that some of your peers had. But are you leaning into those operators? Are you or are you confident you can kind of control the AI flow through the Airbnb, Inc. platform?"
},
{
"speaker": "Brian Chesky",
"content": "Hey, Richard. Yeah. Here's what I think about AI. I think it's still really early. It's probably similar to, like, the mid to late nineties for the Internet. So I think it's gonna have a profound impact on travel. But I don't think, you know, it's yet fundamentally changed for any of the large travel platforms. And so you know, we want to be the leading company for, you know, AI-enabled traveling and eventually living. I'll just talk about a little bit about how we're gonna do that. So most companies, what they're actually doing is they're doing integrations with these other platforms on trip planning. But the trip planning, it's still early. I don't think it's quite ready for prime time. We're actually choosing a totally different approach which is we're actually starting with customer service. So later this year, we're gonna be rolling out, as part of our summer release, AI-powered customer support. You know, as you imagine, we get millions of contacts every year, AI can do an incredible job of customer service. It's gonna speak every language 24/7. They can read a corpus of thousands of pages of documents. And so we're starting with customer support. Over the coming years, what we're gonna do is we're gonna take the AI-powered customer service agent and we're gonna bring it into essentially, Airbnb, Inc. search to eventually graduate to be a travel living concierge. I think it's a really exciting time in the space because you've seen, like, with Deepseek and more competition with models, these models are getting cheaper or nearly free. They're getting faster, and they're getting more intelligent. And for all of this, it's starting to get commoditized. What I think that means is a lot of value is gonna accrue to the platform. And, ultimately, I think the best platforms, the best applications are gonna be the ones that, like, most accrue the value from AI, and I think we're gonna be the one to do that with traveling and living."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Eric Sheridan with Goldman Sachs. Please go ahead."
},
{
"speaker": "Eric Sheridan",
"content": "Thanks so much for taking the question. Maybe just one quick follow-up, Brian, and then I could ask a follow-up. With respect to the AI, I appreciate your answer with respect to outward-looking and how it might change the landscape. Where do you think the potential is internally to apply AI for efficiencies inside the company and create an additional layer of potential margin efficiency and or free cash flow conversion in the years ahead? And then in terms of the way you guys framed the year with exiting it up higher margin trajectory post some of the investments you called out, will there be any change or thought about how your capital allocation process might evolve as you move through 2025? Thanks so much."
},
{
"speaker": "Brian Chesky",
"content": "Alright. Hey, Eric. I'll answer the efficiency deal. I'll wait for the second part. So yeah. There's, like, a couple of efficiencies that you could imagine. Airbnb, Inc., one is obviously customer service. I think that's, like, one of the biggest ones. I've kinda already covered that, but I think that's, like, a massive change for Airbnb, Inc. Other I assume you refer to is essentially engineering productivity. We are seeing some productivity gains. I've talked to a lot of other tech CEOs who and here's what I've heard talking to other, like, tech CEOs. Most of them haven't seen a material, like, change in engineering productivity. Most of the engineers are using AI tools. They're seeing some productivity, I don't think it's flowing to, like, a fundamental step change in productivity yet. I think a lot of us believe in some kind of medium term of a few years, you could easily see, like, a 30% increase in technology and engineering productivity. And then, of course, you know, beyond that, I mean, I think it could be, like, an order of magnitude more productivity because it but but that's that's gonna be, like, down the road. And I think that's gonna be something that almost all companies benefit from. I think the kinda younger, more innovative startup-like companies might benefit a little bit more because they'll have engineers who are more likely to adopt the tool. That's probably pretty important. But I think I think this is what I'm hearing from other people and we're pretty much having the same experience."
},
{
"speaker": "Ellie Mertz",
"content": "Eric, to answer your question with regards to the capital allocation strategy, I would say, no, no meaningful change in terms of strategy. What we've stated consistently over the last two years is that our capital allocation strategy includes, one, obviously, investing in our core operation, valuing M&A where there's relevant opportunities, and three, returning capital to shareholders. Obviously, given the strength of our balance sheet as well as our world-class free cash flow margins, we have the capital to do all three. You can see from our 2025 guidance that we are leaning in through the P&L in terms of investing slightly more in terms of the core operations and in particular new businesses. And then from a returning capital to shareholders, you know, you should look at the volume of repurchase activity in 2024 as a guide with regard to the magnitude in 2025. I would expect us to, you know, be slightly price sensitive and to dial up the quarterly repurchasing based on the underlying stock price."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Justin Patterson at KeyBanc. Please go ahead."
},
{
"speaker": "Justin Patterson",
"content": "Great. Thank you very much. Brian, could you see how how you're thinking about the pace of product innovation versus the past? It sounds like this new tech stack should be beneficial to product velocity. So I'm curious where you saw friction points on the prior tech stack and how you think this new new tech stack really positions you to to execute on those growth initiatives you outlined at at the start? Thank you."
},
{
"speaker": "Brian Chesky",
"content": "Yeah. Hey, Justin. I mean, this tech stack probably like, this project probably started, frankly, six years ago, if I'm not mistaken. So this has been a very, very long thing. We've been doing it for quite a long time. I think the big milestone is that, like, you know, most of the work is now complete. And you're gonna see this year, like, almost every part of the application is gonna be essentially rebuilt from the ground up. What you've seen is, like, we've done 535 upgrades. The vast majority of those upgrades have actually been in the last two years. So every year, we are increasing the throughput of features and upgrades. This summer release is gonna be significantly larger than past ones, and I expect the ones after that will be larger. So it's gonna just basically, what it's gonna lead to is the, fewer engineers being able to basically, ship features faster. And so, you know, there's a pretty, pretty huge gain here. So I think I think what you should expect is this year, we're gonna launch significantly more upgrades than last year, and every year, it should increase."
},
{
"speaker": "Operator",
"content": "Next question comes from the line of Brian Nowak with Morgan Stanley. Go ahead."
},
{
"speaker": "Brian Nowak",
"content": "Great. Thanks for taking my questions. Good good guide, guys. Just two questions. One, so, Brian, as you're as you're thinking about sort of the the new products and new use cases to come from the some of the growth opportunities, launching in May. Can you just talk us through some of the the larger points of friction or opportunities high level that you see from a a guest and a host perspective you're looking to address with some of these products? And then the second one, Ellie, on the on the full year margin guide, the at least 34%, can you just sort of walk us through how you're thinking thinking about the the contribution from the invest sort of growth throughout the throughout the year and as you kind of tumble through the comps for the margin guide?"
},
{
"speaker": "Brian Chesky",
"content": "Yeah. Hey, Brian. I will and are you asking just to clarify the first this is specifically, friction point for new products and services, not product optimizations. Correct? That's right. Yeah. So the, you know, the $200 to $250 million. Yeah. The new new business is running. Yep. Yep. So let me just kinda back up and just give you a little bit of our philosophy. So you know, we spent the last, like, four to you know, four or five years really trying to get to this moment where we could prepare for the next chapter of Airbnb, Inc. What we did, as I said, is we built a tech stack from the ground up. We listened to guest and host feedback made over 500 upgrades, we built this new business organization that Dave is now leading. Become obviously, went from breakeven to quite profitable. So I think we're now ready for this next platform, next next chapter expand beyond our core where Airbnb, Inc. is you know, just a place to stay. And to do that, here's a couple of philosophies a couple principles we have in our philosophy I'll share and I'll just tell you a little bit about the friction. Number one, I think we can do this quite efficiently because we are not gonna launch separate apps or separate brands. We're gonna have one app, one brand, the Airbnb, Inc. app. We want the Airbnb, Inc. app kinda similar to Amazon to be one place to go for all of your traveling and living needs. A place to stay is just really, frankly, a very small part of the overall equation. Every new business we launch, we'd like to be strong enough. It could stand alone, but it makes the core business stronger. You know, I think that each business could take three to five years to to scale. A great business could get to a billion dollars of revenue. It doesn't mean all of them will. And you should be able to expect, like, you know, one or a couple businesses to launch every single year for the next five years. We're gonna start initially with things very closely adjacent to travel. So, you know, when people book an Airbnb, Inc., there's a lot of, like, you know, experiences and services and other things that would make their stay more special. And it would even include things they wouldn't think to search for. And from there, we're just gonna keep expanding, and we're gonna expand out to more host services to enable them to become better hosts. And then eventually, we'll move it, you know, further and further away from our core. I think, like, maybe the analogy of Amazon is a really good one, which is to say, they started with books, the nearest adjacency to books was DVDs and CDs back when people bought physical media, and then they went to, like, I don't know, maybe toys and other things. And eventually, they ended up with fashion, and pretty soon, they were doing things pretty far adjacent from, you know, media and books. So we're gonna probably follow that path. So we're gonna really, really start adjacent to travel, and part of the reason why is a traveler booking a home, what else would they wanna book? And the other great thing is like, we offer these other experiences and services that could potentially bring a new guest that then book more homes in Airbnb, Inc. And I think one of the ultimate goals is you know, Airbnb, Inc. is used by, like, I think, 1.6 billion devices a year. So it's got a pretty big volume of users. But we're not very we're not a very frequently used app. People typically use us once it's right a year. And I would love for it to be one day for people to use this once or twice a week. And so that's kind of one of the goals over the long term."
},
{
"speaker": "Ellie Mertz",
"content": "Great, Brian. Let me talk a little bit about margins over the course of the year. So to restate, or just reiterate the guidance that we provide for the full year, we're going to invest $200 and $250 million in terms of launching and scaling the new businesses. We anticipate that the negative impact to margin from those investments will be heavily weighted in Q1 through Q3. Whereas the revenue obviously won't pick up until we've launched those new products. At the end of Q2. And so we would assume that the benefit from that lift would really be concentrated in terms of our x rate of Q4. But more broadly, I think the, you know, the takeaway from our guide is that even with that investment level, we're obviously maintaining extremely strong healthy margins for our core business. And obviously, the global floor on EBITDA gets you to that number. I think in terms of the general question of comps, I think the most notable comp, I would say, noise is what we described in the letter with regard to Q1. It's obviously in the letter, but just to restate it here. Q1 revenue will be heavily impacted by both the FX headwinds as well as the calendar changes vis a vis or relative to 2024. That will impact not just revenue, but also Q1 EBITDA. We've called that out in the letter just to highlight that. Absent those pieces, the Q1 EBITDA margins would actually be relatively flat."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Ron Josie at Citi."
},
{
"speaker": "Ron Josie",
"content": "Thanks for taking the question. Brian, I wanted to ask a little bit more on the here now. You in the letter, you talked about recent product enhancements around search and better merchandising. Love to hear your thoughts on what what you're finding, what you're seeing with search and merchandising and learnings there to help inform these newer experiences and products that are come down the pike. And then next question is just on nights and experiences both to the acceleration this quarter. Talk to us about the contribution between just the broader travel market being relatively healthy and and these newer products that are launching, the ex like, co-hosting or experiences or the next nine. Thank you."
},
{
"speaker": "Brian Chesky",
"content": "Yeah. Hey, Ron. I'll take the first. Yeah, when you think about the here and now, you know, when we call this out in our letter really around product optimizations. And, Ron, I'll kinda just let's just start, like, three parts. Step one, people come to Airbnb, Inc. It's really we have a huge amount of traffic. We have nearly 5 billion visitor unique 5 billion visitors a year. It's really important that, like, when people come to Airbnb, Inc., they are able to find the right Airbnb, Inc. for them. We've done a lot around, you know, like, we've introduced a personalized welcome tour. Again, people use Airbnb, Inc. only a couple times a year, so it's really important to orient them. So we've got this welcome tour that's personalized to every person. Based on your past searches, we suggest destinations that you we think you're gonna be interested in. Based on past filters, we offer up those filters as essentially, like, quick filters to apply. We've also found that, you know, this is probably obvious, but, our mobile app converts significantly higher than our mobile website. So we've been pushing to get more people to download our mobile app, and now in Q4, mobile bookings represented 60% of our overall bookings up from, I think, 55% the year before. You know, our checkout page, it this sounds like a simple thing, but the checkout page like, the page to to pay, not the checkout Airbnb, Inc., the page to pay, was really, really long, and we found that if you make it shorter, simpler, that leads to a massive increase in conversion. I'm just giving you a couple examples. There's really a long list of dozens and dozens of things again, you know, a hundred basis point increase on a GBV of $80 billion, you know, you're gonna be soon approaching like, $100 million optimizations just one at a time for some of these really, really big efforts. So once you find an Airbnb, Inc., it's important that that Airbnb, Inc. is affordable. And affordability is in our DNA. So we've made a lot of improvements around affordability that have also increased optimization. Like showing the total price display. When guests toggle on total price display, that includes all fees including cleaning fees, we see that people are booking higher value Airbnb, Inc.s. We've also created a lot of tools for hosts. Whether it's monthly and weekly monthly discounts, price tips, search tips, all these things are essentially efforts to make everything more affordable, and it's working. Because during 2024, hotel prices were up year to year while comparable Airbnb, Inc. listings were down year over year in price. So we're making progress. And the last thing is if you find the Airbnb, Inc. is a good price, it's still really important that it's of high quality. For every person who books in Airbnb, Inc., about 90 people book a hotel. And so if we do, you know, around a 500 million IT year and we got the extra hotel grass to use Airbnb, Inc., go from 500 million nights to a billion room nights. So that's a really, really big opportunity. And we think the number one way to do that is to improve the reliability and quality of our service especially your host. So the way to do that is elevate the best and cut the bottom. We introduced guest favorites in October 2023, it's now gotten 250 million nights booked. If you book a guest favorite, customer service rates are down. Trip issues are down, guest net promoter is up, cancellations are down, so it's really great. We also since April 2023, we introduced a new host quality system and removed 400,000 listings that don't meet our or don't meet our guest expectation. Ron, those are essentially the three levers. We have usability, making it easier for people to find the listing by increasing conversion. Affordability, getting prices to be better and more competitive, and then reliability and quality of the service. So again, we've made know, hundreds of updates over the past few years on these, but these are just a couple callouts."
},
{
"speaker": "Ellie Mertz",
"content": "And and Ron, to answer your question in terms of quantifying the Q4 demand. I would say, you know, obviously, we benefited from organic tailwinds across the industry. But in addition to that, all of the product optimizations that Brian shared from our testing of those improvements, we estimate the exit rate growth rate for our business was lifted by a couple hundred basis points due to those improvements. And we see it through improvements in our booking conversion."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of James Lee at Mizuho. Please go ahead."
},
{
"speaker": "James Lee",
"content": "Great. Thanks for taking my questions. I'm sorry I joined the call a little bit late, so I apologize if my question has been repeated. Two questions here. One on experiences. Can you guys talk about maybe some of the friction you're able to resolve in the upcoming launch? Any indication that you can give us on the confidence of a successful launch this time? And secondly, I just want to double click on you know, Brian's commentary on Beyond the Core. Are you thinking about maybe some sort of concierge service, meaning, like grocery shopping, access to spa, to gym, maybe some kind of access to recreation. Is that what we should think about when we think about adjacency to travel? Thanks."
},
{
"speaker": "Brian Chesky",
"content": "Yeah. I can I can handle this? Hey, James. So frictions do you wanna resolve with experiences? Let's ask, though, what were the were some of the challenges the first time around? Well, the first time around, I don't think we integrated the experiences really well. The products. If you go to airbnb.com or app right now, it's pretty hard to find them. The second thing is that when you find the experiences, I don't think they were merchandised as compellingly as they could. Third, there weren't really a lot of integrations with social media. I think social media is a great distribution. And fourth, I think we are completely rethinking the kind of supply we're gonna have. I think it's gonna be really, really compelling. And then fifth, we didn't really market it that much, and I think this we're gonna be a bit more aggressive in marketing then because we're really proud of the quality of product we have. Confidence of how successful the launch is gonna be. You know, I wanna be measured in my response because know, you know, this is a this is a second shot at it. I am extremely confident that this product can be incredibly, incredibly compelling, though. So I think if people give it a shot, I think they're gonna be really in love with the product because people really do actually like the current Airbnb, Inc. experiences, and I think this one's gonna be significantly better. I probably won't say much more, tune in in May, and we're gonna, like, you know, I'll walk you through the entire product and product launch. As far as adjacencies, yeah. I mean, there are you know, dozens and dozens I mean, if you got really granular, hundreds of opportunities. Endless. We could spend many, many years picking all the adjacencies to be able to travel somewhere and list somewhere. Number like, you know, 17, 18% of our nights booked are longer-term stays of more than 30 days. And that's gonna become an even greater share of our business. I think down the road, and so if you think about what all the service need to travel or live somewhere, there's a lot of opportunities. Now the key is not to do them obviously all at once, to be to prioritize, to pick the most differentiated services guests want the most that are, you know, the most compelling, opportunities from a business standpoint and just start from there. We're not we're not gonna go into too many more details, but stay tuned."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Jed Kelly at Oppenheimer. Please go ahead."
},
{
"speaker": "Jed Kelly",
"content": "Hey. Great. Thanks for taking my questions. Just first, can you talk about as you kind of increase your reliability, where are where are you in potentially partnering with some you know, larger companies that might be able to provide these enhanced services. And then just just circling back to North America. I mean, how do you view that market opportunity? I know room nights accelerated mid-single digits, but I'm sure you want it to grow faster. So so just how should we view the North American market? Thank you."
},
{
"speaker": "Brian Chesky",
"content": "Yeah. Why don't I start in with partners? I imagine eventual like, Airbnb, Inc., first of all, we haven't done a lot of partnership. We historically have not had a robust business development or partnerships function. So most of our platform, we feel as kind of a little bit more of a closed ecosystem. I imagine this next chapter of Airbnb, Inc. is much more of an open ecosystem. If you think about the really large tech platforms, they're kinda ecosystem ecosystems, essentially, and they're ecosystems that partner with other companies and developers to build on their platform. And Airbnb, Inc. is the kind of company where there are quite literally thousands of companies like cleaning companies, key exchange, like grocery companies, there's all sorts of companies built on top of Airbnb, Inc., especially local businesses. So I think that Airbnb, Inc., there is a play to the ecosystem where we could partner with local companies and global brands. So we are absolutely thinking about that. It's not the first thing we would do. We'd probably start with kinda first party before we go to third party, but third party integrations is incredibly compelling because why not, like, allow the world to build an Airbnb, Inc.? We don't need to build future by ourselves."
},
{
"speaker": "Ellie Mertz",
"content": "K. Just to talk a little bit about North America. So one to just call it the trends that we saw in the back half of the year. North America, like all other regions, accelerated from Q3 to Q4. What I would say about you know, the the state of play in North America is we believe we can grow faster than we are growing today. And and why is that? I would say one is that North America, despite the scale that we've been able to achieve in North America, is still a market dominated by hotels. Our business continues to be a a fraction of the overall lodging industry, and, you know, there's there's plenty of room to grow. Short-term rental in particular, our business relative to hotels as compared to what it looks like in other regions. I would say second, we've we've mentioned this in prior calls. We look across the states and identify that there's there's several demos that we we just frankly don't do as well as we do in other demos. The ones that we've called out in particular would be the Latino population, the kind of crossover heartland states outside of the coast, and those are areas that we continue to, you know, work to drive penetration and, increase consideration."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Doug Anmuth with JPMorgan. Please go ahead."
},
{
"speaker": "Doug Anmuth",
"content": "Thanks for taking the questions. Brian, can you just talk about in what markets or for what kind of listings you're seeing the cohost network work best and what's really driving them to earn twice as much as other listings. And then, Ellie, I'm just curious where you might be finding the most traction in managing the cost structure to make room for some of these new investments coming up. Thanks."
},
{
"speaker": "Brian Chesky",
"content": "Yeah. Hey, Doug. Co Host Network, just to give people a little bit of background on the Co Host Network, you know, we did a bunch of surveys, and we talked to a lot of prospective hosts. And here's the status surprised us. More than 40% of people we surveyed say they would be interested in sharing their home on Airbnb, Inc., but the biggest obstacle to them doing that was that felt like it was a lot of work. We also noticed there were a lot of people that were hosting Airbnb, Inc. that would like to expand, but they don't have another home to put in Airbnb, Inc. And so we thought, what if we created a marketplace to match people with extra time with people to have home? And that is the Co Host network. The reason why the Co Host listings are so much productive they make about twice as much revenues listings matched by Co Host than other listings. It's because we only invited top hosts on Airbnb, Inc. to become a cohost. So the average rating for a host in Airbnb, Inc. is significantly higher. The majority of listings managed by Co Host, I believe, are guest 85% help manage a guest favorite, 75% of Co Hosts are actually Superhosts. We launched in ten countries with 10,000 cohosts. Those countries where I think it was Australia, Brazil, Canada, France, Germany, Italy, Mexico, Spain, UK, and US. So it was those ten countries, and that's it. You know? And since we've and the average cohost has an exceptional rating of 4.87. That's a really, really good rating. But I was, like, four months ago, five months ago. Today, went from 10,000 cohosts to 15,000 cohosts. We now have 100,000 listings under management. The next plan is to expand to Asia. So the two countries we're focused on are Japan and Korea. And, we'll give you updates as that progresses."
},
{
"speaker": "Ellie Mertz",
"content": "Great. And, Doug, to talk about margins in terms of where there's opportunity for incremental efficiencies? Just to restate our our margin guide every year, we will be looking to invest in new growth opportunities while also finding incremental efficiencies in our core business. In terms of 2025 and and the outlook there, I would say incremental opportunities across our variable costs. So areas like payment processing and customer service opportunities to just be frankly a little bit more efficient and to deliver some margin expansion there. Similarly, we continue to be extremely disciplined with our G&A expenses and headcount growth, allowing for some margin expansion there as well. And then on the marketing line item, in 2024, we did increase our overall marketing intensity over the course of the year because we saw opportunities to lean into. Our current plan for 2025 plans for a flat percent of revenue for the core business on marketing."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Lee Horowitz at Deutsche Bank. Please go ahead."
},
{
"speaker": "Lee Horowitz",
"content": "Great. Thanks for thanks for taking the question. Maybe just on some of the growth markets. You guys highlighted some really healthy growth rates in these expansion regions. And obviously put up nice numbers in the 4Q. But as we look after to the first quarter, nice growth is sort of reverting back to what you did for March of 2024. So can you maybe help us unpack why the success you are seeing in some of these regions is not necessarily pulling up the overall growth rate in the first quarter? And then maybe relatedly to the marketing comments, you just made in terms of it being sort of flat year on year. I guess, how how do we maybe, you know, put together the pieces of, you know, marketing intensity perhaps flat year on year, with a number of different growth regions still out there, that are are probably not quite as large as you want at this point. Like, do you no longer really have to invest in them, or have you reached investment sort of threshold on those? Are you gonna start to get leverage on the investments that you've made in those regions? How come they they don't necessarily need more marketing dollars to deleverage next year? Thanks so much."
},
{
"speaker": "Ellie Mertz",
"content": "Sure. Let me let me start with the latter question. So if you think about how we've been managing our overall marketing dollars, the majority of the spend is on brand marketing. And the way to think about brand marketing is that it is effectively a fixed amount of spend for each market in terms of the minimum amount that you need to spend for that market to be efficient. And so it is not necessarily a one for one, like, performance marketing in terms of how you need to scale it up. And so what we've done over the last couple of years is keep the the growth of spending against our core markets relatively modest while adding on these incremental new markets and the incremental brand marketing dollars that requires. And so as we look forward to 2025, the way that we're able to maintain strong growth in the core markets, but also incrementally invest in a higher level of marketing intensity for the expansion market is not to grow the core market marketing spend faster than revenue. And and that the the way we're able to do that is our lack of of strong reliance on performance marketing which would be entirely variable. Instead, in a market like the US, we have a base fixed amount that is dedicated to brand. On top of which we we surgically add performance marketing. And so the the broad takeaway should be that in particular, in our core markets because they are so heavily reliant on brand, we are not adding dollar for dollar as revenue increases, and therefore, the marketing budget's allowed to expand and be more heavily dedicated to expansion markets."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Justin Post at B of A. Please go ahead."
},
{
"speaker": "Justin Post",
"content": "Great. Thanks. A couple questions. Looks like you know, we've already covered it. US accelerated. Looking back, what what might have pressured the the growth rates and and on a macro level? And do you see those those pressures changing this year? And then, maybe Ellie, you could talk a little about the take rates contemplated in your outlook. What are some of the the positives and and negatives for for take rates? Thank you."
},
{
"speaker": "Ellie Mertz",
"content": "Yeah. Certainly. So let's talk a little bit about North America in terms of what, you know, what 2024 looks like. You'll recall this past summer, North America in particular, we saw at the beginning of the summer peak that there was a pretty material contract in terms of lead times, which made bookings growth in Q3 relatively muted. I think the question at the time was, is this a signal of weakening demand or is this a signal of simply a little bit of a volatility in terms of consumer behavior? When people book their next trip. What we found at the end of Q3 and consistent with our Q3 results that that played through with Q4 is that that volatility and kind of usage bookings growth we saw over the summer was somewhat temporal. And those folks who were, you know, somewhat on the sidelines in terms of making their future bookings in the summer came back to us in the fall and did indeed make bookings. I think subsequent to that, we've certainly seen that past the initial uncertainty leading into the election. The consumer and in particular the North American consumer has been strong and in particular has been been strong in terms of of contemplating future travel. In terms of take rates, if we play back the if we play back last year, let's talk about the puts and takes for last year and how they impact the take rate for 2025. So as you'll recall, we introduced an FX service fee mid-2024. That service fee is approximately 100 basis points applied to 20% of our GBV. So on an annualized basis, you would assume that it would list the implied take rate by about 20 basis points. It did that. However, in Q3, we had some offsets and in Q4, we also had some offsets. So specifically, in Q3, we had elevated made goods, which come in as a contra revenue and offset the the lift we received from the FX service fees. And then fast forward to the last quarter, the offset was a hard comp from some benefits we got to revenue in Q4 of 2023. Associated with breakage of gift cards. So fast forward to 2025, we don't anticipate any of those similar one-offs that will offset the the benefit we get from the FX service fee. And so instead for full year 2025, you should assume that, the implied take rate gets the full benefit of 20 basis points increase on a year-over-year basis. As compared to 2024."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of Ken Gawrelski with Wells Fargo. Please go ahead."
},
{
"speaker": "Ken Gawrelski",
"content": "Thank you. Two, if I may. First, just on the expense side, maybe, Ellie, you talk a little bit going looking beyond 2025. How do you think about the fixed investments you've made to prepare for the product launches in 2025? How should we think about that fixed versus variable component in 2026 and beyond? And then and then second maybe for Brian, you you talked about how you there's still opportunity in North America and the the the bookings of alternative accommodations relative to hotels and still it's very heavily weighted to to hotels. Could you talk about some of the elements you think that that could change that kind of price to value equation for consumers, especially in maybe in urban markets. Where where alternative accommodations had tougher time gaining share versus vacation markets where where you picked up a ton of share? Thank you."
},
{
"speaker": "Ellie Mertz",
"content": "So let me, let me talk about the product investments. Brian has shared that in in the letter we shared that we've sent the the last couple of years effectively rebuilding the tech stack. And so I would say, you know, while that work is not fully complete, a lot of it is behind us. So think from investor standpoint, you should be excited that most of the hard work has been done in terms of rebuilding the tech stack and and frankly modernizing our app that sets us up well to now turn our product road map towards supporting these these new services as well as continuing to perfecting the the core service. So what that means from an expense perspective is that on the go forward, we can increasingly dedicate our product resources to those consumer-facing growth additive features that, you know, obviously, the the consumer benefits."
},
{
"speaker": "Brian Chesky",
"content": "Hey, Ken. Just on your question, couple of things. So with regards let's focus on North American urban markets. That are very heavily dominated by hotels. The vast majority of people going to city in North America are staying in a hotel. Which is good for us and so far that there's so much room to grow. So what are the what are the what's the value equation? It's really four things. Why do people book hotels? Well, the first reason they book hotel is because it's pretty frictionless to book. Why we've been working on all those product optimizations, especially usability, to make it easier to book an Airbnb, Inc. The second is they know what they're gonna get. Whether hotels whether you like the hotel or not, you kinda know what to expect. And so that's why we've been focused a lot on reliability. We're gonna do a lot more on reliability and quality. And third, hotels offer a suite of services on premise. But we think there's obviously endless service that could be offered on Airbnb, Inc. And then finally, think affordability is a reason you'd book Airbnb, Inc. In fact, we have a we have a campaign we've been running. Some trips are better than Airbnb, Inc. And it's been incredibly successful. It highlights different between Airbnb, Inc. and hotels, and it basically says, we're not saying we're better in Airbnb, Inc. hotels for every trip. But if you're traveling with other people, it's almost always better and almost always significantly more affordable on Airbnb, Inc. So just tend to, like, back to zoom out. I believe I don't know when this will happen. But I do believe there's probably a tipping point where a whole bunch of guests that don't consider Airbnb, Inc. or use it only for maybe non-urban markets or for really large group family travel, but don't use it for business travel or urban markets. There's a tipping point where if we keep making the service more reliable, we add more service we make it more affordable, even more frictionless, eventually, there's a tipping point I think a lot of hotel travelers will come to Airbnb, Inc. Or use us for more of their share of wallet. So I think I can't possibly predict when this will happen, you know, but I what I can't predict is how much faster our service improve, and that's gonna happen over the coming years pretty quickly."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Kevin Kopelman with TD Cowen. Please go ahead."
},
{
"speaker": "Kevin Kopelman",
"content": "Thanks. Could you give us an update on how you're thinking about advertising services in your priority list as you're rolling on new businesses? Thanks."
},
{
"speaker": "Brian Chesky",
"content": "Hey, Kevin. I think it it's, like, almost every marketplace that's successful has done this. We've looked at this. We definitely think this is easily a billion-dollar revenue opportunity. It's not a matter of if, it's a matter of when. It's not the most perishable opportunity, so it's not something we'll be doing this year. It's definitely something, you know, on the horizon."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Naved Khan at B. Riley Securities. Please go ahead."
},
{
"speaker": "Naved Khan",
"content": "Okay. Thanks. Maybe just on the know, the urban demand, Brian, and you talked about how a lot of people just book hotel? Can you maybe touch on regulation and do you think do you see movement there in terms of how that might become more favorable, especially the other cities like New York might start to open up? Give us some thoughts there. And then if I have to think about regulation, maybe at a at a bigger scale, so I think Europe has been pretty pretty heavy on regulation. Especially on the on the larger platforms. Any anything in terms of either becoming a deemed gatekeeper or I'm not just any faster would be helpful. Thank you."
},
{
"speaker": "Brian Chesky",
"content": "Yeah. Sure. I'll take the first part, and I'll let you know it take a second. You know, with regards to regulation, let's just let's just frame it. So our top 200 market take comprise the vast majority of revenue. 80% of those jurisdictions have regulations on the books for Airbnb, Inc., regulations as in they recognize us. And we've now collected and remitted around $13 billion in hotel occupancy tax, and we have a, you know, really a great history of partnering with cities. I think the trajectory for cities is increasingly, I think, they're go when we first started, cities didn't really know what to make of us. This is, like, ten, fifteen years ago. I think some people thought Airbnb, Inc. was a problem. And I think increasingly cities are thinking of us as partners, and they're thinking of us as a solution to their problems. Just give a couple examples. Last summer, you know, parents had a really big problem. I hope many like, millions of people were coming to Paris, and they didn't have hotels to put them in. So Airbnb, Inc., we went from 100,000 to about 150,000 homes. Partnering with the IOC loan debt committee and the city of Paris. The French government, we have great support. And we were able to house 700,000 guests. In Paris during the Olympics. Imagine that. That's, like, more than ten Olympic stadiums where the guests were staying in Airbnb, Inc. I think that Paris Olympics was so successful that the city of Milan and the city of LA now looking at how we can be a solution for their challenges with you know, compression nights during the Olympics. And I think cities all over the world are looking at Airbnb, Inc. as a solution to be able to accommodate guests for large events. Where the money goes into local communities, and it, like, you know, limits hotels' ability to essentially create surge pricing. Another solution we've been is during times of disaster. You know, there was a devastating LA fire that I'm sure you're all aware of, about a month ago. And, you know, a large number of people were displaced. Well, Airbnb, Inc. and working with Airbnb.org has housed more than 19,000 residents. Los Angeles that were displaced because of the fire. And so I think generally, the conclusion here is that I think we're developing some really great momentum. I think cities are seeing us as a partner. I think that New York City remains an outlier. They banned the majority of our business. One year later, sorry. One year know, as of, I think, like, last September, the last data I saw, rents, they they they basically banned Airbnb, Inc. with the idea that rents would go down. What we've seen is rents aren't down year over year. In fact, rents are up, I think, 3% year over year. There hasn't been meaningful supply housing stock going back in the market, and guess what happened to hotel prices? They're actually up 7% year over year. So I think New York's a cautionary tale, and I do not think cities are gonna follow it. I think they're gonna, like, see us much more as a solution to a problem."
},
{
"speaker": "Ellie Mertz",
"content": "And then just on your second question, related to DMA, no no real change here. From from last quarter. It it doesn't really apply to us."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Colin at Baird."
},
{
"speaker": "Colin",
"content": "Thanks, and and good afternoon. I guess two quick ones for me. First off, I guess from a competitive standpoint, Brian and Ellie, the tone of the letter comes across, I think, is quite a bit stronger in terms of leading the industry. So I'm curious if that's more of the result of your performance to date or is that more about what's to come in in terms of putting more distance between Airbnb, Inc. and and competitors? And then secondly, on experience, I know we don't have the formal relaunch yet, although I enjoyed a nice food tour recently, purchased the platform. But just curious on the progress you're seeing in repopulating the marketplace or ingesting more and higher quality experiences before the relaunch. Thank you."
},
{
"speaker": "Ellie Mertz",
"content": "Great. Thanks, Colin. Just just giving a little bit of update in terms of the competitive competitive environment. What I would say is that, you know, our results in Q4 and 2024 support that. We continue to gain market share on a year-over-year basis, both globally as well as at a regional level. This is true both from a traffic share as well as a night stay perspective. And what we've seen of late is predominantly market share gains coming from hotels. I think all the product improvements that Brian has shared throughout this call as well as the increases we've seen in terms of brand consideration have really been attracting more frankly classic hotel users to try our product. And has allowed us to continue to to gain market share. I think one of the underlying questions I'm sure people have is vis a vis Vrbo and their strong performance in Q4. What I would say there is that, you know, Vrbo obviously had a very soft comp in terms of their business contracting in the US. Or globally in Q4 of 2023. And in the last quarter, what we see is that the markets that we tend to compete against them in, in particular, non-urban US markets. Was actually one of our fastest growing segments in the US. So even in that comparison point, we feel like we're doing quite well. The other point I would make on the competitive is that we continue to see that on the supply side, we're number one, leading in terms of total supply growth. And number two, in terms of the new listings coming online, the majority come to Airbnb, Inc. and the majority are exclusive. So further extending our differentiation with regard to both the breadth but also the differentiation of the supply that is key to to the brand and key to the the guest value proposition for Airbnb, Inc."
},
{
"speaker": "Operator",
"content": "Our next question will come from the line of John Colantuoni with Jefferies. Go ahead."
},
{
"speaker": "John Colantuoni",
"content": "Thanks so much for my questions. First one on conversion. When when you look at how travelers interact with your booking experience and begin to think about how best to layer in new services over time. Talk about how you're planning to evolve search and discovery to help balance gearing users to your new services while simultaneously maintaining conversion on accommodations. And second, I'd be curious to get your perspective on the opportunity to use new services to create some flywheel effects by which maybe you're acquiring new customers through new products or driving more multiproduct bookings to help increase customer lifetime value. Thanks."
},
{
"speaker": "Ellie Mertz",
"content": "Yeah. So let's talk a little bit. You asked about the conversion funnel and how we think about adding in new products. And and I think the question is really, how do you how do you launch and merchandise new products while not creating some risk to your your core offering? And I think this goes to one of our key learnings in terms of the experiences product that we've had historically versus what we want to put into market in coming months. And one of the insights there is that the the kind of classic generalized traveler does not come to our site or any other site to book their entire trip. Instead, they, you know, tend to book their airline. They tend to book their accommodations. Once they get through that, they're very relieved that that is behind them. And they kind of sit on the sidelines for weeks or months in advance of the trip until they start thinking about what do I need to book to fill out my itinerary. And so when we think about how to launch these new offerings, we want to be very mindful of the guest journey and to be very thoughtful with regard to both personalization and timing around what type of products are we merchandising to the customer at what point? So that we can obviously have the the best conversion impact by merchandising the the right thing. In terms of the flywheel, I think as we have been considering what, you know, both near-term and long-term future offerings will be, we're very focused on adding things to the platform that not only will be solid businesses in and of themselves, but also make the core offering better. So so that is part of our our criteria in terms of selecting new offerings is what if added to the platform would actually know, likely cause people to, one, book more frequently in terms of accommodations. But also come back to the app or or or the service on a more frequent basis than they do today because we have a a variety of offerings that may work not just on their trip, but also when they are in their home markets."
},
{
"speaker": "Operator",
"content": "And that will conclude our Q&A session. I'll turn the call back over to Brian for any closing remarks."
},
{
"speaker": "Brian Chesky",
"content": "Alright. Well, thanks everyone for joining us today. Just to recap, we ended 2024 with nice growth accelerating in incredible momentum heading out of 2025. Free cash flow was $4.5 billion for the year. Representing a free cash flow margin of 40% and our strong balance sheet enabled us to repurchase $3.4 billion of common stock. I'm really proud of what we accomplished, but this is just the beginning. 2025 marks the start of Airbnb, Inc.'s next chapter. Alright. Thank you all."
},
{
"speaker": "Operator",
"content": "That concludes our call for today. Thank you all for joining. You may now disconnect."
}
] |
abnb | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good afternoon, and thank you for joining Airbnb's Earnings Conference Call for the Third Quarter of 2024. As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Airbnb's website following this call. I will now hand it over to Angela Yang, Director of Investor Relations. Please go ahead."
},
{
"speaker": "Angela Yang",
"content": "Good afternoon, and welcome to Airbnb's third quarter of 2024 earnings call. Thank you for joining us today. On the call today, we have Airbnb’s Co-Founder and CEO, Brian Chesky and our Chief Financial Officer, Ellie Mertz. Earlier today, we issued a shareholder letter with our financial results and commentary for our third quarter of 2024. These items were also posted on the Investor Relations section of Airbnb's website. During the call, we'll make brief opening remarks and then spend the remainder of time on Q&A. Before I turn it over to Brian, I would like to remind everyone that we will be making forward-looking statements on this call that involve a number of risks and uncertainties. Actual results may differ materially from those expressed or implied in the forward-looking statements due to a variety of factors. These factors are described under forward-looking statements in our shareholder letter and in our most recent filings with the Securities and Exchange Commission. We urge you to consider these factors and remind you that we undertake no obligation to update the information contained on this call to reflect subsequent events or circumstances. You should be aware that these statements should be considered estimates only and are not a guarantee of future performance. Also, during this call, we will discuss some non-GAAP financial measures. We provide a reconciliation to the most directly comparable GAAP financial measures in the shareholder letter posted to our Investor Relations website. These non-GAAP measures are not intended to be a substitute for our GAAP results. With that, I will pass the call to Brian."
},
{
"speaker": "Brian Chesky",
"content": "All right. Good afternoon, everyone, and thanks for joining. Airbnb had a strong third quarter. Nice and experiences booked accelerated throughout Q3 and into Q4. Despite a slower start to the quarter due to shorter booking lead times compared to last year bookings grew steadily each month returned to double-digit growth by the end of Q3. We had a $123 million nights and experience booked. Revenue grew 10% year-over-year to $3.7 billion. Net income was $1.4 billion, representing net income margin of about 37%. And we generated $1.1 billion of free cash flow. In fact, our total trailing 12 month free cash flow was $4.1 billion, which allowed us to repurchase $1.1 billion of our shares in the quarter. And as of the end of Q3, we have $4.2 billion remaining on our repurchase authorization. Now, during Q3, we continue to make progress across our three strategic initiatives, which are making hosting mainstream, prospecting our core service and expanding beyond the core. Now I am going to share a few highlights about each. First, we're making hosting mainstream. We are focused on making hosting just as popular as traveling on Airbnb. Today, we have over 8 million active listings with growth across all regions and market types. To retain and track new hosts, we prioritize making hosting easier. Last month, as part of our 2024 winter release, we introduced co-host networks, an easy way to find the best local host to manage your Airbnb. Co-hosts are some of our most experienced hosts. They provide personalized support ranges from listing setups, can managing bookings and communicating with guests. Second, we're prospecting our core service. Over the past three years, we've launched more than 535 new features and upgrades to make Airbnb a better service. Our 2024 winner release included over 50 upgrades for guests that make Airbnb a more intuitive and personalized App. This includes features like recommended destinations, suggested search filters and personalized listing highlights. We're also focused on one of the top issues for guests, listing quality. Since last year, we removed over 300,000 listings that failed to meet guest expectations. And we will continue to invest in improving the quality of guest stays. Finally, we're expanding beyond our core. Outside of our core markets, there are many countries and regions that remain underpenetrated and we're focused on these expansion markets as part of a global market strategy and we're seeing great results.. In Q3, the growth rate of nights booked in our expansion markets more than doubled that of our core markets. Now, in addition to driving growth in our expansion markets, we're also preparing for an Airbnb’s next chapter, which will take us beyond accommodations. And you'll see more about this next year. We also saw a number of positive business highlights in Q3. First, guest demand accelerated throughout the quarter. As I mentioned earlier, after a slower start in July, bookings accelerated each month in Q3. Global lead times also normalized throughout the quarter. Now part of this growth has been driven by our App strategy. Nights booked on our App increased 18% year-over-year in Q3. App bookings now account for 58% of nights booked. Now this is up from 53% in the same period last year. And we also saw continued growth of first-time bookers, with the highest growth among young travelers. This is quite exciting. And I'm really excited to share that we recently surpassed 2 billion guest arrivals on Airbnb. Second, our global market strategy is working. We continue to drive growth by investing in underpenetrated markets. While our timing and investment level will vary by market, our strategy is consistent, to make Airbnb local and relevant in more places around the world. Now in each market, we focus on finding product market fit, increasing brand awareness, and driving traffic. And I want to just use one country as an example, which is Japan. Airbnb is still pretty new in Japan and it's pretty unfamiliar to most Japanese travelers. So to raise awareness, we launched a brand campaign last month is centered on domestic travel. Beyond Japan though, we are all so introducing more local payment options and countries around the world like Vietnam, Denmark and Poland and in fact, by spring of next year, we expect to offer nearly 40 local payment methods around the world. Now finally, supply quality is improving on Airbnb. We are focused on removing low-quality supply, as well as make it easier for guests to find the best places to stay. I shared that we removed over 300,000 listings last year. And we are seeing the - we're already seeing this payoff. Customer service contact rates have decreased, guest MPS has improved, and we're also reducing host cancellations, which are now almost 30% lower than a year ago. And we've made it so much easier for guests to find the best place to stay with Guests Favorites. In fact, since launching Guest Favorites a year ago, last November, over 200 million nights have been booked at Guest Favorite listings. All right, next I want to share briefly some highlights from our 2024, which was last month on October 16th. Starting with the Co-Host network. We know that hosting Airbnb is one of the best ways to make money from our home. But not everyone has the time to host. So that’s why we introduced Co-Host Network, an easy way for people to find the best - to find and hire the best local co-host to manage the Airbnb. Co-host offer personalized support for host needs, everything from setting up your listing, demands your bookings and communicating with guests. These are super experienced hosts with an exceptional track record, 73% are super hosts and 84% manage Guest Favorite. Now, when we announced this on October 16th, we launched the Co-Host Network with 10,000 Co-Hosts across 10 countries. In this three weeks since we launched, we've already received interest from over 20,000 potential new co-hosts. This is huge, this is way bigger than we were expecting. And we are making co-hosting easier, we really believe that co-host network will allow us to lock even more high quality supply. And we also introduced safety updates for guests and make Airbnb a more intuitive and personalized App. And some of the features include a personalized welcome tour of the App for first-time guests, suggested destinations, winning guests pass the search bar will recommend locations on their search and booking history. And for our hosting highlights. So when a guest views, a listing, we will highlight the details that are relevant to their search and there are dozens of these features just like these. This is quite literally the beginning of a more personalized Airbnb. Now turning to Q4, last quarter, we talked about shorter booking lead times, but as I shared nights and experiences booked accelerated throughout the quarter, returning to double-digit growth by the end of Q3. While we know the comps from last year will get harder in the back of the quarter, we are anticipating that nights booked will accelerate in Q4 relative to Q3. So with that Ellie and I look forward to answering your questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Richard Clarke with Bernstein. Your line is open."
},
{
"speaker": "Richard Clarke",
"content": "Hi, good afternoon. Thanks for taking my questions. Just a question on supply. It looks like you stopped sort of giving us the year-on-year supply growth I guess because of the removals. I guess,, any color on what’s happening to maybe gross supply growth. And whether the removals you are doing and additions you are doing and seeing any meaningful shift towards professional hosts as you guys do that process or co-listed supply. And then maybe any color on whether this co-hosting is unlocking supply here. You talked about adding co-hosts, but are you getting additional supply due to the co-hosting initiatives?"
},
{
"speaker": "Ellie Mertz",
"content": "Yes, thanks, Richard. Let me talk a little bit about what we've seen on supply. As you probably noted, our initiatives around supply have really morphed over the last 12 months. We can continue to focus on growing our overall supply base. But we incrementally are focused on making sure that we are delivering very high quality levels of supply across the world to our guests. And the two important features that we've done to drive quality are obviously introduction of Guest Favorites a year ago, and then ,second the removals that you called out over the last 12 months. And the interesting thing is, we’ve seen what we hope to have seen from these quality initiatives, in particular, what we see is that, based on encouraging our guests to use Guest Favorites and taking down those listings that we believe do not meet our quality expectations or those of our guests. What we see is that the average rating of our stays goes up. The incident rates go down and customer service contacts go down as well. So, we're seeing the intended impact of those quality efforts, which we believe, one, it improves the guest experience, second, allows for improvements of rebooking rates over time; and third, more broadly increases booking confidence around Airbnb. To the specific questions in terms of what has happened to the supply growth? It continues to be strong and in Q3, we continue to see Supply growth exceed demand by a couple of points. So it continues to be the very healthy, but again the focus more recently has been on incrementally raising the quality bar on Airbnb, not just adding more supply to the platform. Brian, do you want to talk about co-hosting or actually take that as well?"
},
{
"speaker": "Brian Chesky",
"content": "Yeah, I can take. Yeah, I can take that. Richard, it’s a great question. Airbnb, I think we are just scratching the surface of how big this company can become. And the growth rate of demand is going to fall probably in line with the growth rate of supply. And so, one of the questions we had was, well, how do we get millions more listings in Airbnb? And how do we not just get millions of property managed listing? How do we get millions of regular everyday people to put their homes in Airbnb? Well, we are doing obviously a lot of research and we've asked people and we learned two things. The first thing we learned is that, people are very interested in making extra money in the home Ttey already have and make sense, they pay for this asset. That they can make tens of thousand dollars a year. Why wouldn't you want to put on Airbnb? But the second thing we learned was that the number and reason people don't host is because a lot of people say they don't have the time. And so that’s why we ask ourselves, what if we get match people with homes, that don't have time with people have extra time that don't have homes. The Venn diagram would potentially unlock millions more listings and the best part of all was this would be alternative so some of the third-party property management companies if you want to have one of the best host to Airbnb and the average 5 star rating. for co-host in Airbnb is significantly higher than the average rating of a third-party property manager. So that's what we did with the Co-Host Networks. Now we start with 10,000, co-host. We have 20,000 people that apply in the three week expense. And this is going to be something that we're going to be focusing on in the coming years to come. But, to answer your questions very directly, Richard, not only would this unlock more supply, I think in the coming years, this is going to lock millions of listings. I think that they - the vast majority of them are going to be everyday people that are going to list exclusively on Airbnb."
},
{
"speaker": "Richard Clarke",
"content": "Thanks. Thanks very much."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Mark Mahaney with Evercore ISI. Your line is open."
},
{
"speaker": "Mark Mahaney",
"content": "Hey, thanks. Two questions please. You talked about this acceleration or improvement in. room nights as you kind of went through the quarter. Did that come from any particular geographic areas? We'd heard that Europe was one a market that was recovering maybe faster than others. Was that your experience, as well? And then, just back on the co-hosting experience, you had this out in a series of markets for a while. Is it how long do we see materiality come through it? Like have you seen these in relatively small markets where you’ve rolled it out this will become material to the growth rate in those markets already in the 6 to 12 month, period or is this take a just more of like a 12 to 24 month process? Thank you.."
},
{
"speaker": "Ellie Mertz",
"content": "Thanks, Mark. Let me first answer your first question with regard to the acceleration of the business. What we shared in the letter was that for your line to where we were back at the time of the last earnings call, we called out that there was a bit of softness globally related to lead times is specifically what we shared with that. We were seeing continued strength of last minute bookings, but relative softness in terms of the longer lead times. And what we saw over the course of the quarter, specific to both the regions that you called out, but globally was that lead times over the course of July, August and September normalized and came back almost in line to where we were in ‘23. I think you saw that most notably in EMEA and I think probably some of the, long lead time softness that we were seeing in EMEA was certainly related to some distraction around the Olympics because we certainly saw the bookibgs pick up after the Olympics pass, but more broadly that acceleration was seen across all four major regions. And then, on the co-hosting, Brian gave you, I think a broad answer in terms of the expectations there. One of the reasons that we had confidence in terms of launching the Co-host Network more broadly is, the pilots that we've had over the last several years, in particular, in France, what we've seen is that, the co-host themselves are very incremental in terms of going out and attracting high quality listings themselves. Obviously, it will take time for us to scale co-hosting to a level that is, meaningful relative to the scale of our current business. But what we've seen from those pilots is extremely encouraging and we'll continue to build out the network from here on."
},
{
"speaker": "Operator",
"content": "And your next question is going to come from the line of Brian Nowak with Morgan Stanley. Your line is open"
},
{
"speaker": "Brian Nowak",
"content": "Thanks for taking my questions. I have two. Excuse me. The first one, I think that the 4Q EBITDA guide sort of implies a margin somewhere in the 20s around 27%, 28%. Is there any sort of timing factors you call out that are sort of driving the margin down at that level? And then, how do we sort of think about philosophically the levels of investment and sort of the philosophy around investment and margins into next year to sort of go off this 27 number in the fourth quarter? Thanks."
},
{
"speaker": "Ellie Mertz",
"content": "Yes. So Brian, talking a little bit about Q4 obviously, the guide does imply a, several points margin compression relative to last Q4. And you should see that most specifically in terms of both the product development line item as well as marketing. In marketing, we continue to invest in our global expansion markets in our comm strategy around icons and then also Performance Marketing where we're seeing really great efficiencies. There's also a little bit of timing difference in terms of spend from Q3 getting into Q4. But in aggregate, the level of incremental marketing spend on a year-over-year basis is relatively modest. So your second question is, how do we think about the level of investment and philosophy around margins in 25? Let me let me give you a little bit of color in terms of our overall approach as we head into to 2025 Obviously, we will give more color in the following earnings call. But let me just talk a little bit about the approach today. So, if you think about how we've been managing our P&L, I think it's important you're certainly well aware of our history. But I think it's important to reflect on how well we've managed the, the overall P&L since we went public. We've been extremely disciplined in terms of delivering over a quarter basis points of EBITDA margin expansion since 2020 going from negative margins in in 2019 and 2020 to over 35% consistent with our outlook this year. And we’ve demonstrated consistently over these last several years that our business model is, extremely strong. It's extremely profitable and obviously has world-class levels of cash flow generation. And over the long term, I think you can expect that there is opportunity for further margin expansion. But when you remind through where we are right now? We've talked a lot about this. We see a huge incredible opportunity to invest in growth, both investing in growth in our core accommodations business, as well as our new offerings. And so, as we head into 2025, we will continue to lean into our growth initiatives around core optimizations, global markets expansions and new products and services, which is then the question is, how exactly will we be managing the P&L? Let's say for the core business, our goal is every year to make the core business better and more efficient, and deliver greater value for our guests and hosts. And the way we do that is to find incremental efficiencies every year across in particular variable costs. And invest some of that into greater service levels on both sides of the marketplace. In addition to that in terms of the growth investments, in ‘25, we will be investing in our existing expansion markets, as well as a handful of incremental expansion markets and we will be launching new products with our upcoming 2025 spring release. The good news about these investments is that, we intend for them to be relatively capitalized, consistent with our core business. but we will be adding members to our teams and spending to our marketing to support these growth levers. We will provide greater detail on the exact level of investment and growth expectations on our next call early next year."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Justin Patterson with KeyBanc. Your line is open."
},
{
"speaker": "Justin Patterson",
"content": "Great. Thanks for taking the question. Brian, recently you’ve passed the two billion guest milestone and you did that next one billion much faster than your first one billion. As you look at the business today, what do you - what investments you need to make to attract that next billion plus guests to Airbnb when you look at just the types of people taking trips today? What demographics do you under-index on? And how do you think some of these service releases can really bring that next wave of customers? And thank you."
},
{
"speaker": "Brian Chesky",
"content": "Justin, it’s a great question. Maybe I'll just start by stepping back, it's pretty crazy that Airbnb has been used by two billion guests. Because I remember when we started Airbnb, I remember telling investors one day this company be huge, thousands of people will use it. And I think there's been a common like pattern where we keep saying it's going to be big and it’s even bigger than we imagined. And I think the reason why is, the travel industry, as you know, you guys cover it is it's approximate the size of the oil industry. And people love traveling. And one thing I know about the future is more people travel in the past. And, I think that we'll be creative with the new category. And this is the business that is approaching half a billion nights booked a year. And so the question is, well, how do we get to a billion nights a year? Or how do we get a company to even be an order of magnitude bigger one day? Because I'm 43 years old. I started to from my 26. And I feel like I got a couple decades ahead of me. And so, where do we go from here? I think that if you think about the history of this company I think you could maybe break it up into a few chapters. The first chapter was when we had this idea, Tony and I in 2008 - and we went on it really crazy [Indiscernible] And now it’s Phase one. And then I would say the second chapter which are probably in now exiting was the beginning of the pandemic, we lost 80% of our business and then we had the right size the company, become really profitable, go public, listing the customer feedback and really strengthen the foundation for the next chapter of the company. And that’s kind of the stage we are in. And I think the next chapter of Airbnb is starting next May. Because I think the next chapter is really about taking Airbnb and expanding this beyond our core business. And so, I will outline three areas that are going to allow us to grow and let's start with the shortest horizon to a longest horizon. The shortest horizon is actually just our core business. Again, we do, - we're approaching 500 million room nights booked a year, I think our core business could certainly get to a billion nights a year. I am not going to put a time horizon on it, but the way we are going to do that, is we are going to continue to increase quality. For everyone who stays in Airbnb, nine people staying on a town. So the question is, what if we could just 1 of those other people to stay in Airbnb? That's how you get to a billion. And so, we think quality, mansion quality is a part of it. I think our work on affordability and usability are also going to be really, really critical. So we're going to continue to focus on the core business. The next horizon, our Global Market. A huge percent of our business is still concentrated in five countries,The US, Canada, Australia, France, UK. So those are all our core markets. But there are massive opportunities in emerging markets. There's nine of them that I'm focused on in the Americas, it’s Mexico and Brzil. In Europe, it’s Germany, Italy and Spain. And in Asia, it’s the big four countries, which are Korea. Japan, India and China. I think this is what I've described as a medium-term horizon. And, by the way, just as for a second, if there was one company in the world, that you can bet on to expand internationally, I think it will be a global travel network. So, I think there's a huge amount of opportunity here. And the biggest opportunity by far is expanding beyond our core business. I'm reminded of Amazon, one of the biggest companies in the world. And they started as an online book seller and can you imagine if Amazon was only selling books to the half way they would become? And yet we for the last 17 years for the most part have only sold one thing, which is basically vacation rentals Airbnb homes by the night. And so, I think that we have a huge opportunity to expand beyond our core business of accommodations. Amazon went from books to what they do first after books, they did CDs and DVDs and people used to buy both. And that was a very close adjacency. And eventually, they sold everything and then they even sold things beyond consumers to enterprise. I think Airbnb is going to go on it’s own journey and what I expect is every year now, for the coming years, we will launch 1 to 2 new businesses that will generate $1 billion or more of revenue incrementally a year. I'm not going to be able to share everything we're doing or even most of the things we are doing. We like to reveal them during our release, but one thing that we've previewed to you was we are going to be reimagining Airbnb experiences and those are going to be coming next May, but we have some really core other things that we are working on. And it’s going to basically be starting with the nearest adjacencies around travel and over the next decade, we're going to go far beyond travel."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Justin Post with Bank of America. Your line is open,"
},
{
"speaker": "Justin Post",
"content": "Great, thanks for taking my question. I just wanted to ask about the new markets. If you could give us the expansion markets, maybe some of the biggest ones there? I know Japan is one of them and then, how big they are. So we can think about the growth contribution next year. Thank you.."
},
{
"speaker": "Ellie Mertz",
"content": "Yeah, Justin, let me just give you some context in terms of our overall kind of concentration of the business. So, if we think about the core markets and again remember those are US, Canada, Australia, France, and the UK. They currently represent about three quarters of our gross booking value. And then the rest of the world is obviously a quarter. The expansion markets that we're focused on are kind of 15% approximately of the remainder. But in a normalized world should be significantly larger. So if you give, - just to give you a sense in terms of kind of the success that we've had, that encourages us to keep going down this path and adding more expansion markets. I just call out actually Brazil because it was one of our first expansion markets that we began to focus on about two years ago. We introduced localized brand campaigns. We localized the products. We provided incremental payment methods to make it more locally relevant. And if we look at the success of that specific market, would you see - what you would see is that, for Brazil, from a destination nights perspective is actually about three times as large as it was pre-pandemic. And you can see just like paying attention to a particular market deploying, our full funnel marketing strategy, being very thoughtful about product market fit allows us to scale these currently smaller portions of our business to over time a significantly larger proportion. On the other end of the spectrum, I would highlight Japan, which we obviously called out in our shareholder letter, given the recency of our um, of our - the launch of our brand campaign there. That’s obviously a significantly large market. But we are relatively new in the eyes of Japanese travelers. And so if they've opportunity to really introduce ourselves to the local traveler have them under understand the opportunity locally to use Airbnb domestically and begin to scale that business commensurately. And so, when you think about the scale of these markets where we are today, Brian and I characterized this as a medium-term opportunity, because the immediate opportunity is large, but it will take time for us to scale these individual markets such that they have an increasing impact in terms of our consolidated global results given the relative concentration to that."
},
{
"speaker": "Operator",
"content": "And your next question comes form the line of Lee Horowitz with Deutsche Bank. Your line is open."
},
{
"speaker": "Lee Horowitz",
"content": "Great. Thanks so much. A couple of I could? Maybe you, your online travel peers have given color that's what they think their long-term bookings growth how that looks like. I mean, I guess, given your leverage to alternative accommodations, because the assumption is that you guys should be able to go faster. Can you give any color maybe on sort of what you see is the long-term growth algorithm for your core business? And then, what new verticals may add to that on top of that? And then one follow-up if I could."
},
{
"speaker": "Brian Chesky",
"content": "Yeah, Lee, maybe Ellie before you answer the question, can I just say one quick thing? Lee, o don’t think we do alternative accommodations. I think alternative accommodations is what our competitors OTAs do? I think alternative accommodations is a bit of a catch all that includes property managed homes, service apartments, boutique hotels. But I've never heard a customer say alternative accommodations. I hear them say Airbnb. I am going to book in Airbnb. I am going to get Airbnb. And I think we are really in a category of our own. So, just you know, I just think we don't refer to it and we don't think of it as alternative accommodations. So Ellie, over to you."
},
{
"speaker": "Ellie Mertz",
"content": "Yes, thanks Lee. So we think about overall growth algorithm and our growth drivers it's exactly as Brian has described earlier in terms of talking about the opportunity. It really starts with focusing on our core offering and optimizing it such that we are effectively limiting the barriers, to trying Airbnb relative to alternatives in particularly hotels. And so that's why we focus so much on things like affordability and reliability, because we know, for many consumers, even though they're aware of Airbnb, there is a gap in terms of their booking confidence around what they are going to get from us. And so, every quarter, we work at reducing that gap of consideration. And when we look at the business from that perspective, there's a huge amount of growth room ahead even in our core markets, because we know so many consumers consider - continue to consider themselves as hotel guests. not necessarily Airbnb guests. And so, a lot of the optimizations and marketing are both raising considerations, as well as helping people frankly get through our platform more easily by making it easier to book, making it more personalized and getting them the right listing. So, we continue to focus on these core optimizations, because we believe it's a considerable future, current I should say and future growth lever that will continue to pay dividends in particular in our core markets but more globally, more generally globally across our platform. The second component is what I just spoke about in terms of responding to Justin. Our business today is over-concentrated in our core markets and is not necessarily reflective of the commensurate business opportunity across the globe. And so, over the couple of years, you should see, assuming that our global market strategy is successful. You should see the contributions to growth of those expansion markets grow every single quarter and I think the results that we've delivered so far this year suggest that that is, that is working. We just need to continue to scale those businesses such as they contribute to global growth more significantly."
},
{
"speaker": "Lee Horowitz",
"content": "Great. And then, to the extent that sort of your improving 4Q outlook the acceleration is really nice, it is an output of some of the investments that you guys are putting into place driving the kind of gains that you want. Does this give you confidence to throw fuel on the fire and invest more aggressively behind those initiatives? And maybe how we should think about the way that that interplay should play through in terms of margin over the longer term?"
},
{
"speaker": "Ellie Mertz",
"content": "Well, I think where we've seen success. One of the areas is core optimization and so we have built out the product roadmap around that because where we see success in terms of improvements we're making to the booking flow. We continue to keep a stable set of resources against those challenges. So that every single quarter, the price is getting better and we're delivering more gains from those product improvements."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of James Lee with Mizuho. Your line is open."
},
{
"speaker": "James Lee",
"content": "Great. Thanks for taking my questions. The question of core initiatives here, can you guys talk about the progress you have made and affordability, and quality that’s driving, maybe some of the increased bookings that we’ve seen in the quarter ? And also, can you give us an update on the outcome from a service transformation, maybe what's working, what's not and what's yet to be improved? And when do you expect to complete the process? Thanks."
},
{
"speaker": "Brian Chesky",
"content": "Yeah, I got this. Hey James, these are great questions. I'm really excited about it. So, I'll take each, affordability and reliability and customer service. Affordability, it's funny, the first tagline Airbnb ever had was an affordable alternative a hotel. And it was the number one reason that people first tried to use Airbnb. Now I think today that's not the main reason people use Airbnb. I think they use it because they want to travel like a local. They want more space. They want homes in real neighborhood, better equipped, but it's really, really important that we don't ever leave our roots of affordability. And I think in the pandemic, I think there was so much demand, there was constrained supply, prices went up, and I think we addressed it from our affordability risk. So, a couple of years ago, we actually got very, very serious about driving more affordable in Airbnb. And we did a few things. The first thing we did is, we heard a lot of complaints about rising cleaning fees and I set the fees in Airbnb. So we introduced total price display, total price slates exactly what it sounds like you can click it on and see the total price upfront. And, since we’ve done that, more than 300,000 listings have removed or lowered their cleaning fees. But this has been huge. Next, we introduced weekly and monthly discounts. And now more than, - we're introducing more entry points in weekly, monthly discounts.Two-thirds of hosts now offer discounts. In fact, more than half of our hosts offer a monthly discount and now 70% of our nights booked are for monthly stays. We introduced a similar listings tool. So what we noticed was a lot of hosts were overestimating what they could make on a nightly basis, especially new hosts. So we built the tool for you to see other listings in your neighbourhood and 2 million hosts have used this tool. And basically, when most of who use this tool they realize that they need to make sure they are competitive and so it brings the prices in line. Now over the this past release on October 16th, we also added a couple more different features like price tips, hosts can now view suggested prices based on similar listings in that area and search tips. So throughout the guest search, we're going to offer relevant tips to help them find last minute stays. And probably the most important thing you can do to drive affordability is just continue to increase supply. But we know about almost every marketplace is that as supply goes up relative to demand prices come down and so that's a really big effort for us. The results have been the following: In the last two years, while Airbnb prices on a like-for-like basis, if you net out mix shift, has it remains fairly constant hotel prices have gone up considerably. So we believe that we've actually become more competitive from – cancelling relative hotels last year. That’s affordability. Now reliability. Reliability, as I said is probably the most important thing that we can do to drive more growth in our core business. If we do nearly 100 million nights a year in bookings, the question is, how do we get the next 100 million nights booked. And there is no silver bullet, but the closest thing to a silver bullet is quality and reliability. And there is a lot of things we are doing, quite literally dozens. But I can just pick two. The two things I’d pick are at the top, Guest Favorites, piloting the two million best listings in Airbnb. We also highlight the best 1%, 5% and 10% listings. As Ellie mentioned, we’ve got 200 million nights booked just in Guest Favorites. Now, this is amazing. Why it is great? Because number one, customer service contact, these listings are down , our profitability on a per booking basis goes up, NPS is up, because NPS is up that means that rebooking rates are up. That also means the word of mouth is up, but most importantly, a lot of people that wouldn't have considered staying in Airbnb, now would. I mean, I'm going to go on a NIM and say that while the average Airbnb is not as reliable as a hotel, I believe the average Guest Favorite is. And we have two million to choose from. Two million listings is more inventory than Hilton or Marriott, nearly combined, by the way. So there's a lot of selection here. At the bottom-end, just like any company you need to make sure you reward the top performers and you also deal with the people that aren't performing. We've removed more than 300,000 listings over the last year, the last two years of hosts that weren't meeting our quality standards. So, these are just some of the things we're doing on reliability. The last is customer service. And we are going through a really exciting transformation on customer service. I don’t want to be one of the CEOs just brings up AI every earnings call, because I think you got a happy measure, but we are seeing some really great progress on AI-powered customer service. The way we think about customer service Powered by AI is in three phases. Phase 1 is the phase we're in right now. If you were to most of - first of all most of our customer contacts, we get over 10 million contacts here, most of the contacts that we anticipate getting in the coming years aren't going to be phone calls. They're going to be chatting through the App. I think really personally don't like calling customer service and having to dial, and I want to be able to chat. And chat AI can intercept. And so, we think in the future the vast majority of our chats are going to be intercepted in the end directly by the AI agent. And so there's really three phasing for this. Phase 1 is just answer basic general questions. We're rolling out a pilot that could answer basic general questions. Phase two, is personalization, personalize the questions. Phase three is to take actions. So I’ll give you an example, let me just give you one example. Let's say, I were to contact customer service and I’d say, how do I cancel a reservation. In Phase one, what we are doing now AI agent will answer – copy even better the average customer service agent how do cancel a reservation. So Phase 2 is how you cancel reservation step-by-step. Phase 2 personalization, they’ll say, hey Brian, I see you have a reservation coming up in Los Angeles next week. Here is how you cancel that reservation. And Phase three is taking actions. It would say hey Brian. I see you have a reservation come to Los Angeles. Would you like me to cancel it for you? Just tell me yes and I’ll do it for you. I can even handle the rebooking. So this is where we think customer service can go enabled by AI, and we've hired some of the best people in the world to work on this and I really excited to tell you more progress about it."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Doug Anmuth with JPMorgan. Your line is open. Doug, if you could check to see if your line is on mute. And moving forward to our next question from Kevin Kopelman with TD Securities. Your line is open."
},
{
"speaker": "Kevin Kopelman",
"content": "Thanks a lot. A question on the new services that are expected to come out next year. Do we think of those new services as driving some revenue growth right off of that for the second half next year? Or areyou anticipating more gradual rollouts in more of 2026 revenue drivers? Thanks."
},
{
"speaker": "Brian Chesky",
"content": "Yeah, I can take that and Ellie feel free to add. Kevin, the answer is a little bit of both, I mean, we are, the way like – let’s just back up? So Uber, let's just take Uber. I admire that company. They've done really well. When they launched Uber Eats, they launched in one market. And they had it city-by-city market and was very, very gradual. We are not going to do that. We're going to be much more aggressive. When we launch the new offerings next year, they are going to be available immediately in more than a 100 cities around the world. So we believe in trying to reach scale a little more quickly just given how big and how mature we are. So, because of that, we do think there will be some incremental revenue next year, that will hit the financials. But I also just want to like step back and just say that what we've learned from Uber Eats, from Amazon category expansion, from Door Dash, from we can go down the list of marketplaces is, when something's built off of small base, you've got to be patient. I think that there's a, multi-billion dollar revenue opportunities, multiple of them that will be introduced next year. But I also would point people to a 5-year Horizon. For a number of these things to really reach scale, not, they won't reach scale in just a year or two. And part of that is it's a network effect business. We want to roll it out carefully. We want to make sure it’s really well done. Ellie, do you want to add anything?"
},
{
"speaker": "Ellie Mertz",
"content": "The one thing I would add is, Kevin, we will obviously give you much more detailed color next year on the next earnings call. But what you should anticipate is that, some of the investment behind those new services will front run the revenue. So you'll begin to see those expenses or those investments I should say, at the beginning of the year, whereas the revenue will start to scale once we've released the new offering."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Patrick Scholes with /Truist. Your line is open."
},
{
"speaker": "Patrick Scholes",
"content": "Great. Thank you. Good evening. I want to go back to the first question I was asking and ask it maybe a little more direct. Can you provide us in percentage terms what your year-over-year net unit growth was in the quarter? Thank you."
},
{
"speaker": "Ellie Mertz",
"content": "On Supply?"
},
{
"speaker": "Patrick Scholes",
"content": "Yeah. Supply, correct."
},
{
"speaker": "Ellie Mertz",
"content": "Yeah so we had over 10% growth of supply as of the end of Q3, which is down several points based on the removals."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of John Colantuoni with Jefferies. Your line is open."
},
{
"speaker": "John Colantuoni",
"content": "Great. Thanks for taking my questions. Wanted to ask about the Experiences offering. As you get closer to the relaunch next year, how are you thinking about sort of the pace of expansion and scalability? I know, you'd like to keep experiences unique like your accommodations offering. But I'm curious if that means it will take longer to build supply behind it. And maybe, you could also sort of give us a sense for any investments in Tech or marketing that you plan to make around the relaunch of Experiences? Thanks."
},
{
"speaker": "Brian Chesky",
"content": "Yeah, John, really good question. I think we are able to reach a sweet spot where I think we can - we're going to offer something that's really, really unique and we will scale. Now, I want to just moderate expectations that again, these Journeys are going to be multi-year journeys that I do not think that there's a choice. I don't think we need to make a choice between you mean unique or being at scale. I think - by the way, I think our core business proof that a business that’s approaching a hundred billion dollars in gross sales a year. And it's pretty unique, it's pretty different than a hotel. So, I'm not going to certainly promise that experience we'll get to that size, but we do think we have something that's very unique, very scalable available around the world. As far as the Tech and marketing, the great thing about our business is, are you not anticipate very many businesses in the next five years are going to need significant investments. We are certainly nothing like many other companies where they have a lot of either capital allocation or major technical investments or even major marketing investments. Here's another way of saying it. We've already made most of the technology investments. When you see the last four years, a huge amount of what we've done is rebuilt the company from the ground up, not just to make it stronger to offer homes, to make it an extensive platform. One of those companies that we learnt from again was Amazon. I know, I talk a lot about Apple. A lot of people reference Apple when they talk about them because of their big launches. But Apple, Amazon is a very good reference point. Initially, as you know, they built a bookstore. They were based on like, IBM. They had to rebuild the platform and I’d extract the platform and you might call compromising to build offer many room verticals. And so, we want to take every new platform that works certification and build it for the next decade for like 50 or 100 different categories, just like Amazon. So now, I think with the timeline when we offer them, but we've rebuilt the technology already most of it to be able to do that. Now with marketing, I don’t think we are going to market everything as standalone businesses. We really like the idea of marketing, all of Airbnb. In marketing there's these two choices. Are you a house the brand or a branded house? We're a branded house. We're one App. We are one brand and we want to market everything in one Ad. So that's a little bit more how we're going to approach it. And so I think for those reasons we will, of course, be investing. I want to be clear, we of course be investing, but it's not going to be like many other companies where they have to go deep and sort of right and get the new business off the ground."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Jed Kelly with Oppenheimer. Your line is open."
},
{
"speaker": "Jed Kelly",
"content": "Great, great. Thanks for taking my questions. Just two if I may? Can you talk about in areas such as New York City, where the regulations are becoming increasingly difficult? Can you talk about how we should view those and then potentially leaning more into hotels? And then, as you grow outside some of these non-core markets, is it going to be more brand-driven or will you lean more into Performance Marketing? Thanks."
},
{
"speaker": "Brian Chesky",
"content": "Hey Jud. I'll take that. Yes, so let’s talk about New York. Actually, I would like to talk about two cities. I want to talk about a tale of two cities. New York City and Paris. Because both cities need some major decisions on Airbnb recently and I want to distinguish differencing the two. New York City has, might be this before the housing crisis and that’s a very real thing. And so the decided one of the ways they try to feel with that was banning Airbnb. And a year ago, Airbnb was banned and the theory was that if you ban Airbnb, a bunch of homes will come back on the rental market and prices will come down. Well, for the first time we've gotten a year-long longitudinal study of what happened in Airbnb into the city. Rent prices in New York City are not down. In fact, they're up 3.5%. And by the way, hotel prices are now up to 7%. So, a year after banning Airbnb, it's more expensive to live there. And it’s even more expensive to travel there. And I think that New York City is now a cautionary tale of how to deal with Airbnb. Now, the other side is Paris. Paris, France. A couple years ago, we knew the Olympics were coming to Paris, we started working with the City of Paris. And I think that Paris tood a different approach and set us thinking that Airbnb as a problem they started that Airbnb is a solution to their problems which were they weren’t going to have enough housing for the Olympics. And so in the last year, we went from a 100,000 homes in Paris to 150,000 homes in Paris And I'm pleased to announce that 700,000 guests stayed in Paris over the course of the Olympics. 700,000 and that's like 8 or 9 Olympics stadiums worth of guests. Our favourability in Paris has not been higher in years. And cities all over the world are now coming to Airbnb and saying we want to be Paris not New York, can you help us, because there are thousands events going around the world. So I think that’s the most important point I would make that New York and Paris are a tale of two cities and we can be a solution to the problem. We are not the problem. But specific to New York, I’d just say two things. Number 1, I remain optimistic that there will be a task to us to re-enter New York and people be able to stay in homes in Airbnb because there is a constrained number of hotels in New York. And by the way most hotels are only in Manhattan. And they're in Midtown, Manhattan. Do you want to stay in any part of the part of the Manhattan, the Brooklyn, The Bronx and Island Queens you are going to be pretty limited. And to answer the other part of your question, yes We absolutely welcome hotels on Airbnb and we are going to be adding more hotels to Airbnb. Because for Airbnb the win hotels don’t have to lose we own hotels a night and we believe that you should be able to find homes and hotels on Airbnb. So yes, we are focused on hotels in New York City on Airbnb. We are focused on Airbnb’s and stay New Jersey, stay Jersey City, which is actually closer Manhattan, other parts of Manhattan. And I am optimistic that New York there will be a workable solution at some opoint in the future, I don’t know when that will be and they can follow the lead of Paris."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our, next question comes from the line of Stephen Ju with UBS. Your line is open."
},
{
"speaker": "Stephen Ju",
"content": "Great. Thanks. So thanks for taking the question. Som Brian, I guess, on the Experiences, again I'm wondering if there's going to be an angle where this could be something that increases the overall engagement or even raises the overall frequency of usage for you, because, maybe I don’t stay in an Airbnb every weekend. But maybe I tried Airbnb Experience every weekend. So I'm just wondering like how the product development path and how utilization will shift as your selection goes? Thanks"
},
{
"speaker": "Brian Chesky",
"content": "100%, I mean, this is a great point Stephen. Experiences, I absolutely like within, like Airbnb is typically something you book once or twice a year, very, very few people will book Airbnb every month. Unless you are like incredibly prolific traveller and so we struggle from the point, where on the 1 hand, like our average purchase price is over $500, so, like, like the economics are great, on the other hand we have the challenge of low frequency, most people don't travel that frequently. Expansions are going to be, I think, one of many new offerings that you can increase the frequency that can make Airbnb go from an annual App to a monthly usage App or even for some people weekly usage App. And the reason is because Experiences will not be limited just when you travel. Just like they are today. We are designing products, Experiences and new services that will be great when you travel, but you could book them in your own home town like and I think there's a real problem which is what do you what do you want to do on a Saturday? And if you're with your family. Other than the things you already do. If you got a Friday night, what do you do other than going to a restaurant, staying home and watching Netflix I think there is a market for a locals who want to do unique things and I think traveling is how they are going to be expose Experiences, but I do think that some of the people will try them back home. I think the really big opportunity here kind of similar to iPod, when iPod launched you can only use it with a Macintosh. And the really big game for the iPod was once it became Windows compatible. When iTunes be able to Windows all the people that end on the Mac, but iPod end of sales surged. But I do think there is potential place for that down the road experiences. We're gonna position it for most of travelers. But it’’s not going to be exclusive travlers and I do think people are going to come to work frequently."
},
{
"speaker": "Operator",
"content": "And there are no further questions at this time, I would now like to turn the call back over to Brian Chesky."
},
{
"speaker": "Brian Chesky",
"content": "All right. Well, I just want to thank everyone for joining today. And just to recap, revenue was $3.7 billion, which is 10% higher than a year ago. Adjusted EBITDA was $2 billion and our trailing 12 months cash flow is $1.1 billion. Now this is representing a free cash flow margin of 38%. Our strong enables to repurchase $1.1 billion of our common stock this quarter and we're continuing to innovate and our product just keeps getting better. I am so proud that we accomplish and I am satisfied with that. Thank you all for joining."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call, you may now disconnect"
}
] |
abnb | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Ladies and gentlemen, good afternoon, and thank you for joining Airbnb's Earnings Conference Call for the Second Quarter of 2024. As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Airbnb's website following this call. I will now hand the call over to Angela Yang, Director of Investor Relations. Please go ahead."
},
{
"speaker": "Angela Yang",
"content": "Good afternoon, and welcome to Airbnb's first quarter of 2024 earnings call. Thank you for joining us today. On the call today, we have Airbnb’s Co-Founder and CEO, Brian Chesky and our Chief Financial Officer, Ellie Mertz. Earlier today, we issued a shareholder letter with our financial results and commentary for our second quarter of 2024. These items were also posted on the Investor Relations section of Airbnb's website. During the call, we'll make brief opening remarks and then spend the remainder of time on Q&A. Before I turn it over to Brian, I would like to remind everyone that we will be making forward-looking statements on this call that involve a number of risks and uncertainties. Actual results may differ materially from those expressed or implied in the forward-looking statements due to a variety of factors. These factors are described under forward-looking statements in our shareholder letter and in our most recent filings with the Securities and Exchange Commission. We urge you to consider these factors and remind you that we undertake no obligation to update the information contained on this call to reflect subsequent events or circumstances. You should be aware that these statements should be considered estimates only and are not a guarantee of future performance. Also, during this call, we will discuss some non-GAAP financial measures. We provide a reconciliation to the most directly comparable GAAP financial measures in the shareholder letter posted to our Investor Relations website. These non-GAAP measures are not intended to be a substitute for our GAAP results. With that, I will pass the call to Brian."
},
{
"speaker": "Brian Chesky",
"content": "All right. Good afternoon, everyone, and thanks for joining. Q2 marked another strong quarter for Airbnb. We had 125 million nights and experiences booked. Revenue increased 11% year-over-year to $2.75 billion. Net income was $555 million representing a net income margin of 20% and we generated $1 billion of free cash flow. Our total trailing 12 month free cash flow was $4.3 billion, our highest ever, and our strong cash flow allowed us to repurchase $749 million of our shares in the quarter. And as of the end of Q2, we had $5.25 billion remaining on our share repurchase authorization program. Now during Q2, we continue to make progress on our three strategic priorities, which again are making hosting mainstream, perfecting our core service and expanding beyond the core. So I’ll share a few highlights on each. First, we are making hosting mainstream. Last year, we shared a commitment to make hosting just as popular as travelling in Airbnb. We've been focused on raising awareness around the benefits of hosting and providing better tools for hosts. In Q2, we surpassed 8 million active listings driven by continued growth across all regions and market types. We're not just growing supply and we're also committed to ensuring that it's high quality supply. Since launching our updated host quality system last April, we’ve removed over 200,000 listings that failed to meet our guests expectations. And we'll continue to raise the overall quality of listings on Airbnb so we can consistently deliver high quality stays. Second, we're perfecting our core service. We remain focused on making Airbnb more reliable, affordable and a overall better service for hosting guests. We’ve rolled out hundreds of new features and upgrades over the past two years to do this. This includes launching major reliability initiatives like guest favorites which make it easy for guests to find the best listings in Airbnb. Now since launch, last November, we've seen over a 150 million nights booked at guest favorite listings. We've also made dozens of smaller changes that have led to improved usability and booking conversion. These include things like simplified set up and login, improved map, clear cancellation policies and so much more. Now we've made tremendous progress and we'll never stop improving Airbnb. We're going to continue this commitment. And finally, perhaps most excitingly, we are expanding beyond our core. We continue to drive growth by investing in underpenetrated markets. In Q2, growth of gross nights booked on an origin basis in our expansion markets significantly outperformed our core markets on average. Our core markets again are US, UK, France, Australia and Canada. This is largely due to the success of our global expansion playbook which includes a more localized product and marketing approach. We're also expanding Airbnb’s brand positioning beyond travel accommodations with the launch and roll out of Airbnb Icons which is a new category of extraordinary experiences that we launched in May. Now since launch, we see nearly 40 million views of Icons on our site. Helping people understand that Airbnb offers more than accommodations will be critical as we expand our offerings in the coming years. Now, looking back to Q2, we saw a number of positive business highlights. First, guests are increasingly booking on the Airbnb app. We've continued to optimized our mobile website’s app downloads and we believe our approach is working. Nights booked in our app during Q2 increased 19% year-over-year. Now these bookings now comprise 55% of total nights booked and this is up from 50% in the prior year period. Now in addition to our success of mobile downloads and bookings, we're continuing to see growth of first-time bookers on our platform with the highest levels of growth seen in the youngest age demographic. Second, Airbnb is uniquely positioned for special events where continuously more guests choose Airbnb for major holidays and events. The week of July 4th for example represented our single highest week of revenue ever in North America and we saw similar trends in Europe. Now in anticipation of the Olympics which is in Paris, nights booked in Paris through Q2 were more than double what they were this time last year. Additionally, cities hosting matches during the recent Euro Cup in Germany saw an average of more than 20% year-over-year increase in nights booked. And supply has increased to meet the higher demand. So we have 37% increase in active listings in Paris in Q2 compared to the year ago. And these events, what they really do is they highlight Airbnb’s unique ability to disperse travel and spread economic benefits by allowing people stay in local neighborhoods where there are no hotels. Finally, supply growth is improving on Airbnb. We made huge strides for supply growth, we remain just as focus on supply quality. As we improve quality, we believe more people will try Airbnb unlocking even more growth. We have two major initiatives underway to help us do this. First, we're removing low quality supply. As I shared earlier, we've removed over 200,000 listings since April of last year. Second, we're making it easier for guests to find the best stays on Airbnb. We launched guest favorites as well as top listing highlights, which show the top 1%, 5% and 10% of eligible homes on Airbnb. These new features make it easy for guests to find the highest quality homes on Airbnb. In Q2, we also saw active listing managed by Superhosts, some of our highest quality hosts, increase 26% year-over-year. We're proud of our Q2 results. Now, turning to Q3, we're looking forward to another record summer travel season. We're encouraged by the excitement around the Olympics and the Euro Cup and we're also encouraged by the relative strength of Latin America and Asia Pacific which continue to be our fastest growing regions. However, we are seeing shorter looking lead times globally and some signs of slowing demand from US guests and our Q3 outlook incorporate these recent trends. We are watching these trends closely along with the impact any macroeconomic pressures might be causing. And we're continuing to execute against our growth strategy by improving our service, expanding in less penetrated markets and introducing new offerings. We believe this growth strategy will over the long term offset any transitory macro trends. So with that, Ellie and I look forward to answering your questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] And your first question comes from the line of Ron Josey with Citi. You're line is open."
},
{
"speaker": "Ron Josey",
"content": "Great. Thanks for taking the question. I have two please. Brian, just with your last comments on slowing lead times and what not in North America. Can you tell us a little bit more about that when you saw those trends sort of first hit. And then, how it offsets the strength from the Olympics and UEFA and everything else? And that's question one. And maybe a bigger question when we think about expanding beyond the core and perfecting the core service. Post summer release, posts winter release we've seen a lot of key improvements across Airbnb with Guest Favorites, with Icons and the list goes on and on, , how does - when we think about the coming winter release and throughout ‘25 and everything else, how are these newer services helping to influence call it the Airbnb of tomorrow? Thank you."
},
{
"speaker": "Brian Chesky",
"content": "Yes, why don’t Ellie you take the first one about slowing lead times and when we started seeing these trends and I'll take the second one."
},
{
"speaker": "Ellie Mertz",
"content": "Yeah. Yeah, absolutely. So let me double click a little bit in terms of the trends for lead times since the beginning of the year. In both Q1 and Q2, what we saw with that lead times were basically equivalent with what we had seen in 2023. So there wasn't really any timing shift behavior in terms of when guests were booking. What we’ve seen more recently and in particular in July is a shrinking of the lead times and in particular what we've seen is that there continues to be very strong growth of the shorter lead times. So anything from same day to next week to a couple of weeks from now. But what we're not seeing the same level of strength is in those longer lead times. So two months from now, what you’re booking for Thanksgiving what you’re booking for Christmas, and so it's that I would say softness in terms of longer lead times as a big factor in terms of the outlook that we've provided. What I would say additionally is that, over the last couple of years as we emerge from covid, there were several periods where we saw some volatility in terms of overall lead times and in particular some hesitancy for consumers to book those longer lead time trips. I suspect that's what we're seeing right now and the - I would say the silver lining with regard to the trends that we see right now, it's not that consumers are not necessarily going to book that trip for Thanksgiving or Christmas. It just appears that they have not booked it yet. So we're closely following all of the trends on lead times, but it is a factor that informs the outlook that we provided for Q3."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Doug Anmuth with JPMorgan. Your line is open."
},
{
"speaker": "Brian Chesky",
"content": "Sorry, sorry."
},
{
"speaker": "Operator",
"content": "My apology."
},
{
"speaker": "Brian Chesky",
"content": "Sorry, there was a second part of the question. So, Ron, to answer your question about expanding beyond the core business. Where we are is we spent 16 years building a business that's approaching $80 billion in gross booking value that's basically one category, which we call Airbnb which is short term accommodation. It's been pretty amazing how far this single product has gone. And we haven't really charged other than like essentially travel insurance, we haven't really ever really expanded beyond our core business and we do have long-term stays which are [17%] (ph) of nights. We haven't done very much. We began before the pandemic preparing to expand Airbnb. And then when the pandemic hit, we cut back a lot of our resources. We got focused, went back to our roots and really focused on rebuilding our platform, becoming lean, becoming a functional organization and we now have essentially the same amount of employees as before the pandemic and double the revenue and that explains why we have 41% free cash flow margin, one of the most profitable companies in tech. We're now beginning to prepare the next chapter of Airbnb. And I want Airbnb to be one of the most important companies of our generation and to do that, we're going to do more than one thing. We're going to do multiple new things. We're going to have to have multiple new products and multiple new services. This fall, this October, we're going to be launching a new host service which is really important. It's essentially a co-hosting marketplace. So, there are people that have homes but they don't have time. There are other people in the world that have time but they don’t have a home. And so, there's a Venn diagram of people today who have both that get host. But what if we can match those two people together? That would unlock a lot more inventory. That's what we're going to be launching later in October. Then next year we're going to begin to expand Airbnb truly beyond our core business. And we're going to be launching - we're going to relaunch Experiences. I've been asked about Experiences probably every earnings call since we’ve been public, rightly so, because it's very exciting. We've learned a lot of lessons from Experiences. They need to be more affordable. They need to be more unique to Airbnb when you think so you can only find on Airbnb. They should be merchandised, videos not photos. They should be discoverable in the app and we should market them. If we think we do these five things, we think we'll have a hit on our hands and we're working on that. We also have new guests services and new host services that we're launching next year that we're working on. And then every year starting next year, we're going to launch new products and services. I look at Apple, I look at Amazon. Apple at one point was selling iMacs, Amazon was only selling books. We've gotten bigger than either of those companies just selling short-term rentals. But we're ready to go beyond short term rentals. So, the new Airbnb, to answer your question Ron, will be about a lot more than short-term rentals. It's going to be about long-term stays. It's going to be our guest services, host services and many new offerings and you'll begin to see that next year."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Doug Anmuth with JPMorgan. Your line is open."
},
{
"speaker": "Doug Anmuth",
"content": "Thanks for taking the questions. Ellie, just to follow up on I know you talked about the shorter booking window. Are you seeing any change in activity around pricing or class of property? And is there anything to call out across cohorts or income levels? And then, Brian just circling back on expanding beyond the core, are there any expansion markets in particular that you would call out where you're seeing particularly strong traction? Thanks."
},
{
"speaker": "Brian Chesky",
"content": "Yes. So, why don't Ellie, you take the first. I’ll take the second."
},
{
"speaker": "Ellie Mertz",
"content": "Yeah. so Let's talk a little bit generally about ADR, so question was like what are people are actually purchasing on the platform. I would say, generally, so far this year what you've seen is a little bit of ADR appreciation globally. In particular, obviously, but more recently in North America. And what we see there is a big driver of the ADR appreciation is big shifts, which you can assume is what it sounds like people choosing more expensive or larger properties. And I think part of the read through from that can be oh, people are choosing more expensive listings. Therefore, you are seeing stronger demand from higher economic demographics. I think that is one read through. I think another read through is that, if you think about the value proposition of Airbnb, it's that we offer these larger properties and on a per guest basis, they can be quite affordable and frankly more affordable than a hotel. So I think part of that ADR mix shift appreciation that you see is frankly people gravitating to where we actually have some great value, which is the larger Airbnb that that do provide value on a guest level."
},
{
"speaker": "Brian Chesky",
"content": "And to answer your question about expansion markets, maybe a framework I can give to think about how we want accelerate growth, listen, we want to be growing a lot fast than we are. We want to be growing in healthy double-digit growth - double-digit growth and I think we can. And the way we're thinking about accelerating growth is through short-term, medium- term and long-term. Short-term is really optimizing our core business. It's really around affordability, about having high quality stays and just conversion rate increases. Long term is really about new products and services. So, the question you asked about international is interesting because it's kind of like a medium term horizon, like one to three years. And to frame this, Airbnb is in 220 countries and regions. We're one of the most global companies in the world on the Internet, 220 countries and regions. We operate nearly in every country in the world. But there's only really five markets where we're penetrating. And those markers are the US, UK, France, Canada and Australia. And you'd think like, well, if there was one company in the world that would truly be like have a lot of international penetration it’d be a global travel network, right? A website where you want to travel, use one platform to travel around the world. So there's a number of countries. Just to give you a couple of examples of our some big expansion markets, Germany and Brazil we've seen a lot of progress. Those are huge travel markets and the biggest travel markets in the world. And we're continuing to go bigger. In Europe, Italy and Spain, we have low penetration compared to France and UK and these are major destinations. Then in Latin America, we've had a lot of progress in Brazil but there's really Peru, Chile, Colombia, Argentina, these are a huge opportunity markets, and that's Latin America is the fastest growing region alongside Asia. And Asia, you really have like the big four, big five countries. So you have China, Japan, Korea, India and then maybe we could kind of call out Southeast Asia as a holistic region. So what we're going to do is we have an international playbook, which is really product and marketing. First, need to localize the product, you need to make sure you have the right regulation in place. You need to make sure you have the right foundation. We've highlighted in our Investor Letter that we’ve retooled our product for Asia. Asia are different character counts. And so it's more laborious in certain languages to type in so like in Korea and Japan they prefer to do browsing than search. So we've had to retool our product and that's yielded some huge conversion rate increases. So some of these are going to pay back sooner, like some of North - like Switzerland, Belgium, Netherlands, they're going to pay back sooner. Japan is going to be a longer game, but that's one of the biggest travel markets in the world. And I literally think there are tens of billions of dollars of gross booking value increase just by getting all the aforementioned countries to the current market penetration of Canada or Australia. If we can get those countries to Canada, Australia there's tens of billions of dollars and it's just something we've had to focus - we're going to focus on. It's something we hadn't focused on in the last four years as much. We really want to solidify our core business, but now we're focused on it."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Richard Clarke with Bernstein. Your line is open."
},
{
"speaker": "Richard Clarke",
"content": "I just want to unpick the Q3 revenue guidance a little bit more. I guess the - if I look from the balance sheet your funds held on behalf of customers, to me it looks like it's up about 13% year-on-year. So it looks like you're carrying more bookings into the quarter and then you're talking about shorter lead times. So does that mean more bookings in the quarter for the quarter. So just trying to square that with why revenue is slowing down in your guidance?"
},
{
"speaker": "Ellie Mertz",
"content": "Yeah, thanks Richard. So, obviously, that that energy is balanced on - on the balance sheet gives you some indication of the backlog. I would not take those balance sheet items as a one for one read through in terms of the revenue that will be recognized over the course of the quarter. A couple of deviations in terms of why they might not match. One is obviously a good portion of the bookings that we will recognize in a particular quarter are still to be booked within the quarter? That's one aspect. The second is the balance sheet items will reflect the timing of the payments, the - whether it’s pay less upfront or the entirety of the payment and so they're just not a one for one guide. All they do, they do obviously give a time stamped point in time view of the backlog that we have."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Eric Sheridan with Goldman. Your line is open."
},
{
"speaker": "Eric Sheridan",
"content": "Thanks so much for taking the question. Maybe I can ask a two-parter coming back to the booking window. When you've – what you’ve seen over the last couple of years in terms of the booking window evolving from where it was pre-pandemic to where it is post-pandemic how much differ just that booking window look today versus maybe 2019 as opposed to today versus one in two years ago. And when you think about what that shift looks like, how much of that do you think in terms of a shortening booking window are elements of demand-driven Dynamics where the consumer might want to spend less money and be more discerning. Or just elements of normalization that are working in the way back into global travel? Thank you."
},
{
"speaker": "Ellie Mertz",
"content": "Thanks, Eric. So, let's talk about lead times over time. If we look at where we were say in Q2 of 2019, the average lead time across the platform was within one or two days of what it was in Q2 in ‘24? So from the kind of pre-covid to last quarter, there hasn't been some material shifts. What you did see through the path of covid was initially, we saw a massive reduction in lead time because people had no confidence in terms of their ability to book far out. That, that reversed in say the 20 to 2022 to ‘23 time period where people are so eager to travel that they were booking way in advance of their kind of normalized patterns to make sure that they had the trip on the book. They got the most attractive listing at the best price by booking early. And I think fast forward to ‘24 you're seeing up and up through Q2 a very much return to normal. So hopefully that's helpful in terms of the overall four-year arc. In terms of having some color commentary in terms of what we're seeing today, just to reiterate some of the color I provided at the beginning of the call. The last minute bookings are incredibly strong. So they are, I would say much higher in growth rates than what we are guiding to in terms of the average. There seems to be a lot of desire in terms of making sure you get your summer travel in at very elevated rates. But it's being offset by that portion of bookings which is for us about half of the overall bookings, which are a month or longer. And I think it's a minor - it's a minor softness, but it does have impact in terms of our backlog just given the concentration of bookings that happen more than a month in advance. There's just a modest amount of softness that is bringing the average lead times down. And I think what we’ve seen in the past is from time-to-time whether it be a new COVID variant, whether it be a macro headline, whether it be like last year the outbreak of war in Israel. People from time to time have moments where they are not booking in the same timeframe that they did in prior periods, and that's what we're tracking closely right now."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Your next question comes from the line of Brian Nowak with Morgan Stanley. Your line is open."
},
{
"speaker": "Brian Nowak",
"content": "Thanks for taking my questions. Maybe I'll squeeze in two. Let me ask one on the marketing expense comments for you Ellie. You mentioned in the guide marking expense has been real faster than revenue in the third quarter. I guess, the question is how do we think about performance versus brand expend and I think you sort of learned about your marketing spend over the years sort of gives you confidence this could resonate even faster room than growth this time around. And then one for Brian and sort of Gen AI and philosophical strategy. There's a lot of talks that are about top of funnel Gen AI travel assistance. How do you think about taking your leading supply that you have maybe partnering with hotel partners to create a really differentiated top of funnel alternative and hotel booking assistant using all these large language model capabilities?"
},
{
"speaker": "Ellie Mertz",
"content": "Yeah, so, Brian, let me let me talk a little bit about our marketing spend. Let me just back up before I talk about Q3 and remind you of the full year guide that we provided back in February. What we shared in February is that, for the full year we were looking to deliver an EBITDA margin of a minimum of 35%, which was obviously down slightly from the nearly 37% we delivered in ‘23. And the intent on guiding to margin compression on a year-over-year basis was to allow us the flexibility to invest in growth. And what you've seen so far this year is that for H1, marketing as a percent of revenue was effectively flat with where it was in ‘23. But we do intend to lean into those growth investments in the back half of the year starting in Q3, and that's obviously what informs the EBITDA guide that that you saw in the letter. In terms of where we are leaning in on marketing in particular and the confidence around the various channels, let me just talk about a couple of the components of the increase in marketing. So first, consistent with the conversation Brian Chesky just had on international markets. What you'll see in Q3 is that we will be layering on a handful of incremental markets that we will be targeting and effectively turning on our global playbook. In particular, you'll see us try or intend to extend our success that we've seen in Latin American countries like Brazil and Mexico to other markets in that region. Places like Peru, Colombia, Chile, Argentina so there will be some layering on of those incremental markets. We feel like we have had pretty good success there. Obviously it takes time in terms of investments in a market both from a product perspective as well as a marketing perspective to reaccelerate growth. But as the results have shown in terms of the differential between growth rates in our expansion markets and our core markets we feel like our expansion efforts have been successful and so, rolling them out to incremental markets will be helpful over the medium term. In terms of incremental performance marketing, what we've shared with you today that has continued into Q3 is that based on a lot of optimizations that we've made to our performance marketing efforts. We've been able to maintain extremely high efficiencies and so where we see those we do lean in and have quite high confidence in terms of returns."
},
{
"speaker": "Brian Chesky",
"content": "And why don’t take your second question. So Brian Gen AI ChatGPT launched late November 2022. When it launched, I think we all got like incredibly excited. It was kind of like the moment probably some of us first discovered the Internet or you know maybe when I come with launch. And when it was launched you had a feeling that everything was going to change. But I think that's still true. But I think one of the things we’ve learned over the last say 18 months or nearly two years 22 months since ChatGPT launched is that that’s going to take a lot longer than people think for applications to change. If I were to think of AI, I'd probably think about it in three layers. You have the chips. You have the models. And you have the applications. There has been a lot of innovation on the chips. There has been a lot of innovation on the models. We have a lot of new models and there's a prolific rate of improvement in these models. But if you look at your home screen which of your apps are fundamentally different because of the AI? Like fundamentally different kinds of generative AI, very little especially even less in e-commerce or travel. And the reason why is I think it's just going to take time to develop new AI paradigm. ChatGPT is an AI model – interface if that could have existed before AI. And so, all of our paradigms are pre-AI paradigms. And so what we need to do is we need to actually develop AI applications that are needed to the models, no one's done this yet. There's not been one app that I'm aware of at the top 50 app in the app store in the United States that is a fundamentally new paradigm as fundamentally different FC multi-touch was to the iPhone in 2008 and we need that interface change. So that's one of the things that we're working on. And I do think Airbnb will eventually be much more than a search box where you type a destination, add dates and find a listing. It's going to be much more of a travel concierge is having a conversation, learning adapting to you. It's going to take a number of years to develop this. And so, it won't be in the next year that this will happen and I think this is probably what most of my tech friends are also saying, it's going to just take a bit more time. But the answer to your question on what’s possible, a new interface paradigm would allow us to attach new businesses. So the question is, what permission do we have to go into a business like hotel? Well today, we have permission because we have a lot of traffic. But if we had a breakthrough interface we have even more permission. Because suddenly we could move top of funnel and not just ask where you're going but we could point to we could inspire where you travel. Imagine if we add an index of the world's communities we told you we had information about every community and we can provide the end-to-end trip for you. So, there's a lot of opportunities as we develop new interfaces to cross-sell new more inventory. And just to remind everyone we own hotels nights. We bought that before the pandemic. It’s one of the most popular hotel booking apps in the world and we are still investing in hotels. So absolutely there are opportunities down the road with this new interface to sell new things including hotels and everything."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Justin Post with Bank of America. Your line is open."
},
{
"speaker": "Justin Post",
"content": "Great thanks for taking my question. Just on the North America and Europe markets presumably growing a little slower than the average for the company. Any signs of kind of cyclical or macro pressure like shorter trips or people trading down that that could end in and any that could maybe drive some acceleration when the period ends. And second, how do you feel about your market share in those two key regions? Thank you."
},
{
"speaker": "Ellie Mertz",
"content": "Yes, so let me talk. Let me talk a little bit about what we're seeing in both, North America and EMEA. I would say I would go back to my prior comments in terms of just the lead times. That that commentary is true globally so it applies to both northern - North America and EMEA. I would say EMEA has been relatively stable quarter to-date. And so it is not necessarily part of the broader moderation story that we have shared. In terms of North America, there's a handful of components. One is the shorter lead times I would say. A second is North America has a concentration of our long-term stays, nights and what we've seen over the last year is that short term days have grown more quickly than long term stays. And so, the LTS to growth rate is a drag on the average that has an outsized impact on North America and we've just comped with the changes that we made a year ago in terms of our LTS fees which is a bit of a headwind for LTS generally on the platform, but in particular in North America The one other thing I would add in terms of just providing some color on what's happening in the US is couple of regulatory comments. One in particular that we're watching is that in California, the total price display and cancellation grace period, regulations went in went into place on July 1st and we think that's been a little bit of a headwind to our California business. Our California business if you include both guests who reside in California as well as guests who are travelling to California, which is what the new rule is applied to is about 10% of our GVV. So it’s an area that we're watching quite closely just see how quickly consumer behavior normalizes after these regulations have been put into place. And into the comments I made earlier on ADR, I would say we haven't really seen a material move towards trade downs much of the contrary people continue to book our larger more expensive listings. And then in terms of shorter trips, the average from playing has gone down, but that is really a function of the mix shift between short-term rentals growing more quickly than long-term rentals. Less so people choosing a three day trip versus a four-day trip. So I don't think we've seen that the type of tree down behavior that that you're likely asking about. In terms of the second component of your question, market share. When we look at market share, we look at the market of night stays across accommodations. And so that obviously includes all the hotel nights that are either booked directly through hotel or booked through an intermediary. And when we look at market share on that basis is what we see is that, in Q2, consistent with prior quarters, we continued on a year of your basis to gain market share in terms of total nights stayed over the universe of hotel and other travel accommodations. That is also true on a regional basis. We feel like we're doing quite well. As we across the world continue to gain market share."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of James Lee with Mizuho. Your line is open."
},
{
"speaker": "James Lee",
"content": "Great. Thanks for my questions. Two here please. First on experiences. What are some of the frictions and difficult problems you're trying to resolve here. It seems like you have plenty of supply, plenty of listings. So that doesn't seem to be that issue. Can you help us understand something key paint points for both suppliers and customers? And second, I once again noticed in North America and EMEA, you have call out that to see a mix shift to non-urban markets and just want to get some more color on that. Urban markets in general, are you seeing weaker demand or seeing increased competition in the hotels? Thanks."
},
{
"speaker": "Brian Chesky",
"content": "Hey, James, I'll take the first question. So there's five things that we're looking for to do with experiences. The first thing is we want them to be a better price selection. Right now, we think we can have - we can offer more affordable experiences that younger people especially Gen Z could afford. So that's the first thing. We don't really have enough affordable listings. The second thing is, we need more unique inventory. It's really good. The inventory we have is good. In fact the five star rating average for experiences is higher than the five star rating for homes. But we still think we can have even more unique inventory that you could only find at Airbnb. That's not another platform and we want to recruit some of the most interesting people in the world to be on our platform. And we're getting a lot of excitement. The third is we think we can even merchandise them better. I think experience to see more and more insights like with film, with movie, with video. Imagine deciding on a movie but instead of a film trailer, you had some movie stills. Would you go see the movie, you probably wouldn't. You need a trailer. You need a video experience. You saw video first. The fourth it needs to be discoverable in the apps. Right now experiences are really hard to find because those the last four years we've really focused on prioritizing our core business. I mean a lot of people they come to our homepage they don't ever see experiences. You wouldn't know these sell experiences. So we're going to completely reimagine our search and discovery engines to cross-sell experiences after you book a home and to really target the right homes. We were going to show you other guests on the experience, just provide social proof. We're going to bring some of the magic like the countdown in the icons and some of the magic there. And the final thing is awareness for experiences really low. Most people don't know we offer experiences even though we launched them eight years ago. So we're going to actually market them and tell the world about them and we can do this without a lot of incremental investment because we can market homes and experiences in the same ad. So if we do those five things, I think we can dramatically change the trajectory of experiences business."
},
{
"speaker": "Ellie Mertz",
"content": "And James, to your second question, in terms of the mix shift to non-urban market. We call it on the letter because it is a differential in terms of the respective market segments, but there isn't – it’s not a major shift what we are seeing is that growth in non-urban markets continues to be slightly higher than that of urban. I think what that tells you is we have a - I would think differentiated offering in non-urban. And I think the interesting thing about that portion of our business is, it has maintained a - I would say meaningful larger share of our business demand four years post covid than it was previously. And I think over the last four years has been a broadening awareness of the variety of markets that Airbnb is available that hotels simply don't exist and we continue to see great demand for those markets."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Justin Patterson with KeyBanc. Your line is open."
},
{
"speaker": "Justin Patterson",
"content": "Great. Thank you very much. Ellie, I appreciate your comments on margins and real flexibility to invest this year. Could you talk about how long we should see this investment cycle persist and when we could start seeing more meaningful returns? Thank you."
},
{
"speaker": "Ellie Mertz",
"content": "Yes, thank you. So we always have not given a guide for ’25. We will provide you a view on ‘25 as it approaches. What I would say is, if you look at where we have come over the last couple of years, we obviously delivered a substantial amount of margin expansion from where we started. You followed us for some time, but pre - going public we had negative EBITDA margins and four years later, we were able to deliver almost 37% margins last year. So I think we've more than demonstrated the strength of this model both from a profitability basis as well as a free cash flow basis. What we'd like to deliver more of is growth and that's why we have as I said a lower margin target for the current year. And as I said previously, you'll see us start to make those investments in the back half of the year. I anticipate that when you think about both our medium term growth lever of international markets and then what long-term growth lever of expanding the core offerings. Those will require some ongoing investments in order to scale and then deliver the growth. What I think you should also think about though is that all of our expansions to-date have not been very capital intensive. So we will use some of the probability to invest but we don't anticipate any kind of sea change in the foreseeable future around overall profitability levels."
},
{
"speaker": "Operator",
"content": "And you're next question comes from the line of Kevin Kopelman with TD Cowen. Your line is open."
},
{
"speaker": "Kevin Kopelman",
"content": "Great. Thanks a lot. So, if we adjust our Easter impact it looks like you have a little bit of revenue growth slowing kind of each quarter this year expect to see the third quarter. Based on the dynamics you're seeing today do you anticipate some further slowing towards the end of the year, if you look at how space are shaping up for Q4 or do you see anything in your numbers as of now that could lead to stabilization? Thanks."
},
{
"speaker": "Ellie Mertz",
"content": "Yes. thanks, Kevin. So I would say, first, we're not going to provide outlook right now for Q4, but when I when I give you that color on the lead times, I think it's pretty informative from the perspective of, it's not that people are not definitively booking over the long term, if they may not have booked yet. And so, as I shared previously, we have seen some. some movement in lead times over the last couple of years and in many cases people have come booked. They just come and booked at a later time period and so that's certainly something that we will be on the eyes out for in terms of Q4 and beyond. I think also just thinking about how the comps play out for the balance of the year. As you'll recall where we were last year September and October were quite soft and then November and December had a bit of a rebound. So those are the comps that we'll be lapping as we approach the end of the summer heading into Q4."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Nick Jones with Citizens JMP. Your line is open."
},
{
"speaker": "Nick Jones",
"content": "Hey, thanks for taking my question. Maybe just another one on an expenses and philosophically how you're thinking about it. There's plan to relaunch experiences, Brian it sounds like there's not a lot of incremental investment required there, but earlier you kind of talked about launching new products and services every year. So I guess can you speak to how nimble you plan to be with the investment cycle to if demand may be continues to get weaker or versus kind of bouncing back, how should we be thinking about kind of the level of commitment to invest in and what sounds like a lot of new and exciting products and services?"
},
{
"speaker": "Brian Chesky",
"content": "Yeah, I mean we essentially built our forecast to have already have a spread of that between short term, medium term and long term. So in the short term, I mean, the biggest driver of growth in the short term again is conversion increases. Every 1% increase in our business is about $100 million. And we have hundreds of basis points of growth opportunities just in conversion and usability improvements. And then affordability we have quite a few opportunities and then a quality and reliability. Probably one of the biggest variables might be like how we think about expanding internationally like some of the big Asian countries like Japan, we can be very, very nimble. based on the results of Japan. Most of these new services and offering though are going to not cost very much. They're mostly headcount we're talking some teams hundreds of people not thousands of people so you won't really see that. Because this is a network effect business and most of our traffic is going to be taking traffic we already have for accommodations business and cross-selling new offerings. And so, it's really just the cost of acquisition of supply and that's not very expensive because we've found that we can do it fairly efficiently. So most of this it's very nimble. There's not going to be a lot of incremental investment that would materially change. The variability is sometimes it’s probably like marketing especially internationally that's a question."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Jed Kelly with Oppenheimer. Your line is open."
},
{
"speaker": "Jed Kelly",
"content": "Hey great. Thanks for taking my question. Just going back to the urban opportunity and potentially putting more hotels on your platform, can you just talk about philosophically how the company balances putting more supply that you might consider more could commoditize and that can be cross-listed. What that might convert at a higher rate? Thank you."
},
{
"speaker": "Brian Chesky",
"content": "Hi, Jed, so, essentially, I think people come to Airbnb because they want to get something unique. That's what customers think of when they think of Airbnb. That's why we're a noun and a verb. We're one of the only brands in the world like Kleenex or Xerox, that's a noun and verb and it means you can - it's something that didn't really exist before we created this category at a wide scale. That being said, for everyone who books in Airbnb, about 9 people book a hotel. And so, if we can get just one of those guests to book on Airbnb, that's currently booking on a hotel platform we would go from nearly half a billion nights a year to a billion nights a year. And there's two ways to do that. One is the increased reliability of homes in Airbnb, because the number one reason people tell us they book hotels is they are typically more reliable. They know what they're going to get they have a front desk. The other is adding hotels in Airbnb and we're not philosophically misaligned with adding hotels, if we were we would never bought hotels a night before the pandemic. We just haven't prioritized hotels. We think of hotels as a filling in network gap during high occupancy nights. We generally think our if there's an incredible home at a low price, they're always going to choose that but when occupancy goes up they are going to go towards hotels. There are also some use cases where hotels are better and Airbnbs are better. If you need to stay for one night, you're travelling alone, you are business travel and you plug in you plug out a hotel is better. If you're traveling with a group you are travelling for more than three nights and you're travelling in the non-urban area, Airbnb is better. And then, if you're doing something between then you're going to have choices. So, we do think between filling in a network gap and getting more of those one night business travel stays, there is an opportunity to offer hotels in Airbnb and we have a lot of hotels. We have hundreds of thousands of boutique hotels and non-home inventory on Airbnb and we're going to continue to expand that over its years to come. And so there's no philosophical misalignment to add commodity inventory. The philosophical misalign would be if that becomes the majority of our marketplace and people - consumers stop thinking of Airbnb as unique and local. If they start thinking about us that changes the brand then that would be a philosophical misalignment but I don't see that happening anytime soon."
},
{
"speaker": "Operator",
"content": "And your next question comes from Mark Mahaney with Evercore ISI, Your line is open."
},
{
"speaker": "Mark Mahaney",
"content": "I just wanted to ask a question about Paris and the learnings you've had from this. I assume this is the biggest event for Airbnb and a massive popular event in your largest city. So just if that’s true and I think that is, just step back and talk about the learnings of being able to make sure you had enough supply working with local regulators and agencies and in terms of getting messages out to opportunities out to guests as well like this big event that you've pulled off. Just talk about the lessons you've been able to draw from that that'll you know help you set you a better for the next FIFA World Cup and the next World Cup, next Olympics et cetera?"
},
{
"speaker": "Brian Chesky",
"content": "It’s a great question, Mark I'm really glad you asked this. I just want to like take us back down memory lane because in 2007, Airbnb provided housing for a design conference. Then in 2008, we provided housing for the Democratic National Convention. Then in 2009 we provided housing for the inauguration. Our first three moments when we started Airbnb was provided housing for events. In fact, our original premise of our business was at housing for events. It wasn't meant to be ever offered for anything other than events in conferences. And the reason why is because conferences and events especially things like the Olympics and World Cup are unbelievable use cases for Airbnb. And the reason why is I think obvious to everyone. Events typically like to host more guests than they have hotel rooms available for. And people, most people they have, most regular people aren't looking to become Airbnb host and make a long-term commitment to host every week. So a lot of people events coming to town is wanting to host one week and make $1,000 or $2,000. And so what we did is we focused a year ago on Paris. And in the last year we increased our supply in Paris by 37%. We now have nearly 150,000 homes in Paris. We had 430,000 guests stay in Paris so far and counting and that number to continue to climb. So that's equivalent of five Olympic stadiums, I want you to imagine five Olympic stadiums where the guest staying in at Airbnb. The fact is that the Olympics as we know it could not ever happen again, without Airbnb because this 400,000 could not have stayed in a hotel room. And so to do that, what we did is we worked at the City of Paris. I was in Paris 10 days ago. I met with President Macron. I met with his economic team. And we talked about how important Airbnb was to the Olympics happening. And we had a lot of cooperation. We were a title sponsor Olympics. And we targeted this event of at Paris, we Did a lot of local campaign. And so it was so successful that we now looking at the top thousand events in the world, really large ones like the World Cup and Olympics, but also like you know looking at where Taylor Swift is going on concert or looking at different conferences, different like we provide housing for the Berkshire Hathaway conference in Omaha and we worked with Warren Buffett you got the word out. This is over a decade ago. So conferences, festivals, events, Coachella, you go down the list. I think this is the best strategy we have to recruit supply and the supply recruit for an event is not property managers. They are individuals who host occasionally that come only to Airbnb. And cities actually like when Airbnb provides housing for events because we solve a problem for them. So, I'm glad you ask the question. The answer is it worked widely successful. Better than we ever imagined. We're working on the lawn for 2026. We're looking at La Olympics for 2028. But we're also building a strategy for the top thousand events in the world. But I think this is the strategy the only Airbnb can do. Because we basically increase excess capacity in cities all over the world to allow them to temporary as well. And it's really alignment and incentives. So it's been very successful at least that we continue - we'll be playing to expand the playbook."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Stephen Ju with UBS. Your line is open."
},
{
"speaker": "Stephen Ju",
"content": "Okay. great. Thank you. Brian, I want to ask on Airbnb rooms. I would have thought that given its more nascent statement in the economic backdrop that this is should probably be the product that should be growing the fastest. So is there anything that you can call out in terms of product fit or awareness? I think I heard you call out maybe supply shortages earlier. But any factors that might be weighing on the growth rate here a little bit? Thanks."
},
{
"speaker": "Brian Chesky",
"content": "Thanks. Yeah, the reality is the biggest issue with Airbnb rooms it’s just a small percent of our business. It's a very small percentage. So even if it - even no matter how fast it grows it's often very small base. It's how Airbnb started by providing a room and a house. It's very affordable. It's very popular for Gen Z, but it is off a very small base and so you're not going to see a major change to the growth rate of the company based on that. I think the thing but maybe just broad zooming out though, two points I’ll make. The first point is Airbnb is one of the most diverse businesses in the world. We have bedrooms and homes up to tens of thousands of dollars a night luxury villas in Airbnb. We allow you to travel by yourself or with the large groups of up to 16 people. We're in every country nearly in the world, every continent in the world including at one point in article and so we're a very - we're in urban areas. Where in the decades arounds this nations we're off to be impact. So our general philosophy is that something for everyone to have the most diverse array of inventory in the world. The other point I'll just make is an area down the road that would really help Airbnb rooms is continuing to invest in our system of trust. The biggest obstacle to people staying in a room is just the discomfort with staying at a house with a stranger they don't know. One of our core inventions with a system of trust and as more we invest in system of trust, I just gave a lot more of these businesses where strangers to live in the others. So I do think it's still a big long term opportunity for us. But it's often but smaller base and it's never going to be as big as entire home and everything."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Lee Horowitz with Deutsche Bank. Your line is open."
},
{
"speaker": "Lee Horowitz",
"content": "Great, thanks. New on one our nights and on pricing. So Ellie you're talking about putting more investments into place in the second half of this year as a means of accelerating growth. Can you help us better understand sort of the payback periods that you tend to expect on these dollars and over what timeframe you may assess the ROI on these investments in terms of accelerating total company growth rates? And then maybe one on ADRs. You guys are highlighting sort of some building demand pressures in North America, all sign the pointing towards people trading up the whole homes and persisting ADR growth for your entire business again despite weaker growth in your highest ADR region, North America. I guess when we think about. the sustainability of ADR growth beyond the 3Q as you mix away from North America and perhaps see the overall travel demand environment continue to soften, how do you think about your ability to continue growing through that kind of a scenario? Thanks so much."
},
{
"speaker": "Ellie Mertz",
"content": "Yeah, so first let me talk about marketing payback. I would say the way we are looking marketing paybacks is very different based on the channels and investment from a performance marketing standpoint obviously the ROI is very specific and relatively short-term. We think about that in terms of weeks and months not quarters. In terms of Brands we think about that over a longer time horizon. If you think about any particular brand campaign, it needs to be in market for quite some time and it needs to be sustained for you not only to see the benefit, but also sustain the benefit and convert it into actual transaction. So I think about that more from the six months to a year payback period and requires - I would say a consistent level of investment. And then, as a third factor something that I mentioned in terms of an area of investment that is not programmatic. We do need to at the margin build some of our teams that are driving this growth and so that will be in a gradual investment modestly above the headcount growth that we've been targeting over the last couple of years but we think it will help long Payback should I should say high payback in terms of driving acceleration across a variety of initiatives. In terms of pricing, I think there's one question about what is happening at a geo level. I think there's a broader question in terms of the aggregate or global ADRs. To your question in terms of if neighbor is softer than other regions what happens to global ADR obviously mix shift is a huge component in terms of the global ADRs that we report. One Factor in terms of the Q3 guide is the shift a little bit away from North America which as you highlight does have the highest ADRs Over time we would anticipate that as regions like Latin America and APAC become larger portions of our overall business, the global ADR would come down. But those incremental nights are all accretive and the economics behind them still are very strong. So it's a at a global basis, we are we're somewhat agnostic because we can deliver strong economics across a wide range in ADRs."
},
{
"speaker": "Operator",
"content": "And ladies and gentlemen, that will conclude our question and answer session. I will now turn the conference back over to Brian Chesky for closing remarks."
},
{
"speaker": "Brian Chesky",
"content": "Alright, well, thanks for joining us today. Just to recap, revenue was 2.7 billion 11% higher than a year ago, adjusted EBITDA was a Q2 record And our a trailing 12 months free cash flow was $4.3 billion is our highest yet representing a free cash flow margin of 41%. And we've made significant progress over the past few weeks, but there's more to come. In October we're going to share with set of features and upgrades as part of our 2024 winter release. This includes expanding host of co-hosting, setting the stage for host provided services and much more. I'm proud what we accomplished in Q2 and I look forward to sharing more with you next quarter. Thanks for joining."
},
{
"speaker": "Operator",
"content": "And ladies and gentlemen, that concludes today's call and we thank you for your participation. You may now disconnect."
}
] |
abnb | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good afternoon, and thank you for joining Airbnb's Earnings Conference Call for the First Quarter of 2024. As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Airbnb's website following this call. I will now hand the call over to Angela Yang, Director of Investor Relations. Please go ahead."
},
{
"speaker": "Angela Yang",
"content": "Good afternoon, and welcome to Airbnb's first quarter of 2024 earnings call. Thank you for joining us today. On the call today, we have Airbnb Co-Founder and CEO, Brian Chesky and our Chief Financial Officer, Ellie Mertz. Earlier today, we issued a shareholder letter with our financial results and commentary for our first quarter of 2024. These items were also posted on the Investor Relations section of Airbnb's website. During the call, we'll make brief opening remarks and then spend the remainder of time on Q&A. Before I turn it over to Brian, I would like to remind everyone that we will be making forward-looking statements on this call that involve a number of risks and uncertainties. Actual results may differ materially from those expressed or implied in the forward-looking statements due to a variety of factors. These factors are described under forward-looking statements in our shareholder letter and in our most recent filings with the Securities and Exchange Commission. We urge you to consider these factors and remind you that we undertake no obligation to update the information contained on this call to reflect subsequent events or circumstances. You should be aware that these statements should be considered estimates only and are not a guarantee of future performance. Also, during this call, we will discuss some non-GAAP financial measures. We provide a reconciliation to the most directly comparable GAAP financial measures in the shareholder letter posted to our Investor Relations website. These non-GAAP measures are not intended to be a substitute for our GAAP results. With that, I will pass the call to Brian."
},
{
"speaker": "Brian Chesky",
"content": "All right. Good afternoon, everyone, and thanks for joining. Airbnb had a strong start to 2024. We had 133 million nights and experiences booked in Q1, marking our highest first quarter ever. Revenue of $2.1 billion grew 18% year-over-year, primarily driven by continued strength in travel demand and the timing of Easter. Net income was $264 million, representing a net income margin of 12%. For Q1, our free cash flow was $1.9 billion, our highest ever. And for the trailing 12 months, our free cash flow was $4.2 billion, representing a free cash flow margin of 41%. Our strong cash flow allowed us to repurchase $750 million of our shares in the quarter. And at the end of Q1, we had $6 billion remaining on our repurchase authorization. Now, during Q1, we made significant progress across our three strategic initiatives, which are making hosting mainstream, perfecting our core service, and expanding beyond the core. First, we're making hosting mainstream. We remain focused on making hosting just as popular as traveling in Airbnb. And to do this, we're raising awareness around the benefits of hosting, providing better tools, and helping hosts deliver high-quality stays. As we grow, we're also taking action to rapidly improve the quality of stays on Airbnb. In Q1, we removed thousands of listings that failed to meet our guest expectations. And excluding these removals, active listings for accommodations grew 17% year-over-year. And we also saw sustained double-digit supply growth across all regions. This year, we'll continue to raise awareness around hosting and improve the overall host experience. Second, we are perfecting our core service. Over the past few years, we've rolled out more than 430 new features and upgrades to improve our service. In November, we took another huge step forward on reliability with the launch of Guest Favorites, a collection of the top homes on Airbnb based on ratings, reviews, and reliability. Now, since launching Guest Favorites, there have been more than 100 million nights booked at these listings. And we will continue to make it easier for guests to find high-quality and affordable stays. Finally, we're expanding beyond our core. During the quarter, we continued investing in less mature markets to unlock more growth. And in Q1, growth nights booked in our expansion markets grew twice as fast as our core markets. And we're also focused on expanding beyond our core business. Now, this will be a multi-year journey, and we've already begun laying the foundation. Last week, we introduced Icons, a new category of extraordinary experiences by the greatest names in music, film, sports, and more. Icons mark an important next step in helping people understand that Airbnb offers more than just travel accommodations. Now, before I share a few business highlights, I just want to provide some context on why we actually introduced Icons, because they deliver on three key objectives. First, Icons keeps Airbnb's brand relevant and top of mind. With new Icons launching throughout the year, we can introduce more people to Airbnb and highlight what makes us unique. Second, while Airbnb's brand is already recognized around the world, there are specific segments where we want to accelerate growth. And with a broad range of Icons spanning various geographies, demographics, and fan bases, we'll be able to reach key segments in a more targeted way. And third, Icons helped change the way people think about Airbnb and what we offer. And this is going to be critical as we expand beyond accommodations in the coming years. Now, it's still early, but we're really excited about the response we've seen to Icons so far. In just one week, the Icons launch has generated over 8,100 pieces of global media coverage and 371 million social media impressions. And the coverage has been overwhelmingly positive. Now, just to put this into perspective, Icons has already generated more for us than our IPO. It's clear Icons are resonating with people. Now, looking back to Q1, we saw a number of positive business highlights. First, mobile downloads are accelerating. So, to quickly zoom out, nights and experiences booked in Q1 increased 9.5% year-over-year, despite a hard conference this time last year. And we were particularly encouraged by the growth of app downloads. In the U.S., app downloads increased 60% in Q1 compared to a year ago. And global nights booked in our app increased 21% year-over-year. And they now represent 54% of nights booked during the quarter. And this time last year, mobile bookings represented only 49%. So, it went from 49% to 54%. So, we're seeing some really, really good traction. Second, Airbnb is uniquely positioned for special events. Special events is really how we started Airbnb. We really started it to provide housing for conferences and events. And in April, we had over 500,000 guests stay on Airbnb during the solar eclipse in North America. And interestingly, we saw more than twice as many nights stayed on Airbnb along the direct path of the eclipse compared to the year prior, with many of these locations in areas that don't even have hotels. Nights booked in Paris during the summer's Olympics are five times higher than this time a year ago. And Germany is also seeing a similar trend for the Euro Cup this summer, with nights booked nearly double compared to a year ago. Now, supplies also increased to meet the higher demand, including nearly 40% more active listings in Paris in Q1 compared to a year ago. These events highlight that Airbnb's unique ability to disperse travel and spread economic benefits by allowing people to stay in local neighborhoods where there are no hotels. And finally, supply growth remains strong. Now, as mentioned earlier, in Q1, we removed thousands of listings that failed to meet our guest expectations. And excluding these removals, active listings for accommodations grew 17% year-over-year. We continue to see double-digit supply growth across all regions, with the highest growth in regions with the highest demand. Urban and non-urban supply increased at about the same rate, and we saw relatively similar supply growth among individual and professional hosts, with the majority of new listings exclusive to Airbnb. We're really proud of our strong Q1 results, and we're looking forward to another record summer travel season. So with that, Ellie and I look forward to answering your questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question will come from the line of Mark Mahaney with Evercore ISI. Please go ahead."
},
{
"speaker": "Mark Mahaney",
"content": "Thanks. You talk about these kind of leaning into these kind of less mature markets and this doubling of growth rate in some of those expansion markets versus your core markets. Could you give a little more color on which countries and which markets that is? Which countries, I think in the past, you may have mentioned Brazil, but which ones you're leaning into this year? And then secondly, that U.S. app downloads increase of 60% year-over-year. That's an extremely high number for what you would think would be a reasonably well-known app and brand. So what drove that? Do you have any whys behind that? Thank you very much."
},
{
"speaker": "Brian Chesky",
"content": "Yes. Hey, Mark. Why don't I start? So leaning into less mature markets. So if you think about Airbnb, we're obviously in 220 countries and regions. We're one of the most global brands in the world. But our markets with the highest penetration would be U.S., Canada, Australia, France, and U.K. So those five. So the next markets that are the biggest potential TAM would be like Mexico, and Brazil, and Latin America. In Europe, it would be Germany. It would be Italy. It would be Spain. We're also starting to see some traction like Switzerland and Netherlands. And in Asia, it would be Japan. It would be Korea. It would be China. And eventually, a little bit longer game would be India. So these are, and there's a few others in Latin America. So I could kind of keep going. But those are kind of some of the really, really big travel TAMs. And Mark, maybe just one other thing I'll just say. I think a really good thing to look at is our penetration for each country. And while U.S., Canada, Australia are really, really similar, there's a really, really big drop off in a lot of these other markets that are huge travel TAMs, I mean, especially in Asia. And one of the things that we've learned is that Airbnb pretty much resonates pretty equally everywhere once there's the awareness. In fact, I could argue that Airbnb might resonate better in Asia because there's a younger travel population that's not predisposed to hotels and they're on social media. And we are disproportionately on social media versus our competitors. So I'm very, very bullish about that. Now, on U.S. staff downloads, you're right. I mean, it's grown 60% last year. It went from 49% of bookings to 54% of bookings. So at the highest level mark, what drove that was just focused on a roadmap. We have a brand that most everybody, at least in the United States has heard of. And a lot of people download our app, but we've never really focused on optimizing our app from a download perspective. And just to be clear, these numbers were driven organically, not by paid advertising. So it was really just a lot of optimization, different touch points, encouraging people at the right moment to download our app, not being intrusive. We had pushed a lot of people to just, we just pushed them to our mobile website. Our mobile website does not convert nearly at the rate of our app download. And so maybe the highest level point I'll just make is, I think what we've been able to prove in the last three years is when we focus on something, we can drive the numbers. Two years ago, supply wasn't growing, we focused on it. It's now growing 70% net quality. A year ago, we felt like app downloads weren't where they needed to be. We put a team on it, they focused. So I think we're developing a good track record to really be able to move metrics when we focus on them."
},
{
"speaker": "Mark Mahaney",
"content": "Thank you, Brian."
},
{
"speaker": "Ellie Mertz",
"content": "Brian, if I could just add, I think the app download effort is really just part of our broader priority around perfecting the core and optimizing the core business. We identified that not as many of our guests were using the app as they should. And we know that the app is a much better user experience than MoWeb. So it's again, part of a broader suite of roadmap items that are intended to improve and perfect the core experience."
},
{
"speaker": "Mark Mahaney",
"content": "Thank you, Ellie."
},
{
"speaker": "Brian Chesky",
"content": "Thanks, Mark."
},
{
"speaker": "Operator",
"content": "Your next question will come from the line of Richard Clark with Bernstein. Please go ahead."
},
{
"speaker": "Richard Clarke",
"content": "Hi, good afternoon. Thanks for my questions. Just on, you mentioned on the prepared remarks and you mentioned that Q4, that Q1 would have quite a tough comp. And there's calendar effects in there as well. But you're guiding the Q2, it's going to be flat on room night growth. So is there anything you call out in Q2 that's maybe holding that back and how we should think about the rest of the year? And maybe just a similar question on margin, the Q2 guide, I guess a little bit softer than consensus had some calendar in there. Is that including any of the growth investments you talk about or are those things that may come in more the second half of the year?"
},
{
"speaker": "Ellie Mertz",
"content": "Yes, thanks, Richard. Let me just talk a little bit about the trends that we've seen here today to help answer your question. So first, as you point out, as we were heading into 2024, we were widely aware that last January was particularly strong. And so the guide that we've provided back in February included a step down in growth from Q4 to Q1 that was reflective of that hard comp from a year ago. We did experience it. And then since then, we've seen relatively stable growth, which I see as frankly, a really strong statement in terms of both the stability and resilience of leisure travel demand so far this year. I think, something that we've seen this year that is contrasting to last year there was a lot of volatility in terms of the timing of when people booked relative to their check-ins. And so far this year, it's been, frankly, much more stable. Lead times on our platform have been, frankly, generally in line with a year ago, and it just hasn't been at the same level of volatility, again, that we saw a year ago. And so heading into Q2, our guidance reflects this continued stability of booking. Obviously, we'd like to deliver higher growth and stable growth, but our outlook obviously reflects the trends that we have seen quarter to date. To your question on Q2 margins, obviously, we guided, the Q1 results reflect a pretty meaningful year-over-year margin expansion. A big portion of that is due to the timing of Easter. So Easter is not only a benefit to revenue growth in Q1, but it's obviously also a benefit to margin expansion. Those two factors reverse in Q2. It is a headwind to revenue growth, and it is a headwind to overall margins. Two other components in terms of what's putting pressure on margins in Q2. One is just some one-time credits that we had in payment processing a year ago that will not recur this year. And then third, we shifted slightly the timing of our marketing spend, a little bit heavier in Q2 than in Q1, and that will be reflected in terms of marketing as a percent of revenue growing in the quarter on a year-over-year basis."
},
{
"speaker": "Richard Clarke",
"content": "Very helpful. Thank you."
},
{
"speaker": "Operator",
"content": "Your next question will come from the line of Jed Kelly with Oppenheimer. Please go ahead."
},
{
"speaker": "Jed Kelly",
"content": "Hey, great. Thanks for taking my question. Just one on ADRs. They seem to be relatively sticky, and I think a couple quarters ago, you talked about driving value to the consumer. So can you just give us an update on where you are in sort of some of your value initiatives? And then on supply, great supply growth again. Can you talk about how we should think about supply and nights eventually converging to similar growth rates? Thank you."
},
{
"speaker": "Brian Chesky",
"content": "Yes. Hey, Jed. Why don't I take the first one on value initiatives, and I'll let Ellie take the second one. So on providing value, when we started Airbnb, our original tagline was a cheap, affordable alternative to a hotel. And the majority of the primary reason people came to us is because it was a better value than a hotel. And we still think that's a core value proposition that we have to offer. Now, a year and a half ago, we noticed that, there was a lot of concern about Airbnb prices increasing. And so we created a whole team to identify a series of initiatives to modulate our prices, and they're working. And I'll go down the list. One is total price display. So as you know, in travel, especially online travel, there's a lot of progressive fee disclosures. And we decided to have a toggle right on the homepage that you can turn on to show the total price display. Since we've done that, not only do consumers -- not only are consumers going toward the best total value, but it's begun to change behavior in our host community because 300,000 or 300,000 listeners, say, have removed or lowered their cleaning fee as a result. So that was the first thing we did. The next thing we did is we started offering monthly and weekly discounts and much more robust tools for that. Now, this is important because, nearly half of our nights booked are for stays of a week or longer. And now more than two-thirds of our hosts offer a monthly or weekly discount. We also noticed that a lot of hosts that weren't getting booked weren't getting booked because their prices were too high. And they just didn't have really good concepts. So we created a tool called the Compare Listing Tool where people can see how much other people are charging the neighborhood. And they can actually see people who are getting booked, not getting booked. And no surprise, the people getting booked generally have lower prices. We have nearly 2 million hosts that now use the Compare Listing Tool. So those are just a few of the initiatives we've done. We actually have many others as well. The net of all of it is that hotel prices are up year-over-year and Airbnb listings on a like-for-like basis are down. So today the value of Airbnb versus a hotel is better than it was a year ago. And I think that trend line is going to continue given all of our efforts. And maybe the only other thing I'll just say on this is, as we know, loss of supply and demand, as supply grows faster and demand prices go down a little bit. And supply is growing faster in demand. I think that's also relieving some pressure. Ellie, over to you."
},
{
"speaker": "Ellie Mertz",
"content": "Yes, so Jed, to your question with regard to the relative growth rates of supply and demand, just a few comments. I would say first, something that we've shared previously is that in any given quarter, we would not expect supply and demand to grow exactly in line. But when we look over a longer time period, either the last decade or more specifically from pre-pandemic to today, what we do see is that over a period of years, they do grow generally in line. And I would say that continues to be the case. Where we are right now, I would say we're very encouraged to be able to deliver this continued level of very strong supply growth for a couple of reasons. I would say one, we know that more unique, differentiated supply wins and differentiated supply is why people come to Airbnb. I would say second, and Brian made this point, but growing supply allows us to, it really benefits our affordability measures in that more supply obviously but gets more competitive pricing. And then I would say third, relevant to our recent quality initiatives, we see it as an opportunity for, as supply growth is stronger than demand growth, for us to continue to be driving quality. What you saw in the quarters, we obviously did some one-time takedowns of supply that frankly just did not meet our community's expectations. And the fact that supply is growing so rapidly, it allows us to make those cuts, if you will, to the supply base and to be continually upgrading the level of quality that we deliver to our guests."
},
{
"speaker": "Jed Kelly",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Ron Josey with Citi. Please go ahead."
},
{
"speaker": "Ron Josey",
"content": "Great, thanks for taking the question. Brian, I wanted to ask you about search on Airbnb, just following the strength and the benefits of guest favorites. I wanted to better understand sort of, talk to us about post-guest favorites, how search and really conversion rates have improved and really how you feel search can just evolve over time. And then as a follow-up to what we were just talking about around inventory quality, we'd love to hear just the process to ensure that quality listings continue to come on the platform. I think we've talked about verified listings and trophies, but any other thoughts there would be helpful. Thank you."
},
{
"speaker": "Brian Chesky",
"content": "Oh yes, Ron. These are really, really good questions, Ron. So yes, let's start with search. So, we did approximately $10 billion last year in revenue. So the way to think about this is if we can just drive an incremental 100 basis points in growth, that's $100 million. So like the way we look at our conversion rate is like we have teams dedicated to the search experience. And we, over the last year, we, the last 12 months, we've likely driven at least a few 100 basis points of incremental growth just through optimizations of the search flow, because we just get so much traffic. And so just to call out a couple of things that we did, I mean, there's been dozens of dozens, I'll just name a couple. One I already mentioned, mobile app downloads. Now, why do mobile app downloads lead to also more bookings? Because the conversion rate on a native application is typically a lot higher than a mobile website. Number two, just to give you a couple of examples, one of the challenges of Airbnb compared to a hotel is you may type in a location and certain dates and maybe you're on vacation and you don't see exactly the home you need and you might not book a home. You might now open a different app. And we have this carousel that basically offers, hey, if you change your dates by one or two days, here are other listings you can find. And that led to a huge increase in booking. We made improvements to filters. We've made improvements to search input, the search box, making the search box more prominent. So there are quite literally dozens and dozens of improvements that we've made. And I see hundreds of basis points of incremental growth just through essentially optimizing the end-to-end guest flow for our core business. So it's really, really exciting. And a couple of big areas would be maps and location. There's a huge opportunity around that area. So that's on search. On inventory and quality, this is a great question. I mean, we have a really extensive roadmap. Last year we launched guest favorites, as you know. In November, 100 million nights booked have been booked through them. I would say the response to guest favorites has even been greater than I anticipated. We're seeing more people not only book guest favorites, but we're seeing that guest favorites have a fraction of the trip issue and contact rate as non-guest favorites. So guest favorites have between a fifth and a 10th the contact rate as our bottom quartile of listings. And the rebooking rates are much higher. And I also think what Guest Favorites is doing is it's changing behavior to encourage more hosts to become better. And so after that we launched quality highlights in March. Quality highlights, basically what happened was Guest Favorites was the top 2 million listings in Airbnb. But a bunch of people were saying, well how do we know which are the best within those 2 million? So what we did is we have a top 1%, top 5%, and top 10% trophy classification. And this is also really I think popular with guests. We've now removed hundreds of thousands of listings. And we are going to be doing a number of new things. One of the things we are experimenting with is showing to percentile where something falls in a quality distribution as a percentile basis. And then continually adding a lot more supply, and then tightening up our quality control, and really giving a lot more feedback to hosts to become better. I think that a really good opportunity here is to get a lot more listings in Guest Favorites, and to provide host education, host tools for the hosts that are struggling to be much more successful. So there's a pretty big and extensive roadmap to go. And just the last thing I'll say about this is, as big as Airbnb is, and we are approaching half a billion room nights a year, for everyone who stays in Airbnb, somewhere around 8 or 9 people stay in hotels. And when you ask people, why are you staying in a hotel? Airbnb is typically more affordable. It's a more local experience. It's much better for groups and families. People say yes, but hotels are historically a more consistent experience. And so if we can just get one of those travelers from hotels to stay in Airbnb, that would double the size of our business to a billion nights a year. And so we think quality and reliability is a multi-year roadmap. So you're going to be hearing every year major updates from us on quality and reliability."
},
{
"speaker": "Ron Josey",
"content": "Thank you, Brian. Super helpful."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Eric Sheridan with Goldman Sachs. Please go ahead."
},
{
"speaker": "Eric Sheridan",
"content": "Thanks so much for taking the question. Maybe coming back and putting a finer point on some of the topics we've talked about already, Brian. When you think about your top investment priorities for 2024 and beyond, how would you categorize those investments if we put them in buckets such as demand generation, supply growth, and platform and product innovation over the long-term? And in that last bucket, how should we increasingly think about what you're learning about testing and deploying AI across the platform and how it might reduce friction over the longer term? Thanks so much."
},
{
"speaker": "Brian Chesky",
"content": "Hey, Eric. Good to hear from you. So maybe I can just – you had three buckets. Maybe I can give you three slightly different buckets to give you our framework. The way I think about deploying our resources – and when I say resources, probably the most precious resources we have is product and engineering resources. And the way I think about that is we have our core business, we have international expansion, and we have expanding our core business of accommodation. So that's kind of the way we think about our portfolio. And you can imagine they're all totally different horizons. So the majority of our people are still focused on the core business. And I believe that we are just scratching the surface of the size of our core business. Within our core business, we typically have about three different areas of focus. One I just talked about, which is quality and reliability. The next one is affordability, making sure Airbnbs are more affordable hotels. And the third is usability, what I also talked about with search and reducing friction. So that's the first bucket of our investment. And that really will pay off within this year. And so there's – you can get a return on those efforts within a matter of months, because a lot of that – a lot of those changes are software changes. They're immediate. They touch 100% of our user base. And they touch a very large base, our entire GBV. Next is international expansion. International expansion is really supply, demand, and platform. It's all three within international. And you can really bucket into two things. We have to localize the product, and then we have to have a global marketing strategy to go one market at a time. And we've done a lot of really good work over the last few years on international expansion. But I think at this moment, we are ready to step on the gas. And by stepping on the gas, I don't mean it's going to be a significantly greater investment, but a much greater velocity, because we spend a lot of energy updating our products. So most recently, we just – we just updated our application in Asia, specifically in China. And we're bringing a lot of those improvements to Japan and Korea, because the applications work fairly similarly. And so getting these products onto a better standard is a really good first thing that you want to do before you actually step on the gas for marketing. So that's international. And of course, the final thing is expanding the inter-corporate business accommodation. So from dollars and number of people, this is by far the smallest area that we're putting people on now, because it's a small base. But it's actually where I'm spending the majority of my time. And I think the majority of the leadership's time is now being spent focused on transforming the company from an accommodations business to a multi-vertical or multi-category company. And over the next three years, you're going to see this play out quite substantially. So that's the way we think about it, core, international, and then expanding beyond our core."
},
{
"speaker": "Eric Sheridan",
"content": "Great. Thank you."
},
{
"speaker": "Brian Chesky",
"content": "And then I think the other question, sorry, I have to answer the question about how are you, what are we learning about AI and reducing friction? So just a couple of things in AI. First of all, like, we've been using AI for a long time. In the last 12 months, we've made a lot of progress. I'll just give you three examples of things we've done with AI. We've made it easier to host. We have a computer vision model that we trained in 100 million photos, and that allows hosts to, like the AI model, to organize all their photos by room. Why would you want to do this? Because this increases conversion rate when you do this. Number two, we launched last week AI-powered quick replies for hosts. So it basically predicts the right kind of question or answer for a host to pre-generate to provide to guests. And this has been really helpful. And then we've made a really big impact on reducing partisan Airbnb with our reservation screening technology. So now we're going much bigger on generative AI. I think we're going to see, I think we're going to see the biggest impact is going to be on, customer service in the near term. I think more than hotels, probably even more than OTA, Airbnb will benefit from generative AI. And the reason why is just a simple structural reason. We have the most, like, varied inventory. We don't have any SKUs. And we're an incredibly global platform. So it's a very difficult customer service challenge. But imagine an AI agent that can actually, like, read a corpus of a thousand pages of policies and be able to help adjudicate and help a customer service agent help a guest from Germany staying with a host in Japan. It's a very difficult problem and AI can really supplement. Over time, we're going to bring the AI capabilities from customer service to search and to the broader experience. And the end game is to provide basically an AI-powered concierge. So that's where it's going. But it's really focused on customer service at this very moment."
},
{
"speaker": "Operator",
"content": "Your next question will come from the line of Brian Nowak with Morgan Stanley. Please go ahead."
},
{
"speaker": "Brian Nowak",
"content": "Thanks for taking my questions. I have two just to sort of come back to a couple of the topics we talked about. The comp did get easier. So with the comps getting modestly harder in the back half, can you just sort of walk us through maybe micro levels of innovation that can sort of drive stability? Or how do we think about reasonable ranges of outcomes for room-night growth in the second half? And then the second one, you know, Brian, you talked about how like-for-like pricing is more attractive versus hotels. I don't have the transcript exactly yet. But if I look at Marriott and Hilton and their ADRs are up 2% to 3% and your ADRs are also up 2% to 3%, is there something else that you're seeing where the relative pricing is actually becoming more attractive that you can help us understand a little bit more? Thanks."
},
{
"speaker": "Brian Chesky",
"content": "Yes. Why don't I take the second question? And I think, Brian, either you or I cut out. We didn't hear the first part of your question."
},
{
"speaker": "Brian Nowak",
"content": "So do you want to just repeat the first question? Yes. Yes, absolutely. The first question was more for Ellie, where she has – you talked about how you have stable room-night growth now, but I think the comp is a little bit easier from 1Q to 2Q. And with the comps getting a little more difficult in the back half, can you just sort of walk us through some reasonable ranges of outcomes of growth in the back half and maybe micro-level drivers to kind of keep the stability versus drive deceleration?"
},
{
"speaker": "Brian Chesky",
"content": "Ellie, you want to take the first one, and I'll take the second one?"
},
{
"speaker": "Ellie Mertz",
"content": "Yes. So I think you were right in terms of the thinking was that the comparison in Q2 would be a little bit softer. I think what we've seen so far, just to repeat what I said previously, is that, yes, it was clear that there was a hard comp in January. Since then, we've seen, I would just say, a general stability. We are not so far this year seeing the same level of volatility that we saw in 2023 in terms of either movement of lead times or consumer, I would say, hesitancy to book during kind of macro dislocation. So general statement is that, year-to-date, just the trends have been stable, and that's what our Q2 reflects. In terms of the back half of the year, I would say – I don't know if I would characterize the back half of the year as harder comps. I think if you recall, actually, some of the volatility that we and others saw in the back half of the year, there was a bit of a moment of dislocation end of summer heading into October, and in particular, in the month of October related to the conflict breaking out in Israel. So I wouldn't necessarily characterize the back half of the year as being a harder comp. Instead, I think if you think through the growth initiatives that Brian talked about in terms of thinking about where our portfolio of investments lie, I would say we are optimistic that a lot of the core optimizations could have near-term impact as well as the international investments. So those are the places where we're really looking to drive in-year growth above where we are today."
},
{
"speaker": "Brian Chesky",
"content": "And Brian, I'll take the like-for-like question. So specifically, the data we're citing is global like-for-like basis. So what we're comparing is the average price of a global hotel room to a one-bedroom listing on Airbnb in March. And in March, our prices were down 2% and hotel prices were up 3%. So our prices were, again, one-bedroom globally on Airbnb in March was $114, down 2%. Hotels were $148, up 3%. So that's what we're talking about, one-bedroom global. When our ADRs move, obviously the other thing to take into consideration is mix shift. Oftentimes our ADRs do go up because people increasingly, more and more of our travel is group travel. 81% of our trips now have two or more guests and increasingly we're seeing people booking more space, larger homes, just as travel's mixing towards larger groups."
},
{
"speaker": "Brian Nowak",
"content": "That's helpful. Thank you both."
},
{
"speaker": "Ellie Mertz",
"content": "And Brian, that was particularly the case in North America this quarter. On an absolute basis, ADRs were up, but if you exclude the impact of mix, they were flat."
},
{
"speaker": "Brian Nowak",
"content": "Oh, okay. Great. Thank you both."
},
{
"speaker": "Operator",
"content": "Your next question will come from the line of James Lee with Mizuho. Please go ahead."
},
{
"speaker": "James Lee",
"content": "Great. Thanks for taking my question. And just want to follow up the prior question on supply and demand growth. And in other segments of the gig economy services, they seem to benefit when supply exceeding demand. So if you think about, ride sharing and food delivery, because they drive prices down and therefore increasing consumer demand. Should we, think about it in the same path for home accommodation? Are you thinking, expecting maybe a similar trend for your business as well? Thanks."
},
{
"speaker": "Ellie Mertz",
"content": "I would say generally speaking, when we see growth in supply, it is additive to demand. It means that, when people are searching for a particular night in a particular city, if we have more that we can provide them, it is obviously net beneficial. I think I would just, repeat the prior comments that we don't always see kind of in period equivalence by market in terms of the respective growth rates. And that I would say that, there's a primary difference in terms of our business model relative to some of the others that you mentioned in that the frequency of the activity is simply lower and the lead time is also much longer."
},
{
"speaker": "James Lee",
"content": "Great, thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Stephen Ju with UBS. Please go ahead."
},
{
"speaker": "Stephen Ju",
"content": "Okay, thank you so much. So Brian, would we be overreaching if we were to think that Icons is a leading indicator of what should be, I guess, a revitalization or re-imagining of experiences? So, maybe the overnight stay in the [Indiscernible] generates all the media and consumer attention, but maybe this affords you the opportunity to expose the users you're getting to the more everyday experiences. And also secondarily, you've talked about this and the letter talks about this also, the Olympics and the Euro's bump, and there's going to be travelers who are probably not sports fans and who might want to be avoiding Paris and the host cities in Germany altogether. So, is there anything you can share in terms of how additive these two events may be? Thanks."
},
{
"speaker": "Brian Chesky",
"content": "All right, Stephen. Well, that was, you are absolutely not overreaching on Icons. So let me give you a sense. You can think of a company as going through a few phases, especially to start a company. You have an idea, you get product market fit, that's phase one. Phase two is you try to go into hyper growth. We've done that. Phase three, you become a real company, you go public, you generate a return for shareholders. And then the fourth frontier, and very few companies have ever done this, is you reinvent yourself and you go from offering one thing to many things. And a lot of the big tech companies have done this. But one of the companies that I think is a really interesting one to look at is Nike. In the late 70s and early 80s, my recollection, I was born in 81, but my recollection is, I remember, Nike was mostly a running shoe company. And then the 80s, they became more popular with basketball and other things. But at the time, people didn't really think of Nike as a serious basketball shoe. And so they had to not only create a great product for basketball, but they had to actually stretch the brand and open up in people's minds what Nike stands for. And a lot of brands have had to do this. I mean Apple had to do this with the iPod. And I think Airbnb, one of the strengths of our brand also is something that we have to manage which is Airbnb is a noun and a verb. It's synonymous with a category, kind of like Kleenex or Xerox. People say, I'm going to get an Airbnb. I'm going to Airbnb my place. Literally, the name Airbnb has the name B&B in it. So one of the challenges is that people open our app to expect to see stays. And so what we want to do in addition to bringing back experiences, you are totally right, is we wanted to expand Airbnb's brand positioning to include more than just a place to stay. And one of the things you'll notice is when we launched Icons, we said these are extraordinary experiences. We didn't say these are extraordinary stays. We positioned them as experiences. And so you can almost imagine Icons is like we are a car company, but we are starting with a Formula 1 car. And very few people can experience a Formula 1 car, but it captures the magic. It captures the demand. It really expands the brand and increases our permission to be able to go into experiences. And then you kind of move down market. And one of our goals is going to be to bring the magic of Icons to everyone. So I can't probably say too much more about experiences, but absolutely it's not a leap or a stretch whatsoever. Icons is primarily a brand positioning and a brand investment. It obviously wasn't a business. There's only about 4,000 tickets. But we are seeing some really encouraging signs in the last week, a big bump in traffic. It's a lot more top of mind. A lot more people are opening our app. And I just think we are being positioned as more aspirational. And I think people are now starting to think of us for experiences. So I think we've really paved the way for next year. Ellie, do you want to take the Olympics in your own?"
},
{
"speaker": "Ellie Mertz",
"content": "Yes, certainly. So if you look at our history, I would say that special events have always been kind of a good moment for Airbnb to shine and have been overall additive in terms of both our brand perception as well as supply growth. I think what we've seen from prior events, and I'm talking about pre-COVID Olympics, World Cup, Super Bowl, those type of events, what we see is that it should bring a ton of supply onto the platform. And while not all of that supply will persist, a good portion of it does. And so it's a nice supply acquisition moment for us. I would also say it's really additive in terms of signaling to cities how helpful and additive Airbnb can be to those cities to ramp up supply in a very organic and easy way without adding incremental hotel infrastructure that will not be necessarily needed long-term. And I think you see that in particular in Paris right now. We're going to be hugely additive in terms of hosting travelers for the games, whereas the existing infrastructure would not be able to manage such a large inflow."
},
{
"speaker": "Stephen Ju",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question will come from the line of Doug Anmuth with JPMorgan. Please go ahead."
},
{
"speaker": "Unidentified Analyst",
"content": "Hey, this is Dave [ph] on for Doug. Thanks for taking the questions. One for you, Ellie. Can you talk about how you're thinking about the investment levers that provide flexibility and shape your 35% plus EBITDA margin guide for the full year? And can we expect to see these levers get pulled more through the year?"
},
{
"speaker": "Ellie Mertz",
"content": "Yes, so I couldn't hear entirely, but a question about our guide for full year EBITDA margins, a floor of 35%. Let me just talk a little bit. Yes, the investment level."
},
{
"speaker": "Unidentified Analyst",
"content": "Yes, and how you're thinking about investment levers."
},
{
"speaker": "Ellie Mertz",
"content": "Yes, of course. So let me just step back and provide a little bit more color in terms of why the 35%. If you look at our performance since the IPO, pre-IPO, we had a negative 5% EBITDA margin. And behold, three years after the IPO, we delivered nearly 37% EBITDA margins last year. I think we have repeatedly demonstrated the increased strength of this business model in terms of very strong profitability, inclusive of GAAP, net income profitability, as well as free cash flow. And at the same time, where we sit today, we see a huge opportunity in driving incremental growth. And so as we kicked off the year last quarter and looked at our opportunity set, we've identified a handful of areas where we'd like the flexibility to lean in and drive incremental growth beyond what we're seeing today. So where would you see those investment levers on the P&L? It's really two areas. So first, not surprisingly, is marketing. In marketing, we've been very disciplined over the last couple of years. We continue to have a much lower level of marketing intensity than really anyone else in travel. And at the same time, at the margin, we have seen some incremental opportunities to lean in on channels where we're seeing higher ROIs. In Q1, we saw nice, very high ROIs in performance marketing. To the extent that that continues, we would lean in modestly over the course of the year. Additionally, and probably more importantly, Brian talked a little bit about our opportunity set in international markets. And that's also an area where, to the extent that our full funnel marketing investments are working, we would look to top off those investments and to therefore accelerate growth. So marketing is one line item. You will potentially see some margin compression in order to drive growth. The second area, Brian talked about prioritizing our resources and identified that, in many cases, our product development team is our kind of scarcest resource. And I think when you hear us talk about our roadmap, you can obviously infer that we have a very robust list of initiatives that we would like to tackle. And so there's an opportunity to, at the margin, add more personnel over the course of the year to allow us to accelerate that roadmap. And you would see that in particular on the product development line item. So grand scheme of things, no material pivot in terms of our overall financial discipline, but instead a bit of lean into those areas where we believe we can accelerate growth."
},
{
"speaker": "Unidentified Analyst",
"content": "Thank you for the detailed response."
},
{
"speaker": "Operator",
"content": "Your next question will come from the line of Kevin Kopelman with TD Cowen. Please go ahead."
},
{
"speaker": "Kevin Kopelman",
"content": "Great, thanks a lot. I had a question on the May release. You added a couple of small new features to the user profiles, I think on the photos and the travel stamps. Can we see that as a first step towards some of the profile enhancements and community features that you've talked about being interested in in the past and where does kind of building out potentially new community features stand in your priority list? Thanks."
},
{
"speaker": "Brian Chesky",
"content": "Yes, hey Kevin. We spoke in this call mostly about Icons, but I mean, I am equally excited for the results that we've seen for group travel. I'm not going to go through all the metrics, but the metrics have been all really, really positive for group travel features. And in particular, one of the things we've seen is, when people book an Airbnb, the average number of guests is two. So that means that typically for every booking, there's another guest. But typically the other guest hasn't connected their account to Airbnb. So if you travel with a partner or a friend, maybe if you book, the other person doesn't actually have an account or they haven't connected their account. So as we've, and it's strategic for us to get more accounts, that would make sense, right? Especially as you want to sell more things beyond home. We want to have a point of sale for every single person on a trip, not just a point of sale for the booker. So this is really, really critical for us. And what we've seen is a major jump in the number of co-travelers that are now creating accounts in Airbnb and not only creating accounts, but filling out their profile. And so to answer your question, yes, this is the beginning of something much bigger. To probably zoom out, when we started Airbnb, there already were vacation rentals, but they were mostly on classified sites like Craigslist [ph] or there were like paid subscription services like Vrbo. And one of the innovations we brought is we added profiles, payments, two-sided reviews and messaging and those capabilities unlocked really this whole new category. This was what we may call the system of trust. So what we're now doing is we're going to be investing a lot more in increasing our profiles and our profile capabilities, both our account structure, cleaning it up, our identity verification, making, getting more people to complete more robust profiles, increasing their preferences so we have more information about people. And this is so strategic because as trust goes up, more, you can unlock more things for people. And as we know more about you, we can match you better. So, I think in the future, right now, if you think of like the Airbnb solar system, the home is like the sun at the center of the solar system. I think in the future, the profile will be at the center of the solar system of Airbnb and the home will be one of many categories orbiting the profile."
},
{
"speaker": "Kevin Kopelman",
"content": "Great, thanks so much."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Nick Jones with Citizens JMP. Please go ahead."
},
{
"speaker": "Nick Jones",
"content": "Great, thanks for taking the questions. I guess maybe going back to supply and your effort to remove low quality supply. I guess, can you speak to the percentage of the supply that you've removed over time? I think you said 100 to 1,000 that I guess maybe take the removal and I guess the learnings and come back and try to list and provide a kind of a higher quality or better experience. I guess as you continue to remove lower quality supplies, it's becoming a tool to kind of nudge hosts into the behavior you're looking for without actually having to remove them."
},
{
"speaker": "Brian Chesky",
"content": "Yes, I mean, hey Nick, why don't I take the first one? So, the first thing I'll say is the global occupancy on Airbnb is so much lower than hotels. So, even though you type in a certain date and a location, when it's a popular day and location, occupancy can rise at a global level. We are still like, not even close to high occupancy. And so, one of the games we need to do is we want to point them in to the best supply on Airbnb. So, we don't, and so having removed all this supply, we haven't seen a fundamental shift or impact on global bookings because a lot of them either weren't getting as many bookings in the first place, or they were eating up page views, they were lower converting listings, or people were booking them, they were really expensive because they were leading to customer service contacts, which were expensive. And if you went through all that, the revoking rate for them was much lower. Now, as far as the answer to your question about like how many of them come back, I don't have the stats on top of my head. But, I think that like this quality control program, one of the things we've noticed is that a lot of hosts are very coachable and learnable. They're very coachable and they can learn. So I think one of the problems in this category is historically there's these marketplaces have been so hands off that people don't know what it takes to be successful. And as you give them more like metrics, as you give them more incentive to be good, and as you create more boundaries about what's not acceptable in Airbnb, it actually does change behavior and people do come back. So, we're seeing that for sure. And we're seeing that the good people reward and they tend to expand their business. So, I don't have the exact numbers of people that come back, but absolutely, we do think people will come back, if they've remediated some of their issues. And some of what we do too is we'll give warnings to people. So, we don't always have to remove people. We can give warnings first. And warnings are like very, very effective. We're just giving them a heads up. And that actually has a way of increasing the quality of our platform. The last thing I'll just say on this is, we've, what I think makes Airbnb different than our competitors, we have a much more hands-on approach to quality than our competitors. But we are getting more and more hands-on every single year. As we want to get bigger, and we want to capture more of the hotel traveling market, our quality has to go up. And that means that we need to just continue to raise the bar of quality. So, we have a multi-year roadmap where we're going to continue to do so and continue to invest in host education."
},
{
"speaker": "Nick Jones",
"content": "Thanks for the color, Brian."
},
{
"speaker": "Operator",
"content": "Your next question will come from the line of Naved Khan with B. Riley Securities. Please go ahead."
},
{
"speaker": "Naved Khan",
"content": "Yes. Hi. Thanks a lot. Maybe a clarification from Ellie. I think, I heard you say you saw really good ROIs on the performance marketing channels. I wanted to understand better where that came from. And maybe on a related topic, was there any effect from either the rollout of the DMA in Europe in March, or maybe changes to Google search in late March and early April? And then I have a follow-up."
},
{
"speaker": "Ellie Mertz",
"content": "Yes. So, in terms of first, the higher ROIs that we're seeing on marketing, I would say we over the last year have just been frankly very encouraged with the ROIs that we've been able to deliver from that channel. In particular, like what has been driving that? Well, we've been continually testing, improving our performance marketing execution. We have expanded the target audiences. We've expanded our keyword coverage. We've made general improvements to the landing pages. And all of that has been, I would say, quite successful in terms of allowing us to spend marginally more and maintain really great efficiencies. So, really good channel for us, even though it is obviously a minority of our overall marketing spend or strategy. In terms of your second question, impact from the D&A rollout, I would say we haven't seen any meaningful impact. I think primarily that is because the majority, 90% of our traffic is coming to us through direct or unpaid traffic. And so, we have not seen any noticeable impact there yet or at all, I should say."
},
{
"speaker": "Naved Khan",
"content": "Okay. And then, yes, I know it does help. So, maybe just on the changes to the extenuating circumstances policy, I wanted to kind of understand better what kind of led to that change and what kind of impact we can expect from the outside looking in?"
},
{
"speaker": "Ellie Mertz",
"content": "I didn't hear that question. Sorry."
},
{
"speaker": "Naved Khan",
"content": "Sorry, the changes to the extenuating circumstances policy, I think it was tweaked recently to kind of maybe raise the bar on the cancellation."
},
{
"speaker": "Ellie Mertz",
"content": "Extenuating circumstance policy. Brian, do you have any comments on that? I would say we just tried to clarify over time and make that more equitable for our guests and hosts, but no meaningful impact to the business."
},
{
"speaker": "Naved Khan",
"content": "Yes, I agree."
},
{
"speaker": "Operator",
"content": "Your next question will come from the line of Conor Cunningham with Melius Research. Please go ahead."
},
{
"speaker": "Conor Cunningham",
"content": "Hi everyone. Thank you. Just on the under-penetrated international markets, as you develop those, I'm just curious if they're producing the, what you'd expect in terms of key KPIs from, take rate ADR profits, just trying to understand how the mixed changes are going to impact the overall company. And then just one on the 2Q to 3Q re-acceleration. I would assume that the booking window is a little bit more extended this year, given some of the events. Just curious on where you're booked into 3Q right now, just trying to understand the confidence interval there. Thank you."
},
{
"speaker": "Ellie Mertz",
"content": "Yes, sure. So first the question is around economics of our international expansion markets. So if you think about the various factors on our economics, so first there's virtually no change in terms of our underlying take rates by market. So that's not a factor. I would say second, depending on the market that we're targeting, many of these markets will have lower ADRs than our averages. So over time, to the extent that we were incrementally more successful in higher, seeing higher penetration in places like Latin America or Asia Pacific, we would anticipate that the global ADR would come down. And yet all of those nights would be accretive. So it would be market expanding, even if the nights were coming in at a lower ADR. And what we've been able to achieve over time is very strong economics at the booking level for a wide range of ADRs. So it is not a concern for us to be expanding in markets where the average ADRs are lower. It is again, just accretive in terms of the top line and the volume of the business. Your second question is around lead time. I would say generally speaking, as I said previously, our lead times year-to-date have been pretty flat on a year-over-year basis. We did not see a pull forward that maybe some others in the industry mentioned. And yet when we look forward in terms of the backlog for Q3, it's quite strong. And it's that backlog that gives us quite a bit of confidence around the comments we made in the outlook that Q3 revenue should accelerate above the Q2 outlook."
},
{
"speaker": "Conor Cunningham",
"content": "Appreciate it, thank you."
},
{
"speaker": "Operator",
"content": "I will now turn the call back over to Brian Chesky for closing remarks."
},
{
"speaker": "Brian Chesky",
"content": "All right, well, thank you all for joining us today. And I just wanted to say before I wrap up, this was Ellie's first earning call as CFO and the transition has gone incredibly well. Her, Dave and I are really, really focused on this next chapter of growth. So to recap, revenue was $2.1 billion, this is 18% higher than a year ago. Net income and adjusted EBITDA were both Q1 records and our trailing 12 month free cash flow was $4.2 billion, representing a free cash flow margin of 41%. Now we've made a tremendous amount of progress over the past few years. And with the launch of Icons, we're now laying the foundation for our plan to expand beyond our core business. This is just the beginning. Thank you all and we'll see you next quarter."
},
{
"speaker": "Operator",
"content": "That concludes our call for today. We thank you all for joining and you may now disconnect."
},
{
"speaker": "Brian Chesky",
"content": "For business. This is just the beginning. Thank you all and we'll see you next quarter."
}
] |
abt | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good morning and thank you for standing by. Welcome to Abbott’s Fourth Quarter 2024 Earnings Conference Call. All participants will be able to listen only until the question-and-answer portion of this call. [Operator Instructions] This call is being recorded by Abbott. With the exception of any participant’s questions asked during the question-and-answer session, the entire call, including the question-and-answer session, is material copyrighted by Abbott. It cannot be recorded or rebroadcast without Abbott’s express written permission. I would now like to introduce Mr. Mike Comilla, Vice President, Investor Relations."
},
{
"speaker": "Mike Comilla",
"content": "Good morning and thank you for joining us. With me today are Robert Ford, Chairman and Chief Executive Officer; and Phil Boudreau, Executive Vice President, Finance and Chief Financial Officer. Robert and Phil will provide opening remarks. Following their comments, we’ll take your questions. Before we get started, some statements made today may be forward-looking for purposes of the Private Securities Litigation Reform Act of 1995, including the expected financial results for 2025. Abbott cautions that these forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those indicated in the forward-looking statements. Economic, competitive, governmental, technological, and other factors that may affect Abbott’s operations are discussed in Item 1A, Risk Factors, to our annual report on Form 10-K for the year-ended December 31, 2023. Abbott undertakes no obligation to release publicly any revisions to forward-looking statements as a result of subsequent events or developments, except as required by law. On today’s conference call, as in the past, non-GAAP financial measures will be used to help investors understand Abbott’s ongoing business performance. These non-GAAP financial measures are reconciled with the comparable GAAP financial measures in our earnings news release and regulatory filings from today, which are available on our website at abbott.com. Note that Abbott has not provided the related GAAP financial measures on a forward-looking basis, for the non-GAAP financial measures for which the company is providing guidance because the company is unable to predict with reasonable certainty and without unreasonable effort, the timing and impact of certain items, which could significantly impact Abbott's results in accordance with GAAP. Unless otherwise noted, our commentary on sales growth refers to organic sales growth, which is defined in the press release issued earlier today. With that, I will now turn the call over to Robert."
},
{
"speaker": "Robert Ford",
"content": "Thanks, Mike. Good morning, everyone. And thank you for joining us. First, I want to express gratitude to my Abbott colleagues around the world whose hard work and passion with the driving forces of Abbott's continued success. Abbott's commitment to innovation, operational excellence and serving the needs of our customers resulted in another year of exceptional performance, which included achieving sales growth of 9.5% excluded COVID testing, delivering 70 basis points of gross margin profile improvement, driving acceleration in the growth of our earnings per share throughout the year and developing and advancing new products through our rich pipeline. The strong performance resulted in generating $8.5 billion of operating cash flow, which was used to reinvest in the business, fund capacity expansions, repay debt and returned $5 billion to shareholders in the form of dividends and share repurchases. These accomplishments played a key role in continuing our well-established track record for delivering on our financial commitments, which included achieving results that finished at the high end of our initial guidance ranges we provided for 2024. These results included exiting the year with a very strong momentum as fourth quarter sales grew 10%, excluding COVID testing sales, and adjusted earnings per share increased 13% versus the prior year. For 2025, we're well positioned to deliver another year of strong growth. As we announced this morning, we forecast organic sales growth to be in the range of 7.5% to 8.5% and adjusted earnings per share to be in the range of $5.05 to $5.25, which reflects double-digit growth at the midpoint. I'll now summarize our fourth quarter results in more detail before turning the call over to Phil. I'll start with Nutrition. Our sales increased 7% in the quarter. Growth in the quarter was driven by double-digit growth in adult nutrition, led by our market-leading Ensure and Glucerna brands. We achieved a significant milestone last year with annual sales of Ensure surpassing $3 billion. This achievement helped deliver another year of strong performance in adult nutrition, with annual sales of adult nutrition products growing 9% last year. This strong performance is a continuation of a well-established trend, the five year compound annual growth rate in adult nutrition is 9%, which reflects the impact of our well-known and respected brands, favorable demographic trends, the significant investments we've made to expand manufacturing capacity to serve the growing global demand for our products. Moving to Diagnostics, where sales increased 6%, excluded COVID testing sales. Growth in the quarter was led by rapid diagnostics where excluded COVID testing sales increased 16% in the quarter. This was driven by strong demand for our portfolio of respiratory disease tests used to help diagnose influenza, strep throat and RSV. In Core Laboratory Diagnostics, growth of 4% was driven by continued strong demand for our market-leading immunoassay, clinical chemistry, hematology and blood screening testing panels. Excluding the impact of challenging market dynamics in China, the combined growth in all other markets was double digits in the quarter. Turning to EPD, where sales increased 8.5% in the quarter. Growth was well balanced across markets and therapeutic areas that we participate in, including gastroenterology, women's health, CNS and pain management. EPD also delivered broad-based growth across the markets we serve, including double-digit growth in several countries across Latin America, Southeast Asia and the Middle East. By focusing on the therapies most needed in these faster-growing markets, we continue to sustain our long track record of delivering strong growth, which includes a five-year compound annual growth rate for EPD of 8%. And I'll wrap up with Medical Devices, where sales grew 14%. In Diabetes Care, sales of continuous glucose monitors were $1.8 billion in the quarter and grew 23%. For the full year 2024, sales of continuous glucose monitors were approximately $6.5 billion and grew 22%. This included growth of 27% in the U.S. where our market share on a revenue basis has increased by more than 10 share points over the last three years. In electrophysiology, growth of 9% was well balanced across the U.S. and international markets. As expected, growth in the quarter was impacted by a challenging comparison versus the prior year where we saw a sharp increase in demand for our EnSite cardiac mapping systems as customers prepared for the launch of PFA catheters. Excluding the impact of this prior year comparison dynamic, growth would have been double digits globally in the U.S. and internationally. In Structural Heart, growth of 23% was driven by strong performance across our market-leading portfolio of surgical valves, structural interventions and transcatheter repair and replacement products. Structural Heart represents one of the most attractive areas in the field of medical technologies. It is an area that we have invested in heavily, and we're seeing those investments yield outstanding results. Our comprehensive portfolio of products drove an acceleration in sales growth in Structural Heart throughout the year. In Rhythm Management, growth of 7% was led by AVEIR, our innovative leadless pacemaker and Assert, our newest implantable cardiac monitor, which we launched in the U.S. last year. With growth of 7% for the full year, our Rhythm Management business delivered another year of performance that far exceeded the market, and we expect that to continue this year. Last month, we announced that we completed the first-in-human implant of a new version of AVEIR specifically designed to deliver pacing to the left bundle branch area of the heart, activating the heart's natural conduction system. This highly innovative device currently in development was granted breakthrough designation by the FDA. In Heart Failure, growth of 9.5% was driven by our market-leading portfolio of heart-assist devices, which offer treatment for chronic and temporary conditions. In Vascular, growth of 7% was led by double-digit growth in vessel closure products and growth from Esprit are below-the-knee resorbable stent. And lastly, in Neuromodulation, sales grew 8%, driven by strong demand in international markets for our Eterna rechargeable spinal cord stimulation device. So in summary, we delivered another quarter of strong growth, with sales growing 10% and earnings per share growing 13%. For the year, we achieved the upper end of the initial guidance ranges we provided for 2024. We made great progress expanding our gross margin profile, and we expect that progress to continue into 2025. The pipeline continues to provide a steady cadence of new growth opportunities, and we're well positioned to deliver another year of strong growth in 2025. I'll now turn over the call to Phil."
},
{
"speaker": "Phil Boudreau",
"content": "Thanks, Robert. As Mike mentioned earlier, please note that all references to sales growth rates, unless otherwise noted, are on an organic basis. Turning to our fourth quarter results. Sales increased 8.8% on an organic basis and increased 10.1% when excluding COVID testing sales. Foreign exchange had an unfavorable year-over-year impact of 1.4% on fourth quarter sales. During the quarter, we saw the U.S. dollar strengthen against most currencies, which resulted in unfavorable impact on sales compared to exchange rates at the time of our earnings call in October. Regarding other aspects of the P&L, the adjusted gross margin ratio was 56.9% of sales, adjusted R&D was 6.3% of sales, and adjusted SG&A was 26.3% of sales in the fourth quarter. Lastly, our fourth quarter adjusted tax rate was 15%. Turning to our outlook for 2025. Today, we issued guidance for full year adjusted earnings per share of $5.05 to $5.25, which reflects double-digit growth at the midpoint of the range and contemplates an adjusted earnings per share forecast of $1.05 to $1.09 for the first quarter. For the year, we forecast organic sales growth to be in the range of 7.5% to 8.5%. Please note that we are no longer providing separate guidance for the sales growth, excluding COVID testing sales as COVID testing sales represents less than 2% of total company sales in 2024. Based on current rates, we would expect exchange to have an unfavorable impact of around 2.5% on full year reported sales, which includes an expected unfavorable impact of approximately 3.5% on our first quarter reported sales. We expect our full year 2025 adjusted gross margin profile to be around 57% of sales, which reflects an improvement of around 80 basis points versus the prior year. We forecast our full year 2025 adjusted operating margin profile to be in the range of 23.5% to 24% of sales, which reflects an improvement of 150 basis points versus the prior year at the midpoint of range. This improvement is driven by a combination of strong gross margin expansion and operating margin leverage. We forecast our adjusted tax rate to be in the range of 16% to 17%, which reflects an increase compared to last year related to the adoption of the Pillar 2 tax framework. With that, we'll now open the call for questions."
},
{
"speaker": "Operator",
"content": "Thank you. At this time, we will conduct a question-and-answer session. [Operator Instructions] And our first question will come from Robbie Marcus from JPMorgan. Your line is open."
},
{
"speaker": "Robbie Marcus",
"content": "Great. Thanks for taking the question and congrats on a nice quarter and guide. And maybe, Robert, I could start with the 2025 guide, once again guiding to high single-digit organic sales growth, healthy operating margin expansion, and nice to see 10% EPS growth back in the algorithm again. Maybe you could just speak to some of the key growth drivers and how we should think about the different business segments on the top line and some of the components of the operating margin expansion down the P&L? Thanks a lot."
},
{
"speaker": "Robert Ford",
"content": "Sure, Robbie. Yes, it's nice to see kind of the headline print now back to double-digit EPS growth. I think that's probably one of the things that -- it's one of the things you'll see now, Robbie, as we go into 2025. I mean, you've got a lot of growth drivers there. But I think one of the big things is that you don't have the COVID sales decline cloud that's kind of overshadowing all these real strong growth drivers that we got in the business. And you saw that in Q3 as we showed 13% EPS -- sorry, in Q4 as we showed 13% EPS growth. So I think that's one big aspect. It's just not having those sales decline. I mean we've got COVID sales in 2025, but it's, as Phil said in his comments, significantly less from our total revenue perspective. I think it starts with the top line always, Robbie, and the markets that we compete in, they remain attractive. We're seeing acceleration in several of them. I mean we're a very diversified healthcare companies so we get to benefit from all the different dynamics that are going on in healthcare, whether it's increased health and wellness focus from consumers, we get to benefit from that on our Nutrition business. Every treatment requires a diagnostic test, about 70% of them require diagnostic test, so we're seeing continued growth over there. And then we've got two areas where we focus on treatments, whether it's pharmaceuticals or med tech. And so all of those markets, they're accelerating. And then within them, we've got strong product portfolios that are either keeping up with these very high-growth markets, or we're outperforming the market and taking shares. And if you look at the contributions, we've got your current drivers, whether it's Libre, TriClip, Aveir, Navitor, Amulet, all of those products in the cardiovascular space. So the bases are loaded, I would call that. And then you've got a nice on-deck circle and the lineup of Abbott that are coming up right after that, whether it's biosimilars, volt, innovations in the Libre portfolio, some clinical trial readouts. So I think we feel very good about all of the businesses, and you saw all of the businesses improved their growth from Q3 to Q4. So I think it starts with the top line, and I think we're well positioned in them. To your question on the margin drivers, I'd say we've got -- we've done a lot of work on gross margin expansion. We've talked about that committing to a 70-basis-point improvement in 2024. We achieved that. We believe that we can achieve another 80 basis points of improvement in 2025, and that's what's embedded in that guide is continuous improvement on the gross margin in the tune of 80 basis points, will be driven by continued focus on gross margin improvement programs and then mix as some of the higher gross margin products continue to grow ahead of the company average, you get that mix effect. And then down the P&L, I think you've got an opportunity, as we've talked about in the past, to be able to leverage the business and obtain spending leverage across the business. And again, I think that was another challenge we had during COVID or as the COVID was coming down, we really only relied on one lever of margin expansion, which was gross margin equipment. I'd say now you've got two. We actually have two, which is our original formula, gross margin expansion and then spending leverage. So you put all that together, you've got about 16% actually underlying growth in the EPS coming from the top line, the gross margin improvement and the spending leverage. And then we've got, obviously, some friction on FX. I think every company is going to face that as we've seen the strengthening dollar, and increased tax rates, which also aren't a surprise. We've known about that. And so that brings us down to that 10%. So I kind of look at this and say, okay, what you've seen now for 2025 is the Abbott that we know, the Abbott identity that we built, which is high single-digit top line, double-digit bottom line, gross margin improvement, spending, leverage and productivity, strong operating cash flow. We know how to deal with FX. So we deal with it every year, and we're dealing with it again this year and still being able to deliver double-digit EPS. Dealing with a higher tax rate, so I think I saw some notes about calendarization about maybe Q1 not coming in. I could tell you, we looked at our Q1 and all of our gating or EPS is very much aligned to what it was in 2024. It's very much aligned to what it was pre-COVID. So again, all the elements of Abbott and the Abbott identity that we know are there, and we're looking forward to 2025."
},
{
"speaker": "Robbie Marcus",
"content": "Great. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question will come from Larry Biegelsen from Wells Fargo. Your line is open."
},
{
"speaker": "Larry Biegelsen",
"content": "Good morning. Thanks for taking the question. So Robert, I guess you talked about, it starts with the top line. You had another really strong year for CGM with over 20% constant currency growth of $6.5 billion in sales. So I'd love to hear you talk about your expectations for growth in 2025. The status of the Libre 3 supply issues and any color you have on the Lingo launch? Thank you."
},
{
"speaker": "Robert Ford",
"content": "Sure. So let me talk about Libre 3 supply. As we spoke about during the last call, Larry, there was a little bit of a mismatch, but our manufacturing coming up online and the demand that we were seeing, especially here in the US. That caused a little bit of friction there, but as I said, we were in process of getting our new manufacturing site up and running. I was there in November and seen the team and that's going now at full force. So Libre 3 supply with two manufacturing sites up and running and I think you'll start to see throughout the next one or two quarters a change here and a little bit on the NBRxs on the TRxs. I know you guys like to look at those quite often, I guess, those are an important metric to look at it, Larry, but they're not the only metric to see how the businesses are doing. I mean, I think you saw that in our Q4. We're able to grow the US 24%. So there are other elements that aren't measured. I think you also -- you guys also saw the impact of relying exclusively on those data's in Q3 as competitors had challenges also. So it's an important metric to look at, but I would say, it's not the only ones, and I think we've kind of shown that here. So Libre 3 is doing pretty well and it's just going to get better. As I look at 2025, I'd say there are some pretty interesting kind of growth drivers here for us. I'd say, first, as a base case, I still think there's under-penetration in the intensive insulin using segment. I mean, if you look at the US, there's still 25% of that segment that are not on CGMs, and if you think about that international, it's more like 50%. So I still think as a base case to driving all this growth, there's all this opportunity in this segment, but I think there are three areas in 2025 that I believe accelerates that opportunity for us. One of them is obviously basal coverage. And we continue to see with the publication of more clinical evidence, you see more and more markets move towards expanding basal coverage, reimbursement coverage. Now we have a couple of markets where we're the only ones that do have that coverage, whether it's Japan or Canada. These are large markets. So these are great opportunities for us where we've got this head start and we'll keep on driving that. So I think Basel is a big bucket of growth. I think the other area that I talked about as being an area of growth for us is more a kind of share -- ability to take share, and that's through connectivity strategies with insulin delivery systems. We've been talking about all the things that we've been doing with regards to partnership with insulin pump companies. And I think you'll see throughout this year several announcements on connectivity in different geographies, and that's gives us the opportunity to penetrate, albeit a smaller segment, but be able to penetrate that segment and take share. And I think the third area of growth for us of acceleration is just the whole OTC non-diabetes application with the launch of Lingo continue to see very nice trends. We've launched it in a restricted number of U.S. cities, but I think now that we understand what it takes to be able drive adoption with this completely different consumer segment that we'll probably be expanding this and expanding this more nationally here in the U.S. and potentially looking at other areas internationally due to bring this. So I think the Lingo launch is going very well. In several areas, I think, it surpassed some of my expectations, especially regarding reorder rates. And I think those continue, and I think that's going to be another kind of leg of the stool so as to say on growth. So I think those are really the kind of growth drivers that we've got planned for Libre. I think the insulin -- intensive insulin segment is still an opportunity, a pretty significant opportunity. And then you've got these three accelerators on top of that."
},
{
"speaker": "Larry Biegelsen",
"content": "Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Travis Steed from BofA Securities. Your line is open."
},
{
"speaker": "Travis Steed",
"content": "Hey, thanks for taking the question. I wanted to ask about EP growth, so still strong high single digits in the quarter, and I think it was even faster than that, excluding the tough mapping comp. There's a lot of things moving around in that market right now. One competitor had a big setback in DSA and your progress is moving forward with both. So just thinking about how you're thinking about EP growth in 2025 as you bridge the PFA in 2026 and your ability to kind of regain market share once both launches?"
},
{
"speaker": "Robert Ford",
"content": "Sure. Yes, I mean, I think this was not a surprise for us, and it wasn't really driven by any kind of adoption of PFA regarding our Q4 growth rate. In fact, as I've said in previous calls, I think the net effect for us -- net-net effect for us has actually been very positive. What we did have was an execution of that strategy, Travis, where we said, okay, we're going to bridge ourselves, and one of the ways to do that is through our mapping. And that's what really drove our success in 2024 is we did in Q4 of 2023, really taking advantage of our ability to offer the only real open -- truly open mapping system. So that created that comp issue. It was double digits in Q4, 12% in the U.S., 12% internationally. So still seem very good. And I think, again, I would say, these results, I think we outperformed a lot of the expectations that many of you guys had about our EP business. And I think the driver of that has been the team. The team in the field has just been spectacular, I think. And I've been close to them last year and I think what they did was really strong. So, I guess I answered your question in 2025, really looking at what we did in 2024. And I expect to continue to benefit in 2025 from the -- just the general increasing procedure trends. We've got opportunities to grow with some recently launched products, whether it's our GridX, our next-generation mapping catheter, our new Agilis Introducer Sheath, I mean that's a great opportunity for us also. So, yes, it's going to be a little bit more competitive. It's been pretty competitive in 2024. I expect that intensity to increase when it comes to the ablation catheters. But I'm confident that we can maintain a strong position in the mapping segment and everything that comes with all the consumables that come with that. On top of that, our pipeline is very strong. We'll continue to engage KOLs and our customers. We've got an ongoing trial right now with a dual energy source catheter internationally and in the U.S. We've got integration with ICE. We've got kind of new sheets to launch. So, I think the pipeline allows us to continue that interaction with the KOLs and with the users. So, we should expect -- I think you mentioned bridging to PFA in 2026. It's more like 2025 on PFA, at least internationally. So, I feel good about it. And maybe you've got a tail of two halves, where the second half is going to grow faster than the first half as Volt comes on board. But I'd say, for the full year, high single-digits seems like a good place to start, call that our base case. And then to the point that you made about competition and some of the dynamics that have occurred in the last couple of weeks, it's still a little bit too early to tell, but that could be an opportunity for us also. So, I feel good about the business, not only the pipeline, but more importantly, the team that we've got. They're doing an incredible real strong job."
},
{
"speaker": "Travis Steed",
"content": "Great. Thanks a lot."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question will come from Vijay Kumar from Evercore ISI. Your line is open."
},
{
"speaker": "Vijay Kumar",
"content": "Hi Robert. Thanks for taking my question and congrats on a strong finish to the year. I guess I had a two-part question, if you don't mind. Really strong operating margins, driven both by gross margins and operating leverage, but your gross margins are still below pre-pandemic levels. So, I'm curious, when you look at the margins, how sustainable are these trends, perhaps not at triple-digits, but should we be thinking about trend margin framework as gross margins normalize? And my second part is on balance sheet. I'm curious there's been some M&A activity picking up in MedTech. How you're thinking about devices versus diagnostics? I'm curious any thoughts on that cancer screening, MRD, et cetera?"
},
{
"speaker": "Robert Ford",
"content": "I'll let Phil talk to the gross margin and the sustainability of that margin improvement, and then I'll take your balance sheet question."
},
{
"speaker": "Phil Boudreau",
"content": "Yes. Thanks, Robert and Vijay here. On the gross margin front, I think we spoke to this in the last few calls and nothing here has really changed relative to an underlying focus of the business and of the organization, as Robert touched on here. I think the difference in recent years causing that erosion was the significant inflation in commodity prices, which has really resorted back to, I'd call it, normalized inflationary pressures that we're very much accustomed to managing through with our organizations and focus on gross margin expansion. And so what you saw in 2024 was exactly that, the recipe we're accustomed to and the commitment in 2025 to do much of the same. So from expense standpoint, we expect this to continue, and it's not a matter of if, but when we get back to the legacy and historical gross margin profiles."
},
{
"speaker": "Robert Ford",
"content": "Yeah. I guess on your question on balance sheet. I've always talked about this, Vijay. I mean, we do take this kind of balanced approach. I'm not going to give you a formula of how much goes to here, how much goes to their. We do take a balanced approach. And on your M&A question, yeah, there's been an uptake of activity, no doubt. There are some good opportunities out there and whether -- and I don't think you're going to see a change in rate environment, but maybe on the regulatory environment, I think that creates opportunity. I've said that we've got a strong organic pipeline. It allows us to be selective. It allows us to look at opportunities that make sense strategically, but also generate an attractive return. I talked about how ROIC is important for us also. So not just top line, but return on that capital. So we do take a position here of being stewards of that capital. So I'd say, yes, we're in great position. We do have some debt to pay down this year, which we will. I don't anticipate rates coming down to the point that we might want to look at refinancing that. So we'll pay off that debt. It's about $1.5 billion this year. But even with that, we're in a great position with our balance sheet to be able to leverage opportunities that we'll see, talked about them. There's opportunities in med-tech, there's opportunities in diagnostics, and we're in a great position, and it allows us to be selective."
},
{
"speaker": "Vijay Kumar",
"content": "Understood. Thanks guys."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question will come from Josh Jennings from TD Cowen. Your line is open."
},
{
"speaker": "Josh Jennings",
"content": "Hi, good morning. Thanks for taking the questions. I echo Vijay's congrats on a strong finish to the year. Another margin question just because the operating margin guidance for 2025 was some stronger than expected, I think you talked about a lot of the drivers, Robert and Phil, but just a continued positive mix shift from stronger macro device contributions and the strong top line growth. But I was hoping you may just help us think through just the margin expansion opportunities in EPD, Nutrition and Diagnostics. And just with the outsized expansion in 2025, how should we be thinking about sustained open expansion in 2026 and beyond? And then should we be thinking about 50 to 100 basis points a year? I appreciate you taking the question."
},
{
"speaker": "Robert Ford",
"content": "Yeah. I'd like to get to that pre-pandemic gross margin. I mean, I know we talk a lot about this being behind where we were from a pre-pandemic. But our op margin profile, especially after our guidance for 2025 is actually ahead of that. So we've been able to achieve that through our spending and spending efficiencies. But I think that's the right range to have. I mean I think we've always had this notion. I mean, I talked about being able to offset FX and things like that and not provide any surprises. That's part of the algorithm there, which is we're just constantly having to address gross margin. It's not like this initiative either because of inflation or bits of tariffs or anything like that, it's just we're constantly working to improve gross margins. I'd say, on the nutrition side, those gross margins, given what we encountered over the last two years, those came down. But if you look at them, they have been improving sequentially almost like every quarter. We've got a ways to go to get back to where we were in 2022, Josh. That's a little bit more dependent on commodities and freight and distribution, things like that. But I think the teams have got a really good strategy here of kind of working on cost to serve and even, quite frankly, using some pricing where we felt we had to because of some of the increase in those commodities. So I think the Nutrition gross margin is definitely an opportunity that we've got over the next couple of years. The pharmaceutical teams have done an incredible job at maintaining a gross margin under pretty significant FX. I mean they do a fantastic job at offsetting FX. If you look at the margin profile in that business, it's actually increased several -- couple of hundred basis points over the last couple of years. So they've been able to do that also through gross margin. And I think the other element is just ensuring that we keep on driving the med tech business that have accretive gross margins quite frankly, across all of those different business units. And if we can continue to do that, then that's how you get to that model of maybe 50 to 100 basis points every single year. That's our target. We committed to 70, and we deliver to 70, we're now committing to 80 for 2025. And getting us closer to where we were pre pandemic. So I feel good about what we're doing, the strategy we got in place, the discipline that we have as a management team to review these programs and dedicate time. They don't just happen. We got to make decisions. There's oversight. So I feel good about it."
},
{
"speaker": "Josh Jennings",
"content": "Excellent. Thanks, again."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question will come from David Roman from Goldman Sachs. Your line is open."
},
{
"speaker": "David Roman",
"content": "Thank you. Good morning, everybody. I was hoping, Robert, you could go into a little bit more detail on the Structural Heart business. As you kind of break down the pieces that portfolio, you have a balance of drivers, some more legacy like MitraClip and some that are more emerging categories, like TriClip and the tricuspid repair segment. But maybe you could help us think about the evolution of that business, which did very nicely through 2024, and how we should think about that into 2025? And maybe I could just contextualize the broader outlook here, and I appreciate your comments about getting back to the Aveir of high single-digit top line and double-digit bottom line. But it looks like 2025 does carry some headwinds that may prove to be one-time in nature like VBP dynamics in China on the diagnostics side, the transient competition in EP. So maybe you could kind of give us some color on Structural Heart, but also help contextualize the growth rate in 2025, as we think about the long-term as well?"
},
{
"speaker": "Robert Ford",
"content": "Sure. I think it's interesting, like the sixth question comes on Structural Heart after we posted a 23% growth. So thank you, David. As I said in my opening comments, I think this is one of the most attractive areas in med tech. And it's one that we looked at several years ago and said, we're going to build truly a market-leading portfolio of products. And we're not going to just kind of rely on one platform to kind of drive growth, we're really to assemble a full area here and look across the entire area. And even in surgical, I mean I think, I look at our Epic valve, the feedback I keep getting on the surgical side of it is just doing incredibly well and it's really a preferred go-to on the mitral side for surgical repair, but -- replacement. But yeah. I think in the past, David, I think our Structural Heart portfolio was just viewed as MitraClip. And quite frankly, the sales would say, yeah, that's probably the case. But as we've been building out the portfolio, building on our stroke prevention with PFO approval, with Amulet approval and driving growth there, Amulet did very well in Q4 also grew 25%. Getting into the aortic segment, right, and really being a player there that has established now clinical credibility, whether it's through clinical trials, but also actual real-world usage of the product. They've been seeing some of Navitor cases here in the US and just the feedback has been very, very positive. So, building our aortic portfolio there. We're making big investments, whether it's in our clinical trials to build out our indications. We recently talked about -- shared that we are developing a balloon expandable TAVR valve, and we want to have a full aortic portfolio. On the tricuspid side, we were one of the leaders there to say, hey, there's no real good transcatheter opportunity here to treat TR. And TriClip has done very well. It's done extremely well, quite frankly, throughout this year. I think the team has done an incredible job getting approved behind the competitor. I would say right now, our data says that the ratio of repair and replace is about 2:1, and we're leveraging all of that built in kind of infrastructure and scale that we already built with MitraClip. So what you see is a Structural Heart portfolio, $2.5 billion growing, let's call it, mid-teens because it much more diversified and, quite frankly, very competitive products in these high-growth areas. So I think that's going to continue, and we're committed to making these investments. We've got new versions of Amulet launch. We just got an approval for an updated version of TriClip to ease even more of the implant. You're going to see clinical trials read out in this area for label expansion indications in TAVR and in LAA. So this is an area that I think what you're seeing now, that kind of growth rate coming from the investments and just great execution from the team so. What was your -- your question was about growth rate and..."
},
{
"speaker": "David Roman",
"content": "Yes, I was trying to speak a second there was just to contextualize the 25% growth rate given some onetime-ish headwinds like VBP in China Diagnostics and the dynamics in EP being potentially kind of transient as well?"
},
{
"speaker": "Robert Ford",
"content": "Yeah. I mean, listen, every quarter, every year, there's always going to be some headwind. I want to do is here is assemble David, more tailwinds than headwinds, right? But yeah, I mean, you mentioned one, which is a little bit of a headwind for us in our diagnostic business regarding VBP. That's going to be with us in 2025 as they're rolling out new panels of testing that's going to go through that. But outside of that, I'd say, the diagnostics business is doing very well. Q4 growth rates in most areas were actually higher than the full year growth rate in those same areas, US, Latin America, Europe, even Japan was faster in Q4. So yes, we do have a challenge, but most companies are going to do it. And you know what, we've gone through these, David. Every company goes through a VBP, and what we're trying to do is, okay, we're not going to define the company by having this one kind of headwind. We've got a lot more tailwinds to leverage. We still have deal with it. We're still managing it. It's still an important part of the business. But the company is more than just VBP in diagnostics and one important market, but just one market. So I think the growth rate is very robust. I mean, 8% at the midpoint on a base of $40-plus billion, I think is pretty strong and pretty good."
},
{
"speaker": "David Roman",
"content": "Perfect. Thanks for taking the questions."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question will come from Joanne Wuensch from Citi. Your line is open."
},
{
"speaker": "Joanne Wuensch",
"content": "Good morning and thank you for taking the question and nice quarter. I'm curious if you could just sort of step back and talk about the overall health of the MedTech market. I feel like I'm constantly answering questions on things such as volume and price. And looking at you delivering mid-teens revenue growth, and I think you're seeing something that maybe not everybody is seeing, so I'd love to get your view on that? Thank you."
},
{
"speaker": "Robert Ford",
"content": "Sure. I mean, I think it does put us -- I mean, the way our portfolio is structured, Joanne, is that it does give us a little bit of bird's eye view into the entire health care system and the spectrum, right? And I think if you're getting questions on MedTech and MedTech growth, I think all you've got to do is continue to look at what companies are reporting. And what they're reporting is ultimately what we're seeing in the market, which is, it's not a pre-COVID pent-up demand. You are seeing a greater focus from whether consumers or the technologies that are being developed that are attracting more people into these procedures. So I think what we're seeing here is continued utilization growth really driven by whether it's demographics, combined with the innovation. I mean, what the industry is doing in terms of the innovation that we're bringing to the market, it's pretty spectacular and the procedures are getting faster, they're getting less invasive, and that's attracting more people to look at, select these procedures as a real viable first-line option versus guided medical therapy. So I think that's going to continue as long as we continue to see this innovation where we are obviously positioning ourselves pretty strongly in this, and you've seen sequential improvement in the growth rate across quite frankly, a lot of our businesses in MedTech. So I think the utilization is definitely increasing. I think there's maybe some questions, okay, what's going to happen with pricing? We've historically seen some price erosion in the past. I'd say, over the last couple of years, it's actually been pretty stable. So I don't know how that's going to play out. We've got a scenario here where we believe that with our portfolio, we'll see some pretty stable pricing. But I think utilization, combined with stable pricing is what's driving this MedTech growth. And we're seeing it in diagnostics, too. A lot of our diagnostic business is actual hospital-based diagnostics. So, we're seeing those diagnostic tests and those routine diagnostics tests continue to increase, high single, double-digit, low double-digit growth rates in terms of utilization. So, I think that MedTech is benefiting from just this increased utilization and consumers wanting to take care of themselves and looking at these technologies as a viable option for treatment."
},
{
"speaker": "Joanne Wuensch",
"content": "Thank you so much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question will come from Danielle Antalffy from UBS. Your line is open."
},
{
"speaker": "Danielle Antalffy",
"content": "Hey good morning guys. Thanks so much for taking the question and congrats on a really good quarter, strong end to the year. Robert, we've talked in the past, I mean, obviously, we talked a lot about MedTech in the high-growth areas, but some areas where you've excelled or the legacy sort of slower growth businesses, I'm obviously thinking CRM being one of those mid- to high single-digits growth. Can you talk about -- that you find in CRM other legacy businesses. I'm thinking like heart failure, peripheral, and maybe how you're thinking about elevating those growth profiles in 2025, but then also longer term? Thanks so much for taking the question."
},
{
"speaker": "Robert Ford",
"content": "Yes. So, one of our strategies that we looked at a couple of years ago, Danielle, was if you looked at our MedTech business, it was growing like 8%, 9%. And that was a combination of probably like high-growth areas like EP, Structural Heart, Diabetes, even Heart Failure. And 40% of the portfolio was relatively flat and that was mostly our Vascular business and our CRM business. And the way we looked at it is to get our MedTech to be best-in-class, to be able to grow 12%, 13%, 14%, we need to continue the strong growth rate of Structural Heart, EP, Diabetes, et cetera. But we had to find a way to accelerate the growth rate of our Vascular and CRM businesses. And we said, if we can get them, these are historically been flat growth markets. If we can get them to grow 5% the way that would then work out is that we'd be able to elevate our MedTech portfolio to the mid-teens. So, that's what we've been doing over the last couple of years, and the team have been executing on that. I think on the Vascular space, what you've seen us do is kind of used a little bit a combination of organic and inorganic to accelerate and increase our participation in higher growth areas, specifically in the peripheral side. So, -- and I think you started to see that. We've been growing -- this quarter was a good quarter. Our target was around 5% for our Vascular business by having those -- by having stronger pipelines and portfolios in that more Peripheral space. And you're seeing that now start to happen. On the CRM side, our big strategy here was organic and getting to launch a very comprehensive and be the leaders -- sorry, leaders in leadless. So, we launched a single chamber a couple of years ago, launched a dual chamber last year, going to get into conduct and pacing leadless also. And I think that you've seen that over the last two years, our CRM business has grown 7%. And I think we can continue to extend that with the strategy that we're doing, which is to really lead in this area. I actually think that Aveir is probably the most underappreciated opportunities that we have in our portfolio. Look at it right now, you're asking the question towards the end of call, but I think really what you're seeing is these businesses, the focus, the innovation, the execution and now you're seeing those start to deliver on that strategy to bring these flat businesses up to mid -- at least mid-single-digit growth. I think there's the team doesn't like that I characterize them like that. So that's good. I'm glad that they think that they can do better than that. But we've got a lot of opportunity in those big areas, and we think there's innovation to be had in those. So we feel good about it."
},
{
"speaker": "Danielle Antalffy",
"content": "Thank you."
},
{
"speaker": "Mike Comilla",
"content": "Operator, we'll take one more question, please."
},
{
"speaker": "Operator",
"content": "Thank you. And our last question will come from Matt Miksic from Barclays. Your line is open."
},
{
"speaker": "Matt Miksic",
"content": "Hey. Thanks for squeezing me in. Just maybe a follow-up here, given the tech guidance you gave for this year and some of the dynamics in US and overseas or tax policy, It'd be great to get your perspective on maybe the direction of where those things are going. And how we should think about them for having? Thanks so much."
},
{
"speaker": "Phil Boudreau",
"content": "Yeah. Thanks, Matt. There's a lot of narrative at the moment going on. But to your point and to the guide that we referenced in our opening comments here, what we've reflected is all current tax laws and guidance and geographic mix of where our business growth is coming from, which is about a 150-basis-point increase in the midpoint of this guide. That increase in the guide is driven by the increased adoption of the rollout here of Pillar 2 as is currently enacted in countries. And so that's what we reflect. We continue to be a good taxpayer, compliant taxpayer, and we'll see how more of this narrative unfolds here. But currently, we're running the operations and reflecting what's known and as Robert highlighted, absorbing still within the way we run the business."
},
{
"speaker": "Robert Ford",
"content": "Let me -- I want to add in on that one, Matt. I think you'll hear this topic come up quite a bit. And if I just take a bigger picture here. I mean, corporate tax rates tend to get higher politicized and especially during election years, and it's really not a political debate. In the business world, it's just an expense. It's just another form of expense. And in our world, when one expense goes up, you've got to manage and other expenses have got to come down or maybe not increase at the same rate that they were increasing. And I think what you'll find sometimes, you get a small handful of companies that maybe had a really low tax rate and then that viewpoint then gets unfairly applied to every large company, and then you get these predictable narratives of companies have got to pay their fair share, et cetera. The reality is, most companies pay their fair share and then some. I mean, I could talk about Abbott. Our cash taxes are over 20%, and that's one thing that people never talk about is we use these GAAP rates. But what really matters is cash taxes. That's the money that's going to be paid. But more importantly, US companies, companies like Abbott, we play a key role in making the US economy so successful. We're conducting a significant portion of the R&D in the US. We invest billions of dollars in capital projects, which then drive this drop growth. Our CapEx spend has increased over 60% over the last couple of years. We increased our workforce by 20%. And when you increase that workforce, you're investing hundreds of millions of dollars in employee health care and employee benefits. So this Pillar 2 legislation -- this Pillar 2 rule here that got adopted, that's added. And we -- I think this rate that Phil is kind of quote, that's an additional $200 million of expense. That's all it is. It's $200 million of expense that is not going to investing in other areas. And what's even more challenging is of those $200 million, two-thirds of it is actually going to be paid taxes to overseas countries. So that's not really a good policy for the US. And so we're absorbing this. We're managing it. And I think as still said, there are a couple still some new policies or new issues that we have to kind of work on. But I think the overall goal here has got to be to ensure the competitiveness of US companies and US multinationals. And I'm hoping we can get to that during the next 12 months or so. Let me just kind of close then on the call. I think we had a really strong finish to 2024. We exited our Q4 organic sales growth was over 10% and top line, 13% EPS, as I said, finished at the higher end of our range, expanded our gross margin, delivered what we said we were going to do. The pipeline continues to be highly, highly attractive, steady cadence of great new growth opportunities. And I think, to Vijay's question, we've got a balance sheet that's going to provide us a lot of strategic flexibility. So I think we're really well positioned to 2025. So with that, I want to thank you for joining us today."
},
{
"speaker": "Mike Comilla",
"content": "Thank you, operator, and thank you all for your questions. This now concludes Abbott's conference call. A webcast replay of this call will be available after 11 a.m. Central Time today on Abbott's Investor Relations website at abbottinvestor.com. Thank you all for joining us today."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day."
}
] |
abt | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day, and thank you for standing by. Welcome to Abbott's Third Quarter 2024 Earnings Conference Call. All participants will be able to listen only until the question-and-answer portion of this call. [Operator Instructions] This call is being recorded by Abbott. With the exception of any participant's questions asked during the question-and-answer session, the entire call, including the question-and-answer session, is material copyrighted by Abbott. It cannot be recorded or rebroadcast without Abbott's expressed written permission. I would now like to introduce Mr. Mike Comilla, Vice President, Investor Relations."
},
{
"speaker": "Mike Comilla",
"content": "Good morning, and thank you for joining us. With me today are Robert Ford, Chairman and Chief Executive Officer; and Phil Boudreau, Executive Vice President, Finance and Chief Financial Officer. Robert and Phil will provide opening remarks. Following their comments, we'll take your questions. Before we get started, some statements made today may be forward-looking for purposes of the Private Securities Litigation Reform Act of 1995, including the expected financial results for 2024. Abbott cautions that these forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those indicated in the forward-looking statements. Economic, competitive, governmental, technological and other factors that may affect Abbott's operations are discussed in Item 1A, Risk Factors, to our annual report on Form 10-K for the year ended December 31, 2023. Abbott undertakes no obligation to release publicly any revisions to forward-looking statements as a result of subsequent events or developments, except as required by law. On today's conference call, as in the past, non-GAAP financial measures will be used to help investors understand Abbott's ongoing business performance. These non-GAAP financial measures are reconciled with the comparable GAAP financial measures in our earnings news release and regulatory filings from today, which are available on our website at abbott.com. Note that Abbott has not provided the GAAP financial measure for organic sales growth on a forward-looking basis because the Company is unable to predict future changes in foreign exchange rates, which could impact reported sales growth. Unless otherwise noted, our commentary on sales growth refers to organic sales growth, which is defined in the press release issued earlier today. With that, I will now turn the call over to Robert."
},
{
"speaker": "Robert Ford",
"content": "Thanks, Mike. Good morning, everyone. Thank you for joining us. Today, we reported organic sales growth of more than 8%, excluding COVID testing sales and adjusted earnings per share of $1.21. In addition to delivering another quarter of strong financial performance, we accomplished several key objectives this quarter, which included entering new strategic partnerships, launching new products and making several key advancements in our R&D pipeline. And I'll elaborate further on these accomplishments when discussing the performance of our businesses and summarize our third quarter results in more detail before turning the call over to Phil. And I'll start with Nutrition, where sales increased 3.5% in the quarter. Growth in the quarter was led by double-digit growth in the U.S., and this included growth of 12% in U.S. Pediatric Nutrition driven by market share gains in the infant formula business and growth of 11.5% in U.S. Adult Nutrition led by our market-leading Ensure and Glucerna brands. As the market leader in adult nutrition, we continue to expand our portfolio to meet the growing global demand for products that offer a combination of high protein, low sugar to help people optimize their health and wellness. Moving to Diagnostics. Our sales in Core Laboratory Diagnostics increased 4.5% excluding COVID testing sales. Growth in Core Lab was driven by global demand for routine diagnostic testing and continued adoption of our market-leading diagnostic systems and testing platforms, including recent large account wins that will help continue to sustain our growth into 2025. In our rapid and point-of-care diagnostics businesses, we continue to expand our test menus and capitalize on the growing demand for respiratory tests that can be performed at home or in more traditional health care settings. In September, we announced an exciting new partnership with the Big Ten conference to help boost the U.S. blood supply through a blood donation competition. Students, alumni and fans can donate blood for any of the 18 member universities at blood centers located across the country. And our goal with this competition is to help rebuild the nation's blood supply which is currently at an extremely low level, while also helping to create a new generation of blood donors. Turning to EPE, where sales increased 7% in the quarter. Growth was well balanced across the markets and therapeutic areas in which we participate. Our performance this quarter was driven by double-digit growth in several countries across Latin America, Southeast Asia and the Middle East, where our broad product portfolios focused on addressing local market needs continues to enhance our unique position in these markets. From a portfolio perspective, we continue to deliver broad-based growth across our key therapeutic areas of focus, including strong growth in the quarter. in the areas of gastroenterology, cardiometabolic, central nervous system and pain management. We also achieved several milestones this quarter as it relates to advancing our portfolio of biosimilars, which we built and continue to expand through collaboration agreements. The first of these biosimilars is on track to launch in emerging markets in late 2025. And I'll wrap up with our med tech portfolio, where sales grew more than 13%. In Diabetes Care, sales of continuous glucose monitors exceeded $1.6 billion in the quarter and grew 21%. In August, we announced that we had entered into a unique global partnership with Medtronic to connect Abbott's world-leading FreeStyle Libre CGM sensor with their automated insulin delivery systems. Abbott now has partnerships with five of the largest companies that offer automated insulin dosing pumps, allowing more people around the world to benefit from the connectivity with the Libre technology. In September, we announced the U.S. launch of Lingo, our new glucose monitoring sensor available for purchase without a prescription, the Lingo wearable sensor and app track real-time glucose data and provide personal insights in coaching based on your body's reaction to nutrition exercise and other lifestyle choices to help create healthier habits and improve overall well-being. In Electrophysiology, growth of 14% was driven by double-digit growth in both the U.S. and international markets and similar to previous quarters, the growth was broad-based across the portfolio, including double-digit growth in catheters and cardiac mapping related products. We also achieved several important milestones as it relates to our electrophysiology new product pipeline, and this includes completing enrollment ahead of schedule in our VOLT-AF U.S. IDE trial and after we complete the required patient follow-up phase, we expect to file for FDA approval next year. Earlier this month, we announced that we began enrolling patients in our focal FLEX clinical trial designed to assess our new TactiFlex DUO catheter, which offers physicians the option of using PFA and radio frequency energy to treat atrial fibrillation. And finally, we received FDA approval and launched our new adviser HD Grid X mapping catheter, which further enhances the cardiac mapping process when using PFA or RF ablation catheters to treat AFib. In Structural Heart, growth of more than 16% was driven by growth across our market-leading comprehensive portfolio of surgical valves, structural interventions and transcatheter repair and replacement products. This quarter, we continue to capture market share in TAVR and saw accelerating adoption of Amulet and TriClip, which we launched in the U.S. earlier this year. And earlier this month, CMS began the process of evaluating TriClip for a national coverage determination, which, if approved, would help expand the addressable market through broader access in the U.S. for this first of its kind technology. In Ribbon Management, growth of 7% was led by Aveir, our highly innovative leadless pacemaker, and Assert our newest implantable cardiac monitor, which launched in the U.S. last year. In Heart Failure, growth of 14% was driven by our market-leading portfolio of heart assist devices, which offer treatment for chronic and temporary conditions. In Vascular, growth of 5% was led by double-digit growth in vessel closure and coronary imaging, along with Esprit our below-the-knee resorbable stent that launched in the U.S. in the second quarter. And lastly, in Neuromodulation, sales grew 5%, driven by strong demand in international markets for our rechargeable spinal cord stimulation device. So, in summary, we delivered another quarter of strong top line growth with sales growth with sales growing more than 8%. We continue to make good progress expanding our gross margin profile and remain on track to improve our profile by 75 basis points on a full year basis compared to last year. And as you saw, we achieved several important new product pipe loan milestones this quarter, and we're well positioned for a strong finish to the year and have great momentum heading into 2025. And I'll now turn over the call to Phil."
},
{
"speaker": "Phil Boudreau",
"content": "Thanks, Robert. As Mike mentioned earlier, please note that all references to sales growth rates, unless otherwise noted, are on an organic basis. Turning to our third quarter results. Sales increased 7.6% on an organic basis and increased 8.2% when excluding COVID testing sales. Foreign exchange had an unfavorable year-over-year impact of 2.5% on third quarter sales. During the quarter, we saw the U.S. dollar weaken versus several currencies, which resulted in a favorable impact on sales compared to exchange rates at the time of our call in July. Regarding other aspects of the P&L. The adjusted gross margin ratio was 56.3% of sales. Adjusted R&D was 6.5% of sales and adjusted SG&A was 27.2% of sales in the third quarter. Lastly, our third quarter adjusted tax rate was 15%. Turning to our outlook for the fourth quarter. We forecast adjusted earnings per share guidance of $1.31 to $1.37, and based on current rates, we expect exchange to have an unfavorable impact of less than 1% on fourth quarter reported sales. With that, we'll open the call for questions."
},
{
"speaker": "Operator",
"content": "Thank you. At this time, we will conduct the question-and-answer session. [Operator Instructions] And our first question will come from Travis Steed from BofA Securities."
},
{
"speaker": "Travis Steed",
"content": "In Q3 devices were really strong, but Nutrition and Diagnostics came in below expectations, but you still maintain the full year guidance, which is implying a step up of 9.5 or more growth in Q4. So, I just want to understand what happened in those divisions in Q3? And what's giving you the confidence to still reiterate the full year revenue guidance?"
},
{
"speaker": "Robert Ford",
"content": "Sure, Travis. Listen, we got multiple business units here. I think, by my count, it's close to like 17. We always want all 17 to beat and top your estimates here. The reality is sometimes some of them fall short. And then the question is, is there something more long term? Is it more of kind of a onetime kind of challenge? I'd put that more in the second bucket over here. I think one of the benefits that we do have in having a broad diversified portfolio is that when you do have situations like that, Travis, other businesses can overperform and kind of make up for that. And I think that's what you saw in this quarter. I mean, you opened your question with devices did really good, and that's what helped us deliver on our quarter. And as you look forward to Q4, yes, we do have still very high confidence in the businesses, if I was at all concerned about it, I wouldn't have raised our guidance now for the third time this year. So yes, we're still very confident in both the EPS forecast that we've got. I think this is a great quarter now as we're into Q4 and there's less COVID comps, we'll see our EPS grow double digits back to the growth model that we had during pre-COVID. And yes, revenue at that 9.5% to 10% still feel very good about that. The issues that you raised there are kind of onetime in nature. On nutrition, the entire business did really well with the exception of our international pediatric business. U.S. was up 12%; pediatric, U.S. adult was up almost 12%; international adult was up high single digits. So, what ended up happening there is we saw some softness in the beginning of the quarter in some of our international markets for pediatric team quickly determined that it wasn't market. It was actually us and it was our commercial execution or lack thereof that was leading to some share loss. So, team took action pretty quickly in the quarter. We made some personnel changes, we calibrated our demand generation and what ends up happening in the quarter there as a result of that share loss is we didn't want to build excess inventory, so we shorted our sales to the distributors just to align that. But I feel good about what the team has put together. Early indications show that, that was the right move to do, and we've seen good progress there. So yes, disappointed, but the team knows that, and they acted quickly. So, I expect to see international pediatric and overall nutrition growth step up in the quarter. It doesn't change my thinking about nutrition for the quarter or for next year, for the long-term aspect of it, just something that we had to address. And then I think you mentioned Core Lab also came a little bit shorter than expectations. I'd say there, really, the driver of that was just the VBP implementation in China. If you look at our Core Lab business, our International Core Lab business, excluding China, the international business was up double digits. So, the teams in those markets are doing really well. And I'd mentioned this in January, we were going to see the VBP impact the Core Lab business. We had originally forecasted in April, it got delayed and pushed out to Q3. If you look at our growth rate in the first half of this year, it was over 7%. And some of that favorability that we saw in the business and that we rolled into higher guidance as a result of a little bit of that delay here. So, we'll go through the VBP transition. We've done it in a lot of our businesses. There's the pricing impact going forward, there's some transition-related items that happen, whether you're making pricing accommodations for the inventory that's already in the channel, et cetera. So I still feel very good about the business we've got there. I feel good about China continues to be a very attractive market for us. So we'll just work our way through this. But to your question on the quarter, yes, we feel good about the quarter. I wouldn't have kept the guidance if we didn't. We've got great momentum in the business. We're meeting with the management team yesterday. They're very committed and feel good about the momentum. So, I think we'll have a very good year with a good strong close in Q4."
},
{
"speaker": "Operator",
"content": "And our next question will come from Larry Biegelsen from Wells Fargo. Your line is open."
},
{
"speaker": "Larry Biegelsen",
"content": "Robert, I wanted to ask about Libre and just big picture. You had 21% growth in Libre in Q3, which was good, but your competitors obviously having some issues. So, it would be helpful to hear your view of the state of the CGM market, talk about your confidence in the overall CGM market outlook and your goal of $10 billion in sales by 2028. And maybe just give us some color on what you're seeing so far with Lingo?"
},
{
"speaker": "Robert Ford",
"content": "Yes, sure. Larry, I've always been very bullish about this market and talk about this market a little bit differently than when we talk about general med tech markets, right? This is a mass market opportunity that we have. And yes, we grew 21%. U.S. was actually up 26%, and we feel good about the market. The fundamentals are still very much there and they're still very much intact. This is -- you've got about 10 million CGM users globally, I think, right now. And you got over 100 million diabetics in the developed world, over 0.5 billion globally. So yes, I think this is a market that's got mass market potential to it. As long as you stay ahead from a technology perspective, as long as you stay ahead from a scale perspective, as long as you stay ahead from a cost perspective, for me, those are the three elements here that allow us and have guided our strategy from day one. And I don't think that you're going to have some changes in the market when you've got a market that's, whatever, $12 billion, $13 billion, growing 15%. There'll be more players for sure, there'll be more competition for sure. But we feel good about our position and the strategy that we've built. We've thought about this not just for the next year, we've been thinking about this, what is it going to look like a decade from now and how we built our portfolio and our position. So, I feel very good about this market. And I don't think there's anything fundamentally here that's significantly changed, at least from our internal way of thinking about it. So yes, I think this is a great opportunity for us. Libre is -- it will be a $6 billion-plus product. It will grow 20% this year. When we put out the $10 billion target, Larry, we talked about a compound annual growth rate of 15%. So, we're ahead of that, and we're going to work hard to make sure that we stay ahead of that, and we continue to gain share. We'll add $1 billion of revenue this year, add 1 million users. You got opportunities in type 1s on the pump side, on the connectivity side with pens. You've got opportunities with type 2s and basal. I mean I think that's just really still so much opportunity in those markets. So I feel very good about it. And as we've talked about Libre, we always viewed it as a platform. So you mentioned Lingo, glad to see that launch. Just as a reminder, we're really focusing on a very different population with this technology, right? We're targeting people that don't have diabetes. So it's a little bit of a different kind of business model, sale model. But so far, we've seen really, really good early interest. Great, great feedback from the users so far. The app, the data, the website, the Hello Lingo website, the delivery, the whole nonprescription stuff. That's working out very well. The 2 sensor pack is the most popular version right now. And I think that's a good -- it's a great way to start. I was looking at some of the initial reorder rates that came in last night. And wow, was I surprised at really, really much higher reorder rates than what we saw in the U.K., and I thought that I think the team did a really good job at adapting some of the learnings from the U.K. into that. So, I think overall, over time, this is going to be a great opportunity to be able to add to that $10 billion target as we build this user base out. So overall, back to your question on Libre, I feel very good about our position, what we're doing, and Lingo is off to a very good start."
},
{
"speaker": "Operator",
"content": "And our next question will come from Robbie Marcus from JPMorgan. Your line is open."
},
{
"speaker": "Robbie Marcus",
"content": "Congrats on a nice quarter. Robert, I wanted to ask this time of the year, we all -- we're looking for fourth quarter, but we're also turning our focus to 2025. I see The Street sitting at about 7% on the top line, 10% on the bottom line. I wanted to see if you had any comments about how you feel about that or your view into next year, realizing it's still on the early side?"
},
{
"speaker": "Robert Ford",
"content": "Yes. It's a little early to give real specific guidance there, Robbie. But similar to you, we're also looking at '25, we've been looking at '25 also as part of our strategic planning process here, too. So yes, this is the time of the season, right? I'd say, yes, similar to last year, I look at the analyst estimates going into 2025, high single-digit growth, 10% EPS. And like I said last year, that feels like a very reasonable starting point. I think the difference going into 2025 versus when we were coming into 2024 is, as we go into 2025, one of the things that we don't have is what I would call kind of like the COVID cloud at least for a couple of the quarters ahead of us. And that kind of masked a little bit of our underlying kind of base EPS kind of business growth. So, I am looking forward to, in a way, not having that be kind of this kind of comp issue. But I think the high single-digit, 10% EPS, yes, that sounds like a very kind of, I'd say, a reasonable starting point. But if I take a step back also, I look at that and say, okay, here we have a company that's $40 billion in revenue, and we've been driving high single to high single-digit top line growth. I think that's pretty unique for us. And I think one of the reasons that is a combination of two factors. First of all, the markets that we're participating, they're very attractive, Robbie, whether it's their size, their growth outlook, whether their alignment to favorable demographic trends, the positions we have in them, and there's a couple of different types of markets that we're in, right? Markets that are probably a little bit lower from a growth rate perspective, but we've got tremendous scale, tremendous positions in them and that scale and that position disproportionate us and they provide great financial stability to our business. We've got other markets that are very exciting, high-growth markets that our goal there is to enter and capture share, whether it's TAVR or LAA, new diagnostic systems that we'll be launching and then other markets we're building right? And we're building them and creating them with first-of-their-kind types of products, whether it's Lingo that we talked about, TBI testing, leadless, biosimilars in emerging markets, so it's a nice collection of markets that really allow us to set these high single-digit target growth rates for us. And then the other part is pipeline, which is fundamental, right? And I think it's been highly productive. Recently launched products this year are going to contribute about $1 billion of revenue this year, and that's double to what it was in 2023. And I expect that to be the case again next year, right? So, I think it starts at the top line. We've made a lot of effort right now in expanding gross margin and delivering. That was a topic that we talked about last year, expanding margins and gross margin is a key focus of ours. But I also think we've been a pretty proficient allocator of investment. We've invested -- we've done increasing investments in areas that are -- we know are high-growth areas, and we've still been able to generate over $1 billion of spending leverage over the last five years. So, I'd say as we go down the P&L, I think that's another opportunity for us as we go down into 2025 is our discipline in terms of how we make the investments and our focus on gross margin. So, I think the combination of that will allow us to have that op margin expansion. And the balance sheet is in a great year -- sorry, balance sheet is in a great shape here. So, I think we've got all the elements that we need to go into 2025 with great momentum, markets, positions and financial flexibility there."
},
{
"speaker": "Operator",
"content": "Our next question will come from David Roman from Goldman Sachs. Your line is open."
},
{
"speaker": "David Roman",
"content": "Robert, maybe if I could push a little bit more on the investment spending and help us think a little bit about the shape of the P&L on a go-forward basis. During the quarter, you did accelerate R&D and SG&A spending on a year-over-year growth basis. And maybe you could help us think through where are some of those incremental dollars going? How should we think about the trajectory of operating expenses in the context of gross margin expansion? And then with the announced share repurchase program, should we think about that as an effort to keep the share count flat or a view that this is an opportunity to return incremental capital to shareholders and reduce the share count?"
},
{
"speaker": "Robert Ford",
"content": "Sure. Yes, I guess, on the investment side, if you look at what we've done with our expenses here, they've gone from 37% in 2019, down to about 34% this year. So that's where that $1 billion of spending leverage comes, right? If you look at our five-year CAGR, it's high single digits and our operating expense CAGR is about 4%. But it's not a cookie-cutter approach, David. We look at the businesses and look at their opportunities and make those decisions. R&D investments, they're a little bit more-longer term, right? So, once you commit to R&D programs, they tend to be a little bit more-longer term than making some SG&A decisions, where you could toggle up and down a little bit easier. But I mean, I think you could see where some of the growth is coming from, and that's being supported by those investments. Obviously, our med tech portfolio has been getting investments, I'd say, in EP, in structural heart, in diabetes care, in neuromodulation. I mean, all of the businesses, they come with a strategic plan and we look at where it makes more sense, whether it's to put more, more investment in the field with sales force and clinical people, whether it's to make the investment in a clinical trial, so we tend to have a pretty good process about how to do that. We've been making investments in diagnostics, soon we'll probably be talking about a new system that we're going to be launching for a whole new segment of the diagnostic industry. That's a longer-term program that's been a couple of years. So I think we've got a good process about how to make the investments knowing that R&D investments are a little bit more longer than SG&A. So -- and I think that's what we've been able to show. And I think that's one of the reasons we've been able to get to our op margin profile to pre-pandemic levels, which I'm not sure a lot of companies would be able to kind of say that. So -- but we haven't driven our op margin by expenses. I mean we've been driving our top line pretty effectively, too. So I think that's probably the best proof point that we know how to do this allocation and the cycles of the allocation, et cetera. And then I think you had a question regarding share count and buybacks. Listen, we -- as I've said, we've got a pretty balanced approach about how we allocate our capital. I've talked about the importance of the dividend and supporting that growing dividend and we'll continue to do that. The buybacks is just another element in that capital allocation strategy. We just announced that the Board recently approved a new $7 billion buyback program. The previous one that we had approved in 2021 was running down, and we thought it was a good time to put that in place. We've deployed around $8 billion towards buyback over the last five years. We took a little bit of a step up during a couple of years after the acquisitions that we did, we'd stepped that down a little bit. So we've stepped that up. Q3, we did about $750 million. I thought given our strong performance outlook here that we saw a disconnect between what we were doing in our PE ratio, and in fact, I still do. So it made sense to buy shares, and the buyback announcement is just part of our balanced approach to allocating capital, and we've got that authorization set. So if we feel that there is a disconnect going forward, we've got that opportunity to try and correct that. So -- and if that reduces the share count, yes, then it will reduce the share count. But we're not trying to drive our EPS through a lower share count. We're trying to drive our EPS through top line growth, David."
},
{
"speaker": "Operator",
"content": "Our next question will come from Joshua Jennings from TD Cowen. Your line is open."
},
{
"speaker": "Joshua Jennings",
"content": "Robert, I wanted to ask about just structural heart markets. The TAVR market slowing down or decelerating, there's been some investor concerns about U.S. provider capacity and whether there's a bottleneck. I think Abbott is uniquely positioned because you do have offerings in transcatheter aortic, mitral and tricuspid solutions and left atrial appendage occlusion. We've got interventional heart failure interventions coming down the pike. Are you seeing any capacity constraints limiting growth? You had a strong structural heart quarter this in 3Q? Or are you concerned about that? Is that on the horizon or should we just think that hospitals are seeing this growth opportunity as well and building out capacity, adding cath labs, hybrid ORs, et cetera? I'd love to get your view on the current situation and whether you're worried in the next 12, 24, 36 months that we could run into a bottleneck in the U.S.?"
},
{
"speaker": "Robert Ford",
"content": "Not seeing the bottleneck, not forecasting bottleneck, not concerned about the capacity here. Obviously, this is a this is a very growing area not only for those that are developing the technologies, but also for the health care systems that are delivering them and deploying them. I've been to some large centers over the quarter. I've been through some smaller centers over the quarter. There's always challenges, but I put it as a challenge, not specific to a given technology or challenges just whether it's ramping up a new technology, getting more people to train. So -- but I'm not hearing that the centers that we've been working with that capacity is a big rate-limiting factor today. I think if it started to become one and the demand is there, I think history has shown that make the right investments, the investments will be made to accommodate that demand. So -- I mean, this is obviously what's happened in structural heart over the last decade, investments will be made to accommodate that demand. So I'm not hearing that, and we continue to be very excited about the prospects that we had in our structural heart portfolio. I think the team has kind of hit its stride right now. We've got new management, new products launching and I'm very optimistic right now with what the teams are putting together across the entire portfolio. I think like you said, we're one of the few companies here that we can see the full spectrum, right, from -- all the way from surgical, structural interventions, all the occlusion and appendages and then looking at being able to see mitral, tricuspid, aortic, whether it's repair, whether it's replacement, I think the team is hitting its stride right now. And our focus here is going to be on both sides, making the investments on the R&D side. I think we've got a lot of new product investment in structural heart, new clinical trials, new indications, investments over there. And I think the different part of our investment profile, and we've been doing that for many years in mitral -- in structural heart, and I think that's why we have the portfolio we have. I think the piece that we're adding on now is like, okay, we've got the products, now we've got to increase our field presence to support either the market share gain that we aspire to or to support these growing new fields, whether it's tricuspid. So, our focus now is really to start to add more on the field side in these businesses to be able to kind of support that growth. But no, I think this is a tremendous area of growth of opportunity of underpenetration, of R&D, of clinical work. So, we're really excited about it."
},
{
"speaker": "Operator",
"content": "Our next question will come from Vijay Kumar from Evercore ISI. Your line is open."
},
{
"speaker": "Vijay Kumar",
"content": "I had one on, I guess, NEC infant formula. The FDA, CDC and NIH have put out a joint statement. It's a pretty strong statement saying noting that there's perhaps no causative relationship between infant formula and NEC. So, I guess my question is, how does this change Abbott's position in these lawsuits? Does it matter? What else can we expect from the government? Could we expect more announcements similar to this? What shape or form could it be? What can Abbott to do to perhaps ring-fence liabilities related to these cases?"
},
{
"speaker": "Robert Ford",
"content": "Yes, sure. Well, listen, as it relates to our position, it's great to see the statement, and I agree with you, I think it was a very strong statement. It doesn't change what I have been saying, which is and the statement seems to be aligned and support what I hear from the market and what I hear from neonatologists, which is these products are they're medically necessary, they are considered the standard of care, and they're valuable tools. They're valuable tools for the neonatologists in their decisions, in their decisions and their discussions with parents and how to feed premature. And the labels, which is a component in all of this, they've been reviewed by the regulators and never call for net warning. So -- this is a consensus statement made by these three agencies, three regulators here in the U.S. and they're basically -- Vijay, they're actually endorsing an expert panel with dozens of researchers that were conveyed by the secretary of HHS, and I think the researchers issued a 100-page document-or-so. I think they looked at thousands of publications. I think it was 600-specific to the relationship between NEC and feeding. And in that joint statement, the agencies, they reiterated the importance of preterm formula as the standard of care. And they also clearly state there's no conclusive evidence that the formula causes NEC. So, I think this is only one of a handful of times where the three agencies, the most prominent and significant health agencies and regulators in the U.S. have come together and put out a joint statement. Obviously, we saw that during the COVID pandemic. But I think before that, I think it was during the HIV pandemic. So I think the statement says a lot, Vijay. At this point, though, at this point, the judge in our trial right now has not allowed the joint statement or the underlying report to be entered into evidence. I don't know the reasons there, but I think it would be -- we believe that it's the joint statement, the report, the expert testimony, I think those are important pieces of information for a jury to consider as they're making their decisions. So, I don't know how to cap that, but I would say beyond this case and as the cases move to more of the federal side, my expectation here is that the juries in these cases would be allowed to consider the criticality of that important evidence. So, to your question on the liability portion and kind of what to do? If I take a step back on this one, I've been thinking about this quite a bit. But as health care innovators, we develop health care products based on problems that we see. We run the clinical trials. We gather the data. We review the data with the regulators. You guys know this process pretty well. And ultimately, the regulator decides if the products are safe and they're fit for purpose and they decide how they got to be labeled. And that's the country, that's the market that I want to be in, where the products, the labels, they're evaluated through a well-established regulatory process by expert regulators that have unfettered access to the best scientific evidence rather than trying to do this, regulate products through uncertainty and unpredictive jury trials. So ultimately, to your question, if the regulatory process is disregarded, if the science is disregarded, it's going to be very difficult for any company to remain on the market with these products. Taking on that indefinite liability here, at least in the United States, that would be an issue that the United States would confront. It wouldn't be an issue for premature babies in international countries because this issue -- this is not an issue and the products are still available there. So yes, I do think there needs to be some fortitude here by those that can make decisions, prioritize the babies, prioritize preterm babies all 370,000 every single year that rely on these products. Over those that seem to kind of distort and abuse this tort system that we have in our country here for financial gains. I'm hoping it doesn't come to that. But I've been pretty clear that this is -- we stand behind the products, but if the process won't be -- is going to be disregarded then this is something that we will not continue adding to the liability here. So, there's a playbook it seems for these things to happen. You take a decade, 10-plus years to litigate this and come to some resolution. I don't intend to follow that playbook. And I intend to resolve this faster. And yes, there are different ways to resolve this and different ways to look at this. And we are having conversations at all levels to be able to express the concern that this could cause to families here in the United States."
},
{
"speaker": "Operator",
"content": "Our next question will come from Joanne Wuensch from Citi. Your line is open."
},
{
"speaker": "Joanne Wuensch",
"content": "Congratulations on earlier-than-expected completion of enrollment in your PFA catheter clinical trial. But I would really love to get your view on the state of the electrophysiology market. What you're seeing in terms of PFA uptake and how that is impacting your mapping and navigation systems?"
},
{
"speaker": "Robert Ford",
"content": "Sure, Joanne. I mean I think this quarter was a continuation of the trend that we've been seeing since the arrival of PFA. We're growing a little bit lower than the market. The market has kind of grown pretty significantly here. But if you look at our growth rate, prior to PFA, we're actually growing faster now with PFA. And I think there's a couple of factors there. I think you mentioned one of those, which is cardiac mapping. Right now, we're seeing about 90-plus percent of the cases, at least here in the U.S., being masked. If you look at where we were before, Joanne, we were mapping about maybe between 25% and 30% of RF cases, we're now mapping 50-plus. So that is a little bit of a tailwind for us. We're seeing a pretty strong growth in procedures. So -- and I think that's probably what's helped drive some of the market growth that we're seeing. But I also think that the volume increase is actually due to improved treatment guidelines that we're seeing and quite frankly, new technologies that are helping to identify AFib patients, too. So, I think it's a combination of factors there that are helping to drive more producers. And then for us, the RF portion of it is still a growth piece for us. As I said in my comments, we grew ablation catheters double digits, too. So, we're seeing about 20% of the PFA cases, at least the ones that we're mapping, use RF catheters and we're in those cases. So, I think the key thing here is just to at least right now, PFA is really being used for de novo procedures, right? So, if you kind of break that out, it's about of all ablation procedures are de novo. The other two-thiirds are VT ablation, SVT ablation, redos. And in those cases, they're using -- we're still using RF and RF plays an important role there, which is why we've initiated our focal FLEX trial to be able to have the optionality, to be able to toggle between PFA and RF. So, we still think that's an important part there. So -- but I think the team has done a really good job here at leveraging our open mapping system I made comments, we used the open mapping system as a design input for R&D programs to start off with. And now that open system is allowing us to be in more cases and partner more with the electrophysiologists. So I think that is -- that's what we're seeing, and we're very committed to be able to bring PFA to the market. We've completed the enrollment, like you said. And we completed the CE Mark enrollment beginning of this year. So we're committed to the space, but we do feel that it's a full portfolio approach. You need good mapping which is why we invested in our next-generation HD grid. You need to have a PFA portfolio that's pretty complete. You need to have RF, and I think that's what the team has been building, I'd say, very, very successfully."
},
{
"speaker": "Operator",
"content": "Our next question will come from Matt Miksic from Barclays. Your line is open."
},
{
"speaker": "Matt Miksic",
"content": "I'd a follow-up on Libre in the diabetes business. And just a couple of topics that come up quite a bit, the last few months around the market and competition. The first being kind of anything you can comment on regarding your share trends, in particular, in the DME channel, anything you're doing there differently, did differently, what you're seeing as a user of Lingo for the last couple of months, I complemented the team on putting together a great product. Question, just curious about the timing and the plan for Rio and thoughts on potential reimbursement for that certain non-insulin intensive type 2 community. And then lastly, just zooming out for a sec and getting back to your comments and plans for gross margin, how -- if you could to scale the expansion into OTC of Libre in this platform kind of plays a role in hitting your '24 gross margin plans and your plans for expansion going forward as you scale this business?"
},
{
"speaker": "Robert Ford",
"content": "You lined up a lot there, Matt. I'm going to make sure that Mike here helps me stay with all the questions that you laid out there. I mean I think regarding your Libre question on competitiveness, yes, I think the team has done a really good job here in the U.S., not just in the DME channel but at the endo's offices, at the primary care channel, with the basal population. I think it's kind of an all-out all-channel, real strong execution there. U.S., we grew 26% in the U.S. this quarter. And that was having some of the challenges we had there regarding some kind of temporary supply challenges with Libre 3. So, we haven't really unleashed Libre 3 fully yet, and a lot of the share gains that we're getting are with Libre 2. But that piece is behind us. We invested in a new manufacturing line. We have a new manufacturing, a whole brand-new manufacturing facility come up and towards the end of the year. So that will -- as we go into next year, that will all be kind of behind us. So, I think our position here in the U.S. and globally, quite frankly, is strengthened by the product portfolio, the cost position that we had. You're mentioning gross margins in Libre. That's a key aspect here. We've always talked about. You got to have cost leadership here because as the market expands to basal and oral meds, GLP-1 users. And as that population grows, you're going to have a much larger TAM to operate in. But yes, you are going to see -- you're going to have to make some pricing adjustments to be able to get that reimbursement, so you got to have your cost structure in place to be able to benefit, have the top line growth and not have that come at the expense of gross margin. And our gross margins, as we've grown Libre, have actually expanded. As our manufacturing scale continues to ramp up, some of the costs associated with these products, because there's a lot of automation, we've been doing this from day one, some of the costs are depreciation in the equipment. So as a lot of our facilities are running through their depreciation schedules, those will help our gross margins, too. So I feel good about our opportunity to drive the market, to be competitive, to lead in technology, to lead in scale and cost and take advantage of what we believe is a mass market opportunity for us. I think you had a question on Rio. Listen, the initial focus is on Lingo right now. We've got that -- think of Rio as another arrow here in the quiver that we can pull out if we need to ahead of schedule. We do have a schedule. I'm not going to lay out what that schedule is, but for some reason we need to do that, we'll be able to do that. But the focus is on Lingo right now, and we've got a nice opportunity here to build a completely new segment of biowearables with consumers. So..."
},
{
"speaker": "Operator",
"content": "And our last question will come from Danielle Antalffy from UBS. Your line is open."
},
{
"speaker": "Danielle Antalffy",
"content": "Congrats on a really good quarter here. I just wanted to follow up on the structural heart component of the business. Robert, you talked about this earlier in response to Josh's question. But just digging a little bit deeper, as we look into 2025, I mean, you've got potential indication expansion for LAA closure, but you do have some competitive data coming on the tricuspid side of things at TCP and whether or not that chose a mortality benefit. So just curious about how you think about those two markets specifically and sustainable growth in those franchises, there are some puts and takes there. So, I just wanted to get your sense of how to think about that as we head into next year?"
},
{
"speaker": "Robert Ford",
"content": "Sure. Just to remind me again there, Danielle, tricuspid and what was the other one?"
},
{
"speaker": "Danielle Antalffy",
"content": "Sorry, left aerial appendage closure..."
},
{
"speaker": "Robert Ford",
"content": "Yes. Okay. Good. Yes, these are great areas of investment for us. And the investment of money, time, effort, thinking, power, all of that. So, I think, as I said on business hitting its stride, I definitely would say that about the Amulet team. They're definitely hitting their stride. We saw nice growth this quarter, 25% globally, 40% growth in the U.S. here. So -- and we're making the investments. I mean, I think you saw our registry data shows a really good positive results from Amulet, 95% of the closure rates achieved and sustained after 45 days, I think that's pretty good. 90% closure rate when using Amulet for those that have failed proper closure with the competitor product. So -- but we're investing in there. We've got our CATALYST trial that's looking at comparing Amulet to anticoagulants for people that have a risk of AFib, expect to complete that trial next year. And then the team has been working on Amulet 2.0. And I expect that we will be beginning or entering the trial in that business with that product towards the end of this year. So really nice progress on the appendage side, whether -- and quite frankly, PFO, too, is doing really well, and that's a great growth driver for us, too. On the tricuspid side, yes, there's going to be a lot of data coming out over the next 12, 24 months. I expect that. I think with any new category here, Danielle, you're going to have to make the investments. I mean nobody was doing anything from an interventional perspective on the tricuspid, right? So as companies are developing technologies, I think you are going to see a lot of clinical readouts and clinical data more to be able to kind of support the use of these technologies. I think we saw one recently at ESC specifically to TriClip, a European study, and this is the second RCT that's basically confirming what the TRILUMINATE RCTs showed, which is much superior to medical therapy and extremely effective at reducing TR. So, I think that's an area of investment for us. Without a doubt, I think that there's an opportunity here that the team's been working on regarding our full portfolio approach with our structural products, and I think TriClip plays an important role there. We're excited about the NCD that was opened and looking forward to that, so that's another opportunity for us in 2025. But quite frankly, I just think there's a great opportunity here with our team. We've got, I would say, some built-in advantages as it comes to the TriClip product. We've got manufacturing scale, the sales force and all of that. And there's definitely demand and we're seeing that and the launch is going very well. So, I think that, yes, you're going to see more data, and that's good, and it's a growth opportunity for us. I think this is a $1 billion business for us here over time. But you're going to have to make the investments on the clinical side to be able to kind of support the adoption of it. So very excited about structural heart overall. And ultimately excited about the entire company and business. We've had -- yes, I'm really pleased with the performance of the first three quarters. We're on track to finish the year at the high end of the initial guidance that we provided back in January. Sales growth has been strong. Gross margin profile continues to expand. EPS growth is now accelerating throughout the year as we were lapping some of those COVID comps. The pipeline is richer than ever. So, I think we've got great momentum heading into next year. And with that, I'm going to wrap up and thank all of you for joining us."
},
{
"speaker": "Mike Comilla",
"content": "Thank you, operator, and thank you all for your questions. This now concludes Abbott's conference call. A webcast replay of this call will be available after 11 a.m. Central Time today on Abbott's Investor Relations website at abbottinvestor.com. Thank you for joining us today."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day."
}
] |
abt | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning and thank you for standing by. Welcome to Abbott’s second quarter 2024 earnings conference call. All participants will be able to listen only until the question and answer portion of this call. During the question and answer session, you will be able to ask your question by pressing the star-one-one keys on your touchtone phone. This call is being recorded by Abbott. With the exception of any participants’ questions asked during the question and answer session, the entire call including the question and answer session is material copyrighted by Abbott. It cannot be recorded or rebroadcast with Abbott’s express written permission. I would now like to introduce Mr. Mike Comilla, Vice President, Investor Relations."
},
{
"speaker": "Mike Comilla",
"content": "Good morning and thank you for joining us. With me today are Robert Ford, Chairman and Chief Executive Officer, and Phil Boudreau, Executive Vice President, Finance and Chief Financial Officer. Robert and Phil will provide opening remarks. Following their comments, we’ll take your questions. Before we get started, some statements made today may be forward-looking for purposes of the Private Securities Litigation Reform Act of 1995, including the expected financial results for 2024. Abbott cautions that these forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those indicated in the forward-looking statements. Economic, competitive, governmental, technological, and other factors that may affect Abbott’s operations are discussed in Item Ia, Risk Factors to our annual report on Form 10-K for the year ended December 31, 2023. Abbott undertakes no obligation to release publicly any revisions to forward-looking statements as a result of subsequent events or developments, except as required by law. On today’s conference call, as in the past, non-GAAP financial measures will be used to help investors understand Abbott’s ongoing business performance. These non-GAAP financial measures are reconciled with comparable GAAP financial measures in our earnings news release and regulatory filings from today, which are available on our website at abbott.com. Note that Abbott has not provided the GAAP financial measure for organic sales growth on a forward-looking basis because the company is unable to predict future changes in foreign exchange rate, which could impact reported sales growth. Unless otherwise noted, our commentary on sales growth refers to organic sales growth, which is defined in the press release issued earlier today. With that, I will now turn the call over to Robert."
},
{
"speaker": "Robert Ford",
"content": "Thanks Mike. Good morning everyone and thank you for joining us. Today we reported organic sales growth of more than 9%, excluding COVID testing sales. We also reported adjusted earnings per share of $1.14, which exceeded analyst consensus estimates and represents a 16% sequential increase from the first quarter. Based on our performance in the quarter and confidence in our outlook for the remainder of the year, we raised our guidance and now forecast full year organic sales growth, excluding COVID testing sales, to be 9.5% to 10% and adjusted earnings per share in a range of $4.61 to $4.71. Our performance continues to be driven by broad-based growth across the portfolio with growth this quarter led by double-digit growth in medical devices and high single-digit growth in established pharmaceuticals and nutrition. In addition to benefiting from outperforming expectations on the top line, we are also seeing positive contribution from gross margin expansion coming from continued execution from our supply chain teams, lower commodity costs, and favorable sales mix. I’ll now summarize our second quarter results in more detail before turning the call over to Phil, and I’ll start with nutrition, where sales increased 7.5% in the quarter. Strong quarter in the quarter was led by double-digit growth in international adult nutrition and U.S. pediatric nutrition. International adult nutrition continues to perform at a very high level. The five-year compound annual growth rate of this business is more than 10%, which in addition to our market-leading position and commercial execution reflects the impact from positive demographic trends that drive increasing demand for our Ensure and Glucerna brands. Through the investments we’ve made to expand capacity, we are well positioned to continue to capitalize on these secular demand trends. On the topic of litigation, regarding pre-term infant formula and human milk fortifier, Abbott stands by our products and the information provided to the neonatologist specialists who have used them for decades. Necrotizing enterocolitis, or NEC, is a terrible gastrointestinal disease that primarily affects premature infants, and it is devastating to families; however, plaintiff lawyers are advancing a theory that is without merit or scientific support. These products, which are sold for hospital use, are incorporated into a feeding regimen along with human milk by experienced specialists and are an important part of the standard of care for the majority of preterm infants. Their use is supported by medical associations in the United States and other countries around the world. The products and their ingredients have been reviewed and are deemed safe for use by regulators, who have also reviewed their labels. There has been no increase in the rate of NEC, meaning these cases have not emerged in response to a trend or any new information, yet we’re seeing plaintiffs’ lawyers investing millions of dollars in misleading TV advertising in an attempt to move physician decisions from the hospital to the courtroom. Total revenues for these products are about $9 million annually, and have remained at that level for the past several years. If these products were no longer available, physicians would be deprived of the vital food that is needed in the NICU. This would create a public health crisis affecting every state across this country. We believe it’s important for all who have an interest in health of preterm infants, who recognize the need for these products and to take action accordingly. Moving to diagnostics, where sales increased 6% excluding COVID testing sales, growth in the quarter was driven by high single-digit growth in core laboratory diagnostics and double-digit growth in point-of-care diagnostics. In core lab diagnostics, we continued to drive growth through increased adoption and utilization of our market-leading systems and global demand for our extensive testing menus across the areas of immunoassay, clinical chemistry, hematology, and blood screening. While our Alinity family of diagnostic systems first launched more than six years ago, given the long contract cycles common in the diagnostics industry, we continued to see a benefit in our contract renewal and competitive win rates with several recent large account wins expected to increasingly contribute to growth in the second half of the year. Turning to EPD, where sales increased 8% in the quarter, EPD continues to deliver at a high level as this business executes its unique branded generic strategy in emerging markets, where growth is supported by favorable demographic trends, including increasing populations, growing middle classes, and increasing focus on expanding access to healthcare. As you recall, we identified biosimilars as a new strategic growth pillar for this business. With our extensive presence in emerging markets, we have a unique opportunity to scale a licensing model that is capital efficient and can bring access to these life-changing medicines to millions of people in emerging markets. We began implementing this strategy last year when we announced an agreement to commercialize several biosimilars in the areas of oncology and women’s health, with the first of these expected to launch in 2025. We recently completed additional agreements that provide Abbott access to biosimilar versions of market-leading autoimmune disease and GLP1 medications. Biosimilars represent the highest growth segment in the branded generic pharmaceutical market, and we look forward to continuing to build one of the most complete portfolios in the industry. I’ll wrap up with medical devices, where sales grew 12%, in diabetes care, Freestyle Libre sales were $1.6 billion in the quarter and grew 20%. We announced in June that we received FDA approval for two new over-the-counter continuous glucose monitoring systems called Lingo and Libre Rio, which are based on Libre’s glucose technology that is now used by more than 6 million people around the world. While over-the-counter availability is a new option in the United States, we’ve been selling over-the-counter in international markets since Libre launched 10 years ago. Given our clear leadership position in these markets, we have demonstrated our ability to tailor solutions, approach and communication for the various types of users who compose the CGM customer base. Lingo is designed for consumers who are willing to improve their overall health and wellness. The Lingo wearable sensor and app will track glucose, provide personalized data, insights and coaching to help create and maintain healthy habits. Libre Rio is designed for adults with Type 2 diabetes who do not use insulin and typically manage their diabetes through lifestyle modifications. In electro-physiology, growth of 17% was driven by double-digit growth in all major geographic regions, including 17% growth in the U.S., which represents an acceleration compared to the growth in the first quarter. Growth was broad-based across the portfolio and included 20% growth in ablation catheters. In structural heart, growth of more than 15% reflects an acceleration in growth compared to the first quarter and was led by several recently launched products that are driving new adoption and share capture in attractive high growth areas, including TAVR, LAA, and tricuspid repair. This quarter, we launched our tricuspid repair device, TriClip in the United States and continued our trend of capturing market share in the global TAVR market. In rhythm management, growth of 6% was led by Aveir, our highly innovative leadless pacemaker, and in June we announced that we received CE mark in Europe for Aveir to be used in dual chamber pacing procedures, which is the largest segment of the pacing market. In heart failure, growth of 9% was driven by our market-leading portfolio of heart-assist devices that offer treatment for both chronic and temporary conditions. In neuromodulation, growth of 8% was driven by strong demand in international markets for our Eterna rechargeable spinal cord stimulation device, which obtained CE mark in Europe last year. In vascular, we received FDA approval in late April for our Esprit dissolvable stent, a breakthrough innovation for people who suffer from blocked arteries located below the knee. Esprit is designed to keep the arteries open, deliver a drug to support vessel healing prior to completely dissolving over time. New products like Esprit combined with the investments that we made in our vascular business, both organically and inorganically, have expanded our presence in faster growing areas and increased the future growth outlook for this business. In summary, we exceeded expectations both the top and bottom lines and, as a result, we raised our financial outlook for the year. We continue to make good progress on our gross margin initiatives and, more importantly, our pipeline continues to be highly productive, and thus we’re well positioned to deliver strong results for the remainder of the year. I’ll now turn over the call to Phil."
},
{
"speaker": "Phil Boudreau",
"content": "Thanks Robert. As Mike mentioned earlier, please note that all references to sales growth rates, unless otherwise noted, are on an organic basis. Turning to our second quarter results, sales increased 7.4% on an organic basis and increased 9.3% when excluding COVID testing sales. Foreign exchange had an unfavorable year-over-year impact of 3.5% on second quarter sales. During the quarter, we saw the U.S. dollar strengthen versus several currencies, which resulted in more unfavorable impact on sales compared to exchange rates at the time of our earnings call in April. Regarding other aspects of the P&L, the adjusted gross margin ratio was 56% of sales. Adjusted R&D was 6.3% of sales, and adjusted SG&A was 27.7% of sales in the second quarter. Lastly, our second quarter adjusted tax rate was 15%. Turning to our outlook for the full year, we now forecast full-year adjusted earnings per share of $4.61 to $4.71, which represents an increase compared to the guidance range we provided in April. We also raised the midpoint of our guidance for organic sales growth. We now forecast organic sales growth excluding COVID testing sales to be in the range of 9.5% to 10%. Based on current rates, we expect exchange to have an unfavorable impact of more than 2.5% on full-year reported sales, which includes an expected unfavorable impact of approximately 3% on third quarter reported sales. Lastly, for the third quarter we forecast adjusted earnings per share of $1.18 to $1.22. With that, we’ll now open the call for questions."
},
{
"speaker": "Operator",
"content": "Thank you. At this time, we will conduct a question and answer session. [Operator instructions] Our first question will come from Larry Biegelsen from Wells Fargo. Your line is now open."
},
{
"speaker": "Larry Biegelsen",
"content": "Good morning. Thanks for taking the question, and Robert, congratulations on a nice quarter. Thanks for your comments on the NEC litigation. I’m wondering if you have anything to add on that, Robert, and then I have one follow-up question."
},
{
"speaker": "Robert Ford",
"content": "No Larry, I think I said everything I said during my prepared comments. I guess the only add here is I think this is way overblown in terms of its impact, and we are--we’re working to obviously defend our position and--you know, working with all the different stakeholders so that they are aware of the situation, the gravity of the situation as it progresses. But I said all I had to say right now in my prepared comments, and if there’s a need to kind of give further updates, we will."
},
{
"speaker": "Larry Biegelsen",
"content": "All right, thanks. Separately, Robert, your EPD business grew nicely in the second quarter, 17% in both the U.S. and international. What drove that, what are you seeing with PFA in the different geographies, and how are you thinking about the sustainability of that growth before bolt [ph] launches? Thank you."
},
{
"speaker": "Robert Ford",
"content": "Sure, well I’m seeing what I thought I was going to see. It might be a little different from what some of you thought you were going to see, but what we’ve been seeing is obviously an increase in the market, so right now the market has accelerated, seems to be growing above 20%, so when you look at our 17%, it’s lower than the market but it’s actually growing faster than what it was growing pre-pandemic, or just after we had done the acquisition. We’ll see if the--I mean, that growth is obviously in value. We’ll see if the growth in procedures actually translates. We are actually in more procedures than what we were in the past, given our mapping and our teams, but I think it’s a little bit too early to say if the actual number of procedures is going to significantly increase. The market has accelerated, but it’s predominantly, I think, price right now with the introduction of this new product. It’s predominantly being used in de novo procedures, atrial procedures, right, and we think that’s about a third of all ablation procedures, Larry. The other two-thirds, we continue to see, whether it’s re-dos, VT, SVT, ablations, in that case we continue to see RF really being viewed as the better option for those procedures. We’ll see how that’s going to translate over time, but OUS, the penetration is around 10%, 15%. It’s been pretty stable. From the point of view of mapping, I think we haven’t seen a real big change of what we saw during those first couple of months of launch and in the last call, so over 90% of cases here in the U.S. are still being used as mapping. We’ve got a 50 share of those mapping cases. I don’t try and look at different types of denominators to get to that market share, so I make sure my team just basically has the best access and, from what we’re seeing, it’s about 50%. RF catheters, similar to what we saw in the last call, still being used in about 20% of the PFA cases, so we continue to see that. I think the net effect of all of this is the market’s growing, it’s accelerating. We’ve got a strong position. Everything that we’ve talked about in the past, about our opportunity with the mapping and all of the other consumables is there. RF still plays a role, it’s still an important role, and our business has actually grown faster than what it was growing before. If you look at ’19, we were about 12%, ’18 was about 14%, so we’re actually doing better now. I think that is positive for the market, which is why we’ve invested heavily in our PFA portfolio, which will--you will start to see hit the market in the--I’d say next year, I’m not going to try and time the quarter here, but definitely next year. I think this is good and the teams have done an incredible job at executing the strategy that we laid out, so kudos to them."
},
{
"speaker": "Larry Biegelsen",
"content": "Thanks so much. Thanks for the comprehensive answer."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question will come from Travis Steed from BofA Securities. Your line is open."
},
{
"speaker": "Travis Steed",
"content": "Hey, congrats on the good quarter. I wanted to ask about structural heart - really stood out this quarter, accelerated from last quarter. Just curious how much of that is on MitraClip recovery, you got TriClip approved early, how much you’re seeing from the TriClip side and how much is coming in from some of the other newer products, like Amulet and Navitor."
},
{
"speaker": "Robert Ford",
"content": "Sure. Obviously TriClip was an important launch and helped to accelerate the growth rate, Travis, but I think it’s pretty broad-based here. I mean, if you look at TriClip, we were ready to go because we had certain built-in advantages in this area, right - we had the scale, we had the sales force, the manufacturing capacity, so we were ready to go. I think from our estimates here, even though we launched a quarter after our competitor with their system, I think the repair device is already in twice as many accounts as the replacement system, so we had a natural kind of built-in advantage here as we went to the market, and the cases are doing very well. The feedback has been very positive. But I think it’s really broad-based here. Navitor has done very well, both in international markets and in the U.S., and the value proposition is starting to gain more traction - you know, great clinical profile, excellent hemodynamics, and that’s driving a lot of opportunity for us in international and U.S. markets. We shared some data from our registry, from our Japan registry, and great safety also, so that’s doing very well. Amulet, we saw really nice growth in the U.S. for Amulet this quarter - it was about 45%, so that product is doing very well and we’re focusing here on continued, what I would call penetration in same store sales, so we’re about close to 20% in the accounts that we’re in. We’re in about half of the market here in the U.S., so our opportunity here is to continue to expand the sales force and go to newer accounts, so that’s done very well, too. MitraClip, I think we continue to see some continued growth internationally. In the U.S. with competitive activity, that’s kind of slowed down a little bit of the growth, but I think with TriClip now coming into the market and gaining traction, we’ll be able to provide a value proposition across both repair systems and drive there. So structural heart, the growth rate has accelerated from Q1, doing very well, and I’d say it’s really across a full portfolio approach versus just really trying to single out one product or one technology. There’s work we have to do in MitraClip - that’s clear, in the U.S., internationally it’s done very well; but all the other products that I’ve talked about are doing very well and gaining market share, and gaining adoption, so that’s why you saw structural heart’s growth rate actually accelerate, and I continue to see that that’s going to be definitely for the rest of this year and going into next year."
},
{
"speaker": "Travis Steed",
"content": "That’s super helpful. Then on your sensor business, how are you thinking about segmenting the market with Lingo versus Rio, and how do you think those markets are going to develop over time? When you look at your core Libre business, anything to call out, any changes in U.S. versus international market dynamics?"
},
{
"speaker": "Robert Ford",
"content": "Well, you’re trying to cover a lot of ground there with that question. You could probably spend a whole call going through all of that. I think at its highest level, Libre continues to do very well. There’s still a lot of growth opportunity. Obviously the basal opportunity is the biggest one, and we’re doing--having great progress over there, but even in the MDI segment, there’s still a lot of penetration to occur in the MDI segment. I think in the U.S., there’s still about a third of multiple daily injectors that aren’t using CGM, and international developed markets, it’s around 50%, so there’s plenty of growth in Libre. Our strategy here with Lingo and Libre Rio is just really to have a full portfolio and look at this as a platform where we can expand the use of the sensor technology across different types of diabetes populations, but also what is probably the larger market, which is people that don’t have diabetes, right? I think if you--if you take--right now, I would say we’re doing to launch it here in the U.S. and we’re going to start expanding globally, and we’ll see how it looks like and what it takes to win there. But what I do know, based on the U.K. experience, is that it takes some time to educate and communicate with a patient population that, while excited about having new tools to drive healthier habits, they do need some time to understand its use. But I think it’s a pretty big opportunity for us and one that we’ve disproportionately invested to be able to get into this position. I think if you take Lingo and you look at U.S. and Western Europe, the adult population there, you’ve got about 400 million people in those markets. If you take a single-digit penetration rate, a few sensors a year, you’re looking at a multi-billion opportunity there, and we’re not there yet. I think once we’ve got better understanding of how this is going to work, we’ll be better at forecasting it; but just at a high level and looking at it from a total adult population and relatively, I’d say, modest penetration rate, it’s a pretty big opportunity. Like I said in my comments, we’ve done this for a while since we’ve launched internationally, and we’ve learned a lot and we’re going to bring that learning and experience here to the U.S., so it’s an exciting opportunity for us."
},
{
"speaker": "Travis Steed",
"content": "Great, thanks Robert."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question will come from Robbie Marcus from JP Morgan. Your line is open."
},
{
"speaker": "Robbie Marcus",
"content": "Oh great, thanks. I’ll add my congratulations on a good quarter. Two for me, two product questions. Maybe just to follow up on the diabetes Libre question, Robert, how are you thinking about a holistic drive of advertising and word of mouth for these new products, especially as we move into the OTC, versus generating data, and how much will be necessary? I think back five years ago, and where we are today was probably not in most people’s forecasts, and with the amount of data we have showing in non-diabetics how beneficial CGM is, how are you thinking about data versus not data, insurance coverage versus not insurance coverage, and how do the markets look one way or the other?"
},
{
"speaker": "Robert Ford",
"content": "Yeah, I don’t think--so from an insurance coverage perspective, if you’re referring to Lingo specifically for non-diabetes, I think it’s going to be--you know, I don’t think that that’s going to be something that we’re building a forecast assuming reimbursement coverage over it, even though I agree with you - you know, there is nice data that shows that people that don’t have diabetes can benefit from this, Robbie, and it helps sustain behavior modification. Ultimately this is what it is, right - it’s using data to be able to kind of help people that want to stay healthy, give them more information, and ensure that they can refine their habits or change habits. I think that that is at the core there - it’s really communicating directly with consumers. If you think about the diabetes space and how CGM uptake, you needed both a communication with the patient and you needed obviously a communication with the physician. I think that that’s still important for the non-diabetes. I think that some people will want to have some sort of recognition from the healthcare professional that this might be a good investment to do in, right, and the key thing here is just the utilization. I don’t think you’re going to see people that don’t have diabetes use this, you know, a sensor 365 days a year, but like I said, if they’re using a couple times a year, there’s still a benefit, and we’ll be generating data on this over time. I think it’s going to be important to generate data, even if it’s not to communicate to payors to get reimbursement, but even if it’s to communicate to physicians, the primary care and the direct consumers, that there’s a value here of doing that. I think the key thing here is personalization and how do you personalize information and the data and the coaching, so the strategy here is, yes, you’re doing to have to use TV to be able to communicate, but I don’t think it’s--I don’t think given our experience here that you could just go on TV and blast TV advertising and you’ll get this big uptake. You’re going to have to do some on-the-ground kind of gorilla marketing - let’s call it like that, together with TV advertising to really be able to open up the market and then sustain it, right, and sustain its use. That’s how we’re thinking about it, and that’s why we have a separate team completely removed from the Libre and the diabetes team, that they’re focusing on how to execute this strategy. I think it’s more of an S-curve growth versus an out-of-the-gate. I know that everybody is focused on what the sales are in the second half, whether it’s me or the competitor. I think the bigger picture here is, hey, there’s a really big opportunity here and if we do it right, it’s an opportunity that will be more than a flash in the frying pan. It will sustain itself and it could become standard, so."
},
{
"speaker": "Robbie Marcus",
"content": "Great color. One more from me - Aveir and the leadless pacing, particularly the dual chamber now with coverage, I think is an underappreciated opportunity. Maybe if you don’t mind, spend a minute there, how you see this market evolving, and what’s the early feedback on the launch so far? Thanks."
},
{
"speaker": "Robert Ford",
"content": "Yes, I mean, ultimately I think this whole leadless is going to change the growth trajectory of our CRM business. If you look at CRM, it grew 7% last year, it’s grown 7% the first half of this year - it was previously a flat business, and we’ve been doing that, I would say, with good success on dual, but I wouldn’t say that it’s at full cycle yet, because one of the things that we’re working on is ensuring that we’re doing the training and we’re getting physicians comfortable with the procedure, right? It’s a completely different procedure versus what the entire industry has been accustomed to. We’re using mapping, we’re going into the groin versus doing pockets above the chest, so it is a little different and we’re focusing on that. That being said, we’ve been able to accelerate the growth rate just with a single chamber. I think right now after two years, we’ve probably captured about 50 share, but to your point, the bigger opportunity is in dual, and the procedures are going great. Once physicians get several under their--you know, experience with several of them, they’re talking about okay, how do we accelerate this and an opportunity to drive more patients into it, but we want to make sure we’ve got a pretty large base of well-trained, great outcomes physicians across the United States. Listen, this is a $3 billion global segment and there really hasn’t been much innovation in it, and here you have something that’s truly unique and differentiated, and I’d say once we feel that we’ve gotten to a point where we feel good about the capabilities and training and the amount of physician coverage that exists, this is definitely a product that I can see going a little bit more mainstream, having more direct consumer communications because of the value proposition it affords them, so I think this is a great opportunity for us. It might be under-appreciated with the market, but it is definitely appreciated amongst me and the device team and the CRM team, and we’re working hard to get to that point where you can really let it go strong."
},
{
"speaker": "Robbie Marcus",
"content": "Great, thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question will come from Josh Jennings from TD Cowen. Your line is now open."
},
{
"speaker": "Josh Jennings",
"content": "Good morning, thanks for taking the questions. Robert, I wanted to just start asking about just this multi-year trajectory for Abbott. You’ve been delivering top tier organic revenue growth performance over the last two years and potentially have a two-year double-digit stacked comp next year, but I think the team has been publicly stating that potentially the business could outpace pre-pandemic levels, which were in that 7% to 8% range. I think during this call, you’ve put forward a lot that supports that type of trajectory, but maybe just to reiterate your confidence level there, and is this kind of outpacing your pre-pandemic levels over the medium term dependent on M&A, or is this the core business with internal development programs that’s really going to drive this top tier growth out over the next couple of years?"
},
{
"speaker": "Robert Ford",
"content": "Was that an attempt to get to the 2025 kind of question? I’d say, listen - we’ve been saying that we made investments during COVID to accelerate the company, make it stronger, build our portfolio so we could accelerate the growth, right? If you look at the last six quarters, we’ve been delivering top tier, high single digit, double digit growth, and this is on a company that’s doing $40 billion-plus of revenues, so I think that’s pretty impressive. If you look at our med tech portfolio, it was the fastest growing med tech portfolio last year, fastest growing in the first quarter of this year. We’ll see what happens this second quarter, but we’ve positioned the company to be able to deliver this, and do I think that we can continue to deliver this top tier performance throughout this year and into next year? Yes, I absolutely do, because of, one, what we’ve built, and then just the evidence and the proof points that we’ve been able to reliably and sustainably deliver that. So yes, we feel good about our ability. The markets that we’re participating in are attractive, so they are markets that we lead, and when those markets grow, our leadership benefits. There are markets that are attractive that we’re entering, and there’s plenty of opportunity for market share gain; and there are markets that are attractive that we’re building, and there’s no real clinical opportunity--or there’s a clinical opportunity for our products that we’re developing to come in there, so as we build those markets, they become attractive and our position gets solidified. I think that framework applies to all four of our business units have opportunities across those three frameworks. On the M&A front, yes, if we’re able to find an asset that makes sense strategically to us, makes sense financially that could add even further to that growth, then we’ve got the balance sheet to be able to do that; but it’s not dependent--as I’ve told you, it’s really focused on the organic side to be able to deliver this top tier growth."
},
{
"speaker": "Josh Jennings",
"content": "Understood, and thanks for that answer. Another kind of high level question you probably receive regularly, but just wanted--it’s our understanding as well that your team, the Board ever year at least once a year, maybe multiple times a year, is just considering the strategic fit of the four major business units for Abbott, and maybe just if we could get an update on your thoughts on the business combinations and the potential for spins down the line. Thanks a lot."
},
{
"speaker": "Robert Ford",
"content": "Well, we look at our portfolio on an ongoing basis. I don’t think there’s this one moment in the year that we do it - we’re doing it on an ongoing basis, and the company has a history of ensuring that the portfolio that is assembled is not only delivering value to patients and governments and healthcare systems, but it’s also delivering value to our shareholders. We historically haven’t shied away from asking ourselves the questions and answering those questions, and if there’s an opportunity to create value through addition or through subtraction, then the company has shown that it’s ready to do that. I think the two fundamental questions about that is, is there an opportunity to create value for shareholders, and is there somebody that could do better with our businesses? Right now, you look at what we’re doing with our businesses, we’re performing at the highest level across all of the four segments. We’ll see what happens during this earnings season here, but I feel very good about the team and what they’re doing. Obviously there are areas that we could always do better, and we focus on that; but at the highest level, all four of our sectors have been delivering outstanding growth, market-leading growth, and quite frankly innovating and fulfilling our purpose and our mission, which is to help people live healthier lives. I like the diversity. The diversity provides both defense and offense capabilities, and as long as you’re managing them within each one of their segments, allocating capital that is proportionate to their growth and their industry, and we spend a lot of time managing all four segments, then I think we’re doing a good job at running them."
},
{
"speaker": "Josh Jennings",
"content": "Great, thanks a lot."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question will come from David Roman from Goldman Sachs. Your line is open."
},
{
"speaker": "David Roman",
"content": "Thank you and good morning everybody. I was hoping to ask one question on the P&L side and one on the capital allocation side. Maybe I’ll start with the P&L here. As I kind of look at the guidance here for the back half of the year, our math implies it’s something like 100 basis points-plus of year-over-year operating margin expansion, and about 9% EPS growth at the midpoint of the range. Can you maybe talk through some of the drivers that underpin that margin expansion on a year-over-year basis? Obviously we saw a turn here in Q2 versus what we saw in Q1, but maybe walk us through some of the drivers that get to that improved margin and earnings growth performance in the back half of the year."
},
{
"speaker": "Robert Ford",
"content": "Sure, I’ll let Phil take that."
},
{
"speaker": "Phil Boudreau",
"content": "Yes, good morning David. Robert touched a little bit in his opening comments here on some of that expansion already this year, and we’re in a pretty unique position relative to some of our peers in terms of our op margin profile, that we’re already back to pre-pandemic levels, and we did that strategically through managing spend through the ups and downs of COVID testing. As we talked earlier this year, Q1 was really the last big comp on COVID testing impacts on sales and profiles. With respect to margin expansion and gross margin in particular, the guidance for the year is around 75 basis points as you highlight some progress here, and more to go, but the trajectory is there. We’re focused on the things that we can control and execute on, and in particular some of this great portfolio contribution from our sales top line performance, particularly in accretive businesses, is a contributor here, and one that we anticipate will continue to expand here throughout the year. We have dedicated teams in each one of our businesses focused solely on gross margin improvement, productivity yield improvements, cost reductions, innovation that brings accretion to the portfolio. All of those elements are contributors here quarter in and quarter out and continue to contribute through the rest of the year. Then we also have elements--we’ve talked about some of the cycles that we go through, be it in commodities markets and the like, some of the inflation the last few years, that are starting to sort of stabilize and normalize We’re seeing freight and distribution profiles normalize and start to be more a tailwind as opposed to headwind, and we’re also seen in commodity markets as well things not only stabilizing, but coming down and also contributing to tailwinds to gross margin, and anticipate that to persist here as well. The combination of all of those contributes to the confidence here and continuing to drive the top tier sales performance, but also expand margins throughout the year."
},
{
"speaker": "David Roman",
"content": "Super helpful, thank you. Then maybe just on the capital allocation side, maybe thinking about the other side of Josh’s question, if you look across the sector here, we’ve seen M&A pick up a little bit in the second quarter - I think there were two billion dollar-plus transactions announced with transaction multiples starting to trend toward the lower end of historical levels. But could you maybe give us your latest perspective on the M&A environment and how you’re thinking about capital allocation as your cash balance continues to build nicely here?"
},
{
"speaker": "Robert Ford",
"content": "Well, on the capital allocation more broadly, listen - I’ve been pretty clear every call about we have a balanced approach, right? I know you guys cover a lot of companies that have different approaches. Our approach is balanced, and we believe that that balanced approach benefits the long term shareholder. One of the metrics that I believe, David, is a good measure of evaluating capital deployment effectiveness is ROIC, and if you look at ROIC over the last three years, we’ve averaged around high teens, and that’s on the higher end of the med tech peers that we often get compared to, so. We believe that ROIC is a good measure of how effectively we’re deploying the capital, and we look at a balanced approach, so are there internal capital investments that drive future growth. We’ve been talking about all these great opportunities we have, and we’re funding them and they have great returns. Debt pay down - we don’t have much this year, but we took care of some towers last year because we didn’t want--we obviously didn’t want to refinance them. Dividend and buybacks are--you know, the dividend is definitely core to our investment identity, and we intend to continue to grow our dividend, so that is a balanced approach. Even with all of that, we also, as you’ve probably seen, we have opportunity from a balance sheet perspective to deploy that from an M&A perspective, and we’ve been spending time talking about our strong top line and the pipeline that we’ve developed, and that allows us to be a little bit more selective. You look at other transactions that happened and you have to ask, okay, what’s the strategy behind that, and a lot of the time you can see you’re having to sustain your growth rate, right? If you’re in the business of driving top line through acquisitions, then you’ve got to--you know, that’s part of your model, you’re going to have to keep doing that, whether the valuations are right or wrong, or not right. But we look at these strategic fit, can they generate an attractive return, can we make the business better that we’re acquiring. We don’t want to be just a holding, and I think that we’ve shown that when we do, do our acquisitions, that’s the framework, you know - fits in strategically, generates nice return, and we tend to operate them or add value to them than when they were a standalone, so."
},
{
"speaker": "David Roman",
"content": "Appreciate all the perspective, and thanks for taking the question."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question will come from Danielle Antalffy from UBS. Your line is open."
},
{
"speaker": "Danielle Antalffy",
"content": "Hey, good morning guys, thanks so much for taking the question. Congrats on a really good quarter here. Robert, one of the things that struck me when we spoke--I have two product-specific questions, when we last spoke is how you’re looking at the sustainability of historically slower growing businesses and areas exposed to historically slower growing markets, so obviously I’m thinking CRM. Can you talk a little bit about the strategy there - obviously Aveir is a big part of that, and just leadless pacing in general, and how sustainable--I mean, it’s been, like, multiple quarters now of organic growth in the mid-plus single digit range, and then just one follow-up, another product question."
},
{
"speaker": "Robert Ford",
"content": "Yes, well that was part of our strategy as we looked at our med tech portfolio - you’ve obviously got high growth drivers there with EDP, structural heart, diabetes care, neuro, heart failure, and we looked at CRM and vascular, and those are more flat businesses, so the combination of all that is you had a med tech portfolio that was growing 7%, 8%, maybe 9% a quarter there. To get to double digits, we needed those two businesses to get at least to mid single digits, right, and I’d say on the CRM side, our strategy there was to really focus on Aveir leadless pacemakers. You know, there’s a pipeline of products there - I don’t want to tilt my hand here, but we didn’t do Aveir DR and stop there. The team’s gotten R&D programs to continue to advance those and even to look at the ICD market also and what are the opportunities that we can do to innovate. But there is space to innovate in that market, and that for me is important, is the diabetes market, you know, 15 years ago, people would say, gee, that’s a slow growth market - well, now look at it, right? If you focus on innovation on meeting needs, unmet needs, you can turn a market around. From a vascular perspective, as I said in my comments, we’re trying to--we’ve been repositioning the portfolio to more higher growth areas, peripheral areas, endovascular areas, but we started that a little bit later than what we did in CRM, so I expect to start to see our vascular business start to also contribute to a higher growth rate, the same way that CRM is, and that just kind of bolsters our entire med tech portfolio and gets us into that 12%, 13% growth rate, at least that’s our target."
},
{
"speaker": "Danielle Antalffy",
"content": "Okay, that’s helpful. Then the follow-up question is on the structural heart side of things, and I know Amulet has been on the market for a little bit here, but my impression is that now it’s kind of like Abbott is no longer fighting with one hand tied behind their back. Can you talk a little bit about that, and your 45% growth, I think you said in the quarter, where to from here for Amulet? Thanks so much for taking the questions."
},
{
"speaker": "Robert Ford",
"content": "Yes, so it was a great quarter. I think the team’s kind of hitting its stride right now. As I’ve said, our focus here was really to kind of drive adoption in the centers that we were at, versus expansion. The competitor has expanded the market - there is probably about 800 centers that are doing these implants, and we’re probably in about half of it. Now, that’s good, right - that provides a market expansion dynamic here in the U.S., but-. I mean, I’m really encouraged by some of the data that I’m seeing, and I think it starts with the data, right? You know, we had patient registry data come out where we showed that 95% closure rates were achieved post implant and sustained after 45 days, 90% of closure success rate using Amulet, for patients that actually fail to achieve proper closure rate with a competitive product, so I think that there’s an opportunity here for our value proposition, and then we’ve got to continue to invest. We are already investing on our next-generation Amulet, focusing on ease of use, focusing--and we’ll maintain our superiority here that we believe we have regarding the ceiling of LEA. We’re investing in clinical trials, obviously we’ve been public about Catalyst, which is a trial that will compare Amulet to NOAC and to ablation treatment, so this is an exciting market for us and we will continue to invest in it, and ultimately it comes down to really looking at surrounding the electrophysiologist with the most comprehensive portfolio, whether it’s on pacemakers and ICDs, structural heart interventions with stroke preventions, and then obviously ablations and AF treatment. At its highest level, that’s the important side here, is Amulet fits an important role even though we report it as structural heart. It’s really playing a role here to surround the physician, the EP with the tools they need to advance care."
},
{
"speaker": "Danielle Antalffy",
"content": "Thank you."
},
{
"speaker": "Mike Comilla",
"content": "Operator, we’ll take one more question, please."
},
{
"speaker": "Operator",
"content": "Thank you. Our final question will come from Vijay Kumar from Evercore ISI. Your line is open."
},
{
"speaker": "Vijay Kumar",
"content": "Hi Robert. Thanks for taking my question, and congrats on a nice sprint here. I wanted to touch on biosimilars - you know, you brought this up on the call. Can you elaborate on your strategy there? Are you planning to manufacture these products? Is Abbott going to be a CDMO in that space or do you plan to launch your own biosimilars, or is this more of Abbott being a distributor and taking advantage of your brand presence in emerging markets? What is Abbott’s role in that place, and how do you size that market opportunity for Abbott? When should that start contributing to Abbott?"
},
{
"speaker": "Robert Ford",
"content": "Sure. You know, this is one where I’d say there’s a couple phases to the strategy. The core premise of this, Vijay, is if you look at the emerging markets and the disease prevalence that exists in these emerging markets, they’re no different than the disease prevalence in the U.S or Europe. You could look at some of them are higher, etc., but in general there’s an opportunity to bring these biologics into the emerging market. For a variety of reasons, those markets have not been a priority for the originators. Their main focus has obviously been in the international developed markets - U.S., Western Europe, Japan, Canada, Australia, etc., so this provides just a patient need opportunity that we want to size up. What we’ve seen through some of our--you know, we have done some more regional biosimilar deals that we’ve launched, and what we’ve seen is that the growth of the molecule grows significantly once a biosimilar enters in terms of penetration into a patient population. It’s a different dynamic in developed markets, as we know, but in emerging markets the category really expands, so what we wanted to do is to say, okay, before we start to think about manufacturing, before we start to think about that, we want to be able to understand what is the uptake of these products once you go ahead and put a concerted effort to developing these types of products in emerging markets. It fits right into our wheelhouse, where we’ve got relationships with governments, we have relationships with physicians, and we’ve got relationships with the distribution area. The question is how can you do it in--how can you execute that strategy that’s capital efficient and doesn’t erode gross margin of that business, and I give a lot of kudos to the team because they’ve really been able to position our presence in these markets as an advantage to these players that really aren’t focusing on emerging markets, they’re focusing more on the opportunity that exists in developed markets, and now they can partner with one single company, reputable company to be able to use that capacity in other markets. I’d say we’re in the phase right now of, okay, is there sustainability to this, so the deals that we’ve done give us access, our gross margin is not dilutive, and we’re going to see how it goes. As you think about the ramp-up of what we’ve got in the pipeline, we’ll start launching in 2025, but you look at some of the big molecules that will come up for us ’26,’27, that’s I think when some of these very large oncology opportunities that we have will play a huge role for us and accelerate the growth there."
},
{
"speaker": "Vijay Kumar",
"content": "That’s helpful. Maybe one last one on capital deployment. I know it’s been asked - I’m curious on share repurchases. You guys have done phenomenal growth. The street doesn’t seem to be giving credit. Why not? You didn’t see any share repurchase in the first half. Why is Abbott being conservative on share repurchases?"
},
{
"speaker": "Robert Ford",
"content": "Yes, well we’ve done a lot of share repurchases over the last couple of years, say catching up a little bit, to maybe not doing as much repurchasing after the two acquisitions we did in 2017 and 2018. If you look at our repurchases and dividends, it’s been about $20 billion that we’ve returned over the last four years, Vijay - $20 billion in dividends and buybacks, and that accounts for a good amount of our free cash flow over the last couple of years to our shareholders. We’re not--the year’s not over, and again we’ll see opportunities. We’ve got plenty of opportunities to be able to do that, so I’d say I think we’ve done a pretty good here at returning cash back to our shareholders over the last couple of years, and that commitment we’ll maintain, so."
},
{
"speaker": "Robert Ford",
"content": "I’ll just close here. This was a great quarter for us and, quite frankly, a great quarter in connection with five quarters before that, where we’ve delivered above-market growth. I’m really pleased with our continued strong performance. We’ve raised our sales outlook, our EPS ranges for the second time this year. The toughest COVID test comps are now behind us, so I look forward to not having to--you know, we’ll obviously report our COVID testing sales, but you’ll start to see those comps start to dwindle away now, which means then that our EPS is back to growth. I think one of the questions there about showing our EPS exiting the year in high single digits, double-digit kind of range and getting back to our formula, that’s what we’re interested in, and we’ve got a lot of positive momentum here heading into the second half of the year. With that, we’ll wrap up, and thank you for joining us."
},
{
"speaker": "Mike Comilla",
"content": "Thank you Operator, and thank you all for your questions. This now concludes Abbott’s conference call. A webcast replay of this call will be available after 11:00 am Central time today on Abbott’s Investor Relations website at abbottinvestor.com. Thank you for joining us today."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today’s conference call. Thank you for your participation. You may now disconnect. Everyone have a wonderful day."
}
] |
abt | 2,024 | 1 | [
{
"speaker": "Robert Ford - Chairman and Chief Executive Officer",
"content": ""
},
{
"speaker": "Phil Boudreau - Senior Vice President, Finance and Chief Financial Officer",
"content": ""
},
{
"speaker": "Bob Funck - Executive Vice President, Finance",
"content": ""
},
{
"speaker": "Operator",
"content": "Good morning, and thank you for standing by. Welcome to Abbott's First Quarter 2024 Earnings Conference Call. All participants will be able to listen-only until the question-and-answer portion of this call. [Operator Instructions] This call is being recorded by Abbott. With the exception of any participants’ questions asked during the question-and-answer session, the entire call, including the question-and-answer session is material copyrighted by Abbott. It cannot be recorded or rebroadcast without Abbott's expressed written permission. I would now like to introduce Mr. Mike Comilla, Vice President, Investor Relations."
},
{
"speaker": "Mike Comilla",
"content": "Good morning, and thank you for joining us. With me today are Robert Ford, Chairman and Chief Executive Officer; Bob Funck, Executive Vice President, Finance; and Phil Boudreau, Senior Vice President, Finance and Chief Financial Officer. Robert and Phil will provide opening remarks. Following their comments, we'll take your questions. Before we get started, some statements made today may be forward-looking for purposes of the Private Securities Litigation Reform Act of 1995, including the expected financial results for 2024. Abbott cautions that these forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those indicated in the forward-looking statements. Economic, competitive, governmental, technological, and other factors that may affect Abbott's operations are discussed in Item 1A, Risk Factors, to our annual report on Form 10-K for the year ended December 31, 2023. Abbott undertakes no obligation to release publicly any revisions to forward-looking statements as a result of subsequent events or developments, except as required by law. On today's conference call, as in the past, non-GAAP financial measures will be used to help investors understand Abbott's ongoing business performance. These non-GAAP financial measures are reconciled with the comparable GAAP financial measures in our earnings news release and regulatory filings from today, which are available on our website at abbott.com. Note, that Abbott has not provided the GAAP financial measure for organic sales growth on a forward-looking basis because the Company is unable to predict future changes in foreign exchange rates, which could impact reported sales growth. Unless otherwise noted, our commentary on sales growth refers to organic sales growth, which is defined in the press release issued earlier today. With that, I will now turn the call over to Robert."
},
{
"speaker": "Robert Ford",
"content": "Thanks, Mike. Good morning everyone, and thank you for joining us. Today, we reported first quarter adjusted earnings per share of $0.98, which was above analyst consensus estimates. We also raised the midpoint of our guidance ranges for both earnings per share and sales growth. We now forecast full year adjusted earnings per share of $4.55 to $4.70 and organic sales growth, excluded COVID testing related sales of 8.5% to 10%. Organic sales growth, excluding COVID testing related sales was 10.8% in the quarter, which represents the fifth consecutive quarter of double-digit growth. The strong start to the year was driven by broad base growth across a portfolio, including growth of 14% in medical devices and established pharmaceuticals. In addition to exceeding expectations of both top and bottom lines this quarter, we accomplished a number of objectives across the pipeline, including obtaining several new product approvals and achieving important clinical trial related milestones. I'll now summarize our first quarter results in more detail before turning the coal over to Phil, and I'll start with nutrition, where sales increased 8% in the quarter. Strong growth in the quarter was led by double-digit growth in pediatric nutrition, driven by continued market share gains in the U.S. infant formula business and growth across our international portfolio of infant formula, toddler and adult nutrition brands. In January, we launched a new nutrition shake called PROTALITY, which provides nutritional support for adults pursuing weight loss. As people eat less and lose weight from taking GLP-1 medications, undergoing a weight loss surgery, or following a calorie restricted diet. A portion of what is lost is lean muscle mass, which plays an important role in overall health. Combination of high protein and essential vitamins and minerals that totality offers can help people preserve muscle while pursuing their personal weight loss goals. Turning to EPD or sales increased 14% in the quarter. This quarter was a continuation of EPDs impressive trend of strong performance, including double-digit growth in four of the last five quarters. In addition to a strong track record of top line growth, this business has delivered equally impressive gains on the bottom line with an operating margin profile last year that reflected more than 350 basis points of improvement compared to 2019. Moving to diagnostics, where sales increased more than 5%, excluding COVID testing sales. Growth in diagnostics continues to be led by the adoption of our market leading systems and demand for testing that takes place in a variety of settings, including hospitals, laboratories, urgent care centers, physician offices, retail pharmacies, and blood screening facilities. Our development efforts and diagnostics focus on developing new systems and creating new tests that play an important role in making healthcare decisions, expand the accessibility of testing and deliver a result as fast as possible. In April, we received FDA approval for a point of care diagnostic test that could help determine if someone suffered a mild traumatic brain injury or concussion in just 15 minutes. The test is run on our portable i-STAT Alinity instrument, which allows concussion testing to move beyond the traditional hospital setting and into urgent care centers, physician offices, and other locations that are closer to the patient, with nearly 5 million people in the U.S. going to the emergency room to be checked for suspected concussion each year. We believe this test has the potential to transform the standard of care for concussion testing, and I will wrap up with medical devices, where sales grew 14% in diabetes care. FreeStyle Libre sales were $1.5 billion in the quarter and grew 23%. As I previously mentioned, that Libre has several new growth opportunities that will help continue to fuel the strong sales trajectory we have forecasted. One of those growth opportunities relates to the continued expansion of reimbursement coverage for Libre, for individuals who use basal insulin therapy to manage their diabetes. Last year, we announced that Libre became the first and only continuous glucose monitoring system to be nationally reimbursed in France to include all people, who use basal insulin as part of their diabetes management. During this first quarter, Libre obtained reimbursement from a select number of institutional payers in Germany for basal insulin users who also use oral diabetes medication to manage their condition. These select public and private payers cover a limited number of the approximately 1 million basal insulin users in Germany, but this is an encouraging sign of the potential for further coverage expansion not only in Germany but across other European markets. In cardiovascular devices, sales grew 10.5% overall in the quarter, led by double-digits growth in electrophysiology, structural heart and continued acceleration in our cardiac Rhythm Management and Vascular portfolios. In electrophysiology, sales grew 18%, driven by double-digits growth in all major geographic regions and across all major product categories, including double-digits growth in ablation catheters and cardiac mapping related products. We continue to make great progress toward bringing our innovative PFA catheter, Volt to market. In March, we completed enrollment in our CE Mark clinical study, putting us on-track to file for international approval before the end of the year. We also recently began enrolling patients in our U.S. clinical trial called VOLT-AF, which will generate the data needed to support an FDA approval filing. In structural heart, growth of 13% was led by strong performance in several high-growth areas, including TAVR, LAA, mitral and tricuspid repair. Structural heart is an area that we have invested in over the past years in order to create a diversified portfolio that can sustainably deliver double-digits growth. In the past, we relied almost exclusively on MitraClip to drive the growth, but today the portfolio and growth are more balanced and reflect increasing contributions from newer products like Navitor, Amulet and TriClip. In April, we received FDA approval for TriClip, a first of its kind heart valve repair device designed for the treatment of tricuspid regurgitation or a leaky tricuspid valve. Data from the clinical trial supporting this approval demonstrated that, patients who receive TriClip experienced a significant improvement in the severity of their symptoms and quality of life. We are excited to now offer this life-changing treatment option to people in the United States that suffer from this condition. In Rhythm Management, growth of 7.5% was led by AVEIR, our recently launched leadless pacemaker. AVEIR has rapidly captured market share in the single chamber pacing segment of the market and is now being used for dual chamber pacing, which is the largest segment of the pacing market. This revolutionary technology is helping to deliver growth rates in our Rhythm Management business that significantly exceed the overall growth in this market. And lastly, in neuromodulation, sales grew 17%, driven by Eterna, a rechargeable neurostimulation device for pain management. In January, we announced the launch of Liberta, the world's smallest rechargeable deep brain stimulation device, which is used to treat movement disorders such as Parkinson's disease. In summary, we're off to a very good start to the year, exceeding expectations on both top and bottom lines. And as a result, we have raised the midpoint of our sales and EPS guidance ranges. We continue to make good progress on our gross margin expansion initiatives and we're seeing strong returns from the investments we are making across our growth platforms. Our pipeline has continued to be highly productive, delivering several recently new product approvals and we're very well-positioned to continue to deliver strong results for the remainder of the year, and I'll turn over the call to Phil."
},
{
"speaker": "Phil Boudreau",
"content": "Thanks, Robert. As Mike mentioned earlier, please note that all references to sales growth rates unless otherwise noted, are on an organic basis. Turning to our first quarter results, sales increased 4.7% on an organic basis, which as expected includes the impact of year-over-year decline in COVID testing related sales. Excluding COVID testing sales underlying base business, organic sales growth was 10.8% in the quarter. Foreign exchange had an unfavorable year-over-year impact of 2.9% on first quarter sales. During the quarter, we saw the U.S. dollar strengthen versus several currencies, which resulted in exchange having a more unfavorable impact on sales compared to exchange rates at the time of our earnings call in January. Regarding other aspects of the P&L, the adjusted gross margin ratio was 55.7% of sales, adjusted R&D was 6.7% of sales and adjusted SG&A was 29.4% of sales in the first quarter. Lastly, our first quarter adjusted tax rate was 15%. Turning to our outlook for the full year, we now forecast full year adjusted earnings per share of $4.55 to $4.70, which represents an increase at the midpoint of the range compared to the guidance range we provided in January. We also raised the midpoint of our guidance for organic sales growth. We now forecast organic sales growth, excluding COVID testing to be in the range of 8.5% to 10%. Based on current rates, we expect exchange to have an unfavorable impact of approximately 2.5% on full year reported sales, which includes an expected unfavorable impact of approximately 3% on second quarter reported sales. Lastly, for the second quarter, we forecast adjusted earnings per share of $1.08 to $1.12. With that, we'll now open the call for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] And our first question will come from Robbie Marcus from JPMorgan."
},
{
"speaker": "Robbie Marcus",
"content": "Two for me. I'll just ask them both up front. First, Robert, we almost never see Abbott raise guidance particularly on the top line in the first quarter. Looking back over the past, I don't know, 5, 10 years, it's very rare. First part is what gave you the confidence to raise the midpoint of the guidance this early on in the year? And then second, obviously, there's been a lot of concern during the quarter with competitor’s loss in a case for NEC as it relates to infant nutrition. I was hoping you could address that what's your stance on the ongoing litigation? I think there's about a thousand cases that have been filed and any upcoming data points or timelines we should be looking for."
},
{
"speaker": "Robert Ford",
"content": "Let's go first to your question on the guidance, yeah, you're right. I guess I had to go back and take a look at that. I think the last time we did raise in Q1 was in 2016. I would say the framework here, Rob, is we've always done is, we set a guidance at the beginning of the year, which we believe is top tier, and then throughout the year, we want to beat that guidance, and we consider top tier to be high single-digit double-digit EPS growth. And that's obviously excluding the COVID testing portion, which is what investors are really more focused on. So that was the guidance that we set a couple months ago, back in January. We will target always have that top tier guidance and find the appropriate balance between, the opportunities. And obviously the challenge is that bracket that range. If you remember in January, I said I thought that there was more opportunities than risks. I think that some of the risks that we saw in January, I still think they haven't gone away. They are still there, whether it's geopolitics or whether it's FX, those are still there. But clearly the performance of the business continues to be very, very strong. And some of our businesses, a lot of our businesses actually accelerating our in performance. As I said in my comments, five consecutive quarters of double-digit growth here. You look at each of the businesses, EPD consecutive, three consecutive of double-digit growth, great margin expansion, and the teams are now working to be able to introduce biosimilars in all the markets that we are participating in. Nutrition has done an incredible job at recovering share and growing our adult business. We have grown adult over $1 billion versus 2019. Diagnostics continues to have a great track record here, outperforming the market. We have got some great large account wins both in the U.S. and internationally that we're rolling out into this year. And medical devices, I mean, what can I tell you? It is just been a real strong performer. The team's done an incredible job there. Last year, we were the fastest growing MedTech Company, at least from what I have seen from our guidance and from the other guidance’s in the market. That's what it seems to be again this year. So you put all that together, plus the pipeline that's been contributing to an accelerated level, great new product approvals. I put all that together and I just feel that this type of performance that we deliver just gives us the confidence for the remainder of the outlook of the year. We felt comfortable raising the guidance again, in the first quarter, which is as you pointed out something that we don't usually do. I continue to believe going into the second quarter, as we move through that there's probably more opportunities than risks here, as we move forward. I guess that's the framework of raising our guidance in the first quarter, which is something that we usually don't do. Just great performance and great momentum. And then your other question was regarding the net cases. I would say from a date, we have some court cases that will happen in July. So that's maybe a milestone that we want to look at. But if you are asking me about kind of our framework of how we look at this. I'd say, for decades, we've provided specialized nutrition products that help doctors. And I think that's a key thing here. It helps doctors to provide the lifesaving nutrition to the premature infants. How you feed a premature infant, it's a medical decision, Robbie. Health care providers, they're going to use a range of options to meet the unique needs of each baby. That includes mother's milk, that includes pasteurized donor's milk, but that also includes preterm infant formula, because where mother's milk is not available, there is not a sufficient supply of donor milk to satisfy the nutritional needs of all of these premature infants that are born in the U.S. And quite frankly, even when they're available for some premature infants, human milk may lack some of the calories, the proteins, the vitamins et cetera that are necessary to support the nutritional needs of the premature infants. That mother's milk needs to be fortified in order to boost the nutritional output. The medical community, they consider these products to be critical part of the standard-of-care for feeding premature infants. Most of the societies when you read their positions, it is a standard-of-care to use these products. The doctors who work in the NICUs, they've used our products for decades and they continue to do so today. Countless babies, Robbie, have benefited from these products, lifesaving experiences over many, many years and there are clinical studies that have repeatedly established that, these products are safe. These litigation cases, they're really seeking to advance a theory promoted by plenty of lawyers that distorts the science and it distorts everything that we know and it's not supported by the medical community. We are preparing for our cases to be able to kind of lay out the facts, the science and the data and we stand behind our products."
},
{
"speaker": "Robbie Marcus",
"content": "Appreciate it, Robert. Thanks a lot."
},
{
"speaker": "Operator",
"content": "Our next question will come from Larry Biegelsen from Wells Fargo."
},
{
"speaker": "Larry Biegelsen",
"content": "Good morning. I'll echo, Robbie's, congratulations on the strong start to the year here. Robert, I just wanted to focus on EP. A multipart question here, but just one. The EP business grew nicely in the first quarter in the U.S. and outside the U.S. Can you talk about what drove that? What you're seeing with PFA in the different geographies? Your expectations for your EP business going forward before the Volt launch? Just lastly, it sounds like we should expect the Volt approval in Europe sometime next year based on the filing date. Just want to confirm that."
},
{
"speaker": "Robert Ford",
"content": "Sure. Like I said in my opening comments, we completed the trial. There's a six month follow-up, Larry. That means that, we will be on target here to file for CE mark by the end of this year. Then, it's just going to depend on that process. I think that's probably our anchor point here is getting the filing in before the end of the year. Yes, I mean, I'm not surprised by our EP growth. I know many on the call might be, but I'm not surprised. First of all, it's an important therapy. It's an underpenetrated disease. We know there's plenty of growth in this segment, and as a result of that, it's highly competitive. But we haven't been surprised by the growth. If you look at PFA, it's been in Europe for three years. If you average our growth rate over those last three years in Europe, we've been growing mid-teens, and the growth, it remains broad base. It was broad based in Europe, again, this quarter where we saw double-digit growth in ablation catheters. Not just on the mapping side, on the ablation catheter side also but then also great growth on the mapping side, and this technology has now come to the U.S. I think we probably had maybe two months of seeing the technology be rolled out here in the U.S. I think the competitors have been very aggressive here in terms of bringing the technology to the accounts in the U.S., and I can say, we've mapped a lot of those cases, Larry. I'm not going to say we've been in every single case, but I'd say, a vast majority of the cases we've been in there. And there are some similarities to Europe, but there are some differences to Europe. I think one of the things that we saw in Europe was that there was this inclination to use the technology starting off as kind of a one shot. So that had an impact more on the CRYO business than I would say on the RF side. And that's what we saw in our mapping cases. We saw here, at least in the first couple of months, that's where a large portion of those cases occurred, at least the ones that we mapped were in places where they were traditionally used in CRYO. I think the difference that we saw a little bit in Europe is that at least 90% of the cases that we were part of direct or indirectly were using mapping that that number was lower in Europe. So that's probably a little bit of the difference I saw here in the U.S., and that bodes well for us. Our end site system, our mapping system, our mapping catheters are widely viewed as an excellent option here for mapping these PFA cases. We have a large install base. Customers are familiar with it. Don't need a make room, don't need a fight for capital. We've got best in class clinical support. And the architecture here is open, as I've said in previous calls. So it integrates well with these PFA catheters. We actually recently released a software upgrade last month that provides even better visualization to these catheters and potential for faster procedures and less floor time. I think this is a perfect combination, quite frankly, in a time where there's going to be market transition, There's a lot of new products, there's a lot of choices. And when you have a situation like that, I think flexibility is key, and that's what we heard from our customers. One data point that I thought was also interesting to your question of what helped drive that in the cases that we were part of, and we saw, we also observed that an RF catheter was pulled in about a quarter of the cases that we saw. So on top of the PFA catheter, an RF catheter was pulled to do touchups, et cetera. I'd say right now, everything that we've seen in Europe on the positive side is happening. And then I think there's some interesting dynamics here in the U.S. that could be favorable for us also, but it's still very early. If I look at March, we had probably one of our most, we look at cases per day. That was probably one of our highest months. So far so good. And we're excited about the technology, we're excited about our program. We released data on our program and some recent medical meetings that occurred. And the feedback, from those that have been used in our product are very positive. And the integration with EnSite in including like the tissue contact force algorithm and the visualization, all of that is seen as a real promise and a differentiator versus what's being used today."
},
{
"speaker": "Operator",
"content": "Our next question will come from Josh Jennings from Cowen."
},
{
"speaker": "Josh Jennings",
"content": "Great to see the strong start here, the Q1 results. Robert, I was hoping to just ask first on Libre and just internationally, any other payment or coverage decisions that we should have on our radar in various countries. Sounds like you have made sense, some nice progress already in Germany, and then in the U.S. I was hoping you could just help or share your thoughts on the share gain opportunity in integrated pump segment of CGM market versus the share loss risk in the Type 2 non-insulin cash pace segment with a competitive launch share early in 2024. I just have one follow up."
},
{
"speaker": "Robert Ford",
"content": "On your international question, I mean, it's always difficult to forecast exactly by month a quarter coverage kind of payment decisions. I can tell you though that the team has a full global map of all the work that's being done regarding clinical information and negotiations, et cetera. It's difficult to kind of forecast it, but what I have said is on previous calls and on some of my prepared remarks that I think you're going to see this just this build that will be occurring globally in the market as the data proves and shows the clinical medical and health economic benefit by reimbursing for this patient population. And I think we're well positioned there. Internationally, I think we got some pretty large markets already. Canada, Japan, France, Italy, Germany, those are markets that are either fully reimbursed or starting their process. And like I said, I think you will see as the year progresses, whether it's in medical events or just as the year progresses, I think you'll see more coverage decisions. Maybe they don't get splashy, big PR news, but we are seeing continuous increasing there on that. On the U.S. side, I guess I disagree with your premise that I'm going to be trading share gains on the pump side for share losses on the non-insulin side. I mean, I'm just, right now I'm looking at the data, third party audited data, 7 out of every 10 new prescriptions for this basal population, which is primarily served by the primary care channel, 7 out of 10 are going to Libre. I think our product's going to get even more competitive and compelling, I think this is a great opportunity and our objective here is to maintain kind of our shared dominance and our share leadership as it results in this patient segment. But we do have an opportunity here to participate a little bit more actively in what is a little bit more of a smaller segment of the population, but nonetheless a very important one, which is the AID and the market system. There's 150,000 to 200,000 new starts a year. There's an opportunity for share gain also of existing users. I think that, the opportunity to bring a dual analyte sensor with ketones. We showed some data at ATTD this year, that showed the safety benefit or the value proposition of a dual analyte sensor for AID system. I think that's going to be a compelling value proposition. We are working with all the pump companies here and I think as the year progresses, we'll see connectivity occur whether it's with Libre 2 Plus our streaming product or whether it's with Libre 3. This is an area that we are focusing on and it's a new segment for us to compete in. But I don't think that, we are going to be taking our eye off the ball as it relates to the basal opportunity that exists."
},
{
"speaker": "Josh Jennings",
"content": "Understood. Thanks. And then just wanted to ask on the transcatheter tricuspid market, congratulations on the TriClip approval, but there's been some questions around the patient opportunity breakdown between TIER, TriClip and replacement with EVOQUE. Maybe just any internal team thoughts on that patient opportunity breakdown and then maybe you could share on the pricing strategy for TriClip in the setting of competitor pricing its replacement device at a significant premium? Thanks for taking the questions."
},
{
"speaker": "Robert Ford",
"content": "I'm not going to comment on our pricing strategy for competitive reasons. It is a differentiated and novel technology. There is an opportunity, but we'll have to see how this all plays out. You got NTAP submissions and all this stuff going on right now. What we are focused on here is, launching the product and getting cases ramped up and that's what's happening. I got some feedback yesterday from the team after a couple of weeks, real nice cadence of growth. We are obviously focusing on our initial cases on most of the account that were part of our pivotal trial, but just but just real nice cadence growth there and great feedback from physicians and patients post-surgery. I mean, if you're trying to poke at, what's the breakdown going to be about replace and repair, listen, I think it's good to have options. I guess my view here is that, I believe that, probably safety is a key driver here, just to start off with. I think TriClip has shown a very strong excellent safety record, both in clinical trials and real world use. I think that's going to play a key role here in determining repair versus replace. I expect repair or TriClip at least to be the preferred option unless the valves are too damaged and then obviously replacement is the only option. But there is a large pool of patients here. You got 5 million people globally, 2 million people here in the U.S. and it's going to be an opportunity here that we will be generating more data, expand the indication of the product. I think this is easily a $1 billion opportunity for us here as we build the capabilities and as we build more clinical data."
},
{
"speaker": "Operator",
"content": "Our next question will come from Travis Steed from BofA Securities."
},
{
"speaker": "Travis Steed",
"content": "Maybe just while we're on the pipeline, talk a little bit about AVEIR it sounds like that that product's going really well. And then I had a question on gross margins as well. Trying to think about is this the right pace to kind of get back to pre-COVID levels and still the opportunity kind of longer term for gross margins?"
},
{
"speaker": "Robert Ford",
"content": "I think if AVEIR's done very well, I mean, we all know the advantages it has over the competitive system, whether it's single and dual chamber, the longer lasting battery, the ability for replacement, retrievability, upgradeability. It's done very well. From a single chamber perspective, I think we are now at about 50 share of the US market. So that's been doing very well. It's performed, we started doing our dual chamber procedures towards the end of last year. Seeing a nice kind of ramp up over this first quarter here. Focus here really is a really about, it's a completely different procedure, right? If you think about how these devices have been implanted, this is probably the first time in like 30 years that you have like a real meaningful change on how this is done. Our focus here is really getting great clinical results real thoughtful approach here about opening new sensors and training. And that's been working very well for us. And you could see the impact on our growth rate. I mean, historically our CRM business has been relatively flat with some platforms going up, some platforms going down. Our goal here with this program was to get our CRM portfolio to at least be contributor to growth mid-single digits, 6%, 7%. These last couple of quarters we've done seven and a half percent, and so AVEIR's been doing well, and it's going to continue to get better as more and more physicians get trained and we increase the amount of accounts. So I really like the cadence of how we're forecasting this business and the impact that it's going to have on our CRM portfolio. What was your other question?"
},
{
"speaker": "Travis Steed",
"content": "Just on gross margins, kind of thinking about the path back to pre COVID levels over the long term and is this the right kind of cadence that you're -- this year's cadence, the right way to think about that?"
},
{
"speaker": "Robert Ford",
"content": "I think that's a good cadence. I think we're forecasting here about 70 basis points of improvement this year. Feel good about that. I've talked about this not being a question of if, just a question of when, so I think that's not a bad cadence. And we're going to focus on the things that we can control and the things that we can control are obviously our cost and our cost teams and the teams that are working on improving gross margin, they're delivering great results here, while at the same time maintaining high service levels not running to back orders, et cetera. But probably the biggest the biggest opportunity we have here Travis, is just to expand the gross margin through portfolio mix. When you have our medical device businesses growing at mid-teens consistently over the last, whatever, four or five quarters, that has a real strong impact on our gross margin. So a lot of focus on what we control our gross margin, the cadence. That's what we are targeting. It's not really a question of if it's just a question of when."
},
{
"speaker": "Operator",
"content": "Our next question will come from Vijay Kumar from Evercore, ISI."
},
{
"speaker": "Vijay Kumar",
"content": "Robert, I had a two forward question. A lot of questions on pipeline, but I'm curious when people ask us on sustainability of growth, if you could elaborate on pipeline, what else is there? When you look at the future, that gives us the confidence of sustaining its premium growth within the med tech industry. My second part was on the financial modeling side, looks like FX headwinds came in a little bit higher. Prior guidance that is $0.20 headwind to EPS from FX. Did that increase? I'm just curious on because some questions on why the high end of the guidance was not raised. I suspect the FX headwind increase."
},
{
"speaker": "Robert Ford",
"content": "As I said, there are certain challenges that still remain with us from January and FX is one of them. I'll let Phil answer that one. On your question on pipeline, listen, I could spend a whole hour on this just going through the pipeline, but I guess I would bucket them into like three categories, Vijay. I would say you got your current contributors and Libre and Alinity, they still operate like pipeline projects and products. We still got multiple innovations going through them. MitraClip, great familiarity, AVEIR, Navitor, TriClip, Amulet, PROTALITY or our concussion tests, I think got great opportunity and CardioMEMS, I mean, these are all products that I would still characterize them as early innings. Yes, they're established, but they're still early innings and they got a lot of growth rate there. The second group of products I would call, probably near-term future contributors, so think about it in the next 12 to 18 months, these products coming to market and starting to kind of generate revenue there. Our lingo product, I'm very excited about that and bringing that to the U.S. and expanding that globally. Our dual analyte sensor, our Volt system Esprit, which is our drug eluding bioabsorbable stent for below the knee. It will be the first of its kind. We are developing a whole new Alinity system that will target a segment of the market that we currently don't participate in. And there'll be more to come on that. And then just the great opportunity we have with biosimilars into the emerging markets and doing it in a very capital efficient way. And bringing that and leveraging our position there. That's our next 12 to 18 month kind of catalyst there. Then thinking about beyond 2026, I mean, we are working on a PFA, RF catheter. You got leadless, another kind of leadless pacing system that would be launching. We have a second generation Amulet, excited about entry into the IVL market sometime in 2027, coronary DCB, we're working on kind of new TAVR systems also that allow us to branch out into other segments. We've got a whole plethora of new analytes in our bio wearables market that will start to come out and have different applications in 2026. And then on top of that, all the clinical work that we're doing to expand indications, expand market, whether it's in TAVR, whether it's in LAA, whether it's in mitral. So we've got, I'd say a real nice cadence here of products and pipeline beyond, I'd say, the next 12, 18 months. We're looking at this '26, '27, '28 and I feel really excited about that. There's obviously more that we need to do and add, but I think the base here looks really good in terms of the pipeline. And then I think your question on FX, Phil, you want to take that?"
},
{
"speaker": "Phil Boudreau",
"content": "Yes. I mentioned at the onset here, Vijay, in Q1, we saw about a 2.9% headwind on sales growth and we kind of the current rates anticipate something similar here in Q2. From a full year perspective at the current rates, it's about a 2.5% headwind on the top-line. That said, kind of the earnings guide that we have here is in line with the organic sales performance and drop through to earnings on the increased midpoint on EPS guidance."
},
{
"speaker": "Operator",
"content": "Our next question will come from Joanne Wuensch from Citi."
},
{
"speaker": "Joanne Wuensch",
"content": "Good morning. May I add my compliments and congratulations to the quarter? I have two questions put them right up front. The first one is on concussion testing. I'd love to understand the go-to-market strategy for that, how you think about the financial benefit impact and all that kind of good stuff? But I think my second question is a little bit more big picture. As you step back in a post-pandemic environment a couple of years into the CEO seat, how do you think about taking Abbott sort of to the next level? I mean, we all sit here and take a look at an incredibly strong balance sheet. How do you put that cash to work? Are these segments, divisions, ones you want to keep? Or how do you think about adding to it?"
},
{
"speaker": "Robert Ford",
"content": "Sure. On the point of care concussion test, I guess I'd summarize the opportunity here in twofold. I think there's a market conversion component to this, Joanne. I mentioned there are 5 million ER visits to diagnose a concussion. The number one method there to use that is on a CT scan. I think there's an opportunity here to transform that and allow one to get a faster response in that emergency kind of emergency room visit, which is where the -- and the point of care team already have a good position with some of our other blood gas and other assays that we provide to that segment. I think this will slide right into that team. The value proposition here is going to be, okay, what's the cost of the system and can we bend that cost curve. I think we've shown a little bit how we think about things Joanne, if you look at Libre, if you look at Binax, if you look at how we think about pricing our products, when it comes to market conversion and the opportunities that we have there? We'll be able to do it at a nice return for our shareholders. I think that's an important part. The market expansion opportunity that we have, I think is going to still require some work on the product. Right now the product is approved whole blood, but it's a venous draw. We're going to be working on a capillary draw and if you can then run this assay, taking a sample from a finger prick, then you can look at bringing that technology even closer to where the need for a rapid concussion test would be. You could just look at how many universities exist in this country, how many high schools exist in this country? You can do some multiplications there and say, this is a great market creation, market expansion opportunity. I think that that's how we're thinking about it commercially, conversion and creation slash expansion. There's some more work to be done in terms of the product and the claims and the trials there. This will be a multi-year kind of program over here where we'll start to see kind of nice growth in that segment. And then your other question was about the portfolio and balance sheet. And do we like the four segments? The answer to that is yes, we like all the four segments. We feel that it gives us a real unique view into the healthcare system as a whole starting with nutrition that's obviously the bedrock of good health. But then, things happen and you need to get a diagnosis. And we've got a great diagnostic portfolio that we've been expanding on and building on to make sure that we can capitalize on all the different types of modalities and locations where people can get tested. And then, once a physician knows what the problem is, then they got to run through treatment, right? And we do that either through a medicines business or through a medical device business. I think all four segments are super well aligned to the global demographics and trends in healthcare. And so we like that there's always opportunities to add, and we've shown that if there are areas that we feel that we can bring value in a combination then as you mentioned we've got a strong balance sheet and strategic flexibility to do that. As long as we feel that we can add value to that asset. We felt like that about CSI, we felt like that about St. Jude. We felt like that about Alere. And those deals, they obviously help kind of reshape the company and accelerate our growth rates. But I think that's predicated on us really believing that we can kind of bring value and we're not trying to fill some top line gap or some issues. ROIC for us matters, profitability matters. We've got opportunities and we could be a little bit more selective to be able to add, but I like the four segments that we're in. And they've been well to shareholders, especially the long-term shareholders."
},
{
"speaker": "Operator",
"content": "Our next question will come from Matt Miksic from Barclays."
},
{
"speaker": "Matt Miksic",
"content": "Congrats on the really strong quarter, particularly med devices. I had one follow-up on the -- sorry, here, background. One question on structural heart. Robert, you talked a little bit about the portfolio and the combination of the leading peer device and MitraClip of being a little bit more mature in the category of structural heart, but being kind of augmented by some of these new products like most recently, obviously TriClip. And if you could talk a little bit about sort of the momentum in the portfolio as well as how much of the build out of this portfolio is still coming organically or under review kind of strategically, I appreciate it."
},
{
"speaker": "Robert Ford",
"content": "Sure. I mean I didn't want my comments on mitral to be construed like that 1 there is slowing down, and we're relying on others to drive the growth. I mean, that wasn't the intent. If you look at MitraClip this quarter, it's high single digits. And if you look at the last 5 quarters, that's what it's been doing between high single-digits, low double-digits. And that's good. But we always had a view here that this is an attractive area of growth, an attractive area of medical need. And we wanted to be a leader here. So yes, MitraClip, I guess we can call MitraClip, the founding father of our structural heart portfolio. But I think the team here has done an incredible job at bringing organic innovation into the portfolio. So if you look at our structural heart, I mean, we grew 13% today. MitraClip grew high single digits. But it accounted for 3% of that growth. The rest -- the other 10% came from all the rest of the portfolio that's being built. So I think that you'll continue to see that. We'll continue to make investments in this business, continue to make investments in the pipeline. I'd say right now, most of it is organic, whether it's innovating on LAA, innovating on our TAVR side and all the clinical trial that we're doing there. If there's an opportunity inorganically, I just put that in the same bucket that I think I answered kind of Joanne's question here if it makes sense. And we can add it. We've got the flexibility to do it. But the whole strategy here was to say, listen, we're going to build a multibillion-dollar structural heart business that can sustainably grow double digits. And the way to do that is you can't be a division of only 1 product. And I think the teams over the last 4 or 5 years, have done a really good job at building that and there's more opportunity. I'd say probably the one that we're looking at and is very exciting for us is mitral replacement. We've launched our Pendine product, which was more a transapical system. Our Cephea system is the transfemoral transseptal and feedback that we've seen from early implanters, early first in man is that this is a great, great valve. So there's an opportunity there also. So I'd say most organic, but we got the capacity for inorganic if it makes sense."
},
{
"speaker": "Mike Comilla",
"content": "Operator, we'll take one more question, please."
},
{
"speaker": "Operator",
"content": "And our final question will come from Danielle Antalffy from UBS."
},
{
"speaker": "Danielle Joy Antalffy",
"content": "And yes, congrats on a strong start to the year. Robert, we spent a lot of time talking about the durability of growth in the med tech business. So I don't want to get too greedy, but just following up on Joanne's question regarding you guys do have a strong balance sheet. Are there any areas -- I guess sort of how do you feel about the state of the med tech business today? And do you feel there are growth areas within med tech that maybe Abbott isn't participating in today that Abbott could or should participate in today? And where are you looking beyond your current markets, if at all? I'll just leave it to one."
},
{
"speaker": "Robert Ford",
"content": "Sure. I get the attempt for triangulation here in the multiple different ways, and I guess I'll sign a little bit boring here in terms of how I talk about this. I've been public that, yes, we are interested. We look at areas that we can add value to. I'd say, probably the ones that have jumped out more at us in terms of a study and looking at are probably more in the medical device side and on the diagnostic side. We did look at a strategy for biosimilars for our medicines business and that was a pretty capital efficient way to do it. Yes, we're looking. We continue to study, but I'm not going to sit here and telegraph exactly it's this, it's that. I think the key thing here is just, I mean, look at our medtech business did this quarter, look what it did previous four quarters and that allows me to be a little bit more selective. Over the last couple of months we've seen some fairly large transactions in the medtech space. Those seem to be attractive growth areas. I talked about us getting access to some early IVL technology with the CSI acquisition. That's an important area for us to focus on. But I don't feel that, with our strong organic growth that we need to go out and not pay attention to like other key financial metrics that for us are important in terms of ROICs and those, because we've got that strong growth rate in medtech. You won't get me telegraphing here exactly, Danielle, what specific segments we are looking at. What I can tell you is, we have an active team. They study a lot. We look a lot. We follow a lot. If there's a moment that makes sense for us and those segments continue to be interesting, we've got the balance sheet and the track record to show that, we can drive value out of these acquisitions. I'll just leave it like that. Yes, we've got flexibility, that doesn't mean that we don't pay attention to other key financial returns as we're looking at it. I feel that I can do that because we've got such a strong top-line growth and great pipeline and prospects. With that, I'll leave it like that. I'll just close by saying that, we're very pleased with a very strong start to the year. We delivered another quarter of double-digits organic sales growth on the base business. The investments that we've made during all those years of COVID are generating real strong returns. The pipeline continues to be highly productive, as I've outlined. We've got clear visibility to a pipeline all the way out to '27, '28. Obtained several new product approvals that are going to help us accelerate our growth in certain areas. Typically don't raise guidance in the first quarter, but given the strong performance and the outlook and the remainder of the year, we felt comfortable doing that and we're very well positioned to continue to sustainably deliver top tier results. With that, I'll wrap up and thank all of you for joining us today."
},
{
"speaker": "Mike Comilla",
"content": "Thank you, operator, and thank you all for your questions. This now concludes Abbott's conference call. A webcast replay of this call will be available after 11:00 am Central Time today on Abbott's Investor Relations website at abbotinvestor.com. Thank you for joining us today."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day."
}
] |
acgl | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good day, ladies and gentlemen, and welcome to the Q4 2024 Arch Capital Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the company with the SEC from time to time, including our annual report on Form 10-K for the 2023 fiscal year. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends forward-looking statements in the call to be subject to the safe harbor created thereby. Management also will make a reference to certain non-GAAP measures of financial performance. The reconciliations to GAAP for each non-GAAP financial measure can be found in the company's current report on Form 8-K furnished to the SEC yesterday, which contains the company's earnings press release and is available on the company's website at www.archgroup.com and on the SEC's website at www.sec.gov. And now I would like to introduce your host for today's conference, Mr. Nicolas Papadopoulo and Mr. Francois Morin. Please go ahead."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Good morning, and welcome to our fourth quarter earnings call. I'll begin by offering our thoughts and sympathies to all of those affected by the California wildfires. This is a terrible event that will require the effort of many, including insurance companies, to help the affected communities recover and rebuild. At last, we will, of course, fulfill our role in these efforts. As noted in yesterday's press release, we expect the wildfires to result in a net loss between $450 million and $550 million based on an industry loss estimate of $35 billion to $45 billion. Turning now to our results, Arch had a solid top quarter writing $3.8 billion of net premium, which is a 17% increase over the same quarter last year. The $625 million of underwriting income in the quarter is down 13% from last year, primarily due to losses related to cat activities in the second half of 2024. Our full-year results were excellent, with $3.5 billion of after-tax operating income and an operating return on average common equity of 18.9%. Despite an increased level of natural catastrophes, book value per share, a preferred measure of value creation, ended 2024 at $53.11, representing a 13% increase for the year and nearly 24% increase after adjusting for the impact of the $5 per share special dividend we paid in December. The decision to pay a special dividend was the result of Arch's strong financial performance and excellent capital position and represented an effective means of returning excess capital to our shareholders. We also repurchased shares worth $24 million in the fourth quarter. Both the dividend and the share repurchase reflect our ongoing commitment to effective and active capital management. Market conditions within our segments remain favorable with a number of select growth opportunities ahead of us. As you may have heard from our peers this quarter, rate and loss trends vary by line of business. Broadly offset each other. All hands do not point to the same underwriting clock. For example, we are selectively deploying capital to the areas producing attractive risk-adjusted returns such as insurance and reinsurance liability lines, specialty business at Lloyds, and property charter insurance. Alternatively, lines of business where competitive pressures have eroded margins to levels below adequate, our underwriting teams are focused on improving our business mix within each of those lines to ensure our minimum profitability targets are met. Effective cycle management, the key to our strategy, requires empowering underwriters to execute on both sourcing and retaining attractive business without the constraint of production targets. In classes and subclasses where returns do not meet our minimum threshold, we have the agility and the incentives to reallocate capital to more profitable opportunities across our diversified portfolio. And as we have demonstrated throughout our history, we will not hesitate to return excess capital to our shareholders when appropriate. Now I will offer a few highlights about the performance of our underwriting segments starting with reinsurance, which finished the year with a strong fourth quarter delivering $328 million of underwriting income. The full-year results for the reinsurance group were excellent. The segment delivered a record $1.2 billion of underwriting income while writing over $7.7 billion of net premium. At the January first renewal, we grew the reinsurance business by selectively increasing our writings in property liability and specialty lines. Arch's status as a leading global reinsurer is a result of its focus on addressing broker and clients' needs, combined with its underwriting vigilance and high degree of scrutiny on the performance of its business. Throughout the whole market, Arch has had the conviction to increase its support and relevance with brokers and clients, making Arch a more valuable collaborative partner when other reinsurers wavered and in some cases, even withdrew capacity. Now moving to insurance, which also sees some strong growth opportunities in 2024. Overall, Arch and Helene and Milton limited fourth quarter underwriting income to $30 million. For the full year, the insurance group wrote $6.9 billion of net premium, a 17% increase from 2023, and delivered $345 million of underwriting income. Growth was enhanced by the acquisition of the US Midcorp and Entertainment business. Although it's still early, the performance and integration of the Midcorp and Entertainment business are consistent with our expectations and objectives. Organic growth in North America came from our casualty business unit, which more than offset premium decreases in professional lines. International insurance remained a bright spot, writing over $2 billion of net premium in 2024, primarily in specialty lines out of our large platform. Overall, rate increases remained slightly above loss trends, keeping return margins relatively flat in the fourth quarter. The outlook for both North America and international insurance growth is favorable for 2025. Looking ahead, we expect primary market conditions to remain competitive given the attractive underlying margins. However, we have experienced a slowdown in new business volumes as competition for premium volumes has increased. The mortgage segment contributed $267 million of underwriting income in the fourth quarter, resulting in the first consecutive years of delivering over $1 billion in underwriting income. Fundamentals remained positive, including strong persistency of our $500 billion-plus insurance in force portfolio, while the overall credit quality of the book remains excellent. The delinquency rate in our US MI business increased modestly to just over 2% at the end of December but remained near historic lows. Increased delinquency can be attributed to expected defaults in areas hit by natural catastrophes and the seasoning of the insurance in force. Overall, the US mortgage insurance industry remained disciplined despite suppressed mortgage origination due to low housing supply and high mortgage rates. Finally, to the investment group, which delivered nearly $1.5 billion of annual net investment income from an asset base that increased to over $40 billion after accounting for the special dividend. Rising investment yields and the growth of our investable assets from strong operating cash flows provide additional tailwinds for our earnings and book value growth. Overall, 2024 was another excellent year for Arch. Looking ahead, our primary goal is to maintain attractive margins despite expected heightened competition. Our strong underwriting culture, proven track record of cycle management, dynamic capital management capabilities, and progress to date in becoming a data-driven enterprise give me confidence in our ability to navigate ever-changing market dynamics with a clear objective of maximizing shareholder return over the long term. As we officially turn the page to 2025, I want to recognize the hard work and dedication of Arch's nearly 7,000 employees who share in our entrepreneurial culture that demands and rewards excellence to the benefit of our clients and stakeholders. Now I will turn it to Francois to provide more detail on the financials before returning to answer your questions. Francois?"
},
{
"speaker": "Francois Morin",
"content": "Thank you, Nicolas, and good morning to all. As you know by now, we closed 2024 with fourth-quarter after-tax operating income of $2.26 per share, for an annualized operating return on average common equity of 16.4%. For the year, our net income return on average common equity was an excellent 22.8%. Once again, our three business segments delivered a combined ratio of 78.6% for the year. Current accident year catastrophe losses were $393 million for the group in the quarter, split roughly 60% and 40% between the reinsurance and insurance segments respectively. Most of our catastrophe losses this quarter are due to Hurricane Milton, a fourth-quarter event, with an additional contribution from Hurricane Helene, where we saw some delayed emergence of claims given the late occurrence date in the third quarter. As of January 1, our peak zone natural catastrophe probable maximum loss for a single event at a one-in-250-year return level on a net basis increased slightly and now stands at 9.2% of tangible shareholders' equity. Our PML remains well below our internal limits. As we look forward to 2025, with the recent addition of the Midcorp and Entertainment business, and current market conditions in property, we expect our cat load to represent approximately 7% to 8% of our full-year group-wide net earned premium. Our underwriting income in the quarter included $146 million of favorable prior development on a pre-tax basis, or 3.5 points on the combined ratio across our three segments. We recognized favorable development across many lines of business but primarily in short-tail lines in our reinsurance segment, and in mortgage due to strong cure activity. As we discussed last quarter, the acquisition of the mid-corporate entertainment insurance businesses has impacted some key performance metrics for our insurance segment. First, the net written premium coming from the acquired businesses was $393 million for the quarter, contributing 27.1 points to the reported quarter-over-quarter premium growth for our insurance segment. Second, the acquired business lowered the insurance segment's accident year ex-cat combined ratio by 1.6 points this quarter. This result was due to the current quarter's acquisition expense ratio that was lowered by 2.1 points due to the write-off of deferred acquisition costs for the acquired business at closing under purchase GAAP, and an operating expense ratio that was lowered by 0.8 points as our Midcorp operations aren't fully ramped up yet. Partially offsetting these benefits was an increase in the accident year cat loss ratio of 1.2 points, reflecting the underlying results of the acquired business. On a related note, we expensed $99 million this quarter through intangible amortization, more than 75% of which was for the mid-corporate entertainment acquisition. This expense was in line with our expectations as we communicated last quarter. On the investment front, we earned a combined $548 million pre-tax from net investment income and income from funds accounted for using the equity method, or $1.43 per share. Our net investment income this quarter was partially impacted by a $1.9 billion dividend paid in December, which entailed that we liquidate a portion of our investment portfolio. Cash flow from operations remained strong. It was approximately $6.7 billion for the full year, up 16% from 2023. Our effective tax rate on pre-tax operating income was an expense of 6.7% for the quarter and 8.2% for the full year. As we look ahead, we would expect our annualized effective tax rate to be in the 16% to 18% range for the full year 2025, reflecting the introduction of a 15% corporate income tax in Bermuda. On a cash basis, we will start recognizing this with the establishment of the $1.2 billion deferred tax asset at the end of 2023. As you may have heard on other calls, the recent OECD guidance may partially impact the realizable value of the DTA. We will keep you apprised as additional information becomes available. In closing, our balance sheet remains extremely strong with common shareholders' equity of $20 billion after recognition of the $1.9 billion common dividend that was paid in December. Our debt plus preferred to capital ratio remains low at 15.1%. With these introductory comments, we are now prepared to take your questions. Sylvie?"
},
{
"speaker": "Operator",
"content": "Thank you, Mr. Morin. If you would like to ask a question, please press *1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. And your first question will be from Elyse Greenspan at Wells Fargo. Please go ahead."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi. Thanks. Good morning. My first question is on the insurance underlying loss ratio. I mean, I recognize, right, Francois, you highlighted, you know, some of the impact right, from the Allianz deal coming in right a little bit over one point calculated kind of Arch standalone, running at just under fifty seven, which is close to the Q3. Is it right way to think about it that that's about where Arch is and then kind of blend in, write this a little bit over one point from Midcorp so that insurance underlying is somewhere in the range of fifty eight on an ongoing basis, something like that."
},
{
"speaker": "Francois Morin",
"content": "Yeah. That's about right. I think the yeah, the the impact of MC is, call it, know, on the loss ratio, about one point. So whatever the assumption you have around the, you know, pre-MC kinda run rate loss ratio, which is pretty stable has been pretty stable. There's some movements up and down from quarter to quarter, but generally speaking, it's been it's been stable. And introducing the MC maybe adds about a one one point to to that."
},
{
"speaker": "Elyse Greenspan",
"content": "And then my second question is on reinsurance. Right? You guys you know, pulled back a little bit at midyear twenty four. Now the PML went back up, right, but it's flat. You know, one one twenty five with one one twenty four. Did you see conditions get incrementally better at January one. I'm just trying to understand the thought process around, you know, bringing the PMLs back up a little bit."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "No. I think I think what's happening is that we we like the business. So I think, you know, absent the the competitive nature and other people liking the business too, I think we we're looking to write more of this business. We think the the the returns are quite attractive. And I think at one one, we we had we had some opportunity to do so based on our positioning. So I think we we were pleased by that, I think."
},
{
"speaker": "Elyse Greenspan",
"content": "And then I guess the the follow-up to that is, right, the California fire is pretty big loss. Do you see that know, being able to impact other cat renewal seasons in twenty five. Some of it, I guess, might bleed one one twenty six. How do you see the market impact from the California fires? And is this something, you know, where you guys would expect your PML and and cat ridings to go up during the year?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "So I think, you know, the as I mentioned in my remarks, I mean, this is a significant loss for the market. I mean, we pitch it between thirty thirty five and and forty five billion. We believe that a significant part of that losses will go to the reinsurance market. I think it will I think most reinsurer, including ourselves, we we start the year with a loss ratio. You know, in the twenties or the thirties or depending of your luck, maybe higher than that. So I think it would it should, you know, dump all the enthusiasm of you know, many market trying to be heroes and and and and and writing the business. So I would I would think that it it will have a an effect on on on on on the rates at at you know, for the rest of the year. So Thank you. And that's Thank you."
},
{
"speaker": "Operator",
"content": "Next question will be from Michael Zaremski at BMO. Please go ahead."
},
{
"speaker": "Michael Zaremski",
"content": "Hey. Thanks. I guess, first question, I'll just go back to the the catastrophe load guidance. Seven to eight it Probably just obvious, but that so that includes right. It's higher than the historical six day mostly because of the the one q California losses is that correct?"
},
{
"speaker": "Francois Morin",
"content": "A little bit, but also the MCU acquisition adds, you know, on a relative basis, kind of adds a little bit of you know, of load to, you know, to the, you know, to to increase the cat load. Because it's it's it's a heavier property book than people in this know, realize it. It didn't really Impact or PMLs because it's in different zones, it's more distributed. But when we think about you know, the contribution to the to the cat load throughout the year. It it has a meaningful impact."
},
{
"speaker": "Michael Zaremski",
"content": "Okay. I would have actually plugging in the Cali losses. I actually would have thought to lower would have been a little bit higher, but but okay. Good good color. Switching gears just to the I guess one of the elephants in the rooms for for lots of insurers is going back to the kind of the casualty GL umbrella environment. In some of the prepared remarks, was, you know, said that overall rate increases remain slightly above loss trend. I think that was the primary insurance marketplace. Any comments on whether you know, what you're seeing And you're GL book. I know that, you know, you guys are one of the more honest ones. In my humble opinion. And at the investor day, you know, you said you'd probably be adding small amounts to your your GL reserves, but, you know, nothing that that's really too out of out of trend line with what you've you've been doing for a while now and better than the industry. But any updated commentary on what you're seeing there?"
},
{
"speaker": "Francois Morin",
"content": "Yeah. And so I think I'll answer in two parts. One on the position, we didn't add to our reserves. We're very comfortable with the reserve position both both in insurance and reinsurance. You know, our actual versus expected analysis or year end analysis all are supporting that that view that our reserves for prior accident years are are very adequate. So no no concern there. But as we look at, you know, second half of twenty four and into twenty five, you know, yes, we are seeing rate changes keeping up with loss trends, so we're not and even exceeding in some places. So we're comfortable with the the environment there. But we also recognize that there's a lot of uncertainty there. So we are being cautious, prudent. We are in some specific very targeted areas increased our initial loss picks. But it's not I think I wanna make it clear here. It's not as a reflect it's not a reflection of adverse development or, you know, signals or data telling us that we missed a mark on the old years, It's very much a function of the current rate environment and how we perceive the risk around our initial loss picks. And for that reason, we're choosing to be a bit more prudent."
},
{
"speaker": "Michael Zaremski",
"content": "Okay. Got it. And just lastly, real quick. Thanks for the tax rate guidance. Is the DTA that was established is I think some of some peers have said that they're could be tweaks to to the DTA due to guidance from from Bermuda. Is that something that's influx or any way you could kind of a a handicap whether, you know, if it if a DTA was influx, would it change materially or just a little bit?"
},
{
"speaker": "Francois Morin",
"content": "Yeah. I mean, the guidance right now and that's an important thing, it's it's guidance that's not the law, which you know, we do follow, obviously, Bermuda law, which allows us or instruct us really to carry the DTA. The recent guidance from the OECD suggests that you know, we may only be able to realize up to twenty percent of that amount. That is still again, that that's the light of guidance. I mean, things change pretty quick in this when we start talking about taxes, but if know, I I'd say you know, from your perspective, maybe worst case, that's kinda what may happen is that we end up only realizing twenty percent of this amount and the rest we might have to write off at some point you know, in twenty six or late twenty six or twenty seven, But for the time being, Bermuda law has not changed, and that, you know, that's what we're following."
},
{
"speaker": "Michael Zaremski",
"content": "Appreciate the color."
},
{
"speaker": "Operator",
"content": "Thank you. Next question will be from Jimmy Bhullar at JPMorgan. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"content": "Hey. Good morning. So just had a question. A different topic. On MI reserve releases, can you go through the details on what's driving those and how much of that is from the last one to two years versus maybe a few years back? And just your overall expectations for margins in that business?"
},
{
"speaker": "Francois Morin",
"content": "Yeah. I mean, the reserve release has come, you know, from both I mean, from all three of our segments. Right? There there's a meaning again, that's a little bit of of the same story that we've we've been talking about the last few quarters where you know, we based on conditions at the time, I wanna say twenty two and twenty three, we had set up initial reserves on the delinquencies that were reported at the time and turns out that people have been curing and and severity has not been to the level that we thought. So that's just a normal, I'd say, kinda You know, process that the reserving, you know, we go through with our reserves at USMI at say for the other pieces, a little bit of the same, I say, in the CRT business where you know, it's a slightly different methodology, but we have initial loss picks on that business and that has proven out to be a little bit kinda in excess of what we need today. So there's been some releases there, and finally, the international book, a little bit of the same too where you know, there there's different methodologies in place, but the the the long story or the, you know, the short of it maybe is that you know, all three books or all three pieces of our mortgage segments are performing really, really well. So we like the margins. We think the margins are are healthy. We don't see any deterioration in how we think about, you know, the business and the returns we're writing today. So if we're very very excited about it."
},
{
"speaker": "Jimmy Bhullar",
"content": "And then on share buybacks, I'm assuming part of the reason you did a little bit of buybacks this quarter versus none before was just the decline in the stock price. So assuming the stock's stays around here, Reasonable to assume that you'd be active throughout twenty five as well?"
},
{
"speaker": "Francois Morin",
"content": "For sure. I mean, it's something we look at, you know, regularly. I mean, every time all the time. No. I mean, in this particular situation, yes, there's old kinda, you know, opportunity in late in the fourth quarter. But, you know, our capital position remains strong even with, you know, the California California wildfires. I mean, that's part of the volatility we may see from time to time, but, you know, whether again, we we will not sit on a level of excess capital that we don't think we can deploy in the business. So if the if we don't you know, we stink we still think we can grow. We we are bullish about twenty twenty five. The market conditions are still really good."
},
{
"speaker": "Jimmy Bhullar",
"content": "But"
},
{
"speaker": "Francois Morin",
"content": "You know, can we deploy all the capital we have or that we generate, maybe not? And at that point, we'll return it then if the price is right, we think share buybacks are a great way to do that."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yeah. I think the the order of play is that we want to look at where we can deploy capital attractively in the business. I think that we do that all the time, I think. And, yeah, after a while, when, you know, periodically, when we assess our capital position. And if we see that know, the opportunities may not be there to deploy all the excess capital. That's when we consider the the most effective way, I would say, at the time to to return capital to our shareholders. So"
},
{
"speaker": "Jimmy Bhullar",
"content": "Thank you."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Next question will be from Wes Carmichael at Autonomous. Please go ahead."
},
{
"speaker": "Wes Carmichael",
"content": "Hey. Good morning. Thank you. A question on favorable development quarter, particularly in reinsurance. Can you just give us a little bit of color on what drove most of that release and maybe if you had any strengthening. I think you mentioned short tail lines in prepared remarks, but any more color will Okay."
},
{
"speaker": "Francois Morin",
"content": "Yeah. The vast, vast majority is on property cat and property other than cat. So that's what we consider to be short line a short tail. We were flat on casualty. So across the reinsurance segment, so no no development on casualty and, you know, a couple of moves up and down marine, other small lines, other small items, but that's the that's the bulk of it. It's really property. Some is, you know, I'd say prior caps, meaning kinda large events that we had reserved for that are developing a bit favorably. Some of it is just you know, the IBNR we hold for, you know, miscellaneous kinda traditional losses that has proven out to be in excess of what we needed. So that's kinda how we we recognize it this quarter through through those lines of business."
},
{
"speaker": "Wes Carmichael",
"content": "Got it. Thanks. In in prepared remarks, I think maybe a broader comment, but you mentioned some competitive pressure where that's eroded margins in certain lines of business. Can you just talk a little bit about where that might be more pronounced?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yeah. So I think was thinking this question was gonna come up. So so I think, you know, it's it's mainly in in two areas. I would say the most feasible one is you know, I would say public public DNO where, you know, I think we we've seen significant decrease in the last in the last two years. In double digits. That seems to be tempering, but the the you know, it's richer level that you you really have to ask yourself you know, account by account. You know? Is is the overall line, you know, still profitable? And second area that we we are watching is in the is the cyber area where, you know, also on the excess side, we've seen, you know, double digit rate decreases and and and the supply of capacity in both know, public DNO and cyber that that don't seem to be wanting to to to to reduce. I think"
},
{
"speaker": "Operator",
"content": "Did you have any further questions, Mr. McCarmichael?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yeah. I guess, I'll I'll follow-up with one more. But just on on MI and the delinquency pickup, I I think you mentioned that can be impacted by cat exposed areas and you obviously had a couple sizable storms last year, but just hoping you could unpack a little bit with what you saw in the tick up there."
},
{
"speaker": "Francois Morin",
"content": "Yeah. I mean, it's very much part of the natural process. As you'd expect, some people were affected by these events. And, you know, once they, you know, missed two consecutive mortgage payments, they they turned delinquent and, you know, that's what we fully expected would happen in the fourth quarter. About half of the increase in the delinquency rate is is directly attributable to these cap affected areas. I mean, it's it's, you know, that that's our best estimate at this point. The historical cure rate on these types of delinquencies driven by natural events is extremely high. So that's why we think the the financial impact ultimately will be minimal but currently that's, you know, that's how the the process works. They show up in the delinquency rate, and we reserve for those. But Typically, those to get resolved or cured at a high level. Over time."
},
{
"speaker": "Wes Carmichael",
"content": "Thank you."
},
{
"speaker": "Francois Morin",
"content": "And and just quickly, I'll add I mean, just I'll add quickly on the California wildfires, slightly different different type of exposures we expect minimal again, very early, too early to know, but get given the the the types of mortgages that exist in these areas, we would not expect to be impacted at all or very mean, certainly not significantly at all in In the due to the California wildfires."
},
{
"speaker": "Wes Carmichael",
"content": "Understood. Thank you. Yep."
},
{
"speaker": "Operator",
"content": "Thank you. Next question will be from David Motemaden at Evercore. Please go ahead."
},
{
"speaker": "David Motemaden",
"content": "Hey. Thanks. Good morning. I had a question, and I saw the solid casualty reinsurance growth in the fourth quarter as well as twenty twenty four, and it sounded like that continued at one one twenty five. Yeah. I guess I'm wondering if you could just talk a little bit about the rate adequacy specifically within the casualty reinsurance line. I know it it's a it's a broad line, Right. Little surprising to see you guys lean in there. It sounds like others have been more critical on just the rate adequacy there. So I wonder if you could elaborate a little bit on that."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yes. I I think, you know, the we started from a position that we were really, I think, underweight on the on the casualty treaty or insurance. And I think our view and it's true, by the way, on the insurance side is that we You know, we we've tried over the years to You know, to to get to get into program that are more, I would say, specialty, casualty. If you think of it as more with an ENS flavor. So Similar to what we would be riding, you know, growing on the on the insurance side, I think it's it's been it's been a while, but I think based on the you know, the the additional cloud that's you know, the value of the brand on the reinsurance side, I think we've been and and and our ceiling companies, you know, forecasting some wavering from the from from maybe some of the reinsurance or less appetite for the casualty, I think we've been able finally get onto probe you know, programs or insurance programs that we we think are backing the the the right people to take advantage of the of the opportunity. So that has been really the the engine behind behind the growth. It's not you know, we're not underwriting the market. We're just underwriting selective underwriters that we think have the the know how and the and the expertise to to be able to to to deliver attractive return for for us. So"
},
{
"speaker": "David Motemaden",
"content": "Great. Yep. Understood. I yep. Definitely, you guys are are underway there, so that makes sense. And and so maybe just switching gears to the insurance segment. And just wanted to get a little bit more color on the current accident year loss pick increases that you noted. It sounded like it was minor. But wanted to just get a little bit more detail on what lines it was And it didn't sound like that had any impact on the prior year reserve. Any prior year reserve impact. I just wanted to understand, how that's how that happened."
},
{
"speaker": "Francois Morin",
"content": "Yeah. I mean, again, I you know, roughly, if we we break it down, call it a third of the increase is is due to the mid mid corporate entertainment inclusion or addition to the segment. There may another third I'd say it's lines of business where we just you know, reacting to the rate environment and example of that would be professional lines like both cyber and d and o where you know, you guys have seen it, we've seen it, you've heard it. Mean, rates have been coming down over the last couple of years pretty significantly and that's a big part of our book. So naturally, I think you'd expect us and we are booking a higher loss ratio this year than we did a year ago, and that's just a function of the rate environment. So that's an example. Another example is some of our auto warranty product, our gap product, where you know, due to, you know, the, you know, different market conditions, different economic realities with the the value of used cars and and what we insure and what we cover, know, loss ratio inched up a little bit there. So nothing that was surprising to us, but, again, we're reflecting or reacting to the data And, you know, that that's and, you know, obviously, there's always mix a little bit at the end, but those I'd say are some examples of kinda minor, kinda small adjustments that contributed to the overall increase."
},
{
"speaker": "David Motemaden",
"content": "Got it. Okay. That is yeah. So it doesn't sound like that was any GL or umbrella related pick increases. It was it was more in other lines."
},
{
"speaker": "Francois Morin",
"content": "Correct."
},
{
"speaker": "David Motemaden",
"content": "Great. You."
},
{
"speaker": "Francois Morin",
"content": "You're welcome."
},
{
"speaker": "Operator",
"content": "Next question will be from Andrew Kligerman at TD Securities. Please go ahead."
},
{
"speaker": "Andrew Kligerman",
"content": "Hey. Thanks a lot. First question, maybe you could drill down a little more into the casualty lines the E and S areas of casualty. Where you'd like to grow or where you are growing in both insurance and reinsurance, respectively. And then with that, could you give us a sense of the rate changes in those areas in both reinsurance and insurance, respectively."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yes. So those are, I would say, for the large part, similar book of business. So it's really e E and S what we call ENS liability, and it's it's more middle to, you know, high excess layers where we've seen the market know, reacting to the propensity of larger losses in the last last few years. So what's happening in that market is people used to have on the retail side, first, you know, big limits. So once once the once the once the admitted market know, decide that You know, they're not gonna be able to offer those limits anymore. You know, by definition, if you had a two hundred million dollar program with Maybe five or or seven players. You know, now that, you know, the admitted players decide to reduce their limit to ten million, you're gonna need twenty people to And so the the way the market work is and that has been going on for a while, a lot of that business now is getting repriced into the ENS market, not only on the pricing side, but also on the terms and condition. You're able to get exclusion that you will not be able to get on the on the on the on the admitted retail side. So we We like, you know, that that business. We've been riding that business. We've been underway that business for years. You know? And we we have experience We've been riding the business for over twenty years, and we have you know, really specific line of business. I'm not gonna go over it over the the the call, but that we actually have experience in it. We have you know, we know the venues where to ride it. We know, you know, the the the type of severity of claims. We we know we know the exposure to, you know, cover order that's embedded in those in those risk. And so we we're able to selectively And good good companies do that. Effectively pick a subset of the market and we're still getting, you know, very decent rate increases. I think double digits. You know? And I think it has been the weight increase have been going on for a while. They were know, in the twenties, they were in the double digit, then they went to the single digit, then we're back in the double digits of late. And so we we think we're getting rates of a trend. I think we think the business underwritten properly with the right limit think, could be very attractive. But You have to pick and choose. You know, it's it's it's not it's not, again, the the cost of the ball that we make."
},
{
"speaker": "Andrew Kligerman",
"content": "You know, that's very, very helpful answers. I I I guess as I think about it, you know, a lot of your competitors are running scared. On on on the high layer excess of loss casualty just just given the inflationary environment. So so maybe just a little color on and and and you kinda gave some of it just in terms of your experience in the market, but but maybe a little color why you don't fear that that that could get out of hand and, you know, we could wake up one day and just see Arch Arch get hit with with a lot of these things. You know, kind of jumping into the high layers, you know,"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "So this is this is not this is this is what market do. When when you when you have a lot of severity losses, whether it's property or whether it's it's, you know, liability, reaction of the market is to cut limit. So I think if you think think of it. If you have a let's say, fifty million dollar limit. You're writing a hundred million dollar portfolio two short loss, and your loss ratio is a hundred percent. I think what we've seen is people cutting their limit dramatically to fives and tens. So now you know, when we get the full tower losses, the contribution to your portfolio is five or ten million. So it makes you know, the the beauty of diversification, it makes it makes the the your loss ratio a lot more stable. And I think when this happens, because I what what I said earlier, before to do, like, a two hundred million dollar tower, for a program, you needed five seven market because now you need twenty. You know, by definition, it costs a lot more. And so the the the the price adequacy is is is a lot better. So that's what we're seeing."
},
{
"speaker": "Andrew Kligerman",
"content": "Got it. Thanks a lot."
},
{
"speaker": "Operator",
"content": "Thank you. Next question will be from Cave Montazeri at Deutsche Bank. Please go ahead."
},
{
"speaker": "Cave Montazeri",
"content": "Thank you. Another question on cash proceeds, that's why you see good growth opportunities. Seeing good rate increases on the primary side. Because she's also helping quota share of reinsurance. But the city and commissions didn't change much at one one. Despite the adverse development. Carriers continue to face, My question is, what's the incremental supply of casualty reinsurance at one one? Higher than what you would have expected? I know you're writing both, and, yes, we do found the specific line. But it is currently more attractive to write new casualty business on the primary side rather than on the reinsurance side."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yes. So, you know, as as soon as I'll answer the first question, I think the supply casualty, treasury reinsurance, I think we're hearing bubbles of people on on the call saying that they don't think it's effective. So hopefully hopefully, they withdraw. But right now, I think it's there's plenty of people willing to to ride the business. So I think it's you know, it's a lot of the supplies and demand. I mean, Sydney commission will go down the day where people are putting their food on the ground and on the and say, listen. I'm not gonna ride it unless the commission is down two or three percent. So we haven't seen that. Even on the business that we place, we are you know, ourselves, that we we haven't seen that. So I think that so for sure, I think the you know, the math for the reinsurer you know, they get the rate increase. They get a lower commission. It helps you know, justifying why you would write those those those business. So but I think for us, I think we yeah. We are I think we are more bullish on the primary side today on the ENS side because I think that we have a true expertise there. We underwrite the business one by one. And I think we have we that that would say that's I put it on the list. I would say that goes number one. Being able to you know, there there is good companies out of ours before we we admire or we hire on the right of from I mean, being able to To to support those people on the through our reinsurance team, I think next sense to me. So I think, yeah, I think the the commission may be a little high, but I think if you you pick people that can outperform on on the loss ratio, you you you you may still be alright."
},
{
"speaker": "Cave Montazeri",
"content": "Good. And then my second question is still on growth on the primary side this time. Early days, but can you give us an update on how the integration of Medcorp is going? And if the growth prospects how that's evolving versus your expectations prior to the deal?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yes. So I think you know, I think we're pretty much on plan, to be honest. I think the integration is is it's it's it's a it's a big lift, but I think we we are pretty comfortable so far that things are pretty much on plan. In term of the business itself, it's it's already too bad, but, you know, the the business is pretty much what we expected. I don't think it's Okay. It's better or or worse. I think it's pretty much what what what we had planned for. So Just And I think on the the good news for us on the mid cop aspect is that you know, we're seeing some double digit trade increases on the property side. And And is and it's and also the liability side. So I think on the property side, it's really driven by the secondary periods that have you know, that that you know, not only for us, but for others on the on the market side that have been a problem in the past. So people are you know, we're underwriting around it, but also getting rate increase. And we're seeing the same you know, some of the same rate increase on the total liability in the GL."
},
{
"speaker": "Cave Montazeri",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Thank you. Next question will be from Alex Scott at Barclays. Please go ahead."
},
{
"speaker": "Alex Scott",
"content": "Hi. Good morning. First one I have is on the PMLs. And I just wanted to understand, you know, to what degree you all have exposure to aggregate reinsurance treaties and and just when we think about it pro forma for some of the wildfire losses, would that you know, cause any upward pressure of note to the PMLs as we, you know, think about heading into when season."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "So we we we we do some, but we have very little exposure to aggregate aggregate release. I think it's as a as a general Undividing philosophy. It's hard enough to price the severity. You know, the frequency is is is really, really hard to to price. So I think we we do it but, you know, when we we really feel that we have because of the line of business and the exposure, a good we could have a good grab on the on the frequency or, you know, the the the we get enough away from the from the frequency that, you know, maybe providing and I gotta get cover makes sense."
},
{
"speaker": "Francois Morin",
"content": "So we have very limited exposure to aggregate covers."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Terms of the the PML, can you repeat the same question? I'm I'm I'm I just forgot."
},
{
"speaker": "Alex Scott",
"content": "Well, I it it was long the same. I was just trying to understand it. If you had you know, exposure to aggregate treaties, then to what extent would it potentially increase your PMLs? Just thinking through, like, You know, for example, a you know, a primary this morning announced a wildfire number that know, when you look at their baseline cap budget, I think it would know, potentially cause them to to pierce the aggregate."
},
{
"speaker": "Francois Morin",
"content": "Yeah. My guess is immaterial for us."
},
{
"speaker": "Alex Scott",
"content": "Got it. Okay. And then just as a separate follow-up, on on Midcorp, I just wanted to to probe there. Now that you have Look, it sounds like things are going to plan, but could you could you talk about, like, what portion of those premiums that you've gotten in are going through the heavier remediation and and just how we should think about the trajectory of premiums considering that, you know, there's still some remediation work going on in the background."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "I think it's mainly around I would say, the program book of business. When we when we bought Miccoop, memory, again, I think there was a five hundred million dollar book of programs, and this is not what we bought mid corp, and I think we have ourself a significant, I think, I mean, something like you know, in the book of business. I think that's where we try to integrate their teams with our teams and have a very defined risk appetite for, you know, the the the type of under IT manager that we do business with, the the the type of back office integration that we require to get the information very quickly. So I think we we are going through the their book of business to make sure which which one qualify and which one which one doesn't. So"
},
{
"speaker": "Francois Morin",
"content": "Yeah. To add to that, I mean, we have already kinda taken action on a number of programs, but, you know, given the the period to to notice, I mean, it it will start to show more in the second half of twenty twenty five. The impact of those actions. On the top line at least. And certainly we think the bottom line, you know, the loss ratios will follow as well."
},
{
"speaker": "Alex Scott",
"content": "Got you. Okay. Thank you."
},
{
"speaker": "Francois Morin",
"content": "You're welcome."
},
{
"speaker": "Operator",
"content": "Next question will be from Andrew Anderson at Jefferies. Please go ahead."
},
{
"speaker": "Andrew Anderson",
"content": "Hey. Good morning. You'd mentioned deploying capital into London specialty markets. I would have thought that scenario where perhaps a bit more competition has come in and maybe rate is decelerating, but perhaps you'll add a inadequate level. Could you just maybe talk about the growth environment there?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "No. So I think we, you know, we I'm personally and we I think we are bullish in the in the lender market. I think the thing that yeah. There is more competition. I think rates have You know, have flattened in in certain of our certain of our business, but I think the the thing that help us in the London market is that we've grown from being a substandard sub scale business to business today that's right close to, you know, in the London market, probably a a billion five or more of of premium. So we are one of the and the market is consolidating around a fewer number of carriers. So we are we are one of the beneficiary of that consolidation. We're not the only one, but I think we're beneficiary, and we we build the team has done an amazing job building leading capabilities in a in a in a number of lines of business, and that makes a huge difference. So I think you know, we get to pick first, which, you know, business is is a huge advantage."
},
{
"speaker": "Andrew Anderson",
"content": "Thank you. And then maybe just within reinsurance, it sounds like still kinda positive on PropCat. The the other specialty line, I realize there's probably a number of different businesses in here, but it declined in the quarter. Can you maybe just touch on the drivers of the the decrease year over year?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yeah. So I think I think, you know, the first first is the fourth quarter is really smaller so smaller of the fourth quarter. So and, you know, we the thing I want people to to understand on reinsurance, it's true in the insurance as well. It's that we are extremely dynamic, you know, We don't you know, if something, you know, doesn't fit or a city company decide to If I sense happened if a senior company decide to change from proportional to to excess, Premium in itself is never our target. We're not trying to replace the premium. We're actually looking for profitable premiums. Those are two different concepts. So I think, you know, in the fourth quarter, what happened is I think we you know, we're starting to have a negative bias on on cyber be honest. I think we we are a big provider of quota share in the cyber side. So a couple of our contracts you know, we either the Citi company retain more, I think is more or we may have cut back on on on the number one based on the the new terms and condition. That explained most of it. So Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Next question will be from Meyer Shields at KBW. Please go ahead."
},
{
"speaker": "Meyer Shields",
"content": "Great. Thank you very much. I guess one question for twenty twenty five on the insurance segment. You talk about how reinsurance purchase is your reinsurance outward reinsurance. Has I don't know whether that's a market question or a mid score question or both."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Sure."
},
{
"speaker": "Meyer Shields",
"content": "I I think, you know, the may may maybe I understand this, how did it change? Or what what's the outcome? I think the the the one change The one change that we had to do is we had to you know Allianz was buying our insurance to to cover the mid core portfolio, a lot of it being properties, some of it being casualty. So so I think we at one one, I think we on the property side, I think we had to and and and they buy they bought large limit. You know, limits of up to seven hundred or eight hundred million dollars. So I think we had to that was one thing we bought. I mean, so we had to transfer that reinsurance onto, you know, onto an arch you know, managed framework. So outside of the the Allianz CID CID department. So and and within the RCD department. So that happened at one one. I think the team did a You did a great job, you know. And we we kept the capacity, which is a huge part of the the value proposition that the mid corp offer. You know? It's like to be able to compete in the in the middle market, you need large capacity you know, up to seven up to a billion dollars on anyone, you know, account or or or location. So I think we by by being able to do that, I think we secured, you know, a lot of the a lot of the brand or a lot of the value that we we bought I think that was a very satisfactory outcome for us."
},
{
"speaker": "Meyer Shields",
"content": "Okay. Great. Thank you. And then, Francois, you mentioned that there's a lot of property and therefore cat risk within the empty portfolio. Right now, obviously, the underlying loss ratio is elevated. Once all of that is done, should Etsy have a lower attritional loss ratio than the legacy arch side of things because of that cat exposure?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "So I think the yeah. The the the cat exposure of the mid core business is more around the secondary period than it is around the primary period of hurricane and and so I think we that was something attractive for us because he was very complementary to to to the footprint that we that that we that that we had. So I think you know, The going forward, I think, you know, those secondary barriers you know, attritional catalyst ratio, they they remain. That part of the I mean, we we we we oh, we underwrite, you know, we underwrite the flood. We underwrite the the tornadoes, we underwrite the but, ultimately, the so I don't I I really don't expect you know, the attritional loss ratio coming from the mid corp to to a really churns going forward."
},
{
"speaker": "Francois Morin",
"content": "Yeah. That's yeah. I have yeah. Exactly that. I mean, I think pre and post and see after call it, we we fully integrated the business. You know, I would not expect a significant change to you know, the the ex cat loss ratio."
},
{
"speaker": "Meyer Shields",
"content": "Okay. Perfect. That's what I needed done."
},
{
"speaker": "Operator",
"content": "Thank you. Next question will be from Brian Meredith at UBS. Please go ahead."
},
{
"speaker": "Brian Meredith",
"content": "Yeah. Thanks. First, Nicolas DeFranco. I'm just curious. How are you thinking about the potential impact of tariffs on your business?"
},
{
"speaker": "Francois Morin",
"content": "Nothing significant for us at this point. You know, as you know I mean, the businesses are transacted locally, you know, between local carriers and each of the Jurisdictions in which we operate and You know, so so from that point of view, that that's that's don't think there's an issue there or any concern. Does it you know, does it slow down trade in in the broader sense? Maybe. I think that's you know, I could see a potential impact on a, you know, our coal fast investment, for example. I mean, you could see some some reductions in in world trade and and that how that might have an impact. But I think too early to tell would be our answer. But, you know, that's something, obviously, we're we're We're watching."
},
{
"speaker": "Brian Meredith",
"content": "Great. Thanks. And then second question, think you've kinda answered this around that way, but what are you assuming right now in your reserving and pricing with respect to GL, call it, loss trend?"
},
{
"speaker": "Francois Morin",
"content": "I mean, it varies by sell, but, you know, certainly, it's for the excess business, it's double digits. It's like twelve percent to fourteen percent on the primary E and kinda low limit casualties probably around five."
},
{
"speaker": "Brian Meredith",
"content": "That's"
},
{
"speaker": "Francois Morin",
"content": "Five zero six. Yep."
},
{
"speaker": "Brian Meredith",
"content": "Five zero six Mullen County. And then one other one and then quickly switch within here. Y'all have typically done a reasonable amount of structured in your reinsurance. You're you're good at that surplus fleet, that kind of stuff. Are you seeing how much opportunity here in twenty five and twenty six on that?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "We don't you know, we we We don't think so. I think there there there has been a few. Again, it's it's really you know, we are in that business. You know, we need the the margin to make sense for us to write it and I think for a while, we were successful because it seems that some of the traditional players were you know, pulling back. So we got a couple of opportunities to participate at our terms in in a couple of transactions. It looks like the maybe some capacity is coming back, so it's it's it's hard to tell. So it's not Something we we we target, I think, is we we are, you know, we are in that business, and we when when something fits, we do it. And if it doesn't, we just don't."
},
{
"speaker": "Francois Morin",
"content": "Yeah. We're a a not not a typical arch thing, but a little bit more reactive on that type of business. We we don't drive the the demand for it. Sometimes you have a company that may be into may have some capital issues because of cats or any other some other you know, kinda result or could be reserve development. Who knows? So that's where the you know, it's hard to predict whether the demand will be there these products, but we're we're open for business."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Think we benefit there, Yan, of the the the support we offer to some of our precedents. I think we today, especially in the in the US, we have we are multilingual insurer. So we just don't do the CAT. We do the CAT. We do the risk. We do the quarter share. So know, right now, the the the opportunity that we got one one one of those silly companies, the other problem, they think of us as one of the partners. So they so that's how, you know, some of those opportunities opportunities came to us. It's more like because of all the all the things we were doing for them, they're like, listen, we have this problem in March. Could you help us doing this? And then, you know, the the the they looked at it together. So I think that that that probably puts a bit more tailwind in our ability to do this, but, again, they asked to be the right structure or it has to be the right price."
},
{
"speaker": "Francois Morin",
"content": "Great. Appreciate it. Thank you."
},
{
"speaker": "Operator",
"content": "You're welcome. Next question will be from Elyse Greenspan at Wells Fargo. Please go ahead."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi. Thanks. Just a couple follow ups. First one, Francois, was on the the seven to eight point cat load. I just wanna understand that correctly. That does include the fire. So then would would that also be the cat load for twenty six, or are you assuming in that that the fires kinda take the place of another large loss that you might have seen this year."
},
{
"speaker": "Francois Morin",
"content": "Yeah. With that x it it it it does not include the buyers in a a direct way in the January first. This is what we thought the cat losses or cat load was for the year. Now if it turns out that you know, the wildfires, which so far may end up being higher than what our cat load specifically for wildfires for the year would have been, then yeah, there's a chance that we exceed, you know, the total that that total of load, but by the same token, hurricanes end up could end up being lower. So that's truly a a start of the year without any kinda additional knowledge, you know, reflected in that number."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. And then the my second question, on Midcorp, right, when you guys announced the transaction, you said post integration, right, it would run at a low nineties combined ratio. It sounds like from everything you were saying, it's running in track with Plan? So that would still be the target. If you guys said when Like, you know, when when we might see that loan IDs number, like, what year would be considered post integration."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "You didn't say when? It's gonna take some time. You know, I think, you know, those things take always longer. I think, you know, the the goal, I think from what we know today, we I think I'm I'm still very comfortable that we get there Again, we have to finish the integration. There's you know, we we for people, we still operating the the business on Allianz systems. So you can see that there's limit to what we can do you know, in terms of insight. And so we we we're preparing for, you know, a lift over ops that we should happen sometime next year. So I think it's gonna take a bit of time."
},
{
"speaker": "Elyse Greenspan",
"content": "And then just one follow-up, Francois. I think someone asked a question. Anyone I bet Midcorp would maybe one at the same loss ratio once integrated with Meaning, run at the same loss ratio as legacy arch. Is that what you were saying there?"
},
{
"speaker": "Francois Morin",
"content": "Yeah. I mean I mean, I haven't done the math recently, but my my expectation would be that, you know, the, you know, again, the ex cap, accident year loss ratio pre MCE, your legacy arch, and, you know, that same metric once you include MCE after the integration's completed, meaning a little bit of remediation on some of the business we acquired, I don't think would be that different. So I think those would be pretty much in line."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. It. Thank you."
},
{
"speaker": "Francois Morin",
"content": "You're welcome."
},
{
"speaker": "Operator",
"content": "Thank you. I'm not showing any further questions. I would like to turn the conference over to Mr. Nicolas Papadopoulo for closing remarks."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "So thank you for your time today, and I yes. We'll see you next quarter. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. We once again, thank you for attending. At this time, we do ask that you please disconnect your lines."
}
] |
acgl | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day, ladies and gentlemen, and welcome to the Q3 2024 Arch Capital Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded. Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review the periodic reports that are filed by the company with the SEC from time to time, including our annual report on Form 10-K for the 2023 fiscal year. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward-looking statements in the call to be subject to the safe harbor created thereby. Management will also make references to certain non-GAAP measures of financial performance. The reconciliations to GAAP for each non-GAAP financial measure can be found in the company's current report on Form 8-K furnished to the SEC yesterday, which contains the company's earnings press release and is available on the company's website at www.archgroup.com and on the SEC's website at www.sec.gov. I would now like to introduce your host for today's conference, Mr. Nicolas Papadopoulo, and Mr. Francois Morin. Sirs, you may begin."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Good morning, and welcome to our third quarter earnings call. I'd like to begin by wishing the best to my friend and my business partners of 23 years, Marc Grandisson, who retired earlier this month, after the fantastic road under Marc's leadership. While we will miss him, I'm very excited about the opportunities before us. My message to our shareholders, employees, brokers, clients and business partners is that it is business as usual at Arch. Our core objective remains unchanged to be the best-in-class specialty lines insurer in the market. We will continue to execute on the key pillars of our strategy, which are build a diversified mix of businesses, actively manage the underwriting cycle, remain prudent stewards of capital be dynamic managers of a data-driven enterprise and foster a culture that attracts best-in-class talent. Back to the quarter, where Arch generated strong top and bottom line results with an annualized operating return on equity of 14.8% and an 8.1% increase in book value per share. Our third quarter results included $450 million of cat losses across multiple levers, including Hurricane Evan. It's worth noting that this cat loss is within our third quarter seasonally adjusted cap load. Overall, the P&C environment remains very favorable despite increasing competition in many lines of business, making underwriting and risk mitigation increasingly important. Underwriting strategies empower our businesses to respond quickly to their trading environment. This has been and remains a competitive advantage as we pursue those opportunities with the best risk-adjusted return. Industry cat losses have once again exceeded $100 billion for the third quarter. We should continue to support increasing demand for property insurance and reinsurance. Even with this increased cat activity, we believe the property market remains attractive and one in which disciplined underwriters can produce attractive return on capital. [indiscernible] rates continue to outpace trend which is consistent with our hypothesis of a hardening casualty market. We have selectively increased our casualty riding in both insurance and reinsurance as the markets respond to claim inflation and uncertainty around loss trend with higher prices. Turning now to underwriting segments. Our insurance segment was $1.8 billion of net premium and delivered $120 million of underwriting income in the third quarter. Acquisition of the MidCorp and entertainment business from Valiance in August help drive a 20% growth over the same quarter a year ago. We are confident that the mid-core team will be an important part of our growth story as we further enhance our capabilities in the middle market. Excluding MidCorp insurance growth was mid-single digits as we continue to find attractive growth opportunity in casualty programs and our London market specialty business. premiums competitive in E&S property and professional lines. Reinsurance had another excellent growth quarter with net premium return up more than 24% to over $1.9 billion, along with underwriting income of $149 million as our team continued to benefit from a more robust relationship with our brokers and cedents. Growth was driven by property ex cat, including facultative business, casualty and other specialty. Our industry-leading mortgage segment again contributed significantly to our earnings with $269 million of underwriting income for the quarter. Underlying fundamentals remain excellent for the mortgage insurance industry, including strong credit conditions and continued favorable house price appreciation. Mortgage origination activities remains light that new insurance return of $13.5 billion was in line with our expectation as relatively high mortgage rates and continued house price acquisition have kept most buyers on the side mines. Finally, the contribution from our investment portfolio were substantial. In the quarter, Arch Investment Management generated $399 million of net investment income. Significant operating cash flows from our underwriting units should support continued growth of our assets under management, setting us up for strong investment contribution in the years to come. Looking ahead, we like our position and the market opportunities. This is true as we enter a responsible growth part of the P&C cycle where disciplined underwriting and thoughtful rate collection are essential to success. A few final comments in closing. Arch has proven to be an exceptional company defined by a culture of underwriting excellence, underpinned by our core strategies of cycle management and thoughtful capital allocation. That was true yesterday, it is true today and it will be true tomorrow. I'm very excited and proud to lead this company and work with our leadership team as we continue to strive to deliver the greatest value to our clients and shareholders over the long term. I'll now turn it over to Francois to provide some more color on our financial results in the quarter. and then we will return to take your questions. Francois?"
},
{
"speaker": "Francois Morin",
"content": "Thank you, Nicolas, and good morning to all. As you know by now, we reported third quarter after-tax operating income of $1.99 per share for annualized operating return on average common equity of 14.8%. Book value per share was $57 as of September 30 of 8.1% for the quarter and 21.4% on a year-to-date basis. Once again, our three business segments delivered excellent underlying results highlighted by $538 million in underwriting income and an 86.6% combined ratio, which was slightly elevated from an active catastrophe quarter. Our combined ratio was 78.3% on an underlying ex-cat accident year basis. Overall, current accident year catastrophe losses were $450 million for the group in the quarter, split roughly 80%, 20% between the reinsurance and insurance segments. Approximately 45% of our catastrophe losses this quarter are due to Hurricane Helene with the rest coming from a series of events, including Canadian events, smaller named hurricanes, U.S. severe convective storms, flooding in Europe and other events across the globe. As of October 1, our peak zone natural cap probable maximum loss for a single event 1-in-200-year return level on a net basis increased slightly and now stands at 8.1% of tangible shareholders' equity as we incorporated exposures from the MidCorp acquisition on August 1. Our PML remains well below our internal limits. Our underwriting income included $119 million of favorable prior year development on a pretax basis in the quarter, or three points on the combined ratio across our three segments. We recognize favorable development across many lines of business, but primarily in short tail lines in our Property and Casualty segments and in mortgage, due to strong cure activity. As you know, we closed on our purchase of the U.S. MidCorp and entertainment insurance businesses from Allianz on August 1, and I would like to expand on a few items that impacted our financials this quarter. First, the net written premium coming from the acquired businesses was $209 million for the 2-month period, contributing to the reported year-over-year premium growth for our Insurance segment. Second, in accordance with U.S. GAAP, the fair value of the acquired balance sheet does not include an asset for deferred acquisition costs. Therefore, since there is no amortization of deferred acquisition costs associated with the in-force business at the time of the acquisition, the current quarter's acquisition expense ratio is lower than in the third quarter of 2023. This item resulted in a benefit this quarter of approximately 1.9 points in the Insurance segment's acquisition expense ratio. Although we would expect this benefit to become less significant over the next three quarters to four quarters as a larger proportion of our earned premium relates to premium written after the closing date. Operating expenses in the new business were also somewhat lower than ultimately expected as we ramp up operations contributing to a 60-basis point benefit in the quarter. Third, as is required with business combinations, we recorded goodwill and intangibles in connection with the transaction, primarily from the value of the business acquired, distribution relationships, and the present value adjustment related to the reserves for losses and loss adjustment expenses. This quarter, we incurred an expense for the amortization of intangibles of $88 million, $63 million of which was for the MidCorp and entertainment acquisition. We expect our overall amortization expense across the group to be approximately $100 million in the fourth quarter of this year and $195 million in 2025, spread evenly throughout the four quarters. While still early, the mid-core business is performing as expected or even maybe slightly better, and we are satisfied with the progress we are making in our integration activities. Turning to our reinsurance group. The team delivered a very solid 92.3% combined ratio in an active catastrophe quarter. Of note, the reported net written premium growth of 24.5% in the quarter was augmented by reinstatement premiums. Adjusting for this item, the growth rate would have been approximately 22.4%. The mortgage segment reported an excellent 14.8% combined ratio as cure activity on delinquent mortgages is strong and the underlying credit quality of the book remains very high. the reported delinquency rate that USMI inched up slightly this quarter and was impacted primarily by seasonal factors. On the investment front, we earned a combined $570 million pretax from net investment income and income from funds accounted using the equity or $1.49 per share. Our investment income reflects approximately $20 million earned during the 2-month period from the assets we've received in connection with the MidCorp acquisition. Total return for the portfolio came in at 3.97% for the quarter, as there was significant price appreciation on our fixed-income portfolio due to lower interest rates. The appreciation of our available-for-sale investment portfolio resulted in a book value increase of $1.56 per share net of tax. Cash flow from operations remained strong and exceeds $5 billion on a year-to-date basis. Our effective tax rate on a pretax operating income was an expense of 8% for the third quarter in our annualized effective tax rate remains in the 9% to 11% range for the full year 2024. In closing, our balance sheet is strong with common shareholders' equity of $21.4 billion and a debt plus preferred to capital ratio of 14.2%. This level of financial resources gives us flexibility to deploy capital as needed. And continue delivering outstanding results for the benefit of our shareholders. With these introductory comments, we are now prepared to take your questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions]. Our first question comes from the line of Elyse Greenspan with Wells Fargo. Please go ahead."
},
{
"speaker": "Elyse Greenspan",
"content": "Thanks. Good morning. I guess my first question is on the Allianz deal. You gave us some good color on the expenses. But anyway, could you give us a sense of just the impact on the underlying loss ratio within the insurance segment in the quarter?"
},
{
"speaker": "Francois Morin",
"content": "Yes, sure. I mean, just to give you a bit more details on that, the -- call it, the normalized meaning ex cat accident year loss ratio for the segment was $57.6 million. right? And the stand-alone for the mid-core business was 62% in the quarter. So that's how came up. So effectively, kind of increased, call it by 70 basis points and increased the reported loss ratio for the ex-cat loss ratio."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. And then in reinsurance, the margin sometimes does fluctuate quarter-to-quarter but the underlying loss ratio did trend up in the Q3. Was there anything business mix in there that might have impacted that in the quarter?"
},
{
"speaker": "Francois Morin",
"content": "Nothing specific. Again, we will -- we'll go back to our trailing 12 months way of looking at things. I mean I took another look this morning and there's nothing unusual in the quarter. I mean the trends are very consistent. Trailing 12 months are doing very well. So, the answer is nothing to report. I mean there's just kind of some claims happen, some don't. And over the last 12 months, we're very comfortable with the loss picks and how things are behaving."
},
{
"speaker": "Elyse Greenspan",
"content": "And then my last question is on capital, right? You guys have left the Doral ban, just given your excess capital position to doing something to return to shareholders, be that right a quarterly dividend, a special or even a return to repurchase. So, what's the timing there? I thought maybe it was post the end of wind season. Does that still apply? And how are you thinking about how you might look to return capital to shareholders?"
},
{
"speaker": "Francois Morin",
"content": "I mean you hit all the good points. I think it's very much a conversation and it's not a new conversation. It's a conversation we have all the time. And yes, we had certainly mentioned that we wanted to wait till the end of the wind season, which is coming close to an end. And as we get ready for 2025, certainly part of the outlook for 2025 growth opportunities, how -- where we may be able to deploy the capital is something we'll consider as well. But Yes, no question that this is an area that we're focused on. And I'll say you should -- we're not sleeping on it, and we'll report back when there's more to say on that."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Andrew Kligerman with TD Cowen."
},
{
"speaker": "Andrew Kligerman",
"content": "Good morning. Maybe following up on the insurance division and MidCorp. And I think France Swap, I heard correctly the MidCorp impact on the underlying loss ratio was about 60 basis points to 70 basis points, and if that's the case, it kind of moved up a fair amount, like 250 bps year-over-year. So, I'm trying to get a sense of should we be thinking that this is kind of a good run rate underlying number for the loss ratio? How should we think about it going forward?"
},
{
"speaker": "Francois Morin",
"content": "Well, I mean, we indicated that we thought initially, I mean, we have to get, call it, under the hood, we have to understand the business. But we certainly have said that in the first year, we thought this business was going to be breakeven for us. So yes, we should expect a little increase in the loss ratio and the combined ratio for the segment. No question. In terms of run rate, I'd be a little bit hesitant to commit to anything beyond, call it, the first year. I think we're already making adjustments, taking underwriting actions in terms of we like, what we don't like as much. I think there is good traction, good opportunities in terms of the casualty business that they write. The rates right environment is very strong. So that will help, we think, -- so that's -- again, the short-term answer is yes. I think the combined ratio will probably inch up a little bit, but we have very -- definitive ideas and plans on how to bring that down as we move forward."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yes. And I think -- it's dynamic. I mean, again, we I mean if you look at the insurance group overall, it's heavy non-property lines, so the property line attract lower loss ratio. So, we were growing in the property line in the last couple of years and the market now it makes it more difficult. And we have a large component of professional lines where rates have been challenging, so that probably incur Carlos ratio. And then we have casualty where I think we think there is opportunities potentially to grow more with higher margin, but it may come also with a higher switcher than property. So that's a playbook that we are facing."
},
{
"speaker": "Andrew Kligerman",
"content": "Interesting. And maybe breaking down some of the lines of business in insurance what kind of rate are you seeing? And is this rate exceeding loss costs? I suspect it's not in property, but maybe you could talk a little bit about some of the key lines in insurance?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "So, I mean let's talk about casualty, which is talk of the time. I think in casualty, we're definitely seeing rates on the trend -- but there are really good reasons for that. I think the market is going through some pain. And so, I think we are underweight in casualty. We historically underwrite casualty. So now I think based on our own analysis of the pocket of casualty business that we like. We are selectively growing both from the insurance and the reinsurance side. So there, I expect margin to expand. I think if you mention property, if you talk about reinsurance versus insurance, we're mostly focusing on insurance. On E&S property, we think the profitability is actually very attractive. I think over the last few years and post the Hurricane Helene, I think the business has reacted with a lot of rate increase and a lot of change in terms and conditions, which make the business really attractive. So there, I think after year without losses, people have really short. We see a lot more competition coming from Lloyd's, coming from NGS, coming from new entrants that want to have a piece of that business. So, I think we -- our rates are pretty flat, but I think we'd expect that margin on the business will be depend on the reaction to the catastrophes that just happened. So, I think with Milton and Eli, we price expectation with things would stabilize, but ultimate the supply and the demand, there's more supply. We think there's more demand. I think the demand has been constrained by the high price and high deductibles and high retention on the reinsurance side. So, I think we're close to an equitable year -- I think the business will remain attractive for a while."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Mike Zaremski with BMO Capital Markets."
},
{
"speaker": "Michael Zaremski",
"content": "First question is on catastrophes. So, I don't know if you disclosed what you're assuming for Hurricane Helene. I know you're I think the cats were a bit higher than the consensus, but you guys have done a good job of giving us disclosure that you've been taking more risk in Florida specifically and just overall? And then also, should we be thinking about Milton as well. I think there's some conflicting numbers out there on open sure PCS is only a $5 billion so far, but there's some much bigger numbers out there?"
},
{
"speaker": "Francois Morin",
"content": "Yes, sure. On Helene, our view is that it's going to be the type of event that probably will have a bit more leakage than you would otherwise expect. I mean it's just multiple states, and it's a lot of flooding. So, we are currently assuming, call it, a $12 billion to $14 billion industry loss. Which is maybe higher than others? And -- but that's how we see it today. I mean things could change, but that hopefully informs how we thought about the event initially and is reflected in our third quarter numbers. As it relates to Milton, we need to do a bit more work, but we will certainly give you our initial thoughts on that, I think, in the coming weeks in terms of what a loss -- what a range of estimates could be for us. But no question that what we -- what people thought might have been a really scary and large events doesn't seem to have materialized. I think industry estimates are coming down as we speak. So, call it the $30 billion plus or minus market loss seems to be about right, given what we know today. And in terms of our own loss related to that, I mean, again, more to come, but you shouldn't expect anything unusual from us. I think from what we can tell at this point, it should be in a relatively consistent kind of market share for us for an event of that size."
},
{
"speaker": "Michael Zaremski",
"content": "Okay. That's helpful. And -- my last question for Nicolas. Is there any context or color you can add to the -- what -- why the CEO change took place at the number 1 question I'm sure you all have received, and we have two people wondering if it's performance related versus just some other events or anything else? Any color you'd be able to add?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "I didn't understand the deal?"
},
{
"speaker": "Francois Morin",
"content": "The CEO Marc's departure."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Should know that. No. I mean, again, it was a personal decision that is, I think as I said, Marc and I were a good trend. It's a bit bittersweet for me, but based on this decision, I'm actually very excited about the opportunity in front of us. I think Marc is, I think Arch is bigger than any one of us, and I think we have a lot to do, and we have not an exciting thing to continue to do in the coming years. And I think we have a really good management team. We have 7,000 employees that are really engaged. And as I said, I think Arch is an exceptional company, and I'm really looking forward to continue this journey and, certainly, I think Marc departure is not performance related that the guy under his leadership, and I said the company has performed amazingly well."
},
{
"speaker": "Michael Zaremski",
"content": "And I guess, Nicolas is helpful. Obviously, you put your own stamp on the company over time and you're a different type of leader and we're all excited to -- about your position. But I'm just curious, is there now that you are at the Boss, are there certain things we should kind of stay tuned for that have kind of been on your wish list that you'll be able to kind of push through? Or do you kind of expect just more of the same directionally?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "No, not a message to -- it's really business as usual. I think I've been with the company for 23 years, have worked very closely with Marc in the last 5 years or 6 years in setting up strategies, looking at operation changes, looking at culture. So, I think we -- him and I were extremely aligned. So, I think I would not expect any changes in the way we operate."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Jimmy Bhullar with JPMorgan."
},
{
"speaker": "Jamminder Bhullar",
"content": "Good morning. So first, I just had a question on your views on 1/1 renewal and what do you think about the sort of supply-demand imbalance? And has that sort of shifted given losses from Milton -- or is your view consistent with how you would have thought before?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "So, is the question on property cat I assume?"
},
{
"speaker": "Jamminder Bhullar",
"content": "Yes, yes."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yes. So, I think on property cat, I think, as you've seen, we've grown the book quite a bit in the last 2 years or 3 years. So, we think the returns are really attractive. The Yes. I think the we have vet of midterm and Helene in my view, what we hear is that you stabilize the market. And I think there was a lot some supply, as I said earlier, is there from nodes or from MGAs or from our competitors. After 1 year without losses really wanting to get back in the business and realizing that they may have missed out on a profitable line of business. So, what I would expect, and we see it on the insurance side that things have stabilized. And I think my guess is at this stage is that we will do the same on the cat reinsurance side."
},
{
"speaker": "Jamminder Bhullar",
"content": "And more specifically, are you expecting pricing to be down, flat or -- and to whatever extent you're able to qualify quantify would be helpful?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yes. I don't have a crystal ball. I would say, again, it's always the same with programs that are being impacted by losses. I would expect prices to go up. in regions that had no losses, you could see in the bottom of the programs, I think people are still really scared about frequency. So, I'd expect the bottom to middle side of the program to perform well. The upper layers where people seem to be more comfortable to play where competition is coming because you are away from the midsize also, it could be a little bit of weakness, but not really have a strong conviction in a way. But I think mostly stable."
},
{
"speaker": "Jamminder Bhullar",
"content": "And then on casualty reserves, a lot of companies have had adverse development, some on recent years, some money even some on peak over the years as well. Can you talk about your own comfort with your casualty reserves on your legacy book as well as the Watford business?"
},
{
"speaker": "Francois Morin",
"content": "Sure. I mean, reserves is something we looked at. We look at regularly, quarterly, right? So, it's nothing new here. I think we're -- to answer your question, we're very comfortable with our reserve levels. I think from couple of reasons. One is we were -- as Nicolas said, we have been underweighting casualty for a number of years. So as much as, yes, we do feel and see some of the impacts of social inflation and pressures on loss trends on casualty business in general. I mean the fact that we're underweight in those lines has been very helpful. So yes, we are monitoring casualty reserves. There, we have experienced some adverse development, but it's been overall very manageable. And that explains, in our mind, is a big reason as to why rates are moving up because the industry is seeing the pressure and a way to correct for those results is really by getting more rate."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Cave Montazeri with Deutsche Bank."
},
{
"speaker": "Cave Montazeri",
"content": "First question is on growth. I guess, Francois, you've already explained the growth in primary insurance I guess, underlying once you exclude MidCorp, is about 5%. In reinsurance, you also mentioned the impact of reinstatement premium. I think you said it was still 22% growth even adjusting for that, still a big number. Could you give us a bit more color on like what drove that in terms of how much of that was pricing? How much of those like unit growth? How much of that was maybe writing more casualty business. Any type of color on that would be quite helpful, please."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yes. I think for the quarter, I think the driver of the growth was a bit of casualty return mostly our U.S. company, where I think we selectively are trying to -- are getting on programs that we haven't been as rates get better, we think there's opportunities for us to write attractive casualty business. And on the other side of the business that grew is the specialty business, the return. And that's more of business that we wrote 1/1 that is coming in on quarter shares, and some of it is we have a decent size book of business that support Lloyd's [indiscernible] where called Ponat where we get quarter share of what they write net of their protection. So that business is growing. Lloyd's is growing, and we think it's a profitable business. So, we benefit from that. And the second aspect is we have a decent size book of motor United Kingdom motor and that business is really dislocated, it's been dislocated, and we've been playing in that field for a while. And as rates are continuing to go up, and I think they added a 1/1 additional relationship be benefiting of this in the quarter. But it's not any action that we actually took during this specific quarter. So -- the last piece is our facultative operation that has an amazing track record and is one of the leading accusative operation, property operation in North America and -- they also have shown some excellent growth."
},
{
"speaker": "Cave Montazeri",
"content": "Perfect. My follow-up is on the mortgage insurance business. I guess two parts to that question. The first one is the growth in the quarter, was that primarily driven by the Fed cuts that just boosted demand. And I guess linked to that is the pickup in delinquency in mortgage insurance, is that also just linked to more activity? I know you mentioned some seasonal factors. I don't know what those were. If there's any details we can have on that, please?"
},
{
"speaker": "Francois Morin",
"content": "Yes. I'll start with that. I think the delinquency, again, yes, itself, but it's absolutely very much within our expectations. The one thing maybe for people to remember or appreciate is given we've refinanced a significant part of the book in 2020 and 2021. We're now entering call it, the prime years of when delinquencies get recorded. So that's very much part of the -- again, within our expectations, right? So as new loans get on the books. Usually, it takes 3 years, 4 years for them to show a bit of, just call it, really predictable and normal delinquencies. So that explains why in aggregate or delinquency rate is trending up a little bit. And more specifically on the seasonal aspect, I mean, every year, there's fairly predictable behaviors that we see from the borrowers, whether they get their tax refunds and in the first quarter and then they catch up on their mortgages and whether they borrow more to buy holiday presence. So that happens. And then the third quarter is typically expected and seen as we -- I mean, we've seen that in the recent history that the delinquency rate just goes up in the third quarter without any more just seasonal. So again, we're very comfortable with the overall rate. And again, there's a little bit -- the same differential that I mentioned last quarter related to the -- RMIC acquisition is still there. So, it's a pre-financial crisis book that is -- has its own set of characteristics. So, we're, again, overall, very happy, very comfortable with the delinquency rate -- and in terms of the premium, your first part of the question, there's a couple of accounting differences or nuances this quarter. So, I wouldn't read too much, I think, in the growth that we saw this quarter. There's a little bit of a catch-up on premium that was related to old -- or related to Bellemeade transactions on the seed aside. So generally speaking, I'd say the mortgage segment is relatively flat in terms of growth opportunities."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of David Motemaden with Evercore ISI."
},
{
"speaker": "David Motemaden",
"content": "Thanks Francois, thanks. So much for all the detail you gave on the insurance underlying loss ratio, both including and excluding the mid-corp acquisition. So, I guess just sort of running through those numbers there, it looks like if I take out mid-corp, it was about a 57% underlying loss ratio for the sort of core Arch insurance business. And so that picked up a little over 100 basis points versus last quarter and also on a year-over-year basis. So, I'm just wondering if you could help me think through some of the drivers of that increase?"
},
{
"speaker": "Francois Morin",
"content": "Yes. I'd say, again, it's -- Nicolas touched on it, it's growth related in mix, right, in the sense that where you saw us grow this quarter. And I don't think if you have the time to look at in the supplement, how we report the lines of business, which is we have changed this quarter relative to the past, more growth in casualty and other liability lines of business, both -- I mean, primarily on an occurrence basis, claims made, which is more professional lines book and cyber or that has come down. But that business typically carries a higher accident year loss ratio than property business once we remove the cat load. So that is really the big driver of the pickup is really mix as we have grown in the last little while more in casualty and remain relatively flat on property."
},
{
"speaker": "David Motemaden",
"content": "Got it. Okay. That's helpful. I appreciate that. And then maybe a follow-up on the reserves just within insurance and reinsurance. I was wondering if there's any way you could size those moving pieces for us between the short tail and the long tail development?"
},
{
"speaker": "Francois Morin",
"content": "Well, I mean, we -- in total, I mean -- and that will be in the queue, but yes, we definitely very favorable on short tail lines of business, a little bit of adverse on long tail lines. So that's consistent with recent trends. I mean, as I mentioned earlier, we are -- we're seeing a little bit of pressure on casualty, longer-tail lines of business. There's been some favorable in workers' comp, as you've seen, I'm sure, with many of our competitors. I think that's been a consistent story for quite some time. But again, the bottom line in aggregate is we're able to -- we're observing kind of favorable development, lower actual than expected, and that is coming through in our numbers."
},
{
"speaker": "David Motemaden",
"content": "Understood. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Yaron Kinar with Jefferies."
},
{
"speaker": "Francois Morin",
"content": "I think he might have dropped. We're not hearing anything."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"content": "Great. I think we've talked about this in the past, but I wanted to get Nicolas' thoughts on cycle management. Specifically, I guess, with retail distribution and in particular, the mid-core business, is that less amenable to cycle management?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "So, I mean, my view is it's a different type of cycle management. I mean the -- what's attractive with the mid-core business is it's more stable. So, which means that the cycle are more muted. You don't see the same price going up and down like excess D&O public excess D&O. You got 40 and you make up 20 or 10. So, I think in the middle market business, I think you have more -- it's going up slower, and it's going down much lower. So, I think that that provide -- I think we like that provides a much balance to our insurance book that has a large component of larger corporate risk that are more subject to large situations in rates. And the thing that's attractive to us is the value proposition of a carrier in the MidCorp segment is better because usually the distribution partner, the broker rely on the carrier to provide more than one kind of business like -- so you're more important to him. The interaction with the carrier is more valued. So, you create the stickiness that really help -- you're not competing solely on price, where when you deal with a large account and a risk manager price is an important component of the value proposition. But here, I think -- so it's less subject to in my view price competition, which make it more stable and more attractive. And I think the thing that's interesting to us with the MidCorp aquisition is that the timing is pretty good because we've seen price increases on the property side because this book is more exposed to secondary period and the liability component of the book is subject to the discussion that we talked about before. So, I think we -- our timing is really good. I think the book looks to be performing well enough. And so, we're pretty excited to be able to find like a decent chunk of that business and to be at scale and being able to expand our footprint in what we think is a very attractive part of the market."
},
{
"speaker": "Meyer Shields",
"content": "Okay. That's very helpful. And then if I can switch gears a little bit I know it's early on the January 1 discussions for property cat. Is there anything you can share with regard to expectations for seating commission trends in casualty reinsurance?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "So, I'm going to be the wise person here. I think as we insure and including ourselves in see more bad news coming from the past. I think the -- there will be pressure on seating commission. You would expect that -- the question is the supply. I mean the pressure on the seating commission will be muted by the supplier, because if there's more people wanting the business and there's a limited amount of business being placed I think the brokers is going to -- is going to play a big role in minimizing I mean, the directions of where the seating commission are going to be. So, it's going to be some sort of conflict between what the reinsurance wants and what the seating companies are willing to do. And -- but the driver would be the supply versus the demand. And I think -- and what I'm hearing is that there is ample supply in the marketplace."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Yaron Kinar with Jefferies."
},
{
"speaker": "Yaron Kinar",
"content": "Good morning. I apologize for dropping earlier. I wanted to dive a little bit deeper into the other liability occurrence growth in insurance. How much of that came from MC versus just organic or legacy growth?"
},
{
"speaker": "Francois Morin",
"content": "It's a good question. There was a fair amount of E&S casualty business on our kind of like is just organic, right? So that is an area of maybe the most exciting area for us. I mean, where rates are well into the double digits in terms of rate increases. So that is a very, very attractive area the MC book is split. There's some commercial multi-peril -- there's some occurrence of the liability occurrence, so it's a mixed bag. But I'd say I don't have the exact numbers in front of me, but I think you should -- the takeaway is that the rate environment in that particular line of business is very, very good right now."
},
{
"speaker": "Yaron Kinar",
"content": "Okay. And what is it about the third quarter where the environment it seems to have accelerated significantly or at least the opportunity set in other liability occurrence accelerated significantly?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "I think it's just a function of people realizing that the way they were looking at the reserves in the last few years is not exactly playing out. I think COVID for a while muted the claims. So, people kind of in my view, sitting out there to make sure they were not making their own reason. And since COVID, I think we -- we've seen some severity larger world, planted jewelry world, and we've seen -- and we've seen more places where those jewelry awards are taking place larger Europe. So, I think you have like social inflation that's driving much more severity and you have -- so frequency of places used to be County, self-test mixing border, but now you have Georgia, you have some place in Nevada, where certain juries actually, if you get code in one of these journeys, you're going to get a significantly larger work. So, I think it's a combination of frequency and severity and people realizing that they have to -- they have to stay ahead of those. And the normal reaction, which I think is the right reaction for the market has been to cut limits because if you're caught up in one of those difficult juries, you want to have small limits. And typically, when you had, I don't know, $200 million placement with 10 players and suddenly, you have 40 players to complete the placement, some of those layers going to the NS market, you're starting to see some taste increases. And that's what we're witnessing right now."
},
{
"speaker": "Yaron Kinar",
"content": "But if I could maybe flesh this out a little more. What you're describing is not new. I mean, if we go back to previous management meetings, conferences, calls. We have been hearing management talk about this for several quarters, if not years, even in some cases. So, what's happened in this third quarter that seems to have triggered some significant change?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "I think it's just the accumulation in that people took actions, but when actuaries or management look at the chance for the business they're writing today to be profitable, they ask themselves, they need more safety margin. I think it's I think there was some rate increase double-digit trade increases 2 years or 3 years ago. Then we -- for a little while, we went to single digit, and suddenly, we are back in double digit. It tells you that there is paying in the back years of people that have written that business in the early years and in the last few years. And usually, the reaction -- it's not unusual that the reactions are more broad because at some point, management lose faith in the story they've being told, so they require more drastic actions. That's the usual playbook of how market happens."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Brian Meredith with UBS Financial."
},
{
"speaker": "Brian Meredith",
"content": "Nicolas, I want to follow up on that a little, just a little bit. So, I understand what you're saying about your opportunities for growth here in some of the casualty lines. But maybe I can get your perspective a little bit more on what do you think casualty trend is? And where is it going, just because you must be pretty confident in kind of having good grasp on where casualty trend is, given that you're growing and some other are shrinking?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yes. So, I think, I mean, yes, it's a tale of several stories. I think -- at the bottom of the program, I think people can have a pretty good idea what your casualty trend is, whether it's mid-single digit. The issue is when you go excess. If you go in excess of $50 million, if you got excess of $100 million, that's where the trend get to multiply OpEx. And you are certainly in double digits. I think ourselves, in a way, we were lucky we didn't have a huge footprint on the casualty business, but we have enough footprint to be able to do our own analysis. And again, it’s selective. The thing to treat different class of business, different you have to be able to do really selective price increases, analysis to get comfortable that in certain jurisdictions, with certain parts of business, you think the business based on your own actual experience, the business makes sense to be returned. So, it's not -- I would not say it's a sea change that suddenly any pieces of business that come across your desk is going to be profitable. You have to be you have to be selective and have a thoughtful approach to what you want to underwrite. That's a market we are in."
},
{
"speaker": "Brian Meredith",
"content": "Got you. And the same question, I guess, for reinsurance, right? Reinsurance you're kind of relying on the seeds?"
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yes. So again, I mean, the job of the reinsurer is still back the right companies. So, I think we are -- for a while, I think we've been really underweight on the casualty U.S. quota shares and excess of loss. And I think this dislocation in the marketplace has allowed us to get on program that we wanted to get on 2 years or 3 years ago because we like the underwriting. We like the limit discipline. We like the class of business they're right, but we couldn't get on because nobody was exceeding. So, I think we -- and I think there is some sort of a flight into quality of who is here for the long term and who is not. And I think we're benefiting from that."
},
{
"speaker": "Brian Meredith",
"content": "Makes sense. And then, Francois, one quick one here for you on the investment portfolio. I guess, one, where are we looking at new money yields versus current book yields? And where are you deploying the assets you got out of MidCorp. Is there some more potential book yield to come out going forward?"
},
{
"speaker": "Francois Morin",
"content": "Yes. I mean, part of the transaction was certainly some of the -- a good chunk of the assets came in cash. So, our investment team has been very disciplined and thoughtful on where to put that money to work and -- but the good thing is just on money market or cash, we're still getting a decent yield. But yes, I'd say, call it, 4.5% on new money yield, I mean, as you see, the book yield and the new money yields are kind of pretty close to each other right now. We're still very short duration, very high-quality fixed income book, so that's not changing. But yes, there's certainly been, call it, the $2 billion in assets that we got we are putting that to work and trying to fit that into the portfolio as best we can."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Joshua Shanker with Bank of America."
},
{
"speaker": "Joshua Shanker",
"content": "So, I get it, there's less meaty sports talk than ever. But I was wondering, in the past, we've talked about the ROIC on the different legs of the Arch stool reinsurance, insurance mortgage. Could you review right now sort of state of the union on what the return on new capital is for the various businesses?"
},
{
"speaker": "Francois Morin",
"content": "We like all our businesses. That has not changed. The one thing that I'd say right now is -- I mean, fourth quarter, we're a little bit kind of dependent on where the market goes at 1/1. So that is Certainly, reinsurance has been just a really, really good environment for 2024, how does it play out in '25. It's still a little bit early to know for sure. We think it's going to be still a very good market. Is it going to get better to the point where we have the ability to deploy that much more capital in reinsurance, we don't know quite yet. So -- that's kind of the answer. I mean, there were a little bit wait-and-see approach in terms of how the market plays out. But again, what we talked about this morning, the growth opportunities in casualty, in particular, I think are exciting to us. So, both insurance and reinsurance, I think we're ready to play. And mortgage is -- don't want to forget about mortgage. I mean this has been a terrific engine for us. No question that the origination market is not as large as we'd like it to be, but that's okay. I mean we've got terrific earnings coming from the in-force book and we're finding other opportunities outside of primary MI in the U.S., and we're deploying the capital in the right way. So, we're very comfortable with the mix right now."
},
{
"speaker": "Joshua Shanker",
"content": "Would it be wrong to paraphrase that reinsurance is better than insurance and mortgage, but that's pending what happens on 1/1?"
},
{
"speaker": "Francois Morin",
"content": "It's not wrong. I think it's a fair statement. It's better right now. We like to think it's going to stay better, but just don't know quite yet."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "It's a higher component -- reinsurance is a higher component of property business. So, you have to think on the half of the business is property. So, you -- it's high risk, high reward. So, I think we have -- we get better high the high return, but it's also high risk as we saw this quarter. I think the insurance work is much more heavily geared towards casualty and professional lines. So, I think it's an environment that is [indiscernible] but it's a different set of return. I think you have to balance those two. So -- and sometimes, the E in the ROE doesn't do enough of that, I think."
},
{
"speaker": "Joshua Shanker",
"content": "And Francois, you made the comment of the origination market in mortgage isn't quite as strong as you'd like it to be. but also, Arch has lowered its market share of new business compared to where it was 3 years ago or so. If Arch wanted to ramp it up -- is there a possibility of growing that business without improvements in the origination market? Or would that cause pricing and margins to weaken in that business?"
},
{
"speaker": "Francois Morin",
"content": "Yes. It's becoming a more kind of homogeneous market, right? So, I think the risk of trying to grow market share is just as you said, I think you have to cut prices I think we've built a very resilient, very high-quality book through picking different types of loans to ensure different geographies. I think we -- I mean, we are very comfortable with what we've done. But for us to move from the, call it, 16%, 17% market share and say we want to be at 18%, 19%, 20%. Right now, we just don't see that happening because the market, I think, will just react with us, and it will just push prices down. So, I think right now, I mean, I just be surprising for us to grow our market share that significantly in the near term."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yes, we've asked this question all the time. And the answer is that we ended up in the worst place. I think status quo, the current status quo based on the Remember, we're dealing with monoline business. That's all what they have. So, I think, ultimately, they're going to defend their book and we'll end up in a worse place. That has been the analysis that we carried."
},
{
"speaker": "Joshua Shanker",
"content": "Well, thank you very much for all the answers, and I'll let you go to lunch."
},
{
"speaker": "Operator",
"content": "Our next question comes from Elyse Greenspan with Wells Fargo?"
},
{
"speaker": "Elyse Greenspan",
"content": "I'll just shove a few more in before lunch. But my first question is on Hurricane Helene, right? I think you guys said it was 45% of cats. So, I calculate that at just over $200 million, so that's like 1.5% to 1.7% market share, given your 12 to 14 -- is that about what you would expect, I guess, for these large type events? And does that share a good frame of reference when thinking about Milton?"
},
{
"speaker": "Francois Morin",
"content": "I mean, your math is about right, but the Helene is a bit unusual for us. I mean it's a little bit on the elevated side in terms of market share based on some of the accounts we wrote Again, Milton is different because it's Florida only. So, it's -- we have a different mix of business there, a different type of accounts we write. So, I would not draw a correlation or an analogy from the lean, call it, implied market share to what Milton could look like."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. That's helpful. And then my second one, I guess, is a follow-up on reserves, right? We had another company this morning that kind of flagged they're kind of going to take an in-depth review and there might be some movement with their fourth quarter review. It sounds like from earlier questions that you guys really haven't seen like change in loss trends or actual versus expected in the third quarter versus later in the year. But is there anything, I guess, that you're concerned about or anything that's come up with the quarterly reviews that you guys are paying particular attention to will be going to the end of your review?"
},
{
"speaker": "Francois Morin",
"content": "There's nothing unusual. I mean it's something we look at all the time. The trends are relatively stable. I mean we have views going way back that the loss trends that we were seeing in the market were a bit optimistic. So, we've always taken a longer-term view of trends and we review those annually at a minimum, sometimes some twice a year. But yes, really nothing that stands out, that's, I'd say, unusual or that we're overly concerned with. I mean that's the standard kind of themes that we've been talking about for quite some time."
},
{
"speaker": "Elyse Greenspan",
"content": "And then I might just shove one last one in there. You guys have an upcoming Investor Day in a couple of weeks. Is this -- are you going to expecting to use this to lay out bigger strategy, financial targets something on capital, I guess. Can you just give us a little bit of a preview of what you expect to talk to us about in a few weeks?"
},
{
"speaker": "Francois Morin",
"content": "We're just missing you guys in person. So that's why we schedule this. But no, I wouldn't expect anything really unusual from the upcoming Investor Day. We you've known this for a while, the strategy remains the same. Nicolas will obviously be focal point. So, we'll make sure everybody gets to hear a bit more from how we want to shape the company going forward, but I would not message or think that there's anything unusual or kind of a new regulation that you should expect to hear from us in a couple of weeks."
},
{
"speaker": "Operator",
"content": "I would now like to turn the conference over to Mr. Nicolas Papadopoulo, for closing remarks."
},
{
"speaker": "Nicolas Papadopoulo",
"content": "Yes. So, there's not any more questions. So, this will conclude our presentation today. And thank you for your questions, and we see you next quarter."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect."
}
] |
acgl | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good day, ladies and gentlemen, and welcome to the Q2 2024 Arch Capital Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, this conference call is being recorded. Before the Company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the Company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company intends the forward-looking statements in the call to be subject to the Safe Harbor created thereby. Management also will make reference to certain non-GAAP measures of financial performance. The reconciliations to GAAP for each non-GAAP financial measure can be found in the Company's current report on Form 8-K, furnished to the SEC yesterday, which contains the Company's earnings press release and is available on the Company's website at www.archgroup.com and on the SEC's website at www.sec.gov. I would now like to introduce your host for today's conference, Mr. Marc Grandisson and Mr. Francois Morin. Sirs, you may now begin."
},
{
"speaker": "Marc Grandisson",
"content": "Thank you, Jericho. Good morning, and welcome to Arch's second quarter earnings call. We are pleased to report another highly profitable quarter due to significant contributions from all three underwriting segments and strong investment results. Our ability to successfully deploy capital into this extended hard market has fueled excellent risk-adjusted returns. Coupling our cycle management strategy with an emphasis on returns and consistent disciplined execution throughout the enterprise resulted in a record $762 million of underwriting income and an annualized operating ROE of 20.5%. Our results are thanks to our teams that work diligently with deep capability and a long track record of experience to earn these results. Broadly speaking, the P&C environment remains excellent, and opportunities for attractive returns are plentiful even as competition normalizes. The duration and breadth of the current hard market over the last several years has been exceptional, and while rate increases are broadly above trend, disciplined underwriting requires that we keep our eye on the primary goal, shareholder returns. An overly aggressive appetite for growth could come at a cost of eroding underwriting margins. The art of underwriting in this part of the cycle rests on one's ability to know how hard to push and when to pull back. At Arch, we strive to be an active yet disciplined market participant, practicing restraint and patience. We believe that capital allocation is one of our most powerful differentiators. Our priority is to deploy capital into our underwriting units first, where we have the knowledge and experience to better price risk. However, we are always assessing other value-creating opportunities. One example is our previously announced intent to acquire Allianz's U.S. MidCorp and Entertainment businesses. With regulatory approval on MidCorp secured, I'm able to share a few thoughts about the strategic acquisition. The addition of the talented team and their client relationships gives us a greater presence in the U.S. primary middle market while expanding our cycle management toolkit. We will have more to say about the opportunities in the middle market as we integrate our teams. I'll now take a few moments to highlight the performance of our underwriting units this past quarter. Second quarter results from our Property and Casualty segments demonstrate the benefits of our strong leadership throughout the ongoing hard market. The Reinsurance and Insurance segments combined to deliver $475 million of underwriting income and just over $5 billion of gross premium. Reinsurance generated $366 million of underwriting income, despite higher frequency of catastrophic events from secondary perils, both in the U.S. and internationally. Higher premium rates in our diversified book of business enabled us to report excellent underwriting results for the segment, which has built a resilient, stable platform. Due to our view of heightened overall storm risk this year, we chose not to grow our property cat writings at the midyear renewal. We've grown property cat meaningfully over the last few years. But as we learned during the 2002 to 2005 hard market, when there are so many good things happening across the underwriting platform, [why chase] returns and cat exposure at the risk of being unlucky. Property in general is very well priced. We just want to have the right balance across our portfolio. As you have heard from others, casualty lines remain an area of interest that we will continue to monitor as we observe rate increases and ongoing reserve strengthening taking place across the industry. Our Insurance segment contributed $109 million of underwriting income in the quarter. Net written premium growth was 7% this quarter compared to the second quarter a year ago. We meaningfully grew premiums in our programs business and in E&S casualty where rates are improving. In a more competitive market, it's important to be able to quickly reallocate capital to the best relative return opportunities as we have done in the past and remain well equipped to do in future quarters. Our international insurance unit continues to benefit from its position as a lead underwriter at Lloyd's, where a disciplined market is providing attractive growth opportunities in specialty lines. Moving on to P&C and into our Mortgage business. At the risk of repeating myself, the consistently excellent underwriting income delivered by our Mortgage segment quarter-over-quarter provides significant value for our shareholders by producing a solid base of sustained earnings. MI underwriting has been solid across the industry since 2009, and the current environment is one that rewards the MI companies underwriting the risk. This quarter, the Mortgage segment generated $287 million of underwriting income while increasing new insurance written at the U.S. by 12% from the same quarter a year ago. The delinquency rate at U.S. MI remains low compared to historical norms and the credit quality of our portfolio remains high with policyholders and strong equity positions. We are pleased to have successfully closed our acquisition of RMIC in the second quarter. Although no new business comes with this run-up block is emblematic of our ongoing pursuit of finding profitable opportunities in which we can deploy capital. Primarily due to strong cash flows generated by our underwriting operations, our investments portfolio increased to $37.8 billion, generating $364 million of net investment income in the quarter as higher yields continue to move through our portfolio. The eyes of the world are focused on Paris this week as the Olympics get into full swing. One of the toughest events in the decathlon and all around athletic tests featuring 10 events over a range of disciplines, spread over two days. The decathlon is an incredible physical and mental test that requires maximum performance in every event. At the end of the two days, points for all 10 events are totaled up and the individual with the most points is the winner. Similar to a decathlon, in the dynamic insurance market, the ability to perform at a consistently high level across the enterprise is crucial for long-term success, and Arch is built to excel across a multi-disciplined market. Our capital allocation helps ensure that we can focus on the lines that give us the best chance to score points. The first event in the decathlon is 100-meter sprint, and our ability to get out of the gates quickly at the beginning of this hard market position us to score early. Since then, our P&C and Mortgage teams have been racking up lots of points, adding our investments team clearing the bar in the pole vault, and we have an all-around performance that puts us in serious contention for the gold medal, as you would expect from a world-class leadership team. Before I hand it over to Francois, I need to mention the passing of our friend, Dinos, this past June. Dinos was not only an industry legend, he was also a mentor and tremendous leader who steered this company for over 15 years. Dinos led these earnings calls with his keen insights, principle beliefs and trademark humor. He was truly one of a kind. So tonight, please raise a glass, be it Ouzo or Retsina or anything of your choosing to Dinos. You are missed my friend. Francois?"
},
{
"speaker": "Francois Morin",
"content": "Thank you, Marc, and good morning to all. As you know by now, we reported excellent second quarter results last night with after-tax operating income of $2.57 per share, up 34% from the second quarter of 2023 for an annualized operating return on average common equity of 20.5%. Book value per share was $52.75 as of June 30, up 6.9% for the quarter and 12.4% on a year-to-date basis. Once again, our three business segments delivered outstanding results, highlighted by $762 million in underwriting income and a 78.7% combined ratio, 76.7% on an underlying ex cat accident year basis. We continue to benefit from strong market conditions across our businesses as the pricing environment remains disciplined, giving us confidence in our ability to generate solid returns over the coming quarters. Our underwriting income reflected $124 million of favorable prior development on a pretax basis or 3.5 points on the combined ratio across our three segments. We recognize favorable development across many lines of business, but primarily in short tail lines in our Property and Casualty segments and in Mortgage due to strong cure activity. Catastrophe loss activity was in line with our expectations as we were impacted by a series of events across the globe, generating current accident year catastrophe losses of $196 million for the group in the quarter. Approximately 70% of our catastrophe losses this quarter are related to U.S. secondary perils with the rest coming from a series of international events. As of July 1, our peak zone natural cat PML for a single event one-in-250-year return level on a net basis declined slightly and now stands at 7.9% of tangible shareholders' equity, well below our internal limits. For the Mortgage segment, since this is the first quarter end since we acquired RMIC Companies, Inc. and the subsidiaries that together comprised a runoff mortgage insurance business of Old Republic, there are certain items that I'd like to highlight. First, the acquired book of business represented $3.6 billion or a 1.2% increase to our U.S. primary mortgage insurance in force at the end of the quarter. Second, given the risk and forces from older vintages and has been in runoff since 2011, its makeup resulted in an incremental 19 basis points to our reported delinquency rate at U.S. MI. Absent this transaction, our reported delinquency rate would have improved slightly since last quarter. On the investment front, we earned a combined $531 million pretax from net investment income and income from funds accounted using the equity method or $1.39 per share. Total return for the portfolio came in at 1.33% for the quarter. Cash flow from operations remained strong. And a $3.1 billion on a year-to-date basis, we have seen material growth in our investable asset base, which should result in an increasing level of investment income. Our effective tax rate on a pretax operating income was an expense of 9.5% for the second quarter, with our current expected range of 9% to 11% for the full-year 2024. As disclosed last week, we now expect an August 1 close of the transaction to acquire the U.S. MidCorp and Entertainment insurance businesses from Allianz. At this time, we do not have new information to share on the estimated financial impact of the transaction beyond what we provided in early April. Starting next quarter, we expect to update this information to help in developing a forward-looking view of the insurance segment's results, including this new business. All in, our balance sheet is in excellent health with our common shareholders' equity approaching $20 billion, a net debt plus preferred to capital ratio was slightly above 15%. We are well positioned to take advantage of opportunities that may arise as we move forward. Before I conclude my remarks, I also wanted to take a moment to build on Marc's comments and share a word of sincere appreciation for the impact Dinos had on Arch, its employees and many others across the industry. While he will certainly be remembered for his energetic personality and his ability to captivate an audience, we are truly grateful for his guidance, vision and leadership during his career at Arch. Thank you, Dinos. Marc?"
},
{
"speaker": "Marc Grandisson",
"content": "Now, so we don't keep anyone from their lunch, which we know is very important to Dinos. Onto your questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Our first question comes from Elyse Greenspan from Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi, thanks. Good morning. My first question, I guess, is on the insurance side, right? Marc, I think it's been since probably late October of last year with Q3 earnings, you were kind of leading the industry in terms of talking about this casualty market turn. And it's been slow to evolve, maybe it's in line with your expectations, but it just seems it's been slow to get price through those lines. How do you see that transpiring from here relative to price increases in casualty lines?"
},
{
"speaker": "Marc Grandisson",
"content": "Well, like I said – well, good morning, Elyse. I think the point we made last quarter, the quarter before is that the casualty turn and realizing actually how much well or bad you're doing in casualty line takes a while. It has a tail to it. It could take five or six years. So I think we're seeing the – we start to see the early signs of more recent years being a bit more impacted by the inflation that we saw of late. And I think that it will take a while. People are trying to adjust. We're trying to look at the numbers in the triangles that are actually not as good as they used to be. So there's a lot of uncertainty in the space. And I think it will take us several quarters to come to a more stable or a better view of the industry. So the last hard market in casualty started to turn in 2000. And it took until about 2004 to really see the impact and sort of running out of – having to price and rate increase after that point. So it takes several years. Unlike the property cat right at least 2022 something happened at the bottom in the fall, will right away that people are adjusting because the cost of goods sold or losses are known. So this is not surprising to me. I'm expecting a bit more – we're expecting a bit more. We're seeing it through our reinsurance emissions. I think people are slowly, but surely recognizing some of these bad years, but it takes a while."
},
{
"speaker": "Elyse Greenspan",
"content": "And then in terms of just on the insurance side, as you think the underlying, I guess, margin, right, kind of low 90s in the quarter, given your views about price and loss trend, does that feel like kind of the run rate level from here?"
},
{
"speaker": "Marc Grandisson",
"content": "Well, as you know, Elyse, we report the numbers as we see it based on the data that we see. That sort of seems to be the emerging sort of rough average over the last couple of years. There's also a mix going on, Elyse. So things are shifting, as you know, from time to time. So it's hard to compare combined ratio. But right now, based on where we are, it's well within the expectation of getting the returns. And our returns on insurance, we believe are in excess of our long-term target."
},
{
"speaker": "Elyse Greenspan",
"content": "And then the mortgage releases have held steady, Q2 was above the Q1 level. Can you just provide, Francois, maybe a little bit more color on what's going on there and how we could kind of think about run rate level of potential releases within the MI book?"
},
{
"speaker": "Francois Morin",
"content": "Great question. I think – I mean, I and many others have been wrong about taking a forward-looking view of releases on – or favorable development on mortgage in general. I think, right, stepping back, I'd say that early in 2020 – late 2022, early 2023, we are more cautious about the state of the economy and took a view about new notices and average reserves that we are attaching to these notices that was a bit more that didn't turn out to be the case, right? They turnout to be better than what we had expected at that time. The fact that we just had another quarter of more – better cure activity. I don't think a lot of these cures this quarter were related to the 2023 accident year. So we're more positive, I think, I'd say in general about the housing market. So the level of reserving that we're attaching to the new delinquencies is a bit lower than it was a year ago. So maybe directionally, we would not expect to have the same level of reserve releases going forward. But again, not knowing for sure how quickly people are going to cure unemployment, et cetera, I mean, that will be – that will have an impact on the level of reserve releases."
},
{
"speaker": "Elyse Greenspan",
"content": "Thanks for the color."
},
{
"speaker": "Francois Morin",
"content": "Welcome."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Jimmy Bhullar from JPMorgan."
},
{
"speaker": "Jamminder Bhullar",
"content": "Hi. So first, just a question on reserves. You had favorable development overall, and so did many of your peers. But a lot of the competitors had adverse development in casualty for both older and recent years. It doesn't seem like you had that, but maybe you could go into detail a little bit on the development in the second quarter. And then also, why do you feel that you're not as susceptible as some of the competitors do all the casualty issues, either in your book or maybe in the Watford block that you inherited?"
},
{
"speaker": "Francois Morin",
"content": "Yes. Let me take a stab on that. I'm sure Marc will have something to add. I'd say on the part two your question, Jimmy, I'd say the book of business that we have is – I wouldn't call it a standard commercial general liability book of business that some other competitors have. We don't write a whole lot of commercial auto, for example. So that's another line of business that's been a difficult line to get a good handle on the trends and how inflation has picked up in there. So the books that we have in general liability, a, I think, are smaller. Certainly, we think, underweight in those lines of business. Roughly speaking, our insurance book is like, call it, less than 15% what we consider to be of our overall premium, what we consider to be traditional casualty in the GL lines of business. So the mix matters. Certainly, the areas where we write, the business matters. I mean we have an international book within that. So it's not only U.S. where I think we've seen more pain. And then in terms of the favorable – the movements in the quarter, I think, yes, in aggregate, we were favorable, mostly in the short-tail lines. On the longer tail lines, which is primarily GL, I think we were pretty flat. I think it's something we look at carefully. Some noise here and there. But collectively, in aggregate, we're very comfortable with the level of reserves. And so far, our numbers are holding up pretty well."
},
{
"speaker": "Marc Grandisson",
"content": "And what I would add to what Francois just said, and as you know, Jimmy, we're a cycle manager. We also didn't write as much in even the year that we believe are now still very soft year. So that also prevents you from having to – to having outsized no surprise."
},
{
"speaker": "Jamminder Bhullar",
"content": "Okay. And then on a different topic, your capital is building up pretty nicely, and I'm assuming it's enough to fund your growth. And you have done a couple of acquisitions. But how do you think about buybacks or potentially instituting a dividend, given the capital levels that you have?"
},
{
"speaker": "Francois Morin",
"content": "Yes. I mean that – the philosophy has not changed, right? I'd say, certainly, we are on track to close the Allianz acquisition tomorrow, so that will certainly be a draw on that capital base that we have. We are also entering the active wind season, so we'll want to take a look at what – how that develops. But absolutely, going forward, the fact that we historically have been very – I think, very good stewards of capital, we like to deploy it in the business where we can. But if there are no opportunities beyond what we – what's in front of us, in the coming months, we'll do what we've always done is return that capital, and it could be in the form of share buybacks or dividends or any other method."
},
{
"speaker": "Jamminder Bhullar",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from Josh Shanker from Bank of America."
},
{
"speaker": "Joshua Shanker",
"content": "Yes, thank you very much. So Marc, sometime in the past, I think one thing you said to me was that the big surprise was from the hard market of 2024 that pricing stayed good for a lot longer than we thought it would, and we pulled back too early. I mean, clearly, you're not pulling back here, but the growth has decelerated a great deal. Given that you have that 2020 hindsight, how are you looking at this market opportunity and how long it might last compared with what you know from the past?"
},
{
"speaker": "Marc Grandisson",
"content": "Yes. Well, first, Josh, is I'd probably raised my memory what we did wrong in 2004 and 2005, but thanks for reminding me. What I would tell you, Josh, is we talk about this at underwriting meetings. Our underwriters and our underwriting executives are acutely aware of that phenomenon. We also have to remind ourselves that pricing is going up as we talked about, specifically non-casualty, which seems to be the more acute area. I think it will take a longer time to go down or it takes longer to take down, right. It goes up in an elevator and goes on an escalator. So that's probably why we would expect the market to be. I think we're aware of this. Now we have more data, we have more experience, we have an existing platform, underwriters. Many of them have been there through those years. So very confident that we will be more judicious, if you will, in terms of holding the line when the market gets a little bit softer. In terms of growth, we still have like close to 11% growth in P&C, which is a big feat. It's still – it's a very, very good growth. But as I said in my comments, and you probably heard already, Josh, the market is a little bit more reaching equilibrium in terms of supply and demand for the risk. So the question that we have to ask ourselves all the time is, if we push too hard, we might dilute the broader margin and return expectations in the marketplace. So we take this. And not only us, by the way, I think the market is broadly very, very widely behaving the same way. People want to make sure that they get it right and nobody wants to be the first one running out and doing something that will probably jeopardize or not jeopardize, but maybe take down the returns expectations. So it's just that kind of the market, Josh. The equilibrium on the supply and demand for capacity is just coming back more to a more normal level. It's still on the side of the underwriters, but it's clearly moving in a more equilibrium state."
},
{
"speaker": "Joshua Shanker",
"content": "And then continuing on the thought [indiscernible] Jimmy asked. I have a very crude capital model, and I wouldn't recommend anyone else use it. But it does seem like at the pace that the premium is decelerating, you're going to be sitting on some sizable excess capital in a fairly short order. Can you – I guess, talk a little bit about how the Allianz transaction uses capital that might be incorrect? My assumption that it may be – that may be a source that's really causing capital plug there. Or additionally, am I correct that you have at the kind of trajectory, a real capital buildup that's going to need to be utilized in short order?"
},
{
"speaker": "Francois Morin",
"content": "Well, I mean, first, on the Allianz transaction, we disclosed that we were – the rough numbers of capital that we were going to deploy in that transaction is $1.8 billion, which is the premium we're paying to acquire the asset and also the capital that we need to deploy to support the LPT that's coming our way immediately and then the ramp-up of the new business or the renewals that will end up on our balance sheet. So sizable number. And that is so far – I mean, as far as we know, I mean, there's – things are on track to be kind of at that level. To your point, yes, we – I mean, returns have been excellent, and we're very – we're proud of that. But we're not going to accumulate capital just that we can't deploy forever. So the reality is if you give us another couple of quarters maybe, but I mean, we'll definitely have a better view of where things stand by later this year. And then Marc has been talking about the casualty can pick up potentially. So if that accelerates in the third and fourth quarters and early next year, then we want to have the capital ready to deploy there. So that's certainly how we think about a big picture, but it's an ongoing discussion we have here."
},
{
"speaker": "Joshua Shanker",
"content": "All right. Thank you for the answers. Have a good day."
},
{
"speaker": "Marc Grandisson",
"content": "Thanks, you too."
},
{
"speaker": "Operator",
"content": "Our next question comes from Michael Zaremski from BMO."
},
{
"speaker": "Michael Zaremski",
"content": "Thanks. I'll keep with the theme on casualty and social inflation, especially since we do value your thoughts on this. I guess, can you remind us, two part, I believe you've said in the past that Arch's casualty reserve reviews are more geared towards the summer months. And related, now that you've been studying your book and the industry a little bit more. I recall last year, not just – and Marc, you had said, but others have said too that they thought that the casualty pressures would be more large accounts kind of than small accounts. But the data we see so far appears to be that the small account players have really added to the reserves more so. So I don't know if there's any thoughts there? Thanks."
},
{
"speaker": "Marc Grandisson",
"content": "I'll start with the second part of your question. You're exactly right. I think that I said that the large accounts, there are at the ground zero for pressure points on the losses because they're deeper pockets, right? They are larger limits, bigger enterprises, more complex cases and more attractive to the plaintiff lawyers. But you're right, we've seen, as well as everyone else, pressure building commercial auto as well, even of all sizes also going through a similar process. And it impacts, obviously, the umbrella portfolio. But you're quite right. We're sort of a second round sort of the rippling effect starting in ground zero, which is always a larger account, and it's sort of slowly, but surely ripples through the market, and we're starting to see this impact on the smaller packages as well. Smaller policies as well have lower limits. So it's probably easier – well, it seems to be currently in the space, you heard this too, I'm sure, the $1 million limit is what it used to be. So there's probably more of a pressure to pay the full limit as opposed to before maybe the industry was more willing to fight or push back. But again, the $1 million because of all the inflation has changed. In terms of reserve review, I'll say it, but we do a quarterly review of our reserving of every line of business that we do. Our actuaries review it every single time. And we have a change of loss ratio that we get reported on every line of business and sub-line quarterly for all the units that we look at. The one thing that we have as an added benefit at Arch is we have also – we have the insurance group and the reinsurance company, so we're able to compare at the high level of the holding company, Francois and I, as to what the trends are developing and what they're looking like. So it's a constant – I think what we used – what we may have said to you is we used to do an annual trend analysis. Now it's becoming a twice-a-year analysis, and it might accelerate as well. And I would assume that most people are using the same frequency because as we talk about all the time, reserving feed into pricing."
},
{
"speaker": "Francois Morin",
"content": "Yes. The one quick thing just to add on reserving, we monitor actual versus expected experience quarterly. That's a big part of the process. And not only do we do it against our own expectations but we monitor against our external actuaries expectations. So we got two views of how independent groups of actuaries think business or the reserves should develop over time. And that certainly informs the action we take every quarter. And to Marc's point, that's done in all the business units regularly."
},
{
"speaker": "Michael Zaremski",
"content": "Okay. That's helpful. Understood. And just last quickly on catastrophe levels. I think you guys are more open than others on \"normal.\" The Reinsurance segment cat ratio – the load ratio this quarter, is that kind of normal-ish since you guys have grown into property over the years?"
},
{
"speaker": "Marc Grandisson",
"content": "I think – yes. No, I think – no, again, repeating what we said before, and it's always hard to appreciate from your perspective, I'm sure, is that the Reinsurance has more volatility into it. So we tend to look at this on a longer-term average. So sometimes, we have a quarter – I remind everyone here, sometimes we have a quarter where the combined – the current accident year, ex-cap combined ratio and reinsurance goes up a little bit and people say it's a trend, but it's very hard to see this in Reinsurance. Sometimes it's above, sometimes it's below. I think this quarter, frankly, we had no lower attritional losses across the Reinsurance portfolio. And this is what – this what explains that. But if you look on a 12-month basis, it's not as drastic of a move."
},
{
"speaker": "Francois Morin",
"content": "Yes. I'd add to that also, the cat load that we reported or we kind of quoted earlier this year, I mean, we have a view on seasonality when these losses may or may not hit. I mean it's imprecise. Does it happen second quarter? Does it happen third quarter? It's a little bit of a – there's historical data to support that. But big picture, again, what we experienced this quarter was not unexpected. Was not – it was very much within what we thought was reasonable given the growth in the size of the book, the fact that it's broader, it's not only U.S., a lot of international and the different types of exposures that we reinsure primarily, yes."
},
{
"speaker": "Michael Zaremski",
"content": "Okay. That's helpful. And I'll sneak one last quickly on Mortgage just on a macro perspective. Would – if home price appreciation continues at a healthy pace or I guess, resumes at healthy pace with that, is that any factor in kind of the reserve release as maybe it was unexpected? Is there anything there from a very high level we can think about?"
},
{
"speaker": "Marc Grandisson",
"content": "Yes, it would, right? Because by virtue of having house price appreciation, you therefore increase your equity in your home. And the equity in the home is by far the lag thereof is a leading indicator as to whether you're going to have a foreclosure or a loss in your policy. And most of the policies, even if you had another 3% to 4%, whatever we're expecting, next year maybe 4.5% of HPA appreciation, the equity were built. And what happens – and it's very simple, right? The reason why equity matters is because, well, if you're running into trouble, the divorce, you're losing your job, you don't want to lose the equity in the home, you can just turn around and sell it to somebody else and then recapture at least a portion, if not all of the equity that you've built into it that something that people will do in and that the healthy market supply and demand market is such that you'll be able to sell your home with – and capture that equity even after some expenses. So that's what happens on HPA. If it goes too wild like it did in 2007, 2008, but it got into trouble for different reasons altogether. I think the credit space and the weighted mortgages have been originated over the last several years. HPA going up right now would be helpful. It's definitely helpful for us as an MI provider."
},
{
"speaker": "Michael Zaremski",
"content": "Thank you."
},
{
"speaker": "Marc Grandisson",
"content": "Sure."
},
{
"speaker": "Operator",
"content": "Our next question comes from David Motemaden from Evercore."
},
{
"speaker": "David Motemaden",
"content": "Good morning. I had a question on the underlying loss ratio in the insurance business. It was up a little bit year-over-year. That's despite having a higher mix of short tail business within the earned premium mix. Could you maybe talk about what was driving the loss ratio up year-on-year? And was that conservatism you guys are baking in on the casualty lines? Or a little bit of color there would be helpful?"
},
{
"speaker": "Marc Grandisson",
"content": "Yes. It's a pretty small increase. And this is – we don't want to ascribe any more precision to those numbers. They're judgment call quite often times. I think it's just a reflection of the mix and perhaps one on the business, the actuaries may take a little bit more of a conservative or a prudent stance and put a bit more – increase the loss ratio for a certain year or certain line of business or product line. That's really all there is to it. I think the variability around this even on an insurance level, we're a specialty writer. So there's a lot of things going on all at once in our portfolio. It's not very – it's not as predictive, I guess, as we wish we could be. But this is also why we believe we can attract higher returns because there's a lot more uncertainty in selecting the loss ratio pick. I would just attribute it to noise that happens from time to time as well as mix. Francois, anything to add?"
},
{
"speaker": "Francois Morin",
"content": "Good. Yes."
},
{
"speaker": "David Motemaden",
"content": "Great. Thanks. And then Francois, you had mentioned the actual to expected. Wondering if we could just get a little bit more color on that for the quarter? And then if you guys have changed your view of expected losses, just given it appears like claims payment patterns have been extending. So I'm wondering if that's been reflected as well in your expected – expectations?"
},
{
"speaker": "Francois Morin",
"content": "Yes. I think the A versus C work, it's done by line, by year. So yes, there's pockets where – I mean, it's puts and takes, right. There's some that we run favorable, some that there could be a year for when claim shows up and it's going to show adverse. But both quarter-to-date and year-to-date, in aggregate, both by segment, we are running ahead of expectations, which we didn't take the full credit for that. Some of that favorable experience is showing up in their actually favorable prior year development. But the indications are giving us a lot of comfort that our reserve base and our reserve levels are adequate to pay the claims. Absolutely, your question on patterns, that is – I mean, there's a good attempt – good-faith attempt to adjust the patterns with the experience that we have. Again, both internally and the advice or the opinions we get from external actuaries. So that's factored into the expectations that claims may be – may take longer to develop. And we understand that it's an evolving situation. I mean that seems that the patterns are changing over time, but that is fully kind of considered in those numbers."
},
{
"speaker": "David Motemaden",
"content": "Great. Thank you."
},
{
"speaker": "Marc Grandisson",
"content": "Welcome."
},
{
"speaker": "Operator",
"content": "Our next question comes from Charlie Lederer with Citigroup."
},
{
"speaker": "Charles Lederer",
"content": "Hey. Thanks. Good morning. Definitely, I heard Marc's comments on the reasons for the flattening out of property cat growth. Would you say the weather forecast had an impact on that? And could you – could we see you reverse course and reaccelerate if pricing is still good in 1/1 and you have a better view of how much of the MidCorp business you're keeping?"
},
{
"speaker": "Marc Grandisson",
"content": "I'm going to say this is one of the easiest answer, yes and yes to both of your questions, yes and yes. Yes, yes, we believe we took a conviction that there was a heightened – higher likelihood of frequency of events. And you're right, and it could change. This will be a short-term perspective, and this will help inform whatever new vision or new projection and new belief we have will help us make a decision as we get into 1/1 2025 after the wind season is over. Mind you, the business is still very good even with our increased frequency. So it's still a very, very good book of business. We just wanted to have the right balance."
},
{
"speaker": "Charles Lederer",
"content": "Got it. Thank you. And then, I guess, I'm wondering if you guys have your arms wrapped around the CrowdStrike cyber event yet. And if you can help us frame what the losses might be? And if you see any impact on the cyber pricing environment coming out of it?"
},
{
"speaker": "Marc Grandisson",
"content": "Yes, well, on the CrowdStrike, I mean we're still gathering information on our units, want to figure out what's out there and it's not only the – necessarily the cyber, but there might be some other lines of business. So we're just going through it as we speak. It's still kind of hard to disentangle. I mean some people are claiming some losses. They're not insured. So there's a lot of things going on. I think we tend to agree broadly with the market view that $500 million, $600 million to $1.2 billion. That's sort of – it's still a wide range at this point in time. It's going to take a while to know how it develops. I think I would want to – I mean it's not a big number in terms of loss ratio points for all the premium worldwide for cyber, but it's certainly a reminder that there's risk in the portfolio. And it's early now, we haven't seen them any renewals, but I would expect rates could still go down a little bit, but probably not as fast as they were going down. And people are going to probably take a bit of a more of a pause, if you will, to evaluate what it looks like. It can go either way, right? If CrowdStrike does not create a big loss, that might reinforce to believe that it's not as risky. Although, having that event, which was not malicious, happened out of nowhere, and we were all like out of – unable to work for a day, I think it's a good reminder of people that there's still uncertainty and there's some loss potential there."
},
{
"speaker": "Charles Lederer",
"content": "Thank you."
},
{
"speaker": "Marc Grandisson",
"content": "Welcome."
},
{
"speaker": "Operator",
"content": "Our next question comes from Andrew Kligerman from TD Securities."
},
{
"speaker": "Andrew Kligerman",
"content": "Hey. Thank you. Good morning."
},
{
"speaker": "Marc Grandisson",
"content": "Good morning."
},
{
"speaker": "Andrew Kligerman",
"content": "So I was interested in the net written premium there in professional lines. It looked like you were pretty much flattish this quarter year-over-year at $345 million. Could you share some of the puts and takes? Was public D&O awful lot? Did you see a pickup or a decrease in cyber? What were some of the big lines? And how do they move?"
},
{
"speaker": "Marc Grandisson",
"content": "Yes, there's a lot of things in the professional lines. It's kind of hard to disentangle from your perspective. But at a high level, D&O, we're reacting to what's out there. We're still maintaining our positioning. Cyber, we're still making exposure. Rates still go down, so that would go the other way. Health care, we like a lot. So we've grown that book of business. This is within the professional lines. And there's been some re-underwriting of some areas, if you will, at a high level that were not performing as well. So there's a lot of things going on all at once. I think what you're seeing, it was not the 300 – the flattish number is really a sum total of many decisions that were independent from one another. That's really what you can read into this."
},
{
"speaker": "Andrew Kligerman",
"content": "Got it. And along the same lines in reinsurance, property ex catastrophe, it was up quite a bit at $585 million versus $457 million last year. What did you like in the property area in reinsurance?"
},
{
"speaker": "Marc Grandisson",
"content": "Well, it's – in there, there's a lot of different lines, but there's a lot of quota share, some risk excess. We also have a facultative book in there as well. And all these units are taking advantage of the hard market still to this day and picking their spots. And we think the return expectations is not as cat exposed within – there is some cat exposure there, obviously. But we believe the returns are just very, very accretive and very, very favorable. Some of them are opportunistic by nature, right? We might be doing a specific deal in some specific payroll because we think the market is hard as we speak. So some of that was also factored in our writing. So it's a really broad line of business. As you can see, we love that line. We love the opportunities there. It's a little bit more complicated, I would say, to underwrite than a property cat – pure property cat book of business, but we've had the expertise and the knowledge and the willingness to do this for a long time, and we're – we really like to – we'd like to be exposed and do more of that line of business in that current return expectations."
},
{
"speaker": "Francois Morin",
"content": "Yes. And I'll add to that quickly. Just on the accounting side, it's important to remember that the property cat line of business is mostly on an XOL basis where we write all the premium on day one versus this property other than property cat line where the component that is on a quota share basis, the premium is written evenly throughout the exposure period. So they could very well be – there's accounts that we wrote at 1/1, for example, that the ramp-up of that premium is taking place over the four quarters of 2024 as we write the premium. So a little bit of a different kind of accounting policy on those types of reinsurance agreements, and that certainly has an impact on how it shows up in the quarterly numbers."
},
{
"speaker": "Andrew Kligerman",
"content": "Got it. And if I could just sneak one quick one in on the insurance line, the expense ratio picked up by 70 basis points. Should we be thinking about the expense ratio being slightly more elevated as you take on the Allianz book and invest there?"
},
{
"speaker": "Francois Morin",
"content": "Well, the investments that we made through this quarter are not related to that, right? So they are other opportunities, other efforts that we have underway that were predictive analytics, some tech companies that we've invested in. So we feel it's the right time for us to make those investments given how strong the returns are. And we'll see how those develop over time, maybe they slow down the road. But for now, we're very comfortable with the level of investments we're making. In terms of Allianz, just we'll give you more information as we move forward, but there will certainly be some integration expenses that will come through in the insurance segment, specifically going forward. Some of those expenses that will be kind of onetime, and we'll probably report those as part of a transaction cost and others. So that will clarify that for everybody once we close and after we have a time to – some time to digest it. But yes, the investments so far this quarter are for other initiatives."
},
{
"speaker": "Andrew Kligerman",
"content": "Got it. Thank you."
},
{
"speaker": "Marc Grandisson",
"content": "Welcome."
},
{
"speaker": "Operator",
"content": "Our next question comes from Brian Meredith from UBS."
},
{
"speaker": "Brian Meredith",
"content": "Yes. Thanks. A couple of them for you guys. The first, I'm just curious, do you all still stand by the three-year payback period for share buyback when it comes to book value dilution?"
},
{
"speaker": "Francois Morin",
"content": "That has been our practice. It's not a hard and fast rule. I think it's been the practice historically. But again, that's part of the framework of how we evaluate kind of various alternatives. Could we think about extending the payback at some point? And the answer is maybe."
},
{
"speaker": "Brian Meredith",
"content": "Got you. That's helpful. Thank you. And then, I guess, my next question, thinking about M&A here, it looks like you probably have the financial capacity to still do a reasonable amount of M&A. But do you have the kind of, call it, management and strategic – or call it, management capacity at this point as you're integrating the Allianz business or Fireman's Fund business over the next, call it, six to 12 months to do anything? You're going to kind of take a pause here for a while?"
},
{
"speaker": "Marc Grandisson",
"content": "Well, I think, Brian, it's also dependent on the opportunity that we have ahead of us, and we can certainly attract people to help us do any other integration. We have a team between us leading the effort on Allianz also were instrumental in integrating guaranteed way back in 2017, 2018. So we have already some good experience there. So I think we have enough bandwidth for what we're doing now quickly. And if something were to happen right, Francois, was really accretive and interesting, we would find a way to do this. I think that we're not there to work at the time. If something is very favorable to us, we'll expand the effort and the work that needs to get this done."
},
{
"speaker": "Francois Morin",
"content": "I mean these opportunities were – I mean, actually geography-specific and segment specific. So the Allianz acquisition is purely insurance North America. So that absolutely has taken center stage. But if we were to do some other M&A in other parts of the world in the reinsurance segment, that could be a different team most likely that would contribute."
},
{
"speaker": "Brian Meredith",
"content": "Makes sense. And then one other just quick one. I know you don't give us some numbers on the Allianz thing. But is there any color you can give us with respect to how does it add to your PMLs as we think about it going forward? Just looking at the map you provided us, it looks like there's a decent amount of business in kind of cat-exposed areas?"
},
{
"speaker": "Francois Morin",
"content": "Not materially because it's not as much in our peak zone. The book is more diversified, more Midwest, more California, less Florida, which is our peak zone. So in terms of the 1-in-250, marginal impact."
},
{
"speaker": "Brian Meredith",
"content": "Great. Thank you. Appreciate it."
},
{
"speaker": "Operator",
"content": "Our next question comes from Meyer Shields from KBW."
},
{
"speaker": "Meyer Shields",
"content": "Great. Thanks so much. Two quick questions. First, Marc, I think you and Francois both mentioned the elevated frequency predictions for not growing cat premium. Was there any reshaping of the portfolio to move further away from frequency events?"
},
{
"speaker": "Marc Grandisson",
"content": "No, I think that if you look at a high level, I think our exposure was – is more stable. It may have grown a little bit even on a gross basis, but what happened is we just shaped it through retrocession purchases. That's really what we did. And that's how we got back to a more reasonable and more acceptable level of PML."
},
{
"speaker": "Meyer Shields",
"content": "Okay. That's helpful. And second, just sort of for the most recent or up-to-date events, as we've seen more capital markets activity comes back – come back and we've seen that being blamed for pressure on public D&O pricing. Are you seeing any inflection that coincides with recovering activity?"
},
{
"speaker": "Marc Grandisson",
"content": "Not really. I mean the third-party capital that we hear – again, even those third parties, there's a healthy level of rationality in the behavior. So we haven't seen, like I said before, crazy players or mavericks in the marketplace. It's a pretty well-behaved marketplace."
},
{
"speaker": "Meyer Shields",
"content": "Okay. Thank you very much."
},
{
"speaker": "Marc Grandisson",
"content": "Sure, Meyer."
},
{
"speaker": "Operator",
"content": "I'm not showing any further questions. Would you like to proceed with any further remarks?"
},
{
"speaker": "Marc Grandisson",
"content": "Thank you very much, everyone. We'll talk to you again in October."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect."
}
] |
acgl | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good day, ladies and gentlemen, and welcome to the Q1 2024 Arch Capital Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, this conference call is being recorded. Before the company gets started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on this call may constitute forward-looking statements under the federal securities laws. These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the company with the SEC from time to time. Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The company intends the forward-looking statements in the call to be subject to the Safe Harbor created thereby. Management will also make reference to certain non-GAAP measures of financial performance. The reconciliations to GAAP for each non-GAAP financial measure can be found in the company's current report on Form 8-K, furnished to the SEC yesterday, which contains the company's earnings press release and is available on the company's website at www.archgroup.com and on the SEC's website at www.sec.gov. I would now like to introduce your host for today's conference, Mr. Marc Grandisson and Mr. Francois Morin. Sirs, you may begin. Marc Grandisson Thank you. Good morning, and welcome to Arch's First Quarter Earnings Call. We are pleased to report a terrific start to the year. In the first quarter, we posted $736 million in underwriting income and a 5.2% increase in book value per share as we realized the benefits from several years of strong and profitable premium growth. Underwriters in our P&C units continued to lean into hard market conditions, writing $5.6 billion of gross premium in the quarter, a 26% increase from the same quarter last year. Overall, rate changes are exceeding loss trends, and absolute returns remain above our long-term targets, positive indicators in our continued efforts to deliver superior results to our shareholders. Broadly, we are seeing incremental signs of increased underwriting appetite in the market, but this is not surprising, given the favorable conditions that exist. It is still an underwriter's market where Arch can thrive. At the beginning of this hard market, as other providers pull back, Arch sought to establish itself as a key trading partner, aiming to solidify relationships and remain top of mind when it comes to addressing our clients' increased needs. Our success in establishing deeper client connections continues to pay dividends in this extended, yet increasingly competitive hard market. The first quarter served as a reminder of our risky world when an active catastrophe quarter concluded with a major industry loss, as the Dali cargo ship collided with the Francis Scott Key Bridge in Baltimore. Although we recognized a loss related to this event, the virtue of having multiple lines of business with improved and positive expected margins, made this event manageable for Arch. Incidents like this reinforce the importance of our core tenants. One, we practice disciplined underwriting that builds a meaningful margin of safety into our pricing. Two, we take a long-term view of risk and a conservative approach to reserving. And three, we operate a diversified global business that we believe maximizes our total return by mitigating volatility in any one line of business. Capital management has been a key differentiator for Arch and is integral to how we operate our company. Effective capital management requires that we allocate resources to the most profitable underwriting opportunities, while retaining the flexibility to invest in our platform when we find attractive opportunities. One of those prospects came to fruition earlier this month, when we announced our intent to acquire Allianz's US. middle market and entertainment businesses. We see this as a unique opportunity to quickly build scale in the $100 billion-plus US. middle market, a long-term strategic area of underwriting interest for us. Increasing our middle market presence will further diversify our North American insurance platform by adding stable businesses with recurring premiums that can generate attractive returns over the cycle. As a cycle manager, we like having many ponds to fish in, and this acquisition will significantly expand our opportunities in the middle market pond for years to come. I'll now share a few highlights from our segments. As you know, The Property and Casualty market cycle is evolving, but still offers attractive growth opportunities at good returns, particularly for our skilled specialty underwriters, who can use their expertise and experience to differentiate Arch. The first quarter results from our Reinsurance segment were outstanding. Underwriting income for the segment was $379 million, while gross premium written grew by 41% over the same quarter last year. While there is some developing competition, we're observing an increased flight to quality and fully expect to capitalize on that trend as the cycle ages. Our Reinsurance segment is in an enviable position. The in-force book constructed over the last several years is strong and allows us to exercise our underwriting acumen. When opportunities emerge, whether from dislocation in the casualty market or by offering value that others cannot, Arch is there to provide solutions and financial strength to its clients. In our Insurance segment, growth tapered from the highs of the past few years as rate increases slowed and some of the dislocations were met by additional capacity. Overall, conditions remained strong and the market is behaving rationally, two important factors that continue to support growth and strong profit. In the first quarter, we fund growth opportunities in several lines, including Property and Casualty E&S and other specialty lines. Across most of our specialty lines, pricing remains very healthy, and we are able to deploy capital in order to deliver attractive returns above our long-term target of 15%. Like Reinsurance, our Insurance segment has made strong efforts to establish itself as a first-choice provider for its clients, and that manifests in seeing more opportunities. In life, you have to play to win, and in insurance, if you don't see the business, you can't write it. And now let's pivot from P&C to Mortgage, which to borrow from a famous ad campaign just keeps on going and going and going. Our Mortgage segment continues to generate solid underwriting income and risk-adjusted returns from its high-quality portfolio. While Mortgage originations remain tempered by high mortgage interest rates, the persistency of our in-force book remains a healthy 83.6%, while the delinquency rate is near all-time lows. New insurance written is in line with our appetite given market conditions. When the mortgage market picks up again, we're prepared to increase our production. However, if the status quo persists, we're content with our current situation that has extended the duration over which we earn mortgage insurance premium. Competition within the MI industry remains disciplined, which means we are in a good place. Finally, our Investments portfolio grew to $35.9 billion, generating $327 million of net investment income in the quarter. The extraordinary premium growth from our P&C segments continues to increase our float, which provides a significant tailwind to our overall earnings through the next several quarters. In the US, the NFL conducted its annual draft this past weekend. Traditionally, the team that finished last season with the worst record gets the first pick, a chance to select the best college player, while the champions pick last. The player selected with the top picks are expected to be immediate difference makers, even though they are typically selected by a team with multiple deficiencies, making success far from guaranteed. If you're a talented quarterback has nobody to throw the ball to, it can ruin the player's confidence, and the pressure can quickly sabotage a career. Compare this with teams drafting at the end of the round coming off successful seasons with talented rosters in place. They often have the luxury of selecting an excellent player who doesn't need to contribute right away. Instead, these teams select players who can fill a specific short-term role and be given time to grow into a difference maker. Our acquisition of the Allianz MidCorp business is like adding a solid player to a winning team. We already have established all-stars, a winning talent-dense culture in a favorable schedule in the years ahead. Adding the MidCorp team to our diversified franchise makes us better today and tomorrow, and that's a winning proposition. I'll now turn it over to Francois to provide some more color on our financial results from the quarter, and then we'll return to take your questions. Francois?"
},
{
"speaker": "François Morin",
"content": "Thank you, Marc, and good morning to all. As you will have seen, we started out 2024 on a very strong note, with after-tax operating income of $2.45 per share for the quarter for an annualized operating return on average common equity of 20.7%. Book value per share was $49.36 as of March 31, up 5.2% for the quarter. Our excellent performance was again the result of outstanding results across our three business segments, highlighted by $736 million in underwriting income. We delivered exceptional net premium written growth across our Reinsurance segment, a 31% increase over the first quarter of 2023, driven by strong business flow in all our lines of business. Growth was also solid for our Insurance segment, 12% after adjusting for the impact of a large nonrecurring transaction we underwrote in the first quarter last year in our warranty and lenders business unit. Overall, the combined ratio from the group came in at an excellent 78.8%. Our underwriting income reflected $126 million of favorable prior year development on a pretax basis or 3.7 points on the combined ratio across our three segments. We observed favorable development across many units, but primarily in short-tail lines in our Property and Casualty segments and in Mortgage due to strong cure activity. The collapse of the Francis Scott Key Bridge in Baltimore last month, has the potential to become the largest insured marine event in history. Both our Insurance and Reinsurance segments were exposed to this disaster, and our current estimates represent an impact of 2.1 and 3.0 points, respectively, on the combined ratio in these segments results this quarter. We note that the losses for this event were reported as non-catastrophe losses in our ratios. Catastrophe loss activity was relatively subdued and below our expectations across our portfolio, with a series of smaller events generating current accident year catastrophe losses of $58 million for the group in the quarter. Overall, our underlying ex cat combined ratio remained excellent with the increase this quarter relative to the last few quarters, mostly due to the Baltimore Bridge collapse. Despite the impact of this event, our current quarter ex cat combined ratio still improved by 1.4 points from a year ago, as a result of earned rate changes above our loss trend in our P&C businesses and lower expense ratios mostly from the growth in our premium base. These benefits were slightly offset by investments we continue to make in people, data and analytics and technology to improve the quality and resilience of our platform going forward. From a modeling perspective, I'd also like to remind everyone that our operating expense ratios are typically at their highest in the first quarter of the year due to seasonality and compensation expenses, including equity-based grants for retirement eligible employees that were made in March. As of April 1, our peak zone natural cat PML for a single event, one in 250-year return level on a net basis remained basically flat from January 1, but declined relative to our capital to 9.0% of tangible shareholders' equity, well below our internal limits. On the Investment front, we earned a combined $426 million pretax from net Investment income and income from funds accounted using the equity method or $1.12 per share. Total return for the portfolio came in at 0.8% for the quarter, reflecting the unrealized losses on the company's fixed income securities, driven by higher interest rates. Our growing Investment portfolio keeps providing meaningful tailwinds to our bottom line and remains of high quality and short duration. We have grown our investable asset base significantly over the last few years, primarily to significant cash flow from operations. This positive result, combined with new money rates near 5%, should support further growth in our Investment income for the foreseeable future. Income from operating affiliates was strong at $55 million. Of note, approximately $14 million of this quarter's income is attributable to the true-up of the deferred tax asset at our operating affiliate Somers in connection with the Bermuda corporate income tax, a nonrecurring item. Our effective tax rate on pretax operating income was an expense of 8.5% for the 2024 first quarter, slightly below our current expected range of 9% to 11% for the full year, mostly as a result of the timing of tax benefits related to equity-based compensation. As regard to our announcement to acquire the US. MidCorp and Entertainment insurance businesses from Allianz, we are making progress in obtaining the necessary regulatory approvals and are targeting a third quarter close for the transaction. At a high level, the agreement is structured around two related contracts. A loss portfolio transfer of loss reserves for years 2016 to 2023 and a new business agreement for business written in 2024 and after. Overall, we expect to deploy approximately $1.4 billion in internal capital resources to support both contracts, in addition to the cash consideration of $450 million. The overall transaction is expected to be moderately accretive to earnings per share and return on equity, starting in 2025. It is important to note that even when reflecting the capital to be deployed for this transaction, our capital base remains strong with a leverage ratio in the mid-teen range. We maintain ample financial resources and remain committed in allocating our capital in the most optimal way for the long-term benefit of our shareholders. With these introductory comments, we are now prepared to take your questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Elyse Greenspan from Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi, thanks. Good morning. My first question is on the reinsurance market. Marc, I think in your opening comments, you mentioned something about potential dislocation in the casualty market. Are you starting to see casualty market, just opportunities emerge there? I know you've highlighted this, I think, starting in the third quarter of last year. Or is this something that you still think might take a couple of quarters to kind of fully present an opportunity to Arch?"
},
{
"speaker": "Marc Grandisson",
"content": "Yes. The casualty market is going through, I wouldn't say repricing, but not re-underwriting as thorough because it has been already getting -- was hard, getting harder for the last several years. We may have some respite in terms of price increase middle of last year. But I think that the development of the prior year, as we all know, has created a little bit more uncertainties, and inflation is not ebbing. So right now, what we're seeing is people still being very, very careful and disciplined in how they underwrite the business, which leads Arch and gives us opportunity to lean into this even more so. We have grown our casualty book of business on the insurance side quite a bit. Our casualty book is E&S, as we all know, and very specialized in specialty. But sorry, I thought there was some technical difficulties here. Elyse, are you still there? I just want to make sure you can hear me."
},
{
"speaker": "Elyse Greenspan",
"content": "Yes, we can hear you."
},
{
"speaker": "Marc Grandisson",
"content": "Okay. Thank you, you. Thank you, you're a trooper. So the casualty market on the insurance side, we're growing, but I think now we're having more opportunities to grow. I think that there's some kind of -- not repricing, but definitely a focus on that line of business on the Insurance side. On the Reinsurance side, I think we're starting to see some of the renewals that came through and anecdotally it's creating a little bit more friction in terms of renewal of the casualty quota share, for instance. So what we expect right now is the early stages. We don't know how long it's going to last and where it's going to go, but there's clearly a psychological belief within the human system and the human interaction in the casualty that people need and know that we need to get more rate to make up for all the risks and potentially some of the misses that we had in the past."
},
{
"speaker": "Elyse Greenspan",
"content": "And then you guys mentioned the middle market opportunity you saw with this Allianz deal. After this transaction, are there other things on the list like when you think about Insurance, Reinsurance, now middle market and Mortgage. Are there other things that you guys think that maybe down the road, you would need or want to potentially add to the platform?"
},
{
"speaker": "Marc Grandisson",
"content": "Yes. We have a long list of things we'd like to acquire or have part of our arsenal. We talk about Allianz as an acquisition, and that's an important one and a significant one and a very good one for us. We're very pleased with that one. But what we also would want to tell our shareholders is, as you know, Elyse, we've also added teams along the way. So acquisition, a pure acquisition of a company is not the only thing that we're able to do. We've acquired some teams to do contingency, some more terror and everything in between. So we're always on the lookout. Again, as a cycle manager, Elyse, what you want is as many areas to deploy your capital, depending on the market conditions, creates a much more stable enterprise, much less volatility to the bottom line. And again, the more -- the market cycles are not monolithic, they are in multi phases and multi places. So we also have a little bit of an inside baseball. We -- our executive team is always -- almost every other month -- we have a list, a wish list that I will not share with you on this call, but it's a wish list of things that we know for a fact would be accretive and additive to our diversification of our portfolio, and we're always on the lookout for those. Mid market was on the list. And this is what -- so opportunities met the willingness to do it, and this is where we are."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Jimmy Bhullar from JPMorgan Securities, LLC."
},
{
"speaker": "Jamminder Bhullar",
"content": "Hi, good morning. So, just a question on the Baltimore bridge loss that you reported in Insurance and Reinsurance. And I recognize your results were pretty strong overall. But the number seems fairly high that you reported relative to what some of your peers have talked about and also what the industry losses seem to be? So I'm just wondering, I'm assuming most of this is IBNR, but just wondering sort of -- is this because of how much conservatism there was baked into the number? Or maybe the market is underestimating what the losses from the event are eventually going to end up being?"
},
{
"speaker": "Marc Grandisson",
"content": "Well, Jimmy, just at a high level, I'll let Francois talk about the reserving level. But we have been a participant in marine liability for quite a while. I used to underwrite the IGA in the Reinsurance group, way back in '02 or '03. This is nothing new to us. We also acquired Barbican in 2019. So we have -- and we have a stronger presence than we ever had in the London market, which, again, is another marine market positioning. So we do also, we do Insurance, Reinsurance and some retro actually. So it's nothing new to us. We like that business quite a bit, made money over the years. The rates and the returns were and are still acceptable. I mean but sometimes a loss occurs. I'm not sure about what the other ones are thinking about. But we definitely think that this is pretty much in line with what we would have expected the market share to be or what we think our presence in the marketplace would be. I'll let Francois talk about..."
},
{
"speaker": "François Morin",
"content": "Yes. I mean again, we can't speculate or comment on how others may or may not be reserving for this event. For us, it's not unusual. And I'd say that we've taken a very conservative view of the loss and still a lot to be determined, obviously, in terms of who's going to end up paying for it. But -- and the last point you asked last question is, yes, for us right now, it's all IBNR, I mean we don't really have all the specifics to establish case reserves. So we booked it as IBNR and we'll see how things develop."
},
{
"speaker": "Jamminder Bhullar",
"content": "And then on casualty reserves, your overall development was favorable, but was there any pockets of unfavorable within the overall number? And then if you could talk specifically about how your casualty reserves trended for pre-COVID and post-COVID years?"
},
{
"speaker": "François Morin",
"content": "Well, part one of your question, there was really no material development on long-tail casualty lines of business across all years. So both pre-2015 to '19 years and '21 to '23. So we're very comfortable with that. I think our reserves are holding up nicely. And I know there's been some concerns around the more recent years where there's been some signs of adverse in the industry. We're not seeing that. Actually, our metrics or our actuaries are commenting that our actual development is coming in more favorable than expected. Again, very early to declare victory, but that's certainly for us a positive sign, and we'll keep monitoring and see how things develop for the rest of the year."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Andrew Kligerman from TD Cowen."
},
{
"speaker": "Andrew Kligerman",
"content": "Hey, thank you and good morning. Marc, you mentioned that the MI market is going and going and going. How do you think about the favorable prior year developments? I mean last year in the first quarter, it was 25 points this year. In the first quarter, it's another 25 points. I mean does that still continue going forward as well?"
},
{
"speaker": "Marc Grandisson",
"content": "Well, I don't have a crystal ball for the future. But we're -- like everybody else, we're just on the receiving end of a market that's curing better. The borrower is in good conditions. There are programs on the GSEs that help the borrower staying in their homes. Most of those that even would have a delinquency, as we speak, would have a much lower mortgage rate. So they have a lot of incentive to stay in the home and not having to do anything with it, plus there's a lot of equity being built up in the home. So people have -- are sitting on because, as you know, there's been a significant increase in property valuation over three to 4 years. So everything is really indicating that we have a lot of the alignment between starting from the borrower, all the way to the mortgage insurer and the mortgage origination of the mortgage companies to make sure that the borrowers can make the payment, you can refinance, delay or attach it to a lot of things, a lot of tools and toolbox that weren't there, frankly, in '07 and '08 when the crisis happened. So -- but what does that mean in terms of development, we'll have to see what happens. But again, it's been more favorable than we would have said probably 2, three years ago, and we're just -- when we see the data, we just react to it."
},
{
"speaker": "Andrew Kligerman",
"content": "Pretty amazing stuff. And then my follow-up question is around the Allianz acquisition. And I love your analogy about the NFL draft and picking the high-quality players. Some have criticized Allianz as maybe I'll say they weren't a first round draft choice. So with that, what will Arch be able to do to kind of turn them into a first round type player? I mean I know I've heard about data and analytics, but can that help overnight? So I'd like to know what you're going to do there to really enhance that operation?"
},
{
"speaker": "Marc Grandisson",
"content": "Well, there's a lot of things going on. There's a thorough and very complete plan by our unit to first integrate them, making part of our company and our culture. And we'll have to look at everything that we can do to help them out It's an okay, it's okay business, very decent business, but we'll have to make it more of an Arch business, but recognizing some of the cultural differences in the distribution, it's a little bit of a different business. Data analytics is certainly one of them. We also bring to bear. We believe Allianz is a big company and they did a lot of work on this, where we have a strong presence in the US. as well. We also already do some middle market business. So we already have experience in that space. And so we have a -- we have a couple of things, a couple of tricks up our sleeve, if you will, to make it better. I won't go into all the details, obviously, but I think we're pretty excited about what we can do with the asset. And I think like I say all the time, and this is not a comparison with Allianz or us, but truthfully, it adds to the same thing to the Mortgage through UG, they're relatively a bigger piece of our overall enterprise and perhaps they would be in some other company. So that makes it a little bit more exciting and a bit more -- and the willingness from our part, obviously, to invest, right? I'll remind everyone that some of the earnings that we make, we put aside to invest for the future. So we have a lot of things going on, and we're pretty excited."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Michael Zaremski from BMO."
},
{
"speaker": "Michael Zaremski",
"content": "Hey, thanks. Good morning. On the Insurance segment, the underlying loss ratio of 57.5%, I know I'm probably just nitpicking. But I heard the commentary about the impact from the Baltimore bridge. But just curious, you've grown into property, which has a lower loss ratio, attritional loss ratio, I believe. So is there anything going on in the mix, that maybe you're putting in more conservatism on the casualty growth or anything we should be thinking about there?"
},
{
"speaker": "François Morin",
"content": "Mike, I'd say it's just the nature of the business we're in. I think there's going to be some ebbs and flows. There are going to be some -- I wouldn't call them unusual or unexpected developments. There could be 1 or two claims that surfaced in the quarter. We booked them, we recognized adverse or bad news early on and see how things play out. So there's really nothing to say that we want -- that needs to be highlighted. It's really part of the course. And yes, absolutely, this quarter, it turns out that the ex GAAP kind of underlying loss ratio was up, I'd say, 30 bps. And that's just the reality of the world we're in, and we think it's still an excellent result."
},
{
"speaker": "Michael Zaremski",
"content": "Okay. Got it. Second question is probably a quick one, but you all are kind enough to give us guidance on the cat load in the last quarter. I think you said it was in the 6% to 7% range for -- I believe it's just the premiums ex Mortgage segment. Is that expected to change or maybe be towards the high end of that range on a base case scenario as you kind of continue to lean into the hard market conditions as we think about '24?"
},
{
"speaker": "François Morin",
"content": "Well, the comment I made last quarter was -- yes, for the full year on the overall ACGL premium, 6% to 8%. We don't see that changing at this point. I think that was based on our view of how the year had a chance to play out. That's why we gave you a range. We were very happy with the 1/1 renewals. 401s went pretty much as expected and 6/1 so far are holding up nicely. I mean still a little bit of time to go before that gets finalized. But big picture, again, that's the 6% to 8% range for the year in terms of cat load is holding up nicely."
},
{
"speaker": "Michael Zaremski",
"content": "Sorry, is that 6% to 8% on all insurance premiums ex mortgage or just with total company..."
},
{
"speaker": "François Morin",
"content": "Total company-wide, ACGL total."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Dean Criscitiello from KBW."
},
{
"speaker": "Dean Criscitiello",
"content": "My first question was on the net to gross ratio in reinsurance. I saw that it ticked down about 5 points year-over-year. I was wondering, is that a function of buying more reinsurance? Or is there anything else going on there?"
},
{
"speaker": "Marc Grandisson",
"content": "No. I think if you look at the -- it's a good question. If you look at the last 4 or 5 years in the first quarter, you'll see that our net to gross ratio hovers between 65% to 70%. Last quarter last year, it was 70% because we had a larger transaction that came through that was not seated. So it's really just a comparison that's not -- just 1 period comparison is not reflective of what's going on. If you look at the longer term, you look at the 65% to 70%, so nothing changed there."
},
{
"speaker": "Dean Criscitiello",
"content": "Okay. And then the next thing, shifting back to the insurance business, I was a bit surprised to see solid growth within Professional lines given the rate environment there. So can you maybe talk about the market dynamics or the opportunities that you're seeing in that? And is that growth coming from D&O? Or is that within other professional lines?"
},
{
"speaker": "Marc Grandisson",
"content": "Yes. So the -- it's -- the thing -- our professional liability has many things into it. It's got a large company, large public company D&O, it's got some smaller private, also has cyber in it and some professional liability like agents and stuff like this, that's more E&O based. I think that the growth is largely attributed to the cyber. Our teams are leaning a little bit more into it, and we've also acquired a couple of more team or developing a team in Europe, there's a big need for what we realize as a need for cyber in Europe, and that's something that we're starting to grow and see more of. And the reason it's grown in cyber is because even though some of the rates, as we all heard, went down slightly, it's still a very, very favorable, we believe, very favorable proposition for us to underwrite. Also it helps us doing other lines of business because it creates value for our clients. It's still a little bit harder to get in terms of coverage. On the D&O, we would have decreases and increases depending on where the rates are or where we see the relative valuation or the profitability of our portfolio. On that note, the rates in D&O went down about 8% in this quarter, not as bad as it was 1.5 years ago. You heard the comments that the SEAs are down. So there's there's still -- we believe there's still a lot of favorable opportunities in that segment as well. We just have to be a little bit more circumspect when we do this."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of David Motemaden from Evercore ISI."
},
{
"speaker": "David Motemaden",
"content": "Marc, you mentioned in your prepared remarks that you're seeing increased underwriting appetite and developing competition, specifically within Reinsurance. Could you just talk about where you're seeing that, elaborate on that a little bit? And what specific lines you're seeing that in and how you guys are responding to that?"
},
{
"speaker": "Marc Grandisson",
"content": "Yes. I think right now, what we're seeing is more a higher appetite, cyber is one of them. That's for sure, Insurance and Reinsurance, that would also -- I mean, can run the gamut, there are many of them. Typically, right now, what we are the lines that are more short-tail in nature. You can see a little bit more willingness to take some more risk from the competition. And how we react to it is, we have many things we do. We typically will tend to first look at the overall [indiscernible] if the rates go down or if the rates stay as is, with the new conditions, you actually price the business as if it's a new piece of business and what kind of return it will get to you. And if it's a little bit not as much -- or not too close for comfort, we might just decrease our participation. And we also might just stay on the clients that we believe have a better chance to really maneuver through that a little bit sideways market, if you will. It's really an underwriters' market at this time."
},
{
"speaker": "David Motemaden",
"content": "Got it. And just within Reinsurance, the underlying margins there were strong and even better, if I exclude the bridge loss. Can you talk about if there is anything in there that would flatter the results? Or is it more just sort of the earn-in of the property, more short-tail lines and these results are fairly sustainable? I guess how should I think about the sustainability of the results on the Reinsurance side?"
},
{
"speaker": "François Morin",
"content": "Yes. I mean it's a great market, right? And we've been saying that for a few quarters. I think and we've said it before, I think we encourage you all to look at results on a trailing 12-month basis. I think it's a bit more reliable, I think, less prone to volatility that is sometimes hard to predict. But yes. I mean, we -- and Marc said it. I think the quality of the book that's in force right now is excellent, and we're going to earn that in. But whether how -- was this quarter a little bit better than maybe the long-term run rate? Maybe, we don't know. But again, as you try to look ahead, I'd say more of a trailing 12 month, again, view is probably a bit more reliable."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Josh Shanker from Bank of America."
},
{
"speaker": "Joshua Shanker",
"content": "On the other income which doesn't get enough attention, that's Somers and Coface. It was a weak quarter for Coface stock return in 4Q '23, yet the other was quite strong and maybe I'm misunderstanding how to model this, but I bring this up because Coface had an excellent quarter this past 1Q '24. And I'm wondering if that presages a very, very strong other income return for the company as we head into 2Q '24?"
},
{
"speaker": "François Morin",
"content": "Yes. So just to be -- make sure we're on the same page, there's a lag, right? So Coface is booked on a one lag -- one quarter lag basis. So what they just reported for Q1 will show up in our Q2 numbers. Somers is on a real-time basis. And as we know, Somers should follow relatively closely the performance of our Reinsurance book because it's effectively [indiscernible] there's some nuances to it. But big picture, that is booked on a real-time basis and should mirror fairly closely our Reinsurance book. But to your point, yes. I mean if Coface reported out a strong Q1, you should see the benefits of that to flow through in our second quarter."
},
{
"speaker": "Joshua Shanker",
"content": "In theory, there should be -- I guess, if you're saying some correlation between Reinsurance segment underwriting income and Somers, which appears in that other line?"
},
{
"speaker": "François Morin",
"content": "Correct. Yes. It's not perfectly correlated because it's not the whole segment. It's mostly the Bermuda Reinsurance unit that we -- that they follow. Not the entire business, but big picture is still -- I mean, if the market conditions are good and Reinsurance, the Somers will benefit from that on a similar basis."
},
{
"speaker": "Joshua Shanker",
"content": "And if one other numbers question post the S&P Model, the change from a few months ago, is there any way to think smartly about how much excess capital you think you're sitting on or the possibility if you find other interesting M&A items, the ability to quickly deploy?"
},
{
"speaker": "François Morin",
"content": "Yes. I mean that's always an evolving topic, right? I think we are always focused on putting the capital to work in the business where we can. I think we've done a fair amount of that, obviously, this quarter with the Reinsurance growth that we saw. The $1.8 billion that will support the Allianz transaction is another example. We will see how the year plays out. No question that, we're generating significant earnings so that goes to the bottom line. And we'll be patient with it until we can't really find other ways to deploy it. But for the time being, it's -- we're in a really good place in terms of capital and gives us a lot of flexibility."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Brian Meredith from UBS."
},
{
"speaker": "Brian Meredith",
"content": "A couple of quick numbers and one big-picture question for you all. The first one, just quickly, on the Allianz deal, is it possible to give us how much cash you're expecting to come in from the, I guess, [indiscernible] net cash position you're expecting..."
},
{
"speaker": "François Morin",
"content": "Yes, big picture, it's a $2 billion [indiscernible] with dollar for dollar, right? So we get $2 billion in cash, and we were spending $450 million that goes out back to them for the cash consideration. So net-net, it's $1.5 billion of incremental cash that we will get. And the rest on the new business, then it's, call it, it's the premium flow with as we write that business, that's the overall -- over time, that will be the incremental investment income or invested assets that we will get."
},
{
"speaker": "Brian Meredith",
"content": "That's helpful. Second quick question here. You referenced in your commentary higher contingent commissions on ceded business in your Reinsurance. What exactly is that?"
},
{
"speaker": "François Morin",
"content": "A lot of it is third-party capital, right? We -- last year was a very light or a good year for the performance of that book. So some of those agreements, many of them actually pay us a commission that is -- there's a base and then there's a variable aspect to it, then that was kind of a lot -- a large part of that. So that's effectively performance-based commissions on property cat or property business."
},
{
"speaker": "Brian Meredith",
"content": "Makes sense. And then one bigger-picture question here. I'm just curious, on your Reinsurance business, Obviously, during the first quarter, you're getting a lot of [indiscernible] coming in from clients. What are you seeing with respect to reserve development at your clients, right? And how you kind of protect against that and not potentially seeing some of that adverse development that your clients are seeing on your cut of casualty quota share business?"
},
{
"speaker": "Marc Grandisson",
"content": "Yes. So I think the -- Francois mentioned the actual is expected, which is sort of consistent in both insurance and reinsurance on the more recent policy or accident year, which having the right starting point means that you don't really have to correct frequently. So I would say that we're not surprised on the Reinsurance about what we see. But as I said earlier, I think there is anecdotally and some heavy -- a lot of more friction, I would say, between Insurance and Reinsurance companies to make sure that people get an agreement as to what the ultimate book is going to be. So we're hearing this going in the marketplace. Of course, we participate in that, but we're not seeing this as being a big issue for us. And the other years that would have been pre-2020 and 2021, I want to remind everyone that we were very defensive. We do not have a whole lot of those premium and those harder-in-developing areas that people are talking about. So I will say that we see opportunities to write more of those, and we expect to see more opportunities to write more of those types of deals this year, but I wouldn't say that we are the most present in those worst years, if you will."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Cave Montazeri from Deutsche Bank."
},
{
"speaker": "Cave Montazeri",
"content": "I only have one question today on the Florida market. The total reform implemented over a year ago seems to have had some positive impact on the primary carriers, and Reinsurance capital seems to be coming back. This is a market that you guys know very well. Do you have any color you can share with us on the state of the market in Florida?"
},
{
"speaker": "Marc Grandisson",
"content": "No, I think it's -- to your point, some of the adjustments are coming through, but inflation is also picking up. And there's also, as we all hear, there's potentially more activity in the Southeast of the US. in terms of activities and storms. So I think that people are trying to sort out what they will do at this point in time. I think we have already existing relationships that we think will get us a little bit ahead of the game in terms of participating and getting a participation in the marketplace. But bottom line is we expect the Florida market to be well priced and very good from a risk-adjusted basis. Nothing indicates anything else other than that. Even, of course, the -- everything that's been done to take care [indiscernible] and whatever else in between, I think, is helpful. But it's still the largest property cat exposure for everybody around the world. So even if you make some corrections and they have made some corrections, I think we still have a couple of years before we start thinking about having a heavy softening in the market. There might be some here and there, but we still believe the market will be healthy as a reinsurer."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Bob Huang from Morgan Stanley."
},
{
"speaker": "Bob Jian Huang",
"content": "Quick question on M&A side. Obviously, you have historically generated very durable underwriting returns, mainly because of cycle management, in my view. Just curious as you move into M&A and diversify your business mix, does that impact your cycle management ability for retention levels when we think about M&A or potential M&A down the road?"
},
{
"speaker": "Marc Grandisson",
"content": "No, it doesn't change. I mean cycle management is a core principle of ours. And if anything, we'd like to be able to do -- it's going to be a matter of degree perhaps. Some lines of business have more acute cycle management because they're probably more heavily commoditized. I would expect the cycle management to be much softer in the Allianz and the US. MidCorp business. And that's also what's attractive about it, right, because it creates more stability for the portfolio."
},
{
"speaker": "Bob Jian Huang",
"content": "Got it. No, that's very helpful. And then in that case, when we think about M&A or future M&A, is it the first preference to use the excess capital or excess cash you're generating from this business to do the M&A deals? Or is it more preferable to use some of the stocks given where the valuation is and things of that nature?"
},
{
"speaker": "François Morin",
"content": "I mean there's no one answer to that. I think there's always -- I mean, and we talk about M&A, but M&A doesn't happen that often. So there's a size that matters, how much could we need -- would we need to raise in terms of using our own stock? Certainly, in terms of dilution, it's always, we think better to kind of use our cash. But there's many considerations we look at, trying to optimize as best we can all the options. We've got plenty of capacity in raising debt too, if need be. So it's very much a function of each specific circumstance, each specific opportunity. We look at it on its own and go from there."
},
{
"speaker": "Bob Jian Huang",
"content": "Sorry, if I can just have a little bit of clarification on it. Is it fair to say that in that case, cash and debt is more preferable and then equity may be a little bit less or I'm [indiscernible]? So sorry, just maybe a little bit clarification on that."
},
{
"speaker": "François Morin",
"content": "I mean that's been the preference historically. But I mean, again, it's hard to speculate on what could be the next thing. So yes, historically, but things change over time, too."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Michael Zaremski from BMO."
},
{
"speaker": "Michael Zaremski",
"content": "Just a quick follow-up. You mentioned fee income earlier. Arch has a lot of diversified sources of income. Is there a way you can update us on kind of what percentage of your earnings maybe last year was derived from these kind of fee income type arrangements at a high level?"
},
{
"speaker": "François Morin",
"content": "I mean it's grown over the years, for sure. I think that the difficulty or the reality we face is some of these fees are somewhat -- with the expense -- the revenue we get that has some expenses that go with it, and those are kind of co-mingled with our own internal expenses. So isolating, call it, the margin on those contracts is a little bit kind of cloudy. But yes, it's grown. It's part of what we do. It's part of the leveraging our platform, leveraging our underwriting capabilities, in all our segments, right? All three segments have some fee income that comes into the errors. Obviously, Somers is part of that as well. But yes, it's become a bit more sizable for us."
},
{
"speaker": "Operator",
"content": "Thank you. I would now like to turn the conference over to Mr. Marc Grandisson for closing remarks."
},
{
"speaker": "Marc Grandisson",
"content": "Thank you very much for hearing our earnings. Great start of the year. We look forward to seeing you all in July."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect."
}
] |
acn | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Thank you for standing-by. Welcome to Accenture's Fourth Quarter Fiscal 2024 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, today’s conference is being recorded. And I will now turn the conference over to our host, Katie O'Conor, Managing Director, Head of Investor Relations. Please go ahead."
},
{
"speaker": "Katie O'Conor",
"content": "Thank you, operator, and thanks, everyone for joining us today on our fourth quarter and full fiscal 2024 earnings announcement. As the operator just mentioned, I'm Katie O'Conor, Managing Director, Head of Investor Relations. On today's call, you will hear from Julie Sweet, our Chair and Chief Executive Officer; KC McClure, our current Chief Financial Officer; and Angie Park, our incoming Chief Financial Officer. We hope you've had an opportunity to review the news release we issued a short time ago. Let me quickly outline the agenda for today's call. Julie will begin with an overview of our results. KC will take you through the financial details, including the income statement and balance sheet, along with some key operational metrics for the fourth quarter and full fiscal year. Julie will then provide a brief update on our market positioning before Angie provides our business outlook for the first quarter and full fiscal year 2025. We will then take your questions before Julie provides a wrap up at the end of the call. Some of the matters we'll discuss on this call, including our business outlook are forward-looking, and as such, are subject to known and unknown risks and uncertainties, including but not limited to, those factors set forth in today's news release and as discussed in our Annual Report on Form 10-K and quarterly reports on Form 10-Q and other SEC filings. These risks and uncertainties could cause actual results to differ materially from those expressed in this call. During our call today, we will reference certain non-GAAP financial measures, which we believe provide useful information for investors. We include reconciliations of non-GAAP financial measures where appropriate to GAAP in our news release, or in the Investor Relations section of our website at accenture.com. As always, Accenture assumes no obligation to update the information presented on this conference call. Now, let me turn the call over to Julie."
},
{
"speaker": "Julie Sweet",
"content": "Thank you, Katie, and everyone joining. And thank you to our 774,000 people around the world who have worked every day to be at the center of our clients' business and deliver 360 degree value for all our stakeholders. Our performance this year clearly demonstrates the resilience and agility of our business model, the power of our scale and reinvention in action. FY '24 was marked by a challenging market environment, and we have rapidly shifted to where our clients are buying, large reinventions that utilize the scale of Accenture's expertise and ecosystem relationships. And we have yet again put reinvention into action at Accenture with our significant investment and yearly (ph) leadership in what we believe will be the most transformative technology of the next decade, GenAI. As a result, over the last four quarters, we have successfully positioned Accenture for strong growth in FY ‘25. When market conditions improve, we will be well positioned to capitalize them. In FY ‘24, we continue to deliver on our enduring shareholder value proposition to grow faster than the market and take share, deliver earnings growth and margin expansion while investing at scale with strong free cash flow, disciplined capital allocation and significant cash return to shareholders. Turning to our results and the foundation for growth we have built for FY '25. With our clients prioritizing large scale transformations, we doubled down on our strategy to be the reinvention partner of our clients. Our success is reflected in our full fiscal year bookings of $81 billion, representing 14% growth in local currency, including 33 clients with quarterly bookings greater than $100 million in the fourth quarter, bringing the total of such bookings to 125 for the year, 19 more than last year. We are proud to now have 310 Diamond clients, our largest client relationships, an increase of 10 from last year, expanding our base of deep client relationships and the vantage point we have on the market. We delivered revenues of $65 billion for the year, representing 2% growth in local currency, while continuing to take market share on a rolling four quarter basis against our basket of our closest global publicly traded competitors, which is how we calculate market share. We expanded adjusted operating margin by 10 basis points and delivered adjusted EPS growth of 2%, while continuing to significantly invest in our business and our people with $6.6 billion in Strategic Acquisitions, $1.2 billion in R&D, and $1.1 billion in Learning and Development. We generated free cash flow of $8.6 billion allowing us to return $7.8 billion of cash to shareholders. We completed the business optimization actions we announced in March 2023 to reduce structural costs. For the full fiscal year, we had $3 billion in new GenAI bookings, including $1 billion in Q4. And for the full fiscal year, we had nearly $900 million in revenue. The magnitude of this achievement is seen in the comparison to FY '23, where we had approximately $300 million in sales and roughly $100 million in revenue from GenAI. This was an area where our clients continued to buy small deals, and we focused on accelerating our growth here. We have continued to steadily increase our data and AI workforce, reaching approximately 57,000 practitioners against our goal of 80,000 by the end of FY '26. We invested in our people to continue to develop their marketable skills and to help us reinvent our services using GenAI. Our people had approximately 44 million training hours this year, representing an increase of 10%, predominantly due to GenAI training. In addition to being a talent creator through our investment in learning, our talent strategy to succeed over the next decade is to have the best access to talent and to unlock the potential of our talent through, among other actions, ensuring our people feel they are net better off for working at Accenture across four dimensions: marketable skills, working for a purpose, well-being financial, mental and physical and relationships, where our people feel they belong and can thrive. In addition, our leadership in the market requires that we lead in innovation, which in turn requires access to broad pools of talent that provide the variety of perspectives, observations and insights, which are essential to continuously innovate. These strategies depend on us fostering a diverse and inclusive workplace, and our superior execution of these strategies is demonstrated by our global recognition for the third year with the number one spot on the FTSE, Global Diversity and Inclusion Index, an objective measurement of over 15,000 organizations and our recent achievement of having 50-50 gender equality in our advanced technology centers in India, which have over 220,000 people. Our long-term growth depends on thriving communities, and we continue to successfully create value in the communities where we operate, such as our work helping address the United Kingdom's digital inclusion gap, partnering with Tech [indiscernible] on a new program, regenerative AI, that aims to empower people and socioeconomically disadvantaged communities across the country to build their digital skills. Finally, I want to acknowledge how proud we are to have earned the number two spot on Times World's Best Companies list and the top spot on the World's Best Management Consulting Firms list by Forbes. Over to you KC."
},
{
"speaker": "KC McClure",
"content": "Thank you, Julie, and thanks to all of you for joining us on today's call. We're very pleased with our results in the fourth quarter, which were aligned to our expectations and reflect improvement across all dimensions of our business. We continue to invest for long-term market leadership, while delivering significant value for our shareholders. So let me begin by summarizing a few highlights for the quarter. Revenue grew 5% in local currency, driven by mid-single digit growth or higher in seven of our 13 industries, including public service, industrial, software and platforms, health, high tech, energy, and life sciences. We had growth in all three markets, all three services as well as return to growth in consulting type of work for the first time in six quarters. Organic revenue improved as well to slightly positive growth, and we continue to take market share. Adjusted operating margin was 15%, an increase of 10 basis points over Q4 last year. We continue to drive margin expansion while making significant investments in our business and our people. We delivered adjusted EPS of $2.79, which represents 3% growth compared to adjusted EPS last year. And finally, we delivered free cash flow of $3.2 billion and returned $1.4 billion to shareholders through repurchases and dividends. With those high level comments, let me turn to some of the details. New bookings were $20.1 billion for the quarter, representing 21% growth in U.S. dollars and 24% growth in local currency with an overall book-to-bill of 1.2. Consulting bookings were $8.6 billion with a book-to-bill of 1. Managed services were $11.6 billion, with a book-to-bill of 1.4. Turning now to revenues. Revenues for the quarter were $16.4 billion above the mid-point of our guided range, reflecting a 3% increase in U.S. dollars and 5% in local currency. Consulting revenues for the quarter were $8.3 billion, up 1% in U.S. dollars and 3% in local currency. Managed services revenue were $8.1 billion, up 5% in U.S. dollars and 7% in local currency. Taking a closer look at our service dimensions, technology services and strategy and consulting both grew mid-single digits and operations grew low-single digits. Turning to our geographic markets. In North America, revenue grew 6% in local currency driven by growth in public service and industrial. In EMEA, revenue grew 2% local currency led by growth in public service and life sciences, partially offset by a decline in banking and capital markets. Revenue growth was driven by Italy and the United Kingdom, partially offset by a decline in France. In growth markets, revenue grew 9% in local currency, led by growth in banking and capital markets, software and platforms, and industrial. Revenue growth was driven by Argentina and Japan. Moving down the income statement. Gross margin for the quarter was 32.5% compared with 32.4% for the same period last year. Sales and marketing expense for the quarter was 10.7% compared with 10.8% for the fourth quarter last year. General and administrative expenses were 6.8% compared to 6.7% for the same quarter last year. Before I continue, I want to note that results in Q4 of FY '24 and FY '23 include costs associated with business optimization actions, which impacted operating margin and EPS. The following comparisons exclude these impacts and reflect adjusted results. Adjusted operating income was $2.5 billion in the fourth quarter, reflecting a 15% adjusted operating margin, up 10 basis points compared with Q4 last year. Our adjusted effective tax rate for the quarter was 26.2% compared with an adjusted effective tax rate of 27.4% for the fourth quarter last year. Adjusted diluted earnings per share were $2.79 compared with adjusted EPS of $2.71 in the fourth quarter last year. Days service outstanding were 46 days compared to 43 days last quarter and 42 days in the fourth quarter of last year. Free cash flow for the quarter was $3.2 billion, resulting from cash generated by operating activities of $3.4 billion, net of property and equipment additions of $214 million. Our cash balance at August 31 was $5 billion compared with $9 billion at August 31 last year. With regards to our ongoing objective to return cash to shareholders. In the fourth quarter, we repurchased or redeemed 2.1 million shares for $628 million at an average price of $303.07 per share. Also in August, we paid our fourth quarterly cash dividend of $1.28 per share for a total of $808 million. And our Board of Directors declared a quarterly cash dividend of $1.48 per share to be paid on November 15, a 15% increase over last year, and approved $4 billion of additional share repurchase authority. Now I'd like to take a moment to summarize the year. Our fiscal '24 results illustrate the diversity and durability of our business as well as our ability to continue to manage our business with rigor and discipline. We delivered record bookings of $81.2 billion, reflecting 13% growth in U.S. dollars and 14% growth in local currency, with a record 125 quarterly client bookings over $100 million, which positions us well as we begin FY '25. Revenue of $64.9 billion for the year reflects growth of 2% local currency. Before I continue, I want to note that results for the full fiscal year '24 and fiscal '23 include costs associated with business optimization actions, and fiscal '23 results also reflect a gain on investment in Duck Creek Technologies, which impacted operating margin, our tax rate and EPS. The following comparisons exclude these impacts and reflect adjusted results. Adjusted operating margin of 15.5%, a 10 basis point expansion over FY '23. Adjusted earnings per share were $11.95, reflecting a 2% growth over adjusted FY '23 EPS. Free cash flow of $8.6 billion reflected a very strong free cash flow to net income ratio of 1.2. And with regards to our ongoing objective to return cash to shareholders, we returned $7.8 billion of cash to shareholders while investing approximately $6.6 billion across 46 acquisitions. In closing, we feel good about how we managed our business while navigating a challenging macro environment in FY '24 and we remain committed to delivering on our enduring shareholder value proposition while creating 360 degree value for all our stakeholders. And now back to you, Julie."
},
{
"speaker": "Julie Sweet",
"content": "Thank you, KC. Our FY '24 growth was driven by our clients seeking to reinvent using tech, data, AI and new ways of working. Reinvention requires a strong digital core. In FY '25, a significant driver of our growth will continue to be helping our clients with digital transformation, including building out their digital core and then using it to drive productivity and growth. We see the advent of GenAI and its tremendous potential acting as a catalyst for reinvention. Our clients turn to us for our unique combination of services across strategy, consulting, song, Industry X, technology and operations. Our strategists and deep industry functional customer and technology consultants work hand-in-hand with our clients and across services to shape and deliver these reinventions. Our investments in our advanced platforms, our assets and solutions, our process expertise, the insights from our scale and diversification, and our ability to both design and build the solutions, combined with our managed services are key differentiators for us. At the same time, we see AI as the new digital. Like digital, AI is both the technology and a new way of working, and the full value will only come from strategies built on both productivity and growth. And it will be used in every part of the enterprise. We believe the introduction of GenAI signifies a transformative era that is set to drive growth for us and our clients over the next decade much like digital technology has in the last decade and continues to do so. As part of that, we expect that the work to prepare enterprise data, which is the fuel for AI will be an increasing part of our growth. To accomplish reinvention and take advantage of AI, businesses need to focus on talent, their ability to access the best people at the right time, place and cost, the ability to be a talent creator to keep their people market relevant and their ability to unlock the potential of their talent is critical. We see talent as a top C-suite agenda item. Today, our managed services are an important part of our clients' long-term talent strategy. Our ability to harness AI is helping them close talent gaps and our strong expertise across talent, change, HR and organizations differentiates all our services. Our launch of LearnVantage, which provides comprehensive technology learning and training services, helps our clients reskill and upskill their people so they can be a talent creator. Let me give you a few examples of the types of reinventions we are doing. In Financial Services, banking and insurance are on their reinvention journey, while retirement services a $15 billion global addressable market growing at about 6% has lagged behind. We have invested to grow our capabilities and talent to capture this next wave of growth. We are working with TIAA, the largest U.S. provider of lifetime income to accelerate the transformation of the company's retirement record-keeping capabilities and operations. Leveraging the power of AI, automation in the cloud, we are helping the company implement new technologies, making record-keeping processes more efficient over time and easier for their customers. Through this strategic partnership, we are supporting parts of TIAA's record-keeping operations, including back end processes and technology. For example, retirement plan sponsors will experience faster plan changes and participants will find it easier to initiate account openings and investment selections. Together, we are making retirement planning more accessible, efficient and personalized for individuals and clients, helping TIAA need its mission of a more secure in retirement for more Americans. Today, we work with 75% of the world's largest communication services providers. With our strong industry and technology expertise, we are modernizing a global Telecom's core IT operations to drive growth. Through our managed services program, we are consolidating IT vendors, increasing productivity by an estimated 60% and reducing cost by half. We are also infusing our GenAI tools to enhance the software development life cycle and automate manual tasks such as resolving technical issues with customer orders, invoices or service availability. Now this will free up employees to focus on strategic growth initiatives and improve the overall customer experience. We are also implementing new ways of working, and then we'll train and upscale the team to use the new GenAI tools more effectively, helping to create more profitable outcomes for the company. These changes will create a stronger management framework and prepare the company for expansion into new markets. Security continues to be one of the fastest growing parts of our business, reaching $9 billion in revenue this year, representing 23% growth. We are partnering with the Kuwait Government Central Agency for information technology to revolutionize the security posture of its public services and national critical infrastructure. We are implementing and managing a scalable platform powered by GenAI, enabling the agency to act on evolving cyber threats up to 60% quicker than with traditional technologies, including detection response and containment models. In the past, security analysts manually research threats with limited information before handing the incident to the impacted government entity losing valuable time as the attack progressed. But now using a new platform, when analysts open a potential incident, they can quickly drill down into details about the users, systems under attack, type of attack and more with just one click. Thanks to GenAI's ability to process significant amounts of data and automatically elaborate context as a threat is detected, we are supporting our experts in making faster decisions with confidence as we progressively onboard over 60 government entities and while we also develop local talent. The strategic collaboration underscores our commitment to safeguarding Kuwait's digital assets and empowering the nation's journey towards enhanced cybersecurity resilience. A key area for companies to seek reinvention is in marketing, where the potential to use tech, data and creativity to drive growth, drive tangible outcomes for the enterprise. We are very proud to be working with HP and American multinational information technology company and a new global partnership to develop the right data sets, technology and creative for their B2B powerhouse business and brand that fulfils their goal to move away from the traditional agency model to true marketing capability transformation to significantly improve the impact, efficacy and efficiency of their marketing investment with the ability to drive tangible business results. In every industry, there is a challenge or opportunity that GenAI can now uniquely solve. Our deep understanding of both the industry and the technology positions us to be the best at creating real value from GenAI with our clients. For example, in insurance, companies can't typically process 100% of their coverage submissions. This creates a bottleneck for revenue growth. The ability to leverage GenAI to read 100% of submissions allows insurance companies to better assess risk as well as quote and write more policies and do it all more quickly and cost effectively. Utilizing a new set of solutions we created, we're working with QBE Insurance Group, a multinational insurance company headquartered in Sydney, to scale industry-leading AI powered underwriting solutions, replicated across multiple lines of business to help the company to make faster and more accurate business decisions. A series of Board, executive level and all employee learning sessions were conducted to help drive the design and build those solutions that analyze new business submissions for completeness, appetite check and risk evaluation insights. They can now process 100% of submissions received from brokers, greatly accelerating market response time. After nine months in market, these solutions are winning multiple industry innovation awards and early results indicate an increase in both quote to buying rate and premium. This collaboration will enable QBE Insurance Group to identify and select risk more effectively, improve broker and customer experience and support growth. We are collaborating with a major integrated downstream energy provider to drive significant improvements in safety, sustainability and operational performance with three new GenAI powered solutions. We aim to continue to improve safety by using proactive insights from GenAI to inform planners of potential incidents instead of reactively waiting for specific warning signs to appear. This means 90% faster data access, reducing planning time from hours to minutes per task. Another solution will help detect methane leaks in real time and prioritize their resolutions. We also helped build a smart solution for operators and process engineers to drive custom insights to optimize refinery performance and reduce downtime. The energy provider is on a path to set a new industry standard for innovation and refinery operations. One of the most powerful impactful uses of GenAI today across industry is in consumer experience transformation. We are working with Mondelez International, a world leader in snacking with well-known brands like Oreo, belVita and Cadbury to transform their marketing organization with GenAI to help drive consumer behavior. As part of this program, we're standing up a refreshed operating model with a primary focus on upskilling their employees in GenAI technologies. We are also helping enable a new capability to scale content creation and generate personalized text, images and videos across markets. This means exceptional creative can be developed in hours, not weeks, allowing content to be catered to consumers quickly as demands change. The strong digital core we established also allows the company to collect and process real-time data using GenAI to create new contextualized insights that can be easily accessed, shared and used by decision makers across the company. This work will increase the effectiveness and efficiency of messaging to create more impactful experiences. Now let's turn to our acquisitions. Over the last decade, we have built a finely tuned acquisition capability, becoming known in the market as a good home with approximately 70% on average of our acquisitions sole sourced. While our ability to identify and evaluate our acquisitions is critical, it is our ability to integrate them successfully that has made our acquisition capabilities so formidable. As we look forward, we are excited about the opportunity to better serve our clients and differentiate in the market to the acquisitions we've made this last fiscal year. As a reminder, we do acquisitions ultimately to drive our organic growth. Our global footprint, deep client relationships across industries as well as strong ecosystem gives us a unique perspective on growth opportunities. We use acquisitions to scale quickly in growth areas, to build new skills in adjacent markets and to deepen our technology, industry and functional expertise. Over the years, acquisitions have built major areas of growth like what we call Song today in our security practice. Here are a few examples of where we are investing now to lead in the next waves of growth. Starting with capital projects, an over $440 billion addressable global market growing approximately 5%. In FY '22, globally, we had approximately $300 million in capital projects revenue. We entered the U.S. market in FY '23 with the acquisition of Anser Advisory. Since the beginning of FY '24, we expanded our reach into Canada with Comtech in Q1, and this Q4, we acquired BOSLAN in EMEA. We recognized over $800 million in revenue on capital projects this fiscal year '24. Health is an industry still early in digitization, where we see significant opportunity over the next decade. It is a $70 billion addressable global market growing approximately 6%. This year, we added Cognosante in the U.S., creating a new federal health portfolio in our federal service business. We also acquired Nautilus Consulting in the U.K., a digital consultancy specializing in electronic patient records. And we announced our intent to acquire consus.health, a health care consultancy in Germany that offer services ranging from medical strategy and patient management to procurement and logistics, infrastructure management and construction planning services. And in Europe, public service, an industry that is early in digitization with significant investment allocated for transformation, our acquisitions are accelerating our growth and setting us up to take shares in a $46 billion market that is growing approximately 5%. We acquired Arns, Aris (ph) in Germany, a technology services provider supporting the public sector transformation across Europe. In Italy, we acquired Intellera Consulting, one of Italy's main professional services providers operating the public administration and health care sectors, and Customer Management IT and SirfinPA, jointly owned consultancies, supporting the public sector and specializing in justice and public safety. Now it gives me great pleasure to hand over to Angie Park, who'll become our new CFO on December 1, who will take us through our guidance for FY '25. Angie?"
},
{
"speaker": "Angie Park",
"content": "Thanks, Julie. Now let me turn to our business outlook. For the first quarter of fiscal '25, we expect revenues to be in the range of $16.85 billion to $17.45 billion. This assumes the impact of FX will be approximately positive 1.5% compared to the first quarter of fiscal '24 and reflects an estimated 2% to 6% growth in local currency. For the full fiscal '25, based upon how the rates have been trending over the last few weeks, we currently assume the impact of FX on our results in U.S. dollars will be approximately positive 1.5% compared to fiscal '24. For the full fiscal '25, we expect our revenue to be in the range of 3% to 6% growth in local currency over fiscal '24, which includes an inorganic contribution of a bit more than 3%. And we expect to invest about $3 billion in acquisitions this fiscal year. For operating margin, we expect fiscal year '25 to be 15.6% to 15.8%, a 10 basis point to 30 basis point expansion over adjusted fiscal '24 results. We expect our annual effective tax rate to be in the range of 22.5% to 24.5%. This compares to an adjusted effective tax rate of 23.6% in fiscal '24. We expect our full year diluted earnings per share for fiscal '25 to be in the range of $12.55 to $12.91, or 5% to 8% growth over adjusted fiscal '24 results. For the full fiscal '25, we expect operating cash flow to be in the range of $9.4 billion to $10.1 billion, property and equipment additions to be approximately $600 million and free cash flow to be in the range of $8.8 billion to $9.5 billion. Our free cash flow guidance reflects a free cash flow to net income ratio of 1.1 to 1.2. We expect to return at least $8.3 billion through dividends and share repurchases as we remain committed to returning a substantial portion of cash to our shareholders. Finally, as part of our routine review of our capital structure, we expect to tap the long-term debt market in the near term to increase our liquidity for general corporate purposes as we look to optimize our capital structure and reduce our cost of capital. We expect to raise a modest amount of debt. In connection with that, there would be no change to our capital allocation strategy, which includes how we look at and use D&A (ph) or our strong credit ratings and our net leverage will remain low. We have incorporated the potential for long-term debt into our guidance, including the interest expense. With that, let's open it up, so that we can take your questions. Katie?"
},
{
"speaker": "Katie O'Conor",
"content": "Thanks, Angie. We will now take your question. I would ask that you each keep to one question and a follow up to allow as many participants to ask a question. Operator, would you provide instructions for those on the call?"
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] We'll go to the line of Tien-Tsin Huang of JPMorgan. Please go ahead."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Hey. Thank you so much. Yeah, really strong bookings. I wanted to think about how that translates into revenue visibility. If you don't mind, I know Accenture doesn't normally talk about ACV, but can you maybe comment on the current relationship between ACV and TCV and how that's evolving? It seems really important to us as we think about revenue and visibility. Duration looks like it's up, but you also have a lot of large deals converting as well, so can you comment on that?"
},
{
"speaker": "Angie Park",
"content": "Hi, Tien-Tsin. Good morning. It's Angie. So let me cover guidance because maybe it will help to paint a picture of how we're thinking about the full fiscal year. I think it's really important. Let's start with how we ended Q4. If you think about the 5% growth that we posted in the fourth quarter, what we highlighted was that we did have slight growth in organic, which is important as we exit the year. And as you just talked about, over the last few quarters, we've really pivoted our business to what our clients are buying, which are the large transformation deals. And what that does is it positions us better than compared to the same time last year on the revenue that we've already sold. From an inorganic contribution, I do want to highlight that overall, we expect a bit over 3% for the year, which would imply with our guidance of 3% to 6%, that at the bottom end of the range, organic is flat. And then at the top end of the range, we're growing 3% in organic growth. And then as you peel it back and you look at the revenue growth that we see, it is broad based, and we saw that coming out of Q4, we see it across the market and across all of our industry groups. And then as -- when you look at it by type of work as well, what we see right now is that both consulting and managed services, we see low to mid-single digit growth rates for the year. And so stepping back with the color and how we're looking at our guidance, we're very pleased with how we have set ourselves up that and positioned ourselves for fiscal '25."
},
{
"speaker": "Julie Sweet",
"content": "Yeah. And so Tien-Tsin, what that means is, we're not commenting specifically on ACV and TCV because as you said that isn't. But the way to think about the confidence level and going to the year, right, is that we told you that we had a strategy to have more megas. We've shared with you that we had 19 more of these bookings than last year, $100 million or more. So you can see there's a big quantum. And so as you think about going into the year, we've got a bigger base of revenue coming from these larger deals coming online than we did going into fiscal year '24. And so that's really how we're trying to help you all think about it is by being clear about that strategy and how -- and the quantum of that, and that's how we then think about the year. So hopefully, that gives you some more insights together with the view on the guidance."
},
{
"speaker": "Tien-Tsin Huang",
"content": "No, it does and it's very reasonable as well, just to say that loud out. Just on the acquisition side, Julie, I think I asked it last quarter, so I'll ask again. I know you've been very busy. I like the examples that you gave around the productivity you're getting from some of the deals and the examples you gave again. But how about just overall appetite this year, are you still seeing good opportunities? Could we see a stepdown or a pause in the short term, anything else to add?"
},
{
"speaker": "Julie Sweet",
"content": "Yeah. So what I would say is, as Angie just said, our inorganic plan for the year, like, in terms of -- as you think about revenue guidance, we kind of -- we're going into the year with nearly 3%, and we think we'll -- right now, the plan for is a little bit above 3% is what we're seeing for fiscal year '25. And that reflects an expected plan right now of about $3 billion of deployed capital. So a step down from last year and probably more backend loaded as we look at our pipeline. Now obviously, we always have the ability to flex up or down. We only tie it to the opportunities in the market, but that’s how we’re seeing this year as we think about our investments."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Perfect. Thank you. Well done. Thanks."
},
{
"speaker": "Julie Sweet",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "We'll go next to the line of James Faucette with Morgan Stanley."
},
{
"speaker": "Unidentified Participant",
"content": "Great. Thanks for taking our question, guys. This is Antonio (ph) on for James. I wanted to actually dig into the technology segment. I know cloud is a big component of this. Could you talk through how clients spend on these cloud migration projects has been trending over the last 90 days and how we should think about cloud growth going into fiscal year '25? And then I have a follow-up after."
},
{
"speaker": "Julie Sweet",
"content": "Hi, Antonio. I'm not going to think about it in the last 90 days is just think about like sort of where we've been and where we think we're going, right?"
},
{
"speaker": "Unidentified Participant",
"content": "Yeah."
},
{
"speaker": "Julie Sweet",
"content": "So, in cloud, you still have a lot of migration that's happening, but on more of the high-performance compute applications. So things like mainframe, right? So -- and you also still have some clients who are very, very early in their cloud journey. And one of the things I talked about in the script, for example, was like retirement services. Like that's an entire segment where they're very, very early in the cloud journey. And so at the same time, you've got companies that are very early, just starting their cloud journey. You have those who are farther along who are now getting to the harder applications like mainframe. And then we still have a lot of modernization because what happened in the pandemic, people who were trying to get to the cloud to get the infrastructure savings, have not yet done the modernization. And that modernization, of course, feeds into all the things we do, right, brings the industry and the functional expertise. And so as we look going into FY '25, we continue to see those strengths. So we expect that cloud is going to continue to be a significant driver of growth but on all of those dimensions, right? And the high performance compute as well requires very deep industry knowledge, like doing mainframe in the context of health is very different than the context of banking. So hopefully, that helps you."
},
{
"speaker": "Unidentified Participant",
"content": "Got it. No, that's helpful. And then, I wanted to ask on the organic headcount. It actually looks like that ticked up quite a bit. Could you comment on your hiring strategy and in what geographies you're sort of looking to shape that?"
},
{
"speaker": "Angie Park",
"content": "Yeah. Why don't I start and then Julie add (ph) any additional comments as well. So as you can see, I mean, I want to start with how we're exiting the year. We saw slight organic growth in Q4, and we see that momentum into FY '25. You will have also seen that we added about 24,000 people this year in Q4, which is reflective of the momentum that we see in the business. And as always, right, looking ahead, we will always hire for the skills and the demand that we see. And just more broadly, I would just remind us that as you think about us, as a business, our core competency is balancing supply -- managing supply and demand. And you see that through our utilization rates, which continue to be in the 92% range."
},
{
"speaker": "Julie Sweet",
"content": "And we're hiring -- from a talent strategy, right, we are hiring primarily in India. So a lot of that hiring is technology in India and, of course, also addresses -- we are refreshing our pyramid at this time. So you've got kind of the new college graduates coming in. So there's really no change in our talent strategy. We hire all over the world. And in technology, which is a big driver of the growth that we're seeing now and going into FY '25, that is a lot of hiring in India."
},
{
"speaker": "Unidentified Participant",
"content": "Great. Thank you, both."
},
{
"speaker": "Operator",
"content": "We'll go next to the line of Jason Kupferberg with Bank of America."
},
{
"speaker": "Jason Kupferberg",
"content": "Good morning, guys. Thanks. I wanted to pick up on the commentary about the consulting outlook for fiscal '25. You said up low to mid-single digits. I think that's very consistent with the exit rate of 3% coming out of fiscal '24. So does that imply that you are not building much of a discretionary spending recovery into this initial F '25 guide?"
},
{
"speaker": "Angie Park",
"content": "Yeah. Hi, Jason. Good morning. How are you? And let me just give you a little bit of color on that as you think about the types of work and the question that you just asked. If you think about our range overall, so we're at 3% to 6% for the full year. And what this assumes is, at the top end, we see more of the thing, right, in terms of the discretionary spending environment. While at the bottom end, it allows for further deterioration in the discretionary spend environment over what we experienced in FY '24."
},
{
"speaker": "Jason Kupferberg",
"content": "Okay. That's very helpful. And then maybe one for Julie. I just wanted to get your broad take on the macro backdrop. I mean, I guess, what are decision makers telling you right now versus three months ago? What are they waiting to see to open the discretionary budget a little bit more?"
},
{
"speaker": "Julie Sweet",
"content": "Yeah. Well, the environment is really more of the same and that environment has been kind of a cautious environment. Right now, they're going into budget season. So as always, we'll really see in January and on February, but there hasn't been much of a change, right? The macro is kind of the same. Obviously, there's some events going to come up in the fall that people are thinking about, but there's not like a big tone change, right? And I think, because if you look at the macroeconomic environment, FY '25 is going to click down in the U.S., maybe a little bit better in Europe. But overall, not a lot of improvement. So we're not hearing -- I'm not hearing from CEOs, and I'm talking to them almost every day, some big like, hey, now we're ready to go spend more, right, in discretionary spending. So it's really just more of the same. And by the way, one of the changes that we made this last fiscal year '24 was normally we do for decades, our big promotion period was in December, and then a small one in June. And so in fiscal year '24, we switched these, right? We said we have a lot more visibility in our business in January or February because that's where budgets are set. So we did that this past year and had a really big promotion, a very nice promotion, I would say, not really big, but very nice promotion in this past June. We've now permanently shifted that promotion cycle. So we will do our big promotion cycle in June and our smaller one in December to better match when our clients are setting their budgets and we have better visibility. And that's what we're seeing again. The justification for that is clear that we're really no IT spending and spending on our services in the budgets in January, February."
},
{
"speaker": "Jason Kupferberg",
"content": "Thanks for all the color."
},
{
"speaker": "Julie Sweet",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "We'll go next to the line of Keith Bachman with BMO."
},
{
"speaker": "Keith Bachman",
"content": "Hi. Good morning. Thank you very much. I wanted to revisit on M&A, if I could, and just get some clarification. In FY '24, you spent, as you noted $6.6 billion, which was up about 160% year-over-year. And if we sort of do the math on what your normalized multiples are to revenue, it looks like you're starting the year of FY '25 with 3 points of M&A help. And so I just want to understand, is that the right way to think about it? And then Julie, you had indicated that you plan to spend $3 billion more in M&A this year, and it will be, as you said, backend weighted. But I'm just struggling why M&A is that $3 billion number is even second half weighted, why M&A isn't 4% or more for the year?"
},
{
"speaker": "Angie Park",
"content": "Let me just start with peeling back our inorganic contribution a bit. As we look at the deals that we closed in '24, it's nearly 3% contribution, right? And so with the backend loaded approach in our capital deployed, we do see a bit over 3%, and that's just the math."
},
{
"speaker": "Julie Sweet",
"content": "Yeah. It's just timing, right? It's not quite 3% going in because a lot of this closed at the end of Q4, right? And so it's just its timing, right? And it's the way we see our pipeline developing, right? Because we have a view of what we're going to -- we think we're going to spend in Q1 and Q2 and how that rolls in."
},
{
"speaker": "Keith Bachman",
"content": "Okay. Let me transition the bookings then. As you think about FY ‘25, and I know you don't guide to bookings, it's more of an output, but any puts and takes that you want us to think about in terms of the book-to-bill ratio in FY '25 that might be higher or lower? Any kind of cadence there? And if you don't mind, was there an M&A help in the August quarter bookings as well or signings, excuse me?"
},
{
"speaker": "Angie Park",
"content": "Why don't I start, in terms of the way to think about our bookings, we were super pleased with the $81 billion of bookings that we had for the year, which was 14% growth, which included the 125 quarterly client bookings over $100 million. And so I think that, that we were super pleased with. And you saw that in our book-to-bill and our growth rate in managed services was driven by our large transformation deals. For us, over time of our four trailing quarters, we're always looking for our consulting book-to-bill to be 1.0 or better and for our managed services to be 1.2 or better and nothing has changed there."
},
{
"speaker": "Julie Sweet",
"content": "Yeah. And there was nothing in M&A about our bookings in Q4."
},
{
"speaker": "Keith Bachman",
"content": "Okay. Many thanks."
},
{
"speaker": "Julie Sweet",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "We'll go next to the line of Bryan Keane with Deutsche Bank."
},
{
"speaker": "Bryan Keane",
"content": "Good morning. Julie, I just want to ask about GenAI. I think bookings were up almost about $300 million in the third quarter sequentially, up about $100 million this quarter. Anything about the cadence there of GenAI and fall through there that you can help us understand?"
},
{
"speaker": "Julie Sweet",
"content": "Sure. So yeah, so we ended with $3 billion bookings for the year, and we'd expect in FY '25, another healthy increase. We know there's clear demand. We're starting to see more of our clients move from proof-of-concept to sort of larger implementations, which is important. So the size of those bookings is kind of, is clicking up. And also, we're continuing to see kind of at least every other one has got data pull-through and even that's kind of moving up. So we're kind of going into the year, we'd see -- we'd expect another healthy increase in our bookings and our revenue from that and also that data will continue to kind of be a bigger and bigger part of that building out of the digital core because one of the biggest limitations on using GenAI today and why it's going to take a while is our client needs data and our clients have a lot of work to do on data, which is, of course, a big opportunity for us."
},
{
"speaker": "Bryan Keane",
"content": "Got it. And then just a clarification on the guide. I know the fourth quarter organic growth was positive, and we're talking about fiscal year '25 revenue guide of 3% to 6% on a constant currency basis. And if you back out the acquisitions, I think you guys said on the low end, we're talking about flat organic growth, that would be a slight step down from the fourth quarter, which is -- would be a little surprising given some of the momentum that you guys are seeing in bookings and in headcount growth. So just wanted to make sure I understood what that low end might imply and why would there necessarily be a step down from where the fourth quarter kind of ended? Thank you."
},
{
"speaker": "Julie Sweet",
"content": "Yeah. No. And the way we're thinking about it, right, we're going into the year with momentum. We had executed on the strategy around the bigger deals. So we have a stronger base of revenue. We've got the acquisitions. And so on the bottom end of the range, what we would see, like the most likely reason to be there is if there was a deterioration in the discretionary spend environment, right? So we're trying to just kind of give some flexibility. We’re not seeing that, right? We sell more of the same this quarter. And so as we kind of go into the year, at the top end of the range, it’s the current environment going forward. And at the bottom of the range, if you were to ask me today, what is that mostly accommodated is if there was a deterioration in spending, right, so -- because of kind of the way we’ve positioned ourselves."
},
{
"speaker": "Bryan Keane",
"content": "Great. Thank you."
},
{
"speaker": "Julie Sweet",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "We'll go next to the line of Dan Dolev with Mizuho."
},
{
"speaker": "Dan Dolev",
"content": "Hi. Thanks for taking my questions. Great results and great guidance here. Two questions on GenAI. Are you seeing more of your conversations being less replacement and reallocation and purely incremental on G&A? And then I have a follow-up."
},
{
"speaker": "Julie Sweet",
"content": "Well, I think it starts with, we're not seeing a change in what our clients are spending on IT, right? So -- but what we are seeing is the continued trend of trying to save money on IT to free up the spending on areas of GenAI. So on the one hand, right now, we haven't seen a change in overall spending. We'll see what the budgets come in January, February, but we're not expecting a big change. But what we also are seeing is that as they're saving money, they want to invest it in things like GenAI and data. So that's really the dynamic that's going on, save to invest, but we haven't seen signs of overall change."
},
{
"speaker": "Dan Dolev",
"content": "Got it. And then a quick follow-up on margins. Can you maybe touch on the GenAI services margin, how it stands versus your traditional business? I think that would be really helpful for investors. Thank you."
},
{
"speaker": "Julie Sweet",
"content": "Are you -- I mean, are GenAI margin and sort of -- is that different from when we're doing GenAI versus other GenAI technology?"
},
{
"speaker": "Dan Dolev",
"content": "Correct. GenAI services versus your traditional consulting business."
},
{
"speaker": "Julie Sweet",
"content": "Look, GenAI is still a small part of our business, and I wouldn't really think about it as having a particularly different margin profile at this time. And as you probably heard in our -- in my script that a lot of time we're starting to embed GenAI in our larger deals and so we're not really thinking about it as like a sort of a separate way. So I wouldn't think about it too differently than our usual business."
},
{
"speaker": "Dan Dolev",
"content": "Got it. Thanks. Well, great momentum. Thank you."
},
{
"speaker": "Julie Sweet",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "We'll go next to the line of Jim Schneider with Goldman Sachs."
},
{
"speaker": "Jim Schneider",
"content": "Good morning. Thanks for taking my question. Very helpful commentary on the client outlook on limited discretionary spend. But can you maybe help us understand or unpack, when you talk to them, what are they looking for to release discretionary spend? Is it more macro factors, whether that be rates, election or regulatory or is it more micro factors tied to their IT budgets? And if it's the latter, what are the things they're looking for in terms of getting increased clarity on those priorities going into 2025?"
},
{
"speaker": "Julie Sweet",
"content": "Sure. It's a good question. And it's really -- overall, there is a sense of the macro, right? Because if you look at the -- a lot of our clients are global. If you look at the macroeconomic, there isn't a big change. There's kind of going into next year, like the U.S., which is a big market, it looks like it's going to be down a little bit. Europe's up a little bit, but still not great. And so kind of if you start with they're not seeing a big change in the macro. But then you really have to look at it industry by industry because each industry has factors. So for example, in the energy industries, they're super focused on how much investment they have to do and the change – and the shift in climate change and renewables. So there's a big appetite for major investment. So there's no catalyst that says, oh, like I've got a ton of thought. They've got a lot of big investments, right? If you look at consumer goods, where a lot of the consumer goods companies are not able to get pricing. They've got to get up volume, which means they've got to drive down their -- they've got to improve their efficiency and their manufacturing costs, and that takes big investments because manufacturing. Our latest research says like two-thirds of the journey in digitization is still to come. And so those are big investments. And so I can kind of take you through industry by industry. The reality is, it's obviously good growth for us is the digitization journey is still very early in many, many industries, that's like public service is another great example. So they've got big transformations going. And at the end of the day, if you're a big enterprise, like, the deals that are smaller, right, they do not move the needle. And when you've got big investments, that's where they're focused because they see now the potential of things like GenAI, and everyone's like we got to get going, that's really what's driving it. So that's why we're not having a bunch of discussions about like I can't wait to unlock that spending. Our discussions are entirely on help us move faster with our bigger information. That's really what we're focused on."
},
{
"speaker": "Jim Schneider",
"content": "That's very helpful. Thanks. And then maybe as a follow-on, you referenced several verticals there. Can you maybe, as you prospectively look into fiscal '25, call out maybe one or two verticals where you expect the most improvement and maybe one or two where you see potential risk of deterioration? Thank you."
},
{
"speaker": "Angie Park",
"content": "Yeah. Hey, Jim. Nice to talk to you. I think that as we look across FY '25 in our overall guide of 3% to 6%. We see broad-based growth across -- it's really broad-based across all of our industries as well as our services and markets."
},
{
"speaker": "Jim Schneider",
"content": "Great. Thank you."
},
{
"speaker": "Katie O’Conor",
"content": "Operator, we have time for one more question, and then we’ll wrap up the call."
},
{
"speaker": "Operator",
"content": "Thank you. And that will come from Bryan Bergin with TD Cowen."
},
{
"speaker": "Bryan Bergin",
"content": "Hi. Good morning. Thank you. On GenAI, can you give us a sense of the size of some of the largest individual programs have reached? And then as it relates to internal productivity progress, may be comment on any of the service lines where you're seeing the earliest impacts as it relates to productivity or any metrics that you can share in more advance programs?"
},
{
"speaker": "Julie Sweet",
"content": "Sure. I don't want to start like giving tons of data on this. But like you went from deals that were -- in GenAI that were, on average, kind of sub-$1 million, right, that you've now got some that are above $10 million, right? So that's still the smaller end because you're sort of moving into production and scale. But you're starting to see these things move from POCs to larger bookings. And then with respect to internal productivity and our guidance, of course, takes into account what we're seeing. As I've been talking about is that the first area that we anticipate -- remember, we're trying to embrace GenAI fastest because we think it's a big differentiator with our clients. And so in our managed services is where we're seeing the most because that's where we have a platform. So you all remember we used to talk about myWizard. Now we talk about GenWizard, right? But what we're seeing is that the technology and the productivity is like similar ways before. So if you go back to 2015, 2016, when we first introduced myWizard, right? So it's not really different than the kinds of productivity that we've been experiencing. And here, of course, there's an added wrinkle in that GenAI, in order for us to use it with our clients, they have to allow us to use it and they have to prioritize. And they have a lot of other areas where they want to use GenAI that's not necessarily in their technology productivity where they're already many of our clients are using our platforms, they're using AI, etc. So there's a lot of factors that kind of go into the pace of how quickly we can use it even if we're ready to use it now in many places. So hopefully, that's helpful because it is a little bit different in that sense because our clients have to prioritize where they want to use GenAI, too."
},
{
"speaker": "Bryan Bergin",
"content": "Okay. That's helpful. Thank you. And then I appreciate your commentary on the capital returns on the balance sheet and understanding this has overall been a tougher environment, while M&A outlay has been on the upper end. But just curious how we should be thinking about the potential magnitude of leverage in the model going forward? Just any guardrails we should consider?"
},
{
"speaker": "Angie Park",
"content": "Yeah. And a couple of things that I would say around that. We indicated that it's going to be modest. We'll maintain our strong credit ratings and net leverage will be low. And so -- and included in our guidance that we provided you, we have also allowed for the potential for the interest expense and in our overall guidance, which is in addition to the variability that we may see in operating margin throughout the year."
},
{
"speaker": "Bryan Bergin",
"content": "Okay. Thank you."
},
{
"speaker": "Julie Sweet",
"content": "Great. Well, thank you, everyone, for joining us. Before I wrap up, I want to thank KC, who's been an amazing partner and friend these last five years. They've been quite some five years, as we all know, just a few things in the environment that we've gotten together work with. And so I'm really excited for KC and her next chapter. And KC, would you like to say a few words?"
},
{
"speaker": "Katie O'Conor",
"content": "I would, thanks, Julie. I just want to offer my sincere thanks to the investor and analyst community for the decade plus of console and support. It's really meant a lot to me. It's really been appreciated. Thanks a lot, and best wishes to all of you."
},
{
"speaker": "Julie Sweet",
"content": "So I want to thank everyone for joining us and thank all of our people for what you do every day, allowing us to create 360 degree value and giving us a lot of confidence in our success in FY ‘25. And thanks again, KC, and welcome Angie to your new role, and we’ll see you all in the next quarter."
},
{
"speaker": "Angie Park",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "This conference will be available for replay beginning at 10:00 a.m. Eastern Time today and running through mid-night on December 18. You may access the AT&T replay system at any time by dialing 1-866-207-1041 and entering the access code of 9225580. International callers may dial (402) 970-0847. Those numbers again are 1-866-207-1041 or (402) 970-0847 with the access code of 9225580. That does conclude our conference for today. Thank you for your participation and for using AT&T Event Conferencing. You may now disconnect."
}
] |
acn | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Ladies and gentlemen, thank you for standing by. Welcome to Accenture's Third Quarter Fiscal 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Managing Director, Head of Investor Relations, Katie O'Conor. Please go ahead."
},
{
"speaker": "Katie O'Conor",
"content": "Thank you, operator, and thanks everyone for joining us today on our third quarter fiscal 2024 earnings announcement. As the operator just mentioned, I'm Katie O'Conor, Managing Director, Head of Investor Relations. On today's call, you will hear from Julie Sweet, our Chair and Chief Executive Officer and KC McClure, our Chief Financial Officer. We hope you've had an opportunity to review the news release we issued a short-time ago. Let me quickly outline the agenda for today's call. Julie will begin with an overview of our results. KC will take you through the financial details, including the income statement and balance sheet, along with some key operational metrics for the third quarter. Julie will then provide a brief update on our market positioning before KC provides our business outlook for the fourth quarter and full fiscal year 2024. We will then take your questions before Julie provides a wrap up at the end of the call. Some of the matters we'll discuss on this call, including our business outlook are forward-looking, and as such, are subject to known and unknown risks and uncertainties, including but not limited to, those factors set forth in today's news release and as discussed in our Annual Report on Form 10-K and quarterly reports on Form 10-Q and other SEC filings. These risks and uncertainties could cause actual results to differ materially from those expressed in this call. During our call today, we will reference certain non-GAAP financial measures, which we believe provide useful information for investors. We include reconciliations of non-GAAP financial measures where appropriate to GAAP in our news release, or in the Investor Relations section of our website at accenture.com. As always, Accenture assumes no obligation to update the information presented on this conference call. Now, let me turn the call over to Julie."
},
{
"speaker": "Julie Sweet",
"content": "Thank you, Katie, and everyone joining. And thank you to our 750,000 people around the world who work every day to deliver 360-degree value for all our stakeholders. Before we get into the quarter, I want to thank KC, who's been an excellent partner for these last five years, and our three other extraordinary leaders who are stepping down in the next two quarters, Jean-Marc, Ellyn, and Paul. Each have given over 36 years of service and demonstrated strong stewardship in developing outstanding successors, including Angie, who you all know from her former role as Head of Investor Relations, who will succeed KC on December 1. As always, we are executing a smooth leadership transition to the next generation with our strong bench of great leaders. Now, on to the quarter. I am pleased this quarter to bring to life yet again the resilience and agility of our business, as our actions to remain laser-focused on our clients' needs and quickly adapt to market conditions can be seen in our results, which are building a foundation for stronger growth as we go into Q4 and next fiscal year. As you know, this fiscal year, our client spending developed differently than we expected at the beginning of the fiscal year. And these conditions continue, with clients prioritizing large-scale transformations, which convert to revenue more slowly, while limiting discretionary spending, particularly in smaller projects, with delays in decision-making and a slower pace of spending as well. In response, we have moved quickly to adjust by leveraging our unique strengths, our end-to-end services, including deep industry and functional expertise that enable these large-scale transformations or what we call reinventions. We're also leveraging our deep technology expertise and ecosystem partnerships and our learning machine and culture that gives us the agility to shift to new areas of demand, including, for example, GenAI while continuing to invest at scale for future growth. Here is how these strengths and our strategy are demonstrating results three quarters into the fiscal year. With our clients prioritizing large-scale transformations, we have accelerated our strategy to be the reinvention partner of our clients. Our success is reflected in our bookings of $21.1 billion, including another 23 clients with quarterly bookings greater than $100 million, bringing the total of such clients with these bookings to 92 year-to-date, seven more than last year at this time. This focus on being the reinvention partner is an important part of our strategy to return to stronger growth. As we enter next year, as this work ramps, the revenue from these large-scale bookings is expected to continue to layer in throughout the year, and we are also well-positioned to capture increases in discretionary spend when it comes back because of the strategic positioning these deals bring at our clients. We also have leaned into the new area of growth, GenAI, which is comprised of smaller projects as our clients primarily are in experimentation mode, and this quarter we hit two important milestones. With over $900 million in new GenAI bookings this quarter, we now have $2 billion in GenAI sales year-to-date, and we have also achieved $500 million in revenue year-to-date. This compares to approximately $300 million in sales and roughly $100 million in revenue from GenAI in FY 2023. Leading in GenAI positions us to help our clients take the actions needed to reinvent and to benefit from GenAI, which frequently means large-scale transformations. We are also taking an early lead with an eye toward long-term leadership in this critical technology, which is still in the early stages of maturity and adoption, despite its rapid evolution. We have built our expertise in making strategic acquisitions over the last decade, leveraging a strong balance sheet, and we have used this expertise to expand into new growth areas, scale in hot areas and geographies, and continue to build strength in our industry and functional consulting. We deployed $2.3 billion of capital across our geographic markets in Q3 across 12 acquisitions, bringing the total number of acquisitions to 35 with invested capital of $5.2 billion year-to-date as compared to $2.5 billion for the entire FY 2023. As a learning organization and talent creator, we continue to invest in our people with approximately 13 million training hours this quarter. This averages 19 hours per person, representing an increase predominantly due to GenAI as we continue to prepare our workforce for the infusion of GenAI across our business in the coming years. We also continue to steadily increase our data and AI workforce, reaching approximately 55,000 skilled data and AI practitioners against our goal of doubling our data and AI workforce from 40,000 to 80,000 by the end of FY 2026. We continue to take market share on a rolling four-quarter basis against our basket of our closest global publicly traded competitors, which is how we calculate market share, with revenues of $16.5 billion for the quarter, up 1.4% in local currency and slightly above the midpoint of our FX adjusted range. We expanded adjusted operating margin by 10 basis points and delivered free cash flow of $3 billion. I want to congratulate our 97,000 people we have promoted around the world through June 1, including 702 to Managing Director and 64 to Senior Managing Director, reflecting our commitment to providing vibrant career paths. We are recognized as a Top 10 Place to Work in 10 countries, representing more than 70% of our people, number two in Argentina, Brazil, and the Philippines, number four in Singapore, number five in Costa Rica, Finland, and Indonesia, number seven in the US, and number 10 in Chile on the Great Place to Work list of Best Workplaces and number two on Business Today's Best Companies to Work For in India. And in recognition of our strong brand, we are proud to earn the number 20 position on Kantar BrandZ's prestigious Top 100 Most Valuable Global Brands list, our highest rank to date, with an 11% increase in brand value to $81.9 billion. Our scale across strategy, consulting, technology, and operations, and our breadth and depth across industries and functions make us uniquely capable of helping our clients reinvent using technology, data, AI, and new ways of working. Before turning to KC, I want to give a little more color on our acquisitions this quarter, which yet again demonstrate the strategic importance of both our ability to invest, and our expertise in identifying, attracting, and integrating great companies joining Accenture. Let's start with new areas of growth. We completed our acquisition of Udacity to scale our technology learning and training services and to help our clients reskill and upskill their people. Udacity is a critical part of our LearnVantage digital learning platform, which we announced last quarter as a new area of growth for the future. Building on our expertise in customer-focused consulting, we invested to help drive our clients' growth agendas. We acquired Unlimited, an award-winning customer engagement agency with a deep understanding of human behavior as evidenced by its proprietary human understanding lab and AI-powered data insights platform. We acquired The Lumery in Australia, a marketing technology consultancy that helps leading organizations deliver seamless customer experiences and transform their marketing services. It provides industry and platform consulting services, including marketing, advisory, and planning, implementation across entire technology stacks, operational excellence, and simplification. We closed our acquisition of GemSeek in Bulgaria, a leading customer experience analytics provider helping global businesses understand customers through insights, analytics, and AI-powered predictive models. And we closed MindCurv, a global digital -- a cloud-native digital [indiscernible] experience and data analytics company specializing in composable software, digital engineering, and commerce services. Now, let's turn to scaling and hot industries. We acquired Cognosante, a provider of innovative technology solutions for US federal health, defense, intelligence, and civilian agencies. With this acquisition, federal services is creating a new federal health portfolio for its business. We invested in Customer Management IT and SirfinPA, which will provide the public sector with technology, support, and justice and public safety in Italy. We see public service and, in particular, health, intelligence, and defense as highly strategic industry focus areas globally for the next several years. And we invested in Teamexpat, focusing on testing integration for lithography systems in the semiconductor industry, another attractive industry segment. Our investment in Flo Group, a leading European consultancy and Oracle business partner, who specializes in global supply chain logistics is helping us scale in supply chain, also a major growth area. Finally, we're scaling in attractive geographic markets. We acquired CLIMB, a technology-based consultancy based in Japan, where we continue to experience very strong revenue growth. Over to you, KC."
},
{
"speaker": "KC McClure",
"content": "Thank you, Julie. And thanks to all of you for taking the time to join us on today's call. We are pleased with our Q3 results, which were in line with our expectations and reflect continued investment at scale. We continue to serve as a trusted partner for our clients, while running our business with rigor and discipline. Now, let me summarize a few of the highlights for the quarter. Revenues grew 1.4% local currency with mid-single digit growth or higher in seven of our 13 industries, including public service, industrial, high-tech, life sciences, energy, utilities, and health. We also continue to see improvement in our CMT industry group. And we continue to take smart share. As a reminder, we assess market growth against our investable basket, which is roughly two dozen of our closest global public competitors, which represents about a third of our addressable market. We use a consistent methodology to compare our financial results to theirs, adjusted to exclude the impact of significant acquisitions to the date of their last publicly available results on a rolling four-quarter basis. Adjusted operating margin was 16.4%, an increase of 10 basis points over Q3 last year, and includes continued significant investments in our people and our business. Finally, we delivered free cash flow of $3 billion and returned $2.2 billion to shareholders through repurchases and dividends. Year-to-date, we've invested $5.2 billion across 35 acquisitions. With those high-level comments, let me turn to some of the details, starting with new bookings. New bookings were $21.1 billion for the quarter, representing 22% growth in US dollars and 26% growth in local currency, with an overall book-to-bill of 1.3. Consulting bookings were $9.3 billion with a book-to-bill of 1.1. Managed services bookings were $11.8 billion with a book-to-bill of 1.5. Turning now to revenues. Revenues for the quarter were $16.5 billion, a 1% decline in US dollars and a 1.4% increase in local currency, and slightly above the midpoint of our FX adjusted guidance range, as the FX headwind was approximately 2% compared to the 1% headwind estimated at the beginning of the quarter. Consulting revenues for the quarter were $8.5 billion, a decline of 3% in US dollars and a decline of 1% in local currency. Managed services revenues were $8 billion, up 2% US dollars and up 4% local currency. Taking a closer look at our service dimensions, technology services and strategy and consulting grew low single digits and operations was flat. Turning to our geographic markets, in North America, revenue grew 1% local currency, led by growth in public service, partially offset by decline in banking and capital markets. In EMEA, revenues declined 2% local currency with growth in public service, offset by declines in banking and capital markets and communications and media. Revenue growth in Italy was offset by a decline in France. In growth markets, revenue grew 8% local currency, led by growth in banking and capital markets and industrial. Revenue growth was driven by Argentina and Japan, partially offset by a decline in Australia. Moving down the income statement, gross margin for the quarter was 33.4%, consistent with the same period last year. Sales and marketing expense for the quarter was 10.6%, compared to 10.5% for the third quarter last year. General and administrative expense was 6.3%, compared to 6.5% for the same quarter last year. Before I continue, I want you to note that in Q3 of FY 2024 and FY 2023, we recorded $77 million and $347 million in costs associated with our business optimization actions, respectively. These costs decreased operating margin by 40 basis points and EPS by $0.08 this quarter and operating margin by 210 basis points and EPS by $0.42 in Q3 of last year. In Q3 of last year, we also recognized a gain on our investment in Duck Creek Technologies, which impacted our tax rate and increased EPS by $0.38. The following comparisons exclude these impacts and reflect adjusted results. Adjusted operating income was $2.7 billion in the third quarter, reflecting an adjusted operating margin of 16.4%, an increase of 10 basis points from adjusted operating margin in the third quarter of last year. Our adjusted effective tax rate for the quarter was 25.5%, compared with an adjusted effective tax rate of 24% for the third quarter last year. Adjusted diluted earnings per share were $3.13, compared with adjusted diluted EPS of $3.19 in the third quarter last year. Days sales outstanding was 43 days, compared to 43 days last quarter and 42 days in the third quarter of last year. Free cash flow for the quarter was $3 billion, resulting from cash generated by operating activities of $3.1 billion, net of property and equipment additions of $124 million. Our cash balance at May 31 was $5.5 billion, compared with $9 billion at August 31. With regard to our ongoing objective to return cash to shareholders. In the third quarter we repurchased or redeemed 4.3 million shares for $1.4 billion, an average price of $320.41 per share. As of May 31, we had approximately 3.3 billion of share repurchase authority remaining. Also in May, we paid a quarterly cash dividend of $1.29 per share for a total of $811 million. This represents a 15% increase over last year. And our board of directors declared a quarterly cash dividend of $1.29 per share to be paid on August 15, a 15% increase over last year. In closing, we feel good about our results in Q3 and are now working hard to deliver Q4. We remain focused on capturing growth opportunities while continuing to invest in our business for long-term market leadership. Now let me turn it back to Julie."
},
{
"speaker": "Julie Sweet",
"content": "Thank you, KC. As I mentioned earlier, we're seeing more of the same in terms of the demand environment. Now let me give a little context on how we're executing our strategy to be the reinvention partner of choice and why we're uniquely positioned to be helping our clients on AI. It is important to remember that while there is a near universal recognition now of the importance of AI, which is at the heart of reinvention, the ability to use GenAI at scale varies widely with clients on a continuum. With those which have strong digital cores genuinely seeking to move more quickly, while most clients are coming to the realization of the investments needed to truly implement AI across the enterprise, starting with a strong digital core from migrating applications and data to the cloud, building a new cognitive layer, implementing modern ERP and applications across the enterprise to a strong security layer. And nearly all clients are finding it difficult to scale GenAI projects because the AI technology is a small part of what is needed. To reinvent using technology, data, and AI, you must also change your processes and ways of working, rescale and upscale your people, and build new capabilities around responsible AI, all with a deep understanding of industry, function, and technology to unlock the value. And many clients need to first find more efficiencies to enable scaled investment in their digital cores and all these capabilities, particularly in data foundations. In short, GenAI is acting as a catalyst for companies to more aggressively go after cost, build the digital core, and truly change the ways they work, which creates significant opportunity for us. And this is why clients are coming to us. We are able to help our clients with this AI rotation because of our broad services across strategy and consulting technology and operations, as well as everything customer through Song and digital manufacturing and engineering through Industry X and our relevance across the functions of the enterprises and 13 industries. Our privileged position in the technology ecosystem has never been more important. We are working closely with our ecosystem partners to help our clients understand the right data and AI backbone that is needed and how to achieve tangible business value. Now let me give you a few examples of the complex work of reinvention and building a digital core. We are partnering with Currys, a leading European technology retailer to unlock new growth and cost savings by accelerating its adoption of new technologies. First, we will move their operations from a legacy data center to a new cloud platform using pre-built and customized solutions to create a powerful digital core. This unified data foundation allows us to deploy automation and generative AI in key growth areas, such as repair centers, customer service, e-commerce, procurement, and in-store experiences, delivering faster, more efficient services to their customers. The move to a new platform supports the company's sustainability goals, reducing energy consumption by transitioning to a more efficient cloud infrastructure. Now, Currys' employees will be empowered to serve their customers better by offering high-touch experiences, both online and in-stores. We're working with Independence Health Group, IHG, a leading health organization headquartered in Southeastern Pennsylvania on a transformation journey to modernize end-to-end operations, improving the way they serve current and future generations of customers. We will help migrate nearly 2 million members to a new digital-first platform, expected to drive immediate improvements in existing business processes. This will lay the foundation to leverage advanced technology and generative AI to proactively manage members' health. We are also helping reskill and retrain their operations staff, creating opportunities for employee development. With this reinvention, Independence continues its ongoing efforts to increase service quality, improve experiences, and enable better health outcomes, positioning them for new areas of growth in the rapidly changing healthcare landscape. Digital core work also requires deep industry expertise as we work with our clients to design the right tech, data, and AI to reinvent their enterprise and their industry. We are helping Macy's, an iconic American retailer with a technology modernization effort. As a strategic technology execution partner, we will migrate their mainframe systems to a cloud platform, a move that will enhance their operational efficiency and scalability. This will allow Macy's to be more agile and enable growth. We are helping the Central Bank of the United Arab Emirates, the regulatory body responsible for the country's banking and insurance sector with a digital transformation to strengthen the financial system's stability and contribute to growth, innovation, and diversification in the sector, in line with the UAE's national vision. Our program will deliver advanced analytics along with AI-driven automation to improve supervisory capabilities and streamline activities for licensed financial institutions by creating best-in-class processes to support regulatory compliance. We will also modernize the bank's enterprise data management by implementing a single unified portal to provide a holistic view of the financial services ecosystem, all of which will enhance the UAE's position as a global financial center. We are partnering with Virgin Media O2, a leading carrier services provider in the UK to support regional businesses to realize the promise of 5G, opening new revenue streams and stimulating growth in the telco market. We will bring to market solutions built on our edge orchestration platform, which combines edge computing, data AI, GenAI, and embedded security. This will enable use cases such as quality inspections, safe workplace management, and behavior monitoring to improve operations and customer experience. Whether it's enabling safe communication on building sites, creating a fan experience while handling crowds and busy venues, or supporting vital devices and clinician workflow in healthcare, Virgin Media O2 can now offer businesses a range of flexible, secure, and affordable solutions that boost efficiency, growth, and performance. And with our managed services and customer operations, we can work together with Virgin Media O2 to scale this growth. Security is a critical part of reinvention in the digital core. We saw continued very strong double-digit growth in our security business this quarter. We are partnering with the US Navy to enhance its cybersecurity operations with cutting-edge capabilities that will strengthen its data security posture and support mission readiness. More than ever, data and information are critically important to national security. Our solution sets are configured to provide defensive cyber operations across Navy networks to help safeguard digital assets and mission operations. Together, we will help ensure the US Navy can combat evolving cyber threats, protect our sailors at sea, and defend American interests around the world. Once clients have a strong foundation, they can explore new opportunities to drive growth and efficiencies with GenAI. We are helping a leading global food and beverage company who already built a strong digital core as part of its reinvention journey to now leverage the power of generative AI to create new value. Together, we developed a digital shelf console pilot, a GenAI engine that accelerates content creation for e-commerce and optimizes it to drive sales. The engine empowers marketers to audit and customize content at scale, expected to reduce time to deliver one year's worth of content to just eight working days and save costs of up to 80% quickly and effectively. Once they scale, this enables the company to produce more targeted content with significant time and cost efficiency, increase sales, and transform customer experiences. We have partnered with National Australia Bank, one of the country's largest financial institutions to strategically implement and scale generative AI to create material value at speed, enhance relationship-driven customer service, and drive operational efficiencies. We worked on a methodical build of a secure and robust GenAI platform built within the bank's existing strategic data platform with the creation of 200 generative AI use cases in backlog. To date, over 20 use cases have been tested across the bank with eight of these enterprise-grade pilots underway and a number of those scaling and already delivering value. We also co-created a methodology for delivering GenAI projects from experiments to scalable deployment, ensuring each stage delivers tangible business benefits. While doing so, National Australia Bank and Accenture are putting safety at the core of the approach through responsible AI and risk policies alongside developing in-house AI expertise and literacy. One of the areas of richest opportunities for our clients is customer experience transformation, which uses the unique capabilities of Song across creative customer insights and deep technology expertise. Song grew mid-single digits this quarter. We are helping Saudia Airlines, the national flag carrier of Saudi Arabia, to launch an innovative digital platform to transform the travelers experience. Powered by GenAI, the platform will provide a one-stop solution enabling customers to seamlessly plan their journeys, book flights, and modify their trips in just a few words, all while providing a personalized and conversational experience. The platform is continuously evolving and will integrate more services over time. This modernization will support Saudia Airlines' vision of redefining the standards of travel in a digital world. We continue to see strong demand for digital manufacturing and engineering services. Industry X grew high single digits in Q3. We are supporting a large Asia-Pacific automobile manufacturer on their reinvention towards software-defined vehicles. We will help accelerate software development and create a software center of excellence to optimize quality, cost pressures, and delivery times. This center of excellence will manage four key workstreams, advanced driver assistance systems, in-vehicle infotainment, electrical and electronics, and powertrain. By leveraging our expertise and strategic partnerships, we are empowering them to strengthen and evolve its in-vehicle software, providing advanced functions and services throughout the vehicle's lifecycle. This enables the company to drive innovation, enhance driver and passenger experiences, and realize the full potential of software-defined vehicles. And we will continue to leverage all of our strengths to manage the current macro conditions and constrained spending while investing in leadership for the future. Back to you, KC."
},
{
"speaker": "KC McClure",
"content": "Thanks, Julie. Now turning to our business outlook. For the fourth quarter of fiscal 2024, we expect revenues to be in the range of $16.05 billion to $16.65 billion. This assumes the impact of FX will be about negative 2% compared to the fourth quarter of fiscal 2023 and reflects an estimated 2% to 6% growth in local currency. For the full fiscal year 2024, based upon how the rates have been trending over the last few weeks, we now expect the impact of FX on our results in US dollars will be negative 0.7 compared to fiscal 2023. For the full fiscal 2024, we now expect our revenues to be in the range of 1.5% to 2.5% of growth in local currency over fiscal 2023, which assumes an inorganic contribution approaching 3%. We continue to expect business optimization actions to impact fiscal 2024 GAAP operating margin by 70 basis points and EPS by $0.56. For adjusted operating margin, we continue to expect fiscal 2024 to be 15.5%, a 10 basis point expansion of fiscal 2023 results. We now expect our adjusted annual effective tax rate to be in the range of 23.5% to 24.5%. This compares to an adjusted effective tax rate of 23.9% in fiscal 2023. We now expect our full year adjusted earnings per share for fiscal 2024 to be in the range of $11.85 to $12, or 2% to 3% growth over fiscal 2023 results. For the full fiscal 2024, we continue to expect operating cash flow to be in the range of $9.3 billion to $9.9 billion, property and equipment additions to be approximately $600 million, and free cash flow to be in the range of $8.7 billion to $9.3 billion. Our free cash flow guidance continues to reflect a very strong free cash flow to net income ratio of 1.2. Finally, we continue to expect to return at least $7.7 billion through dividends and share repurchases as we remain committed to returning a substantial portion of our cash to our shareholders. With that, let's open it up so we can take your questions. Katie?"
},
{
"speaker": "Katie O'Conor",
"content": "Thanks, KC. I would ask that you each keep to one question and a follow-up to allow as many participants as possible to ask a question. Operator, would you provide instructions for those on the call?"
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Your first question comes from the line of Tien-tsin Huang from JPMorgan. Please go ahead."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Thank you so much, and congrats to KC and Angie. I'm excited for both of you guys. I just wanted to ask upfront, just for Julie, maybe you mentioned stronger growth next year. Hoping you can just elaborate on that at a high level. I know there's a lot of moving pieces. On one hand, you have a big backlog, a lot of large deals. You have strong inorganic growth, but on the other hand, the sector is struggling with this weak discretionary spend, and there's uncertainty with global elections in the second half of the year. So just -- I know you can't give formal guidance until next year. I know consensus is at, what, 6%? Can you just give us maybe just some high-level considerations that are worth underlining as we're recasting our outlook for next year? Thank you."
},
{
"speaker": "Julie Sweet",
"content": "Sure, and thanks for the question, Tien-tsin. So, let's just anchor on our strategy for growth and what you're seeing in three quarters into the year, because obviously, expectations at the beginning of this year were different in terms of how things develop with spending. So, what did we do? We leaned into what do clients need, and they need these reinventions, they need these big, large-scale transformations. And so, what you've seen us to do is, like, you've got to go with what the clients need, and that's what they're buying. And so, we have accelerated our leaning into these large transformation deals, which is why you see that we have seven more than last year at this time of clients with bookings of over $100 million. Now, these convert to revenue more slowly, but as we're accelerating, you'll know that they ramp up and they will start to layer in. And we are very uniquely positioned in this market to be able to do these large-scale transformations because they require the combination of services, everything from the ability to help them move faster through our managed services, our industry expertise. Everyone wants to do that with the eye towards GenAI, so even though the transformations are often in preparation for GenAI, they want to work with the partner who really understands GenAI, and so how do we get there faster. And so, as you think about the reinvention strategy, that's a strategy we've been executing for a couple of years, and we uniquely can lean in, and that -- you're seeing the results of that this quarter with the acceleration of -- compared to last year, of clients with that level of bookings and those, of course, then ramp next year. The second is, our leaning into where we are seeing growth in smaller deals because remember that discretionary spending is constrained, overall spending constrained, and particularly in smaller projects. But what did we do, right? We see GenAI as the new growth. We have an incredible ability to pivot our people. You can see the specialists in data and AI growing. We started at 40,000, we're at 55,000 now against our goal of 80,000 by the end of 2026. We're also training our people. You saw that big increase, because we're preparing our people. You're now doing a transformation. It may not be GenAI, but you have to understand GenAI. And so, we're uniquely able to train our people at scale to understand GenAI. And how is that translating? We'll look at our bookings this quarter now getting to $2 billion, three quarters into the year as compared to $300 million last year and $500 million in revenue. So starting to be meaningful, right? In terms of the numbers, we were at $100 million for all of last year. So we expect to continue to lean into GenAI. And what it's doing is very interesting from where we were, say, three quarters ago. It's acting as the catalyst to understand what you have to do. So I'll finish here and then I'll just, of course, mention our ability to invest in inorganic. But right now from a perspective of like the pull through, we're still reprioritizing. But every other GenAI project now is leading to some data project, because people are understanding, hey, this is a great technology and I'm not ready. So we feel really good about being very well positioned as spending increases, when it does increase because of what we're doing. And then finally, remember we invest in acquisitions to drive organic growth. Like that is -- so it's all about future growth. And I gave a lot in the script today to just help bring to life just how strategic our ability to invest is as we think about future growth. So not trying to comment at all on FY 2025. We'll call it like we see it. But we also want to be clear that our strategy is working and these deals will ramp up."
},
{
"speaker": "KC McClure",
"content": "Yes, maybe I'll just add, Tien-tsin, just how we feel just within this fiscal year. So, we're very pleased with where we landed in Q3. When you look to Q4, we do have, and you see that in our growth rate, a clear uptick in our growth rate for the fourth quarter. And I think importantly included in that is the expectation that our consulting type of work in Q4, Tien-tsin, will return to growth and that we haven't had growth in consulting type of work since Q2 of last year."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Good. No, thank you both for that. I'll be less wordy with my follow-up. Just on the inorganic piece, can this pace continue?"
},
{
"speaker": "KC McClure",
"content": "I'll let Julie talk about -- add on here. But in terms of our -- let's talk about capital allocation. And we've always said this, we have the ability, and I think it's a differentiator of ours, to be able to invest and approach the market as whenever we see something that we want to execute. And that remains unchanged. And we've been able -- and you've seen us do that over all the different business cycles. And importantly, when we do that, we're able to continue all parts of our capital allocation in terms of share buybacks and dividends as well. So, from a financial standpoint, we have a very strong balance sheet. We have the ability to continue to flex up and down as we see fit from a capital allocation standpoint, Tien-tsin."
},
{
"speaker": "Julie Sweet",
"content": "Yes, Tien-tsin, and I think we'll make the decision as we go into next year as to what level we want to drive for next year. So, I think we'll comment next quarter."
},
{
"speaker": "Tien-Tsin Huang",
"content": "That's perfect. I know you've been able to amplify the growth of what you bought. So, that's why I asked. Thank you."
},
{
"speaker": "Julie Sweet",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Dave Koning from Baird. Please go ahead."
},
{
"speaker": "Dave Koning",
"content": "Yes. Hey, guys. Thanks so much. One thing I noticed, debt was up to $1.6 billion or so. Sequentially, it was the highest. Really, in 20 years, you've almost had no debt, and you have a lot of cash. So, I guess, what's the strategy around borrowing money now? And maybe it's just geographic cash positions, too."
},
{
"speaker": "KC McClure",
"content": "Yes. No, that's a great question. So, in terms of our cash, you said that we started the year at $9 billion, and now we're little bit -- we are about $5.5 billion. And we do have some debt. It's very small, as you mentioned, for a company of our size. We do have a -- we had a credit facility that we put in right during the pandemic, and we continue to have a credit facility. It's about $5.5 billion. It's a five-year credit facility and what you just see, Dave, is that we're just exercising some of that credit facility, kind of normal treasury operation."
},
{
"speaker": "Dave Koning",
"content": "Okay. And maybe just as a follow-up, margins this year up at the lower end of kind of normal and certainly scale, just the growth this year being a little slower, maybe the acquisitions. And just as we kind of look forward, the margin puts and takes, how should we think that with acquisition spending maybe a little higher, does the next few quarters remain kind of putting a little pressure on margins or how should we think of just the moving parts of margins going forward?"
},
{
"speaker": "KC McClure",
"content": "Yes, sure. So I'll just obviously keep my comments to this year, to 2024, but -- and maybe I'll just point out where we are and what we are continuing to assume. So we stated last quarter that we'd be at 10 basis points of operating margin expansion and we reconfirmed that, Dave, for the full year, again this quarter, and we feel confident in our ability to do that. So if you look at -- we run our business to operating margin. If you look at gross margin and overall what we've been saying on pricing and just importantly, when we talk about pricing, we mean the margin on the work that we sell. What I think is really important for us is that, we've been able to operate our business with rigor and discipline in how we run ourselves in an operation -- in efficient operations of Accenture and be our own best credential as we absorb kind of higher selling costs, which you would expect. We're looking at our record $60 billion of bookings and also the continued pressure and pricing that we've had across the business. So with that, we feel really good. And if you look at it, we grew 1% in quarter one. As an example, we were able to do 20 basis points of margin expansion. We grew 1% this quarter, and we were able to do 10 basis points of margin expansion. So we feel good about the way we run our business with rigor and discipline."
},
{
"speaker": "Dave Koning",
"content": "Great. Thanks and nice bookings."
},
{
"speaker": "KC McClure",
"content": "Thank you."
},
{
"speaker": "Julie Sweet",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Bryan Keane from Deutsche Bank. Please go ahead."
},
{
"speaker": "Bryan Keane",
"content": "Hi, guys. Good morning and congrats, KC. A great run at Accenture. You were awesome. So, I want to ask on managed services on the bookings, the $11.8 billion, that was an outsized number. How much of that is new bookings versus renewals? And maybe give us some flavor on what caused that spike in growth."
},
{
"speaker": "KC McClure",
"content": "Yes. Maybe I will give you the -- I'll talk a little bit about the numbers. In terms of, it is a record bookings for managed services. As Julie's -- and as we've been talking, it is obviously based on the larger transformational deals that we're doing. Well, those larger transformational deals, just to be clear, Bryan, they do have both consulting and outsourcing -- excuse me, managed services type of work with them. They do have, as you would expect, a larger portion of managed services type of work. So when you see what we were able to do this year, we're already at 92, seven more than last year. And we did have a very strong managed services bookings, as you noted, in Q3. We don't really do a breakout in terms of extensions or new, but there's always -- we always have a healthy mix, I would say, of both. That's what we strive to over rolling four quarters in our business always and no difference there."
},
{
"speaker": "Julie Sweet",
"content": "Yeah. And just maybe a little color, Bryan. As you think about this idea of reinvention, Virgin Media O2 was a great example, because there, right, we have a combination using our Edge platform to provide -- help O2 provides -- Virgin Media O2 to provide these new services. And at the same time, we're supporting it with our customer operations, supporting their growth so that they can scale. And right now, clients, of course, they're looking for growth, they're also looking for transformation and efficiency. The other thing I'd say is, this is a great example of how we're embracing GenAI. You've heard us talk in the past about our myWizard platform, which helps in our managed services. We now -- that's become Gen Wizard and we're seeing that our embracing -- early embracing of using Gen AI where it's ready to be used has been a real differentiator in our technology managed services. So, we're very focused on helping our client, who move faster using our expertise and leverage our digital investments in order for them to transform and reinvent faster and you're seeing that focus."
},
{
"speaker": "Bryan Keane",
"content": "Got it. And just a follow-up, just looking at some of the dimensions breakout, when I look at operations being flat, just any call-outs for that. I know it was negative last quarter, so it's turned a little bit here, but just trying to understand the growth there and the prospects. Thanks."
},
{
"speaker": "Julie Sweet",
"content": "Yes, no, it's -- we're really pleased that it's, that ticked up this quarter and it's a very strategic part of our business. Think about it really is like sort of two-ways, right? So we remain number-one in our industry in finance and accounting and we're embracing again GenAI there to help differentiate our platform. And so, there's a focus that we're seeing in our clients as they're saying, okay, we need to -- we really understand how much more we need to digitize and we need to do that in the enterprise, they're excited about our ability over-time. Again, it's very early days still in Gen AI over-time to help build our -- we're building our SynOps platform, we're building in GenAI and that helps them have less to build-in in their enterprise side by partnering with us. And so that's -- we think a really great differentiator. And then we continue to diversify into areas that are in the core of our business, whether -- core of our industries for our clients, whether it's claims and underwriting and insurance, or supply-chain for consumer goods and industrial or core banking in the financial services. So we feel really good about the business and kind of continue -- and its continued prospects."
},
{
"speaker": "Bryan Keane",
"content": "Thank you."
},
{
"speaker": "Julie Sweet",
"content": "Thanks, Bryan."
},
{
"speaker": "Operator",
"content": "Your next question comes from the your next question comes from the line of Rod Bourgeois from DeepDive Equity Research. Please go ahead."
},
{
"speaker": "Rod Bourgeois",
"content": "Hey guys, and very best wishes to KC as well. Julie, you mentioned that the demand environment is sort of more of the same. At the same time, it appears you've seen some growth mending in certain key areas. I'm particularly interested in the growth improvement in the CMT vertical and in strategy and consulting. Can you talk about what's enabling those growth improvements and a sense of the outlooks for CMT and S&C? Thanks."
},
{
"speaker": "Julie Sweet",
"content": "So, really want to compliment our entire team on the work that they're doing with our clients in CMT. So, as we've been talking about that for now for a little while and we start to see things like the Virgin Media O2 deal. So our teams are working with our clients on what do they need. And they're focused on getting rid of technology debt, because that's critical in order to use some of these new technologies. They're focused on using the new technologies. So we have a number of clients that -- while it's still small, are working on GenAI. And then being very focused on efficiencies. And then finally network. So, really across the board what I would say is the industry was challenged. We have been just focused on going to where they need help and you're seeing that result in our results. And then on strategy and consulting, again, it's all about being focused on what do our clients need. And so, we've pivoted many more people, for example, toward cost and strategy. So cost takeout is a big theme, and particularly for our strategy. We are seeing a lot of growth still in things like implementing modern ERP platforms with the focus on the digital core. And again, at Accenture, it's not just technology, right? It's about we're the number one player with all of these technology ecosystem players, but our clients want to do it faster. They need the industry expertise. And so, you saw a number of examples in the script about how we're putting in these platforms and we're doing so within an industry context. And so, I'd say cost takeout and move the cloud data platforms wrapped around with industry and functional expertise, that's where we're seeing the growth. And we just continue to remain laser focused on more people, more focus, working with the clients on what they need to buy."
},
{
"speaker": "Rod Bourgeois",
"content": "Great. Thanks for that. And you're seeing revenue mix incrementally shift into managed services, and I'm curious if you think some of that mix shift towards managed services is due to secular forces, or are you purely seeing that mix shift as just a cyclical phenomenon?"
},
{
"speaker": "KC McClure",
"content": "Yes, I think, it's -- in terms of what the real driver is, it's the larger deals that have a little bit of both in those -- both components of a sector and cyclical and what you're talking about. So it really is just based on the larger deal."
},
{
"speaker": "Julie Sweet",
"content": "So just think about Accenture is very uniquely positioned in this market. Clients are prioritizing large scale transformations. And doing those and getting the efficiencies and moving faster, managed services is a highly strategic component of being able to do that. And this is where Accenture, with such scale in both strategy, in both consulting type of work with managed services is really able to lean into what are clients buying now."
},
{
"speaker": "Rod Bourgeois",
"content": "Got it. Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Bryan Bergin from TD Cowen. Please go ahead."
},
{
"speaker": "Bryan Bergin",
"content": "Hi. Good morning and congrats KC and the other leaders on the retirements and appointments. First question I wanted to ask on the consulting existing revenue-base performance, can you just talk about how base business runoff kind of progressed within the minus 1% local currency performance? I heard your comment on the 4Q consulting or just returning to growth. I'm trying to understand if that's a reflection of sustainable stabilization potentially and really gauge whether you're reaching a point where the new consulting bookings conversion should more than offset the existing base runoff moving ahead."
},
{
"speaker": "Julie Sweet",
"content": "Yes. So, Brian, in terms of what we'll give -- what we'll talk about is really is what I just mentioned on Q4. I guess -- and I understand what you mean by a base runoff. We don't really think of it that way. We kind of look at it as maybe our terms will be whether we have booked and backlog and what are we already -- and what's new coming in from these sales. And so, I get -- so just kind of going with those two points, the way we evaluate and we talk about it, Brian, is from a year-over-year basis, looking at both the components of what we've already sold for the next quarter and then what we see in our pipeline and how we see those sales will convert to revenue, that's how we kind of assess what we think that we will be overall. And again, very pleased that consulting -- we do feel that and see that it will return to growth. And I think it's a milestone that we haven't had in a number of quarters, so we'll pleased with that. And we'll comment on anything else for next year, next year, I mean in September."
},
{
"speaker": "Bryan Bergin",
"content": "Okay. And then bookings, obviously, very solid here. Can you just comment on pipeline and any bookings expectations worth calling out for 4Q?"
},
{
"speaker": "Julie Sweet",
"content": "Yes. Overall, we feel good about our pipeline. And we don't put -- we don't give guidance to next quarter bookings. But we feel good."
},
{
"speaker": "Bryan Bergin",
"content": "Thanks."
},
{
"speaker": "Julie Sweet",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of James Faucette from Morgan Stanley. Please go ahead."
},
{
"speaker": "James Faucette",
"content": "Great. Thank you very much. I wanted to follow up on the acquisition activity. It's obviously been really robust, providing a lot of good opportunities. Can you give us any sense collectively across the acquisitions you've been doing and maybe what you are looking at in terms of what the growth rates of those businesses are generally or collectively when you do the acquisitions? And I know there's a target to accelerate those, how the growth rates tend to change as those companies are absorbed into [index center] (ph), even if directionally."
},
{
"speaker": "Julie Sweet",
"content": "Yes, I mean, I think in terms of -- make sure I'm answering your question is, when we look at overall at our acquisitions, they all come with -- they're typically higher growth business cases that we have from the companies that we buy and we have a base case that comes with the organization and we assess that growth rate. And then we obviously put in pretty significant synergy cases that are -- without going through kind of metrics that are a pretty high bar for those acquisitions to deliver to, along with a broader center. And that's why integration is so important in what we do, because we're not just having a great business case, that is maybe half of what you need to do, but the key really is in how you integrate to deliver to that, and we have a very strong track record. And so, what you'll see is, you could just maybe get the sense to your question, is look at how many we've done over the last five years and you can see how we've been able to continue to grow our business throughout that time. And it is really continuing to fill our organic growth."
},
{
"speaker": "James Faucette",
"content": "Got it. And then quickly, one of the areas where you've leaned in on and was mentioned in the prepared remarks is the government and healthcare sector, really strong growth there obviously. How should we be thinking about that as a long-term or medium-term potential grower in that segment and any -- and how are you thinking about the investment needed to continue to drive that? Thanks."
},
{
"speaker": "Julie Sweet",
"content": "Thanks. We feel really good about that vertical. Obviously there's a lot of transformation that's going on in public service. You see health is a big driver, defense is a big driver. There's a lot of infrastructure support, whether it's IRA in the U.S. or what the EU has been doing as well. And of course, a lot of the digital transformation hasn't happened in the public service and health, And so, we see that now being the time and you're seeing that in the results. So we feel very confident and we think about the investment like we do all our industries. I mean, remember, we have 13 industry groups. We have -- the diversification is a key part of both our resilience and our growth strategy. And so, at any given time, we're investing differently depending on the growth trajectory. And as we called out this quarter, we've been investing significantly in public service, because we see the next several years this being a big growth area and we're making those investments now."
},
{
"speaker": "Katie O'Conor",
"content": "Operator, we have time for one more question, and then Julie will wrap up the call."
},
{
"speaker": "Operator",
"content": "Okay. That question comes from the line of Keith Bachman from BMO. Please go ahead."
},
{
"speaker": "Keith Bachman",
"content": "Hi. Many thanks. And first, Casey and Paul, special congratulations as you make the transition. I wanted to ask a question, and I'll just make it concurrently in the interest of time. And Julie, I think I'll direct this to you. Number one, on BPO, one of your competitors just talked pretty openly about pricing's been under pretty material duress as of late, and I wondered if you would echo that? And I'm really curious as to why. Why do you think pricing has been under duress? And how do you think about impacting future growth? And then the second area that I wanted to ask about is, Song. Thank you for the comment on mid-single digit growth. And I'm really interested how you think GenAI will impact over your digital agency over the next 12 to 24 months. And the reason I ask the question is, we also spend a lot of time with companies like Adobe that have significant -- generative AI is going to have a significant impact on digital agencies. And some of the agencies are talking about seat reductions because of the value associated with generative AI. And I'm just wondering if you could comment on how you think generative AI will impact the growth potential of Song. And that's it for me. Many thanks."
},
{
"speaker": "Julie Sweet",
"content": "Great. KC, why don't you quickly cut pricing, and then I'll do Song."
},
{
"speaker": "KC McClure",
"content": "Keith, I would say just in terms of pricing, and we've been commenting on this for quite some time. You are correct in that, we've had overall in our entire business continued pricing pressure. So, I mean, that's the way I would reflect on that statement -- on your question [indiscernible]."
},
{
"speaker": "Julie Sweet",
"content": "Yes, it's overall is a tight market, So that's what you normally see. On Song, here's where we are so unique, because our business is not an agency business, right? The agencies are part of an incredibly differentiated value proposition where you have creative and technology and digital and by the way managed services. And so, we see this as a huge opportunity because we are embracing it as fast as possible to help our clients get value, but we put it together with all of these other services. So we were happy to see the uptick in growth this quarter with Song and long term where we really think it's great. And remember, this is our playbook, right? We embrace technology. We've done it in every wave. We've done it when we did managed services. Remember in 2015, we had SynOps and myWizard. Our business is to help our clients be more efficient and grow. That is what we do. And we use technology in how we deliver it. And we help them use technology and how they operate. And so, we see GenAI as yet another way that we're going to embrace it. We're going to be fast. And we're going to do what we do for clients. And that is a very exciting opportunity, so we feel really good about our Song business. Great. So, thanks everyone for the questions and the time today. In closing I want to again, as always, thank all of our shareholders for your continued trust and support, and all of our people for what you're doing for our clients and for each other every day. Thanks so much for joining."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T teleconference. You may now disconnect."
}
] |
acn | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning. Thank you for standing by, welcome to Accenture's Second Quarter Fiscal 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode, later we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Managing Director, Head of Investor Relations, Katie O'Conor. Please go ahead."
},
{
"speaker": "Katie O'Conor",
"content": "Thank you, operator. And thanks, everyone, for joining us today on our second quarter fiscal 2024 earnings announcement. As the operator just mentioned, I'm Katie O'Conor, Managing Director, Head of Investor Relations. On today's call, you will hear from Julie Sweet, our Chair and Chief Executive Officer; and KC McClure, our Chief Financial Officer. We hope you've had an opportunity to review the news release we issued a short-time ago. Let me quickly outline the agenda for today's call. Julie will begin with an overview of our results. KC, will take you through the financial details, including the income statement and balance sheet, along with some key operational metrics for the second quarter. Julie will then provide a brief update on our market positioning before KC provides our business outlook for the third quarter and full fiscal year 2024, we will then take your questions before Julie provides a wrap-up at the end of the call. Some of the matters we'll discuss on this call, including our business outlook are forward-looking, and as such are subject to known and unknown risks and uncertainties, including but not limited to those factors set forth in today's news release and discussed in our Annual Report on Form 10-K and quarterly report reports on Form 10-Q and other SEC filings. These risks and uncertainties could cause actual results to differ materially from those expressed in this call. During our call today, we will reference certain non-GAAP financial measures, which we believe provide useful information for investors. We include reconciliations of non-GAAP financial measures where appropriate to GAAP in our news release or in the Investor Relations section of our website at accenture.com. As always, Accenture assumes no obligation to update the information presented on this conference call. Now let me turn the call over to Julie."
},
{
"speaker": "Julie Sweet",
"content": "Thank you, Katie and everyone joining, and thank you to our 742,000 people around the world who work every day to deliver 360 degree value for all our stakeholders. I'm pleased with our performance in an uncertain macro. Our results highlight the benefit of the deep trust our clients have in us, our capabilities to do the most complex work at the heart of their businesses, the privileged position we hold within the ecosystem and our ability to invest for the next waves of growth. We continue to see momentum in the quarter and how we are executing on our strategy to be the trusted reinvention partner of our clients, with a record 39 clients with quarterly bookings greater than $100 million. These large transformational wins position us to capture more growth as spending increases. We also had over $600 million in new GenAI bookings taking us to $1.1 billion in GenAI sales in the first-half of the fiscal year, expanding our early lead in GenAI, which is core to our clients reinvention. We now have over 53,000 skilled data and AI practitioners against our goal of doubling our data and AI workforce from 40,000 to 80,000 by the end of fiscal year 2026. We are laser-focused on the needs of our clients and this focus is reflected in our bookings of $21.6 billion, representing our second highest quarter on record. This included $10 billion of bookings in North America, our highest ever. We continue to take market-share with revenues of $15.8 billion for the quarter, flat compared to last year and slightly above the midpoint of our range. As we turn the page on the calendar year, we saw another turn of the dial unconstraining spending by our clients, including spending on our services, particularly in parts of EMEA and North America. This was evident in the composition of our new bookings, which came in differently than expected. We see clients continuing to prioritize investing in large-scale transformations which convert to revenue more slowly, while further limiting discretionary spending particularly in smaller projects. We also saw continued delays in decision-making and a slower pace of spending. We are pleased that despite these conditions our focused efforts to return to growth resulted in North America and CMT, showing improvement over last quarter. We are running our business with rigor and discipline and we remain on-track with the business optimization actions we announced last year to reduce structural costs to create greater resilience. We delivered adjusted EPS growth of 3%, we continue to invest significantly in our business to drive additional growth in highly strategic areas with $2.1 billion of capital deployed across our geographic markets in Q2 in 11 acquisitions, bringing the total investment in acquisitions to $2.9 billion in H1 across a total of 23 acquisitions. We also continue to invest in learning for our people with approximately $10 million -- 10 million training hours in the quarter, representing an average of 14 hours per person. In recognition of the 360 degree value we create, we are proud that we earned the number one position in our industry for the 11th year in a row and number 33 overall in Fortune’s list of the World's Most Admired Companies. We ranked number one in our industry and number three overall on the JUST Capital CNBC list of America's Most Just Companies. And we have been recognized by Ethisphere as one of the World's Most Ethical Companies for the 17th year in a row. An important part of our growth strategy is to use our strong balance sheet to invest in order to scale higher-growth areas and expand into new growth areas. We have a strong track-record of delivering on this strategy. Here are some highlights from the quarter. In North America, we invested in supply-chain, an area with significant reinvention ahead with the additions of inside sourcing in [indiscernible] and on-process technology. We acquired Navisite site to help clients across multiple cloud providers enterprise applications and digital technologies, modernize their digital core, and in Song, we acquired Work & Co to help our clients drive growth by designing and bringing digital brand strategies to market and operationalizing world-class digital products at scale. In EMEA, we are investing to help clients build their digital core and drive growth. In the UK, we invested in 6point6, which will help our clients transform their digital capabilities and modernize their legacy systems. We also acquired in the UK, Redkite with its full stack data expertise that will help our clients accelerate their performance with data driven intelligence and AI. And in Germany we added Vocatus, which will accelerate our clients' growth strategies using behavioral economics modeling to develop pricing strategy and sales concepts for B2B and B2C models. Similarly, in good markets our acquisitions position us to drive our clients' growth agendas by expanding our capabilities in marketing and customer experience with Rabbit's Tale in Thailand and [GIC] (ph) in Singapore, helping clients in Indonesia, capitalize on their fast-growing digital economy. Our ability to invest to fuel our organic growth is a competitive advantage and as our clients continue to transform, we announced earlier this month that we will invest $1 billion over the next three years in Accenture LearnVantage, which will provide comprehensive technology learning and training services to help our clients re-skill and upskill their people. Our investment includes the acquisition of Udacity, a digital education pioneer, which we expect to close by the summer. Once closed, we will have revenue in the zone of $100 million annually. These services are highly strategic and they enhance our position as a reinvention parts are of choice, because talent is at the top of the agenda for CEOs. For example, we are helping Merck, a global biopharmaceutical company known as MSD outside of the United States and Canada launching groundbreaking Generative AI training program for their employees to create world class digital leaders. As a renowned thought leader in the biopharmaceutical market, Merck has long-lead the way in investing in its people and helping them build the skills and expertise needed to develop breakthrough therapies. Digital, data, analytics and AI play a pivotal role in discovering, developing, manufacturing, and providing access for patients to medicines and vaccines. By once again investing in its people, Mark will be able to continue delivering on its promise to use the power of leading-edge science to save and improve lives around the world. Over to you KC."
},
{
"speaker": "KC McClure",
"content": "Thank you, Julie. And thanks to all of you for taking the time to join us on today's call. We were pleased with our overall results in the second quarter with our second highest quarter of new bookings. We continue to invest at scale to strengthen our leadership position, while delivering value for our shareholders. Now let me summarize a few of the highlights of the quarter. Revenues were flat in local currency, with mid-single digit growth or higher in six of our 13 industries, including public service, life science, utilities, energy, health and high-tech. While our CMT industry group improved this quarter, we continue to see pressure as expected. And we continue to take market share. As a reminder, we assessed market growth against our investable basket which is roughly two dozen of our closest global public competitors, which represents about a third of our addressable market and we use a consistent methodology to compare our financial results to theirs. Adjusted to exclude the impact of significant acquisitions. Through the date of their last publicly available results on a rolling four quarter basis. Adjusted operating margin of 13.7% decreased 10 basis points, compared to Q2 last year and year-to-date operating margin is flat. This includes continued significant investments in our people and in our business. We delivered adjusted EPS in the quarter of $2.77, reflecting 3% growth over adjusted EPS last year. Finally, we delivered free cash flow of $2 billion and returned $2.1 billion to shareholders through repurchases and dividends. In the first half of the year, we've invested $2.9 billion in acquisitions across 23 transactions. With those high-level comments, let me turn to some of the details, starting with new bookings. New bookings were $21.6 billion for the quarter, representing a 2% decline in both US dollar and local currency, with an overall book-to-bill of 1.4. Consulting bookings were $10.5 billion with a book-to-bill of 1.3. Managed services bookings were $11.1 billion with a book-to-bill of 1.4. Turning now to revenues, revenues for the quarter were $15.8 billion, flat in both US dollars and in local currency, and we're slightly above the midpoint of our guided range. Consulting revenues for the quarter were $8 billion, a decline of 3% in both US dollars and local-currency. Managed service revenues were $7.8 billion, up 3% in both US dollars and local-currency. Taking a closer look at our service dimensions, technology services grew low-single digits and operations and strategy and consulting declined low-single digits. Turning to our geographic markets. In North-America revenue was flat in local currency with growth in public service, offset by declines in banking, capital markets, software and platforms and communications and media. In EMEA, revenues declined 2% in local currency with growth in public service, offset by declines in communications and media and banking capital markets. Revenue growth in Italy was offset by declines in the United Kingdom, France and Ireland. In growth markets, revenue grew 6% in local currency, led by growth in banking, capital markets, industrial, public service and chemicals and natural resources. Revenue growth was driven by Japan and Argentina, partially offset by declines in Australia and Brazil. Moving down the income statement, gross margin for the quarter was 30.9% compared with 30.6% for the same-period last year. So marketing expense for the quarter was 10.3% compared to 9.9% for the second quarter last year. General and administrative expense was 6.9% compared to 6.8% for the same quarter last year. Before I continue, I want to note that in Q2 of FY 2024 and FY 2023, we recorded $150 million and $244 million in costs associated with our business optimization actions respectively. These costs decreased operating margin by 70 basis-points and EPS by $0.14 this quarter and operating margin by 150 basis-points and EPS by $0.30 in Q2 of last year. The following comparisons exclude these impacts and reflect adjusted results. Adjusted operating income was $2.2 billion in the second quarter, reflecting an adjusted operating margin of 13.7%, a decrease of 10 basis-points from adjusted operating margin in the second quarter of last year. Our adjusted effective tax rate for the quarter was 18.8% compared with an adjusted effective tax rate of 20.4% for the second quarter last year. Adjusted diluting earnings per share were $2.77 compared with adjusted diluted EPS of $2.69 in the second quarter last year. Days services outstanding were 43 days compared to 49 days last quarter and 42 days in the second quarter of last year. Free cash flow for the quarter was $2 billion resulting from cash generated by operating activities of $2.1 billion, net of property and equipment additions of $110 million. Our cash balance at February 29th was $5.1 billion compared with $9 billion at August 31st. With regards to our ongoing objective to return cash to shareholders, in the second quarter we repurchased or redeemed 3.8 million shares for $1.3 billion at an average price of $352.35 per share. As of February 29th, we had approximately $4.6 billion of share repurchase authority remaining. Also in February, we paid a quarterly cash dividend of $1.29 per share for a total of $813 million. This represents a 15% increase over last year. And our Board of Directors declared a quarterly cash dividend of $1.29 per share to be paid on May 15th, a 15% increase over last year. In closing, we remain laser focused on capturing growth opportunities in the market and delivering value for our clients. As you know and expect of us, we will operate with rigor and discipline, while continuing to invest for long-term market leadership. Now, let me turn it back to Julie."
},
{
"speaker": "Julie Sweet",
"content": "Thank you, KC. Let me give a little more color on the demand environment, all strategies continue to lead to technology and reinvention. Our clients are navigating an uncertain macro-environment due to economic, geopolitical and industry-specific conditions. And in response, we are seeing them thoughtfully prioritize larger transformations, building out their digital core to partnering, to improve productivity, to free-up more investment capacity to focus on growth and other initiatives with near-term ROI. Our focus on being at the center of our client's business doing their most complex transformational work provides us with resilience see overtime, as demonstrated by the fact that our top 100 clients have been clients for over 10 years. There is now near universal recognition of the importance of AI, which is the heart of reinvention. The ability to use AI at scale, however, varies widely with clients on a continuum with those which have strong digital cores generally seeking to move more quickly, while most clients are coming to grips with the investments needed to truly implement AI across the enterprise and nearly all are finding it difficult to scale, because the AI technology is a small part of what is needed. To reinvent using technology, data and AI you must have the right digital core, change your processes and ways of working, reskill and upskill your people and build new capabilities around responsible AI. All with a deep understanding of industry and function in order to unlock the value. And many clients need to first find more efficiency to enable scaled investment in all these capabilities, particularly in their data foundations. We are able to help our clients with this AI rotation because of our broad services across strategy and consulting, technology and operations as well as everything customer through Song and digital manufacturing and engineering through Industry X. And our relevance across the functions of the enterprises in 13 industries. Our privileged position in the technology ecosystem has perhaps never been more important. Generative AI is rapidly evolving and still in the early stages of maturity and adoption. And we are working closely with our ecosystem partners to help our clients understand the right data and AI backbone that is needed and how to achieve tangible business value. I will now bring to life the complex work we are doing at the heart of our clients' businesses. Building on the back of a long trusted partnership, we are working with Mondelez International, a world-leader in snacking with well-known brands like Oreo, belVita and Cadbury. To continue to drive growth and be an industry-leader. Having laid the foundations of a strong shared services modeled model powered by leading technology platforms and data and AI foundation we are now working on an ambitious reinvention of their digital core. We will design and implement a single cloud-based platform. We'll also modernizing the finance function and transforming their supply-chain planning and warehouse management capabilities. This will enable faster availability of products for customers to have more sales growth and maximum profitability. This new digital core will also allow Mondelez to further reinvent how they satisfy customers through the adoption of new technologies like Generative AI. Cloud continues to be the foundation of the digital core. Our cloud business grew high-single digit this quarter as clients do work across the cloud continuum from migration to modernization, to new business models to working at the intelligent edge. For example, we're helping Riyadh Air, a digitally native airline based in Saudi Arabia, become the world's first fully cloud-based airline. We will equip the brand-new airline with a cloud-only infrastructure enhanced cyber security and AI driven operations. Our capabilities will ensure that Riyadh Air’s digital core is future-proof and remains legacy free, enabling the airline to use cutting-edge technologies such as cloud, data and AI to scale quickly and deliver a seamless and more personalized travel experience for its customers and employees. This will also help the company to scale as it plans to operate over 100 destinations by 2030. We are partnering with Belden, a global networking solution organization on a cloud transformation program that will help them become a platform business. Unlocking the power of edge, data and AI to drive new business opportunities and enhance the customer experience. This platform will be powered by edge to cloud technology, allowing them to collect and analyze real-time data from industrial environments and improve operational efficiencies. This will provide valuable data driven insights to Belden and to their clients in industries where real-time insights are crucial. This reinvention will enable them to break-down operational technology silos, allowing them to become a key player in the digital twin domain. We will also help enable this new service in the market, this strategic partnership will support Belden's reinvention from a product company into a data engineering and insights company that leverages the power of platforms. We are focused on helping our clients, leverage the power of AI quickly, generating tangible business value, leveraging our investment in differentiated tools that accelerate results. Our AI Navigator has helped clients across industries outline their value case, AI architecture and AI solutions and our recently-announced AI switchboard is already helping clients with the complex new need for integration across LLM models. For example, one of the largest [indiscernible] companies is currently testing the switchboard to compare how the same prompt would be interpreted by different models and how they perform before deciding on which model to use. Ultimately an enterprise-wide AI rotation requires a strong data foundation, we are working with Telstra, Australia's leading telecommunications and technology company on a radical simplification and modernization of its data ecosystem, accelerating its efforts to become AI powered. We are modernizing and consulting over 50 disparate enterprise data sources into a small integrated set forming Telstra's governed and secure data and AI core, allowing Telstra to rapidly scale bespoke Generative AI capabilities in the future. Our work will also support the company's efforts to develop responsible ethic and secure market leading AI frameworks, while helping their teams provide quicker, more effective and more personalized customer interactions. One of the areas of riches opportunities for our clients is customer experience transformation, including with Generative AI, which uses the unique capabilities of Song across creative customer insights and deep technology expertise. Song grew low-single digits this quarter, we continue to help clients reimagine marketing to drive growth. We're helping ExxonMobil, an energy super major transform and optimize its end-to-end fuels marketing operations to drive future growth. With our global capabilities, our managed services will leverage our SynOps platform to drive automation and deliver measurable efficiencies across the fuels marketing business. We are strengthening our partnership with Best Buy, a leading consumer electronics retailer across multiple fronts to reimagine the customer experience, optimize costs and drive growth. By leveraging data and Generative AI, we are helping to transform their contact center operations and improve customer and employee experience. We are also pleased to have entered into an agreement with Best Buy for lifecycle management of our own Accenture devices in North America and our creating a joint offering end-to-end field service advice support for clients. We have already applied this new offering to a major TV provider, marking our first entry into this new market. These strategic initiatives underscore our commitment to helping Best Buy, achieve superior customer experiences, operational efficiencies and growth. Security is essential to reinvention, moving beyond IT to protecting the core assets of the business and evolving the critical role of security as technologies change. We saw very strong double-digit growth in our security business this quarter. We are working with one of the largest electric utility holding companies in the United States to integrate their operational technology into a seamless unified cyber security solution. Together, we will enhance our security capabilities by implementing advanced monitoring and response, vulnerability management and security automation. This will help reduce the risk of secure of cyber events in their grid environment protecting critical infrastructure serving tens of millions of people. We continue to see strong demand for digital manufacturing and engineering services. Industry X grew double-digits in Q2. We're working with Indo Count Industries Limited, a global leader in the home textile space on digital transformation to simplify operations, support its ambitious growth plans and maximize e-commerce opportunities. We will build a cloud-enabled digital core, powered by data and analytics that will help standardize, digitize and automate processes and operations. From supply chain to logistics to manufacturing, the new platform will enable more efficient inventory management, quality standardization optimal energy consumption and better customer experiences. Together we will reinvent their operations and help expand our business in India, Middle-East and North America, the UK and Europe. And we continue our support for corporate green transformation by promoting carbon footprint compliance to the calculation and visualization of greenhouse gas emissions. To create a market where consumers can choose environmentally conscious products and services [indiscernible] visualize the carbon footprint of each product is necessary. For example we're assisting, Matsumoto Precision, a precision machine parts processing company based in Japan to gain more detailed insight into the sustainability of their projection and achieve their decarbonization goal. We implemented a solution through our manufacturing platform that uses individual manufacturing performance information to record and report the CO2 emission on a per product basis. This will allow Matsumoto Precision to enhance understanding of the environmental impact of their business and contribute more effectively to the realization of a decarbonized society. Back to you, KC."
},
{
"speaker": "KC McClure",
"content": "Thanks, Julie. Now let me turn to our business outlook. For the third quarter of fiscal 2024, we expect revenues to be in the range of $16.25 billion to $16.85 billion. This assumes the impact of FX will be about negative 1% compared to the third quarter of fiscal 2023 and reflects an estimated negative 1% to 3% positive growth in local-currency. For the full fiscal year 2024, based upon how the rates have been trending over the last few weeks, we continue to expect the impact of FX on our results in US dollars will be about flat compared to fiscal 2023. For the full fiscal 2024, we now expect revenue to be in the range of 1% to 3% growth in local-currency over fiscal 2023, which assumes an inorganic contribution approaching 3%. We continue to expect business optimization actions to impact fiscal 2024 GAAP operating margin by 70 basis-points and EPS by $0.56. For adjusted operating margin, we now expect fiscal year 2024 to be 15.5%, a 10 basis point expansion over fiscal 2023 results. We now expect our adjusted annual effective tax rate to be in the range of 22.5% to 24.5%. This compares to an effective tax rate of 23.9% in fiscal 2023. We now expect our full year adjusted earnings per share for fiscal 2024 to be in the range of $11.97 to $12.20 or 3% to 5% growth over fiscal 2023 results. For the full fiscal 2024, we continue to expect operating cash flow to be in the range of $9.3 billion to $9.9 billion. Property and equipment additions to be approximately $600 million and free cash flow to be in the range of $8.7 billion to $9.3 billion. Our free cash flow guidance continues to reflect a very strong free cash flow to net income ratio of 1.2. Finally, we continue to expect to return at least $7.7 billion through dividends and share repurchases as we remain committed to returning a substantial portion of our cash to shareholders. With that, let's open it up so that we can take your questions. Katie?"
},
{
"speaker": "Katie O'Conor",
"content": "Thanks, KC. I would ask that you each keep to one question and a follow-up to allow as many participants as possible to ask a question. Operator, would you provide instructions for those on the call."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] And one moment please for your first question. Your first question comes from the line of Tien-Tsin Huang from JPMorgan. Please go ahead."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Hi. Thank you. Good morning to all of you. Julie, just a big picture, maybe two simple of a question, but just curious to get your thoughts on where we are in the cycle for IT services spend, because we've been doing sector softness for quite some time now, Accenture has done well, you have very large deal activity come through, short-term cycle stuff is always little pressured as you said, where are we in terms of seeing maybe things bottoming or short-cycle discretionary spend returning?"
},
{
"speaker": "Julie Sweet",
"content": "Yes. I mean, Tien-Tsin, I think it's hard to predict at this point anything other than what we see right now. Right? So what's different than 90 days ago. Well, as we said in December, we really get visibility into our clients' budgets in January, we say that every year, right? And so, as the calendar year, we turn the page, what we saw was a further tightening of spending at our clients. Particularly [indiscernible] our services and particularly on the smaller projects. So from that sort of trend perspective, 90 days ago we didn't see the same level. Now you kind of turn the dial a little bit more constraints and that's where we see the budgets being set for calendar year 2024, right? And as you said though, in this environment we're taking market share and we're seeing building momentum on our strategy to be the reinvention partner with a record 39 clients with bookings over $100 million. So what does that tell you, right? So, the clients understand the importance of the technology-led transformation. And the fundamentals remain the same. There is a lot more reinvention ahead. We're still -- when you look at where is cloud, both migration and modernization, we say about 80% of the opportunities ahead. Data and AI, but 90% of the opportunities ahead. Re platforming in cloud-based platforms. About 65% of that opportunity ahead, based on who has actually adopted that more modern platforms and security. Well, I think security can be kind of forever ahead, but at least 65% ahead. And that's before you get to thinking about areas like digital manufacturing, engineering services, where that technology has only been coming online, even in the last couple of years sort of the modern technology. And of course, customer also extraordinarily early days. So, where we really focused on is meeting clients where they are today. So that prioritize the large transformational deals and then be positioned to capture the spending when it increases. And we see the sort of the industry has been very strong, because all clients have to get there. They need to get to the technology transformation. They need to get the reinvention and that's why you're seeing -- even as the constraints you're seeing that early interest in GenAI. I mean, $1 billion sales in the first-six months of the year, that is the fastest we have ever built sales in an emerging technology. And what it tells you is that, clients understand the importance of AI that they're going to have to reinvent every part of the enterprise and that's exactly where everything we've done for the last decades at Accenture. Being the company that can go from strategy to build, to operations, deepen industry and functional expertise, because the strategy and consulting all comes together for this moment to be the partner for reinvention across the enterprise, not just to build the technology, but to use it to reinvent and that's exactly what you see in these results, which is why I'm super confident about the industry and the future."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Yes. No, I'm confident that Accenture will be there to catch-all that like you said, but maybe as my follow-up with the GenAI bookings any trends on deal size. And in confidence that, that some of these early bookings will convert to become a part of this whole large $100 million plus deal activity across more pull-through from GenAI, that question makes sense."
},
{
"speaker": "Julie Sweet",
"content": "So couple of things. What you see in our resilience is that, we are doing these bookings over $100 million and that's what kind of layers that. That just gives you that base rate of resilience during this period. As we said, we're seeing further constraint on the smaller projects. That's why you've got the updated guidance, right? But the pace of these larger deals, we feel really good about from a resilience perspective. And then, you know how this straight, you're at the client, you are at the heart of their business, you're really doing the strategic work that's what all these large deals represent. And then as spending increases you catch the pent-up demand and that's kind of how we see it and that's how we've run it in the past. And by the way, of course, as you know, we're really investing inorganically to capture more growth which you also start to see. Particularly at the back-end of our fiscal year. Thanks, Tien-Tsin."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Bryan Keane from Deutsche Bank. Please go ahead."
},
{
"speaker": "Bryan Keane",
"content": "Hi, good morning. KC, if Accenture does 1% constant currency in the third quarter, that's kind of the midpoint of the range. I guess the implied midpoint for 4Q is a ramp-up to 6% constant currency. What kind of visibility do you have going into a number of the midpoint like that in the fourth quarter?"
},
{
"speaker": "KC McClure",
"content": "Yes. Hi, Bryan. Thanks for your question. And you're right, you're obviously your math is correct, that that would be what our guidance would say. In terms of visibility, look, it's really no different than what we have anytime in the past in this part of the year for our full-year guidance. Obviously, we are not forecasting that the whole year we just have the back-half of the year, there's no difference in visibility as it relates to what we've done in any other time of the year -- any other year at this time. And we do our same at analysis and outlook to provide you with our guidance of the 1% to 3%."
},
{
"speaker": "Bryan Keane",
"content": "Got it, got it. And then, Julie. Just thinking about the clients need to update their data in order to leverage AI and scale. Why isn't that translating into stronger demand in the business, you would think that everybody would turn-around and spend considerably on short-term to get that ramp-up in order to get AI to leverage it, but it doesn't quite translate. I'm just trying to figure out the disconnect there?"
},
{
"speaker": "Julie Sweet",
"content": "Yes, so there is two things. So first of all, it's about prioritization. Right? So their overall constrained on spending. So, you make choices as opposed to it being additive. So they are not able to allocate extra budget, they're prioritizing their budget. So you're seeing more of a substitution right now as opposed to, hey, we need to do this, let's add to the budget and that's tied to the uncertain macro, that's putting people constraint. I had one banker say, if the corporates have put themselves on a diet, given the macro. Right? The second thing, Bryan is, you have to remember that you can't just jump to the great data foundation. You need to be in the cloud. You've got to have modern platforms. And so what you should read into the higher clients -- the clients during these higher bookings rate is that, they're doing the big transformations oftentimes to be ready to put in the data foundation, right? There's only still 40% of workloads are in the cloud. 20% of those roughly haven't been modernized. Many of our clients haven't put in the platform, if you don't have the major ERP platforms that are modern, you don't create a data foundation to fuel GenAI in isolation. So you've got to build the digital core. And as we've said, there's a lot more to go. And that's what's driving these larger complex transformations like, people will not like to do these big transformations in a sense of the other big, they're hard, they're complicated and they need to do them in order to ultimately be able to use the AI, not just in a part of the business or as a proof-of-concept, but really to transform and get the value they now see and so it's -- again, you can't jump to AI, you've got to put all the pieces, and a lot of clients aren't there yet. Which is our opportunity."
},
{
"speaker": "Bryan Keane",
"content": "Got it. Thank you for taking the questions."
},
{
"speaker": "KC McClure",
"content": "Thanks, Bryan."
},
{
"speaker": "Julie Sweet",
"content": "Thanks, Bryan."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of James Faucette from Morgan Stanley. Please go-ahead."
},
{
"speaker": "James Faucette",
"content": "Great. Thank you very much. Wanted to follow-up on the questions around, particularly AI, etcetera. I recognize like everybody is kind of at different stages. How should we think about: first, the timeline in terms of preparing and getting ready to implement news solutions, etcetera, and then moving into the full implementation? And how we should think about that affecting Accenture’s business? And like you mentioned, you've talked about some record bookings or the number of new customers over $100 million, like how that will ramp-in the timeframe?"
},
{
"speaker": "Julie Sweet",
"content": "Yes, so maybe just -- let me just start with like the strategy around capturing the growth opportunity from GenAI. So, this is the same playbook that we have used in every wave of new technology evolution. When we went from mainframe to client-server then to cloud and Software as a Service and then to RPA and AI driven automation when you saw things like myWizard and SynOps. We have the same strategy, the strategy starts with, we want to be the first-mover to help our clients use the technology. And that's why what we're doing with our investments of $3 billion to create solutions for them and you see that coming through with our sales in Generative AI, which, as I've said on earlier, are the fastest we've ever seen in sort of these new technologies where there's a lot of interest and we're the leader. So we want to be the first-mover in helping our clients use it. The second part of our strategy is to be the first-mover in using the technology itself to serve our clients. And we did that would like the digital, with AI automation, with all of our platforms. And with that said, it's a proven formula, because if we invest big to be early and be the first-mover, then we're positioned to capture all the opportunity in our -- with our clients, because they need to adapt it and transform. And as I just went through, that requires a lot the digital core, then you've got to actually use it to change new ways of working to upskill your talent and build new capabilities like responsible AI. When we are able to be the first-mover, which we are already starting now to use GenAI and how we deliver, that enhances our competitive position. It makes us more differentiated and, of course, it also then allows our clients overtime the more we use the GenAI to achieve the results they need at a lower cost, which frees up their investment capacity to do the massive reinvention. And of course, we are in the best positioned to be their partner as they reinvest in using the tech and AI to [Technical Difficulty] lot of the digital core that's got to-be-built, you can't jump that step. It's not a magic technology. But then as you build it, you then have to go function by function to change the ways you work to actually get the productivity and the growth. So we really see this as being kind of the next decade of what our clients are going to be focused on and we are positioning ourselves to be their partner and be the first-mover in both places."
},
{
"speaker": "KC McClure",
"content": "Yes. And maybe I'll take the layering in question on the larger deals and talk a little bit about how that's going to work for the back-half of the year as it relates to guidance. So we have the larger deals that were terrific in our second quarter and our whole first-half of the year. But you're right, they do layer-in slower than the smaller deals and we see pressure in the volume of our smaller deals. And that's why we have the 1% to 3% guidance for the full-year. Now we do feel-good about delivering to this guidance and what that means for H2, and that really is for a few reasons that we've talked about before, but let me just kind of reiterate. The first is that, our competitive advantage is that we have the ability to invest. You saw us do that in H1 and Julie talked about that, with investing more in acquisitions this year, in the first half than we did all of last year. And that's really important because that drives inorganic growth. But again, we do that really to fuel organic growth, but we see that coming online in the back half of the year. The second thing is that, we have done these larger transformation deals, but also the ones from the previous years. And we see that continuing to benefit us as it relates to revenue as they will layer on in the back half of the year. And that really just speaks to the resilience of our strategy, both in terms of being what Julie has talked about, being where our clients need us and our inorganic strategy to continue to benefit to pivot to scale in new areas of growth. And so, that's how that all comes together in terms of revenue conversion from those larger deals and when they come online, James. And maybe I'll just also add, what that means from a type of work for the entire year. What we now see from the context of the 1% to 3% is, our consulting type of work will be about flattish. And we see our managed services growing to about mid-single digit growth for the year."
},
{
"speaker": "James Faucette",
"content": "Great. Thanks for the color to both of you. And then quickly KC, just in terms of that investment. How do we think about like how that affects the margin expansion. I mean typically one, you're doing acquisitions, there a little bit of time before you can start to get people to the same type of trajectory as Accenture on margin expansion, but just trying to get a sense of how we should think about that impacting as well?"
},
{
"speaker": "KC McClure",
"content": "Yes. Thanks for that. Well, first of all, I'm just -- I just want to put out that I'm really pleased with our profitability in the first half of the year and the outlook for profitability for the full year. Our margin is flat, but we have EPS growth for the first half of the year, profit growth of 5%. And that really just points to the rigor and discipline that we continue to operate our business in. But really importantly, as Julie talked about, all the investments we're making in our business and our people continue. So as you look at the back-half of the year, we now see the 10 basis points expansion is where we see it. Again, very important, continue to have high levels of investment in our people and our business. And EPS, we see for the whole year at about 3% to 5%. One thing I will point out just to help all of you. We did benefit from the first-half of the year in our EPS with higher non-operating income, which makes lot of sense on interest income, on our higher cash balance. In the first-half, you see our cash went from 9% to 5%. So great cash, we can -- no concerns will continue with our capital allocation strategy, but just as you model in the back half of the year, you'll see that not surprisingly with lower cash flow will have lower interest income. So just as you're working through your EPS for the first-half and second-half, that's something that you might want to consider."
},
{
"speaker": "James Faucette",
"content": "Super helpful. Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Bryan Bergin from TD Cowen. Please go ahead."
},
{
"speaker": "Bryan Bergin",
"content": "Hi, good morning. Thank you. So Julie, I'm curious just based on your conversations with leaders, what might be the catalyst here to have clients release spending programs and kind of lean back into shorter cycle work. As economic data generally holds up, are we just in a slower for longer backdrop or just kind of hoping that you can share some color on how you're thinking about a recovery internally and what enterprises really are watching and waiting for?"
},
{
"speaker": "Julie Sweet",
"content": "Look, I think there's going to be a couple dynamics, right? Remember they just set budgets. So we're kind of assuming there are the budgets for their calendar year and we see in general, most of this constraint is tied to the uncertain macro. So those are the kind of things. They set budgets and they've got uncertain macro."
},
{
"speaker": "KC McClure",
"content": "Yes. And just a reminder that everything that we're talking about in terms of giving guidance. I know all of you know this, but just as a reminder, our fiscal year-ends on August. Right? So there -- it's a little bit over halfway through the calendar year."
},
{
"speaker": "Bryan Bergin",
"content": "Okay, okay, that makes sense. And then as it relates to GenAI, just kind of a revolutionary versus evolutionary kind of questioning here. Just given how much work needs to be done for most clients to really do anything with large language models, how do we interpret that as a driver of your growth? So meaning, does GenAI enabled you to potentially drive a higher-level of growth when spending does become more normal or should we think about this more as a next tech wave that enable comparable levels of normalized growth just because of how long this might all take for large enterprises to get there?"
},
{
"speaker": "Julie Sweet",
"content": "Yes, what I'd say is, this is this is more about -- like we think of this as like prior technology waves. Right? Each one has been a little bit faster in terms of that, but especially when you look at kind of where our clients are on the continuum of building out that digital core, there is a lot to go and you really need that to fully realize it. So we see this is more like our prior kind of the way these things have evolved in the past. Right now, that's what we see."
},
{
"speaker": "Bryan Bergin",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Dave Koning from Baird. Please go-ahead."
},
{
"speaker": "Dave Koning",
"content": "Yes. Hey guys. Thanks so much. I guess my question, are you seeing your clients probably having much lower attrition, just like every company has low employee attrition, right now. Are you seeing them take their own employees, their own IT employees and just do more internally right now? And is that a little bit of just the demand issue right now?"
},
{
"speaker": "Julie Sweet",
"content": "We certainly are seeing -- obviously, our clients have invested in more technology internally at our advice. Right? We've said to them during the pandemic with technology being so important, they should be building up their technologies. So there is clients, they've got a lot of clients, not all of it, because it really depends on your positioning to some of our clients, that's really not the differentiator. So they want a smaller IT and they've got others who built it up and it really depends on where they are. But sure, I mean, we certainly got clients doing more -- doing more in-house as part of it and we've got other clients outsourcing more. So like, it's really all over the map, because it's very company specific as to what makes sense for their strategy."
},
{
"speaker": "Dave Koning",
"content": "Yes. Okay, thanks. And just one quick follow-up for KC. The tax rate, clearly you lowered guidance just on the tax-rate itself. Is that something one-off to this year or is that something now that just seems more normalized?"
},
{
"speaker": "KC McClure",
"content": "Yes. So, there's really four things that every year are the same, that really influence our tax rate. And just really is how those things come together. There are geographic mix of income, any settlements from previous years, any increase that we need to do on prior year tax liabilities, and lastly, the impact of our equity on our tax rate. So these four things really are confluences the same every year, depending on how they fall. That's going to influence where we land on our tax rate. And so, we -- this year we saw them favorably in aggregate. So we're able to keep our 2 point range, but drop by 1%."
},
{
"speaker": "Dave Koning",
"content": "Okay. Well, thank you guys."
},
{
"speaker": "Julie Sweet",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Jamie Friedman from Susquehanna. Please go-ahead."
},
{
"speaker": "Jamie Friedman",
"content": "Hi. Good morning, everyone. I have a really big picture question. I'm curious, Julie, how you feel about Accenture’s role in the broader context of technology like software and cloud? And I realize in your prior very thoughtful answer about technology architectures. That was a great structure as was your innovation session back on February 16th. But it does seem like other parts of tech are doing better than services. So I'm just interested in your perspective on services in the context of broader tech spending?"
},
{
"speaker": "Julie Sweet",
"content": "No, absolutely. It's a great question. Services are where you can dial back more easily than when you're signing-up for licenses for technology that you need. So you'd imagine and just what we're seeing that, when you are constraining overall spending, your discretionary spending, you go to like service providers where you're saying, I can pause for that. I can wait for that. And at the same time you've got in other parts of it, like with software where you've got to fix things you really need to invest in and you've got different licenses. So it's really not different than other cycles. Services have a bigger opportunity to say, it's a little more discretionary, let's wait. Even if I bought the licenses, I'm going to wait to actually incur the costs, because a lot of times the cost of the services can be significantly higher than the software licenses, because you've got all the change that you've got to do and all that around. So again, we don't see anything sort of different than when you've got an uncertain macro you look around for your discretionary spending and you cut that. And that's why, of course, you're seeing still the big transformations happening because it's not discretionary and they really got to re-platform in that. So it's like nothing mysterious about is kind of what I consider kind of normal in this kind of a macro."
},
{
"speaker": "KC McClure",
"content": "That's right. An. I think just as a reminder, even with all that we still have the record spend with us with $40 billion of bookings for the first half of the year."
},
{
"speaker": "Jamie Friedman",
"content": "Yes, those are great things. All right, I'll jump back. I'll jump back in the queue. Thank you, Julie. Thanks KC."
},
{
"speaker": "Katie O'Conor",
"content": "Operator we have time for one more question and then Julie will wrap-up the call."
},
{
"speaker": "Operator",
"content": "Okay. That question comes from the line of Ashwin Shirvaikar from Citi. Please go ahead."
},
{
"speaker": "Ashwin Shirvaikar",
"content": "Thank you. Hi, Julie. Hi, KC."
},
{
"speaker": "Julie Sweet",
"content": "Hi, Ashwin."
},
{
"speaker": "Ashwin Shirvaikar",
"content": "Going back to -- Hey. Going back to the question of bookings, are clients actually visiting existing bookings ones that they sign maybe last year and at times prior, relooking at them using the lens of applying sort of rapidly evolving GenAI capabilities. To what extent is that happening and then that kind of implies, obviously -- can we can reuse those past bookings and backlog as an indicator of future growth and how soon that can layer-in?"
},
{
"speaker": "Julie Sweet",
"content": "Yes. I'll take that. Just maybe more just the financial kind of mechanical part of it. We have not seen a change in us working the work that's already been contracted, what we would call our backlog and what we talked about was really spending on new sales, new services and their smaller projects and that's the dynamic that we have factored into our guidance for the year."
},
{
"speaker": "Ashwin Shirvaikar",
"content": "Got it. And then the other question was on LearnVantage and Udacity, I thought that was a particularly interesting deal. If you could walk us through maybe the mechanics of that deal? And every company is investing in talent care, there seems to be a bit different approach maybe. Can you just talk about the rationale, the downstream impact and so on?"
},
{
"speaker": "Julie Sweet",
"content": "Sure, thank you. Because it's -- I'm super passionate about what we're doing with LearnVantage, because it is so critical for our clients. Talent is the number one agenda item for CEOs. The number one. And when you think about what reinvention means, the clients have to do and AI rotation and they have to do a talent rotation. And what LearnVantage does is, it first and foremost provides the ability for everything from the Board to the C-Suite to business users, to the technologists to get the technology training they need to make the right decisions on AI, for example. To be able to become deeper in the new technologies. And so it really goes from the Board to the technologist. And with Udacity what we're able to provide is essentially the same approach Accenture uses, right? So, we spent over $1 billion ourselves. You saw our latest average 14 hours per employee. And we have -- we use learning science to learn and do. Most of our clients are unable to do that. The big differentiator for us in the market here is that, we Accenture know when you train someone we have to then put them on a job, and they have to get paid to do something, so they are work ready. So we're bringing that expertise now at scale to our clients. And what Udacity does is the same thing, they use exports mentors, they have a real project work that they then coach people on. So it's that same sort of approach of learn and do, but our companies -- our clients don't have all the work that we do, so Udacity has created this ability. And so -- and it's coupled then with Accenture's deep understanding of what it takes to train and be work ready. So we're really excited about it. Our clients are excited about it, they've been coming to us. We've been doing this learning and this enables us now to do it at scale. And again, we want to be the reinvention partner. So the more that we can fill all of the needs of our clients around that, the better position that we will be. So we see LearnVantage is highly, highly strategic. And by the way, it also has, we have a managed service today to actually manage the learning services that companies are now doing internally, which we also expect to -- we're investing and expect to grow. So, very excited. And then finally, [indiscernible] responsibility is our -- as corporates to bring our people along the journey. And so when people worry about things like AI in displacement, we feel that our ability to bring like who then upskilling expertise to help our clients be able to bring their people is really, really important. It's important for our communities. It's important to their Board’s and we also consider it really important because it's the right thing to do."
},
{
"speaker": "Ashwin Shirvaikar",
"content": "Got it."
},
{
"speaker": "Julie Sweet",
"content": "Great. So thanks, everyone. In closing. I want to thank all of our shareholders for your continued trust and support all of our people for what you do every day. To assure you that we are working every day to continue to earn that trust. Thank you."
},
{
"speaker": "Operator",
"content": "That does conclude your conference for today. Thank you for your participation and for using AT&T Teleconference. You may now disconnect."
}
] |
acn | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Thank you all for standing by. Welcome to Accenture's First Quarter Fiscal 2024 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Katie O'Conor, Managing Director, Head of Investor Relations. Please go ahead."
},
{
"speaker": "Katie O'Conor",
"content": "Thank you, operator, and thanks everyone for joining us today on our first quarter fiscal 2024 earnings announcement. As the operator just mentioned, I'm Katie O'Conor, Managing Director, Head of Investor Relations. On today's call, you will hear from Julie Sweet, Chair and Chief Executive Officer; and KC McClure, our Chief Financial Officer. We hope you've had an opportunity to review the news release we issued a short time ago. Let me quickly outline the agenda for today's call. Julie will begin with an overview of our results; KC will take you through the financial details, including the income statement and balance sheet, along with some key operational metrics for the first quarter; Julie will then provide a brief update on our market positioning before KC provides our business outlook for the second quarter and full fiscal year 2024; we will then take your questions before Julie provides a wrap up at the end of the call. Some of the matters we'll discuss on this call, including our business outlook, are forward-looking, and as such, are subject to known and unknown risks and uncertainties, including, but not limited to, those factors set forth in today's news release and discussed in our annual report on Form 10-K and quarterly reports on Form 10-Q and other SEC filings. These risks and uncertainties could cause actual results to differ materially from those expressed in this call. During our call today, we will reference certain non-GAAP financial measures, which we believe provide useful information for investors. We include reconciliations of non-GAAP financial measures, where appropriate, to GAAP in our news release or in the Investor Relations section of our website at accenture.com. As always, Accenture assumes no obligation to update the information presented on this conference call. Now, let me turn the call over to Julie."
},
{
"speaker": "Julie Sweet",
"content": "Thank you, Katie and everyone joining, and thanks to our 743,000 people around the world for their incredible dedication and commitment every day, which is how we are able to consistently deliver 360 degree value for all our stakeholders. I am pleased that we delivered on our commitments this quarter, while continuing to invest significantly in strategic areas to drive the next waves of growth, including extending our early leadership in generative AI, and we did so against a macro backdrop that continues to be challenging. Starting with our financial results. Our bookings were $18.4 billion, representing 12% growth in local currency. We had 30 clients with quarterly bookings greater than $100 million in the quarter and over half were in North America, representing the trust our clients have in us to be at the center of their major programs, spending and ongoing reinvention. We delivered revenues of $16.2 billion for the quarter, at the top-end of our FX adjusted range, representing growth -- 1% growth in local currency. We continue to take market share. As expected, we continue to see lower discretionary spend, which particularly impacts our consulting type of work as well as slower decision making and our CMT industry group continues to be challenged. We remain on track with the business optimization actions we announced in March to reduce structural costs to create greater resilience. And finally, we expanded adjusted operating margin by 20 basis points and delivered adjusted EPS growth of 6%, while continuing to invest in our business and our people. Turning now to our investments. We closed 12 acquisitions this quarter for a total of $788 million in strategic areas across our geographic markets. In North America, we are continuing to build out our new growth area of capital projects, an $88 billion addressable market in North America, which we entered in August with the acquisition of Anser Advisory. In Q1, we added Comtech, a consulting and program management company for infrastructure projects in Canada. We also invested in the next digital frontier with our supply chain acquisition of The Shelby Group. We expanded our cloud capabilities with the acquisitions of Ocelot Consulting and Incapsulate. And we invested in digital marketing in the healthcare industry with the acquisition of ConcentricLife. In EMEA, we expanded our cybersecurity capabilities with the acquisition of Innotec in Spain, enhanced our business process services in the insurance industry with the acquisition of ON Service GROUP in Germany, and invested in digital healthcare and talent with the acquisitions of Nautilus Consulting and The Storytellers in the UK. Finally, in Growth Markets, we are focused on the cloud opportunity with the acquisition of Solnet in New Zealand, along with cybersecurity with the acquisition of MNEMO in Mexico, and on digital marketing services with the Song acquisition of SIGNAL in Japan. Our ability to invest at scale to fuel our organic growth is a competitive advantage. For example, in EMEA, we are focusing on pivoting our CMT business. We are investing with Vodafone to create a strategic partnership to commercialize its market-leading shared services operations and unlock new sources of growth and efficiency, enhance speed to market and new customer opportunities for their operating companies and partner markets. Together, we plan to create a new data and AI-driven shared services model and a scaled, commercially-driven and more efficient organization with higher-quality services and enhanced speed to market for its portfolio of offerings. The new unit will utilize Accenture's world-class technology, transformation and managed services such as its digital solutions and platforms and deep AI expertise. It will also tap into our well-known learning capabilities to continuously create new skilling and career paths for our -- for its people. This move speaks to Vodafone's ambition to work in new ways, reduce structural complexity, reinvent their company and the industry. And of course, we continue to invest in learning for our people with approximately 8 million training hours in the quarter, representing an average of 12 hours per person. Turning to generative AI, our growth and investments. We continue to take an early leadership position in GenAI, which will be an important part of the reinvention of our clients in the next decade. Last quarter, we shared that we had sold approximately 300 projects with $300 million in sales in all of FY '23. Demand continued to accelerate in Q1 with over $450 million in GenAI sales. As you know, we are investing $3 billion in AI over three years. For many of our clients, 2023 was a year of generative AI experimentation. We are now focusing on helping our clients in 2024 realize value at scale. We are excited about the recent launch of our specialized services to help companies customize and manage foundation models. We're seeing that the true value of generative AI is to deliver on personalization and business relevance. This is driven by context and accuracy, data readiness along with foundation model choices and customization are some of the most important steps and decisions that companies will make in the next year as they pursue value. Our clients are going to use an array of models to achieve their business objectives. Our proprietary switchboard allows a user to select the combination of models to address business context or factors like cost or accuracy. And we will offer rigorous training and certification programs to organizations using these new services to customize and scale GenAI solutions and transform every link in their value chain. We are also investing in AI acquisitions. For example, we recently announced our intent to acquire Ammagamma, an Italy-based firm that helps companies advance their uses of AI and generative AI technologies. With this acquisition, we will add 90 experienced AI professionals, many specializing in generative AI along with the expertise that includes engineering, mathematics, economics, historians, philosophers and designers, who will join our growing network of professionals in our advanced center for AI. And we are progressing towards our goal of doubling our deeply skilled data and AI practitioners from 40,000 to 80,000, with an additional 5,000 practitioners as of Q1. Finally, a few additional highlights of the 360 degree value that we created this quarter. We recently achieved our highest brand value and rank to date on Interbrand's prestigious Best Global Brands list, increasing to $21.3 billion and ranking number 30. We jumped from number 17 to number 10 on the 2023 World's Best Workplaces list by Fortune and Great Place to Work. This recognition is particularly noteworthy, because it is based on feedback from our people. We were recognized for the seventh year in a row on the Wall Street Journal list of Best-Managed Companies for excellence in customer satisfaction, employee engagement and development, innovation, social responsibility, and financial strength. And we also received the top score for social responsibility and are among the top 10 for customer satisfaction. We continue to lead in our ability to attract people with different backgrounds, different perspectives, and different lived experiences. Our success is reflected in the top score on the Human Rights Campaign Corporate Equality Index in the U.S. for the 16th consecutive year for leading equitable workplace policies, practices and benefits for LGBTQ+ people. And today, we are proud to present an update to our 360-degree value reporting experience, which is available on our website, because we believe that transparency builds trust and helps us all make more progress. Over to you, KC."
},
{
"speaker": "KC McClure",
"content": "Thank you, Julie. Happy holidays to all of you, and thanks for taking the time to join us on today's call. We are pleased with our Q1 results, which were in-line with our expectations and include continued investments at scale to strengthen our position as a leader in the market. Once again, our results illustrate our ability to manage our business with rigor and discipline and deliver value for our shareholders. So, let me begin by summarizing a few of the highlights for the quarter. Revenues grew 1% local currency with mid-single digit growth or higher in five of our 13 industries, including public service, industrial, utilities, health and energy. As expected, we saw continued pressure in our CMT industry group. And we continue to take market share. As a reminder, we assess market growth against our investable basket, which is roughly two dozen of our closest global public competitors, which represents about a third of our addressable market. We use a consistent methodology to compare our financial results to theirs, adjusted to exclude the impact of any significant acquisitions through the date of their last publicly available results on a rolling four-quarter basis. We delivered adjusted EPS in the quarter of $3.27, reflecting 6% growth over EPS last year. Adjusted operating margin was 16.7% for the quarter, an increase of 20 basis points over Q1 last year and includes significant investments in our people and our business. Finally, we delivered free cash flow of $430 million and returned $2 billion to shareholders through repurchases and dividends. We also invested $788 million in acquisitions across 12 transactions in the quarter. With those high-level comments, let me turn to some of the details, starting with new bookings. New bookings were $18.4 billion for the quarter, representing 14% growth in U.S. dollars and 12% growth in local currency, with a book-to-bill of 1.1. Consulting bookings were $8.6 billion, with a book-to-bill of 1.0. Managed services bookings were $9.8 billion, with a book-to-bill of 1.3. Turning now to revenues. Revenues for the quarter were $16.2 billion, a 3% increase in U.S. dollars and 1% local currency, and we're at the top-end of our guided range adjusted for a foreign exchange tailwind of approximately 1.5% compared to the 2.5% estimate provided last quarter. Consulting revenues for the quarter were $8.5 billion, flat in U.S. dollars and a decline of 2% in local currency. Managed services revenues were $7.8 billion, up 6% in U.S. dollars and 5% in local currency. Taking a closer look at our service dimensions: technology services grew mid-single digits, operations was flat, and strategy and consulting declined mid-single digits. Turning to our geographic markets. In North America, revenue declined 1% in local currency. Growth was led by public service, offset by declines in communications and media, software and platforms, and banking and capital markets. Before I continue, I want to highlight that for this fiscal year '24, we have reorganized our geographic segments. Europe is now EMEA and includes the Middle East and Africa, which were previously included in Growth Markets. The reclassification for prior years can be found in our Investor Relations website. In EMEA, revenues grew 2% in local currency, led by growth in public service and banking and capital markets, partially offset by a decline in communications and media. Revenue growth was driven by Italy, Austria, and France, partially offset by a decline in the United Kingdom. In Growth Markets, we delivered 5% revenue growth in local currency, driven by growth in chemicals and natural resources, public service, and banking and capital markets. Revenue growth was led by Japan. Moving down the income statement. Gross margin for the quarter was 33.6% compared to 32.9% for the first quarter of last year. Sales and marketing expense for the quarter was 10.5% compared with 9.8% for the first quarter of last year. General and administrative expense was 6.4% compared to 6.6% for the same quarter last year. Before I continue, I want to note that in Q1, we recorded $140 million in costs associated with our business optimization actions, which decreased operating margin by 90 basis points and EPS by $0.17. The following comparisons exclude these impacts and reflect adjusted results. Adjusted operating income was $2.7 billion in the first quarter, reflecting a 16.7% operating margin, an increase of 20 basis points from operating margin in Q1 last year. Our adjusted effective tax rate for the quarter was 23.2% compared with an effective tax rate of 23.3% for the first quarter last year. Adjusted diluted earnings per share were $3.27 compared with diluted EPS of $3.08 in the first quarter last year. Days services outstanding were 49 days compared to 42 days last quarter and 48 days in the first quarter of last year. Free cash flow for the quarter was $430 million, resulting from cash generated by operating activities of $499 million, net of property and equipment additions of $69 million. Our cash balance at November 30th was $7.1 billion compared with $9 billion at August 31st. With regards to our ongoing objective to return cash to shareholders, in the first quarter, we repurchased or redeemed 3.8 million shares for $1.2 billion at an average price of $311.90 per share. At November 30th, we had approximately $5.4 billion of share repurchase authority remaining. Also in November, we paid a quarterly cash dividend of $1.29 per share for a total of $810 million. This represents a 15% increase over last year. And our Board of Directors declared a quarterly cash dividend of $1.29 per share to be paid on February 15th, a 15% increase over last year. So, in closing, we remain committed to delivering on our long-standing financial objectives, growing faster than market and taking share, generating modest margin expansion and stronger earnings, while at the same time investing at scale for our long-term market leadership, generating strong free cash flow and returning a significant portion of that cash to shareholders. And now, let me turn it back to Julie."
},
{
"speaker": "Julie Sweet",
"content": "Thank you, KC. As we begin our second quarter, we remain laser-focused on creating value for our clients. The pace of spending continues to be impacted by the macro environment. Our business in the UK in particular, in Q1, saw even greater challenges than we expected last quarter. The fundamentals of our industry remain unchanged. All strategies continue to lead to technology and companies need to reinvent every part of their enterprise using tech, data and AI to optimize operations and accelerate growth. To do so, they must build a digital core. Strategy and consulting, which brings our deep industry and functional expertise is critical to how we differentiate by helping our clients ensure they drive business value from their digital core. We are continuing to see significant demand in areas like cloud migration and modernization, modern ERP and data and AI, including GenAI, platforms and security, all of which represent areas of great opportunity and is still early with more digital core to be built in the future than has been done to date. Let me bring to life the significant opportunities still ahead with examples from the quarter. Our cloud momentum continued in Q1 with strong double-digit growth, reflecting the ongoing significant market opportunity. We estimate only 40% of enterprise workloads are in the cloud, of which only 20% or so are modernized, an 80% opportunity remaining. Clients are continuing to prioritize the digital core as evidenced by strong demand for cloud migration. We're working with a leading insurance provider to continue their cloud transformation. Together, we are migrating hundreds of applications to a cloud-based platform, enabling the company to exit their data centers by 2025. To date, we have migrated more than half of their apps to the cloud. And this is not just a migration. We are modernizing applications and accelerating automation to integrate disparate data more easily from acquisitions and help the company move into new markets. And we are helping reshape their organizational mindset, drive cultural change and find new ways of working, including the creation of a new IT service model to lead complex transformations with agility and speed. This transformation will reduce legacy complexity and technical debt, enable more cost effective back-office operations, and drive growth and innovation, ultimately helping the company provide more affordable and personalized insurance solutions for families and businesses. And for those clients who have made significant progress on their migration, they are investing to modernize and innovate across the cloud continuum, extending cloud to the edge, unlocking greater value with more opportunities still ahead. For example, we recently announced an expansion of our strategic partnership with McDonald's to help it execute their technology strategy and leverage the company's scale to unlock greater speed and efficiency for customers, restaurant teams and employees. This new work supports McDonald's ambition to connect restaurants worldwide with cloud technology and apply generative AI solutions across McDonald's platforms. Accenture also will support the acceleration of automation innovation and the enhancement of the digital capabilities of McDonald's employees. Accenture's deep understanding of the McDonald's business, industry and technology will help unlock opportunities in their ongoing digital investments as McDonald's reinvents the customer experience and stays ahead of their customers' changing needs. Turning to data and AI. We estimate that less than 10% of companies have mature data and AI capabilities. This is a critical part of building the digital core and we see this embedded in our larger transformations, in work focused on data and AI modernization and in the opportunities of generative AI. We help leaders such as BBVA, a global financial services group, to stay ahead of the curve by continuing to reinvent its business model with GenAI. For example, we are building a GenAI-powered financial coach assistant to help them disrupt customer centricity in the banking industry while they reinvent their digital core to also become even more efficient. This work is a continuation of our ongoing GenAI implementation which is transforming BBVA's operations and digital marketing and is helping employees be more productive. Thanks to its strong digital core, BBVA can continue to reinvent across their enterprise by applying GenAI. We're also helping a global hospitality group to support its content production capability and marketing communications across its hotel brands, tailoring content to guests' evolving needs. This new data-driven content supply chain model will create personalized, flexible and efficient marketing communications content across every customer touchpoint. Spanning both physical and digital communications, this service will be available to all marketing professionals enabling content production management from its initial brief to performance measurement and content optimization. This will increase the effectiveness of its digital marketing programs, drive more traffic to its branded website, and deliver exceptional customer experiences, all while reducing costs. Platforms are a core component of the digital core and are critical to our clients' transformations. We estimate 60% of the opportunity is still ahead as clients upgrade their core platforms. We are working with OCBC Group, a Singapore-based multinational banking and financial services corporation, on a two-year transformation journey to modernize their human resources organization. We will shift key HR functions such as hiring, talent management, and career development to the cloud and create a next-generation HR operating model with enhanced capabilities. Together, we will drive operational efficiency with a strategic focus on future talent readiness, employee experience, and AI-driven decision-making. And by providing a scalable framework to meet evolving business needs, we'll free up HR capacity to provide high-value advisory work and empower business and HR leaders with analytics and insights to facilitate better talent decisions. Security is also essential to a digital core, and we continue to see very strong double-digit growth in our security business this quarter. While the opportunity to continue to grow and expand, we estimate that currently only 36% of business leaders are confident that their organizations are cyber resilient, representing at least 64% of untapped potential. An example of our important work with our clients to build secure organizations is Fortrea, a global contract research organization of about 19,000 people that provides clinical trial and research services for life sciences companies in more than 90 countries. We're working with Fortrea to deliver database outcomes and health-related insights, which require adherence to regional and local industry and government regulations. As they continue to grow and enter new markets, they need a partner to ensure that their cybersecurity program remains resilient and compliant with security best practices. We will co-create, architect, and operate a series of global cybersecurity services and capabilities through our managed services. Our partnership will help Fortrea grow its business, utilizing flexible risk and security strategies. We are focused on helping clients reimagine marketing and their customer experience to drive growth. Song demand continues to remain strong with double-digit growth in Q1. We are collaborating with Peugeot, a French automotive brand, to lead strategic and creative direction for its global communications. The partnership supports Peugeot's ambition to engage a younger audience and become a leader in the electric vehicle market. Accenture Song will manage global communications across all traditional and digital media channels. The first campaign will be a full 360 integrated launch of the all-new electric fastback SUV E-3008 in early 2024. Finally, we continue to see strong demand for digital manufacturing and engineering services. We estimate that only 5% of enterprises have scaled, matured digital capabilities across their organizations. Industry X grew strong double digits in Q1. We are working with a leading global -- a leading German multinational car manufacturer to engineer the next generation of infotainment system. Using our deep industry expertise and software engineering capabilities, we will support the implementation of a new flexible platform that enables the next level of in-car experience with cutting-edge customer features while minimizing complexity and maximizing the software we use across hardware generations. We're working with a global food manufacturer on a total enterprise reinvention strategy to modernize its supply chain, reduce operating costs, and position it for the future. We will transform key supply chain processes such as planning, procurement, manufacturing, and distribution. AI and intelligent automation will optimize end-to-end supply chain operations and achieve greater efficiency and agility. It will also help the company leverage data for better decision making and implement portfolio optimization to ensure the right assets are focused on for investment to maximize returns and minimize risks. This self-funded program is expected to generate significant productivity gains with ongoing savings fueling further capability builds and bottom-line growth. Back to you, KC."
},
{
"speaker": "KC McClure",
"content": "Thanks, Julie. Now, let me turn to our business outlook. For the second quarter of fiscal '24, we expect revenues to be in the range of $15.4 billion to $16 billion. This assumes the impact of FX will be about negative 0.5% compared to the second quarter of fiscal '23 and reflects an estimated negative 2% to positive 2% growth in local currency. For the full fiscal year '24, based upon how the rates have been trending over the last few weeks, we continue to assume the impact of FX on our results in U.S. dollars will be about flat compared to fiscal '23. For the full fiscal '24, we continue to expect our revenue to be in the range of 2% to 5% growth in local currency over fiscal '23, with the inorganic contribution now expected to be more than 2%. We continue to expect business optimization actions to impact fiscal '24 GAAP operating margin by 70 basis points and EPS by $0.56. The following guidance for full year '24 excludes these impacts. For adjusted operating margin, we continue to expect fiscal year '24 to be 15.5% to 15.7%, a 10 basis point to 30 basis point expansion over adjusted fiscal '23 results. We continue to expect our annual adjusted effective tax rate to be in the range of 23.5% to 25.5%. This compares to an adjusted effective tax rate of 23.9% in fiscal '23. We continue to expect our full year adjusted earnings per share for fiscal '24 to be in the range of $11.97 to $12.32 or 3% to 6% growth over adjusted fiscal '23 results. For the full fiscal '24, we continue to expect operating cash flow to be in the range of $9.3 billion to $9.9 billion, property and equipment additions to be approximately $600 million, and free cash flow to be in the range of $8.7 billion to $9.3 billion. Our free cash flow guidance reflects a free cash flow to net income ratio of 1.2. Finally, we continue to expect to return at least $7.7 billion through dividends and share repurchases as we remain committed to returning a substantial portion of our cash to our shareholders. With that, let's open it up so we can take your questions. Katie?"
},
{
"speaker": "Katie O'Conor",
"content": "Thanks, KC. I would ask that you each keep to one question and a follow-up to allow as many participants as possible to ask a question. Operator, would you provide instructions for those on the call?"
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Your first question comes from the line of Jason Kupferberg from Bank of America. Please go ahead."
},
{
"speaker": "Jason Kupferberg",
"content": "Good morning, guys. Happy holidays. I just wanted to start with a question on the revenue guidance for Q2. The midpoint there would suggest 1 point of deceleration, but we do have an easier comparison, and there was a return to positive growth in consulting bookings. So, just hoping you can help us reconcile that and then maybe comment on the second half reacceleration that is continuing to be implied in the guide, maybe slightly steeper than previously thought. Thank you."
},
{
"speaker": "KC McClure",
"content": "Yeah, great. Thanks, Jason. Happy holidays to you, too. So first, let me first start in terms of our guidance. I'll first start with Q1. And as you heard us say, we were really pleased with our Q1 performance. And as you stated, our Q2 guidance is the same as Q1. And maybe a couple of things that I'll point out compared to what we thought 90 days ago, and as Julie mentioned, we do see some differences in EMEA, particularly in the UK, where we're focused on repositioning the business back to growth, and that's going to take some time. But Jason, what is the same is that we are still operating in an environment, which is the same that we described last quarter, where the discretionary spend and the decision making is slow. And so right now, as you expect, and you know that we do this every year, we're talking to our clients right now about their '24 budgets. And so that's all, again, to be expected. When we look forward into H2, to start with just what the math is, we continue to see higher growth in the back half of the year. That's going to start with higher growth in Q3. And our confidence in our H2 increased growth is really based on a few things. Again, reiterating what we talked about at the beginning of the year versus our results in Q1, so we're confident, again, that we were able to deliver across the board as we expected in the first quarter. And also then, as Julie mentioned quite a bit, we made a lot of investments in our business in the quarter, and that's helping us pivot to higher growth areas. In addition to that, as we talked about last quarter, the same remains, we do have our revenue positioned in the back half of our year from these larger transformation deals. So that has not changed. We continue to see that. And then, we just need to continue to layer in our new sales as we get closer to the back half of the year. So, we're really very pleased to reiterate the 2% to 5% revenue guidance that we had at the beginning of the year."
},
{
"speaker": "Jason Kupferberg",
"content": "Okay. That's helpful. And just as a quick follow-up, what should we expect in terms of second quarter bookings for consulting and management -- managed services year-over-year? I know managed services has a particularly tough comp. Thanks again."
},
{
"speaker": "KC McClure",
"content": "Yeah. So, Jason, I know I've been giving color and basically kind of guiding to future quarter bookings, but as you know really well covering up for so long, bookings can really be lumpy. So, I'm not going to give that color anymore, go forward. What I would say is the best way to think about demand for our business is the revenue guide that we give. And we gave revenue guidance for the second quarter as well as our 2% to 5% for the full year. And obviously, we'll continue to do that. And I'll just put in that we do feel good about our pipeline. We have a very solid pipeline."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Tien-Tsin Huang from JPMorgan. Please go ahead."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Hey, perfect. Yeah, I just want to follow up to Jason's question just with the bookings, which is better than expected, and your large deal backlog is quite large now. Just the visibility on the timeliness of those conversions? Have you seen any signs of pushout or delays or that kind of thing? Just trying to understand the conversion potential."
},
{
"speaker": "KC McClure",
"content": "Yeah. So maybe just a couple of things on that. So I think, conversion can be really mainly impacted by the mix, right? So, the mix of deals that we have. So, let's just start with, overall, we haven't seen any change in the conversion based on the mix of work. So, strategy and consulting which converts faster than with operations. There's been no change within those different parts of our business, no change in the conversion. What we have talked about, and we've been consistent, that there's really been -- there's no change over the last 90 days in our discretionary spend environment, and that is consistent with our expectations. So -- and we haven't been reliant, and we're not reliant on a change in that macro to get to our full-year guidance. So, what does that mean? Hopefully you guys can hear me. The lower -- a little trouble in the line. Okay. Is that there -- as we have lower discretionary spend, that does impact the conversion, Tien-Tsin, as you know, but we have factored that all into our guidance."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Understood, KC. Thanks for that. And just my quick follow-up. I know you've been really busy with acquisitions, and Julie, you listed a bunch of them. Is there a change here in the rhythm of acquisitions or your appetite? It sounds like the revenue contribution is up a nudge, but -- up a little bit. But you tell me. I didn't know if there was a change in your thinking here on the deal. Thanks."
},
{
"speaker": "KC McClure",
"content": "Yeah. I'm going to maybe give a little bit of color and then I'll certainly hand it over to Julie. Just more from a financial perspective, I think -- and as you know this really well, but our competitive advantage really is our investment capacity that allows us to pivot to higher areas of growth. And we can do that and invest through every cycle, and you've seen us do that. And I really think that is clearly a differentiator for us. You see that with our strong start this quarter. Julie talked about the 12 acquisitions, $800 million of spend, and we have five more that we've announced for Q2. All of that, and we're reconfirming op margin expansion of 10 basis points to 30 basis points. I think it's important to see that in terms of our strategy, we're continuing to do this to really fuel organic growth. And lastly, I think one of the parts that really distinguishes us is our capital allocation framework, which is durable yet flexible. So, we're able to flex up and do inorganic to the degree that we see that we'd like to, while at the same time, continuing to increase our return to our shareholders. So, I think it's really, really great."
},
{
"speaker": "Julie Sweet",
"content": "Great. Yeah. And there's no change in the strategies in the sense of we're still trying to -- we're still investing to either scale in hot areas or add new types of skills. So, you see that we're executing in capital projects like we described, right? In August, we did the -- yeah, in August, we did the Anser Advisory. We just added Canada. And then, of course, adding the niche skills in consulting and whether it's industry or functional. So, no change in strategy. But I would reiterate that it is really a huge competitive advantage for us that we can invest across the cycles. You saw that we did that in the first year after the pandemic, where we significantly increased, and again, always to drive organic growth and position ourselves for those next waves. So, you're going to see the AI acquisitions. You saw health in the UK, another great area of growth, capital projects. So, think about our strengths here is how we accelerate pivoting to growth."
},
{
"speaker": "KC McClure",
"content": "And then, I'll just add, Tien-Tsin, that you heard me mention in guidance, that we are going to do now more than 2% in organic contribution for this year."
},
{
"speaker": "Julie Sweet",
"content": "Yeah."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Yeah. No, I'm sure you'll amplify the growth of what you buy. Just wanted to check on that. That's helpful. Thank you."
},
{
"speaker": "Julie Sweet",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Ashwin Shirvaikar from Citi. Please go ahead."
},
{
"speaker": "Ashwin Shirvaikar",
"content": "Thanks, and congratulations on the performance. Happy holidays from me. I wanted to ask about, as you have conversations with your clients with regards to budget and spending priorities into next year, if you can comment, first of all, on that? And then, it's only a couple of quarters since sort of the GenAI kind of took hold, but it's a fast-moving technology, and I want to kind of inquire into whether the nature of those discussions has changed or become more meaningful, gone past proofs of concept and so on."
},
{
"speaker": "Julie Sweet",
"content": "Great. And happy holidays to you, too. Great question. So first, with respect to -- on your first point around what's happening in the market on client budgets is what I would say is that we're having lots of discussions that are pretty similar to what we've been talking about, which is, how do you prioritize in a more cautionary environment? So, we'll really know how that will play out in January as always because this is when we -- they finalize. But what I'd say is it's a consistent thing I've been talking about, which is in a cautionary environment, in a tough macro, we're helping clients prioritize. And they're in the things that we talked about in the script again today, things like building the digital core. It's using the technology to drive both growth and cost. And I would just say on the macro side, right, is that, our clients, we recognize you cannot cut yourself to growth. And if you think about the examples that I used in today's script, most of them were both cost and growth, right? Because that is what our clients are focused on, is how are they going to grow revenue despite whatever the environment is. And that, of course, is our unique capabilities to be able to do both. And then, with respect to GenAI, so first of all, I just want to say $450 million in sales this quarter, we're very pleased with. I mean, it demonstrates we are leading here. All of last year, it was $300 million. And to your point, the conversations are changing. You have examples like BBVA, which we talked about earlier in my script, where we're starting to use it at scale. Our clients want to get out of proofs of concept to material value, and we're super well positioned. Why? GenAI is not plug and play. It is not just technology. In fact, it's closer to any other technology. Think about cloud, that's farther away from the heart of the business. In order to scale, you have to deeply understand the technology, which is still rapidly changing, and the business value. And this is Accenture's leadership position, right? We have strategy. We have consulting, deep industry and functional expertise. We're the biggest partner with every major player. We're working with them at a product level and we can bring those two things together. So, think of 2024 as being the shift for our clients from experimentation to scale, and we believe we're at the best position to lead that shift to value."
},
{
"speaker": "Ashwin Shirvaikar",
"content": "Understood. I want to ask also about operations performance. It did decelerate meaningfully. I think it was high-single-digit growth, and now it's flat. Is that also a reflection you mentioned just now, maybe a pivot from cost savings to revenue generation maybe is beginning? Is that what's happening or are there other factors in here?"
},
{
"speaker": "KC McClure",
"content": "Yeah. Maybe just in terms of the quarter performance, operations came in as expected. As we talked about at the beginning of the year, Ashwin, we do have some impacts in CMT that impact operations, and so we'll see that growth may fluctuate as we go throughout the year. As part, though, of our overall guidance for the full year of managed services continuing to be mid-single to high-single-digit growth for the year."
},
{
"speaker": "Julie Sweet",
"content": "Yeah. And in fact, I would say, it's the opposite. Operations, which was impacted, by the way, by CMT, for example, look, it's going to build similar to the way Accenture is going to build over the course of the year. Actually, the sweet spot of operations is that it does both cost and growth. So, the BBVA example includes operations, Fortrea includes operations. So, these are -- our managed services are highly strategic because they are typically able to do both. Think about IT transformation. Our managed services are as much about modernizing. So, in IT, modernized tech is what drives growth. So, we really see our strength being that our managed services are strategic. And one of the reasons is that we do them in the context of understanding the industry and the function. So, we're not back office. We're bringing that strategy and consulting expertise to make sure that it isn't just a cost play. And that's an important differentiator for us."
},
{
"speaker": "Ashwin Shirvaikar",
"content": "Got it. Thank you both."
},
{
"speaker": "Julie Sweet",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Bryan Bergin from TD Cowen. Please go ahead."
},
{
"speaker": "Bryan Bergin",
"content": "Hi, guys. Good morning. Happy holidays. I wanted to start on your some of the expectations around shorter cycle and discretionary work within S&C and SI. Do you have a sense of stabilization forming there or cuts still occurring in those areas? And maybe can you give us a sense on how you expect consulting to do in the second quarter?"
},
{
"speaker": "Julie Sweet",
"content": "Yeah. So, look, we're -- as KC said earlier, we're operating kind of the same environment we have for the last few quarters, right? Discretionary spend is down. And we're right in the middle of the budget cycle, so next quarter, we'll have a much better view of what's there. But if you sort of look around in the environment, there aren't a lot of green shoots on the economic side. And obviously, the volatility on the geopolitical side continues. And so, as KC said, we're not planning right now for kind of a change in the macro, which means that we're not planning for a change in discretionary spending. We just don't see that being meaningfully different as we go into 2024. And obviously, we'll update you. But that's why when you think about the question earlier on revenue conversion, our level of smaller deals is just down. It's going to stay down for a while, which means that how revenues going to -- how sales are going to bleed into revenue is going to be consistent with what we've been seeing. So -- and then, you want to comment?"
},
{
"speaker": "KC McClure",
"content": "Yeah. Just in terms of, Bryan, on the overall growth, there's no change from what we said at the beginning of the year in terms of our full-year outlook for consulting type of work. We see low-single-digit positive growth for the full year. That's in our 2% to 5%. And Q1 came in as we expected, which was negative 2%."
},
{
"speaker": "Bryan Bergin",
"content": "Okay. That's helpful. And then, just a clarification around the M&A. So first, I don't know if you mentioned M&A in the first quarter, the contribution to growth, and we're saying greater than 2% for the full year. Just to be clear, that's just rounding around 2% or upwards of 3%? Thanks."
},
{
"speaker": "KC McClure",
"content": "Yeah. So, we're saying more than 2% for the full year, and it can fluctuate by quarter, so we really just stick to our guidance for the overall year."
},
{
"speaker": "Julie Sweet",
"content": "Right. And if we get close to 3%, we'll talk about that. But right now it's more than 2%."
},
{
"speaker": "KC McClure",
"content": "More than 2%."
},
{
"speaker": "Julie Sweet",
"content": "Right. Because we gave you guidance, so it's down definitely more than 2%. And remember, we only do deals that we think are good deals. So, what we see right now is a lot of good deals that is going to get us to above 2%. And if that -- we have a lot of financial flexibility, so if that changes, we'll update if it gets above 3%."
},
{
"speaker": "Bryan Bergin",
"content": "Thanks. Happy holidays."
},
{
"speaker": "Julie Sweet",
"content": "Happy holidays."
},
{
"speaker": "KC McClure",
"content": "Same to you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Dave Koning from Baird. Please go ahead."
},
{
"speaker": "Dave Koning",
"content": "Yeah. Hey, guys. Thanks so much. One thing I noticed, I guess, gross margin growth, year-over-year expansion in gross margin was the strongest in about nine quarters or so. Is that just lower attrition, offshore shift? Maybe walk through why that's gotten nicely better."
},
{
"speaker": "KC McClure",
"content": "Yeah. Hey, Dave. Thanks for the question. So, as you know, we run our business to operating margin, which we did 20 basis point expansion this quarter. And I will mention that if I didn't already, that the 10 basis point to 30 basis point that we have for the year, we might see more variability as we go throughout the quarters. But now back to gross margin, you're right, we did see expansion this quarter, but it's really hard to look at that in isolation. And why is that? Well, there's various things that can go in and out of gross margin in terms of increased or decreased spend. So, for example, one would be acquisitions. There's a lot of -- some of the investment acquisitions, some of that spend will go into gross margin, and that can be lumpy as we go throughout. As you know, it also depends on where people spend their time. So for example, you saw that, yes, we had improvement in gross margin, but then we also had increased sales and marketing costs, which is a result of people spending more time out in the market selling to create the $18.4 billion in sales that we have. So that's why -- again, we look at those components, but really at the end of the day, we always continue to run our business to op margin."
},
{
"speaker": "Dave Koning",
"content": "Got you. Thanks for that. And then, maybe as a follow-up just to Jason's question at the beginning on kind of the back-end loaded growth. If I just put in normal sequential patterns in Q3 and Q4, I get to about 2% constant currency, so the low-end of guide. Is there a scenario given bookings were really good this quarter that it actually, the progression sequentially in the back half of the year is better than normal and then that kind of gets to the better parts of the guidance range for revenue?"
},
{
"speaker": "KC McClure",
"content": "Yeah. So, I think, obviously when you do -- what you're just kind of talking about is a bit of the math. What I would tell is give you the year-over-year way we look at it in terms of our guidance, right? So, we had 1% growth this quarter with strong bookings, right, 1% revenue growth with strong bookings. We see Q2 shaping up the same way year-over-year. And again, just reinforcing that we do see fuel in our sequential growth in the back half of the year based on the transformation deals that we have signed. That's no different than what we talked about at the beginning of the year. We've layered in then the sales that we expect as we go throughout. And that -- there's no difference to how we're doing our range that gets us to the 2% to 5% range. I would say at the top end of our range, again, as we said, last quarter, just when we said guidance, that when -- to get to the top end of our guidance range, you would see S&C reconnecting with growth would be one thing that we'd see. And you would probably also see the mid- to high-single digits that we've been referencing consistently in managed services be more like high-single digits. So hopefully that helps, Dave."
},
{
"speaker": "Dave Koning",
"content": "Yeah, that's helpful. Thanks, guys. Nice job."
},
{
"speaker": "Julie Sweet",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Bryan Keane from Deutsche Bank. Please go ahead."
},
{
"speaker": "Bryan Keane",
"content": "Hi, guys. Good morning. I just wanted to ask on the clarification on the UK market in particular. I know the economy has been weak there for a couple years. So -- and I know it's been a call out for kind of the quarter. What exactly happened in the UK? And then, what's the outlook for that?"
},
{
"speaker": "Julie Sweet",
"content": "In the UK, as you said it, it has been kind of challenge for a couple of years, and we have a big banking capital markets business there, and we're really trying to pivot to more growth there in other areas. That's why you saw the acquisitions that we did, for example, this quarter. And what we're seeing is that it's just taking longer than we anticipated to really move into the other areas. And banking capital markets, which we've talked about, has been more challenged, particularly in the UK. And so, it's really about how long it's taking us to pivot. And we think it's going to take some time. So, I'm not going to call exactly when, but we do think it's going to take some time, and it's taking more time than we anticipated going into the fiscal year. So, we've got a good team. We're on it. And again, this is where you're going to see us do more acquisitions to diversify our business there as we reposition that."
},
{
"speaker": "KC McClure",
"content": "Yeah. Maybe just also, Bryan, just for context, it's about 6% of our overall business, a little bit more than $4 billion that we have in the UK."
},
{
"speaker": "Bryan Keane",
"content": "Got it. No, that's helpful. And then, KC, just to make sure we understand, the comments on the margins, given the movement in acquisition and the pick of an acquisition, there could be some fluctuations in given quarters. You're not going to have it perfectly 10 -- in the range of 10 basis points to 30 basis points per quarter. Any quarters to call in particular where it could fall below the range given the ramp of acquisitions and the ramp of investments? Thanks."
},
{
"speaker": "KC McClure",
"content": "Yeah. I don't want to really guide to the quarter because 10 basis points or 20 basis points on a quarter, that's spend, Bryan, as you know. That's kind of big and small in terms of the dollar amount that we're talking about. So, we're going to guide overall to the full year of 10 basis points to 30 basis points for the full year. And I just wanted to point out that we might have some periods where it's just a little bit more variable than what you've seen us do over the years."
},
{
"speaker": "Bryan Keane",
"content": "Got it. Thank you. Happy holidays."
},
{
"speaker": "KC McClure",
"content": "Thanks, Bryan."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Darrin Peller from Wolfe Research. Please go ahead."
},
{
"speaker": "Darrin Peller",
"content": "Hey, thanks guys. Just want to touch on headcount growth. I mean, it's still -- I think it's still a bit decelerating. And so, what are the expectations going forward, I mean, just given the backdrop of an acceleration on the revenue in the second half of the year? And then, Julie, maybe we could just touch on the linearity of the business one more time. Just if we could revisit the mix of the kind of business you're seeing now and the revenue per head you'd expect, or maybe just directionally, what you'd anticipate based on the mix we're seeing and what demand is for?"
},
{
"speaker": "KC McClure",
"content": "Yeah. So, thanks for that, Darrin. So, I'll talk about -- in terms of our people, in terms of number of people we have, first, I'll start with, as you know, managing supply-demand is really our core competency. And you can see that in our ability to manage our utilization at high levels. And I'll just point out that for the last 13 quarters, our utilization has been 91% or higher. And so, we hire for the skills that we need and we hire where we need them. And what you're pointing out is that we had about a 1% increase year-over-year in our headcount, as well as about a 1% sequentially. And that's in-line with what we -- how we see revenue going for the rest of the year. So there's really no change there. And as it relates to the revenue per head and the non-linearity, I mean, we do have automation. We do have value-based projects. So, while there still is a, obviously, connection to the amount of people that we have, we have been able to break that. There are parts where we are able to not fully disconnect, but not completely rely on headcount to drive revenue."
},
{
"speaker": "Julie Sweet",
"content": "And Darrin, in terms of just demand, right, so I'd kind of anchor to, first of all, we're seeing demand for transformational deals. So, in an environment like this, the thing that I look at most is, are we continuing to have our clients do more than $100 million of bookings, right, which is in our industry, we are a real standout here. And what does that mean? That means that we continue to be at the heart of where clients are spending to do material transformations. That's where you want to be so that you're positioned when inevitably discretionary spending, the pace goes back up, the macro changes, you want to be at the heart. So, at times like this, that's what I'm really looking at. And that's where you're seeing -- I will tell you, this is one of the most exciting times in the market. Like you just take what we are announcing today on McDonald's. I talked about in the script, right? Incredible company, technology driven. We've been their long-time partner. Just expanded the partnership to take it all the way to the edge and reinvent their restaurants and their crew experience. This is going to be really cutting work at the edge, because that's where we're starting to see the leaders in cloud go, and we're leading there. Those are the kinds of things that then you see how they're going to expand. There's so much opportunity still in these big areas of cloud, of data, and AI. But cloud itself, yes, we've done a lot of migration. There's still more migration to go, but even more importantly, you've got to take it all the way to the edge. So, from a demand perspective, we continue to see the transformations that move the needle for cost and growth, and that's what we're expecting. From a mix perspective, we're not seeing a big change between managed services and consulting. The mix we're seeing is that in this environment, you're seeing less of the smaller deals, which convert to revenue faster, and more on the larger deals. And that's been around for a while, and that's what you're going to continue to see. And we are laser-focused on making sure we are winning in the reinvention, the transformation, and at the same time massively pivoting to GenAI, right? And our clients have so much work to do to be able to use GenAI, but you can see the momentum in our business, right, from that change from $300 million of all of last year to $450 million in a quarter. And I'll just remind you, that's not the pull-through. That's not data. We are very pure because we really want to be sharing with all of you where is GenAI in the market. So, we're pretty excited about where we are today and what's ahead."
},
{
"speaker": "Darrin Peller",
"content": "That's really helpful. Look, you guys have obviously managed well through what was a softer discretionary demand environment. So, I guess, my question would be, if we thought about what a normalized run rate of revenues on really S&C would be, if we just said today's a normal, no longer softer discretionary environment, where do you think the difference is? I mean, I know it's probably hard to give an exact or precise estimate, but how much upside is there when we get that back?"
},
{
"speaker": "Julie Sweet",
"content": "Well, we have a good -- a really strong strategy in consulting business. And so, we're very positive about that business growing. But beyond that, I think, Darrin, we're not going to start to predict growth rates. But in the meantime, it is a huge differentiator. Nobody has that combination that we have, and that is what is driving the resilience of our business to be at the core of our clients' agenda. Thanks so much, Darrin."
},
{
"speaker": "Darrin Peller",
"content": "Great. Thanks, guys."
},
{
"speaker": "Katie O'Conor",
"content": "Operator, we have time for one more question, and then Julie will wrap up the call."
},
{
"speaker": "Operator",
"content": "Okay. That question comes from the line of James Faucette from Morgan Stanley. Please go ahead."
},
{
"speaker": "James Faucette",
"content": "Great, thank you so much. I want to just ask a couple of follow-up questions to those that have already been asked. First on the inorganic contribution, appreciate that it's going to be better than 2%. Can you talk a little bit about whether that increased activity is -- or how you would balance that increased activity between just better valuations and more opportunities from a purely financial perspective in the market versus it sounds like some of the acquisitions you're doing, you're just trying to push into new strategic areas, and just wondering how you're balancing those strategic imperatives versus perhaps a little better valuations?"
},
{
"speaker": "Julie Sweet",
"content": "Yeah. I mean, I wouldn't call out -- I wouldn't say that this activity is because of better valuations, right? At any given time when we look at the market, right, and we see where are the growth opportunities, we want to move quickly and we look at organic versus inorganic ways of moving quickly. We never do anything purely inorganic, right, or purely organic. And so, think about our acquisitions as being matched to what is the opportunity in the market and what's the best way to capture that growth quickly, right? And so, the strategy of categories is the same, right? So, there are new areas that we want to go into, like capital markets. That's an investment decision. We go into a certain number of those. We're executing now with rigor. We went and bought Anser Advisory. Now we bought the next one in Canada, right? So that's just about -- it's a great growth area and we're trying to pivot. And the best way to do that to build something that we don't have already organically is to make some inorganic acquisitions and then that becomes organic growth and we're able to kick in our recruiting machine. If you think about the UK, health is a great area. We just bought a health company, right? So, you look at the market and you say, \"If I want to diversify, what's the fastest way to diversify into new areas?\" And that's where often inorganic can help us do that through these niche acquisitions and consulting and industry. And then, you've got just massive opportunities like cloud and security, where you saw some of those acquisitions in supply chain. And that's all about both adding phenomenal talent quickly and scaling to go after a market that's today, right? So, that's how we think about it. It's extremely rigorous. We always have a decision what's the best way to get there organically or inorganically. And inorganic is always about acceleration and driving organic growth. So, it's very consistent. We've been doing it in a very disciplined way. And in these kinds of environments, we believe the companies that invest win. And that is why we do actions like we did last year to increase our business resilience and enable us to be really well positioned to invest when others are not."
},
{
"speaker": "James Faucette",
"content": "That's great color. I appreciate that. And similarly, just on bookings activity and AI contribution, there are clear acceleration in the AI level of activity, et cetera. When you're talking to clients and that kind of thing, how are they thinking about AI budget allocation versus other initiatives, et cetera, right now? Are they looking at it as, \"Hey, this is an incremental investment that we need to be making given the pace of change in technology,\" or are they trying to really use that spend or have that spend be to offset some other projects maybe that they're going to curtail a little bit sooner? Just trying to think about as that continues to build, how we should think about it being incremental versus substitutive within a lot of the budgets."
},
{
"speaker": "Julie Sweet",
"content": "Right now we're seeing a lot of reprioritization, right, because -- I mean, obviously the market is growing. Like, we're growing. The market is growing. So, spending in technology is increasing. It's not increasing as fast as it was increasing a couple of years ago, right? So, spending on technology is increasing. But within that, you're seeing more prioritization. And our research, everybody's research is saying, hey, more spending on AI. For lots of companies, it's also more spending mostly on building that digital core, because many companies don't have the data estates in order -- they're not in the cloud. They don't have the data in order to use the GenAI. So, think of it as a real focus on building a digital core to enable as well. So, market is still growing. It's more about prioritization of where that spending is going. Okay. Great. Thank you so much. So, in closing, I want to thank all of our shareholders for your continued trust and support in all of our people for what you do every single day. And I wish everyone a happy and a healthy holiday season. Thank you for joining today."
},
{
"speaker": "Operator",
"content": "That does conclude your conference for today. Thank you for your participation and for using AT&T Teleconference. You may now disconnect."
}
] |
adbe | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Q4 and FY2024 Adobe earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Steve Day, SVP, DXCFO, and Corporate Finance Interim Head of IR. Please go ahead, sir."
},
{
"speaker": "Steve Day",
"content": "Good afternoon, and thank you for joining us. With me on the call today are Shantanu Narayen, Adobe's Chair and CEO; David Wadhwani, President of Digital Media; Anil Chakravarthy, President of Digital Experience; and Dan Durn, Executive Vice President and CFO. On this call, which is being recorded, we will discuss Adobe's fourth quarter and fiscal year 2024 financial results. You can find our press release as well as PDFs of our prepared remarks and financial results on Adobe's Investor Relations website. The information discussed on this call, including our financial targets and product plans, is as of today, December 11th, and contains forward-looking statements that involve risk, uncertainty, and assumptions. Actual results may differ materially from those set forth in these statements. For more information on those risks, please review today's earnings release and Adobe's SEC filings. On this call, we will discuss GAAP and non-GAAP financial measures. Our reported results include GAAP growth rates, as well as constant currency rates. During this presentation, Adobe's executives will refer to constant currency growth rates unless otherwise stated. Non-GAAP reconciliations are available in our earnings release and on Adobe's investor relations website. I will now turn the call over to Shantanu. Thanks, Steve."
},
{
"speaker": "Shantanu Narayen",
"content": "Good afternoon, and thank you for joining us. In Q4, we achieved revenue of $5.61 billion, representing 11% year-over-year growth. In our digital media business, we delivered record net new ARR of $578 million, and our digital experience business achieved subscription revenue of $1.27 billion, representing 12% year-over-year growth. 2024 was a year of records for Adobe. We achieved record revenue of $21.51 billion, representing 11% year-over-year growth. GAAP earnings per share was $12.36, and non-GAAP earnings per share was $18.42, representing 5% and 15% year-over-year growth, respectively. We had several new milestones with our AI innovations enabling us to add more than $2 billion in digital media net new ARR and surpass $1 billion in the ending book of business for Adobe Experience Platform and native apps. The digital experience business crossed $5 billion in revenue, making us one of the mission-critical providers of marketing technology in the world. We exited the year with $19.96 billion in RPO and cash and short-term investments of $7.89 billion. 2024 was also a transformative year of product innovation. We delivered foundational technology platforms and introduced multiple generative AI models in the Adobe Firefly family, including imaging, vector design, and most recently, the Yo. Adobe now has a comprehensive set of generative AI models designed to be commercially safe for creative content, offering unprecedented levels of output quality and user control in our applications. We reimagined creativity and productivity for a broader set of customers with Adobe Express, the quick and easy create-anything app. The deep integration of Fireflies across our flagship applications in Creative Cloud, Document Cloud, and Experience Cloud is driving record customer adoption and usage. Firefly Power Generation's across our tools surpassed 16 billion, with every month this past quarter setting a new record. We enhanced document productivity with AI assistant in Adobe Acrobat and Reader, unlocking even greater value from the trillions of PDFs around the world. We've successfully scaled Adobe Experience Platform and native apps to deliver the fundamental infrastructure required for customer engagement. We're accelerating automated decisioning, empowering audiences, journeys, and channels to deliver truly personalized experiences at scale. We set the stage to drive an AI content revolution by bringing content and data together in Adobe Gen Studio, integrating high-velocity creative expression with enterprise activation. The release of Adobe Gen Studio for performance marketing integrates Creative Cloud, Express, and Experience Cloud and extends our end-to-end content supply chain solution, empowering freelancers, agencies, and enterprises to accelerate the delivery of content, advertising, and marketing campaigns. I'll now turn it over to David to discuss the momentum in our digital media business."
},
{
"speaker": "David Wadhwani",
"content": "Thanks, Shantanu. Hello, everyone. In Q4, we achieved net new digital media ARR of $578 million and revenue of $4.15 billion, which grew 12% year-over-year, fueled by innovation in both our creative and document businesses. We ended the year with just over $2 billion of net new digital media ARR for the first time ever as a result of accelerated product innovation, record traffic to adobe.com, and engagement on social and mobile, as well as increasing value for enterprise customers through Firefly Services and GenStudio. We bring together our creative and experience clouds. On the document cloud side, PDF continues to be the global standard for digital. Adobe Acrobat is revolutionizing the way people engage with them across mobile, web, and desktop. We took a major step forward in FY2024 with the introduction of AI Assistant in Acrobat and Reader. AI Assistant and other AI features like liquid mode and Firefly are accelerating productivity through faster insights, smarter document editing, and integrated image generation. A recent productivity study found that users leveraging AI Assistant completed their document-related tasks four times faster on average. AI Assistant is now available in Acrobat across desktop, web, and mobile, and integrated into our Edge, Chrome, and Microsoft Teams extensions. In Q4, we continued to extend its value with specialized AI for contracts and scanned documents, support for additional languages, and the ability to analyze larger documents. In Acrobat Web, our integrations with Adobe Express allow users to generate images and quickly stylize content. We saw AI Assistant conversations double quarter over quarter, driving deeper customer value. In Q4, we achieved document cloud revenue of $843 million, growing 17% year-over-year. We set a record for net new Document Cloud ARR of $173 million, with ending ARR of $3.48 billion, growing 23% year-over-year. Other highlights include continued growth of monthly active users, which grew over 25% year-over-year, surpassing 650 million paid and free users. Strong top-of-funnel momentum through Acrobat web with monthly active users up nearly 50% year-over-year. Strength in Acrobat Pro single app, in both Document Cloud and Creative Cloud offerings. A great back-to-school season with a new AI Assistant in education for students. Key enterprise customer wins include Abbott Laboratories, BWI GmbH, Defense Information Systems Agency, Kaiser Permanente, Novo Nordisk, Truist, UScellular, and the US Department of State. Creative Cloud also had a strong year. As demand for content continues to grow across mobile, desktop, and streaming platforms. Adobe MAX, the premier creativity conference, showcased our FY2024 innovation and drove over 0.5 billion video views across all channels. We have made major strides with our generative AI models with the introduction of Firefly image model three enhancements to our vector models, richer design models, and the all-new Firefly video model. These models are incredibly powerful on their own, and their deep integration into our tools like Lightroom, Photoshop, Premier InDesign, and Express have brought incredible value to millions of creative professionals around the world. We have brought our creative and experienced clouds together through the introduction of Firefly services in GenStudio, addressing the growing need for scaled content production in enterprises. Firefly generations continue to accelerate and have now crossed 16 billion cumulative generations. In Q4, we achieved $3.3 billion revenue, which grew 11% year-over-year. Net new Creative Cloud ARR was $405 million. Other highlights include adoption of Adobe Express by approximately 4,000 businesses in the quarter, and an 84% year-over-year increase in the number of students with access to Express Premium as part of this year's back-to-school season. Adobe Express saw strong ecosystem growth with over 180 plugins available in the Express marketplace and integrations with leading social productivity and collaboration apps like ChatGPT, Google, Slack, Wix, Box, HubSpot, and Webflow, significantly increasing our customer reach. The launch of the Fireflies video model and its unique integration in Premiere Pro unlimited public beta garnered massive customer interest, and we look forward to making it more broadly available in early 2025. This feature drove a 70% increase in the number of Premiere Pro beta users. Enhancements to Firefly image vector and design models include four times faster image generation and new capabilities integrated into Photoshop, Illustrator, Premiere Pro, and Adobe Express. Strong adoption of Lightroom mobile with customers embracing innovations like generative remove and lens blur, as well as quick actions, which streamline editing and increase discovery and adoption of premium features. Just this morning, Adobe Lightroom was recognized as the Mac app of the year in Apple's annual App Store Awards. The launch of the new Frame.io v4 streamlines creative management for video projects, enabling end-to-end editing capabilities and seamless collaboration between editors and their stakeholders. Firefly services adoption continued to ramp as enterprises such as Pepsi and Tapestry use it to scale content production given the robust APIs and ease of creating custom models that are designed to be commercially safe. Key enterprise customer wins include Alphabet, American Express, Coca-Cola, Johnson & Johnson, LVMH, Nestle, Procter & Gamble, T-Mobile, and the US Department of Defense. Our AI product releases and business evolution in FY2024 have set the stage for another strong year ahead as we expand to new audiences, deliver more value to existing users, and increasingly integrate our digital media and digital experience clouds to create differentiated business solutions. We will do this by accelerating the adoption of freemium offers, including Express, Lightroom, and Acrobat on web and mobile, as well as expanding access to Acrobat AI Assistant delivered strong financial performance in FY2024. Growing our core creative business by continuing to expand our AI innovations in our flagship applications as well as bringing them to web and mobile. In addition, we will soon introduce a new higher-priced Fireflies offering that includes our video models as a comprehensive AI solution for creative professionals. This will allow us to monetize new users, provide additional value to existing customers, and increase ARPU. And further accelerating Fireflies services, which saw significant demand in FY2024, integrating it into GenStudio to provide enterprises with solutions to exponentially scale their content production capabilities with AI. We're thrilled with the response to our innovations in FY2024, excited to release new capabilities, and look forward to delighting customers in the year ahead. I'll now pass it to Anil."
},
{
"speaker": "Anil Chakravarthy",
"content": "Thanks, David. Hello, everyone. The Experience Cloud business had a strong close to the year, achieving revenue of $1.4 billion for the quarter and a record $5.37 billion in revenue in fiscal 2024. Subscription revenue in the quarter was $1.27 billion, representing 12% year-over-year growth. The book of business for Adobe Experience Platform and native apps, real-time CDP, customer journey analytics, and journey optimizer surpassed $1 billion in the quarter, with 48 of the Fortune 100 companies now leveraging these solutions. The market opportunity for customer experience management is large and growing. Both B2B and B2C companies are selecting Adobe as the strategic technology partner to accelerate customer acquisition, engagement, and retention. Our leading solutions spanning content, data, and customer journeys empower businesses to drive top-line growth while simultaneously delivering productivity gains. The AI innovations we have delivered enable our customers to accelerate the delivery of personalized experiences at scale and have been built to satisfy enterprise governance requirements. Adobe Experience Platform AI Assistant empowers marketers to automate tasks and generate new audiences and journeys. Adobe Experience Manager generates variations and provides dynamic and personalized content creation natively through AEM, enabling customers to deliver more compelling and engaging experiences on their websites. We are transforming the content supply chain for enterprises with Adobe Gen Studio, which natively integrates multiple Adobe applications across Creative Cloud and Experience Cloud, including Express, Firefly, Workfront, Experience Manager, Customer Journey Analytics, and Journey Optimizer. Gen Studio enables agencies and enterprises to unlock new levels of creativity and efficiency across content creation and production, workflow and planning, asset management, delivery and activation, reporting, and insights. Adobe Gen Studio for performance marketing is a great addition to the Gen Studio portfolio, offering an integrated application to create paid social ads, display ads, banners, and marketing emails by leveraging preapproved on-brand content. It brings together creative teams that define the foundational requirements of a brand, including guidelines around brand voice, channels, and images, with marketing teams that need to deliver numerous content variations with speed and agility. We are seeing strong customer demand for Adobe Gen Studio for performance marketing since its general availability at MAX. Gen Studio is the answer to address how marketing is going to transform in the era of AI for CMOs, CIOs, and CFOs. Other highlights include an expanded partnership with Amazon to make Adobe Experience Platform available on Amazon Web Services and extend our leadership across enterprises. Enterprises will soon be able to access the full power of AEP and native apps on AWS. Integration partnerships with Google's Campaign Manager 360, Meta, Microsoft Advertising, Snap, and TikTok offer marketing teams a holistic view of campaign performance directly in Adobe Gen Studio to optimize the ROI of their ad spend. Strong industry analyst recognition in major analyst reports, including the Gartner Magic Quadrant for Digital Commerce and the Forrester Wave for Cross-Channel Marketing Hubs. In particular, Gartner recognized Adobe's critical capabilities for multichannel marketing, such as our differentiated ability to adapt customer journeys in real-time based on customer behavior. AI innovations delivered in the premium tiers and add-ons helped us close our largest bookings quarter ever, with key global customer wins, including Air Canada, Alliant, American Express, Bank of America, BMW, Centene, CIBC, Cisco, Disney, Fanatics, Gap, GM, JPMorgan Chase, PayPal, Samsung, Tesco, and Wells Fargo. Digital remains a critical growth imperative for businesses around the world. Adobe Digital Insights, which analyzes trillions of data points, reported that both Black Friday and Cyber Monday sales hit record highs of $10.8 billion and $13.3 billion, jumping 10.2% and 7.3% from last year, respectively. We expect the full holiday season to hit $240.8 billion, up 8.4% year-over-year. With the availability of our new offerings in FY2025, Adobe has a unique opportunity to capitalize on the breadth of these solutions to further optimize our integrated go-to-market field organization. We're expanding our enterprise go-to-market teams to sell these integrated solutions that cut across digital media and digital experience globally under the new Gen Studio umbrella. We've seen early success for this strategy that included Express and Firefly services in Q4. As we enable our worldwide field organization in Q1, we anticipate acceleration of this pipeline throughout the rest of the year and beyond. We are confident of continuing our leadership and momentum into 2025. I will now pass it to Dan."
},
{
"speaker": "Dan Durn",
"content": "Thanks, Anil. Our earnings report today covers both Q4 and FY2024 results, highlighting growth drivers across our businesses, and I'll finish with financial targets. We are proud of the performance we have driven in FY2024, delivering record revenue, EPS, and operating cash flows while aggressively investing in AI product innovation. New AI releases, including Express, Acrobat AI Assistant, Firefly services, DX premium tiers, and Gen Studio for performance marketing, have expanded the portfolio of products, driving proliferation and meaningful Gen AI monetization. We had a strong finish to the year, with records in digital media net new ARR and digital experience bookings. In FY2024, Adobe achieved record revenue of $21.51 billion, which represents 11% year-over-year growth as reported and in constant currency. GAAP EPS for the year was $12.36, and non-GAAP EPS was $18.42, growing 5% and 15% year-over-year, respectively. FY2024 business and financial highlights included digital media revenue of $15.86 billion, net new digital media ARR of $2.00 billion, digital experience revenue of $5.37 billion, cash flows from operations of $8.06 billion, RPO of $19.96 billion exiting the year, and repurchasing approximately 17.5 million shares of our stock during the year. In the fourth quarter of FY2024, Adobe achieved revenue of $5.61 billion, which represents 11% year-over-year growth as reported and in constant currency. GAAP diluted earnings per share in Q4 was $3.79, and non-GAAP diluted earnings per share was a record $4.81, growing 17% and 13% year-over-year, respectively. Q4 business and financial highlights included digital media revenue of $4.15 billion, net new digital media ARR of $578 million, digital experience revenue of $1.40 billion, cash flows from operations of $2.92 billion, and added $1.82 billion to RPO in the quarter. In our digital media segment, we achieved Q4 revenue of $4.15 billion, which represents 12% year-over-year growth as reported and in constant currency. We exited the quarter with $17.33 billion of digital media ARR, growing our ending ARR book of business 13% year-over-year in constant currency. Adobe achieved document cloud revenue of $843 million, which represents 17% year-over-year growth as reported and in constant currency. In the quarter, we added $173 million of net new Document Cloud ARR, growing our ending ARR book of business 23% year-over-year in constant currency. Fourth quarter Document Cloud growth drivers included strong growth across Reader and Acrobat on web and mobile, and extensions such as Edge and Chrome, Acrobat subscription demand across all customer segments, routes to market, and geographies. Accelerated adoption and monetization of AI Assistant driven by product enhancements and delivery of French and German language support. And year-end seasonal strength in the enterprise. We achieved creative revenue of $3.30 billion, which represents 10% year-over-year growth or 11% in constant currency. In the quarter, we added $405 million of net new creative ARR, growing our ending ARR book of business 11% year-over-year in constant currency. Fourth quarter Creative Cloud growth drivers included strong demand for new subscriptions for Creative Cloud all apps, across individuals, teams, enterprise, and education. Strength and Creative Cloud single latch for Acrobat Pro, Lightroom, and Photoshop. Momentum with new subscriptions in emerging markets, demand for Adobe Express across education, SMB, and enterprises. And adoption of Firefly services in the enterprise. Turning to our digital experience segment. In Q4, we achieved revenue of $1.40 billion, which represents 10% year-over-year growth as reported and in constant currency. Digital Experience subscription revenue was $1.27 billion, growing 13% year-over-year, or 12% in constant currency. Fourth quarter digital experience growth drivers included a strong finish to the year with the largest ever bookings quarter, and robust performance across geographies, including the US and EMEA, and multiple verticals, including financial services. Strong subscription revenue growth led by Adobe Experience Manager, Adobe Journey Optimizer, real-time customer data platform, customer journey analytics, and work front. Continued strength in retention and expansion across our enterprise customers with digital experience solutions being leveraged by 85 of the Fortune 100 companies. Momentum with AEP and native apps, with FY2024 ending book of business surpassing $1.0 billion and growing greater than 40% year-over-year. And strong bookings for our Umbrella Gen Studio solution with interest and momentum for our new Gen Studio for performance marketing offering. Adobe's effective tax rate in Q4 was 15.5% on a GAAP basis and 18.5% on a non-GAAP basis. RPO exiting the quarter was $19.96 billion, growing 16% and CRPO growing third percent year-over-year as reported. Our cash flows from operations in the quarter were $2.92 billion, and ending cash and short-term investment position exiting Q4 was $7.89 billion. In Q4, we entered into a $2.5 billion share repurchase agreement, and we currently have $17.65 billion remaining of our $25 billion authorization granted in March 2024. Now turning to our FY2025 financial target. We measure ARR on a constant currency basis during the fiscal year and revalue ending ARR at year-end. FX rate changes between the end of FY2023 and the end of FY2024 have resulted in a $117 million decrease to the digital media ARR balance entering FY2025, from $17.33 to $17.22 billion, and is reflected in our investor data. We expect an approximate $200 million headwind to FY2025 revenue as a result of the effect of foreign exchange, and a smaller impact of the continued move to subscriptions from perpetual offerings. Factored into our financial targets is an ongoing strategy to introduce new tiered subscription offerings and add-ons. For FY2025, we're targeting total Adobe revenue of $23.30 to $23.55 billion. Digital Media segment revenue of $17.25 to $17.40 billion. Digital media ending ARR book of business growth of 11.0% year-over-year. Digital Experience segment revenue of $5.80 to $5.90 billion, Digital Experience subscription revenue of $5.375 to $5.425 billion. GAAP earnings per share of $15.80 to $16.10. And non-GAAP earnings per share of $20.20 to $20.50. We expect non-GAAP operating margin of approximately 46% and a non-GAAP tax rate of approximately 18.5%. For Q1, fiscal 2025, we're targeting total Adobe revenue of $5.63 to $5.68 billion. Digital media segment revenue of $4.17 to $4.20 billion, digital experience segment revenue of $1.38 to $1.40 billion, Digital Experience subscription revenue of $1.27 to $1.29 billion. GAAP earnings per share of $3.85 to $3.90. And non-GAAP earnings per share of $4.95 to $5.00. For Q1, we expect non-GAAP operating margin of approximately 47% and non-GAAP tax rate of approximately 18.5%. In summary, I'm proud of our outstanding performance, which combines robust product leadership, velocity of innovation, and financial discipline, positioning us to achieve strong revenue and EPS growth in the year ahead. Shantanu, back to you."
},
{
"speaker": "Shantanu Narayen",
"content": "Thanks, Dan. This quarter, Adobe was once again recognized for our exceptional culture and leadership, including on Forbes' World's Best Employers, Fortune's 50 AI Innovators, and Fortune's Best Workplaces in Technology in the Wall Street Journal's Best Managed Companies list. At MAX, we announced a new global initiative aimed at helping 30 million next-generation learners develop AI literacy, content creation, and digital marketing skills, using Adobe Express to thrive in the modern workforce. Working with education partners in schools, nonprofits, and online learning platforms to provide training, certifications, and career pathways. Our strategy to unleash creativity for all, accelerate document productivity, and empower digital businesses represents a massive addressable market opportunity. Adobe continues to build on its strong foundation of transformative innovation, category and brand leadership, financial performance, and profitable growth. We're delivering Adobe Magic to an expanding set of global customers and executing on the massive market opportunity ahead. Adobe couldn't be better positioned for 2025 and beyond. Thank you, and we will now take questions. Operator,"
},
{
"speaker": "Operator",
"content": "Thank you. If you would like to signal with questions, please press star one on your touch-tone telephone. If you're joined today using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that is star one if you would like to signal with questions. And the first question will come from Kash Rangan with Goldman Sachs. Again, Kash, if you could press star one on your touch-tone telephone. Again, star one on your touch-tone telephone. We'll go next to Michael Turn with Wells Fargo."
},
{
"speaker": "Michael Turn",
"content": "Hey. Thanks very much. I appreciate you taking the question. David, you mentioned in your prepared remarks a few things focusing on expanding innovations, including newer higher-priced Fireflies offerings and actually accelerating Firefly by integrating further into Gen Studio. I was hoping you could just maybe expand on how you're thinking about the adoption curve of those efforts. And as a second part, Dan, if you can just add any commentary on how you're incorporating some of these newer efforts into the forecast if there's conservatism just given they're newer or just how to think about that, also useful. Thank you."
},
{
"speaker": "David Wadhwani",
"content": "Sure. Yeah. I'll go ahead and get started. So AI obviously has been a huge area of focus for us, and, frankly, our community has been using it at amazing rates. So we're very excited you heard that 16 billion generations that we talked about in the prepared remarks. And that's really a function of the investments we've made in creating the broadest set of models. We've talked about imaging vector design in the past. We now have video and audio in beta form as well. And the foundational difference between what we do and what everyone else does in the market really comes down to three things. One is commercially safe, the way we train the models. Two is the incredible control we bake into the model. Three is the integration that we make with these models into our products. Increasingly, of course, CC flagship applications, but also in Express and Lightroom and these kinds of applications, but also in Anil's DX products as well. So that set of things is a critical part of the foundation and an adorable differentiator for us as we go forward. Now as we introduce the video model, which we expect to have in market early next year, that's going to create an opportunity to further tier our creative cloud offerings. As you surely understand, video generation is a much higher value activity than image generation. And as a result, it gives us the ability to start to tier creative cloud more actively there. In addition to that, we introduced this year, we introduced Fireflies services. That's been off to a great start. We have a lot of customers that are using that. A couple we talked about on the call include Tapestry. They're using it for scaled content production. Pepsi, for their Gatorade brand, is enabling their customers to personalize any merchandise that they are buying, in particular, starting with Gatorade bottles. And these have been very, very productive for them, and we are seeing this leveraged by a host of other companies for everything from localization at scale to personalization at scale to user engagement or just raw content production at scale as well. And then last, not to get missed in all of this, is everything we're doing with AI Assistant. AI Assistant for Acrobat is off to an incredibly strong start. And we see it continuing to accelerate. So all of this has built a great foundation for us in FY2024. It's given us a lot of signal from our customer base, and it's really we've learned a lot that we intend to apply as we optimize the value and, you know, the tiering for our customers going forward."
},
{
"speaker": "Dan Durn",
"content": "Yeah. And just building on David's comments as it relates to the FY2025 guide, we talk about all of the great innovation that's in flight. I would say the velocity of innovation is greater today than it's ever been. We called out products like Express, AI Assistant, Firefly, premium tiers in DX, Gen Studio. The good thing is they're meaningful contributors today to the financial performance and extrapolating the momentum that we see in those products, taking a point of view on the future pipeline of innovation, how we bring that to life, deeply natively integrated into our products and further extend the value we offer to customers as well as the additional segments we can access. All of this comes together to take a perspective of what 2025 looks like based on the strong start that we have and the meaningful contribution in FY2024."
},
{
"speaker": "Michael Turn",
"content": "Thanks very much."
},
{
"speaker": "Operator",
"content": "And we'll take our next question from Alex Zukin with Wolfe Research."
},
{
"speaker": "Alex Zukin",
"content": "Guys. Thanks for taking the question. I guess maybe to the point that you just alluded to in terms of AI being meaningful as part of the broader roadmap for business. Can you maybe talk about how you're thinking about the growth driver from Fireflies from Gen Studio and when kind of how will we see that percolate through the year in terms of the net new digital media ARR? Is that something that you think is more going to be showing up in the DX business? It'd be great to get some color there. And then anything, Dan, that we should think through given the new guidance methodology around seasonality, linearity, for the digital media business."
},
{
"speaker": "David Wadhwani",
"content": "Sure. I'm happy to take that. So first of all, yeah, as we mentioned, we're really excited about the FY2024 momentum that we're seeing that we're carrying into it. And you know, we've had this conversation in the past around, you know, how we about the growth algorithm for the digital media business. So maybe let me reiterate a little bit of that. We've talked about this in the context of p times q plus v in the past. You know, where p is new users bringing in more people into the franchise. We're continuing to do that. Obviously, with the introduction of Express, we're seeing a lot of great growth there, whether it's through our phones channel reaching out to SMB, whether it's reaching out to the mid-market or whether it's working more closely with Anil and the DX business and the integrations we have between Express and the DX business reaching into large companies. We're doing a lot in terms of proliferation of Express into education. We've done a number of partnerships that we talked about with Box, ChatGPT, HubSpot, and others, but also our own products like Acrobat Workflows, from Acrobat and Reader into Express. So really pushing to drive more new customers into the franchise in addition to the continued growth that we're getting in our core creative products. Second, in terms of the core creative products, this is where the queue, the price actually increases with core value because when we're introducing Firefly models into the mix, we get the opportunity to integrate them more into the flagship applications. And as I mentioned earlier with the Fireflies web application, we have the opportunity to create more tiers across the creative products so that we can get people in the right plan for their needs. And we're very bullish about video and the breadth of our customer base that are going to need access to these video models. Again, remember, they're integrated deeply into our applications, including Premiere. We're very excited about what that could mean for us. And then lastly, the business value for customers and enterprise or corporate, that's where the value-based selling that we do along with the digital experience business really plays out. Firefly Services, as I mentioned, with Gatorade, Tapestry, and a whole host of others that have come. Everyone in this space is driving towards personalization of that content, and they absolutely need a scaled production and automation pipeline to generate more content. And that's where Firefly services does. And as it has hit this level of escape velocity, and in particular, Gen Studio so that it becomes a more holistic solution as we go into FY2025 and accelerate that. And that's, you know, Alex, that's what's leading to the guide of 11%. If you really take a step back, that's one of the best guides we've given in terms of, you know, next year ARR growth. But one thing maybe to keep in mind is the composition of growth is going to be a little different next year compared to FY2024. Again, the growth algorithm is new users, new products, and value and pricing. New users and new products will be a more significant part of the mix as we go into FY2025. And we look forward to sort of that foundational base of the business growing and driving the business."
},
{
"speaker": "Dan Durn",
"content": "And then just to build on that, Alex, and I appreciate the question around the shape of FY2025. Here's what I'll share about it. We all know we changed the guidance methodology into 2025. The guide around the ending ARR book to business growth. We just have a strong point of view. It's a better indicator of business health trajectory. David talked about the growth algorithm, the growth agenda at the company, new subscribers, is the predominant driver of growth. Has been continues to be. The second leg Cross sell. Upsell. This is something the company is trying to really great skill at over time. Once we bring people into the Adobe ecosystem to journey them through the rich set of technologies and products that we have to bring them deeper into the ecosystem, that's an important element. And then lastly, you know, David mentioned pricing. This is about how we segment the product portfolio, the value, that we deliver to our customers. So as we think about the innovation, as we think about the growth algorithm, and as we think about increasingly monetizing the rich set of innovation that we've already brought to market, as well as in the pipeline to be brought to market. Quarterly profile, we view it as less important. Really wanna focus on revenue, and EPS. Focus, on the annual book of business growth. We think that's the most important way to look at the business. It's also how we as the management team run the business."
},
{
"speaker": "Alex Zukin",
"content": "Understood. Thank you, guys."
},
{
"speaker": "Operator",
"content": "And the next question will come from Kirk Materne with Evercore ISI."
},
{
"speaker": "Kirk Materne",
"content": "Yeah. Thanks very much. David, I was wondering if I could just follow-up on your last comment on sort of obviously driving new users, new adoptions, you know, incredibly important. I just is there pricing sensitivity, meaning you're delivering so much value. I think that pricing given the value you're delivering, would be a bigger lever. You know, unless there's pricing sensitivity. Could you just walk through that a little bit more? Because it feels like you should be able to get sort of all three vectors going at the same time, whereas I know you're gonna focus more on bringing people in and making them successful. But I'm sort of I guess, is there something else on the pricing side that I'm missing why you're not getting that as well? Thanks."
},
{
"speaker": "David Wadhwani",
"content": "Yeah. And we've talked about this in the context of proliferation versus short-term monetization and how we have to balance both of those, and that's something that we take very seriously and we look at that. If you look at the lower end of the market as we have entered with Express and Lightroom Acrobat. And by the way, this the web and mobile motion for us has been productive in bringing in a lot more new users. And so you'll expect to see us do more of that and introduce more products in that segment. In FY2025 as well. And there is certainly price sensitivity at that side of the market. When it comes to both premium users and also converted to paid users. We'll continue to enable that. When it comes to the core business, and this is the business of creative professionals, we are very focused on introducing new value that is going to create more segmentation and more tiering and, you know, get aligned value and pricing to what we are delivering there. So we do see a tremendous amount of opportunity there going forward. Because the value that we bring and the efficiency we bring to the content creation process there is very significant. Again, and then last and certainly not least, as we talked about in core enterprises, that's where we've been able to sort of cross that chasm from p times q business over to a value sale business, and we are able to start to get more automation and workflows in place there as well. So it's a mix of these things. You know, we are gonna continue to balance. We are obviously tracking, and we believe that proliferation as we've said, you know, for some time maintains is one of the top priorities because we know that if people start using our products today, we have the opportunity to continue to deliver value two for a long time to come. And so that balance is what we try to do, and it's a management judgment call, but we think we're getting it right."
},
{
"speaker": "Kirk Materne",
"content": "I guess a quick follow-up for Dan. Dan, obviously, Black Monday fell into your first quarter, this current year. Any color you can offer in terms of what that meant, if at all, to create a cloud net new ARR this quarter?"
},
{
"speaker": "Dan Durn",
"content": "Yeah. The Black Friday, Cyber Monday played out about as expected. You know, we've been talking about a multiyear trend where commercial activity shifting left in terms of timing. We run our promotions over a larger window of time to reflect consumer behavior, and we see similar pattern commercially from our customers this year. That we've seen in prior years. If we think about online shopping this year, up 8.4%. You can see last year, that's up from 4.8%. So a nice step up this year versus last year. But you can see Cyber Monday from a contribution standpoint. Even though the growth last year was down relative to this year, Cyber Monday grew at 9.6%, this year at 7.3%. Just illustrates the flattening of the profiling consumer behavior around that. So you know, performance as expected."
},
{
"speaker": "Kirk Materne",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "And the next question will come from Keith Weiss with Morgan Stanley."
},
{
"speaker": "Keith Weiss",
"content": "Excellent. Thank you guys for taking the question. A lot of excitement from you guys on the conference call about the pace of innovation going on in the business. And we hear excitement from creative professionals, and they talk about an acceleration in the pace of innovation. But apologies to state the obvious, but investors aren't feeling that excitement or aren't showing that excitement. Stock is a major underperformer on a year-to-date basis. Down again on an after-hours basis today. And I would point to it's the lack of acceleration that we're seeing in their numbers. Right? Digital media net new ARR this quarter grew just organically, grew 2%. You're guiding to decelerating growth into the forward year despite all this innovation. And I think the question that it brings up in investors' mind is there some leak in the bucket. Right? All this innovation, new monetization avenues, pricing going up, but the growth is going in the wrong direction. Like, is there a part of the equation that's not working? Is there share losses? Is there something that we're not seeing that is taking away that momentum in the numbers that's not it? We're not seeing the acceleration in the numbers if you will."
},
{
"speaker": "Shantanu Narayen",
"content": "Okay. So maybe I'll talk about I mean, if you take a step back and think about the year, and I'll certainly address the feedback that you're sharing. From our perspective, you know, when we guided at the beginning of the year, when we reguided then in the middle of the year to $19.50 and then when we guided in Q3. I mean, the reality is we beat all those three targets that we had issued, beginning of the year, middle of the year, and end of the year. I think specifically maybe as it relates to the Q4 digital media net new ARR and thinking about it from the creative, the one thing that I'll point out there is that, actually, creative did better than probably is evident in that if you think about the contribution of Acrobat that went into the creative bucket. Versus the document cloud business. So certainly, Acrobat continues to do well. Record, as you saw, but the non-Acrobat contribution in creative actually had more growth. Than what you would see if you just look at it from a Creative Cloud ARR. I think to your bigger question about what's happening in the business, and as we think about it, you know, at the scale of the business right now, certainly, as this entire world moves towards generative AI, as David said, we're executing on both the proliferation play at the bottom with Express and Acrobat. And at the high end, with the Creative Pro and with the enterprise, we are seeing significant adoption of that. And I think Gen Studio will also be a good unlock because Gen Studio actually brings this all together in the enterprise in a way that nobody else can. And so when we think about Firefly services, you think about the custom models, you think about the ability to move all of that into campaigns at pace, we are seeing significant traction in that particular space. So you know, the business is going through a change as it relates to the lower end. But for the core creative as well as for the enterprise, it's actually, you know, headed absolutely in line with our expectations. With good acceleration. And on the consumer communicator space, I think the traction that we're seeing with Express on proliferation also gives us a lot of optimism for how that part of the business is also doing well. And so, you know, we take our target seriously. It's the beginning of the year. We wanna go keep executing and innovating on it. To the point that I think you as well as others have asked, is there, you know, opportunity in the growth agenda, not just to think about the innovation and the offerings, but to make sure that as we tier these, that the pricing and the value is appropriate, absolutely. And, you know, I think you'll continue to see us. I think David mentioned that in his prepared remarks as well as Dan did. That you'll see us also have new tiered offerings. That reflect that value that we're providing. To the creative pro as well as to the business segment."
},
{
"speaker": "Keith Weiss",
"content": "Excellent. Thanks for the feedback."
},
{
"speaker": "Operator",
"content": "And moving on to Keith Bachman with BMO."
},
{
"speaker": "Keith Bachman",
"content": "Hi. Thank you very much. I wanted to ask David to you if I could on Doc Cloud specifically. Growth was certainly strong this quarter. And I just wanted to understand some of the context associated with durability. And if you could break it into some of the parts, it looks like your monthly active users, it continues to grow well. And in addition to that, how are you thinking about leveraging the value there in terms of price, specifically within the growth of Doc Cloud. And again, the broader question is just on the durability of Doc Cloud grew 23% over the course of the quarter in terms of ARR, trying to understand how durable it is and what the pieces are, and then I have a follow-up."
},
{
"speaker": "David Wadhwani",
"content": "Yeah. I think Document Cloud has been, you know, if you think about the fact that we're 40 years into this business, it's really just the foundation is the fact that PDF has become the de facto standard for unstructured data. The world. And Adobe and Acrobat are the most trusted providers of solutions for that, and that's really what is the foundation of what is driving the business, including the fact that it's the most secure platform for leveraging and accessing the content. I think what is there are two things that are really the growth drivers of this business or a number of things. First is exactly like you said. I mean, monthly active users and free and paid is a key stat that we keep looking at. You know, we are very effective at picking free users of Reader and converting them to paid users of Acrobat. And we continue to do that across more surfaces that used to be predominantly a focus on desktop applications. As we've noted in the past, we now have edge integrations, Chrome integrations. We're also available in Teams. We're also available on mobile devices for, you know, iOS and Android. And the mix of all those continue to grow on a monthly basis. Of the things that we are doing to drive that growth is helping people see the value of sharing a link to the PDF as opposed to sharing the document itself, that in doing so, you get a lot more control in terms of the conversation and feedback and review around that. But it also drives the fact that the recipient is then guaranteed to be viewing the PDF in an Adobe surface that we can then use to close that viral loop and drive, you know, further top of funnel opportunity to convert. So that foundation is very strong. In addition to that, AI Assistant has been really a phenomenal ad, you know, unlike many other players in the space, we don't require significant, you know, security and governance reviews because people can have conversations around the documents that they view. And one of the big things that I think has been unlocked this year is moving not just by looking at a PDF that you happen to be viewing, but being to look at and have a conversation with multiple documents, some of which don't even have to be PDF. So that transition and that, you know, gives us the ability to really take Acrobat and make it more of a general-purpose productivity platform. And that's really what drove the adoption that we saw in education this year. So another way of saying that the core foundation of Acrobat continues to be strong and is actually getting stronger with the MAO increasing. But the new value we're adding with AI Assistant takes Acrobat to an entire new level in terms of value."
},
{
"speaker": "Shantanu Narayen",
"content": "Maybe the thing I'll add to that is the durability of that to your point in languages as we roll that out in languages. As we roll it out across multiple documents, and as we roll it out in enterprises and B2B specifically. So again, significant headroom in terms of the innovation agenda of how Acrobat can be made even more meaningful as a knowledge tool within the enterprise."
},
{
"speaker": "Keith Bachman",
"content": "Okay. It just sort of leads into my follow-up question if I could sneak it in as we've talked about during the course of this call tonight the various drivers of growth for ARR. And I just wanted to specifically ask about consumption as we think about FY2025 and the question is, is that gonna be a contributor towards ARR growth, or should investors really be thinking about trying to match my seats, if you will, and really shouldn't it be about consumption being additive growth in 2025. That's it for me. Thank you."
},
{
"speaker": "Shantanu Narayen",
"content": "I think, Keith, you're gonna see, quote-unquote, consumption, add to ARR, in two or maybe three ways more so in 2025 than in 2024. The first, and David alluded to this, is if you have a video offering and that video offering that will be a pure consumption, you know, pricing associated with it. I think the second is in Gen Studio and for enterprises. And what they are seeing with respect to Firefly services, which again, I think David touched on, you know, how much momentum we're seeing in that business. So that is in effect a consumption business as it relates to the enterprise. So, you know, I think that will also continue to increase. And then I think you'll see us with perhaps, you know, more premium price offering. So the intention is that consumption is what's driving the increased ARR, but it may be as a result of tier in the pricing rather than a consumption model where people actually have to monitor it. So it's just another way much like AI assistance is of monetizing it. It's not like we're gonna be tracking every single generation for the user. It'll just be at a different tier. And we think that that's both a better way to deliver value as well as to get the monetization."
},
{
"speaker": "Operator",
"content": "And moving on to Brad Zelnick with Bank of America."
},
{
"speaker": "Brad Zelnick",
"content": "Okay. Wonderful. Thank you. I'll ask a question, David, of you, please. You in the past, you've provided some good color. It sounds like there's momentum there. It seems like this would be the year with all the Firefly services integration into the core franchises. We could see some acceleration and conversion of that funnel. So we'd love to get some update from you on that effort and how you see that unfolding throughout the year. Thank you."
},
{
"speaker": "David Wadhwani",
"content": "For a second, you actually cut out. And so you said Firefly. We heard that. Did you mention any other product before we answer that question, Brad, just to make sure we capture your question?"
},
{
"speaker": "Brad Zelnick",
"content": "Really just Firefly services across all the franchises, you know, Photoshop, Lightroom, etcetera. You know, what could that integration effort do to the conversion activity with the top of funnel?"
},
{
"speaker": "David Wadhwani",
"content": "Yeah. So a number of So first of all, you're exactly right in terms of, you know, Firefly is a platform and a foundation that we're leveraging across many different products. As we talked about, everything from Express and Lightroom and even in Acrobat on mobile, for our broad base, but then also in our core creative products. Photoshop, Illustrator, Premiere, and, you know, as we've alluded to a number of times on this call with the introduction of video, even a standalone offer, for Firefly that we think will be, you know, more valuable from a tiering perspective there. And then into Firefly services through APIs and connection to Gen Studio. So we are looking at leveraging the power of this AI foundation in all the activities. As it relates to top of funnel and conversion, we're very excited. Let's start with new users and more closer to the low end of the market. We're very excited with the signal we're getting from Express and Lightroom on mobile and web. Again, you know, as we've talked about Express is seeing some really good new user acquisition. We added 4,000 new businesses this year. We increased education, you know, access by 84% this back to school versus last back to school. We're seeing, you know, really strong adaption through social, digital, mobile traffic as well. So we see that when we invest in mobile and web, we are getting some very positive signals. In terms of user adoption and user conversion rates. So we're using Firefly very actively to do that. And by the way, the fact that Firefly continues to be the only commercially safe, you know, model integrated into these apps does matter when it comes to, as I said, adding 4,000 new businesses. The second thing is we are seeing in the core creative business, when people try something like Photoshop, the onboarding experience is faster to success because of the use of generative AI and generative capabilities. So you'll start to see us continuing to drive more proliferation of those capabilities earlier in the user journeys, and that has been proven very productive. But we also noticed that more people use generative AI, again, we've always had good retention rates, but the more people use AI, the longer they retain as well. And so we are definitely leveraging generative AI for that entire flow in the funnel."
},
{
"speaker": "Operator",
"content": "And as we're past the top of the hour, I just have time for one more question. Thank you."
},
{
"speaker": "Operator",
"content": "And that question will come from Jay Vleeschhouwer with Griffin Securities."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Thank you. Good evening. Dan, you noted that your current RPO was up 13% in the quarter. Which results in a 10% three-year CAGR for current RPO. Would you expect that over time or at least in fiscal 2025, that your current RPO growth be closer to what you just reported for Q4 or might revert more to the lower three-year CAGR? And then for David, if I could, just since there were so many mentions of tiered offerings, is the concept there more around functionality at the product level as compared to the olden days of tiering that was more about segmentation and packaging, as in the old CS days or is it more currently around the functionality that you're offering on a product-by-product basis?"
},
{
"speaker": "Dan Durn",
"content": "Yeah. Thanks, Jay. And what I definitely don't wanna do is get into guiding of CRPO. But when I take a step back and think about the rhythm and flow of the business, what we're seeing on the enterprise side, winning large transformational deals, exiting the year with the largest bookings quarter ever, having premium tiers in that product portfolio momentum around AEP and apps continuing to grow at scale, when we think about content supply chain and bringing cross-cloud opportunities together that really get at meaningful pain points of customers over time. And then we think about the innovation that we're driving through the digital media business, I feel really good about our ability to continue to drive the business going forward, and I'm very encouraged by what I see."
},
{
"speaker": "David Wadhwani",
"content": "Yeah. And then just adding on briefly to the question on tiering. Yeah, Jay. It's if you think about what we've done over the last year, there's been a bit of experimentation. Obviously, a the generative credits model. What we saw with Acrobat was this idea of, you know, it's a separate package and separate SKU that created a tier. That people were able to access the feature through. And as we learn from all of these, we think, as Shantanu had mentioned earlier, that the right tiering model for us is gonna be a combination of feature, access to certain features, and usage limits on it. So the higher the tier, the more features you get and the more usage you get of it."
},
{
"speaker": "Shantanu Narayen",
"content": "And since that was the last question, let me again maybe in quick summary just talk about first, you know, we had a strong 2024. But I think that really sets us up even better for a strong 2025. Given the innovation that we've had, I think as it relates to all three businesses that we have, the Creative Cloud with everything that we've done around AI, we have a lot of momentum going into the business and a really great diverse portfolio in terms of both the customers as well as our offerings. Acrobat continues to perform really well with AI Assistant as we bring it to other languages, get more vertical, use cases for that particular solution and extend it beyond a single document, we continue to think that the Document Cloud has significant opportunity ahead of us. And I think bringing that all together with digital experience, Q4 was really an extremely strong quarter as it related to us bringing all these solutions together in Gen Studio. I think much like we did with AEP and apps and data and have driven that to a billion-dollar business. I feel just the same amount of excitement with what we can do with content and AI and how we can accelerate the creation of that all the way from ideation to the multiple variation that's required. So we look forward to sharing more with you. At the end of our Q1, but in the interim, thank you for joining us. And happy holidays."
},
{
"speaker": "Operator",
"content": "Thank you. That does conclude today's conference. We do thank you for your participation today."
}
] |
adbe | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day and welcome to the Q3 FY'24 Adobe Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Jonathan Vaas, VP of Investor Relations. Please go ahead."
},
{
"speaker": "Jonathan Vaas",
"content": "Good afternoon and thank you for joining us. With me on the call today are Shantanu Narayen, Adobe's Chair and CEO; David Wadhwani, President of Digital Media; Anil Chakravarthy, President of Digital Experience; and Dan Durn, Executive Vice President and CFO. On this call, which is being recorded, we will discuss Adobe's third quarter fiscal year 2024 financial results. You can find our press release, as well as PDFs of our prepared remarks and financial results, on Adobe's Investor Relations website. The information discussed on this call, including our financial targets and product plans, is as of today, September 12, and contains forward-looking statements that involve risk, uncertainty and assumptions. Actual results may differ materially from those set forth in these statements. For more information on those risks, please review today's earnings release and Adobe's SEC filings. On this call we will discuss GAAP and non-GAAP financial measures. Our reported results include GAAP growth rates as well as constant currency rates. During this presentation, Adobe's executives will refer to constant currency growth rates unless otherwise stated. Non-GAAP reconciliations are available in our earnings release and on Adobe's Investor Relations website. I will now turn the call over to Shantanu."
},
{
"speaker": "Shantanu Narayen",
"content": "Thanks, Jonathan. Good afternoon and thank you for joining us. Adobe had an outstanding third quarter. We saw strength across Creative Cloud, Document Cloud and Experience Cloud, achieving revenue of $5.41 billion, representing 11% year-over-year growth. GAAP earnings per share for the quarter was $3.76 and non-GAAP earnings per share was $4.65, representing 23% and 14% year-over-year growth, respectively. Our success reflects our strong execution against an ambitious innovation agenda to deliver value to our customers. The product advances we've launched in the past 18 months are delighting a huge and growing universe of users and enterprises, empowering them to unleash their creativity, accelerate document productivity and power their digital businesses. Our vision revolves around Adobe's deep technology platforms across Creative Cloud, Document Cloud and Experience Cloud which, when integrated, provide significant differentiation and value. We are amplifying creativity and productivity by enabling the convergence of products like Photoshop, Express and Acrobat as knowledge workers and creatives seek to make content more compelling and engaging. We're bringing together content creation and production, workflow and collaboration and campaign activation and insights across Creative Cloud, Express and Experience Cloud. New offerings including Adobe GenStudio and Firefly Services empower companies to address personalized content creation at scale with agility and enable them to address their content supply chain challenges. Adobe's customer-centric approach to AI is highly differentiated across data, models and interfaces. We train our Firefly models on data that allows us to offer customers a solution designed to be commercially safe. We have now have released Firefly models for Imaging, Vector and Design and just previewed a new Firefly Video model. Our greatest differentiation comes at the interface layer with our ability to rapidly integrate AI across our industry-leading product portfolio, making it easy for customers of all sizes to adopt and realize value from AI. Firefly-powered features in Adobe Photoshop, Illustrator, Lightroom and Premiere Pro help creators expand upon their natural creativity and accelerate productivity. Adobe Express is a quick and easy create-anything application, unlocking creative expression for millions of users. Acrobat AI Assistant helps extract greater value from PDF documents. Adobe Experience Platform AI Assistant empowers brands to automate workflows and generate new audiences and journeys. Adobe GenStudio brings together content and data, integrating high-velocity creative expression with the enterprise activation needed to deliver personalization at scale. Overall, we're delighted to see customer excitement and adoption for our AI solutions continue to grow and we have now surpassed 12 billion Firefly-powered generations across Adobe tools. I'll now turn it over to David to discuss the momentum in our Digital Media business."
},
{
"speaker": "David Wadhwani",
"content": "Thanks, Shantanu. Hello everyone. In Q3, we achieved net new Digital Media ARR of $504 million and revenue of $4 billion, which grew 12% year-over-year, fueled by innovation in both our Creative and Document businesses. With Document Cloud, we continue to reinvent how people create, edit, share, review and sign digital documents with PDF and Acrobat across mobile, web and desktop. For decades, PDF has been the de facto standard for storing unstructured data, resulting in the creation and sharing of trillions of PDFs. The introduction of AI Assistant across Adobe Acrobat and Reader has transformed the way people interact with and extract value from these documents. In Q3, we released significant advancements including the ability to have conversations across multiple documents and support for different document formats, saving users valuable time and providing important insights. We're thrilled to see this value translate into AI Assistant usage, with over 70% quarter-over-quarter growth in AI interactions. In addition to consumption, we're focused on leveraging generative AI to expand content creation in Adobe Acrobat. We've integrated Adobe Firefly image generation into our Edit PDF workflows. We've optimized AI Assistant in Acrobat to generate content fit for presentations, emails and other forms of communication. And we're laying the groundwork for richer content creation, including the generation of Adobe Express projects. The application of this technology across verticals and industries is virtually limitless. Tata Consultancy Services recently used Adobe Premiere Pro to transcribe hours of conference videos and then used AI Assistant in Acrobat to create digestible event summaries in minutes. This allowed them to distribute newsletters on session content to attendees in real time. We're excited to leverage generative AI to add value to content creation and consumption in Acrobat and Reader in the months ahead. Given the early adoption of AI Assistant, we intend to actively promote subscription plans that include generative AI capabilities over legacy perpetual plans that do not. In Q3, we achieved Document Cloud revenue of $807 million, growing 18% year-over-year. We added $163 million of net new Document Cloud ARR. Other highlights include. Expanded Acrobat customer value with multi-document support for AI Assistant, enhanced meeting transcript capabilities and support for larger documents. Optimized AI Assistant for mobile, web, and desktop experiences, including voice-enabled conversations on Android. Continued strength of PDF-based collaboration, with shared links growing greater than 70% year-over-year. Increased top of funnel through Acrobat Web, with monthly active users growing over 35% year-over-year as a result of link sharing and our Microsoft Edge and Google Chrome extensions. Key enterprise customer wins include Amazon, Charles Schwab, Disney, Home Depot, KPMG, RedBull, Sutter Health and the US Treasury Department. With Creative Cloud, the demand for creative expression and design across media types and surfaces has never been greater. Consumers are sharing edited photos more than ever. Students need to create school presentations that stand out. Creative professionals are being asked to create more images, designs and videos faster than ever before. Small businesses are looking to engage prospects on social channels. And large enterprises are defining their content supply workflows to deliver personalization at scale. AI has the potential to empower creative professionals, communicators, consumers and organizations of all sizes to be more creative and productive. Our strategy is to build technology that will create more streamlined and precise workflows within our tools, through features like Text-to-Template in Express, Generative Fill in Photoshop, Generative Recolor in Illustrator, Generative Remove in Lightroom and the upcoming Generative Extend for video in Premiere Pro. We're exposing the power of our creative tools and the magic of generative AI through Firefly Service APIs so organizations can generate and assemble content at scale. As we integrate Firefly innovations throughout our tools, usage continues to accelerate, crossing 12 billion generations since launch. The introduction of the new Firefly Video model earlier this week at IBC is another important milestone in our journey. Our video model, like the other models in the Firefly Family is built to be commercially safe, with fine-grained control and application integration at its core. This will empower editors to realize their creative vision more productively in our video products, including Premiere Pro. With Express, we're on a multi-year strategic journey to dramatically expand our reach across customer segments. Adobe Express is our AI-first content creation application fulfilling our mission to enable creativity for all. The all-new release of Express across web and mobile earlier this year has been embraced by millions of users. They love how easy it is to create anything in Express with strong enthusiasm for our image editing features, powered by Photoshop, video editing capabilities, powered by Premiere Pro, document and presentation workflows, powered by Acrobat, and unparalleled generative AI features, powered by Adobe Firefly. Our integration of Adobe Stock and design templates with our unique Firefly Design Model ensures that content created in Express can stand out. Express empowers a broad array of individuals and businesses, from solopreneurs to the largest enterprises in the world. We're continuing to grow Express as we ramp our go-to-market activities to support recent product releases, including Express for individuals, Express for Education, Express for Teams and Express for Enterprises. As a result, in Q3 we drove 70% year-over-year growth in cumulative exports. We onboarded over 1,500 businesses and millions of students. In Q3, we achieved $3.19 billion in revenue, which grew 11% year-over-year in constant currency. Net new Creative Cloud ARR was $341 million. Other highlights include. New AI-powered features in Photoshop that accelerate core creative workflows and streamline repetitive tasks. Generative Fill in Photoshop was upgraded to Firefly Image 3, Generative Image was made generally available, and the new Selection Brush and Adjustment Brush Tools were introduced, making selective edits easier than ever. Broad-based innovations in Illustrator, including significant improvements to vector generation, enhancements to text-to-pattern and the all-new Generative Shape Fill. These advances unlock new ways for pro designers and illustrators to quickly bring their vision to life. Strong adoption of the latest version of Lightroom and Lightroom Mobile, which now includes the new Generative Remove feature. Millions of users have non-destructively removed unwanted objects from their photos with a single click. Strong demand for Firefly Services, which provide APIs, tools and services for content generation, editing and assembly, empowering organizations to automate content production while maintaining quality and control. Total API calls tripled quarter-over-quarter. Acrobat Pro single app continues to be a growth driver in Creative Cloud, reflecting the increasing adoption of PDF as a preferred format to create, collaborate and share visually compelling content. Key enterprise customer wins include The Brandtech Group, Dentsu, Estee Lauder, Google, MediaMonks, Meta, MLB, Newell Brands, PepsiCo, Stagwell Group and the US Navy. We look forward to hosting Adobe MAX, the world's largest creativity conference, next month in Miami, where we will welcome more than 10,000 members of our global community and engage with hundreds of thousands more online. We will hear from inspiring creators and unveil innovations across our clouds. In summary, we are excited about the pace and caliber of innovations across our Digital Media products and the continued execution across multiple growth drivers. I'll now pass it to Anil."
},
{
"speaker": "Anil Chakravarthy",
"content": "Thanks, David. Hello everyone. In Q3, we achieved Experience Cloud revenue of $1.35 billion. Subscription revenue was $1.23 billion, representing 12% year-over-year growth. Customer Experience Management remains top of mind for B2C and B2B companies around the world as they focus on digital strategies for customer acquisition, engagement, retention and expansion. Enterprises want an integrated platform to deliver personalized experiences at scale to their customers while maximizing the ROI of their marketing and customer experience investments. Through the integration of Experience Cloud and Creative Cloud, Adobe is uniquely positioned to combine the right content, data and journeys in real time for every customer experience. The revenue growth we are driving across our categories content, commerce and workflows, data insights and audiences, and customer journeys, all built on the Adobe Experience Platform, demonstrate the strength of our business. Global brands trust Adobe to build their content supply chain and deliver personalization at scale, making us the number one digital experience platform in the industry. Customers are embracing the opportunity to address their content supply chain challenges with Adobe GenStudio. With native integrations across Experience Cloud and Creative Cloud, GenStudio empowers marketers to quickly plan, create, store, deliver and measure marketing content and drive greater efficiency in their organizations. Financial services leader Vanguard is creating an integrated content supply chain to serve the strategic goal of deepening their relationships with a broad range of investors. Leveraging the GenStudio solution, Vanguard was able to increase quality engagement by 176% by focusing on one-to-one personalization and to realize millions in savings by improving content velocity and resource allocation with an end-to-end content creation workflow. Other highlights include. The general availability of Adobe Content Hub, further enhancing the value of Adobe Experience Manager Assets. Content Hub enables brands to reimagine how creative assets are used across their organization and with external agencies, driving content velocity and major efficiency gains. AEM Assets is used by the majority of the Fortune 50, including 8 of the 10 largest media companies, 9 of the 10 largest financial services companies and 8 of the 10 largest retailers. Increasing importance and adoption of Workfront to streamline workflows across marketing organizations and agencies. We extended our leadership in this category through the general availability of Adobe Workfront Planning, which delivers a comprehensive view of all marketing activities in an organization and enables teams to optimize marketing planning and execution. Global brands including Deloitte, Interpublic Group and NASCAR are using Workfront Planning to drive productivity gains and meet the rising demand for highly personalized marketing campaigns. Continued momentum for Adobe Experience Platform and native applications including Real-Time Customer Data Platform, Customer Journey Analytics and Adobe Journey Optimizer. We expanded our AEP portfolio with the general availability of Adobe Journey Optimizer B2B Edition, which leverages generative AI to deliver personalized experiences to buying groups, the decision-makers, practitioners and stakeholders responsible for major purchasing decisions. Strong industry analyst recognition, including the Forrester Wave for B2B Revenue Marketing Platforms, and three IDC Marketscape reports across Digital Asset Management and Headless Digital Commerce for both Enterprise and Mid-Market. Key customer wins include Dentsu, Home Depot, Humana, IBM, Johnson & Johnson, Mayo Clinic, Newell Brands, Premier League, Stagwell Group, TD Bank and UPS. We look forward to unveiling new customer experience management innovations across content, data and journeys at MAX next month, showcasing integrations across Express, Creative Cloud and Experience Cloud for freelancers, solopreneurs and marketers across agencies and enterprises. Our pace of innovation, commitment to customer value, global partner ecosystem, and category-defining solutions position us to continue our market leadership. I will now pass it to Dan."
},
{
"speaker": "Dan Durn",
"content": "Thanks, Anil. Today I will start by summarizing Adobe's performance in Q3 fiscal 2024, highlighting growth drivers across our businesses, and I'll finish with financial targets. In Q3, Adobe achieved record revenue of $5.41 billion, which represents 11% year-over-year growth as reported and in constant currency. Our focus on both growth and profitability has been a cornerstone of our operating philosophy for years, rooted in strategic prioritization, relentless innovation, and laser-focused execution. Our Q3 results reflect this approach. We're making significant investments in our technology platforms, launching global campaigns to expand our customer base, and attracting top-tier talent, while delivering world-class cash flows and profitability. Third quarter business and financial highlights included. GAAP diluted earnings per share of $3.76 and non-GAAP diluted earnings per share of $4.65. Digital Media revenue of $4.00 billion. Net new Digital Media ARR of $504 million. Digital Experience revenue of $1.35 billion. Cash flows from operations of $2.02 billion and RPO of $18.14 billion exiting the quarter. In our Digital Media segment, we achieved Q3 revenue of $4.00 billion, which represents 11% year-over-year growth or 12% in constant currency. We exited the quarter with $16.76 billion of Digital Media ARR, growing our ending ARR book of business 13% year-over-year in constant currency. Adobe achieved Document Cloud revenue of $807 million, which represents 18% year-over-year growth as reported and in constant currency. We added $163 million of net new Document Cloud ARR, which was a record for a Q3, growing our ending ARR book of business 24% year-over-year in constant currency. Q3 Document Cloud growth drivers included. Usage and MAU growth across Adobe Reader and Acrobat. Usage and MAU growth via third-party ecosystems, including Google Chrome and Microsoft Edge extensions, which are driving free-to-paid conversion. Demand for Acrobat desktop and mobile subscriptions across all customer segments and Geographies. Strength in monetization of our AI Assistant with new Acrobat subscriptions. Strength in SMBs driven by our reseller partner network and strength in enterprise and public sector sales, with a number of large deals closing in the quarter. We achieved Creative revenue of $3.19 billion, which represents 10% year-over-year growth or 11% in constant currency. We added $341 million of net new Creative ARR in the quarter, growing our ending ARR book of business 11% year-over-year in constant currency. Q3 Creative growth drivers included. New subscriptions for Creative Cloud All Apps across customer segments, including Teams, Enterprise, and Education with back-to-school demand. Strength across our Acrobat Pro, Illustrator, Lightroom and Photoshop single apps on Adobe.com. Growing demand for our AI-first Adobe Express offerings in mobile, emerging markets and Education. Early monetization of our new Firefly Services solution in the enterprise segment. Continued momentum with new subscriptions in emerging markets and contribution from customers stepping up to our higher-value Creative plans at renewal. Turning to our Digital Experience segment, in Q3 we achieved revenue of $1.35 billion, which represents 10% year-over-year growth as reported and in constant currency. Digital Experience subscription revenue was $1.23 billion, growing 12% year-over-year as reported and in constant currency. Q3 Digital Experience growth drivers included. Strong subscription revenue growth at scale of AEP and native applications, up greater than 50% year-over-year. Strong subscription revenue growth with Adobe Experience Manager and Workfront. Success in booking transformational deals as well as individual solution selling. Continued strength in retention and expansion across our enterprise customers and growing pipeline for our GenStudio solutions to address the content supply chain opportunity. Turning to the income statement and balance sheet. In Q3, Adobe delivered year-over-year EPS growth of 23% on a GAAP basis and 14% on a non-GAAP basis. This was primarily driven by revenue growth and disciplined prioritization of our investments, which resulted in operating margin strength in Q3. The company continues to deliver world-class margins while making significant investments in AI model training and inferencing capacity. Adobe's effective tax rate in Q3 was 17.5% on a GAAP basis and 18.5% on a non-GAAP basis. RPO exiting the quarter was $18.14 billion, growing 15% year-over-year as reported or 16% in constant currency. Current RPO grew 12% year-over-year exiting the quarter. Our ending cash and short-term investment position at the end of Q3 was $7.52 billion and cash flows from operations in the quarter were $2.02 billion. In Q3 we entered into a $2.5 billion share repurchase agreement and we currently have $20.15 billion remaining of the original $25 billion authorization granted in March 2024. We will now provide Q4 targets, which factor in current macroeconomic conditions and year-end seasonal strength. For Q4 we are targeting. Total Adobe revenue of $5.50 billion to $5.55 billion. Digital Media net new ARR of approximately $550 million. Digital Media segment revenue of $4.09 billion to $4.12 billion. Digital Experience segment revenue of $1.36 billion to $1.38 billion. Digital Experience subscription revenue of $1.23 billion to $1.25 billion. Tax rate of approximately 16% on a GAAP basis and 18.5% on a non-GAAP basis. GAAP earnings per share of $3.58 to $3.63 and non-GAAP earnings per share of $4.63 to $4.68. In summary, I am proud of our year-to-date performance, which stems from a powerful combination of product leadership, rapid innovation, diversified business and financial discipline. Given the massive markets we are catalyzing, I am confident in our ability to drive growth and industry leadership. Shantanu, back to you."
},
{
"speaker": "Shantanu Narayen",
"content": "Thanks, Dan. Adobe's focus on responsible innovation, with customers at the center, continues to be a unifying purpose for the company. The Content Authenticity Initiative, which we founded in 2019, now counts over 3,300 members across the digital ecosystem, all committed to enhancing trust and transparency with Content Credentials. In five years, this mission has gone from a vision to reality with companies including Amazon, Google, Leica, Meta, Qualcomm, Sony, TikTok and others all committing to implementing Content Credentials. The US Department of Defense became the first federal government agency to implement Content Credentials by applying them to official DoD images. We're teaming up with Governor Gavin Newsom on a new initiative to boost digital and media literacy skills in K-12 schools and higher education institutions in California. By providing educational content, programming, and resources to schools across the state, we can help empower California's future workforce for success in an AI-powered world and use this as a blueprint for other states and countries. Next week, we will bring employees together for our annual Adobe for All conference to celebrate our vision and purpose and the impact that has on our customers and communities. I am confident that Adobe's culture, innovative product roadmap, global market opportunity, trusted brand and the unwavering commitment of our employees will continue to drive our success. Thank you and we will now take questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] And the first question will come from Alex Zukin with Wolfe Research."
},
{
"speaker": "Alex Zukin",
"content": "Hey, guys. Thanks for taking my question and congrats on what looks like a very strong quarter. It's one question, but it's a two-parter. The quarter itself, particularly on the Digital Media ARR looked very strong. It looked unseasonably strong because you haven't grown net new ARR sequentially in the 3Q, I think, in almost four years. So maybe just comment like what drove this unseasonable strength. Is it pricing, AI traction, and particularly the Document Cloud net new ARR? But at the same time given all the product momentum you went through in the script, it's a bit confusing to understand why the Q4 guide is the lowest it's ever been sequentially for Q4 on net new Digital Media ARR, which I think makes people a little nervous about maybe the go-forward, the next year performance. And so maybe just address this dichotomy because it looks kind of seasonally a little bit different than what we're used to. And I think it's weighing on the stock after hours."
},
{
"speaker": "Shantanu Narayen",
"content": "I'm happy to start Alex and then David can certainly also add to that. I mean, to your point, we had a strong quarter, when I think about Digital Media, Document Cloud to the point that you made, Acrobat continues to perform the AI Assistant, and the SKU that we have associated with Acrobat continues to perform well. As we had said, we expect Creative to show a growth-on-growth year-over-year, and so that also played out exactly as we expected. And you know it was a strong end, when you look at it as it relates to the last few weeks' performance, we saw the typical strength that we would see going into Q4. I can see how you're saying, you're looking at the sequential guide. We're looking at it and saying it's the strongest ever Q4 target that we have put out there for Q4, Alex. And so I think we just continue to focus. We would expect Creative to again grow when you talk about growth-over-growth, net new ARR in Q4. And all of the new initiatives that we're talking about, AI, et cetera, continue to perform. So from our perspective, when we look at what we guided to the second half of the year, to your point, Q3 is stronger. We expect a seasonally strong Q4 and then continued innovation should continue to drive growth."
},
{
"speaker": "David Wadhwani",
"content": "Yeah and maybe I'll just add a couple of things to what Shantanu, said. Again, just a little bit more context behind the strength in Document Cloud. Obviously, link sharing and what we've done with reader distribution across mobile, web, and desktop, that's really what continues to drive this business, and that underlying strength is going to continue not just in Q3, but it's going to be something that we're able to bet on and grow on going forward because we've got a lot of flow optimizations associated with that. As we look at Creative Cloud, again, we have a broader set of offerings than we've ever had, right? We have things like with Creative Cloud, we have higher-value, higher-priced offers, thanks to AI innovation that's happening in the base plans that are impacting how the Creative Cloud business is doing. We also have a broader set of offerings than we've ever had now with web and mobile, including Premium and lower-priced offerings that are driving more proliferation. And the blend of those two things also sort of comes into the strength of the quarter and how we see things going out. But as you look at the second half overall, we came into the second half with a strong expectation of how the second half is going to play out. And frankly, it's playing out as we expected in terms of the aggregate Q3, Q4 numbers. In terms of the specifics on timing, Q3 was a little stronger than you expected, and for a good reason given seasonality. I think a lot of that can be explained by a few deals that would have historically just closed in Q4, closing earlier than expected in Q3, and that changed the dynamic in terms of the linearity that you would typically see between Q3 and Q4."
},
{
"speaker": "Alex Zukin",
"content": "Very helpful guys. Thanks again."
},
{
"speaker": "Operator",
"content": "And our next question will come from Mark Murphy with JPMorgan."
},
{
"speaker": "Mark Murphy",
"content": "Thank you so much and I'll have my congrats. David, I'm wondering if you can compare the AI monetization opportunity that you're sensing with the image models relative to the future potential with your audio and video models, just for instance, how many tokens might be consumed when someone is generating a video versus an image. And then tying in with that, just how optimistic are you maybe being able to solve some of the limitations with the current video generation models where the facial expressions can lack realism or they can't handle the object interactions or they don't provide enough detail or resolution in the videos?"
},
{
"speaker": "David Wadhwani",
"content": "Yes. Happy to take that. Let me just sort of take a little bit of a step back and talk about the core strategy that we have for AI and the conversion then in terms of how we think about monetization. So I think we've been incredibly consistent with what we've said dating back a year, year and a half ago where we talked about the fact that we were going to develop the broadest set of models for the creative community and we were going to differentiate the models based on quality, commercial safety, integrateability into our tools and controllability. And as you've seen very methodically over the last 18 months, we continue to bring more and more of that innovation to life. And that fundamentally is working as we've now started to integrate it much more actively into our base. If you look at it with photography, we now have in our tool generative remove, we have AI-assisted edits. In design, we have Generative Pattern, Generative Fill Shape. We have, in Photoshop, we have Gen Remove. We also have Gen Fill and I can continue on with all the generations, but we've also now started to integrate it in Firefly services for what we're enabling enterprises to be able to access and use in terms of batchwork and through APIs. If you look at sort of how that's played out, as we talked about, we're seeing accelerated use and generative credits being consumed because of that deeper integration into all of our tools. And that is playing out as we expected. When you look at then how that converts to monetization, first and foremost, we've integrated it, a lot of that value into our core products and with more value and more pricing. We're also seeing that when people use these generative features, they retain better. We're also seeing that when people come to Adobe to try our Creative Cloud applications or Express application, they're able to convert better. And so there are all these ancillary implied benefits that we're getting. But in terms of direct monetization, what we've said in the past is that the current model is around generative credits, which is, I think, where you're going with this. And we do see with every subsequent capability we integrate into the tool, total credits consumed going up. Now, what we are trying to do as we go forward, we haven't started instituting the caps yet. And part of this is, as we've said all along, we wanted to really focus our attention on proliferation and usage across our base. We see a lot of users excited about it. It's some of the most actively used features that we've ever released. And we want to avoid the generation anxiety that people feel. But we're watching very closely as the economy of generative credits evolves. And we're going to look at instituting those caps at some point when we feel the time is right and/or we're also looking at other alternative models. What we did with Acrobat AI Assistant has proven to be very effective. And so we're also considering other opportunities like having standard CC plans that have a core set of generative capabilities, but also having premium API, sorry, premium AI plans that will include things more like video and other things. So, we're very happy about the innovation that's coming. And we see the opportunity to engage very deeply in the monetization. But we want to play it out over time and proliferation continues to be our primary guide. And then lastly, in terms of quality, I don't know if you had a chance to see some of the videos we put out there, integrated directly into Premiere, also text to video, image to video, more controllability. We have also the ability now to generate not just scenes with humans and dogs and organic animals, but all these like overlays and things that creative professionals actually want to work with. And so we're very excited about the set of things that they can get out of the box and get going. And human faces and things will just continue to get better. We have a lot of great research that you'll start to see. And I hope you get to play with the models because we've taken a huge step forward there."
},
{
"speaker": "Shantanu Narayen",
"content": "Mark, maybe I'll just add a little to what David said, which was great. I spent a couple of hours with our video team. They have just absolutely hit it out of the park. I mean, the work that they've done, which is leveraging the image models with video. And again, I think to David's point, the integration with Premiere, that's what we've always said. It's the integration of the model and the application that differentiates it. I think when other models first came out, people were like, wow, you can describe it. That's just such a small part of where the value is. And the real value is you have a video, you want to extend it. It's a game changer in terms of what we can do. So really excited about the stuff that we're doing in video. And again, to David's point, this will be monetized differently from the way we have for images, which was part of the sort of base value pricing. So, the way I answer your question is, and the third thing I would say is, remember, we have the ability to create custom models as well. And so when you ingest the video that people want to edit, the ability to extend that is not just dependent on what the model is, but also on what the new data is. And again, that represents really a unique ability for us. So, hopefully all those three demonstrate why we're leading the pack in terms of how people can derive value in the nonlinear editors, which is where the action is going to be."
},
{
"speaker": "Mark Murphy",
"content": "Thank you very much."
},
{
"speaker": "Operator",
"content": "And moving on to Keith Bachman with BMO."
},
{
"speaker": "Keith Bachman",
"content": "Hi. Thank you very much. I appreciate taking the question. I wanted to pick up a little bit on how we should be thinking about, David, you just mentioned monetization. And will consumption, you think, as we start to turn the year, can consumption contribute to ARR growth as we look at FY'25? Because I think there's pervasive fears that the state of competition may in fact limit your ability to turn on that monetization, if you will, from either consumption or price. And I just wanted to see if you could lace in consumption against the backdrop of competition."
},
{
"speaker": "Shantanu Narayen",
"content": "From our perspective, Keith, I think when you look at what we have with the apps and the models, we just continue to think that's uniquely differentiated. Firefly services, which is, you can think of that also as a consumption model where we have that, it's off to a really good start. Our ability to give enterprises the ability to automate content, create custom models within enterprises, we're seeing real traction because it's a differentiated solution in that it's designed to be commercially safe. And as it relates to the core subscription models, again, David said this, but I'll reiterate it, which is, the core subscription models for products like Photoshop and Illustrator, I think, the differentiation is the combination of the model and the technology. And in video, I think, we will find additional ways to monetize it. So, I'm not sure who specifically you're referring to as it relates to competition in this space, but from our perspective, it's just unique. I mean, if you look at the acceleration of what we've seen of generations in Photoshop, Illustrator, Lightroom, it's clear that we're actually extending the value rather than having other people to catch up."
},
{
"speaker": "David Wadhwani",
"content": "And then one other thing I'd just emphasize there is that the commercial safety is so important to businesses of all sizes frankly and that is something that we feel very, very, very differentiated in addition to everything Shantanu said."
},
{
"speaker": "Keith Bachman",
"content": "Okay, great. And then perhaps for my follow-up, I wanted to pick up on Alex's first question. But you're guiding net new ARR down 3% year-over-year in Q4. And I think investors are, but thereby taking that as perhaps a framework when you look at next year, but is there anything that net new ARR will be down next year? And I know you don't want to give guidance for next year, but just any kind of thoughts you want to address as it relates to the guidance associated with net new ARR being down in Q4 versus a framework that we might want to apply for the FY'25 net new ARR?"
},
{
"speaker": "Shantanu Narayen",
"content": "You're right, Keith. We're not going to give FY'25 guidance. We'll certainly share more at MAX and we would expect like we did last year that at the December earnings call, we'll give color on fiscal '25 ARR, but I'd say a couple of things. First, as it relates to again the performance of the second half because to Alex and your question, if there are questions around Q3 and Q4 and what that trend means, again, we will hope to have record net new ARR in fiscal '24, which I think is a great thing. We gave 1,950 at the end of Q2. We're clearly on track to beat that number, which we take as a positive sign. And the other thing, maybe perhaps, tactically for you folks to think about as well, as it relates to the Q4 guidance, typically, you have Black Friday and Cyber Monday in the same quarter. This time, Cyber Monday, I believe, is in Q1. And so as it relates to our Q4 performance, it's the highest target that we've ever issued. We will go out and then continue to execute and continue to innovate. So that's the way I look at the business, Keith."
},
{
"speaker": "Keith Bachman",
"content": "Okay. Thank you, Shantanu."
},
{
"speaker": "Operator",
"content": "And the next question will come from Saket Kalia with Barclays."
},
{
"speaker": "Saket Kalia",
"content": "Okay, great. Hey, guys, thanks for taking my question. David, maybe for you. You touched on some of the drivers in Document, which was super helpful. But I'd love to maybe go one level deeper into some of the dynamics in that business, which of course continues to grow net new ARR at a really nice clip. So maybe we can just talk a little bit about, are there any pricing headwinds or tailwinds that we should keep in mind specifically for Document Cloud. And also maybe you can give us a sense for sort of where Document Cloud is in its journey to maybe becoming more of a subscription-heavy business. Do those make sense?"
},
{
"speaker": "David Wadhwani",
"content": "The first part does. Let me try to address the whole thing. The question on subscription-heavy, it is a very strong subscription business for us already, but I'll touch on that and hopefully, I'll address your question. So first, if we take a step back and look at Document Cloud, I mean the foundation of everything we're doing here is incredibly strong and it's a machine we've had for a long time, but it continues to perform incredibly well. And what I mean by that is the platform proliferation of what we have with Acrobat and Reader. The fact that we have 40 years into this business, the rise of PDF and PDF becoming the de facto standard for content as a unstructured content as a whole is a remarkable foundation for us to be building on. And the distribution we have across desktop, web, mobile, including web extensions is really the foundation of everything we do because that becomes the top of funnel for us. You layer on top of that the fact that generative AI in general has come out where unstructured content, especially PDF unstructured content, the 3 trillion PDFs out there that we believe are out there has suddenly inherently much more value than it did a year ago. And this whole ecosystem is set up well for us. In addition to that foundation, we've also been over the course of the last few years, really transitioning the way people share because if you think about PDFs and Acrobat in general, one of the most important things people do is they produce the PDF to share it with others, often for comment and review engagement and by increasing sharing via links versus sharing as an attachment, we see a lot more engagement and interaction that we're able to benefit from and that also helps with the top of funnel and we can provide more value. Then on that platform, what we've done is with AI Assistant, we focus on consumption for the last nine months, starting with the ability to look at a single PDF and ask questions of that PDF. Then we sort of then we added support for multi-docs, so you can now have five or six PDFs that you're having a conversation with. We added support for multiple formats. So you can look at PDFs, but you can also drag in Word documents or PowerPoint documents or a link to a meeting transcript that you have. We are adding in the process of adding language support for other languages optimizations. We're now starting to work on document type optimization. So if it's a contract, we know how to optimize the results even better than if it's a marketing document. And that's all about consumption. But in addition to consumption, we're now expanding because these conversations that happen with these documents are inherently about getting some insight and then sharing that insight. We've also started to do things that you can create richer content on the back end of it. So Firefly is embedded now in Edit PDF workflows. We have the conversational content and now able to generate emails and presentations and those kinds of things. We've now embedded in the Convert PDF workflows, the ability to output to Express and create richer media outputs and you can start to see all of this stuff coming together in a very real way already, but also in the months ahead. The last thing I want to say on this too is that what's really working out well for us is that when we are outpitching this opportunity, not just in terms of the individuals that use it, but also businesses, is that we don't have any security concerns, right. Our data governance model is the same data governance model that's happened. If you have access to the documents, you can have conversations with the documents. And so it makes it a much easier thing for enterprises to adopt because there's no systemic or governance changes. And so all of that continues to drive more adoption. And as I said on the prepared remarks, Document Cloud is substantially a subscription business, but now with AI Assistant being available to subscribers and not as directly to perpetual users, we expect that to continue to transition even further."
},
{
"speaker": "Saket Kalia",
"content": "Super helpful. Thanks, guys."
},
{
"speaker": "Operator",
"content": "And the next question will come from Jay Vleeschhouwer with Griffin Securities."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Yeah. Thank you. Good evening. David, I'd like to follow up on something that you said on the second quarter call. And that was that you said at the time that you were for the rest of the year going to quote, pour gas on your GTM, and as well engage in a full-funnel campaign later in the year. So the question is, could you update us on that? I mean, it does seem to be in no small part corroborated by some of your internal investments that we've been able to see, for example, in your ICX team, your go-to-market positions across multiple products, strategy positions and so forth. But you've made this commitment for a substantial expansion, but do you think you need going forward to continually accelerate the pace of investments in go-to-market or do you think at some point, perhaps soon you can begin to taper that off and then leverage that capacity to revenue growth and thereby margin expansion?"
},
{
"speaker": "David Wadhwani",
"content": "Jay, I think, we might have to have you join our marketing organization, given how much you know about the market dynamics. But great question. And so first and foremost, again, if we're going to talk about Express, let's take a little bit of a step back and understand the dynamics of where we are in the evolution. I think what we had talked about in Q2 was that not only do we feel like we have an incredible product now, but that product is built on a brand new platform, that has the ability to develop AI functionality as a native part of that platform. So the speed of innovation that we've been adding capabilities to Express is really been a breakneck speed and we're very excited about that. Features like native integration of Firefly, so that everything that's generated here is commercially safe, which again like I said, is important to individuals and to businesses, but doing it with more control, things like style and structure match and integrated into the image viewer, the video viewer, editor and the design surfaces. So very excited about that. In addition to those basic capabilities that are so foundational, this is really the design model that we've been talking about Firefly design model. This is where it's surfacing the most, and so you combine what we're doing with templates and design model and people are able to create and they effectively get access to an infinite number of templates, right. We believe that we're moving from a template-centric, a set of tools for communicators to an AI-centric set of tools and we feel that with our design model and everything we have, we're fundamentally going to create better content that stands out ultimately. We also have great workflows that we've developed with Photoshop and Illustrator and Acrobat. And we've integrated all of this in ways that are fundamentally effective for businesses, including bulk creation and assembly capabilities. So small businesses all the way through enterprises are able to leverage this for their designer-to-marketer workflows. In addition to all of that innovation, to your point, we've really been focused on the go-to-market since last time. Since we last spoke or right before we last spoke in Q3, we expanded the offer set significantly. We've always had Express for individuals in market, but we added Express for Teams, Express for Enterprise and we just launched Express for Education, this back-to-school year with a lot better support for classrooms and teacher student workflows as well. On the marketing side, we've been ramping that very actively. It's a net new audience to Adobe. I mean, that's something to really recognize. This isn't about shifting existing audience over solely. It's about getting access to a new audience. And so for that, we have to employ both traditional means with a focus on awareness campaign, but also leveraging social, because that's where this audience is. So, you'll see us doing a lot more on social as a result. And then on the back of all that, we're ramping our direct sales. We have a very at-scale inside sales motion that we're starting to lean into. We have a very significant direct sales motion that we have in enterprises and mid-market that we're leveraging. Adobe.com journeys, we have a lot of businesses and individuals coming on Adobe.com and doing a lot more optimization in the App Store. And that's really what you're starting to see in the numbers we shared with strong usage at 70% year-over-year. Cumulative exports, strong business momentum with over 1,500 businesses sold and really great our best back-to-school season ever with millions of students now enabled on it. So, that's the foundation. And if you're, the one thing I would say is, yes, we started pouring gas on it and we're going to pour more gas on it, not less in the months and years ahead."
},
{
"speaker": "Shantanu Narayen",
"content": "Maybe two other things, Jay, just big picture. I mean we continue to invest in all of the key long-term things, whether it's training of models, whether it's Express, whether it's AEP and apps, whether it's GenStudio, while delivering what I think are phenomenal margins. And so we'll continue to make those trade-offs in terms of growth and profitability and maybe a little tongue-in-cheek. Part of the reason why David has the ability to invest as much in marketing is he uses the best marketing technology in the world from Anil."
},
{
"speaker": "Anil Chakravarthy",
"content": "That is true."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And our next question will come from Tyler Radke with Citi."
},
{
"speaker": "Tyler Radke",
"content": "Yes. Thanks very much for taking the question. I wanted to ask you about the Digital Experience side of the business. So RPO looks pretty strong in terms of sequential additions. The implied guide for Q4 was a bit lighter than consensus. I know you did talk about some unusual dynamics in terms of seasonality, Cyber Monday, but could you just talk about the strength and underlying dynamics you're seeing in the business heading into Q4? Thank you."
},
{
"speaker": "Anil Chakravarthy",
"content": "Yes. When we look at the Digital Experience business, we are pleased with the overall execution of the business. We have a big opportunity with what we call personalization at scale where whether it's a B2C company or a B2B company, the ability to deliver personalized customer experiences to consumers or to hundreds of thousands of business customers, individuals within businesses. This is important for every company in the world and we have the integrated platform and the applications to be able to help them deliver those kinds of experiences. And we have the unique ability to bring together the right content, the data, customer data and the customer journeys across our Experience Cloud and the integration with Creative Cloud to deliver those personalized experiences. And that's pretty unique to what we can do at Adobe. And that's one of the things that we are seeing in the dynamic in the enterprise market is the enterprises are scrutinizing all the deals that they want to do. I think in this case, they look at our offerings and see the ability to not only help with growth, they also look at the efficiency gains that we can help them create. And that's helping us as enterprises scrutinize the spend. And when you look at our guide, we're obviously, we are focused on, most closely on our subscription business and that's the business that continues to grow strongly and we're showing good performance on the subscription business. And our overall revenue is a combination of subscriptions and services where we really are focused on working with a broad global partner ecosystem to make sure that we deliver services to our customers and help them realize value from our offerings."
},
{
"speaker": "Tyler Radke",
"content": "Thank you."
},
{
"speaker": "Shantanu Narayen",
"content": "Hey, operator, we're at the top of the hour. We'll sneak in one more question and then wrap up. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. That question will come from Brent Thill with Jefferies."
},
{
"speaker": "Brent Thill",
"content": "Thanks. Dan, just back to the guide. Can we just drill in? I know that you mentioned there were a couple of factors that were at contemplated. I'm just curious if there's anything else that you're seeing that is different in terms of end demand or any softness. I know the US decelerated a little bit, EMEA accelerated."
},
{
"speaker": "Shantanu Narayen",
"content": "No, Brent. I mean I think we had a strong Q3 and we continue to see the momentum in the business. And it's our typical considered targets that we do and I focus on execution. So, we're not seeing anything as it relates to a change in the business dynamics. I also mentioned that the last few weeks of Q3, as you know, the summer seasonality ends, we saw the traditional strength that we expect to see on our web traffic. So, I think, MAX is coming up. We have an exciting agenda in terms of what we are going to be talking about in terms of MAX. And so I mean if I take a step back and think about it, given this is the last question, I mean, from my perspective, strong Q3 across every aspect of our business, revenue, EPS, Digital Media ARR, DX, Subs revenue, Acrobat certainly also continued to show the strength. We have momentum in the business and the innovation roadmap, I mean, across all of the key initiatives that we've been talking about, whether that's Express, GenStudio and the excitement that people have associated with automating all of that content, AEP and Apps on the data side, imaging and video, the work that the Digital Media team has done on Photoshop and on Illustrator and then what's coming down the pike on video. And Firefly Services, I think, the AI monetization as well, which I know is a theme of a number of people that have asked, whether it's Acrobat, whether it's the Premium SKUs as it relates to Experience Cloud, whether it's what's happening on Gen Fill and the usage of Gen Fill, Lightroom and Lightroom Mobile. I think we're clearly demonstrating how AI can both drive value for our customers and therefore, we acquire new customers and retain customers better. So, yes, it feels good. We look forward to seeing all of you at MAX and we're going to just continue to focus on innovation and delighting our customers. But thank you for joining us."
},
{
"speaker": "Jonathan Vaas",
"content": "Yes. Thanks, Shantanu, and we do look forward to the Investor Event that we'll be holding in Miami at MAX on October 14th, where we will be doing a Q&A with management. We hope to see many of you there. And with that, thank you for joining the call, and this concludes the event."
},
{
"speaker": "Operator",
"content": "Thank you. That does conclude today's conference. We do thank you for your participation. Have an excellent day."
}
] |
adbe | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Q2 FY 2024 Adobe Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Jonathan Vaas, VP of Investor Relations. Please go ahead."
},
{
"speaker": "Jonathan Vaas",
"content": "Good afternoon and thank you for joining us. With me on the call today are Shantanu Narayen, Adobe's Chair and CEO; David Wadhwani, President of Digital Media; Anil Chakravarthy, President of Digital Experience; and Dan Durn, Executive Vice President and CFO. On this call, which is being recorded, we will discuss Adobe's second quarter fiscal year 2024 financial results. You can find our press release, as well as PDFs of our prepared remarks and financial results, on Adobe's Investor Relations website. The information discussed on this call, including our financial targets and product plans, is as of today, June 13, and contains forward-looking statements that involve risk, uncertainty and assumptions. Actual results may differ materially from those set forth in these statements. For more information on those risks, please review today's earnings release and Adobe's SEC filings. On this call we will discuss GAAP and non-GAAP financial measures. Our reported results include GAAP growth rates as well as constant currency rates. During this presentation, Adobe's executives will refer to constant currency growth rates unless otherwise stated. Non-GAAP reconciliations are available in our earnings release and on Adobe's Investor Relations website. I will now turn the call over to Shantanu."
},
{
"speaker": "Shantanu Narayen",
"content": "Thanks, Jonathan. Good afternoon and thank you for joining us. Adobe had an outstanding quarter, achieving revenue of $5.31 billion, representing 11% year-over-year growth. GAAP earnings per share for the quarter was $3.49 and non-GAAP earnings per share was $4.48, representing 15% year-over-year growth. Our success is driven by growing customer value through an innovative product roadmap. The advances we are delivering across Creative Cloud, Document Cloud and Experience Cloud are enabling us to attract an expanding universe of users. Everyone from creators, communicators, students, entrepreneurs and businesses of all sizes are using our products to unleash their creativity, accelerate document productivity and power their digital businesses. Adobe's highly differentiated approach to AI is rooted in the belief that creativity is a uniquely human trait and that AI has the power to assist and amplify human ingenuity and enhance productivity. We're innovating across data, models and interfaces and natively integrating AI across all our offerings. In Creative Cloud, we have invested in training our Firefly family of creative generative AI models with a proprietary data set and delivering AI functionality within our flagship products including Photoshop, Illustrator, Lightroom and Premiere. We're reimagining creativity for a broader set of customers by delivering Adobe Express as an AI-first application across the web and mobile surfaces. Since its debut in March 2023, Firefly has been used to generate over 9 billion images across Adobe creative tools. In Document Cloud, we're revolutionizing document productivity with Acrobat AI Assistant, an AI powered conversational engine that can easily be deployed in minutes. This enhances the value of the trillions of PDFs which hold a significant portion of the world's information. Acrobat AI Assistant features are now available through an add-on subscription to all Reader and Acrobat enterprise and individual customers across desktop, web and mobile. At the end of May, we celebrated the five-year anniversary of Adobe Experience Platform, which we conceived and built from scratch and which is on track to be the next billion-dollar business in our Digital Experience portfolio. We released AEP AI Assistant to enhance the productivity of marketing practitioners through generative AI, while expanding access to native AEP applications. With Adobe GenStudio, we're bringing together products across our clouds including Creative Cloud, Adobe Experience Manager, Workfront, Adobe Journey Optimizer and Customer Journey Analytics as well as Adobe Express for Business to address the massive content supply chain opportunity. Our approach to empower marketers to quickly plan, create, manage, activate and measure on-brand content is resonating with customers and validating our leadership across data, content and journeys to deliver personalized experiences at scale. We're extending our applications to integrate third-party text, image and video models and partnering strategically to create multi-modal large language models offering customers greater choice in tools and further enhancing the value of our leading applications and solutions. We're driving strong usage, value and demand for our AI solutions across all customer segments and seeing early success monetizing new AI technologies across our Digital Media and Digital Experience businesses. Given this rich product roadmap, focus on execution and customer demand in the first half of the year, we are pleased to raise our annual Digital Media net new ARR, Digital Experience subscription revenue and EPS targets. I'll now turn it over to David to discuss the momentum in our Digital Media business."
},
{
"speaker": "David Wadhwani",
"content": "Thanks, Shantanu. Hello everyone. In Q2, we achieved net new Digital Media ARR of $487 million and revenue of $3.91 billion, which grew 12% year-over-year. On the Document Cloud side, PDF has become a global standard for automating business and consumer workflows, and Acrobat is the platform of choice to view, edit, share and collaborate with these documents. We continue to see steady growth in monthly active users of our Document Cloud solutions, including Acrobat Reader, Acrobat Standard and Pro, and our signature, share and review workflows across mobile, web and desktop. The introduction of Acrobat AI Assistant, made generally available in April for English documents, marks the beginning of a new era of innovation and efficiency for the approximately 3 trillion PDFs in the world. Acrobat AI Assistant is empowering everyone to shift from reading documents to having conversations with them in order to summarize documents, extract insights, compose presentations and share learnings. AI Assistant is available as a standalone offer for use in Reader and as an add-on to Acrobat Standard and Pro. We're seeing early success driving adoption of AI Assistant as part of our commerce flows and remain optimistic about the long-term opportunities. In Q2, we achieved Document Cloud revenue of $782 million, growing 19% year-over-year. We added $165 million of net new Document Cloud ARR, which was a Q2 record, with year-over-year ending ARR growth of 24% in constant currency. Other business highlights include, general availability of Acrobat AI Assistant support for document types beyond PDF, meeting transcripts and enterprise requirements; Acrobat link sharing for PDF-based collaboration continues to grow rapidly, more than doubling year-over-year and driving viral new user adoption; free monthly active users of Acrobat Web grew over 60% year-over-year, as a result of link sharing and our Microsoft Edge and Google Chrome extensions; continued strength with free-to-paid digital conversion, as a result of product led growth optimizations; strong growth in the SMB segment for our Teams offering, driven by a combination of seat expansion and new account wins; Key enterprise customer wins with AstraZeneca, Chevron, State Government of Florida, State of Illinois, United Healthcare Services and Wells Fargo. Turning to Creative Cloud, creative professionals are leading the global charge to meet the everincreasing demand for engaging content across a variety of platforms and channels. Enterprises rely on creative professionals to produce differentiated content to drive increasingly personalized marketing campaigns. Solopreneurs and small businesses need to stand out in a crowded digital landscape with engaging videos and designs. Educators are passionate about providing students with the visual communication skills needed to thrive in the decades ahead. Consumers are increasingly looking for ways to share their stories digitally. Creative Cloud, Express and Firefly Services are uniquely positioned to catalyze this opportunity for everyone, by leveraging the promise of generative AI. Our Creative Cloud flagship applications continue to release new features that are significantly improving user onboarding while simultaneously delivering an unprecedented level of power and precision. Generative Fill and Generative Expand are already two of the top three features used by customers on the latest version of Photoshop. Text to vector support is off to a great start in Illustrator. Remove Object is the fastest growing feature in Lightroom mobile. Our preview of generative AI capabilities in Premiere won Production Hub Award of Excellence at NAB, the largest video show in North America. We are integrating our leading applications with Firefly and third-party generative AI models to deliver the richest, most engaging content. Our vision for Adobe Express is to provide a breakthrough application to make design easy for communicators worldwide, leveraging generative AI and decades of Adobe technology across web and mobile. Our launch of the all-new Express application on iOS and Android earlier this quarter is off to a strong start, with monthly active users doubling quarter over quarter. This week's Design Made Easy event, which focused on Express for Business, was another big step forward for us. Companies of all sizes are excited about the integrated power and commercial safety of Firefly, the seamless workflows with Photoshop, Illustrator and Adobe Experience Cloud and enterprise-grade brand controls that are now part of Express for Business, making it the optimal product for marketing, sales and HR teams to quickly and easily create visual content to share. We also announced the general availability of Firefly Services and Custom Models at Summit. The platform makes API calls and model customization available to developers, accessible through low-code, no-code tools and integrates with our Experience Cloud products. Firefly Services can power the creation of thousands of asset variations in minutes instead of months, and at a fraction of the cost. This allows us to monetize the volume of content being created through automation services. The increasing availability of Firefly in Creative Cloud, Express, Firefly Services and the web app is giving us opportunities to access more new users, provide more value to existing users and monetize content automation. These integrations are driving the acceleration of Firefly generations, with May seeing the most generations of any month to date. In Q2, we achieved $3.13 billion in revenue, which grew 11% year-over-year. Net new Creative Cloud ARR was $322 million. Other business highlights include, the launch of Express for Business, including support for brand controls and template locking, Firefly custom models, bulk creation and generation of variations, presentation and print capabilities, and workflows with Photoshop, Illustrator and Experience Cloud; the release of Firefly Image 3 Foundation Model with high quality image generation and more control with structure and style reference; the release of the Photoshop beta, with Reference Image and advances in Generative Fill; the debut of Generative Remove in Adobe Lightroom, enabling anyone to remove unwanted objects from any photograph non-destructively with stunning, high-quality, photo-realistic results; the release of the Premiere beta, with new audio workflows driving strong usage; the deep integration of Firefly in Substance 3D, which provides an easy way to create textures and materials from reference images; the introduction of an all new Frame.io, streamlining workflows across content types on a flexible and intuitive collaboration platform; key enterprise customer wins include Credit Agricole, FedEx, Infosys, Rakuten, Ralph Lauren, Samsung, Schneider Electric and Volvo. We're excited about the accelerating pace of innovation across the Digital Media business and pleased with the adoption of AI functionality as well as its early monetization across Document Cloud and Creative Cloud, including our flagship applications, Firefly Services and Express. We're pleased to raise our annual net new ARR target to $1.95 billion and excited to deliver on our rich product roadmap in the second half. I'll now pass it to Anil."
},
{
"speaker": "Anil Chakravarthy",
"content": "Thanks, David. Hello, everyone. In Q2, we achieved Experience Cloud revenue of $1.33 billion. Subscription revenue was $1.2 billion, representing 13% year-over-year growth. We are the industry leader in helping enterprises deliver personalized experiences at scale to their customers by combining the right content, customer data and journeys in real time. When we introduced Adobe Experience Platform five years ago, it was a revolutionary approach to address customer data and journeys. Today, we're the number one digital experience platform, and AEP with native apps is well on its way to becoming a billion-dollar business. We're now transforming the content supply chain for enterprises with Adobe GenStudio, enabling them to produce content at scale, leveraging generative AI through native integrations with Firefly services and Adobe Express for Business. Enterprise customers, both B2C and B2B, view customer experience management and personalization at scale as key areas of differentiation, making it a priority investment for Chief Marketing Officers, Chief Information Officers and Chief Digital Officers. We are excited by the customer interest and adoption of our latest innovations, including AEP AI Assistant, a generative AI-powered conversational interface that empowers practitioners to automate tasks, simulate outcomes, and generate new audiences and journeys. For example, customers like General Motors and Hanes brands have been working with AEP AI Assistant to boost productivity and accelerate time to value, while democratizing access to AEP and apps across their organizations. Marriott International is a great example of a customer that's expanded its decade-long relationship with Adobe and turned to Adobe Experience Cloud to orchestrate highly personalized guest experiences across online reservations and the Marriott Bonvoy mobile app. Adobe Real-time CDP and Adobe Journey Optimizer enabled Marriott to connect data from disparate sources and activate relevant experiences in moments that matter, helping the company match individuals with the best options across its portfolio of more than 30 brands and nearly 9,000 properties. Other business highlights include: continued momentum with AEP and native applications, growing subscription revenue 60% year-over-year in Q2; AEP innovations announced at Summit include Adobe Journey Optimizer B2B addition, a new application for B2B customers built on AEP to orchestrate account-specific buying group journeys; federated audience composition, which enables enterprises to minimize data copy and generate audiences directly from their enterprise data warehouses; and real-time CDP collaboration, a new clean room application for brands and publishers to collaborate in a privacy safe way to discover, reach, and measure their high-value audiences in a world without third-party cookies. GenStudio innovations to address enterprise content supply chain needs across workflow and planning, creation and production, asset management, delivery and activation, and reporting and insights. Recent advancements include contextual search in Adobe Experience Manager assets, which enables users to find the right asset and variation in their growing digital libraries. Adobe Workfront Planning, which provides every user with a unified view of all activities across the marketing life cycle through highly visual marketing campaign calendars and dynamic briefs. And AEM Generate Variations, which accelerates the creation of audience-specific content variations to drive personalized web experiences. Strong industry analyst recognition including Gartner's Magic Quadrant for Content Marketing Platforms and leadership for both IDC's B2C and B2B MarketScapes for digital commerce applications. Key customer wins include Amazon, British Telecom, Comcast, Mercedes-Benz, Maruti Suzuki, Nationwide Building Society, Novo Nordisk, ServiceNow, Stellantis, Ulta Beauty, and U.S. Department of the Treasury. We have enabled our vibrant partner ecosystem of system integrators and agencies to deliver advisory and implementation services across our product portfolio. We look forward to engaging with customers and major agencies at the Cannes Lions Festival later this month. Our category-leading solutions, robust pipeline, and tremendous scale position us to drive strong growth in the second half, and we are raising our subscription revenue target for the year. I will now pass it to Dan."
},
{
"speaker": "Dan Durn",
"content": "Thanks, Anil. Today, I'll start by summarizing Adobe's performance in Q2 fiscal 2024, highlighting growth drivers across our businesses, and I'll finish with financial targets. In Q2, Adobe delivered strong top line growth and industry-leading profitability while accelerating the pace of innovations we're delivering to market across Document Cloud, Creative Cloud, and Experience Cloud. In the quarter, Adobe achieved record revenue of $5.31 billion, which represents 10% year-over-year growth or 11% in constant currency, with strength across all three clouds. This performance stems from the diversification of Adobe's business across our market-leading products, business models, customer segments, and geographies. When combined with our talented employees, strong execution and world-class financial discipline, you have the ingredients that make this company incredibly resilient. Second quarter business and financial highlights included: GAAP diluted earnings per share of $3.49 and non-GAAP diluted earnings per share of $4.48; Digital Media revenue of $3.91 billion; net new Digital Media ARR of $487 million; Digital Experience revenue of $1.33 billion; cash flows from operations of $1.94 billion; and RPO of $17.86 billion exiting the quarter. In our Digital Media segment, we achieved Q2 revenue of $3.91 billion, which represents 11% year-over-year growth or 12% in constant currency. We exited the quarter with $16.25 billion of Digital Media ARR, up 13% year-over-year in constant currency. Adobe achieved Document Cloud revenue of $782 million, which represents 19% year-over-year growth as reported and in constant currency. We added $165 million of net new Document Cloud ARR, which was a record for Q2. Q2 Document Cloud growth drivers included: demand for Acrobat subscriptions across all customer segments and geographies; new user acquisition resulting from increasing Reader MAU; a great start monetizing AI Assistant through our digital channel; strong usage and engagement from Acrobat Web as well as through our Chrome and Edge partnerships, which are driving free-to-paid conversion; growing team subscription units sold to SMBs, both through adobe.com and our research channel; and strength in our enterprise solutions, demonstrating the importance of PDF as a source of unstructured data in business workflows. We achieved Creative revenue of $3.13 billion, which represents 10% year-over-year growth or 11% in constant currency. We added $322 million of net new Creative ARR in the quarter. Q2 Creative growth drivers included: new subscriptions for Creative Cloud All Apps with particular strength in digital acquisition on adobe.com, with multiple product releases during the quarter driving customer engagement and demand; strong growth of single apps, including in imaging, photography, design, and stock; accelerating customer interest and usage for our new Express Mobile and Express for Business offerings; strong renewals as customers migrate to higher-value, higher ARPU Creative Cloud plans that include Firefly entitlements; continued subscription unit growth, with particular strength in emerging markets; and strength from SMBs adopting our team offering as well as in the enterprise segment with ETLA adoption. We're pleased with the performance of the Creative business in the first half of the year, fueled by strong commercial subscriptions in both Q1 and Q2. As we look at the momentum we're carrying into the back half, we expect to deliver year-over-year growth of Creative net new ARR in Q3 and Q4 and are raising our Digital Media net new ARR target for the fiscal year. Turning to our Digital Experience segment. In Q2, we achieved revenue of $1.33 billion, which represents 9% year-over-year growth as reported and in constant currency. Digital Experience subscription revenue was $1.20 billion, growing 13% year-over-year as reported and in constant currency. Q2 Digital Experience growth drivers included: subscription revenue strength from transformational accounts; market leadership with AEP and native applications, with subscription revenue growing 60% year-over-year; additional subscription revenue strength across the data insights and audiences and customer journey categories; and accelerated adoption of our AEM and Workfront solutions from businesses looking to solve their content supply chain challenges. Turning to the income statement and balance sheet. In Q2, Adobe delivered year-over-year EPS growth of 24% on a GAAP basis and 15% on a non-GAAP basis. This was driven by revenue growth and disciplined prioritization of our investments, which resulted in non-GAAP operating margin strength in Q2. The company continues to deliver world-class gross margins while investing in groundbreaking AI capabilities. Adobe's effective tax rate in Q2 was 18.5% on a GAAP and non-GAAP basis, in line with our expectations for the quarter. RPO exiting the quarter was $17.86 billion, growing 17% year-over-year as reported or 18% when factoring in a 1-point currency headwind. Current RPO grew 12% exiting the quarter. Our ending cash and short-term investment position at the end of Q2 was $8.07 billion, and cash flows from operations in the quarter were $1.94 billion. In Q2, we entered into a $2.5 billion share repurchase agreement, and we currently have $22.7 billion remaining of the $25 billion authorization granted in March 2024. We will now provide Q3 targets as well as updated fiscal 2024 annual targets, factoring in current macroeconomic conditions as well as strong momentum across our business, our current FX outlook into the back half of the year with the U.S. dollar remaining stronger as compared to our original expectations when we set our FY 2024 targets in December, and an expected strong seasonal finish to the year in Q4. For Q3, we're targeting: total Adobe revenue of $5.33 billion to $5.38 billion; Digital Media net new ARR of approximately $460 million; Digital Media segment revenue of $3.95 billion to $3.98 billion; Digital Experience segment revenue of $1.325 billion to $1.345 billion; Digital Experience subscription revenue of $1.20 billion to $1.22 billion; tax rate of approximately 18% on a GAAP basis and 18.5% on a non-GAAP basis; GAAP earnings per share of $3.45 to $3.50; and non-GAAP earnings per share of $4.50 to $4.55. For fiscal 2024, given our first half performance, we are now targeting: total Adobe revenue of $21.40 billion to $21.50 billion; Digital Media net new ARR of approximately $1.95 billion; Digital Media segment revenue of $15.80 billion to $15.85 billion; Digital Experience segment revenue of $5.325 billion to $5.375 billion; Digital Experience subscription revenue of $4.775 billion to $4.825 billion; tax rate of approximately 20.5% on a GAAP basis and 18.5% on a non-GAAP basis; GAAP earnings per share of $11.80 to $12; and non-GAAP earnings per share of $18 to $18.20. In summary, I'm extremely pleased with the company's performance in the first half of the year and the momentum we see in our business. Adobe's product leadership, velocity of innovation, diversity of our business, and financial discipline make us unique, enabling us to deliver strong top and bottom line results through dynamic market conditions. I'm confident in our ability to catalyze transformative long-term trends that will position us to win over the next decade. Shantanu, back to you."
},
{
"speaker": "Shantanu Narayen",
"content": "Thanks, Dan. Adobe remains one of the greatest places to work in the industry, and I want to thank our employees for their relentless dedication to supporting our customers and communities. We continue to invest in hiring, including new college grads and interns to bring the best and brightest talent to Adobe. This quarter, Adobe was recognized among Fortune's 100 Best Companies to Work For, Glassdoor's Best-led Companies and the Civic 50 List of the Most Community-minded Companies in the U.S. Demand for our category-defining products and services continues to grow. Our business fundamentals and market tailwinds are strong, and we look forward to building on our momentum in the second half and beyond. Thank you, and we will now take questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Our first question will come from Mark Moerdler with Bernstein."
},
{
"speaker": "Mark Moerdler",
"content": "Thank you very much and congratulations on the quarter and especially the strong net new ARR. I'd like to ask a little more color on specifically the net new ARR that we saw in Creative Cloud. Can you give us a sense of what the contribution near term, medium term to Digital ARR from seat growth versus upsell versus consumption, things like Adobe Stock and AI credits, even rank ordering or quantifying? Anything you can give us -- to give us a sense of what's driving that number? And that would be very helpful in really understanding what's going on in the drivers of that number. Thanks."
},
{
"speaker": "Shantanu Narayen",
"content": "Sure, Mark, let me start and then certainly, David and Dan can add. To your point, we had a strong quarter. And I think what's really driving the quarter, big picture, continues to be the innovation that we're delivering. And the way AI is actually making our applications both more affordable, easy to onboard as well as, frankly, higher-value users. New users are still a big driver of the growth that we continue to see in the business. On the Document Cloud side, a lot of that has to do with the introduction of AI Assistant and the fact that people are migrating to the higher-value products. And on Creative Cloud, I would say the things that we're doing on imaging with Firefly and what we've seen both in Photoshop and Lightroom. I think in the prepared remarks Dan certainly talked about what's happening with also each of the different segments. So the SMB segment actually had a strong quarter. Enterprise continues to have a strong quarter. So across the board, Mark, we actually saw strength in the business."
},
{
"speaker": "Operator",
"content": "And our next question will come from Alex Zukin with Wolfe Research."
},
{
"speaker": "Aleksandr Zukin",
"content": "Hey, guys. Thanks for taking the question and congratulations on this incredible result. I wanted to ask kind of just similar to Mark's question, just how much gen AI demand did you see in the quarter in terms of -- for sort of both the Creative Cloud portfolio and Digital Media, in Creative Studio as well as in GenStudio? And how does it kind of help to pick up more on the enterprise side of the business, on the SMB side of the business? Help us understand that progression and maybe how you're planning for it in the back half of the [indiscernible]."
},
{
"speaker": "Shantanu Narayen",
"content": "Sure, Alex. Again, maybe I'll start with that. And just taking a step back, I think we've talked about the platform that we have for gen AI that constitutes data, as well as models and finally, interfaces. On the models, we released Firefly services. We've started to see some customer wins in Firefly services. So they're using it for variations, and these are the custom models that we're creating, as well as access to APIs. I would say that's early in terms of the adoption, but the interest as customers say how they can ingest their data into our models as well as custom models, that's really ahead of us, and we expect that to continue to grow in Q3 and Q4. I think the biggest opportunity for us and why we're really excited about gen AI is in the interfaces, because that's the way people derive value, whether it's in being able to complete their tasks faster, whether it's being able to do new workflows. And I would say in that particular space, Acrobat has really seen a significant amount of usage as it relates to AI Assistant. And Photoshop, I'll have David again add, but Generative Fill and what we are doing there, what we are doing in Illustrator. And that both for existing customers as well as for prospects who now come in and say, the products are becoming increasingly more productive for us, that's what's really driving the value there. And last but not least, the AI-first applications. When we think of an application like Express, Express is all about reimagining what we can do for creatives by sort of leapfrogging existing technologies and providing an AI-first application. And so that's also off to a good start."
},
{
"speaker": "David Wadhwani",
"content": "Yes. And just to add to a little bit of what Shantanu said, Alex. We've talked a lot about how FY 2023 was the year that AI was in the playground, and this is the year we need to bring it into production. And a lot of that is industry-wide, but we're in a pretty special position as it relates to that. So to Shantanu's point, a lot of active releases this quarter, right? Acrobat AI Assistant, Firefly updates in Photoshop, Firefly was introduced for the first time into Lightroom, Express Mobile launched, Express for Business launched. We launched Firefly services for enterprises to produce content at scale. So, as you can see, there was a ton of innovation of our core -- in our core applications around generative AI. You put that together with some of the activations that we've done at Summit, and we did at Max London and we're getting our word out very broadly. It starts to create this ability to not just look at and play with AI, but actually use it as part of your workflow. So that's been deeply integrated into everything we do. And that's the key point, the interfaces that people work out if we bring AI there, everyone becomes more productive."
},
{
"speaker": "Shantanu Narayen",
"content": "And maybe one last thing, Alex. Sequentially, if you look at it from a route to market, Digital had a very strong quarter as it relates to what we did on adobe.com. We had talked about enterprise doing well in Q1 as well, that continued. And SMB also, the interest in our teams product also continued to do really well. So I think sequentially, I would point to SMB and Digital's strength as driving the further growth."
},
{
"speaker": "Aleksandr Zukin",
"content": "That's super helpful. And then maybe just one on the macro. Just given your guys' purview, like what is the story that you're seeing in terms of the macro on the demand environment? Clearly again, you're commenting on solid performance in the SMB and in the enterprise. Is there any areas that you're seeing pockets of weaknesses that's really vertical-dependent? Just maybe give a comment on kind of how we should think about it as we look to the rest of the year."
},
{
"speaker": "Shantanu Narayen",
"content": "I think from a macro perspective, what I think differentiates Adobe more than any other company is how differentiated and how diverse the set of products that we have. And again, from individual consumers all the way to enterprises, our products are mission-critical. And so at this scale, it's all about execution. And the business cycles will come and go, Alex, but we're actually continuing to focus on execution and converting the pipeline and the interest and the awareness of AI into monetization. And so, we just will be ruthlessly focused on continuing to execute against that. So nothing really to report different on the macroeconomic environment from our perspective."
},
{
"speaker": "Aleksandr Zukin",
"content": "Awesome. Keep doing what you're doing, guys."
},
{
"speaker": "Operator",
"content": "And our next question will come from Saket Kalia with Barclays."
},
{
"speaker": "Saket Kalia",
"content": "Okay, great. Hey, guys, thanks for taking my question here and echo the congrats on the quarter. Maybe for both, Shantanu and David. There are clearly just so many layers to the Firefly monetization story. But I think one theme that's coming out a little bit in this call and particularly interesting route to monetize is just the increased engagement that Firefly helps drive in your flagship products, right, or I think we call it sort of the interfaces, right? An example there would be like Generative Fill for Photoshop. And you've clearly started expanding that to other flagships like Premier and Illustrator. Maybe to go one level deeper, is there a way that you think about the potential opportunity from things like higher retention rates? Or any other way that -- I know it's really tough to size, but how have you sort of thought about it even qualitatively?"
},
{
"speaker": "David Wadhwani",
"content": "Yes, it's a great question. And yes, the core has been -- from the very beginning, we've talked to you guys about our primary focus for generative AI is about user adoption and proliferation, right? And that has continued to be the primary thing on our mind. And it's the primary thing on our mind for multiple reasons. And to your point, there are many different ways that we can monetize this. First is, as you think about the growth algorithms that we always have in our head, it always starts with, as Shantanu said, new users, right? And then it's about getting more value to existing users at higher ARPU, right? So in the context of new users, first and foremost, we want to make sure that everything we're doing generative AI is embedded in our tools, starting with Express, right? So we have Express in the market. We're seeing a lot of adoption and usage of Express in the market. As that's happening, we're infusing generative AI more and more into Express in a whole host of ways. And that's really helping, everything from our marketing message for the completeness of the AI offering in there, all the way through to user engagement and success in onboarding and retention. Similarly, though, this is having the same effect in our core Creative products as well, right? The introduction of Firefly combined with some of the product-led growth work we've been doing, in particular, something called the Context Bar makes it easy for new users coming in to just be more successful out of the gate which then, of course, helps with both conversion and retention. And then with AI Assistant, the ability to sort of embed that into the purchase flow for Acrobat and get a high attach rate, we always talk about that as a would you like fries with it moment at Adobe when someone's going through the checkout flow, it's just a great way for people to say, look, this is value I want, I want to add it and buy up to the higher plans. So there are a lot of different mechanisms that we see. But by far, the strongest is going to be the fact that we are seeing people like in Creative Cloud migrating to the higher-priced plans because they include Firefly. And so we just want to get more value to these users as well."
},
{
"speaker": "Shantanu Narayen",
"content": "And in terms of the generation, Saket, I think we talked about it. We did a great job at MAX in London talking about some of the new functionality and releasing. Photoshop, I think we're up to 9 billion generations, and actually, I think the greatest amount of generations was in May. So the momentum clearly is the more we integrate this functionality into our interfaces, the more that usage is really driving adoption as well as retention."
},
{
"speaker": "Saket Kalia",
"content": "Very helpful. Thanks, guys."
},
{
"speaker": "Operator",
"content": "And our next question comes from Brent Thill with Jefferies."
},
{
"speaker": "Brent Thill",
"content": "David, on Express, you mentioned the success you're seeing. Can you maybe drill into some of the other metrics and accomplishments that you're seeing out of Express this quarter?"
},
{
"speaker": "David Wadhwani",
"content": "Yes. For starters, there's a lot of buzz of Express here at Adobe coming off the event we just had earlier this week, but it's really based on the fact that the innovation in Express is on a tear, right? A few months ago, we introduced an all-new Express for the web. This quarter, we introduced an all-new Express for mobile. We introduced Express for Business. We also now have, as we've just talked about, been more deeply integrating AI features, whether it's for imaging generation or generative fill or text effects, character animation, design generations more deeply into the flow for Express. And that combination has led to an incredible set of metrics over the last quarter, in particular, but building throughout the year. Express MAU is growing very quickly. We talked about on the -- in the script earlier that MAU on mobile has more than doubled quarter-over-quarter, which is fantastic to see. And cumulative exports, if you look at year-over-year it has grown by over 80%. So really feeling good about sort of the momentum we're seeing. But if you take a step back, I think it is important to take a step back and understand our vision. Express that is now in market is built on a brand-new platform, right? And that brand-new platform lays the groundwork for the AI era. And this will be -- Express will be the place that anyone can come and create through a combination of conversational and standard inputs. That's the vision that we have. And I think it's an opportunity for us to really leap forward in terms of what we can do on the web and mobile at Adobe. And it's taken us a little time to get here. It hasn't happened overnight. But now that we are here, we are going to pour the gas on go-to-market, right? You know what we can do with our data-driven operating model. We've been ramping up what we're doing in Digital and Adobe.com journeys. We now can do the same thing and unleash all of that expertise in the mobile app store. You know what we're capable in terms of our product-led growth motions. We've now embedded Express Workflows into Acrobat Editor. We obviously have been embedding it into Creative Cloud workflows. And also, as we showed at Summit with Anil, we've embedded it into our Experience Cloud workflows as well. In addition to all of that, we're now unleashing our inside sales force to target the small/medium businesses. Our education teams are really gearing up for the back-to-school launch for K-12 and higher ed. And our field and enterprise sales now have Express for Business. So -- and we're doing all this globally, right? It's a massive market, and we're ramping up and we're ready to go."
},
{
"speaker": "Brent Thill",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And the next question comes from Gregg Moskowitz with Mizuho."
},
{
"speaker": "Gregg Moskowitz",
"content": "Hey, thank you very much. And I'll add my congratulations. For your Creative business, how are you thinking about the Q side of the P times Q equation over the balance of the year? Based on these numbers anyway, I would certainly assume that you had really healthy unit growth in Q2. And I'm wondering if you expect that to continue."
},
{
"speaker": "David Wadhwani",
"content": "Yes. I mean, again, I think what -- it is this mix of product innovation that we've been putting out there and the steady drumbeat of that. A lot of it getting attention because of the quality and the hooks of AI and being able to sort of bring people, onboarding them quickly and successfully into the product. And then as we talked about, the more they use these AI features, the more they retain. And we feel really good about really that whole workflow. So yes, the new user growth continues to be our primary focus. And when you add in everything we're doing with Express, we're -- again, like I said, we're off to the races and we feel very good about the momentum on new user acquisition and existing member retention."
},
{
"speaker": "Shantanu Narayen",
"content": "And Gregg, as you're aware, I mean, certainly with Express, we also have the model of customer acquisition as it relates to people coming in through trial and free and then conversion. So we are seeing the interest level as it relates to Express, in particular, significant interest."
},
{
"speaker": "Gregg Moskowitz",
"content": "And Shantanu, since you also called out the strength in Digital earlier, including driving new Creative All Apps subscriptions from your website, are you doing anything different that's helping to drive that behavior? And if so, is that something you think can continue as well?"
},
{
"speaker": "Shantanu Narayen",
"content": "I would, Gregg, sort of modesty say, we've been world-class at sort of driving that for a long time now. But the team, I think, continues to do an amazing job. And I would say David referred to the DDOM. Adobe Home is now sort of increasingly the way that we're driving a lot of people to get aware of our new products. And so, I would say the mobile part as well and the mobile journeys, as we've got these mobile products, whether it's Lightroom or whether it's certainly, Express, that's an area of increasing focus for us. And the traditional sort of understanding where search terms are, I think we're getting better and better at that, which leads to way more digital traffic for us. So I think it's across the board. But I'd also highlight, I mean, the commerce team that we have at Adobe that understands what the segments are and how for those particular segments we can attract people, that's great. I mean, I think in the prepared remarks, Dan also talked about the strength in emerging markets. And I think the beautiful part about AI is that since they need access to the cloud to get all of the AI functionality, emerging market growth has been really strong for us."
},
{
"speaker": "Gregg Moskowitz",
"content": "Very helpful. Thank you."
},
{
"speaker": "Operator",
"content": "And moving on to Keith Weiss with Morgan Stanley."
},
{
"speaker": "Keith Weiss",
"content": "Thank you guys for taking the question. And again, congratulations on a really solid set of results in an environment where not very many software companies have been able to beat and raise in this type of uneven environment. I wanted to maybe focus in a little bit on the question that Mark Moerdler asked, in particular on what gives you guys the confidence to see a return to year-on-year growth and Creative Cloud net new ARR. It declined in Q2, it declined in Q1. And if I'm not mistaken, the decline in Q2 was a little bit steeper than what we saw in Q1. So what are the particular drivers and maybe some detail on those drivers that give you guys the confidence that, that trend line that has been actually heading in the wrong direction is going to head in the right direction now? We're actually going to see growth in those metrics in Q3 and Q4?"
},
{
"speaker": "David Wadhwani",
"content": "Yes. Thanks, Keith. This is one of the areas that I think we've shared with you the complexity of the year-over-year comparisons in the first half based on prior pricing marks that we had. But more importantly, to your point, the year-over-year complexities are now behind us. And we're very excited about the momentum of the first half and how it sets us up for the second half, frankly, across both Document Cloud and Creative Cloud. Both are really momentum stories. The 478 -- the 487, sorry, just to be clear, the $487 million that we printed this time is obviously strong performance, and it implies that both CC and DC came in over what the growth -- the guide would have implied otherwise, right? So it's giving us a lot of good momentum going into the back half. Now the momentum is really driven by three things, and just I'll try to share a little bit more context here and hopefully gives you. First is new user acquisition, right? We're seeing Express starting to perform well in terms of bringing a lot of new users into the franchise across mobile and web. AI Assistant in Reader has been a really nice start for us, and we've been very pleased with how the uptake on that's going. And then Firefly itself, as I mentioned, has been increasingly more productive in terms of bringing in onboarding users and then retaining users because of the growth. We continue -- as we drive that more holistically throughout the product set, we start to see more people using it, including, as Shantanu mentioned earlier, in emerging markets. So we are seeing very good strength and usage in emerging markets, and that has certainly been a bright spot for us, which is something that obviously represents a lot of potential and upside for us. In terms of existing customers, the migration has been going very well for us as well. So, more people are moving to the higher-priced, higher-value plans because of the Firefly capabilities. We're even seeing this in enterprises where people are moving up to the highest versions of Creative Cloud, which is what we call it, Creative Cloud Enterprise 4, because they get more access to features beyond just generation. They have more collaborative capabilities beyond just kind of sharing via e-mail. And we're starting to see that create a nice momentum in upgrade cycles in the enterprise segment as well. And then certainly, let's not forget the new offerings, too. While still early, automation and content production is something that we're driving effectively in a lot of these accounts with Firefly services. So that mix of new users, existing user migration, and also the new offerings that we have in market are driving that growth formula that we talked about, which is now P times Q plus V for value with these automation systems."
},
{
"speaker": "Keith Weiss",
"content": "That is a great answer. Thank you so much."
},
{
"speaker": "Operator",
"content": "And we have a question from Brad Sills with Bank of America."
},
{
"speaker": "Bradley Sills",
"content": "Oh, great. Thank you so much. I wanted to ask a question around the generative credit component to your pricing here. It seems like with all the progress you've made embedding Firefly across the key flagship products and the engagement levels that you're seeing, we should start to see perhaps some ramp in that generative credit component to your pricing. Is that a fair assessment? Would you expect to start to see that coming in? Or should we look to other services like the video capabilities that you're going to be launching shortly as a key catalyst there? Thank you."
},
{
"speaker": "Shantanu Narayen",
"content": "I think you're right, Brad. When we think about what we've done with imaging and video, we've done the right thing by making sure the higher-value paid plans that people don't have to think about the amount of generative capability. And so there, the balance between for free and trialist users, they're going to run into the generative capability limits and, therefore, have to subscribe. But for the people who actually have imaging and vector needs, that they're not constantly thinking about generative, I think we actually got it right. To your point, as we move to video, expect to see different plans because those plans will, by necessity, take into account the amount of work that's required to do video generation. So you're absolutely right as a sort of framework for you to think about it. The two other things that I would say is, I mean, clearly, Express is really being driven by sort of the need for AI and how people are able to describe what they want and get the final output. When David talked about exports, just to clarify what that means is people who have successfully got what they want to get done, done. And that's a key measure of how we are doing it, and AI is certainly facilitating and accelerating that. And last thing I would say, Brad is, as you know, on the Acrobat side, it's a slightly different model which we like, which is anybody who has Reader and is looking at a document, they can have an upsell to their AI Assistant. If you have Acrobat Pro, you can upsell to the AI Assistant. And if you're a brand new acquisition of a user when you're coming in, the adoption of the highest-value products, so between Standard Pro and Pro Plus Assistant, we've been pleased to see how many people are migrating to the Pro Plus Assistant. So hopefully, that gives you some color of how we think about it differently by product."
},
{
"speaker": "Bradley Sills",
"content": "Very helpful. Thank you, Shantanu."
},
{
"speaker": "Operator",
"content": "And we'll take a question from Brad Zelnick with Deutsche Bank."
},
{
"speaker": "Brad Zelnick",
"content": "Great. Thank you so much and congrats to all of you. I don't want Anil to feel left out, so I'm going to ask a DX question. Anil, it's good to hear AEP is on track to become the next billion-dollar business for Adobe. Can you expand on the journey and drivers that get you there? And in particular, how important are cloud migrations? And how do you see AEP AI Assistant perhaps accelerating the journey to $1 billion? Thanks."
},
{
"speaker": "Anil Chakravarthy",
"content": "Thank you, Brad. Appreciate it. As you know, I mean, customer experience management and especially it's been a hugely important priority area for Chief Marketing Officers and with CIOs and Chief Digital Officers as well. And for us, we are focused on personalization scale, which is really built around the AEP platform. We're the largest provider in this space. We're growing faster than any of our peers, and we're the number one Digital Experience platform as a result. And that has really helped us keep the momentum. When you think about the AEP AI Assistant, it's doing a couple of things. One, it's really making it easier for customers to deploy use cases. When you think of use cases that they have around, for example, generating audiences and running campaigns around those audiences, these are things today that require some data engineering. They require the ability to put these audiences together. So they require marketing and IT teams to work together. The AEP AI Assistant is making it much easier for marketers to be able to do it themselves and be able to deploy a lot more use cases. So as there's more usage, it will help drive more consumption and help drive the growth in terms of number of profiles, number of users, and we help -- we see it helping us grow towards that billion-dollar business."
},
{
"speaker": "Brad Zelnick",
"content": "Great to hear, and keep up the great work, guys. Thanks."
},
{
"speaker": "Jonathan Vaas",
"content": "Hey, operator, we're almost at the top of the hour. We'll take two last questions and then wrap up. Thanks."
},
{
"speaker": "Operator",
"content": "Thank you. We'll take a question from Kash Rangan with Goldman Sachs."
},
{
"speaker": "Kash Rangan",
"content": "Hi, thank you very much. You guys could have three separate earnings calls because you have three different businesses that even the smallest one is very large. So yes, sorry, Anil, Dave, and Shantanu, I may not be able to ask all the questions that I want. I'm sure we have plenty. But I'll just keep it super high level, Shantanu. Generative AI, it seems to swing back and forth. Just so early in its evolution, the possibilities seem magical sometimes, endless sometimes, sometimes it feels very disappointing. But with every quarter that Adobe is executing on this path, where do you stand with the question that we do get from investors? Will generative AI be so good that it's the end of the creative process? So we don't need creative folks, that software will do everything? That sounds a little far-fetched, but I'm just throwing it out there to see how you would react that proposition. Same in Experience Cloud as well. Could generative AI create its own marketing campaign, put marketing people out of business? Or maybe it doesn't. I'm sure you have strong views. Maybe flipped on the other side, it does create category growth on the other hand, not category compression. So sorry for that super high-level question, but that seems to be a big debate on the stock here, at least from the long-term perspective. Thank you so much."
},
{
"speaker": "Shantanu Narayen",
"content": "Yes, Kash. I think there are two things when we talk to investors that are perhaps on their mind. I mean, I think the first is it's fair to say that the interest that exists right now from investors as it relates to AI is all associated with the infrastructure and chips and perhaps rightly so because that's where everybody is creating these models. They're all trying to train them. And there's a lot of, I think, deserved excitement associated with that part of where we are in the evolution of generative AI. If the value of AI doesn't turn to inference and how people are going to use it, then I would say all of that investment would not really reap the benefit in terms of where people are spending the money. And so we're always convinced that when you have this kind of disruptive technology, the real benefits come when people use interfaces to do whatever task they want to do quicker, faster, and when it's embedded into the workflows that they're accustomed to because then there isn't an inertia associated with using it. So with that sort of as a broad segment, I am a big believer that generative AI is going to, for all the categories that we're in, it's actually going to dramatically expand the market because it's going to make our products more accessible, more affordable, more productive in terms of what you -- what we can do. I'm still acting CMO at the company, and I see the excitement around how we can, with agility, create way more content, create variations. When Anil talked about personalization at scale, I think there are two aspects to it, right? I mean, the first was always data, and Anil and the team have done a great job with sort of the real-time customer data platform to get that. And that's hydrated with users. But the real value is when you infuse that with the right content to make that personalized experience. So I think the demand is there for way more content than people can do, and generative AI is going to be an accelerant in that as well. And so net-net, I am absolutely betting on the fact that five years from now, there will be more people saying, I'm using creative tools to accomplish what I want, and there'll be more marketers saying, I can now, with the agility that I need, truly deliver a marketing campaign and an audience that's incredibly more specific than I could in the past. And that's Adobe's job to demonstrate how we are both leading in both those categories and to continue to innovate. But I recognize and I understand the question that exists in the industry associated with AI. If the value doesn't accrue to interfaces, I'll leave you with that. I think the investment would not be as beneficial as I believe it can be."
},
{
"speaker": "David Wadhwani",
"content": "And maybe one thing to add to that, Kash, just to build on what Shantanu was talking about. I think the other thing we get asked a fair amount is about the comparison between different models, right? So Firefly might be better at something. Midjourney might be something at something else. DALL-E might do something else. And the key thing here is that around this table, we get excited when models innovate. We get excited when Firefly does something amazing. We get excited when third-party models do something because our view, to Shantanu's point, is that the more content that gets generated out of these models, the more content that needs to be edited, whether it's color correction, tone matching, transitions, assembling clips, or masking composite images. And the reason for this is that this is not a game where there's going to be one model. Each model is going to have its own personality, what it generates, what it looks like, how fast it generates, how much it costs when it generates that, and to have some interface layer to help synthesize all of this is important. And so just sort of to note, we've said this before but I'll say it again here, you will see us building our products and tools and services leveraging Firefly for sure, but you'll also see us leveraging best-of-breed personalities from different models and integrate them all together."
},
{
"speaker": "Kash Rangan",
"content": "Awesome, the message here is that, gen AI is going to create more growth in the category. And Shantanu, you did that with the pivot to cloud. You grew the category, so here we go again. Thank you so much."
},
{
"speaker": "Shantanu Narayen",
"content": "Thanks, Kash."
},
{
"speaker": "Operator",
"content": "And next will be Jake Roberge with William Blair."
},
{
"speaker": "Jacob Roberge",
"content": "Hey, thanks for taking the question and I'll echo my congrats on the great quarter. I know it's early, but what's been the feedback and customer behavior for those users that are on Firefly services and GenStudio? And then thinking more longer term, what type of price uplift could you see from those customers over time, just given what you said about the acceleration in Firefly generations being driven by those products? Thanks."
},
{
"speaker": "David Wadhwani",
"content": "Maybe I'll start with customer zero. Right before this meeting, I was in a meeting with our CMO. And well, sometimes it's hard to tell, he's running the CMO or CEO head, but CMO this time. And we were reviewing a full-funnel campaign that we're planning on launching later this year. And exactly as Shantanu mentioned earlier, we saw benefits in terms of cost of the campaign, faster time to market for the campaign, and the amount of content that we can create to personalize that campaign. And that is one of those things that we've been doing more and more around our DDOM, which has actually been very productive for us, as you can see this quarter, and what we're pitching to other customers. So we've been working with -- we listed some of the customers earlier, but we've been working with a long list of customers on everything from accelerating the content creation for social, accelerating content creation for regional, and then increasing the number of amount of content that's created for increased personalization, which then, of course, flows through all of the Experience Cloud products that Anil is working on to get targeted better."
},
{
"speaker": "Shantanu Narayen",
"content": "And Jake, maybe in terms of what I would say we're seeing usage of, I think the initial usage of Firefly services in most companies was all around ideation. How can they create multiple variations of them and in the ideation process really just accelerate that ideation process? Most companies are then starting with as they're putting it into production, how can they, with the brand assets and the brand guidelines that they have, do this in terms of the variations, whether they be geographic variations or they be just variations? I mean, if you take a step back also, every single ad company right now will tell you that the more variance that you provide, the better your chances are of appropriately getting an uplift for your media spend. So I would say that most companies are starting with creating these variations for geographies. The other one that we see a fair amount of is engaging with their communities. So when they want their communities to have assets that they have blessed for usage within community campaigns, that's the other place where Firefly services are being used. And a company has a community portal where the community can come in, take something and then post whether it's on whatever social media site that you want. So I think that's the initial one. All of the agency companies are companies that have actually even publicly said how GenStudio is something that they have embraced. But even the large media companies, because the media companies are certainly interested in understanding how all of this gen AI could be used to automate as well as accelerate the amount of content that they can produce. So hopefully, that gives you some color of it. If there's been sort of the questions that they ask along the way, which hopefully and actually, luckily, we have great answers, it's all around the indemnification and how they can use it. And I would say that continues to be a really key differentiator for us. But since that is the last question, let me just say I'm proud of how we executed in Q2, both across the product innovation, delivery as well as the go-to-market because clearly, a number of you asked how we were able to put together these numbers where others have perhaps talked about the macroeconomic environment. We certainly remain focused on leveraging technology to light a broader set of customers. And at the end of the day, to the questions that we were asked, we believe that the real value of AI will be in the interfaces that individuals, enterprises use to accomplish their tasks and workflows. And we think we're incredibly well positioned. So thank you for joining us."
},
{
"speaker": "Jonathan Vaas",
"content": "Thanks, everyone. This concludes the call."
},
{
"speaker": "Operator",
"content": "Thank you. This does conclude today's conference. We do thank you for your participation, and have an excellent day."
}
] |
adbe | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Q1 FY 2024 Adobe Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jonathan Vaas, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Jonathan Vaas",
"content": "Good afternoon, and thank you for joining us. With me on the call today are Shantanu Narayen, Adobe's Chair and CEO; David Wadhwani, President of Digital Media; Anil Chakravarthy, President of Digital Experience; and Dan Durn, Executive Vice President and CFO. On this call, which is being recorded, we will discuss Adobe's first quarter fiscal year 2024 financial results. You can find our press release as well as PDFs of our prepared remarks and financial results on Adobe's Investor Relations website. The information discussed on this call, including our financial targets and product plans, is as of today, March 14, and contains forward-looking statements that involve risks, uncertainty and assumptions. Actual results may differ materially from those set forth in these statements. For more information on those risks, please review today's earnings release and Adobe's SEC filings. On this call, we will discuss GAAP and non-GAAP financial measures. Our reported results include GAAP growth rates as well as constant currency rates. During this presentation, Adobe's executives will refer to constant-currency growth rates unless otherwise stated. Non-GAAP reconciliations are available in our earnings release and on Adobe's Investor Relations website. Adobe Summit is just around the corner in Las Vegas at The Venetian Convention and Expo Center beginning on Tuesday, March 26. Following the day one keynote, we will host an Investor Meeting at 2:00 PM Pacific Time. The event will be webcast live and the replay will be available on Adobe's IR website. More details about the summit are available at summit.adobe.com. I will now turn the call over to Shantanu."
},
{
"speaker": "Shantanu Narayen",
"content": "Thanks, Jonathan. Good afternoon, and thank you for joining us. Adobe had a strong first quarter. We achieved $5.18 billion in revenue in Q1, representing 12% year-over-year growth. GAAP earnings per share for the quarter was $1.36, and non-GAAP earnings per share was $4.48, representing 18% year-over-year growth. Our performance reflects the essential role that Adobe products play in driving the global digital economy. We're delivering on our strategy to unleash creativity for all, accelerate document productivity and power digital businesses. Adobe Creative Cloud, Document Cloud and Experience Cloud are more critical than ever to the success of creators, communicators, students, entrepreneurs, and businesses of all sizes with AI serving as an accelerant for all. We are a leader in delivering generative AI across all our clouds. We're taking a highly differentiated approach across data, models and interfaces. Our proprietary data is built on decades of deep domain expertise across creative, documents and customer experience management. We leverage large language models, as well as have invested in building and delivering our proprietary models in the creative document and marketing domains. Our IP-friendly approach is a differentiator for creators and enterprises. In addition, we've innovated by delivering generative AI directly in products with releases in Adobe Photoshop, Illustrator and Express across both desktop and mobile. AI Assistant in Acrobat and Reader unlocks the tremendous value of the trillions of PDFs around the world. We're bringing generative AI to Adobe Experience Cloud and will demonstrate our AI Assistant for Customer Experience Management at Adobe Summit. Every student, communicator, creative professional and marketer is now focused on leveraging generative AI to imagine, ideate, create and deliver content and applications across a plethora of channels. Adobe is uniquely positioned through the combination of Express, Firefly, Creative Cloud, Acrobat and Experience Cloud to deliver on this immense market opportunity. The success we are already seeing with our GenStudio offering in the enterprise is validation of our leadership, and we expect that success to translate into other segments as we roll out these solutions throughout the year. We are driving strong usage, value and demand for our AI solutions across all customer segments. We're successfully monetizing our innovations with particular strength in Q1 in the Enterprise segment across our Digital Media and Digital Experience businesses. This strength is reflected in our strong RPO growth of 16% year-over-year. We're pleased with a strong Q1. We have a phenomenal product roadmap that we're executing against to bring AI innovation across our global customer base and we're just getting started. I'll now turn it over to David to discuss the momentum in our Digital Media business."
},
{
"speaker": "David Wadhwani",
"content": "Thanks, Shantanu. Hello, everyone. In Q1, we achieved a net new Digital Media ARR of $432 million and revenue of $3.82 billion, which grew 13% year-over-year. The world's information whether it's an enterprise legal contract, a small business invoice or a personal school form lives in trillions of PDFs. We were thrilled to announce Acrobat AI Assistant, a massive leap forward on our journey to bring intelligence to PDFs. With AI Assistant, we're combining the power of generative AI with our unique understanding of the PDF file format to transform the way people interact with and instantly extract additional value from their most important documents. Enabled by a proprietary attribution engine, AI Assistant is deeply integrated into Reader and Acrobat workflows. It instantly generate summaries and insights from long documents, answers questions through a conversational interface, and provides an on-ramp for generating emails, reports and presentations. AI Assistant is governed by secure data protocols so that customers can use the capabilities with confidence. We are pleased with the initial response to the English language beta and look forward to usage ramping across our customer base as we release other languages later in the year. We will monetize this functionality through a monthly add-on offering to the hundreds of millions of Reader users as well as the Acrobat installed base across individuals, teams and enterprises. In Q1, we achieved Document Cloud revenue of $750 million, growing 18% year-over-year. We added $143 million of net new Document Cloud ARR, which was a Q1 record with year-over-year ending ARR growth of 23% in constant currency. Other business highlights include Acrobat Web continues to be an incredible source of customer acquisition with monthly active users up over 70% year-over-year and surpassing 100 million users in Q1. Acrobat extensions for Microsoft Edge and Google Chrome and our Acrobat Mobile offerings continue to accelerate free-to-paid conversion. Increased viral adoption through link sharing and stakeholder collaboration drove over 300% year-over-year growth in the number of PDF files sent. Key enterprise customer wins include Berkshire Hathaway, Merck Sharp & Dohme, Northrop Grumman, Porsche, and the U.S. Navy. On Creative Cloud, creativity is the currency of differentiation in our digital-first world. Every creator and business is focused on building their brand and engaging with their audiences through standout content. Creative Cloud remains the solution of choice for the world's creators, whether their medium is design, photography, video, illustration or 3D. Adobe Express is inspiring millions of users of all skill levels to design more quickly and easily than ever before. In the year since we announced and released Adobe Firefly, our creative generative AI model, we have aggressively integrated this functionality into both our Creative Cloud flagship applications and more recently, Adobe Express, delighting millions of users who have generated over $6.5 billion assets to date. In addition to creating proprietary foundation models, Firefly includes a web-based interface for ideation and rapid prototyping, which has seen tremendous adoption. We also recently introduced Firefly Services, an AI platform which enables every enterprise to embed and extend our technology into their creative, production and marketing workflows. Firefly Services is currently powered by our commercially safe models and includes the ability for enterprises to create their own custom models by providing their proprietary datasets as well as to embed this functionality through APIs into their email, media placement, social and web creation process. Early adopters like IBM are putting Firefly at the center of their content creation processes. IBM used Adobe Firefly to generate 200 campaign assets and over 1,000 marketing variations in moments rather than months. The campaign drove 26X higher engagement than its benchmark and reached more key audiences. In Q1, we achieved $3.07 billion in revenue, which grew 12% year-over-year. Net new Creative Cloud ARR was $289 million. Other business highlights include new the launch of the new Adobe Express mobile app beta brings the magic of Adobe Firefly AI models directly into mobile workflows. The first-of-its-kind integration with TikTok's creative assistant makes the creation and optimization of social media content quicker, easier and more effective than ever before. Express Web usage continues to ramp nicely with total exports more than doubling year-over-year and overall Express adoption is expected to accelerate even further, given the positive reception we're seeing from the mobile beta. Generative Fill in Photoshop continues to empower creators to create in new ways and accelerate image editing workflows. Q1 saw the highest adoption of Firefly powered tools in Photoshop since the release of Generative Fill in May 2023 with customers adopting these features across desktop, web and most recently, iPad, which added Generative Fill and Generative Expand in December. The beta release of AI-powered Enhance Speech and new audio workflows drove premiere beta usage to record highs. Adobe video tools were the go-to choice at Sundance Film Festival with over 80% of this year's entrants using Adobe software. The introduction of Behance Pro, a new offering to serve the rapidly growing Behance community empowers members to build their brand and find opportunities, and for businesses to hire talented creators through the Behance platform. The unveiling of new research like the preview of our music generation models and editing tools last month and our video auto dubbing models earlier today have inspired our Creative Cloud and Express customers. The introduction of Firefly Services for enterprises drove notable wins in the quarter, including Accenture, IPG and Starbucks. Other key enterprise wins include AECOM, Capital Group, Dentsu, IBM, Nintendo and RR Donnelley. Given the size of opportunity we see with generative AI, we continue to focus on driving innovation, adoption and usage of our AI solutions. In Q1, we saw strength across both clouds with record new commercial subscriptions in Creative Cloud for Q1, and strong product-led growth in Document Cloud. You can expect to see the product advances and Express with Firefly on mobile. Firefly Services and AI Assistant in Acrobat drive ARR acceleration in the second half of the year. We're excited about our product roadmap. The 6.5 billion assets generated to date include images, vectors, designs and text effects, and we can't wait to share the work we're doing on audio, video and 3D through research sneaks and product announcements in the coming months. I'll now pass it to Anil."
},
{
"speaker": "Anil Chakravarthy",
"content": "Thanks, David. Hello, everyone. Experience Cloud business had a great first quarter, achieving $1.29 billion in revenue and was our strongest Q1 on record for new business. Subscription revenue was $1.16 billion, representing 12% year-over-year growth. Companies are prioritizing digital investments to improve marketing agility and customer engagement while driving growth and profitability. Adobe's holiday shopping report which analyzes trillions of data points, showed strong online spending during the 2023 holiday season, growing 4.9% year-over-year to $222.1 billion, a new record for e-commerce as well as mobile shopping, which surpassed desktop for the first time and drove 51.1% of online sales. Our Adobe Experience Cloud applications span the entire customer funnel from acquisition to monetization to retention. As the global leader in the Digital Experience Platforms category, Adobe offers businesses a single view of their customers' data across every channel, allowing them to create precise segments and deliver personalized experiences regardless of when and where the customer interacts with their brand. Over the last five years, our organic innovations in Adobe Experience Platform, Realtime CDP, Journey Optimizer, and Customer Journey Analytics have made us the leading platform for customer experience management given the scale of the profiles, campaigns and interactions we process, which now exceed 500 trillion segment evaluations per month. Today, rollout of personalization at scale has been limited by the number of content variations you can create and the number of journeys you can deploy. We believe harnessing generative AI will be the next accelerant with Creative Cloud, Firefly Services and GenStudio, providing a comprehensive solution for the current supply-chain, and generative experienced model automating the creation of personalized journeys. Adobe GenStudio is the generative AI first application that allows marketers to quickly plan, create, store deliver and measure marketing content in a single intuitive offering. With state-of-the-art generative AI powered by Firefly Services, marketers can create on-brand content with unprecedented scale and agility to deliver personalized experiences. Adobe GenStudio natively integrates with multiple Adobe applications across Creative Cloud and Experience Cloud, including Express, Firefly, Workfront, Experience Manager, Customer Journey Analytics, and Journey Optimizer. It can be used by brands and their agency partners to unlock new levels of creativity and efficiency in marketing campaigns. Business highlights include momentum with Adobe Experience Platform and native applications with the combined annualized book of business surpassing $800 million in the quarter. Demand for Adobe Experience Manager, Workfront and GenStudio to address the enterprise content supply chain. Global agencies, including Accenture, Havas, IPG, Omnicom, and Publicis have standardized on Adobe as their technology platform of choice for their own workflows and to optimize creative collaboration with the world's leading brands. Strength in Adobe Journey Optimizer on Adobe Campaign as companies look to deliver more personalized experiences across channels and surfaces. Adobe was recognized as a leader in the Gartner Magic Quadrant for Digital Experience Platforms for the seventh consecutive year, as well as the Forrester Wave for Digital Experience Platforms. Adobe Experience Manager assets was also named a leader for the fourth consecutive time in the Forrester Wave for Digital Asset Management. Key customer wins include Carl Zeiss, Comcast, Home Depot, NASCAR, Nestle, PayPal, Rogers Communications, Santander Group, Starbucks and Walgreens. Later this month, we are excited to host Adobe Summit, the world's largest digital experience conference in Las Vegas, where we will be joined by thousands of customers, partners, and developers from around the world. We look forward to showcasing a number of product innovations, including a new generative experienced model, advances in Adobe GenStudio, a new AI Assistant in Adobe Experience Platform, new capabilities in RT CDP for first-party data activation and expanded Firefly Services offerings. We will articulate our vision and playbook for brands to achieve a new level of personalization at scale in the era of generative AI. We look forward to sharing our exciting product roadmap and hearing from our customers and how Adobe is helping them transform their business. We were off to a fast start in Q1 and look forward to continuing the momentum and leadership in Q2 and beyond. I will now pass it to Dan."
},
{
"speaker": "Dan Durn",
"content": "Thanks, Anil. Today, I'll start by summarizing Adobe's performance in Q1 fiscal 2024, highlighting growth drivers across our businesses, and I'll finish with financial targets. In Q1, Adobe delivered another quarter of double-digit top line growth with robust margins that result from product leadership, strong execution, and financial discipline. The pace of our product innovation across Document Cloud, Creative Cloud, and Experience Cloud is leading to customers making large multi-year commitments to Adobe. And you see the result of those customer investments in our RPO performance, which accelerated to 16% year-over-year growth. In the quarter, Adobe achieved record revenue of $5.18 billion, which represents 11% year-over-year growth, or 12% in constant-currency. Business and financial highlights included GAAP-diluted earnings per share of $1.36 and non-GAAP diluted earnings per share of $4.48. Digital Media revenue of $3.82 billion, net-new Digital Media ARR of $432 million, Digital Experience revenue of $1.29 billion, cash flows from operations of $1.17 billion, RPO of $17.58 billion exiting the quarter, and repurchasing approximately 3.1 million shares of our stock during the quarter. GAAP EPS came in lower due to the $1 billion payment resulting from the termination of the Figma transaction. Absent the termination payment, our cash flows from operations would have been $1 billion more, and GAAP EPS would have been $2.19 higher. The termination payment impacts both Q1 GAAP EPS and our full-year fiscal 2024 GAAP EPS. In our Digital Media segment, we achieved Q1 revenue of $3.82 billion, which represents 12% year-over-year growth, or 13% in constant currency. We exited the quarter with $15.76 billion of Digital Media ARR, up 14% year-over-year in constant currency. Adobe achieved Document Cloud revenue of $750 million, which represents 18% year-over-year growth as reported and in constant currency. We added $143 million of net new Document Cloud ARR in the quarter. Q1 Document Cloud growth drivers included demand for Acrobat subscriptions across all customer segments and geographies. Continued growth of Acrobat Web demonstrating the success of our flagship products across multiple surfaces, growing monthly active users in our Acrobat Reader Funnel driving free-to-paid conversion. New user acquisition resulting from our Microsoft Edge and Google Chrome partnerships. Strength in our Teams business with up selling our new Acrobat offering which includes integrated signed capabilities, and strong demand from businesses of all sizes, demonstrating the mission criticality of our Document Solutions. We achieved Creative revenue of $3.07 billion, which represents 11% year-over-year growth, or 12% in constant currency. We added $289 million of net new creative ARR in the quarter with ending ARR growing 12% year-over-year in constant currency. Overall CC pricing actions performed as expected in the quarter. Q1 net new Creative ARR grew more than 20% year-over-year, excluding the impact of pricing actions associated with both Acrobat CC and All Apps in the year-ago quarter and Creative Cloud in Q1 FY '24. Q1 Creative growth drivers included new subscription growth, including strong adoption of Creative Cloud All Apps across geographies and customer segments. Strong single-app customer demand in creative categories such as imaging and photography, and continued growth of stock and Frame.io. We again saw strength in emerging markets, which we continue to believe is a massive growth opportunity and outstanding performance of Creative Cloud in the enterprise including early traction of Firefly services. Turning to our Digital Experience segment. In Q1, we achieved revenue of $1.29 billion, which represents 10% year-over-year growth as reported and in constant currency. Digital Experience subscription revenue was $1.16 billion, growing 12%year-over-year as reported and in constant currency. Q1 was a tremendous start to the year for our Experience Cloud business with growth drivers, including: success closing transformational deals across geographies and verticals with large enterprises that are choosing Adobe to be their end-to-end customer experience management platform, continued momentum with AEP and native applications with the annualized book of business growing more than 60% year-over-year, strong customer adoption of our content, campaign and Workfront solutions, and continued strength with customer retention and expansion across our products. Customer Experience Management remains an enterprise imperative. And as a leader in the category, we see a robust pipeline as we look into Q2 and beyond. Turning to the income statement and balance sheet. Adobe's effective tax rate in Q1 was 36% on a GAAP basis and 18.5% on a non-GAAP basis. The Q1 GAAP tax rate came in higher than targeted due to the Figma termination payment. RPO exiting the quarter was a record $17.58 billion, growing 16% year-over-year as reported and in constant currency. Our ending cash and short-term investment position exiting Q1 was $6.82 billion, and cash flows from operations in the quarter were $1.17 billion. In Q1, we entered into a $2 billion share repurchase agreement, which effectively exhausted our prior $15 billion authority. As a result of our strong trajectory of growth and profitability, we are announcing a new $25 billion share repurchase program, which demonstrates Adobe's continued commitment to returning capital to our shareholders. In light of the momentum across our business and factoring in the macroeconomic environment, for Q2, we're targeting total Adobe revenue of $5.25 billion to $5.30 billion; Digital Media net-new ARR of approximately $440 million; Digital Media segment revenue of $3.87 billion to $3.90 billion; Digital Experience segment revenue of $1.31 billion to $1.33 billion; Digital Experience subscription revenue of $1.165 billion to $1.185 billion; tax rate of approximately 18.5% on a GAAP and non-GAAP basis; GAAP earnings per share of $3.35 to $3.40, and non-GAAP earnings per share of $4.35 to $4.40. In summary, fiscal 2024 is off to a strong start. By combining the power of product innovation and executional excellence, Adobe is driving consistent profitable growth. We're delivering on our product roadmap, and we have the right strategy to monetize these innovations into the back half of the year and beyond. Adobe is incredibly well-positioned to capitalize on the secular trends that will shape the next decade. Shantanu, back to you."
},
{
"speaker": "Shantanu Narayen",
"content": "Thanks, Dan. We're the leader in three large and growing categories and have delivered groundbreaking innovation across Creative Cloud, Document Cloud and Experience Cloud. We believe that AI augments human ingenuity and expands our addressable market opportunity. I'm proud of the pace and the responsible manner in which we have embraced and delivered generative AI capabilities across our product portfolio. As a result of our strategy and execution, we're confident in our ability to attract new users and deliver value to existing customers to drive growth and profitability. I'd like to thank our 30,000 employees for their continued dedication and unwavering focus on innovation and execution. It is particularly exciting to be named to Glassdoor's Best Places to Work, Fortune's Most Admired Companies, and he JUST 100. Thank you, and we will now take questions. Operator?"
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Our first question comes from the line of Kirk Materne with Evercore ISI. Go ahead."
},
{
"speaker": "Kirk Materne",
"content": "Yeah. Thanks. Thanks very much for taking the question. I guess maybe this is for David or Dan. Obviously, you guys called out that new creative ARR was up more than 20% year-over-year when you exclude the pricing increases which infers a pretty major pricing headwind that we're seeing right now. Can you all just try to parse out how that's going to play out over the year? I know David you mentioned ARR will go up in the back half of the year, but that it’s just tough I think to reconcile what's going on in the business on a normalized basis, and when we might see that sort of translate more into the metrics that everybody follows. Thanks."
},
{
"speaker": "Dan Durn",
"content": "Yeah. I'll start and others can go ahead and add on. First of all, we do -- as we look at the book of the business, it is a strong start to the year with Q1 coming in at a high watermark with $432 million across the entire business. As we look specifically at Creative Cloud, I just want to sort of make sure everyone takes a step back and looks at our strategy to accelerate the business because I think the growth drivers here are very clear. We are focused on expanding access to users with things like Express on mobile. We want to introduce new offers across the business with things like AI Assistant and also existing capabilities for Firefly coming into our core Firefly, our core Photoshop and Illustrator and flagship applications. We want to access new budget pools with the introduction of Firefly Services and GenStudio as we talked about. And the early signs, as you point out in Q1 results are really suggesting that those growth drivers are taking hold. As you talked about normalizing for FY '23, FY '24 pricing actions, we grew the CC business about 20% year over year. Other key things to look at is that we set another record for new commercial subscriptions in Q1, and the business growth remains stable at -- if you look back at revenue 12% -- if you look forward at ARR 12%. So the stability and the diversity of the business is strong. And as we enter the back half of the year, we have capabilities for Creative Cloud pricing with Firefly that have already started rolling out late last year, as we talked about, and we'll be incrementally rolling out throughout the year. We're ramping Firefly Services and Express and Enterprise. As we talked about, we saw a very good beginning of that rollout at the -- toward the end of Q1. We also expect to see the second half ramping with Express Mobile and AI Assistant coming through. So we have a lot of the back-end capabilities set up so that we can start monetizing these new features which are still largely in beta starting in Q3 and beyond. And as it relates to pricing, it's what we've talked about in the past. We had two pretty significant pricing actions that benefited FY '23, the first one being the Acrobat price increases that we had put out with the new value that we had introduced with sign capabilities, and also a CC price increase that we introduced in FY '22 that was rolling into FY '23. Both of those are rolling off as we have now introduced the new pricing for CC with Firefly, and overall, the roll-off of the prior pricing is more significant than the new pricing that we've introduced."
},
{
"speaker": "Kirk Materne",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "And we will take our next question from Brent Thill with Jefferies. Please go ahead."
},
{
"speaker": "Brent Thill",
"content": "Thanks. Shantanu, the magnitude of the beat this quarter was -- there was roughly half the absolute beat you've had in past quarters and then the guide obviously, lower for next quarter. I think everyone is asking is this some type of AI headwind? Is this macro? Is this execution? Can you just comment on -- and maybe it's none of these things, but can you just comment on what you think you're seeing in the current quarter?"
},
{
"speaker": "Shantanu Narayen",
"content": "Yeah. Happy to, Brent. And again, I'll reiterate that as it relates to us taking our targets pretty seriously. I mean, when we guided to $1.9 billion for the year, I mean, we had factored in both, as David mentioned, what was likely to happen in the pricing and how that rolls off, as well as the product roadmap, and when AI Assistant and Acrobat would be available, when Express, which is now in beta, would be available. So I think it factored in all of those. I guess if you are looking at it from accomplishment, we look at it and say hey, we did $410 million. I think last year we did $432 million. If we look at the guide and we're on track as it relates to the $1.9 billion, and to hopefully exceed that guide. And so from our perspective, it's playing out. Maybe the other color, Brent, that I would provide is given the desktop products are still in beta, and there we look at value and there we look at utilization. And so I think we gave you some numbers on the $6.5 billion generations that we're seeing, the really positive feedback that we're getting in Acrobat that continue to give us optimism associated with how that is. I think where there's tremendous interest and where if you look at it from an AI monetization, the two places that we're monetizing extremely in line with our expectations. The first is as it relates to the Creative Cloud pricing that we've rolled out. And as you know, the generative packs are included for the most part in how people now buy Creative Cloud, that's rolling out as expected. And the second place, where we are monetizing it is in the entire enterprise as it relates to Content and GenStudio. And I'm really happy about how that's monetizing it. I mean, that's a combination, Brent, of when we go into an enterprise for creation, whether we provide Creative Cloud or a combination of Express, what we are doing with asset management in AEM, workflow, as well as Firefly Services to enable people to do custom models as well as APIs. We're seeing way more monetization earlier, but again, very much in line with expected. So again, I look at the quarter and I feel really good, both about the product delivery as well as the way monetization is turning out. I mean, it's clear, I guess, a little bit from sort of what we've seen that expectations were perhaps a little higher, both in terms of what we would guide for Q2, but I'm really optimistic about what we have done."
},
{
"speaker": "Brent Thill",
"content": "Thanks, Shantanu."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Brad Zelnick with Deutsche Bank."
},
{
"speaker": "Brad Zelnick",
"content": "Great. Thanks so much for taking my question. My question is for Dan. You're not raising the full-year guide, and I appreciate it's still early in the year, but I think we're all hoping you can at least affirm it for us. But you also -- you pushed out the enforcement of generative credit limits for some products beyond April that were originally expected sooner. What's the thinking behind this decision? And what are you seeing thus far in terms of credit consumption and purchasing patterns of those credit packs? Thanks."
},
{
"speaker": "Dan Durn",
"content": "Yeah. Thanks, Brad. I'll jump in on the first part, then toss it over to David for the second. So we're not updating the targets. What the targets we provided for the full year, they're, as of the December call. What we did share on the call was the material change that we saw in Q1 as a result of the Figma termination payment. We talked about the GAAP EPS impact. It rolls through Q1 and it'll certainly have an effect for the full year. And it's $2.19 as a result of the $1 billion payment. And I think with that, I think you have everything you need relative to where we set our targets, but we're not going to be updating them on this call."
},
{
"speaker": "David Wadhwani",
"content": "Yeah. And I'm happy to add a little bit. Yeah, in terms of the timing of the -- when we start enforcing credits, don't read anything into that other than right now, we are still very much in an acquisition mode. We want to bring a lot of users in. We want to get them using the products as much as possible. We want them coming back and using it. One thing I do want to state because I know there's a lot of energy around how do these credits play out over time. In the last few weeks, we've done a couple of sneaks that could also be instructive. Last month, we snuck music composition, where you can take any music track, you can give it a music type like hip hop or orchestral or whatever, and it will transform that initial track into this new type of music. Just this morning, we snuck our ability to do auto dubbing and lip-syncing, where you give it a video of someone talking and saying English, and then you can translate it automatically to French or Spanish or Portuguese or whatever. As you can imagine those actions will not take one credit. Those actions will be much more significant in terms of what they cost. So right now, Alex, the primary point is about proliferation and usage. We're going to be bringing in a lot more new capabilities throughout the tools that will drive more usage, and we're going to be bringing in more expensive capabilities as well. And as we've talked about, you should start to see that ramp through the year, and we feel very comfortable with the adoption we're seeing. Just one last thing to call out, as we mentioned on the call, highest number of users using generative AI in Q1 ever so we're very excited about the trajectory."
},
{
"speaker": "Shantanu Narayen",
"content": "And maybe just to add a little bit more of how we're thinking about it as it relates to the monetization of AI. I think we're in early stages as it relates to experimentation. So we're looking at both what the value utilization is as well as experimentation. The value utilization is actually really positive for us. I think, as it relates to the monetization and the experimentation, we have the generative packs, as you know, in Creative Cloud. I think you will see us more and more have that as part of the normal pricing and look at pricing because that's the way in which we want to continue to see people use it. I think in Acrobat, as you've seen, we are not actually using the generative packs. We're going to be using more of an AI Assistant model, which is a monthly model. As it relates to the Enterprise, we have both the ability to do custom models, which depends on how much content that they are creating, as well as an API and metering that we've rolled that out and we've started to sell that as part of our GenStudio solution. So I think it's fair to say, and I certainly monitor what everybody else in the industry is saying. The good news about this is the interface integration that we've done in all our apps and the utilization, and I think the experimentation will enable us to determine how we best attract the largest number of customers that we can who are new to Creative Cloud. We've talked about that as it relates to Firefly attracting new customers. Certainly, I think the number of Q1 commercial subscriptions was another record. So we're absolutely doing everything that we intended to experiment as we roll this out, Brad. So I wanted to accentuate that as well."
},
{
"speaker": "Brad Zelnick",
"content": "Thank you so much. Very helpful."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Michael Turrin with Wells Fargo Securities. Please go ahead."
},
{
"speaker": "Michael Turrin",
"content": "Hey, great. Thanks. I appreciate you taking the question David, couldn't help but notice you led off your prepared remarks section with the Document Cloud. Can you speak to the enthusiasm you're seeing on the document side? And when we think about the mix of Digital Media growth for the year, should we expect it will continue to trend towards that Document side? Or is it more the second half where some of the creative enhancements start to layer on more meaningfully we could start to see that shift back a bit? Thanks."
},
{
"speaker": "David Wadhwani",
"content": "Yeah. Happy to talk about that. We were very -- and continue to be very happy with the performance of Document Cloud. If you really look at trying to understand sort of how that plays out Document Cloud, the growth is a combination of both our go-to-market efforts and our product innovation. On the go-to-market effort side, think about the fact that Reader continues to be a top-of-funnel for us and we continue to see Reader monthly active user growth. So the potential of people we can convert over to paid subscribers continues to grow. We also talked about the fact that Acrobat Web has been a major contributor to our growth. So we're seeing 70% year-over-year growth in terms of Web MAU, and we crossed 100 million monthly active users for the first time on the website. And of course, we're doing a lot of work with product-led growth to drive the Journey users to some of that value that drives conversion. So that's all we're doing on the go-to-market side. On the side of product innovation, our strategy over the last couple of years has been to make PDF the starting point of a workflow, right? And so that's why we integrated Sign directly into that so that people could use their PDFs and start a transaction for their business. And that continues to grow very nicely, and it's a great selling point for an integrated service. We also introduced link sharing a few years ago for commenting and reviewing with groups and teams. We saw that link sharing grow 300% year-over-year so that's a huge point of value, but it's also a huge point of viral growth. That's also what when someone receives that, it's another opportunity for us to bring them into the value of the broader offering. And you can expect to see that with AI Assistant as well. So obviously, everyone is looking at AI Assistant in Acrobat. I certainly hope all of you are using it, should make your lives more effective. Not just for insight. We think that there's a lot of opportunity for monetization of insight for AI Assistant on our core base of Acrobat users, but also for the first time doing consumption-based value. So the hundreds of millions of monthly active users of Reader will also be able to get access to AI Assistant and purchase an add-on pack there too. So it's a really broad base to look at how we monetize that, but it's also the start of the ability to take your conversation and generate emails and presentations and continue that process. So the combination of all of that is a really potent combination of go-to-market efforts and product innovation. So we continue to be bullish about this. So the second part of your question, we are -- as we've said multiple times on the call, we are very excited about all the innovation that's coming out that's just starting to ramp in terms of monetization and/or still in beta on the Creative Cloud side. We expect that to come out in Q3 and we'll start our monetization there. So we continue to feel very confident about the second half acceleration of Creative Cloud."
},
{
"speaker": "Michael Turrin",
"content": "I appreciate all the details there. Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Saket Kalia with Barclays."
},
{
"speaker": "Saket Kalia",
"content": "Okay. Great. Hey, guys, thanks for taking my question here. Maybe for both David and Shantanu. Clearly, a lot of news around video creation using generative AI during the quarter, of course, with the announcement of Sora. Maybe the question for you folks is, can we just talk a little bit about how you think about the market impact that generative AI can have in the video editing market and how maybe Firefly can participate in that trend?"
},
{
"speaker": "Shantanu Narayen",
"content": "Sure. Saket. I mean, I'll start and then David can add. I mean, firstly, I think the advances, whether it's in OpenAI or our own models that certainly, David and I have the pleasure of looking at on a weekly basis, the advances are amazing because you have to -- when you're thinking about video solve some other fundamental problems like physics, right, I mean, if you have somebody walking on a street, how do you make sure that they don't go through a building or go through the floor? And so I think some of those video advancements that we have seen within Adobe have really addressed some of those hard problems. A big picture, though, video I think will be even more of an accelerant for editing applications. I think this notion that the next Oppenheimer will be done using a text-to-video prompt is just -- it's not going to happen for decades. And so I think actually more so in video, there's going to be an accelerant for people saying how do I get an on-ramp as it relates to using text to video and then edit that using our applications. And so I think I'm really particularly excited about what we can do with premiere as well as with After Effects as it relates to video. So net-net, I would say, Saket, the technology is impressive. We have our models, we have integrated into our interfaces. We're also partnering. I had a really great conversation with Jensen recently about what we can do as they are investing in video. Certainly, he would love to partner with us, and we're looking together to see how we can push the envelope on video as well using their models, whether it's Edify or Nemo. And so I think really early days, we're seeing a whole bunch. I hope -- and David mentioned this look at some of the lip sync stuff that we've done as well, which allows you to auto-dub and translate into languages. So we intentionally released a little bit of that demo. So really great advances. But net-net video is going to be even more of a need for editing applications in order to truly take advantage of generative AI."
},
{
"speaker": "David Wadhwani",
"content": "Yeah. And maybe I'll just add a few things. First of all, as Shantanu mentioned, the research in the industry and certainly with Sora is very impressive and exciting. It's also very consistent with the models that we're developing. So we think that there is -- there will be, as there was with video -- sorry, imaging, there will be multiple models that come out, including the Adobe model later this year, and we should start to see a lot of innovation there like we've seen in imaging. We've already started to sneak a couple of things that Shantanu talked about. So you will see text-to-video capabilities from us later this year. But you'll also see it with transparency around the training data that we have, you'll see it with more tool ability and controllability. You'll see it integrated into our tools as well. Now, all of that said, I do want to be very clear with what Shantanu said, which is that we see the proliferation of video models to be a very good thing for Adobe. And we're going to work with OpenAI around Sora. You're going to see us obviously, developing our own model. You're going to see others developing model. All of that creates a tailwind because the more people generate video clips, the more they need to edit that content, right? So whether its Premiere or After Effects, or Express, they have to assemble those clips, they have to color-correct those clips, they have to tone match, they have to enable transitions. So we're excited about what we're building, but we're just as excited about the partnerships that we see with OpenAI and others coming down this path. And if you take a step back, you should expect to see more from us in the weeks ahead with imaging and vector and design, text effects, and in the months ahead with audio and video and 3D. We're very excited about what all of this means, not just for the models, but also for our APIs and our tools."
},
{
"speaker": "Saket Kalia",
"content": "Super helpful. Thanks."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Alex Zukin with Wolfe Research. Please go ahead."
},
{
"speaker": "Alex Zukin",
"content": "Hey, guys. Thanks for taking the question. And I just -- mine is going to be more of a clarifying question because it's clear that from a number of comments, whether it's outperforming Digital Media ARR in the quarter to accelerating Creative ARR in the second half to maybe doing better than $1.9 billion in the full year for Digital Media ARR. My question is very simple. Can you reiterate -- not update, but reiterate the guide that you gave in December for Digital Media ARR in net news specifically for this year, and maybe puts and takes around how we should think about to the question earlier, the second half versus first half tailwind, headwind around pricing?"
},
{
"speaker": "Shantanu Narayen",
"content": "Yeah. So we take our guide seriously. Q1 played out as expected. It was ahead of where we were last year. Our Q2 guide is ahead of where the guide was in Q2. We're talking about acceleration into the back half of the year. If I didn't feel like our full-year guide was achievable, we would have a different conversation. We're confident in the targets that we put out there, our ability to meet them. If there's an opportunity to do better, we certainly will. So we feel good about where we sit in the first half. And as we look forward into the second half, the momentum we see from an innovation standpoint integrating into our products, what we see going from beta to GA, we feel good about the momentum into the second half."
},
{
"speaker": "Alex Zukin",
"content": "Perfect. Thank you, guys."
},
{
"speaker": "Operator",
"content": "And your next question comes from the line of Karl Keirstead with UBS. Go ahead."
},
{
"speaker": "Karl Keirstead",
"content": "Thank you. Dan, maybe I'll continue with this subject that Alex was getting at. So I think what's tough about modeling ARR of late is it's very difficult to see the impact of the price actions. It feels like a black box to us. So I'm wondering if you could help us get aligned for the second half, and offer some qualitative color on the extent to which the prior period price actions roll off. Is that more of a 3Q or 4Q phenomenon? Is there any way you could help size that impact, just to feel good about David's earlier comment about that roll-off being a big part of the second-half ARR acceleration? Thank you."
},
{
"speaker": "Dan Durn",
"content": "Yeah. So there was two pricing actions that we had taken in 2022. In May of 2022, we pushed forward a pricing action, and then October of 2022, we pushed forward the Doc Cloud line optimization, where we integrated Sign. The one-year anniversary of those pricing actions from May of 2022 and October of 2023, or -- I'm sorry, October of 2022 will be behind us on the one year anniversary. So you will still see some Q3 impact from pricing actions in the year-ago period. Q4 will be a clean look for the company, at least two months in Q4 will be a clean look. The actions that we're taking right now from both a pricing and a product standpoint on the Creative side will be more apparent in the back half of the year into the end of the year."
},
{
"speaker": "Karl Keirstead",
"content": "Okay. That's helpful."
},
{
"speaker": "David Wadhwani",
"content": "I think the other way I would look at it, honestly -- sorry, go ahead."
},
{
"speaker": "Dan Durn",
"content": "Go ahead, David."
},
{
"speaker": "David Wadhwani",
"content": "Well, the way I would look at it, in terms of the rhythm of the numbers and how you've seen sort of what transpired in 2023, and how we look at 2024, and the path to $1.9 billion and beyond, the way I would look at it is we're ahead in Q1. We're ahead in Q1. We're giving you all the reasons why we think there's more product coming and more monetization coming in the rest of the year. And that's what gives us the confidence associated with the targets. I guess there's this question of every quarter, do we reiterate targets? Do we update targets? What does that mean? And the way we've always thought of it is, if it was a way -- if we didn't have confidence, we would give you that. We have confidence associated with the numbers, but we're not in the business of every quarter, looking at every number. And let's go down one other number, which was the GAAP EPS. Certainly, there's an impact, as you know, in the GAAP EPS associated with what we did as it related to the Figma sort of transaction, and therefore the impact to GAAP EPS in Q1. So I think, from my perspective, the quarter and the year is playing out just as we did, and I feel more confident now than I did when we gave you our annual targets. I'll leave it at that."
},
{
"speaker": "Karl Keirstead",
"content": "Yeah. We got it. Thank you."
},
{
"speaker": "Operator",
"content": "And we will take our next question from the line of Jay Vleeschhouwer with Griffin Securities."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Thank you. Good evening. And with respect to Firefly, it's obvious that you are significantly ramping up your investments there, at least judging by the number of relevant open positions you're looking to fill for Firefly development, many of which are seemingly fairly senior. Could you comment on your pipeline of being able to bring in the requisite amount of developmental capacity to support everything you're doing with Firefly and everything else that David in particular talked about? And relatedly, on go-to-market in the last few months, you've been opening up the aperture for sales positions globally. Could you comment on what the thinking is behind that? And again, whether the population is there for you to bring in to meet your sales headcount needs? Thank you."
},
{
"speaker": "David Wadhwani",
"content": "Yeah. Let me take the first one and then Anil can answer the question on sales. As it relates to the momentum we're seeing with Firefly, I think there are multiple layers of it. One is obviously, we're seeing the quality of the models. We're seeing a differentiated approach as it relates to the training data, as it approaches contribution of assets from our community and how we compensate those folks. And so that's not just an Adobe perspective, but it's playing out obviously, in enterprises as they look at what are the models that they can consider using for production workflows. We're the only one with the full suite of capabilities that they can do. It's a really unique position to be in, but it's also being noticed by the research community, right? And as the community starts looking at places as if I'm a PhD that wants to go work in a particular environment, I start to ask myself a question of which environment do I want to pick. And a lot of people want to do AI in a responsible way. And that has been a very, very good opportunity for us to bring in amazing talent. So we are investing. We do believe that we have the best -- one of the best, if not the best, research labs around imaging, around video, or around audio, around 3D, and we're going to continue to attract that talent very quickly. We've already talked about we have the broadest set of creative models for imaging, for vector, for design, for audio, for 3D, for video, for fonts and text effects. And so this gives us a broad surface area to bring people in. And that momentum that starts with people coming in has been great. The second part of this too is managing access to GPUs while maintaining our margins. We've been able to sort of manage our cost structure in a way that brings in this talent and gives them the necessary GPUs to do their best work."
},
{
"speaker": "Anil Chakravarthy",
"content": "And regarding the sales positions in Enterprises. In Enterprise, we're in a strong position because what we -- I mean, this area of customer experience management, it remains a clear imperative for Enterprise customers. Everybody is investing in this personalization at scale, and current supply chain. These help drive both growth and profitability. So when you look at these areas, these from an enterprise perspective, these are a must-have. This is not a need to have. And that's helping us really attract the right kind of talent. We just onboarded this week a VP of Sales who have prior experience and a lot of experience in Cisco and Salesforce, etc. So that's an example of we're really bringing on some excellent enterprise sales talent."
},
{
"speaker": "David Wadhwani",
"content": "And I don't know if Jay, you were asking for -- building your model, or if you were looking for a job? But if you're interested in any of these positions, let us know more."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "More the former."
},
{
"speaker": "David Wadhwani",
"content": "Okay."
},
{
"speaker": "Jonathan Vaas",
"content": "Hey, operator, we're coming up on the hour. Let's try to squeeze in two more questions. Thanks."
},
{
"speaker": "Operator",
"content": "Thank you. We will take our next question from Kash Rangan with Goldman Sachs."
},
{
"speaker": "Kash Rangan",
"content": "Hey, thank you very much. Looks like there is more trust in AI and Excel models than what you're actually saying qualitatively on this call. I just wanted to give you an opportunity to debunk this hypothesis that is going around, that AI, it is generating videos and pictures, but the next step is it's going to do the actual editing and put out Premiere Pro use or whatnot. So that is probably the existential threat that people are debating. So why don't you see if we could take a shot at why that scenario is very unlikely that right now it's about generation of images and then your tools pick up where the generation stops and you do the processing, right? So help us understand why this can coexist with AI. That's a philosophical question. And Dan, one for you. Besides the net new ARR that you've already reported on Creative and DM, what are the other indicators such as new business bookings that you don't quantify necessarily that you qualitatively saw in Q1 that makes you feel good about the year? Thank you so much."
},
{
"speaker": "David Wadhwani",
"content": "Great. So maybe I'll take your first part, and Dan obviously, can take the second. So as it relates to generated content, I'm going to sort of break it up into two parts. One is around the tooling and how you create the content, and the second is around automation associated with the content. I think if you take a step back before we even get into either one of those, there is no question that there's a huge appetite because of personalization at scale, the need to engage users, the need to build your personal brand online. That content is going to explode in terms of the amount of content being created, and it's going to explode because of one of two things. The first is around the ability to create audio clips, video clips, images, vectors. These are things that get users started. It's a great for ideation. You'll see in a few weeks that some of the incredible work the team has been doing around ideation on Firefly.com. And once those things are created, they do flow into our tools for the production, work and process. We're clearly seeing a huge benefit from that because the more content that gets created, the more editing that's required, and that's what's driving more commercial CC subscribers this quarter than any other Q1 before. So that's the foundation of it. The second part of this, though, from an editing perspective is the controllability of -- and the editability of not just pixels and vectors and timelines, but also the editability of the latent space itself. The latent space being the core capability -- core model capabilities that actually generate the output. We have a lot of research that we've already started releasing, the first of which was Style Match, and you'll start to see more and more of that actually coming out at summit and beyond. But we are, in my mind, very, very clearly the leader in terms of creating models that can also be tooled on top of. So that combination of the models getting better and the controllability of those models, we're in a remarkable position for that. So we benefit from that. The second part, Kash, is around automation. So as people are generating more content, you clearly need to be able to automate that content and how it's created. And that's really where Firefly Services come in. First, it's built on the strength of our Firefly models, say for commercial use integrated into our tools, but it also adds the ability to have custom models so control what kinds of information or brand and content it's trained on for both brand styles and product replica, and it's also part of an ecosystem of API services, not just generate something which is a core part of it like text to image, or Generative Fill or Generative Expand, but also process. So once you generate some images through APIs and automation, you want to be able to remove the background, you want to be able to blur the depth, you want to auto tone, you want to apply actions to that image. And then the last is you want to be able to assemble that for delivery. Firefly services don't just generate something, but they let you have that entire ecosystem, and then you can embed that using low code, no code environments into your flows, and we are already embedding it into GenStudio and all of the capabilities that we're shipping. So I think the core part of this is that as more of this content creates, you need more tool ability. The best models are going to be the models that are safe to use and have control built in from the ground up. And I think we have the best controls of anyone in the industry, and they need to be able to be done in an automated fashion that can embed into your workflow. So I think all three of those vectors point to benefits for Adobe."
},
{
"speaker": "Kash Rangan",
"content": "That's very convincing."
},
{
"speaker": "Dan Durn",
"content": "And then as we think about the forward-looking, a couple of points I would turn to, just think about cash flow in Q1. Strength of our cash flow, once you normalize for the $1 billion termination payment, that's up 28% year-over-year. When you think about RPO, 3 point acceleration sequentially, and when I break that up on deferred revenue, unbilled backlog, you saw that acceleration in each of those subcomponents, which as you look through that acceleration, the near-term underscores the strength of the business and it underscores the longer term strength we have around the momentum of the business. When I think about individual product commentary, we talked about it a lot on this call. You see record commercial subscriptions in the Creative business. In Q1, you see engagement going up on the products. Usage of Firefly capabilities in Photoshop was at an all-time high. In Q1, Express exports more than doubling with the introduction of Express Mobile in beta now going to GA in the coming months, AI Assistant Acrobat, same fact pattern. You can see that momentum as we look into the back half of the year. And from an enterprise standpoint, the performance in the business was really, really superb in Q1, strongest Q1 ever in the enterprise. So there's a lot of fundamental components that we're seeing around performance of the business that give us confidence as we look into the back half of the year."
},
{
"speaker": "Kash Rangan",
"content": "Super. Thank you so much, Dan."
},
{
"speaker": "Operator",
"content": "We'll take our next question from Keith Weiss with Morgan Stanley. Please go ahead."
},
{
"speaker": "Keith Weiss",
"content": "Excellent. Thank you, guys, and I appreciate you squeezing me in. I'm going to take one last crack at this. Shantanu and team, we definitely, hear your confidence in the business, but obviously, the stock market reactions reflecting investors are worried about something. And the two things that worry investors more so than anything is uncertainty number one, and number two is back half ramps, right? And so I think what investors would really love to hear is Dan Durn actually say we still expect to do $1.9 billion in net new Digital Media ARR, and get some certainty there, and then also have a little bit more certainty or a little bit more explanation of what are the building blocks to that second half ramp? Which products are expected to go GA? Are we including stuff like document intelligent -- intelligence? Is there new monetization avenues that we're putting into the back half? Or is there just some mechanism within sort of the Creative Cloud pricing that's going to turn on in the back half of the year? Any further specifications in there, I think would help sort of close the gap between your confidence and sort of the lack of confidence exhibited by the after-hour reaction."
},
{
"speaker": "Shantanu Narayen",
"content": "And let me tackle that, Keith, and maybe I'll just tackle it by taking a couple of the other questions as well, summarizing that and ending with your question associated with the financial results. I think the first question that I hear across many folks is, hey, with the advent of AI and the increase in the number of models that people are seeing, whether they be image models or video models, does that mean that the number of seats, both for Adobe and in the world, do they increase or do they decrease? To me, there's no question in my mind that when you talk about the models and interfaces that people will use to do creative content, that the number of interfaces will increase. So Adobe has to go leverage that massive opportunity. But big-picture models will only cause more opportunity for interfaces, and I think we're uniquely qualified to engage in that. So that's the first one. The second one, I would say, is that does Adobe innovate, and when we do that, do we only leverage the Adobe model, or is there a way in which we can leverage every other model that exists out there? Much like we did with plugins, with all of our Creative applications, any other model that's out there, we will certainly provide ways to integrate that into our application. So anybody who is using our application benefits not just from our model creation, but from any other model creation that's out there. The way we first started to execute against that is in the enterprise because for us, the enterprise and the ability to create custom models so people can tweak their models to be able to do things within Photoshop that are specific to a retailer or a financial service was where we focus. But long term, certainly, as I've said with our partnerships, we will have the ability for Adobe in our interfaces to leverage any other model that's out there, which again, further expands our opportunity. I think as we play out the year, when we gave our targets for the $1.9 billion in ARR and the $410 million in Digital Media ARR for Q1, it factored in both our product roadmap and how things would evolve in the year. All of the product roadmaps we knew whether it was Acrobat, whether it was Express, whether it was Firefly, whether it was Creative Cloud, or whether it's GenStudio that brings all of these together, we knew the product roadmap, which we're executing against. In the first half of the year, a lot of that was beta, and in the second half of the year, a lot of that's monetization. It's playing out as expected. If anything, I would say the excitement around that, and in particular, the enterprise is faster than expected. And so I think our ability to monetize it just -- not just through new seats but also through these new Firefly services is expanded as it relates to what we are doing. And then as it relates to your question around financial results and the go-forward execution, we gave a Q1 target, we beat the Q1 target. And that gives us confidence that the financial target that we gave at the beginning of the year, we're ahead of that. And that's how I'll play it out. You're right. You have to model it. You can look at last year's model and look at last year's model and say, hey, they got to $1.913 billion. If they're ahead, does that fundamentally change Adobe's thesis on why we get to $1.9 billion and beyond, and in my mind it doesn't. And so that's the way I would answer that question. We have to go execute against the opportunity that we have. I look forward to those who are at Summit. I'm sure we'll have a little bit more conversation. But Q1 was a strong start. It was a strong start against product execution. It was a strong start against the financial metrics that we outline, and we're going to go do it again, Keith. So that's how I'd answer your question. So thank you all for joining."
},
{
"speaker": "Keith Weiss",
"content": "Excellent. That's super helpful."
},
{
"speaker": "Shantanu Narayen",
"content": "And with that, I'll hand it back to Jonathan."
},
{
"speaker": "Jonathan Vaas",
"content": "All right. Thanks, everybody. I look forward to speaking with many of you soon. And this concludes the call. We look forward to seeing you at Summit."
}
] |
adi | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Analog Devices Fourth Quarter Fiscal Year 2024 Earnings Conference Call, which is being audio webcast via telephone and over the web. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would like to now introduce your host for today's call, Mr. Michael Lucarelli, Vice President of Investor Relations and FP&A. Sir, the floor is yours."
},
{
"speaker": "Michael Lucarelli",
"content": "Excellent. Good morning, everybody. Thank you for joining our Fourth Quarter Fiscal 2024 Conference Call. Joining me on the call today are ADI's CEO, Vincent Roche, and ADI's CFO, Rich Blue Shield. All of our materials can be found at investor.analog.com. Onto disclosures: Information about this discussion includes forward-looking statements, which are subject to certain risks and uncertainties as further described in our filings with the SEC. Actual results could differ materially from the forward-looking information as these statements reflect our expectations only as of this call. We undertake no obligation to update these statements except as required by law. In terms of gross margin, operating and non-operating expenses, operating margin, tax rate, EPS, and free cash flow, comments today will be on a non-GAAP basis, which excludes special items. When comparing our results and historical performance, special items are also excluded from prior periods. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures and additional information about our non-GAAP measures are included in today's earnings release. Please note, references to EPS are on a fully diluted basis. And with that, I will turn it over to ADI's CEO and Chair, Vincent Roche."
},
{
"speaker": "Vincent Roche",
"content": "Thanks very much, Mike, and a very good morning to you all. Our first quarter results reflected the continued steady recovery from our second quarter cyclical bottom with revenue, operating margin, and earnings per share all finishing above the midpoint of our outlook. For the full fiscal year 2024, revenue finished at $9.4 billion with earnings per share of $6.38. The headwinds we faced in fiscal 2024 were most notably pronounced post-pandemic inventory digestion and the challenging macro backdrop muting demand recovery. Despite the external challenges, however, our business model and disciplined execution delivered an impressive 41% operating margin for the year and a free cash flow margin of 33%, up from 29% in fiscal 2023. Importantly, we continued investing in key value generation and capture initiatives to better position ADI to solve our customers' most difficult challenges at the Intelligent Edge. In R&D, which is our first call on capital, we continue to strengthen our world-class analog foundation while extending the scope of our innovation capabilities with investments in digital software and AI. Those investments resulted in, for example, last month's launch of ADI's new CodeFusion Studio software development platform, creating a resource-rich hub and ensuring a programming environment for embedded co-development in support of our analog mixed signal power and digital franchises. To better secure the increasingly connected intelligent edge, we also launched the ADI Assure Trusted Edge Security Architecture, which will enable cybersecurity capabilities on ADI products. The addition of new tech stack capabilities to our tremendous analog foundation enables us to deliver ever more sophisticated innovations for our customers. Our intense focus on R&D is reflected in the double-digit growth of our design win pipeline during fiscal 2024. That growth was enhanced by momentum in our Maxim revenue synergies pipeline across such areas as GMSL, healthcare, and data center power, putting us firmly on a path to achieving our goal of $1 billion in revenue synergies by 2027. Now, to accelerate pipeline growth and conversion, we continue to evolve our digital customer engagement platforms to support a greater range of technical expertise and customer needs. We also expanded our cadre of field engineering experts to provide world-class support and service to our global customer base. Our customers value our thought leadership, the breadth and depth of our cutting-edge technology stack, the strength and resilience of our supply chain, and our service and support integrity. Let me share a few examples with you now. In Industry 4.0, semiconductor content as a percentage of CapEx investments continues to expand rapidly as factories integrate IT and OT to connect and software-define the factory floor. This is creating tremendous growth for ADI's sensor-to-cloud automation solutions, with a large number of customers leveraging our sensing, power control, and deterministic Ethernet technologies. On the factory floor, our intelligent motion and positioning solutions are being designed into robotic systems by several large customers, expanding our content per robot by three times. In our Instrumentation and Test business, ADI's cutting-edge analog signal and power capabilities are the foundation for the leadership position we've established in the AI-related SoC and high-bandwidth memory test market, where our content per tester stretches into the hundreds of thousands of dollars. Now looking ahead, we're developing additional mixed signal and digital capabilities to further reduce test time and power requirements, which we believe will result in more than 20% additional ADI content per test. Within the healthcare sector, our precision signal processing and real-time connectivity solutions are critical to the rapidly expanding surgical robotics market. And in the fast-growing continuous glucose monitoring space, we have won multiple opportunities across several customers. Our unique digitally enabled analog front-end solutions increase the accuracy and power efficiency of sensors and enable a better patient experience by extending battery life from days to weeks. Aerospace and defense has remained our most resilient industrial segment during this downturn, with stellar design win pipeline growth. We expect revenue growth to accelerate to a double-digit level next year due to increasing global defense budgets and the proliferation of space communication systems that rely on our higher value integrated RF modules and subsystems. Within automotive, the performance advantages of our battery management systems are driving substantial pipeline growth among OEMs. In addition, we're also seeing momentum for these solutions in electrical grid storage systems. These trends, combined with recent wins, give us confidence that our BMS revenues should return to growth in fiscal 2025 with meaningful contributions from our higher value wired solution. The proliferation of higher content vehicles that use more power management connectivity and an increasing number of sensor platforms is expanding our content across all vehicle types, combustion engines, hybrids, and indeed full EVs. This trend drove our GMSL and A2B connectivity and functionally safe power franchises to new high watermarks in fiscal 2024, and with a record design win pipeline, we expect this growth to persist."
},
{
"speaker": "Michael Lucarelli",
"content": "Notably, we added to our portfolio of connectivity solutions by launching our Ethernet to the Edge bus solution, or U2B, which is an enabler of the software-defined vehicle vision. And out of the gate, we have design wins with several major OEMs, including BMW. In communications, we've seen a positive inflection in the wireline market and expect that growth to continue in FY 2025 and beyond. Our confidence is based on significant new wins, including a high precision controller for the optical module and the high-performance compute leaders' AI systems, and our next-gen power solutions, which will begin shipping later in 2025. We're also experiencing tremendous demand from leading data center customers for our new innovative hot swap solution, which significantly extends power and control capabilities for AI-based servers. In consumer, new wins coming to market are driving strong growth. We expect this momentum to continue in the years ahead, given new wins across power, audio, optical, and touch in portable applications at multiple key customers. We've also seen growth in wearables. For example, our VSM platform's superior accuracy at lower power is becoming ever more critical for customers seeking to differentiate by capturing and processing more biomarkers. We've seen design momentum accelerate and content opportunities expand at wearable market leaders as well as in disruptors bringing miniaturized form factors to market. In wearable acoustic systems, our combination of ultra-low power and neural processing with application-specific audio processing algorithms is enabling next-generation noise cancellation and hearing augmentation. We're leveraging these technology innovations in several B2B markets. In addition, turning now to manufacturing, we've invested $2.7 billion in CapEx since acquiring Maxim to increase our capacity and enhance resiliency. We also expanded our foundry partnership with TSMC earlier this year to secure additional 300-millimeter fine-pitched technology capacity at their Japan fab. These investments enable a more flexible hybrid manufacturing model, further insulating our supply from regional shocks and increasing our swing capacity to around 70% of revenue in the coming years. This unique ability helps us to capture the upside in strong demand backdrops and better protect our gross margins during more challenging times. So in closing, I'm very proud of how ADI has managed through one of the worst inventory digestion cycles our industry has ever seen. While the macro backdrop presents challenges, I'm confident in our continued recovery in fiscal 2025. And with that, now I'll pass it over to Rich."
},
{
"speaker": "Richard Puccio",
"content": "Thank you, Vince. And let me add my welcome to our fourth quarter earnings call. I'll start with a brief recap of fiscal 2024 results. Revenue of more than $9.4 billion, down from the record fiscal 2023, driven by broad-based inventory digestion and sluggish end demand. Gross margin of 67.9% reflects lower revenue factory utilization and mix headwinds. Decline in revenue and gross margins were partially offset by lower operating expenses, which resulted in an operating margin of 40.9% and EPS of $6.38. Moving to fourth quarter results, revenue of $2.44 billion came in above the midpoint of our outlook for a 6% sequential increase, a 10% decline year over year. Industrial represented 44% of our fourth quarter revenue, finishing up 2% sequentially and down 21% year over year. Continued strength in AI-related test, aerospace and defense, and a return to sequential growth in automation more than offset slower end demand driven by a weaker macro backdrop. For the full year, industrial decreased 35% from a record 2023, with every major application declining double digits except aerospace and defense, which significantly outperformed the rest of industrial. Automotive represented 29% of quarterly revenue, finishing up 4% sequentially and down 2% year over year. This was notably better than our original expectation due to steadily improving demand from China throughout the quarter. For the year, automotive declined 2% from a record fiscal 2023 as double-digit growth across our functionally safe power and leading A2B and GMSL connectivity franchises were offset by broad-based inventory digestion and production headwinds. Communications represented 11% of our quarterly revenue, finishing up 4% sequentially and down 18% year over year. Stronger demand from data center customers for our solutions drove low double-digit sequential growth in our wireline business, which more than offset the decline in wireless. For the year, communications decreased 33%, and similar to the fourth quarter, we saw a relative outperformance in our wireline business over wireless. Lastly, consumer represented 16% of quarterly revenue, finishing up 22% sequentially and 31% year over year, driven by higher share in wearables, premium handsets, and gaming applications. For the year, consumer decreased just 1% with double-digit growth in portable applications, balancing double-digit declines in our prosumer business, which is more industrial-like in nature. Now on to the rest of the P&L. Fourth quarter gross margin was 67.9%, flat sequentially as product mix headwinds offset modestly higher utilization rates. OpEx in the quarter was $655 million, up approximately $35 million sequentially, driven primarily by merit increases, which resulted in an operating margin of 41.1%. Non-operating expenses finished at $55 million, and the tax rate for the quarter was 12.1%. All told, EPS was $1.67, which finished above the midpoint of our outlook. Despite a tough year, we took decisive action to strengthen our financial position, and I'd like to call out a few results from our balance sheet and cash flow statement. We ended the quarter with approximately $2.4 billion in cash, short-term investments, and a net leverage ratio of 1.2. Inventory finished approximately $20 million higher than the third quarter, while days of inventory decreased to 167. Channel inventory finished slightly below the low end of our seven to eight-week target as we continue to prudently manage our supply. Operating cash flow for the quarter was more than $1 billion and more than $3.8 billion for fiscal 2024. CapEx was $165 million for the quarter and $730 million for the year, resulting in fiscal 2024 free cash flow of more than $3.1 billion or 33% of revenue. During the year, we returned $2.4 billion to shareholders via $1.8 billion in dividends and $600 million in repurchases. Now moving on to guidance for the first quarter. Revenue is expected to be $2.35 billion, plus or minus $100 million. Notably, this implies year-over-year growth when compared to a normalized 13-week first quarter of fiscal 2024, a good indication that we're past the trough and in gradual recovery. We expect sell-in to be roughly equal to sell-through in this quarter. At the midpoint, we are expecting a seasonal decline on a sequential basis as noted last quarter. Industrial, automotive, and communications are each expected to decline by low single digits, with consumer down around 15%. Operating margin is expected to be approximately 40%, plus or minus 100 basis points. Our tax rate is expected to be 12 to 14%. And based on these inputs, EPS is expected to be $1.53, plus or minus 10 cents. I'll conclude by noting a few items as we begin the new fiscal year. As Vince mentioned, we made great progress building a more agile and resilient hybrid manufacturing model. As such, we expect our CapEx spend will moderate back to our long-term model of 4 to 6% of revenue in fiscal 2025. We expect this normalized CapEx level and planned receipt of investment tax credits tied to both the US and European CHIPS Acts will provide tailwinds to fiscal 2025's free cash flow. Importantly, while we have delivered on our commitment to return 100% of free cash flow since our Maxim acquisition, fiscal 2024's return was lower due to our decision to increase balance sheet cash during this period of macroeconomic uncertainty and to help us extinguish $400 million of debt coming due in fiscal 2025. That said, investors can expect us to revert to our targeted return of 100% of free cash flow in fiscal 2025. I'm now going to turn it back to Mike for Q&A."
},
{
"speaker": "Michael Lucarelli",
"content": "Thanks, Rich. Let's get to the Q&A session. I ask that you limit yourself to one question to allow for additional participants on the call this morning. If you have follow-up questions, please re-queue. The waiting question time allows. With that, we have our first question, please."
},
{
"speaker": "Operator",
"content": "Thank you. For those participating by telephone, dial in. If you have a question, if your question has been answered and you wish to be removed from the queue, please press star one one again. If you're listening on a speakerphone, please pick up the handset when asking your question. We'll pause just for a moment to compile the Q&A roster. And I show our first question comes from the line of Chris Danley from Citi. Go ahead."
},
{
"speaker": "Chris Danley",
"content": "Hey. Thanks, guys. Just a little color on the auto strength. Can you talk about how big China is as a percent of your auto business? And then within that, how much of the strength was from, say, EV versus ICE or all these EV startups that we're hearing about from China? Thanks."
},
{
"speaker": "Richard Puccio",
"content": "So I'll give you a little bit of the perspective, Chris, on the auto near term. So on the last call, we expected the sequential decline in Q4 given the drop we talked about in bookings during Q3. An adjustment to production for multiple of our OEMs. However, toward the end of Q3, bookings started to improve and that continued throughout our Q4, with stronger demand in China reflecting EV volume growth, share gains, and content growth. As for the other geos, we saw broad weakness, but upside in the U.S., which returned to sequential growth driven mainly by our BMS and wireless BMS portfolio. Secular demand for ADAS and next-gen infotainment continues to drive strength globally for our functionally safe power, audio, and video solutions. Content and share growth in these areas have helped offset broad inventory headwinds resulting in a shallower correction in other end markets. I'd also note that while BMS is still facing inventory headwinds broadly, we saw a strong uptick in China reflecting the expanded share we talked about on our Q2 call compounded by volume growth in the region. BMS also improved in the U.S., including growth for our higher content wireless solution, which is now 10% of total BMS. And as Vince mentioned, design win activity was strong in 2024, giving us confidence that BMS will return to growth in fiscal year 2025."
},
{
"speaker": "Vincent Roche",
"content": "A little more color, Chris, than what Rich has just said. So you know, we've got a really high-performance portfolio. We've got many, many different SKUs, if you like, in that portfolio. And, you know, we're playing the high-performance game with the big players in China for merit. So that's the same business there."
},
{
"speaker": "Michael Lucarelli",
"content": "And they've got some comments on the US-China kind of relative what's the mix of China. Our China business looks a lot like ADI enterprise where industrial are more of the two biggest percent of our revenue in China. I think about 80% of the China business. Comms is in the teens, consumers below 5%."
},
{
"speaker": "Chris Danley",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of CJ Muse from Cantor Fitzgerald. Please go ahead."
},
{
"speaker": "CJ Muse",
"content": "Yeah. Good morning. Thank you for taking the question. Vince, you talked about a number of company-specific drivers that should allow you to outperform in calendar 2025. So I was hoping you could kind of use that as a backdrop and then maybe layer in kind of your thoughts on how the cycle will kind of emerge from today's trough. And you know, what your kind of thoughts are in terms of pushing, you know, business through 2025 and 2026. Thank you."
},
{
"speaker": "Vincent Roche",
"content": "Yeah. Thanks, CJ. So yeah, obviously, we've already stated our first quarter will be down, so we expect to start getting back to a positive growth trajectory in the second quarter. I think during 2025, if I were to kind of rank the market recoveries, you know, I think it'll be led by industrial. We have very healthy customer inventories. The channel is below seven weeks, and that's a big part of the supply chain into the industrial sector. You know, you couple that with the green shoots that we've mentioned already in areas like AI, tests, and aerospace and defense, which I called out in the script. So I think the compare is easier overall. And, you know, as a result, I think industrial, given the signs we see, will recover briskly in 2025. I've been in consumer, we have a much more diversified business than we've ever had. We've better portfolio than we've ever had. Inventory is normalized and we're already seeing the benefits. We saw it in our in our 4Q results, three and 4Q results, the strength of our consumer business. I think next is the comms business. You know, it declined by over 30% in 2024. And I think that was really an inventory digestion too. So we feel at this point that we're through the worst of the supply normalization. And as we talked about in the scripts, we're beginning to see steady demand improvement, particularly in wireline. Driven by the build-out of these new externalized intelligence systems. And you know, the AI infrastructure. So we're not seeing much on the wireless side. We've I think at a low point in wireless during 2024. So I think it'll all depend on the carrier CapEx investments in 5G moving ahead. Last but not least, the automotive sector. We expect to see continued momentum in areas of function, we say power, the connectivity things that I spoke about, and, essentially, it's globally to be driving share and penetration across all the different types of platforms. So you know, we've had a tough year in 2024 in BMS. 2025, we had expect to see that get back to a better shape, get back to a growth pattern. And you know, given that all of us down just 2% in 2024, it's a tough compare moving ahead. But overall, we feel that we'll be on a solid growth path as well. So that's the ranking, CJ, it's a long answer to a simple question. Thanks, CJ."
},
{
"speaker": "CJ Muse",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Vivek Arya from Bank of America Securities. Please go ahead."
},
{
"speaker": "Vivek Arya",
"content": "Thanks for taking my question. My question is on Q4 Industrial and then how it sort of shaped fiscal 2025. I think for Q4 industrial, if I'm not mistaken, you had expected sales to grow high single digit. I think they went up only modestly. And then you're guiding Q1 Industrial down again sequentially. So Vince, my question is Industrial really out of the woods, what helps it grow above seasonal? Because just assuming seasonal growth for the rest of fiscal 2025 may not be sufficient, right, to really grow fiscal 2025 at a strong pace. So just maybe help us you know, understanding what's happening in the industrial market and when do you expect it to start growing above seasonal trends next year?"
},
{
"speaker": "Richard Puccio",
"content": "So, Vivek, I'll take that and so Q4, as you mentioned, was a bit lower than we expected. Driven largely by weakness in the broad market and our decision to reduce channel inventory during the quarter. Now as you know, reducing channel inventory has an outsized impact on our industrial business. At the same time, we did see continued strength in ADAS instrumentation and test and a return to sequential growth in automation. If you remember, in the prior two quarters, we've seen significant declines in automation. So to see that return to sequential growth was a very positive sign. You know, taking a step back, we've grown industrial sequentially now for two quarters. Of what we said was our trough in Q2 of 2024. So we feel pretty good that the recovery is still unfolding for us. And now we're gonna wait and give a bit to see what the macros do. But if I look to 2025, you know, one of the important signals for us continues to be we have been under shipping demand for the better part of 18 months. You know, and if you just normalize that for even our historical patterns, or the market patterns, you know, it would indicate we've under shipped something like 20%. Which is how we get confidence in coming out of Q1's seasonal down, we will start to see growth again in industrial in the remainder of 2025. Obviously, the slope of that will be covered a bit by the macro backdrop."
},
{
"speaker": "Vivek Arya",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Joe Moore from Morgan Stanley. Please go ahead."
},
{
"speaker": "Shane",
"content": "Hi. Thank you for letting me ask a question. This is Shane from Morgan Stanley on behalf of Joe Moore. Just on your automotive business, how have customer orders and pricing discussions tracked for the growth areas of your portfolio, such as A2B, GMSL, and functional safe power? And then how have they progressed for the sort of other half of the automotive business?"
},
{
"speaker": "Richard Puccio",
"content": "So I don't break that into two pieces, I guess. I'll talk about pricing first. So from a pricing perspective so far with customers, it's been largely as expected and continuing to exhibit the stability that we've talked about previously. Right? We continue to focus on the high end where our customers value performance versus price. You know, we can commend ASPs for X the industry average. And that has continued to grow over the cycle. You know, as particularly as we, you know, look across our broad large customers, you know, we're becoming more and more important moving from a essentially, a tier two contracting with tier ones to actually partnering with the OEMs at the early stages of design. You know, and we've talked about before prices set at the design in. Tend to stay pretty fixed throughout a long period of time. So sometimes over a decade on average. Although, there is some volume discounts that come through, so we trade off incremental volume for small decreases in price. And then we do look to mitigate those discounts with our vintage increases on our older products. The other thing that's helping on the pricing stability is we are clearly broadly across costs in our business experiencing inflationary environments, which supports continued stability on the pricing side."
},
{
"speaker": "Michael Lucarelli",
"content": "And your company, guys, well, love the pieces of the automotive business. You're right we break it down. We got two One, we call it, like, the growth areas. Vince outlined a bunch of those, GMSL, A2B, functionally safe power, and BMS. They make up about half our revenue in auto. Those grew in 2024 over 10%. The other part of the business, the other 50%, is really more standard product portfolio that goes across all the OEMs all customers, and really goes up and down in production. That piece was down about 10% in 2024. And you fast forward to 2025, I think it was be more or the same? Or we see a lot of growth come from those GMSL, A2B, functionally safe portfolio. And we said a couple of times, I called BMS and returned to growth as well."
},
{
"speaker": "Vincent Roche",
"content": "Go next question, please."
},
{
"speaker": "Operator",
"content": "Thank you. And I show our next question comes from the line of Tore Svanberg from Stifel. Please go ahead."
},
{
"speaker": "Tore Svanberg",
"content": "Yes. Thank you. Vince, I had a sort of bigger picture question, especially as we embark on this new cycle. So as I navigate your website, I just see some more software products. And I'm just wondering as AI continues to move to the edge, what do you see as a differentiation here for Analog Devices? Especially in relation to some of your other analog signal peers?"
},
{
"speaker": "Vincent Roche",
"content": "Yeah. Thanks, Tore. Well, software is not particularly new to ADI in the sense that, you know, for many decades, now, we've had a vibrant DSP franchise. With a lot of, you know, tool chain capability, a lot of algorithmic capability, but we've begun really, I think, over the last decade, taking a more application view to the world across all our core markets, industrial, automotive, communications, etcetera, etcetera. And, you know, we've begun moving up the stack from the core base of analog signal power technologies. So we use, I would say, more algorithmic technology to kind of, at the copilot, so to speak, with the core franchise. So everything we do in software is essentially supports the cutting-edge strength that we have in the analog mix signal and power solutions. And you know, it's increasingly important for our ADI to present our solutions to our customers in a way that makes us easier and more enjoyable for them to use our solution that could complexity and sophistication of what we bring to them. So, you know, over the last couple of months, we announced two new parts to our software story. One is what we call CodeFusion Studio. And, essentially, what that is is an open-source software development environment that includes software development kits, tools, debuggers, and so on and so forth. And that enables our customers to get access. Know, to be able to embed ADI's analog and digital technology into their end system solutions. And the second piece is, it goes without saying, cybersecurity is top of mind for everybody. So we've released what we call the ADI Assure platform. And, essentially, what it is, it's a new security architecture that enables us to provide a root of trust from the hardware rights into the cloud, so to speak, and to understand the movement the creation and movement of data across that spectrum. So you know, we are spending more on software than we've done. But we're taking a very holistic view and I'd say using software to drive the innovation system of the company, the innovation within our products around our products, and making it easier for our customers to access our solutions. That's it in a nutshell, I think."
},
{
"speaker": "Operator",
"content": "Thank you. And I show our next question comes from the line of Stacy Rasgon from Bernstein. Please go ahead."
},
{
"speaker": "Stacy Rasgon",
"content": "Guys. Thanks for taking my question. I wanted to ask about gross margins. What are your thoughts on gross margins into Q1 as revenue declines? And do you think the Q1 is the bottom as it does seem like you do think revenue grows off of there? Like, how do we think about the trajectory off of that gross margins in the next year, what does it take to get them back into the 70% plus range?"
},
{
"speaker": "Richard Puccio",
"content": "Stacy, I'll take that one. So Q4 gross margin was lower than we'd expected due to mix. So with consumer and auto being so much stronger while industrial was weaker, you know, that created some downward pressure because then we had talked about a slight sequential increase, which we didn't see. For Q1, we expected slower slightly lower gross margin given sort of normal factory shutdowns around the holidays. As well as the seasonally lower revenue. You know, if we think about the when will we see sort of the 70% this is gonna continue to be driven by mix and utilization as we grow revenue. Right now, industrial is pretty low mix. And utilization, while no longer decreasing and coming off of our low points back in Q2, remain sort of well below optimal levels. Know, if you wanna think about it from a longer-term perspective, from a revenue view, we'd likely, you know, need revenue in the $2.7 billion plus to start seeing 70%. From a 2025 sort of sequential perspective, as we do, as we mentioned, expect revenue to recover to growth coming out of the Q1 seasonality. We would expect to see gross margin improvement as we work through the back half of the year. And then, obviously, as we've talked about the back half macros will determine how much revenue growth we get and how much incremental margin we see."
},
{
"speaker": "Michael Lucarelli",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Timothy Arcuri from UBS. Please go ahead."
},
{
"speaker": "Timothy Arcuri",
"content": "Thanks a lot. Rich, you just mentioned that fiscal Q2 is gonna be up. I'm wondering what you consider normal seasonal to be in fiscal Q2. It seems like it's up about three to four. So that's the first part of my question. And then the second part is, you sort of strip out autos, I wonder, like, how is book to bill if you could sort of, you know, strip out autos versus normal? Is it trending pretty much as you would? Thanks."
},
{
"speaker": "Michael Lucarelli",
"content": "Yes, sir. So I'll grab the first question and then go to the book and build question. I was like, I lost the bet to myself. I thought the two key question me with the top three questions were number seven. So yep. That's what that'll go sometimes. But you're right. We keep on seasonality strength. What does seasonal mean into you? It's been a while since seasonality. Usually, you see industrial and auto up. About mid-single digits in Q2. Communication's up some, not as much. Maybe flat up slightly. Well, consumers down a little bit. So overall, you're up about to mid-single digits in a portal company level. Again, that's seasonal trends. There's a wide band. On that, typically how we think about Q2 for a seasonal perspective."
},
{
"speaker": "Richard Puccio",
"content": "Yeah. On the booking side, so as we talked about after the decline in Q3 in auto, total bookings returned to growth driven by continued growth in industrial and a rebound in auto. Overall book to bill was below one, which we would say is pretty normal at this point. Reflecting our seasonally lower Q1 outlook. You know, regionally, bookings were up everywhere, excluding the Americas. And that largely reflects the seasonal decline in consumer."
},
{
"speaker": "Timothy Arcuri",
"content": "Thanks, Tim. Thank you."
},
{
"speaker": "Operator",
"content": "And I show our next question comes from the line of Ross Seymore from Deutsche Bank. Please go ahead."
},
{
"speaker": "Ross Seymore",
"content": "Hi, guys. Thanks for letting me ask a question. Vince, a bit of a longer-term question for you. Cycle to cycle, you know, the good news is it sounds like you found the bottom especially on the industrial side. And you mentioned that it was kind of the worst downturn from an inventory perspective in a long, long time. I guess my question is the prior peak, I guess, in your fiscal 2023 is that attainable? And what are the puts and takes to get to that? Because I guess from a big picture question, was that overinflated or was that a realistic target that we should look forward to? And if so, at what time?"
},
{
"speaker": "Vincent Roche",
"content": "Yeah. Thanks, Ross. Well, I think, you know, first and foremost, our portfolio is in better position than it's ever been. I would say ADI's connection with our customers, big and small, is better than it's ever been. You know, we're investing in believe, in the right areas in the R&D sector. Our pipeline coming out of 2024, it grew double digits year over year. Opportunity pipeline. So I think the company is well positioned. We've also been very, very I would say, taking a very almost purest view to how we flush inventory. So my sense is you know, we've got a supply chain that is well capable of meeting what we believe will be good demand during 2024. To get back to the kind of the 2023 levels, you know, we believe that our business is capable of growing double digits. So, you know, through the rest of the decade here, given the position we've got, the demand that we see, the opportunity pipeline. So and I think know, we will see a good down payment on that future prospect. During 2025."
},
{
"speaker": "Operator",
"content": "Thank you. And I show our next question comes from the line of William Stein from Truist Securities. Please go ahead."
},
{
"speaker": "William Stein",
"content": "Oh, great. Thanks for taking my question. Vince, I think you mentioned data center power management in the prepared remarks, but I'm hoping you can dig into this a little bit. There's been quite a bit of all very know, what some people call charismatic design win up opportunities in that end market. I know that at least one of the companies you acquired, Maxim, had a significant effort in 48-volt PMEC, and I suspect Linear had something there as well. I wonder if you can comment as to the medium-term opportunity as you all see it and maybe any comment on design win traction there. Thank you."
},
{
"speaker": "Vincent Roche",
"content": "Yeah. Thanks, Will. So you know, first off, if you just put the entire data center business in ADI perspective, you know, we have really two elements to our power story. I think one is the power solutions that go around the computing chips, and the rest of the, you know, the server infrastructure. The second piece is the control units, things like hot swapping, supervisory, so on and so forth. We've had good traction of that business a long, long time. We've got some new products coming to market. That will continue to boost us in terms of ASP, share, and so on and so forth. We're also getting good traction with our optical control solutions right up to 1.6 terabits. So that's kind of the landscape of products and technologies that we have. You know, if you're going to win anything in this in these this data center business you've gotta play an ecosystem game. So we play with the processor companies. We're playing with the data center companies themselves. And, you know, again, we're picking our places very, very carefully. We're going for the highest end solutions where we can make a big difference in the energy space. By the way, we're even attaching energy solutions at, you know, kind of the more between the grid and the data sector. So we view this power is just merely part of the an energy solution, and we're looking at that from the intersection with grid right down to the chip."
},
{
"speaker": "Richard Puccio",
"content": "Thanks, Will. Can we get to our last question, please?"
},
{
"speaker": "Operator",
"content": "Thank you. And I show our last question comes from the line of Joshua Buchalter from TD Cowen. Please go ahead."
},
{
"speaker": "Joshua Buchalter",
"content": "Hey, guys. Thanks for squeezing me in. Wanted to ask about utilization rates. I think you might be the only company in broad-based semis that called out higher utilization rates this quarter. How should we think about how you're thinking about that trending into fiscal 2025? Are you you know, it sounds like sell-in is matching sell-through. Should we just think about that ramping basically directionally and linearly with your revenue or any other puts and takes we should keep in mind as we think about the impact of margins? Thank you."
},
{
"speaker": "Richard Puccio",
"content": "Yeah. So I guess I would start with, you know, from a utilization perspective. We've talked about our agile. You know, one of the reasons we've been able to bring utilization levels up is our ability to swing capacity back into our internal fabs. So I think as I've mentioned, we're still not at anywhere near a normalized utilization rate. Our ability to swing during the downturn has allowed us to continue to grow off the drop that we talked about in Q2. So we have seen two quarters of sequential modest I would say modest sequential increases in utilization and as the revenue picks up as we work our way through best fiscal year 2025, I expect that utilization to continue increase to continue."
},
{
"speaker": "Michael Lucarelli",
"content": "Alright. Thank you, Josh, and thanks everyone for joining us this morning. A cockpit transcript will be available on our website. Thanks again for joining the call. Have a great Thanksgiving."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's Analog Devices conference call. You may now disconnect."
}
] |
adi | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Analog Devices ' Third Quarter Fiscal Year 2024 Earnings Conference Call, which is being audio webcast via telephone and over the web. I'd like to now introduce your host for today's call Mr. Michael Lucarelli, Vice President of Investor Relations and FP&A. Sir, the floor is yours."
},
{
"speaker": "Michael Lucarelli",
"content": "Thank you, Kevin. And good morning, everybody. Thanks for joining our third quarter fiscal 2024 conference call. With me on the call today, ADI's CEO and Chair, Vincent Roche; ADI’s CFO, Richard Puccio. For anyone who missed the release, you can find it in relating financial schedules and investor.analog.com. Onto the disclosures, information we're about to discuss includes forward-looking statements which are subject to certain risks and uncertainties as further described in our earnings release and our periodic reports and other materials follow the SEC. Actual results could differ materially from the forward-looking information, as these statements reflect our expectations only as a date of this call. We undertake no obligation to update the statements except as required by law. Revenue, adjusted gross margin, operating and non-operating expenses, operating margin, tax rate, EPS and free cash flow in our comment today will be on non-GAAP basis, which excludes special items. When comparing our results to historic performance. Special items are also excluded from prior periods. Reconciliation of these non-GAAP measures to most directly comparable GAAP measures and additional information about our non-GAAP measures are included in today's release. And with that, I'll turn it over to ADI's CEO and Chair, Vince?"
},
{
"speaker": "Vincent Roche",
"content": "Thanks very much, Mike, and a very good morning to you all. The stronger demand for a high-performance product portfolio and skillful execution resulted in third quarter revenue of more than $2.3 billion, operating margin north of 41%, and EPS of $1.58, all above the midpoint of our outlook. These favorable results, combined with improved customer inventory levels and order momentum across most of our markets, increase my confidence that our second quarter marked the cyclical bottom for ADI. My optimism remains guarded, however, as challenging economic and geopolitical conditions are limiting a sharper recovery. We continue to balance near-term fiscal discipline with strategic investment in our long-term growth initiatives, positioning ADI to capitalize on the extraordinary opportunities that we see ahead. Now I'd like to draw attention to our industrial end market, which is our largest, most diverse, and most profitable business, generating durable revenue streams that last close to two decades, on average. As our business begins to recover from the pandemic's volatility, we're excited about the tremendous long-term growth opportunities of the industrial market. We offer our customers an unparalleled suite of high-performance solutions stretching from antenna to bits, sensor to cloud and nanowatts to kilowatts. Our extensive technology portfolio, combined with our deep domain expertise and engineering muscle, has enabled us to secure leading positions across the most attractive industrial sectors. Now, with growing digital software and algorithmic capabilities augmenting our cutting-edge analog portfolio, ADI is strongly positioned to solve our customers most difficult challenges in factory and process automation, energy efficiency, secure connectivity and many, many more. To illustrate the power and potential of our industrial franchise, let me share with you a few examples of how our recent innovations are unlocking new revenue streams and positioning us for strong growth in the years ahead. For example, our Instrumentation and Test business, which includes scientific instruments, electronic test and measurement, and automated test equipment is essential to the important scientific and technological advancements of the digital era. Within automated test equipment, for example, our next generation solutions increase channel density and throughput, while reducing energy consumption by up to 30% per system. These are crucial parameters for testing complex, high performance compute GPUs and high bandwidth memory systems for AI. As the AI infrastructure build up remains a priority for global hyperscalers, we expect growth to continue into 2025 and indeed well beyond. Turning now to Aerospace and Defense, which has been our most resilient business during this downturn, ADI's domain expertise and high performance portfolio across orphan microwaves, high speed and precision converters, power and MEMS uniquely positions us to deliver complete edge solutions offering our customers scale, velocity and lower total cost of ownership. As an example, we're building upon our programmable Apollo signal chain platform today to create full software defined RF communications and sensor systems, which has the potential to increase our sound by five times in commercial, defense and aerospace communication systems. Indeed, we see a path to double-digit revenue growth in this sector in 2025, fueled by several high value design wins that are going to production. In Automation, though we've seen a slow recovery to date, we remain strongly confident in its future growth potential as the benefits of increased productivity are ever more clear. Customers are prioritizing enhanced digitalization and IT/OT integration on their factory floors. Their deployments of in-line instrumentation and advanced robotics are driving the need for more sensing, edge processing, secure connectivity, and car management. Within robotics, we're seeing a progression from fixed-arm machines to autonomous and mobile robots to eventually humanoid robots. This evolution creates additional opportunities for a precision signal chain franchise. And sensing, connectivity, and motion-controlled subsystems with fully isolated and efficient power solutions can drive content from hundreds of dollars in robots today to thousands in autonomous and humanoid robots. What is additionally exciting about these advances is their broad applicability beyond factories, such as surgical robots and imaging systems in healthcare. ADI's products have the potential to dramatically improve a surgeon's effectiveness through a more precise surgical experience with lower latency connectivity. Additionally, patients gain the potential benefits of shorter hospital stays and fewer complications. The evolution in robotics is expected to unlock billions of dollars of potential opportunity for a high-performance analog, mixed signal, power connectivity, and sensing solutions. We see the potential for a doubling of our robotics revenue in the years ahead. Turning now to Energy Transmission and Distribution, our customers are modernizing and digitalizing the electrical grid to respond to exponentially accelerating energy demand driven in part by the proliferation of electric transportation and rapid AI adoption. This process is resulting in a grid that is distributed dynamic and bidirectional, a paradigm shift from the past model of linear stable supply. We're working with traditional suppliers and disruptors to enable the necessary intelligence for the new grid from decentralized power plants to the distribution edge. We're leveraging our analog and algorithm capabilities in cutting-edge energy monitoring and management solutions. Additionally, our battery management technology increases capacity and improves energy utilization in the grid's renewable energy storage systems. This reimagined intelligent grid of the future has the potential to expand our return by over $10 billion and creates tailwinds for our energy franchise for many years to come. Given the synergies across our industrial portfolio, our pace of innovation and the emergent signs of market recovery, we're optimistic for our industrial business that has turned the corner and ‘25 will be a robust growth year. So in closing, our investments in high-performance analog solutions are enabling us to intersect with and leverage the numerous concurrent secular trends that transcend the business cycle and will propel us into the future. Our commitment to our customers' success and to impactful innovation will be the path that carries us there, ultimately increasing long-term shareholder value. And so with that, I'm going to turn it over to Rich, who'll take you through the numbers."
},
{
"speaker": "Richard Puccio",
"content": "Thank you, Vince. And let me add my welcome to our third quarter earnings call. Third quarter revenue of $2.31 billion came in above the midpoint of our outlook, finishing up 7% sequentially and down 25% year-over-year. Industrial represented 46% of revenue in the third quarter, finishing up 6% sequentially and down 37% year-over-year. Every major application increased sequentially except for automation, which declined at a much slower pace than it had in previous quarters. Automotive represented 29% of revenue, finishing flat sequentially and down 8% year-over-year. We saw continued double-digit growth year-over-year for our industry-leading connectivity and functionally safe power platforms. Conversely, automotive production cuts are extending inventory digestion across customers, particularly impacting our legacy automotive and electrification businesses. Communications represented 12% of revenue, finishing up 10% sequentially and down 26% year-over-year. Slowing customer inventory digestion enabled both wireless and wireline growth sequentially. And lastly, Consumer represented 14% of revenue, finishing up 29% sequentially and increased year-over-year for the first time since 2022. We saw diversified growth across applications with notable strength in portables and gaming. Now let's move from the top line to the rest of the P&L. Third quarter gross margin was 67.9%, up 120 basis points sequentially, driven by higher revenue, higher utilization and favorable mix. Operating expenses in the quarter were $619 million, up modestly sequentially, driven primarily by higher variable compensation. Operating margin of 41.2% exceeded the high end of our outlook. Nonoperating expenses finished at $70 million and the tax rate for the quarter was 10.8%. The net result was EPS of $1.58, which finished near the high end of our outlook. Our financial position is solid and I'd like to call out a few items from our balance sheet and cash flow statement. We ended Q3 with more than $2.5 billion of cash and short-term investments and a net leverage ratio of 1.2. Inventory decreased $51 million sequentially and days declined to 178 from 192. As planned, we reduced channel inventory further this quarter with weeks ending near the low end of our 7 to 8 week target. Operating cash flow for the quarter and trailing 12-month was $0.9 billion and $4 billion respectively. CapEx for the quarter and trailing 12-month was $154 million and $1 billion respectively. For fiscal ‘24, CapEx is tracking to our $700 million plan, which is down roughly 45% versus 2023 as our hybrid manufacturing investment cycle tapers. Not included in these figures are the anticipated benefits from both the European and U.S. CHIPS Act. During the last 12 months, we generated $2.9 billion of free cash flow or 30% of revenue. Over this same time period, we have returned $2.8 billion via dividends and share repurchases. As a reminder, our strategy is to return 100% of our free cash flow to our shareholders over the long term. Now I'll turn to the fourth quarter outlook. Revenue is expected to be $2.4 billion plus or minus $100 million, up 4% sequentially at the midpoint. We expect sell through to be roughly equal to sell in this quarter. At the midpoint on a sequential basis, we expect industrial and consumer to increase, communications to be flattish and automotive to decrease. Operating margin is expected to be 41% plus or minus 100 basis points. Our tax rate is expected to be between 11% and 13% and based on these inputs, EPS is expected to be $1.63 plus or minus $0.10. In closing, our third quarter results and fourth quarter outlook support our view that we have passed this cycle's trough. However, challenging economic and geopolitical conditions are limiting a faster demand recovery. I will now give it back to Mike for Q&A."
},
{
"speaker": "Michael Lucarelli",
"content": "Thanks, Rich. Let's get to our Q&A session. We ask that you limit yourself to one question in order to allow for additional participants on the call this morning. If you have a follow -up question, please requeue and we'll take your question if time allows. With that, we have our first question, please."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from Tore Svanberg with Stifel."
},
{
"speaker": "Tore Svanberg",
"content": "Yes, thank you so much. Great to see the turn here. Vince, could you maybe elaborate a little bit more on this sort of mixed environment, right? Because inventories have bottomed, access to inventories have bottom, at the same time end demand seems to be kind of mixed. So, as you navigate through this period, could you elaborate a little bit on your visibility, how's backlog trending? Are you finally starting to see new products ramping more into production? Because these are typical signals that you want to see at the beginning of a new cycle."
},
{
"speaker": "Vincent Roche",
"content": "Yes, thanks, Tore. Well, I'd say first and foremost, we run this company on POS signals. That's how we plan our production, how we run the company operationally. So, we pay very, very close attention to what's happening in terms of the end market demand. And my confidence has increased since last quarter that indeed 2Q was the cyclical bottom. We've exited 3Q with very, very lean channel inventory. We've taken inventory of our own balance sheet though. We're positioned with a very, very healthy backlog of inventory on our own balance sheet so that the anticipated demand upsurge as we expect in 2025 were very, very well equipped and ready to meet that. So foray in the fourth quarter, as we've said, we expect to see continued sequential growth. And indeed, we'll also see, I think, particularly in the industrial area, continued improvement on customer inventory levels. So, look, it's all the whole recovery, the ramp of the recovery will depend on the macro situation. But nonetheless, given the design wins, we've a record design win pipeline in the company. So we're facing many, many secular tailwinds with a very strong pipeline, a very, very good supply line, and with a very, very lean inventory on the customer's balance sheet. So that gives me the optimism, Tore, that we're very, very well positioned coming into the new year."
},
{
"speaker": "Operator",
"content": "Our next question comes from Joseph Moore with Morgan Stanley."
},
{
"speaker": "Joseph Moore",
"content": "Yes, thank you. My question is on the trajectory of automotive versus industrial. It seems like automotive entered into an inventory correction a little bit later, and so far, has been much less severe. I guess you sort of talked about some ongoing headwinds in that space. Can you just talk about what overall drawdown might you expect in automotive and where are we in customers kind of growing down safety stock inventory"
},
{
"speaker": "Richard Puccio",
"content": "So, Joe, this is Rich, and I'll take a crack at that one. So, I'll just level set a little bit from our perspective. And what we're seeing in the market cars continue to become more electric and software-defined, which is also driving our semi-content growth, largely trying to address increased battery densities, more sensors displays. And we do expect that is going to be a long-term tailwind to our business. However, and this is where we're starting to see some of the pullback. The vehicle market has softened in the near-term. We're seeing our customers pull back on their production. And at this point, we're seeing them start to choose to burn off some inventory. So we are seeing that, right? The softness is evidence in our results. Auto has been down year-over-year for two straight quarters and we expect it will be down again in 4Q. And from a bookings perspective, we did see a decline in bookings in auto. In particular, we've seen inventory digestion in our legacy auto and in our BMS portfolios. And we expect that's going to continue into at least the fourth quarter, particularly when you consider the challenging purchasing environment that currently exists for customers. However, to your question around the peak to trough unless our returns to pandemic levels, we don't see the peak to trough being nearly as dramatic as we saw in our other end markets. The underlying secular growth trends that I described driving higher semi content. Also, we've continued to see more penetration and value capture across all vehicle types, whether it's ICE, plug-in hybrid of electric or full electric in the fastest growing applications. If you think about that, ADAS, digital cockpit and electrification. So we will be down, but we don't expect that the cycle depth to be as severe as we saw, for example, in industrial."
},
{
"speaker": "Joseph Moore",
"content": "Great, thank you very much. And I guess as a follow-up, are you seeing that behavior any different regionally? Is the China automotive market different than the western markets in terms of where they are?"
},
{
"speaker": "Vincent Roche",
"content": "No, I'll say overall, it's pretty unanimous across all markets. I'd say China, all of us did okay. We talked about some design and branding there, so that's helping offset some of the softness. But it's an overall comment, auto is a bit weaker today than it was 90 days ago, whether it's North America, Europe or Asia."
},
{
"speaker": "Operator",
"content": "Our next question comes from Vivek Arya with Bank of America Securities."
},
{
"speaker": "Vivek Arya",
"content": "Thanks for taking my question. Vince, glad to hear about your optimism about turning the cyclical corner. Do you think the environment allows for sequential growth to continue into Q1? Seems like industrial could grow, autos, I'm not sure, given some of the bookings commentary. And consumer tends to be down seasonally. So just conceptually, how should we model the shape of this recovery into Q1? Thank you."
},
{
"speaker": "Vincent Roche",
"content": "Yes, well, at this point it's hard to call, given that the environment is still a little, let's say, a bit of disequilibrium, but I think generally speaking, we would probably expect to see a bit of a seasonal decline in the first quarter, and then a bounce back in the second, and I think that's the sentiment, but overall I maintain my outlook that we will see a brisk growth year in ‘25."
},
{
"speaker": "Richard Puccio",
"content": "And then I'll help you out a little bit on the seasonality question. It's been a few years now since we've seen seasonal trends in our business. You're right. If you look back over the past 10, 15 years for ADI, consumers down 10%-plus sequentially in 1Q, and the BV markets of industrial, auto, and comms are down low single digits, as Vince said, there's probably no belief today that we'd be any better than seasonal given where we are today, but we'll update you in 90 days of how we feel about 1Q."
},
{
"speaker": "Vincent Roche",
"content": "Yes. I think the big modulator for us will be what happens in industry in particular, and what I can tell you is that the various C-suite conversations I've had with our industrial customers would suggest that their optimism is also strong for ‘25."
},
{
"speaker": "Operator",
"content": "Our next question comes from Timothy Arcuri with UBS."
},
{
"speaker": "Timothy Arcuri",
"content": "Thanks a lot. I just wanted to ask on that answer. So you were above seasonal in fiscal Q3 or above seasonal in fiscal Q4. Sounds like you're not willing to commit that you're going to be above seasonal in fiscal Q1. The street's modeling like 5% or 6% above seasonal for fiscal Q1. Was there something that happened in bookings? Did bookings like slow in the last couple of weeks or the last month or something to make you not want to commit to the fact that fiscal Q1 would be above seasonal or just that it's 90 days away and you just don't want to comment on it? Thanks."
},
{
"speaker": "Vincent Roche",
"content": "I'll start out on the street expectations and then Rich talk a little about bookings. We never guided 1Q. I think the street makes up -- the street expectation for 1Q. I think the street is of everyone better than seasonal for a calendar 4Q or a fiscal 1Q. I would hope of a snapback. I would say, yes, there are things that have changed in 90 days, but we're optimistic about ‘25 and full year. We just don't know if it's above seasonal in that outlook for a good year in ‘25. I'll pass it to Rich to go through some of the bookings dynamics."
},
{
"speaker": "Richard Puccio",
"content": "Yes, so from a bookings perspective up until Q2, as we talked about, we'd seen three straight quarters of broad-based bookings improvement. However, Q3 was different. We saw continued bookings growth for industrial, consumer, and communications, but we did see automotive orders decline, which resulted in a modest drop in our total bookings during the quarter. We did still end with a book to bill around parity. If I look at it from a geographic perspective, regionally bookings were the weakest in Europe. Americas was modestly weaker, which offset bookings growth in Asia."
},
{
"speaker": "Operator",
"content": "Our next question comes from Toshiya Hari from Goldman Sachs."
},
{
"speaker": "Toshiya Hari",
"content": "Hey, good morning. Thanks for taking the question. It was good to see inventory on your balance sheet come down again, and you guys spoke to channel inventory coming down as well. As you look forward, what are your thoughts on utilization rates internally? How are you engaging with your foundry partners, and what's embedded in your October quarter outlook as it pertains to the channel? Thank you."
},
{
"speaker": "Richard Puccio",
"content": "So, as I noted in the last call, we said both utilization and, in fact, gross margins had bottomed in Q2, and that is proving to be true. From an inventory in the channel perspective, the expectation is we will ship to end demand. We are currently at the very low end of our range in the channel at seven to eight weeks. And I think we've mentioned previously if we saw continued improvements, we would start shipping to end demand. So we will do that in the fourth quarter."
},
{
"speaker": "Toshiya Hari",
"content": "Thank you."
},
{
"speaker": "Vincent Roche",
"content": "Obviously, when it comes to the balance, we have a hybrid manufacturing system which enables us to keep utilization rates as high as possible internally, and when our factories run out of capacity, then we have lots of choices externally for silicon capacity. So obviously, we've got a lot of inventory on the balance sheet, and our factories are well capable of improving utilization rates as the demand continues to improve over the coming quarters."
},
{
"speaker": "Toshiya Hari",
"content": "As a quick follow-up, I think your internal utilization rates last quarter were in the mid-50s, if I'm not mistaken. Are you at or above 60% at this point, or if you can comment on that."
},
{
"speaker": "Richard Puccio",
"content": "We have to be -- given our look at the utilization towards as we give the rate, I would say there were lower last score to move in higher here in 3Q and 4Q, and there were well off the normal level, they're all called 85% to 90% utilization."
},
{
"speaker": "Toshiya Hari",
"content": "Got it, thank you."
},
{
"speaker": "Richard Puccio",
"content": "And then I'll give you some context -- I'll give you some little context. What does this mean as utilization ramp? What does that mean for gross margins? If you look at the decline of gross margins over the past year or so, about half the decline relates to utilization, the other half relates to mix. So you can see as you listen, pick up what that means for gross margin expansion."
},
{
"speaker": "Operator",
"content": "Our next question comes from Stacy Rasgon with Bernstein Research"
},
{
"speaker": "Stacy Rasgon",
"content": "Hi, guys. Thanks for taking my question. I was hoping you could give us a little more granularity on the segment guide for next quarter. And then you said industrial, and I think consumer up and auto down. Any more for the color, like is consumer usually up, is it up double digits, is industrial up mid-single, auto down by low single, like any further color you could give us on the segments would be helpful."
},
{
"speaker": "Vincent Roche",
"content": "Sure, Stacy, I'll grab that one. Yes, so let's start with consumer. You're right, consumer's up about double digits, about 10% or so embedded in our outlook. Industrial's had another also solid growth quarter, probably high single digits sequentially. We had cases about flattish plus minus, depending on kind of how things go here, and although the weak market as we discussed and hit a little bit earlier on the call, probably down low single digits sequentially."
},
{
"speaker": "Stacy Rasgon",
"content": "Got it. That's helpful. If I could have a quick follow up, just how are you thinking about OpEx growth in the next quarter? It was pretty well under control this quarter. Is there anything that drives that up? Like what do you think about the OpEx trends as we're going to the end of the year?"
},
{
"speaker": "Richard Puccio",
"content": "So Stacy, I'll take that one. So obviously we exceeded the high end of our outlook in the third quarter, given the beat on gross margin and revenue as well as our continued cost management. Our Q4 guide obviously does imply a modest margin contraction sequentially despite our expectation for higher revenue and gross margin. The main driver of that is our increase for merit increases that will go into effect during the fourth quarter. So that will be a downward pressure as we head into the fourth quarter."
},
{
"speaker": "Vincent Roche",
"content": "I mean, the big margin on our OpEx, Stacey, is obviously the bonus. And that obviously with declining profit and revenue over the past several quarters, that dropped accordingly. Now, with increase, with growth in revenue and improvement in profitability that will obviously increase. But that's self-funding, so to speak."
},
{
"speaker": "Stacy Rasgon",
"content": "Got it. How much do the OpEx go up then?"
},
{
"speaker": "Vincent Roche",
"content": "For our fourth quarter outlook, I’d say sequentially increase in our OpEx around 5%."
},
{
"speaker": "Operator",
"content": "Our next question comes from Christ Danley with Citigroup."
},
{
"speaker": "Christopher Danley",
"content": "Thanks guys. First, just a little clarification on inventory in the auto market. Vince, I said it, I think at the beginning you talked about inventory is very lean out there, but then you're also saying that there's inventory digestion going on in the automotive market. Can you just expand on that a little bit?"
},
{
"speaker": "Richard Puccio",
"content": "Dan, I'll grab that, and then Vince, talk about the overall customer inventory. Yes, I think every market spawned in different cases of inventory digestion. We feel good about industrial consumer comms have really normalized inventory levels. There are pockets on the auto side that's still, I'll call it digesting. I mean, production levels have been cut over the past quarter, whether it's an ICE car or an EV car. That impact inventory levels and desire to hold inventory on their balance sheets. From that standpoint, Chris, I don't know, Vince, if you have anything to add."
},
{
"speaker": "Vincent Roche",
"content": "I think, Chris, overall, we've seen the worst is behind us, I think, in the industrial consumer and comms market. But automotive, I think, is a sector where we will see some inventory digestion issues into at least the early part of 2025."
},
{
"speaker": "Christopher Danley",
"content": "Great. Thanks. That's helpful. And then just a quick clarification on industrial. How would you characterize your, I guess, booking/ visibility on the industrial market now versus three months ago? Is it roughly the same, or has it improved a little bit?"
},
{
"speaker": "Richard Puccio",
"content": "Hey, Chris, it's Rich. I would say visibility is pretty consistent. And as we talked about, we're seeing continuing growth sequentially across all of the sub-elements of industrial with the exception of automation, which we are seeing improvements, but not yet seeing growth."
},
{
"speaker": "Operator",
"content": "Our next question comes from Harlan Sur with JPMorgan."
},
{
"speaker": "Harlan Sur",
"content": "Good morning. Thanks for taking my question. So for fiscal ‘23, China domestic consumption, I think was about 18% of their total revenues, it was the worst performing geography. Last couple of quarters where bookings in China have been growing sequentially. Did that translate into sequential revenue growth out of the region in the July quarter? And then it looks like orders from the China region grew sequentially in July. How are they trending so far quarter-to-date? Are you still seeing sort of positive signs out of this region?"
},
{
"speaker": "Vincent Roche",
"content": "Yes, we continue to see strong performance from a bookings perspective in China. We did see double digit growth across industrial, auto and comms being slightly offset by a decrease in consumer. So China does continue to perform well. And our design win and our pipeline there are very strong."
},
{
"speaker": "Operator",
"content": "Our next question comes from Joshua Butler with TD Cowen."
},
{
"speaker": "Joshua Butler",
"content": "Hey, guys, thanks for taking my question. Maybe you can walk through some of the puts and takes into gross margin into the October quarter. Back the envelope, I'm getting to roughly stable sequentially despite the revenue increase and I imagine utilization is improving as well. How much of that is mixed? And in particular, is there any changes in the pricing environment as we get sort of through this digestion into what I would imagine is a more competitive environment. Thank you."
},
{
"speaker": "Richard Puccio",
"content": "Yes. I'd say it's, as we previously mentioned, it is significantly impacted by the favorable mix. Obviously, we get a benefit out of the revenue upside. From a pricing perspective, and I've talked about this before, we continue to see pretty stable pricing, and I do expect that to continue. Obviously, it's different by geography and for big and small customers, but on balance, we are continuing to see stable pricing, and I expect we will see that going forward."
},
{
"speaker": "Vincent Roche",
"content": "Once our products are installed in a particular customer's design, they tend to, in the industrial business, they will stay for decades, and pricing is very, very stable there. Where the pricing, or the competitiveness, is for new sockets, new wins, but nothing is new there. Now, we as a company -- we play in the high end of the game in terms of innovation, service, support, and so on and so forth. So that's the game we play. In the game we will continue to play. We significantly higher ASPs than most. And those ASPs increase with each new generation of product. So I think overall, as Rich said, the pricing environment is stable. And so I don't see that as a headwind on margin."
},
{
"speaker": "Michael Lucarelli",
"content": "Thanks, Josh. I think that's all the time we have for questions today. I thought we had a little more time, but it's August. You guys can go out there and enjoy the weather a bit. So thanks for joining us, all. We look forward to future calls with you guys, and have a great rest of summer."
},
{
"speaker": "Vincent Roche",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "This concludes today's Analog Devices Conference call. You may now disconnect."
}
] |
adi | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Analog Devices' Second Quarter Fiscal Year 2024 Earnings Conference Call, which is being audio webcast via telephone and over the web. I'd like to now introduce your host for today's call Mr. Michael Lucarelli, Vice President of Investor Relations and FP&A. Sir, the floor is yours."
},
{
"speaker": "Michael Lucarelli",
"content": "Thank you, Judy. And good morning, everybody. Thanks for joining our second quarter fiscal 2024 conference call. With me on the call today, ADI's CEO and Chair, Vincent Roche; and ADI’s CFO, Richard Puccio. For anyone who missed the release, you can find it in relating financial schedules and investor.analog.com. Onto the disclosures, information we're about to discuss includes forward-looking statements which are subject to certain risks and uncertainties as further described in our earnings release and our periodic reports and other materials follow the SEC. Actual results could differ materially from the forward-looking information, as these statements reflect our expectations only as a date of this call. We undertake no obligation to update the statements except as required by law. Revenue, adjusted gross margin, operating and non-operating expenses, operating margin, tax rate, EPS and free cash flow in our comment today will be on non-GAAP basis, which excludes special items. When comparing our results to historic performance. Special items are also excluded from prior periods. Reconciliation of these non-GAAP measures to most directly comparable GAAP measures and additional information about our non-GAAP measures are included in today's release. And with that, I'll turn it over to ADI's CEO and Chair, Vince?"
},
{
"speaker": "Vincent Roche",
"content": "Thank you very much, Mike. Good morning, and a big welcome to you all. In the second quarter, a strong focus execution resulted in revenue of $2.16 billion, with profitability and earnings per share finishing above the high-end of our outlook. With 2Q now behind us, we believe, we've passed the low point of this cycle. Notably, global manufacturing PMIs, which are highly correlated with our core business are improving, customer inventories are stabilizing and our bookings have improved for a third consecutive quarter. Our growing optimism remains guarded, however, as short-term economic and geopolitical uncertainty persists. As such, we will continue to manage the near-term with great discipline, as we fund and execute against our longer-term strategic priorities to drive increasing levels of value for all of our stakeholders. With that framing, I'd like to share some examples with you of how we are continuing to strengthen ADI's high performance franchise across all markets and creating unique growth drivers that will be additive to what we hope will be a strong cyclical recovery. For example, in healthcare, we have exciting wins in areas such as the rapidly expanding surgical robotics market, where the performance of our precision signal processing and connectivity solutions is critical. In the fast growing, continuous glucose monitoring space, we've won multiple opportunities across several customers. Our unique digitally enabled analog front end solutions increase the accuracy and power efficiency of sensors and extend battery life from days to weeks. In industrial automation, the growth of the digital factory is accelerating upgrades to higher bandwidth, deterministic industrial Ethernet that can support up to 10x the number of edge devices across the factory floor. We believe our leadership position with key customers will create a durable revenue stream, beginning next year that can grow to several hundreds of millions of dollars as deployments ramp over time. Turning to automotive. Our solid performance is being driven by the proliferation of higher content vehicles that use more power management, more connectivity and an increasing number of sensor platforms that open new signal processing opportunities for ADI. The increasing content per vehicle is a pervasive trend across all vehicle types’ combustion engines, hybrids and full EVs. For example, in advanced safety, we've increased our GMSL design wins from 12 to 15 of the top 20 OEMs, and expanded our engagements at two European and one Korean OEM, who intend to deploy our high performance, high bandwidth connectivity solution across a larger share of their fleets. We've also seen strong attach for functionally safe power, which is used with sensors and displays in ADAS systems and recently increased share at the leading global car manufacturer. In electrification, we've expanded our battery management system share at leading Chinese OEMs and more than doubled our BMS share in upcoming European OEM model launches, and two manufacturers intend to deploy our higher content wireless solutions starting next year. Now I'd like to use the rest of my prepared comments today to share our perspective on the role that artificial intelligence is playing and will play at ADI in the future. This technology has clearly reached a tipping point and our AI opportunity spans from sensor to cloud. While we've been adding algorithmic and software intelligence to our products now for decades, we've expanded the scope and pace of our investments in recent years. Today, we are increasingly leveraging AI in and around our products, as well as in our operations to more fully meet our customers' needs and extend our industry leadership. We're deploying AI internally to help to accelerate engineering development, enhance manufacturing efficiency and create a better customer experience. But the majority of our activities are centered around product portfolio innovations that position us to take advantage of AI's enormous potential. We see this business opportunity coming in two distinct waves. The first wave focused on infrastructure is now underway and as we all know is growing very rapidly. In order to tackle the intensified energy and processing demands of AI compute systems, data center customers are investing in new vertical power architectures. As we highlighted previously, our vertical power technology, which can reduce power losses by up to 35% compared to existing architectures is gaining traction with hyperscalers. We continue to leverage our heterogeneous integration expertise to create more efficient, smaller vertical power solutions that deliver more value and enable us to capture more share in this nascent space. Power efficient computing though is just one challenge the AI ecosystem faces. Data must also be transported efficiently, securely and at much, much greater speeds. This is driving wireline customers to upgrade connectivity infrastructure, sparking a transition to 800 gigabit and 1.6 terabit optical modules. At the electro optical interface, our ability to provide high performance solutions that integrate analog, digital and memory in a reduced form factor is indeed a key differentiator. Our high precision controller was recently designed into a 1.6 terabit optical module used in the next gen AI systems of the high performance compute leader. In industrial, AI is fueling extraordinary demand for high bandwidth memory and high performance compute. This in turn is driving a new growth vector for our instrumentation and test business, particularly in SoC and memory test. We are working with key players globally to enable faster digital scan speeds, higher channel density and the improved energy efficiency necessary to scale production of AI systems. The significantly greater amount of ADI content in these systems is positioning our high performance compute and memory test sectors for record revenues in the near to mid-term. The opportunity ahead for ADI is to compound the impact of this first wave by bringing application-specific AI models and high performance compute right down to the physical edge, creating greater system value with added improvements in latency, power efficiency, security and cost. Let me share some examples of how we are working to amplify the second wave. For example, in acoustic systems, we are combining our application specific algorithms with ultra-low energy processing hardware to enrich our audio platform offerings. We are also developing a mixed signal processor with embedded neural networks that enable a system to learn and adapt to the highly variable nature of sound in real time. Excitingly, we have strong traction with multiple customers in this area. Now in the same vein, we're leveraging our rich domain expertise with our growing processing capabilities to enhance our advanced connectivity platform in next generation 5G radios. For example, we've implemented the first AI enabled technology, combining an energy efficient real time neural network with an AI assisted development tool to give customers the ability to solve their linearization challenges in a fraction of the time. In our power management platform, we're using AI to address the arduous challenge of tuning power trees for volatile consumption patterns in data centers. Our solutions reduce complexity for power engineers and compress the time required from weeks to hours, helping to lower costs, and of course, accelerate time to market. The ADI is always operated at the physical edge, where the world's most important real data is born. As multimodal AI becomes more pervasive at the edge and a diversity of sensor types is used to unearth deeper insights, we expect to see an explosion of demand that will accelerate growth for our broad signal chain, as well as power portfolios. In short, ADI's AI future looks bright across the continuum of sensor to cloud. In closing, I'm very proud of how our team has executed in one of the largest downturns the semiconductor industry has seen. More importantly, I've never been more excited about how we are positioned for the future and what it holds for ADI. With that, I'm going to hand it over to Rich."
},
{
"speaker": "Richard Puccio",
"content": "Thank you, Vince. Let me add my welcome to our second quarter earnings call. As a reminder, our first quarter 2024 was a 14 week quarter, so we are going to limit our comparisons this quarter to year-over-year only. Second quarter revenue of $2.16 billion finished above the midpoint of our outlook. This result was down 34% year-over-year. Industrial represented 47% of revenue in the quarter and was down 44% year-over-year. As expected, all applications were impacted by inventory digestion. However, aerospace and defense revenues outperformed broader industrial. Automotive represented 30% of revenue and was down 10% year-over-year. Continued growth in our leading connectivity and functionally safe power franchises balanced broad-based declines elsewhere. Communications represented 11% of revenue and was down 45% year-over-year. Inventory digestion and weaker demand impacted both our wireline and wireless businesses. Lastly, consumer represented 11% of revenue and was down 9% year-over-year with growth in portables, partially offsetting declines across other applications. Now let's move from the top-line to the rest of the P&L. Second quarter gross margin was 66.7%, down sequentially and year-over-year, driven by unfavorable mix, lower revenue and lower utilization as we continue to reduce inventory. Operating expenses in the quarter were $598 million, down significantly year-over-year, driven by lower variable compensation and strong organization wide execution on cost control. Operating margin of 39% exceeded the high end of our outlook. Non-operating expenses finished at $64 million and the tax rate for the quarter was 10.6%. The net result was EPS of $1.40 above the high end of our outlook. Our financial position is solid, and I'd like to call out a few items from our balance sheet and cash flow statement. We ended Q2 with more than $2.3 billion of cash and short-term investments and a net leverage ratio of 1.1. During the quarter, we raised $1.1 billion of debt for general corporate purposes, including upcoming debt maturities. Inventory decreased $74 million sequentially, and days declined to 192 from 201. As planned, we have reduced channel inventory this quarter with weeks ending at approximately eight. Operating cash flow for the quarter and trailing 12 months was $0.8 billion and $4.3 billion respectively. CapEx for the quarter and trailing 12 months was $188 million and $1.2 billion respectively. We continue to expect fiscal '24 CapEx to be roughly $700 million, which is a reduction of approximately 45% versus 2023, as our hybrid manufacturing investment cycle tapers. Not included in these figures are the benefits from both the European and U.S. CHIPS acts. During the last 12 months, we generated $3.1 billion of free cash flow or 29% of revenue. Over the same time period, we have returned roughly 110% of our free cash flow via dividends and share repurchases. As a reminder, our policy is to return 100% of free cash flow to our shareholders over the long-term. Now I'll turn to the third quarter outlook. Revenue is expected to be $2.27 billion plus or minus $100 million, up 5% sequentially at the midpoint. Once again, we expect sell through to be higher than sell in. At the midpoint, we expect all B2B markets to increase sequentially with the fastest growth in industrial, and for consumer to exhibit seasonal strength. Operating margin is expected to be 40% plus or minus 100 basis points. Our tax rate is expected to be between 11% 13%, and based on these inputs, adjusted EPS is expected to be $1.50 plus or minus $0.10. Before passing it back to Mike to begin Q&A, I'll share some final thoughts on our near-term. As Vince indicated, we believe we are at the beginning of a cyclical recovery as our bookings increased throughout the quarter and we exited 2Q with a book-to-bill above parity for the first time in well over a year. No doubt cyclical transitions can be challenging, but they also provide opportunity for outsized business acceleration when approached with a balance of fiscal discipline, smart risk taking and strong execution. ADI has always excelled in these areas and we look forward to driving outstanding value for our stakeholders in the quarters to come. With that, I'll pass it back to Mike for Q&A."
},
{
"speaker": "Michael Lucarelli",
"content": "Thanks, Rich. Let's get to the Q&A session. We ask that you limit yourself to 1 question in order to allow for additional participants on the call this morning. If you have a follow-up question, please re-queue and we'll take your question if time allows. With that, we will have our first question please."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Tore Svanberg from Stifel."
},
{
"speaker": "Tore Svanberg",
"content": "Yes. Thank you and congratulations on finding the recovery here. I had a question about the outlook for Q3, specifically in Industrial. I think you indicated that, you expect Industrial to be the strongest performer this quarter. I was hoping you could talk a little bit about what's behind that strength between end market demands, inventory replenishment and if there's any sub-segments within industrial that's driving that outperforming growth?"
},
{
"speaker": "Richard Puccio",
"content": "Sure, Tore. This is Rich, and I'll take that one. Industrial obviously is our most diversified and profitable end market, and it's weathered an unprecedented broad-based inventory correction over the past year. Importantly, we expect Q2 was the bottom for industrial and it will grow in the second half starting here in 3Q. Stronger PMIs are supporting the broad-based bookings we've seen for the three consecutive quarters now. As mentioned in the prepared remarks, we are planning to reduce channel inventory further in Q3, which impacts industrial more than any other market. This will be more than a year of under shipping consumptions, one reason we believe inventory headwinds have stabilized for industrial. Given these dynamics and the exciting design wins and AI related tailwinds in our instrumentation and test business, which Vince alluded to, we feel strongly we are at the beginning of the industrial recovery."
},
{
"speaker": "Vincent Roche",
"content": "Yes. I think one other piece of color, Tore, is that, the obviously, the aerospace and defense business is doing well. We've a lot of high prospects for that over the coming years. But I think, in general, geographically, it's been on the upward in terms of demand and across most of the segments, and particularly the ones that Rich pointed out."
},
{
"speaker": "Michael Lucarelli",
"content": "Tore, on the outlook comment, you're right. Just to clarify what we said, of the B2B markets, industrial grow the fastest, consumer will grow faster than industrial in 3Q. If you want to just kind of back it down a little bit, consumer is probably growing about 10% sequentially and industrial is probably closer to mid-single-digits and the other two markets are probably a little bit below that industrial level, but all markets should grow in 3Q."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Stacy Rasgon from Bernstein Research."
},
{
"speaker": "Stacy Rasgon",
"content": "Hi, guys. Thanks for taking my question. I wanted to ask about the book-to-bill. It's above one. Is it above one in all the segments, or is it just above one in industrial?"
},
{
"speaker": "Michael Lucarelli",
"content": "Yes, sure. It's actually good question. It's above one in all end markets. Not all applications within end markets are above one though. And if you think about the shape of that bookings throughout the quarter, we talked about last earnings call, bookings improved. It started below parity and exit the quarter above parity and that's across all markets and geographies. But again, I reiterate, it's not all applications and we talked a little bit about on the last question about what applications are above one. You can think of some instrumentation, some automation, some aerospace and defense within industrial. Broad-based improvement in bookings across all market geographies is really the main takeaway."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Toshiya Hari from Goldman Sachs."
},
{
"speaker": "Toshiya Hari",
"content": "Hi. Good morning. Thank you so much for taking the question. I wanted to ask about the back half of the calendar year and how you're thinking about the shape of the recovery. Vince, you've lived through many cycles. I think typically the same way we underestimate the magnitude of the pace of the downturn, we collectively underestimate the pace of the upturn. I'm curious if you expect this upturn to be similar to past cycles and we kind of follow those patterns or do you see anything in the marketplace today or anything from customers that would indicate something materially different in terms of the shape of the upturn? Thank you."
},
{
"speaker": "Vincent Roche",
"content": "Thanks, Toshiya. Look, first off, we believe we've seen the bottom of the cycle. As Mike indicated, the stronger PMIs that we've seen, particularly in the industrial sector, give us a lot of confidence, and there's a strong correlation between our industrial business, which is about half of the company's total revenue. As we've said now a few times, bookings and backlog coverage for the next several months beyond this quarter would give us strong indications that we expect continued growth during the second half of the year. I'll also point out, I think for 2025, we will have a brisk growth year, that's my sense. We are asked all the time, what's the shape going to be? I don't really know what the exact shape is going to be, but I think we're on the upward trajectory. We have confidence in that across the board."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Vivek Arya from Bank of America Securities."
},
{
"speaker": "Vivek Arya",
"content": "Thanks for taking my question. Vince, what is the right way to understand the true change in end demand, if we set aside all the inventory fluctuations? For example, is it worthwhile seeing what the distribution sell through do year-on-year in Q2? What is the assumption for Q3? Does that inform us in any way about can Q4 be seasonal, whatever is the version of seasonality? I'm just trying to see, the right apples-to-apples way of looking at what is end demand doing, setting aside all this inventory noise."
},
{
"speaker": "Vincent Roche",
"content": "Yes. Look, I think it's very hard to answer that question, simply because when history is written, we're going to get the average of what's happened pre-pandemic and post-pandemic. There's been so much ringing in the system, demand overshoot and then demand undershoot. But my sense is, certainly from our perspective, I think we are very well-positioned to be able to capture the upside if things grow faster than we expect. We have got a lot of inventory on the balance sheet. We've kept inventory closer to ADI less downstream. We've got as well a tailwind here from AI, which I think is going to be a multi-year tailwind. We have got that pushing us along. But at the same time, still we've got high interest rates, we've got still relatively high inflation in many places. I think ultimately the size of the recovery and the pace of the recovery will have a strong economic and geopolitical tone to it. But, overall, my sense is, we'll see good growth for the remainder of this year and strong growth in 2025. Beyond that, I think we've got many, many growth drivers that we feel very confident about. We're selling more value into each of our customers and each of our segments. I feel good about the place that semis are in as an industry right now as well in terms of overall demand, as the edge becomes more intelligent and the cloud builds out. But very, very hard to give you an answer on the puts and takes. I mean, the dynamics of the relatively near-term are hard to decode. But what we can tell you is, given where PMIs are at, given where our demand is at, we are in a recovery phase."
},
{
"speaker": "Richard Puccio",
"content": "Vince, I would add to that. While it's impossible to get perfect visibility into our end customer inventory, certainly the signals that we monitor tell us that, customer inventories are much healthier than they were previously as we enter the second half. This is also aided by our belief that, we have been under shipping under consumption for over a year now both in the channel and direct."
},
{
"speaker": "Vivek Arya",
"content": "But that's Quantification, right, of what the sell through has been in the reported quarters year-on-year?"
},
{
"speaker": "Vincent Roche",
"content": "Yes. I can help you out there, Vivek. I think your question is kind of what sell in versus sell through. We talked about last year. We talked about reducing the channel inventory by about $100 million. We achieved that in our 2Q. We actually did a little better than that. As you look to 3Q, we'll reduce channel dollars again, but not by that much, not nearly $100 million, much less than $100 million. So, we're getting more normal in the channel as our weeks are coming down into our target range. That normalization is helping some of the growth, but sell through is also increasing in 3Q from 2Q, which is really how we drive the business and look at for indication. As you fast forward to 4Q, if these bookings continue, we don't know. There's no reason to think we won't be more in balance in 4Q from a ship in versus ship out perspective as well, and then we'll see how 1Q goes from there. I think that's kind of the question you're asking is, there's piece Rich talked about and Vince talked about the customer's inventory that's leading out. If you look at us and what we're shipping in the channel that's also normalizing setting us up for a good second half in 2025."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Christopher Danley from Citigroup."
},
{
"speaker": "Christopher Danley",
"content": "Can you talk about the gross margin drivers from here? Maybe touch on utilization rates and inventory trends and some of your competitors have talked about pricing returning to historical norms. If that happens, can you still get the gross margins back to the previous peak?"
},
{
"speaker": "Richard Puccio",
"content": "Sure. I'll take that one. From a gross margin and utilization perspective, we talked a little bit about this in the first quarter call. We expect both utilization and gross margin bottomed in our Q2. However, we do expect the pace of gross margin expansion in the second half to be modest. Specifically for Q3, we anticipate gross margin a bit above 67%. Looking from here, gross margins expansion is going to be dictated by continued revenue growth, mix of business and utilization. From a balance sheet perspective, since our peak in Q3, we've reduced balance sheet inventory significantly, including over $70 million in Q2. For the third quarter, we expect to reduce inventory again by a lesser amount than in Q2. Overall, we executed pretty strongly against our inventory reduction goals, while mitigating the impact on gross margin, leveraging our dynamic hybrid manufacturing model. One of the things that's been super helpful in protecting us in this trough is the flexibility to swing capacity back into our fabs to help to maintain utilization. We've done that effectively, which is why we called the floor on utilization. I expect that utilizations as the demand continues to increase will start to increase and aid in our margin expansion. From a channel, as Mike mentioned, from a channel perspective, our goal was to reduce by $100 million we achieved. We will reduce an additional amount in Q3 to a lesser degree. Ultimately, we expect that this will get us firmly back into our target range of seven to eight weeks of inventory in the channel."
},
{
"speaker": "Vincent Roche",
"content": "Let me make a comment on the pricing side of things. Across the portfolio, our pricing has been very, very stable and I expect that to continue. Our products are very sticky. The franchise is very, very diversified. It's got lots of long life products in it. We tend to hang on to our sockets for, I think, on an average more than a decade. Clearly, where the competition is for the new sockets. But ADI has the premier innovation system in the analog mixed signal space and we have been pushing that innovation. While others are focused on volume, we're focused on value. I think it's a very, very different approach to things. We are not a commodity supplier at all. So we are not immune to price pressure, but we are more protected I think and we have better meat because of the innovation that we generate. I'll note as well, our ASPs are more than 4x the average. It's our innovation premium that enables us as well to capture more value and to produce the kind of gross margins that that we do."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Ross Seymore from Deutsche Bank."
},
{
"speaker": "Ross Seymore",
"content": "Hi, guys. Congrats on marking the trough and turning the corner. Vince, I wanted to ask a bigger picture question. I think it's been four years since you guys bought Maxim and I believe it was four years prior to that with Linear. How are you looking at the M&A environment? Are there any kind of pieces to the puzzle that you wish you had?"
},
{
"speaker": "Vincent Roche",
"content": "Thanks, Ross. We've always acquired assets that get ADI ahead of customers' needs. We tend to take a long-term view, get ahead of our customers' needs. Obviously, we've been very, very selective. I will say, Ross, it's fair to say that, in terms of scale and scope of analog high performance franchise, we are where we need to be. Analog mixed signal power, we've got a wonderful power franchise now. But we've been adding, I alluded in my remarks or stated in my prepared remarks that, we have been putting more software content, more digital content and we've also been for about seven or eight years now developing machine learning, neural networking capability. Those are areas where as the world becomes more and more software defined, that is clearly an area where ADI has been organically investing. We've done some more tuck-in type acquisitions as well that help us in that area. But I think right now, we are really focused on making sure that, we fully capture all the synergies, from the revenue synergies from Maxim. But we're always looking, by the way. We're always looking for assets. But clearly I think analog is complete and it's other areas we're now looking."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Mark Lipacis from Evercore ISI."
},
{
"speaker": "Mark Lipacis",
"content": "Hi, thanks for taking my question. Vince, it's for you, I think. If you look at your -- if you adjust your revenues for the step function increase that you had for pricing, it looks like on a unit basis, you're shipping 25% below the trend line. I don't think you shipped that far below your long-term trend line since the world financial crisis. At the same time that's happening, you talked about your customers lowering, the supply chain lowering inventories, you are lowering inventories. It seems like there's a real risk that the industry is setting up for you and the industry is setting up for like a really tight supply environment, maybe even as they're early as the end of this year or early next year. I'm wondering, how do you think is there a risk that we enter that kind of a scenario? It seems like your customers never learn about trying to get their inventories right and the order see you on time. Is there something that's changed in your operations that will enable you to adjust to that, what has historically happened, which is your customers overshoot on the downside on their inventories and then come in at the last second when things are really tight?"
},
{
"speaker": "Vincent Roche",
"content": "Yes. Well, yes, I think surging demand is a problem of a high quality. And as -- we have virtually 200 days of inventory in our balance sheet, stage primarily at the die socket level. So that gives us a tremendous amount of output that we could bring within weeks to the market. It's a question of packaging and test to a first approximation. Obviously, we're carrying finished goods as well. We have also spent $2.5 billion plus on making sure that we have internal capacity in our 4 internal fabs to be able to meet the demands across the nodes that produce most of the revenue for ADI. We've got great partners, partners like TSMC, for example, who are a critical part of our hybrid manufacturing model. So I think in terms of the ability to be able to address a really short order snapback is good, just given the coverage that we've got with internal inventories. Our distributors are carrying virtually 8 weeks as well as inventory. And then we've got all this new capacity. We've more than doubled the internal capacity on the critical nodes that address every single market that we that we participate in. So I think in terms of manufacturing agility, inventories, we're in good shape."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Harlan Sur from JPMorgan."
},
{
"speaker": "Harlan Sur",
"content": "Great job on the quarterly execution. Within your distribution business, it's about 60% of your overall revenues. You can monitor sell-through in near real-time which allows the team to tightly control the inventories into this channel. On the direct business, less visibility on consumption levels of inventory here. I think direct customer orders to you are probably the best indicator of where they are in terms of their inventory targets. So is the return to quarter-on-quarter growth in July and second half optimism on growth being driven by order growth at direct customers as well? And then just any qualitative differences on the residual excess inventory distri versus direct?"
},
{
"speaker": "Michael Lucarelli",
"content": "Yes, Harlan, it's Mike. Yes, the direct order we talked about our -- direct orders as well as channel orders, but what's driving the growth is direct sales, out of the channel on a sell-through basis as well imaged directly to our end customers. So yes, it's not about -- we're not growing because the channel is refilling. We're growing because there's real demand out there on the end market level across all of our markets."
},
{
"speaker": "Richard Puccio",
"content": "We expect to reduce both balance sheet and channel inventory further in Q3 while growing."
},
{
"speaker": "Michael Lucarelli",
"content": "Did that [indiscernible] to your question, Harlan?"
},
{
"speaker": "Harlan Sur",
"content": "Yes, it does."
},
{
"speaker": "Michael Lucarelli",
"content": "We'll go to our last question, please."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Joseph Moore from Morgan Stanley."
},
{
"speaker": "Joseph Moore",
"content": "Great. I wanted to also touch on your margin profile. You used to peak with operating margins in kind of the low 40s. And now you're -- as you said you would, in a very difficult trough, you're troughing for the full year, probably above 40%. So that's pretty good structural improvement. Can you talk about that, what's going on if you sort of look over a decade, why is your through-cycle margin profile going up so much?"
},
{
"speaker": "Richard Puccio",
"content": "Yes. So I think a couple of things, right? As we talked about -- the resiliency of our manufacturing process allows us to swing capacity in and out which allows us to offset some of the down cycle pressure on margins because we're able to keep utilization at a higher level given that swing capacity. Obviously, we continue to look for productivity and are executing on productivity improvements across all of our internal fabs. So I think that helps. And then if you think at an overall operating margin perspective, we've been demonstrating and we'll continue to demonstrate pretty strong operational control over expenses. Look, we expect we'll continue to see expansion in the margin as we grow and as revenue returns to a growth phase, we will get comfortably back into our long-term margin model."
},
{
"speaker": "Vincent Roche",
"content": "Yes. I think, Joe, as well, in addition to what Rich has said, it's important to point out that, first and foremost, we're innovation-centered, and if you look at the vintage bands of our products in each of the segments, the big segments that we address, industrial, automotive, consumer and communications, we're seeing ASP increases year-on-year. We're putting more value into our products. We're capturing more value. So I think that is kind of the root of things when I look forward. That's -- I mean that's what's happening to -- that's the origin, if you like, of the margin story for ADI. Our diversity helps us a lot. Our franchise isn't as price-sensitive as many. And as I said earlier, the life cycles matter. When we get our products designed in the pricing is tremendously stable. The other thing that's been happening from a price dynamic over the last several years is that whereas Moore's Law kind of taught everybody that we could give back a lot of the value that was generated in prior years, in the New Year. That has stopped. We asymptote roughly to zero now. We don't give price away. We compete for sockets, computed innovation, but that is really the origin of ADI's margin story."
},
{
"speaker": "Michael Lucarelli",
"content": "All right. Thank you, Joe, and thanks, everyone, for joining us this morning. A copy of the transcript will be available on our website, and all reconciliations are there as well. Have a great Memorial Day weekend, and thank you for listening on ADI's call."
},
{
"speaker": "Operator",
"content": "This concludes today's Analog Devices conference call. You may now disconnect."
}
] |
adi | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning and welcome to the Analog Devices’ First Quarter Fiscal Year 2024 Earnings Conference Call, which is being audio webcast via telephone and over the web. I'd like to now introduce your host for today's call Mr. Michael Lucarelli, Vice President of Investor Relations and FP&A. Sir, the floor is yours."
},
{
"speaker": "Michael Lucarelli",
"content": "Thank you, Josh. And good morning, everybody. Thanks for joining our first quarter fiscal 2024 conference call. With me on the call today, are ADI’s CEO and Chair, Vincent Roche and ADI’s CFO, Richard Puccio. For anyone who missed the release, you can find it in relating financial schedules and investor.analog.com. Onto the disclosures, information we're about to discuss includes forward-looking statements which are subject to certain risks and uncertainties as further described in our earnings release, our periodic reports and other materials follow the SEC. Actual results could differ materially from the forward-looking information, as these statements reflect our expectations only as a date of this call. We undertake no obligation to update the statements except as required by law. Revenue, adjusted gross margin, operating and non-operating expenses, operating margin, tax rate, EPS and free cash flow in our comment today will be on non-GAAP basis, which excludes special items. When comparing our results to historic performance. Special items are also excluded from prior periods. Reconciliation of these non-GAAP measures to most directly comparable GAAP measures and additional information about our non-GAAP measures are included in today's earnings release. As a reminder, the first quarter of 2024 was a 14-week quarter. And with that, I'll turn it over to ADI's CEO and Chair, Vincent Roche, Vince?"
},
{
"speaker": "Vincent Roche",
"content": "Thank you very much, Mike, and good morning to you all. But before I begin, I'd like to welcome ADI’s new CFO Richard Puccio to the call, which is only a few weeks in, but we're very excited to have him on board. He brings tremendous financial experience and capability from complex technology sectors, which I think will be very valuable, as we continue to extend our leadership in the Intelligent Edge era. I'd also like to recognize Jim Mollica for serving as Interim CFO and thank Jim for his continued partnership and contributions to our success. Now on to the results for the first quarter. ADI delivered revenue of more than $2.5 billion, operating margins of 42% and earnings per share of $1.73, all above the midpoint of our outlook. As we previously discussed, the inventory rationalization that our customers that began during the middle of 2023 is expected to continue through our second quarter. Encouragingly, first quarter bookings improved sequentially, growing our confidence that inventory related headwinds will largely subside this quarter. That said, the macro situation remains challenging, and the shape and timing of a second half recovery will be governed by underlying demand. Importantly, the strength of our balance sheet, operational agility, and prudent capital management are serving as well during this downturn. We've invested heavily in R&D, customer engagement, activity and manufacturing resiliency, fueling our future growth, even as we maintain the industry leading profitability that supports our practice of robust capital returns. To that end, I'm pleased to highlight that we announced the 7% dividend increase yesterday, making 2024 the 20th consecutive year of higher dividends for shareholders. Now, digging a little deeper into our investment philosophy, we continue to focus on anticipating our customers’ future needs. And what's becoming a software-defined AI-driven world leveraging pervasive sensing, Edge computing and ubiquitous connectivity. The technological complexity facing our customers is compounded by their need to deliver solutions that are both secure and extremely power efficient. So let me share a little more now about how we are strategically allocating our capital to deliver more solutions value to our customers, and further support their confidence in the long-term supply assurance? Since our acquisition of Maxim, we've increased our engineering population by around 10% complementing our world class Analog talent, with increasing levels of digital software, AI, and systems expertise. This breadth of engineering gives ADI the capabilities to tackle more of our customers' challenges, and grow our sell-in across markets. In addition, as our engineers increasingly work shoulder to shoulder with our customers to co-architect their solutions, we further deepen our understanding of their technological and market complexities. This strengthens our ability to deliver increasingly stronger innovation from components to physical Edge systems. And I'd like to share now a few examples of what I mean. For example, in the industrial sector, digital transformation is driving investment in Edge-based connectivity and control platforms that enable secure power efficient monitoring and control of automation systems. Last month, Honeywell announced it will use ADI's Deterministic Ethernet and software-configurable IO solutions across their factory automation and building management offerings. Our portfolio enables customers to securely deliver end-to-end signal integrity between the Edge and the cloud in a power efficient and highly flexible platform configuration. This system approach enables us to capture three times more value, and we expect additional design wins due to high customer interest globally. In the automotive sector, we've aligned our business to the second are trends of electrification, advanced safety systems, and immersive digital in-cabin experience. For example, our Gigabit Multimedia Serial Link or GMSL Solution continues to gain broader adoption, as customers seek to extend high performance data and video capabilities across their fleets. We’ve recently increased our share at a top three global auto manufacturer extending our position across all their brands and quintupling our GMSL opportunity at that customer. In datacenters, AI and machine learning computing systems require orders of magnitude more processing and thus energy, compared to traditional workloads. Our portfolio of high-performance power and protection solutions, specifically designed for vertical power delivery is helping customers re-architect their datacenter systems to improve power delivery and system performance. Last quarter, we secured a significant design win from a large hyperscale customer for our multiphase vertical power solution that reduces power losses by 35% when compared to conventional ones. In Healthcare, this market continues to digitalize to enable more predictive and preventative treatment regimens. ADI has been on the forefront of this transition, and I'm pleased to let you know that we've recently received FDA clearance for a non-invasive remote monitoring platform, that enables home-based management of chronic diseases such as congestive heart failure. This solution leverages our deep domain expertise, leading-edge capabilities across signal processing and sensor modalities, and unique algorithms that enable medical providers to act early, precisely and effectively. As a platform, this also allows us in the future to use our data-driven AI algorithms to make this even more personalized. This advance unlocks a new growth vector for ADI, adding more than $5 billion of new sell-in. Switching now to the evolution of our supply chain, I'd like to share some of our progress in manufacturing resilience, which is a growing priority for our customers. Over the last two years, we've invested record levels of CapEx to expand our capacity and to enhance resiliency. Now with line of sight to achieving our goal of doubling front and back-end internal capacity in 2025 and will begin to significantly reduce our capital spend. Notably, approximately 10% of our investments have been focused on implementing more efficient systems that will deliver sustainability benefits, including greatly reducing input resources and emissions, which, overtime, will also lower our operating costs. These investments enable a more flexible hybrid manufacturing model and will increase our swing capacity to around 70% of revenue in the coming years. This unique ability helps to capture the upside in strong demand backdrops and better protect our gross margins during more challenging times. Complementing these organic investments, we also extended our foundry partnership with TSMC to secure additional 300-millimeter fine-pitch technology capacity at their Japan subsidiary. Our investments, combined with the support of our foundry partners will enable us to manufacture our products in multiple geographic locations, enhancing our resiliency and giving our customers greater optionality and assurance over their supply chains. So in closing, as always, we're keeping one eye on the present and one eye on the future. I have confidence in the steps that we're taking to preserve our capital and navigate the near term challenges while ensuring that we make the necessary investments to increase our competitiveness and accelerate our business in the future. And so with that, I'd like to pass the microphone over to Rich."
},
{
"speaker": "Richard Puccio",
"content": "Thank you, Vince. And let me add my welcome to our first quarter earnings call. I'm excited to have joined ADI and look forward to helping the company navigate the near term while ensuring we are well positioned to capitalize on the tremendous opportunities ahead of us. Despite continued challenging business conditions, we achieved first quarter revenue, which was slightly above the midpoint of our outlook or down 8% sequentially and 23% year-over-year. Industrial represented 48% of revenue in the quarter, down 12% sequentially and 31% year-over-year. As expected, we experienced broad-based weakness as customers continue to work down their inventory levels. Automotive, which represented 29% of revenue, was up 2% sequentially and 9% versus the year ago period, representing 14 consecutive quarters of growth. Notably our leading connectivity and functionally safe power solutions collectively increased double digits year-over-year. Communications, which represented 12% of revenue, declined 10% sequentially and 37% year-over-year. On a sequential basis, wireline fared relatively well driven by AI-related demand, while wireless decreased as global investments in 5G remain depressed. And lastly, consumer represented 11% of revenue, down 7% sequentially and 22% year-over-year driven by continued sluggish end demand across applications. Now on to the rest of the P&L. First quarter gross margin was 69%, down sequentially and year-over-year, driven by unfavorable mix lower revenue and lower utilization. OpEx in the quarter was $679 million, down 2% sequentially despite the extra week, driven by lower variable comp, disciplined discretionary spend and structural cost improvement. As a result, operating margin of 42% finished near the high end of our outlook. Non-operating expenses finished at $75 million, and the tax rate for the quarter was 11.8%. All told, EPS was $1.73, slightly above the guided midpoint. Now on to the balance sheet. Cash and equivalents increased more than $340 million sequentially and ended the quarter at $1.3 billion. Our net leverage ratio remained below 1. Inventory decreased nearly $90 million sequentially, driven primarily by finished goods, while days increased to 201 due to lower revenue. Channel inventory dollars declined again in 1Q with weeks of inventory finishing slightly above our target range of seven to eight weeks. Moving on to cash flow items. Over the trailing 12 months, operating cash flow and CapEx were $4.6 billion and $1.3 billion, respectively. We continue to expect fiscal 2024 CapEx to be approximately $700 million. As a reminder, these are gross CapEx figures, not including any of the anticipated benefits from both the U.S. and European Chips Act. Over the last 12 months, we generated $3.2 billion of free cash flow or 28% of revenue. During the same time period, we have returned more than $4.2 billion through dividends and share repurchases. And since our Maxim acquisition, we have returned nearly $12 billion or more than 130% of free cash flow to shareholders, reducing share count by 8% while also increasing our dividend per share by 33%, including our most recently announced 7% increase. As a reminder, we target 100% free cash flow return over the long term. We aim to use 40% to 60% to grow our dividend annually with the remaining free cash flow used for share count reduction. Now moving on to guidance. Second quarter revenue is expected to be $2.1 billion, plus or minus $100 million, once again, we expect sell through to be higher than sell-in. At the midpoint, we expect all end markets to decline sequentially with the largest decline in industrial as we continue to meaningfully reduce channel inventory. Operating margin is expected to be 37%, plus or minus 100 basis points. This includes the impact of unfavorable mix and lower utilization as we further reduce balance sheet inventory. Our tax rate is expected to be 11% to 13%. And based on these inputs, EPS is expected to be $1.26 plus or minus $0.10. In closing, the actions we've taken to protect profitability in the near term as well as the natural shock absorbers embedded in ADI have enabled us to maintain strong profitability even as our quarterly revenue has fallen significantly from its peak. Importantly, with the strength of our financial profile and the growing importance of our technology, we will continue to invest confidently in our future, regardless of where we are in the cycle. I will now give it back to Mike for Q&A."
},
{
"speaker": "Michael Lucarelli",
"content": "Thanks, Rich, and welcome to the call. Let’s get into our Q&A session. We ask that you limit yourself to one question in order to allow for additional participants on the call this morning. If you have follow up question, please requeue, and we’ll take your question if time allows. With that, we have our first question, please."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Our first question comes from Joseph Moore with Morgan Stanley. You may proceed."
},
{
"speaker": "Joseph Moore",
"content": "Great, thank you. You guys are guiding down now mid-30% year-on-year. If I go back to historic drawdowns, you haven't seen revenue fall that far other than 2001, 2009, where we had kind of significant demand destruction. So it kind of looks like the worst inventory correction maybe we've ever seen. Can you just talk to that? Does that reflect how much inventory excess there might have been? Or just any kind of sense check as we approach the bottom as to why the downturn looks kind of severe?"
},
{
"speaker": "Vincent Roche",
"content": "Yeah. Thanks, Joe. I think first and foremost, the -- if you like, the events that caused the supply chain fracture was unique. And every single segment was impacted every single customer, every single business. So this is truly the broadest base demand inflection I've ever seen in my 30-something years with ADI. And I've been through all those different perturbations. So I think that's the uniqueness of the event itself, I think is what caused the level of impact. And we see everything compounded. We saw the supply chain fracture. Then we saw the shortage, and then we got the behavior that we typically see in a shortage situation. You get double ordering, you get holding. And we're seeing that everywhere. The area that we've probably seen, I would say, the biggest correction is in the industrial market. And I think our sense is that it began in the second -- kind of the second half of the past year. And that will take four to five quarters to correct, I believe, from the beginning of the decline to when we start to see growth again. So I think that's pretty much it. But now we're in a situation where the lead times are very uniform. And actually, we got ahead of the supply chain issues, I think, faster than most. We've got our lead times back into better shape than most quite quickly. And so we saw the downturn, I think, more quickly than others. So all that said, Joe, I think the underlying demand for our products and technologies in the years ahead. We remain very, very bullish about that. And I expect, as we've indicated that we'll see a return back to growth in the second half of our fiscal year."
},
{
"speaker": "Michael Lucarelli",
"content": "Thanks, Joe. Operator, next question please?"
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from Stacy Rasgon with Bernstein Research. You may proceed."
},
{
"speaker": "Stacy Rasgon",
"content": "Hi, guys. Thanks for taking my questions. Rich, I was wondering if you could give us a little more color on the segment guidance next quarter. I know you said everything down in industrial worse. But I mean like industrial has got to be down probably more than 20% sequentially, and that would probably still assume everything else is down double digit sequentially. Is that what you have in mind? And any further color you could give us would be great."
},
{
"speaker": "Michael Lucarelli",
"content": "Yeah. I'll grab that one. It's Mike. So you're right to think industrial is the weakest. I would say, 20% sequentially, sure, you can put that number in your model if you want to, 20% plus or minus sequentially. I would say comms is also probably worse in the midpoint of your guidance, so down more than the 16% we guided to. While auto and consumer probably do a bit better, but are both down pretty significantly sequentially as well. And really, the big driver on the industrial piece, as we laid out is the channel reduction in the -- for the inventory in the channel, which is impacting industrial more so in other markets. I hope that helps, Stacy."
},
{
"speaker": "Stacy Rasgon",
"content": "Yeah."
},
{
"speaker": "Michael Lucarelli",
"content": "We’ll go to the next question."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from Chris Danely with Citi. You may proceed."
},
{
"speaker": "Chris Danely",
"content": "Hey, thanks, guys. Just to follow up on that question. How much of this downturn do you think is just pure inventory correction versus demand? And then any comments you could you could have on just demand trends as far as what you're hearing from the distribution channel and your customers?"
},
{
"speaker": "Michael Lucarelli",
"content": "Sure. I'll start and then I think Vince will add some clarity also on it, but this really is a supply-driven demand correction, what you're seeing here. And Vince outlined that in the answer to the first question where the supply chain fracture lead times extended for an extended period of time. Those have normalized. We're still seeing what are happening as our customers is, they build a lot of inventory over that time. Why our lead times are extremely long. Now our lead time is back to normal, so they're seeing them reduce their balance sheet inventory to match our short lead times, so the cycle times match up. So really also a majority supply chain some demand. There's some areas of pockets of weakness in demand. But really overall, I'll call it more of a supply than demand correction in our business. And we talked about in the script and as well the press release that supplied normalizing here in our second quarter."
},
{
"speaker": "Vincent Roche",
"content": "Yeah. I think, Chris, if we look at the two halves of FY24, I believe the first half is all about inventory in digestion and digestion. And as Mike said, we largely get through that part of the headwind by the end of our second quarter. And then in the second half, all the indications our bookings are getting stronger, cancellations are abating. Our conversations with customers suggest that we'll begin to return to a growth pattern in the second half. The big question is the macroeconomic dial where that's positioned. And I think at the margins, if I look at where we are this quarter versus last quarter, at least from a macro standpoint, maybe with the exception of China, we're more bullish than we were."
},
{
"speaker": "Chris Danely",
"content": "All right. Thanks, guys."
},
{
"speaker": "Michael Lucarelli",
"content": "Thanks, Chris."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from Vivek Arya with Bank of America Securities. You may proceed."
},
{
"speaker": "Vivek Arya",
"content": "Thanks for taking my question. Vince, on the last earnings call, you mentioned bookings were stabilizing. I think this quarter, you're saying bookings are improving. And I'm curious which end markets are showing the best recovery in bookings? And then importantly, how should this inform us about what ADI will see as we get into the July quarter? Should we be assuming some kind of seasonal recovery, should we assume things flatten out first? And if I could attach kind of part B of that, which is what happens to gross margins as you start to see that flattening out and potential recovery? So just the shape of what recovery looks like in sales and margins if bookings flatten and now they seem to be improving?"
},
{
"speaker": "Vincent Roche",
"content": "Yeah. Well, I think, look, as soon as demand in flex, and we get back into a more normalized growth pattern, Vivek, everything will improve. Our utilizations will improve. We have under-shipped the channel, we've under-shipped our customers. So we've been working very, very hard in the company to make sure that when demand and flex that we will get a -- we've got the supply in place. We've got lots of finished goods and deadstock inventory. So we're in a great position to address the recovery. On the first part of your question about where are we seeing the bookings improvement, pretty much everywhere, pretty much everywhere, across all the segments. And if you look at industrial, I'd say the two healthiest parts of industrial right now is, as we message to the external world, aerospace and defense and healthcare, they've got fundamentally quite different drivers to, say, the factory automation or instrumentation business. But those two sectors are holding up better than the rest. But even in a more traditional industrial sector like instrumentation, all of these new high-performance computing systems need you test equipment, so that benefits ADI. So I think, in general, it's true to say, maybe with the exception of our wireless business, most sectors are seeing a return to a more normalized bookings pattern."
},
{
"speaker": "Richard Puccio",
"content": "And Vivek, I'll give you a little more color on the gross margin outlook. So in the last call, we talked about gross margin will be 68% to 69%. We came in at the high end, a good result given the large drop in industrial that we've been talking about and with an inventory takedown of almost $90 million quarter-over-quarter. The 2Q outlook implies 67% plus or minus, a bit lower than what we thought would be given the weaker revenue, especially in industrial and the fact that we're taking down factory starts further in 2Q to reduce inventory by another $50 million to $100 million. And if I think a little bit further out to the half two outlook, tough to predict right now is the revenue and the shape of the revenue recovery will be the governor on gross margin trajectory. But our best sense is gross margin trends higher in the second half, as we don't see utilization going much lower as inventory continues to decline meaningfully at these start levels and we'll continue to leverage our swing capacity."
},
{
"speaker": "Michael Lucarelli",
"content": "And Vivek, as you asked a three-part question, I'll chime in as well for third quarter outlook. I know you gave me the outlook question. So it's hard to say, right? Our lead times are 13 weeks are lower. So we don't really have visibility into the third quarter today. But if you look back over history over the past decade, our B2B markets are about flattish sequentially in 3Q from 2Q, sometimes they're up a little bit, sometimes they're down a little bit depending where you are in the cycle, while consumers start seeing some holiday builds kind of up mid- to high single digit sequentially. So that's kind of historical context. We're not guiding in the third quarter, but that's how we should frame it. And then to add on to what Vince said about bookings. Bookings actually increased last quarter, and the quarter before that. So 4Q and 1Q bookings both improved. And what's interesting now is you look at our bookings, they're approaching parity, which is a good sign that we just see a pickup in the back half of the year."
},
{
"speaker": "Vivek Arya",
"content": "Very helpful. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from Harlan Sur with JPMorgan. You may proceed."
},
{
"speaker": "Harlan Sur",
"content": "Hi, good morning. Thanks for taking my questions. So if I look at fiscal '23, China was about 18% of your total revenues. It was the worst performing geography down about 13% for the full year. Because Lunar New Year was so late this year, it feels like this did add a little bit of uncertainty at the beginning of this year, but obviously, now we're post-Lunar New Year. What are the demand signs out of this region? Are orders also growing sequentially in the China regions? Are cancellations also showing signs of stabilization patterns as well? Maybe even signs of a potential pickup in the China region? Just want to get your views."
},
{
"speaker": "Michael Lucarelli",
"content": "So if you take a step back from a geo perspective, whole regions are weak, North America, Europe, China. China has been weakest the longest, I would say. The rest of Asia is doing better than the big three, but still weak as well. And like I said, China is the weakest source of demand. Around Chinese New Year, honestly, if there's something unique about it, we called out. But I think what Vince said in the last question basically was bookings are improving globally as well as in China before and after this year. So really no impact from Chinese New Year and kind of the commentary we've made."
},
{
"speaker": "Harlan Sur",
"content": "Perfect. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from Toshiya Hari with Goldman Sachs. You may proceed."
},
{
"speaker": "Toshiya Hari",
"content": "Hi, good morning. Thanks so much for taking the question. Vince, I'm curious how you would characterize sell-through today versus sell-in. I think at a conference a couple of months ago, you had mentioned that sell-in was tracking 15% to 20% below sell-through. Is that still the right ballpark number? And is that what you're seeing in the current quarter? And I guess, if so, if the end demand environment doesn't deteriorate over the next six, nine months? Could there be a quarter later in the year where your revenue run rate is tracking above $2.5 billion, $2.6 billion? Thank you."
},
{
"speaker": "Michael Lucarelli",
"content": "I'll grab the first part of that on the sell-in and sell-through part of it, Toshi. So selling and sell-through really relates to the channel. We reduced our channel inventory dollars the past two quarters, I would call it around a $50 million reduction, plus or minus per quarter over the last two quarters. Looking at embedded in our guidance is a much bigger reduction of channel inventory. If you want to put a number around $100 million or so in our outlook, that's probably what we're seeing on the channel side. So we're reducing a lot in the channel. Now as you look at the back half of the year, from a channel perspective, we think the sell-in and sell-through should be better matched given the actions we've taken over the last three quarters. And I'll pass it to Vince to talk a little about the customer inventory situation on the end customer side."
},
{
"speaker": "Vincent Roche",
"content": "Yeah. On the customer side of things, we've been monitoring very, very carefully across the various segments. Our customer shipment rates, their inventories and their ADI goods on hand. And we're clearly under-shipping our customers' current demands. So we feel that we've got a situation now in terms of our -- we're in a good inventory position on hand. Our customers are beginning, as Mike indicated, to replenish their order books, ADI's goods. And that gives us the confidence as the book-to-bill approaches unity that we're seeing the worst of the inventory correction. And in the second half, we will get back to a more normalized growth pattern. So as Mike said, there's a very good balance between the direct channel, the distribution channel in terms of the inventory situation, but we're ready for the upsurge."
},
{
"speaker": "Toshiya Hari",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from William Stein with Truist Securities. You may proceed."
},
{
"speaker": "William Stein",
"content": "Great. Thanks for taking my questions. I want to welcome, Rich, but direct a couple of questions to Vince, please. Vince, the more vertical capabilities that you talked about, it sort of suggests that you're needing to either partner more closely with a smaller number of customers or maybe you wind up pushing somewhat into their capabilities and are potentially competing with some of them. And I wonder how you contemplate managing that dynamic?"
},
{
"speaker": "Vincent Roche",
"content": "Yeah. Will, thanks very much. You're -- unfortunately, the line shopped. I think I got your question about verticalization, competing with our customers potentially. Hopefully, you can hear me, okay, that it's not a two-way line problem here. Will, look, the -- we've been on a journey over many, many years now to continue to build out our core component franchise, but also add more value to our solutions. Our business has become more solutions-oriented particularly over the last decade in every single segment that we play. And that kind of domain application-driven engineering that ADI has been distinguishing it so at the edge over the last decade, that will continue, and we're continuing to build that. I talked on the -- in the prepared remarks about this point of care, acute health care solution that we've just brought to market where we've got an FDA approval. I think what's happening, Will, in the world is that there are certain places like that where we have a white space to attack. We're building a complete solution that has both hardware and software makes a lot of sense. But the truth is, even in the traditional markets and with the larger customers that we deal with, more and more footprint capture, if you like, has been taking place. Why? Because we tame our customers' complexity. And I've talked before about the asymmetry and capabilities in the Analog space between the capabilities ADI has got and our customers have got. They expect us actually to add more solution value and build more complete solutions and clearly define where the line is between where their core value is versus where ADI's core values. So I think we're not competing with our customers, but we have very vibrant discussions about where we draw the line of the labor divide, so to speak."
},
{
"speaker": "William Stein",
"content": "That helps. If I can ask a follow-up. You talked a bit about AI. It's sort of a familiar topic to us lately. Maybe too much so."
},
{
"speaker": "Vincent Roche",
"content": "Not much."
},
{
"speaker": "William Stein",
"content": "There's a narrative here where there are some creative capabilities, in fact, I would say, engineering-focused capabilities that maybe made more efficient or productive with Generative AI. In a world where the story about Analog design engineer capability being so limited and that driving a significant advantage for ADI. I wonder if that story changes at all because of this capability. Have you started using this for circuit design? Or do you anticipate that it could be used by others, either competitors or customers? Thank you."
},
{
"speaker": "Vincent Roche",
"content": "Yeah, it's a good question. Well, look, everybody is trying to figure out the meaning of the AI in their businesses. We're using AI today in our tool chains. We're using machine learning and AI in our products, around our products. We're starting to use it in our business. And I think -- I believe that anything that can be -- anything that is routine -- and that can be automated, that's the way of technology. Technology automation will take over the things that are more routine. We play very much at the high end of the performance spectrum. So unless there's generative intelligence that can outperform our imaginations, which I don't see any time in the foreseeable future. We're truly in a realm where the intellectual property value and the learning system that we've got in this company will matter more and more. But yeah, I think we view AI as a tremendous opportunity. As clearly in the product development process from how the products are designed, what we put as ingredients in our products, and we're also, by the way, putting AI into the customer support tool chain. So it is a part. We're embracing it, and we believe that it will be an accelerator and the copilot, if you like, with our engineering population."
},
{
"speaker": "William Stein",
"content": "Thank you."
},
{
"speaker": "Michael Lucarelli",
"content": "Thanks, Will, it sounds like from your cell phone line, we do need some more 5G coverage. So next question, please?"
},
{
"speaker": "Operator",
"content": "Thank you. One moment for questions. Our next question comes from Timothy Arcuri with UBS. You may proceed."
},
{
"speaker": "Timothy Arcuri",
"content": "Hi, thanks a lot. Can you talk to any period costs versus underutilization charges that you're taking? And any of those -- how much of a headwind are those now? And how much will those help you as they might reverse themselves coming out of the downturn? Thanks."
},
{
"speaker": "Michael Lucarelli",
"content": "So I think your question is on how much of the impact on our gross margins underutilization versus mix. I think if you look here, our peak gross margins were about 74%. Our outlook, as Rich pointed out, embeds about 67%. That decline is really mix and utilization, about equal parts, I'll call it. As you look to the back half of this year, it depends what mix is going to do. I think industrial is bottoming here, so that should help a little bit. From a utilization standpoint, Rich also pointed out, our starts are low enough to reduce inventory meaningfully. We've been doing that. We'll do it again in 2Q. So I don't see it starts going down, they're probably start going up, which should provide a tailwind to gross margins. How fast the gross margins pick up really depends on those 2 factors, how fast the revenue picks up and how much of it relates to the industrial sector."
},
{
"speaker": "Timothy Arcuri",
"content": "Okay, Mike. But I guess, are there any inventory charges? That's the question."
},
{
"speaker": "Michael Lucarelli",
"content": "So from inventories, yeah, I would say, a good question. You're right. We have a lot of inventory. As you can see on our balance sheet. The -- there's no acceleration of inventory charges in our gross margins. The inventory charge from a reserve standpoint have been elevated for the past few quarters, and they probably stay that way as you go into the back half of this year into next year. But that's not a headwind anymore. It's already kind of built in the run rate."
},
{
"speaker": "Timothy Arcuri",
"content": "Okay, awesome. Thanks, Mike."
},
{
"speaker": "Michael Lucarelli",
"content": "We will go to our last question, please."
},
{
"speaker": "Operator",
"content": "One moment for our last question. And our last question comes from C.J. Muse with Cantor Fitzgerald. You may proceed."
},
{
"speaker": "CJ Muse",
"content": "Yeah. Thank you for taking the question. You talked about auto being down sequentially, but seeing, I guess, the best performance out of all the different segments. Curious if you can kind of walk through what you're seeing from Tier 1 auto correction and whether you think that will be completed exiting April as well? Thanks so much."
},
{
"speaker": "Michael Lucarelli",
"content": "Yeah. Sure. From the auto standpoint, C.J., I would say, yes, there is definitely an inventory correction going on in auto like or market as Vince pointed that out, the supply fracture at everyone is, to a lesser degree, than auto than other markets, but it's not really because of the inventory. It's because of the growth drivers in that business, whether it's BMS, GMSL AB functional safe power, the growth in those areas are offsetting the overall call it inventory digestion in automotive area. You're right to say that on the Tier 1 side or the OEM side, there's some froth inventory. But we're seeing that being digested. Will it be all complete? By the second quarter, we'll see, but I do feel good about those growth areas continue to grow this year. And for the full year, will auto grow, I don't know. We'll see. But it really depends on how strong the growth is in the growth areas and how much of the overhang on the inventory side is. But net-net, we do feel good about auto being our best performing end market here in 2Q and for the full year '24."
},
{
"speaker": "Vincent Roche",
"content": "All right. Thank you, CJ. Thanks, everyone, for joining our call this morning. A copy of the transcript will be available on the website. Thanks for joining us, and have a great rest of the day."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's Analog Devices conference call. You may now disconnect."
}
] |
adm | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to ADM Fourth Quarter 2024 Earnings Conference Call. All lines have been placed on a listen-only mode to prevent any background noise. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin."
},
{
"speaker": "Megan Britt",
"content": "Welcome to the fourth quarter earnings conference call for ADM. Our prepared remarks today will be led by Juan Luciano, Chair of the Board and Chief Executive Officer; and Monish Patolawala, our EVP and Chief Financial Officer. We have prepared presentation slides to supplement our remarks on the call today, which are posted on the Investor Relations section of the ADM website and through the link to our webcast. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to numerous risks and uncertainties. ADM has provided additional information in its reports on filed with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation and the materials. Unless otherwise required by law, ADM assumes no obligation to update any forward-looking statements due to new information or future events. In addition, during today's call, we will refer to certain non-GAAP or adjusted financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are available on our earnings press release and presentation slides, which can be found in the Investor Relations section of the ADM website. I'll now turn the call over to Juan."
},
{
"speaker": "Juan Luciano",
"content": "Thank you, Megan. Hello, and welcome to all of who have joined the call. Please turn to slide four where we have captured our fourth quarter and full-year performance highlights. Today, ADM reported fourth quarter adjusted earnings per share of $1.14, and full-year adjusted earnings per share of $4.74, in line with the midpoint of our guidance for the full-year. Total segment operating profit was $1.1 billion for the fourth quarter and $4.2 billion for the full-year. Our trailing four-quarter adjusted ROIC was 8.3%. And cash flow from operations before working capital changes was $3.3 billion. Though 2024 presented a variety of challenges, our diligent focus on improving operation has made a positive impact across the network. We achieved strong crush volumes in canola and rapeseed, as well as our -- in our LATAM region. We made progress in addressing challenges in North America in soy assets, reducing unplanned downtime, and improving crush volumes in the month of December. We successfully ramped up run rates to meet demand at our Spiritwood facility over the course of 2024. We achieved a strong year in Starches & Sweeteners, where improved plant performance led to 3% higher production volume year-over-year, helping several product lines in our North America business set operating profit records. We made progress in addressing demand fulfillment challenges in EMEA flavors, while successfully integrating two new flavors acquisitions announced in early 2024. We improved our safety record significantly with a more than 35% year-over-year reduction in Tier 1 and 2 process safety incidents across our global network. In addition, we advanced key innovation initiatives in areas such as biosolutions and health & wellness, continuing to support growing customer demand in these parts of the business. And through this, we were able to maintain a strong balance sheet to ensure continued investment in the business and return of cash to shareholders and earlier today we announced an increase in our quarterly dividend making our 93rd consecutive year of uninterrupted dividends. As we wrap up 2024, we are encouraged that we're gaining operational momentum and we see opportunities to drive additional value. But we also recognize that the external environment continues to pose uncertainties and challenges. Please turn to slide five. We've entered 2025 knowing that we need to remain agile to manage through shifts in both trade and regulatory policy around the world along with the related impacts on geographic supply and demand. With a global asset base and constantly evolving product innovation, our team is prepared to pivot as needed to support the resiliency of the Ag, food, energy and industrial sectors we serve. We're taking these factors into account as we define our business priorities for 2025 with an emphasis on continuing to improve in the areas we control. First, we are focused on execution and cost management. Having made progress on the issues that impacted North American soy operations, we are applying that experience to the broader global network to drive further operational improvement and cost reductions. Similarly, we are applying what we learned from addressing demand fulfillment challenges in EMEA flavors to drive improvements in similarly challenged areas such as pet nutrition. We're actively managing our sourcing efforts to take advantage of lower pricing in many of our core input costs such as chemicals and energy. This cost agenda has also supported realigning our focus on data analytics to identify and assess new savings opportunities quickly. We're aggressively managing our SG&A and corporate cost as we make shifts in the business portfolio and lean into our strengthening digital capabilities. We have been diligent in finding ways to prioritize our own organization's work which has highlighted opportunities to eliminate non-critical third-party spend and structurally align our organization against our most critical efforts. As part of this prioritization effort, we announced that we're taking targeted action across both business and corporate functions to reduce approximately 600 to 700 roles including approximately 150 unfilled positions. Decisions impacting our team members are never easy to make and we are ensuring these colleagues are receiving transition support and an opportunity to apply for other critical roles within the company. In total, we anticipate the result of these cost actions to deliver in the range of $500 million to $750 million over the next three to five years with $200 million to $300 million in 2025. In conjunction with improving our cost position, our second focus is on strategic simplification. As a company that has grown substantially over the past decade, we are continually evaluating how our portfolio balances the evolving needs of our customers, our expectations to achieve our returns objectives, and our ability to be the most efficient operators of each part of the business. Both the current external environment and our performance in specific business segments and geographies over the past few years have highlighted additional opportunities to strategically assess how we are focusing our operational capabilities. With this, we are considering a phased approach to areas of potential simplification looking at our business through a variety of lenses with a particular focus on places where we see a history of performance challenges, deteriorating demand and or excess capacity that do not have a clear path to improvement, assets that may require capital investment that does not meet our expected returns objectives, opportunities for targeted synergy acceleration including potential closures and divestiture where we see an overlapping capabilities and asset footprint, determining who is the best owner/operator for assets that might not be assessed as critical to ADM's future growth trajectory. And along with these, we are ensuring our organization, both our colleagues and strategic partners, are aligned and focused on the most critical sources of value. We have currently identified a pipeline of approximately $2 billion in portfolio opportunities. And we will execute on this over time with the objective of maximizing value for ADM shareholders. Please turn to slide six, where we will talk about two more areas of focus in 2025 associated with capital management. First, as we look at the strategic growth opportunities, we will continue to invest in value drivers. Our strategy continues to be based on the balance of both productivity and innovation, And growth-oriented organic investment remains part of that equation. We've highlighted areas where investments have been paying off over the past year, from our modernization and digitization efforts across our facilities, to the ramp-up of additional capacities such as Spiritwood to support renewable diesel demand, to the global partnerships we have announced in regen ag, supporting farmers' resiliency. All of these represent targeted areas where our business segments are evolving with our customers and finding ways to deliver a strong return on our investments. Looking now to 2025 and beyond, we will continue to make targeted investments in part of the portfolio where we can drive further growth and differentiation, whether that's continuing plant digitization and upgrading our equipment to enhance operating leverage, expanding destination marketing volumes in targeted markets, continuing to build out our decarbonization solution portfolio, or supporting the continued evolution of the biofuels and energy sector. Investments in areas such as biosolutions, destination marketing, and biotics have helped us to drive double-digit growth and serves as a model for new investments. The portfolio above represents proven winners that are not only organically improving ADM, but also helping us establish foundations for the next wave of growth. We will also continue to return cash to shareholders through our traditional channels. In 2024, we kept our focus on returning capital to shareholders through repurchases and dividends, all while maintaining our leverage ratio at our desired target. We have extended our existing share repurchase program by 100 million shares, which we will approach opportunistically and to address dilution. We've announced another dividend increase, continuing the cycle of annual increases for over 50 consecutive years. And through this, we expect to maintain a leverage ratio of approximately 2.0 times. To summarize, looking across the focus areas for 2025, we are committed to continuing to improving the areas we control, and we feel confident that this will allow ADM to deal with external uncertainties and challenges while positioning the company for long-term success. Our team has managed our business through multiple challenging windows of time over nearly 125 years. And I fully expect us to rise to the occasion again in 2025. With that, I will hand it over to Monish to share a deeper dive on 2024 financial results and our 2025 outlook."
},
{
"speaker": "Monish Patolawala",
"content": "Thank you, Juan. Please turn to slide seven. Before jumping into segment performance, let me quickly recap some of the financial highlights for the fourth quarter and full-year 2024. While the fourth quarter played out largely as expected, we experienced negative pressure from market conditions later in December. For the full-year, we finished within our previously guided adjusted earnings per share range. The team remained focused on key self-help actions to finish the year and enter into 2025 on a stronger footing. Now, transitioning into highlights on segment performance and starting with AS&O. To start, let me provide some perspective on the broader market environment and the dynamics that shaped the fourth quarter. The operating landscape was challenging in the fourth quarter, with biofuel and trade policy uncertainty at the forefront. Ample global supplies, higher crush rates from Argentina, and uncertainty in biofuel and trade policy negatively impacted the crush environment. We also experienced high manufacturing costs. As a result, soybean and canola crush execution margins were approximately $10 per ton and $20 per ton lower respectively versus the prior period. Also included in the fourth quarter results for our crushing subsegment were $52 million of insurance proceeds related to the partial settlement of the Decatur East and Decatur West insurance claims. Increased pretreatment capacity at renewable diesel facilities as well as the continued elevated import levels of used cooking oil also weighed on both biodiesel and refining margins during the quarter. From a food oil perspective, we continue to experience softer demand from customers as they looked to cut costs. The origination environment was supportive in North America as the logistical challenges related to the U.S. river level eased compared to the prior year. Overall, against this backdrop, AS&O segment operating profit for the fourth quarter was $644 million, down 32% compared to the prior year period. For the full-year, AS&O's segment operating profit for the fourth quarter was $644 million down 32% compared to the prior year period. For the full-year AS&O segment operating profit of $2.4 billion was 40% lower versus the prior year. Looking at subsegment performance for the full-year, Ag Services' subsegment operating profit of $715 million was 39% lower versus the prior year, driven primarily by lower South American origination volumes and margins, in part due to industry take or pay contracts. The stabilization of trade flows also led to fewer opportunities in our global trade business. Crushing subsegment operating profit of $844 million was 35% lower versus the prior year as ample global supplies drove more balanced supply and demand conditions, which negatively impacted margins throughout the year. Executed crush margins were approximately $10 per ton lower versus the prior year in soybean and approximately $15 per ton lower in canola versus the prior year. There were net negative timing impacts of approximately $165 million year-over-year. The full-year also included $76 million of insurance proceeds for the partial settlement of the Decatur East and Decatur West claims related to the incidents in 2023. Refined products and other subsegment operating profit of $552 million was 58% lower compared to the prior year as increased pretreatment capacity at renewable diesel facilities, higher imports of used cooking oil, aggressive competition among food oil suppliers to serve customer demand, and biofuel policy uncertainty negatively impacted margins. There were net negative timing impacts of approximately $430 million year-over-year. Equity earnings from the company's investment in Wilmar was $336 million for the full-year, 11% higher compared to the prior year. Turning to slide eight, carbohydrate solutions unfolded as expected in the fourth quarter as operating profit was largely in line with the prior year. The results reflected robust demand for ethanol; however, higher industry production drove a lower margin environment. Results also reflected strong North American starches and sweeteners performance, as well as $37 million of insurance proceeds related to both the partial settlement of the Decatur East and Decatur West insurance claims. For the full-year 2024, carbohydrate solution segment operating profit of $1.4 billion was flat compared to the prior year. Starches and sweeteners subsegment operating profit of $1.3 billion was slightly higher compared to the prior year, as strong volumes and margins in North America were offset by weaker co-product values and lower margins in EMEA and ethanol. The full-year also included $84 million of insurance proceeds for the partial settlement of the Decatur East and Decatur West claims related to the incidents in 2023. Vantage Corn Processes subsegment Operating profit of $33 million was 28% lower compared to the prior year as lower margins due to the higher industry production more than offset robust demand for ethanol exports. Turning to slide nine, in the fourth quarter in the nutrition segment, weaker consumer demand and ongoing headwinds from unplanned downtime at Decatur East drove lower organic revenues. Operating profit was $88 million in the fourth quarter, higher year-over-year due to improved mix, lapping the negative non-recurring items in the prior year and insurance recoveries of $46 million related to the partial settlement of the Decatur East insurance claim. The quarter also included a negative impact due to higher cost of goods sold associated with the termination of an unfavorable supply agreement. Fully on nutrition revenues was $7.3 billion up 2% compared to the prior year. On an organic basis, revenue was down 3%. Human nutrition revenue was roughly flat organically as headwinds related to the unplanned downtime and down time at Decatur East and texturants pricing offset improved mix and volumes in flavors and health and wealth. Animal nutrition revenue declined due to unfavorable mix, negative currency impacts in Brazil and lower volumes due to demand fulfillment challenges. Full-year nutrition segment operating profit of $386 million was 10% lower versus the prior year. Human nutrition subsegment operating profit of $327 million was 22% lower compared to the prior year, primarily driven by unplanned downtime at Decatur East and higher manufacturing costs, partially offset by improved performance in the health and wellness business, favorable mix in the flavors business, and M&A contributions. The human nutrition subsegment full-year results also included $71 million of insurance proceeds for the partial settlement of the Decatur East claim related to an incident in 2023. Animal nutrition subsegment operating profit of $59 million was higher than the prior year due to higher margins supported by cost optimization actions to improve mix and an increase in volume. Please turn to slide 10. In 2024, the company generated cash flow from operations before working capital of approximately $3.3 billion, down 30% relative to the prior year due to lower total segment operating profit. Despite the decline, solid cash generation supported our ability to invest in our business and return excess cash to shareholders. In 2024, the company returned $3.3 billion in the form of dividends and share repurchases allocated $1.6 billion to capital expenditures to support the reliability of our assets and cost efficiencies, and approximately $1 billion to M&A announced in 2023 and completed in January 2024. Our strong capital structure remains a critical differentiator for the company. We will continue to seek opportunities to further strengthen our balance sheet to provide us financial flexibility to organically invest in the business to enhance returns and create long-term value. As Juan mentioned, targeted portfolio simplification actions, including consolidation and divestitures, will help align our focus on value creation. At the same time, we remain committed to returning cash to shareholders and will look to offset dilution and opportunistically seek share repurchases. We recently announced an increase in our quarterly dividend as well as an extension of our share repurchase program which is up to an additional 100 million shares over the next five-year period. Please turn to slide 11. We have already touched on some of the external market dynamics that we navigated in December, and several of these dynamics are expected to persist and create pressure on our first-half results for 2025, particularly for our AS&O segment. These include market headwinds related to U.S. biofuel policy uncertainty that had negatively impacted U.S. vegetable oil demand and biodiesel margins, higher global soybean stock levels and an increase in Argentinian crush rates, which have pressured global soybean meal values, and trade policy uncertainty with Canada and China, which has driven volatility for canola crush margins. Taken together, these factors are driving significantly lower meal and vegetable oil values, which is reflected by replacement crush margins in North America near $40 per metric ton for soybean and $50 per metric ton for canola. In both cases, these are well below the levels that we experienced in the first-half of last year. As we look to the second-half of 2025, we see signs that make us optimistic about margin improvement over the course of the year. One clear indication is board crush value signaling a carry in the market in the second-half. Additionally, as we progress through the year, we expect policy uncertainty to clear and strong fundamentals to support better crush and biodiesel margins. In particular, we expect clarity on 45Z guidance to support strong U.S. demand for crop-based vegetable oil. We also expect expansion of global biofuels policy to support global vegetable oil demand. Key examples include Brazil with increases in biodiesel mandates and the newly implemented SAF mandates in Europe. Lastly, we expect improvement in the livestock sector to support robust meal demand. Overall, with the market set up into 2025, we are focused on operational improvements and accelerating cost savings to partially mitigate the less favorable market conditions and be in an excellent position to capture opportunities in the second-half. Turning to slide 12, we have provided details that support our 2025 outlook for each segment for the first quarter and the full-year. Starting with Ag services and oil sales, in the first quarter, we expect segment operating profits to be down approximately 50% relative to the prior year period, led by declines in crushing and RPO. On crushing, we anticipate both soybean and canola execution crush margins to be significantly lower than the prior year period. In RPO, lower biodiesel margins are expected to drive significantly lower operating profit for the subsegment in the first quarter compared to the prior year period. For the full-year, we expect AS&O segment operating profit to be below to similar with 2024. Operational improvement should support higher volumes and lower manufacturing costs, which will partially offset the impact of lower margins for the segment. For the full-year, we expect soybean crush execution margins to range from $45 to $55 per ton, down approximately $5 per ton at the midpoint versus the prior year. We expect canola crush execution margins to range from $50 to $70 per ton, down approximately $20 per ton at the midpoint compared to the prior year. For RPO, we expect operating profit to be down significantly compared to the prior year. We expect insurance recoveries related to the Decatur East claim of $25 million compared to the total recoveries of $76 million in 2024. In carbohydrate solutions for the first quarter, we expect segment operating profit to be low by approximately 5% to 15% compared to the prior year period. Strong margins and volumes in North American starches and sweeteners are likely to be offset by lower results in the EMEA region as higher corn costs and increased competition negatively impact margins. In ethanol, robust export demand is likely to support strong volumes. However, higher industry run rates are expected to result in break-even ethanol EBITDA margins. For the full-year, we expect lower carbohydrate solution segment operating profit relative to the prior year period, as strong volumes and margins in North America expected to be more than offset by margin moderation in EMEA and ethanol. For the year, we anticipate ethanol EBITDA margins to be in the range of $0.05 to $0.10, down approximately $0.10 at the midpoint compared to the prior year. We expect insurance recovery of approximately $10 million compared to the insurance recovery of $84 million in 2024. In nutrition, we expect first quarter operating profit to be down 50% compared to the prior year period. We expect to face higher raw material costs and negative impacts associated with continued downtime at Decatur East. We also expect lower demand for plant based protein, higher insurance costs and increased competition in texturants to drive lower margins in the segment. Notably, excluding the effects of $46 million of insurance proceeds we received in the fourth quarter of 2024, we expect Nutrition operating profit to be approximately flat sequentially in the first quarter. For the full-year, we anticipate Nutrition operating profit to be higher compared to the prior year with low to mid-single-digit revenue growth led by our Flavors business. Strong performance from recent acquisitions and improved supply chain execution is expected to support increased volume and an improvement in cost in human nutrition, helping to offset the headwinds associated with the ramp-up of operations at Decatur East. In animal nutrition, we anticipate continued mix benefits from cost optimization actions as well as an improvement in profitability of our Pet business. We expect insurance recovery of approximately $25 million compared to insurance recovery of $71 million in 2024. Now looking at the consolidated outlook on slide 13, earlier today, we announced that we expect adjusted earnings per share to be between $4 to $4.75 per share. In considering this range, it is important to keep in mind the following: We expect lower margins in AS&O and carb sol to create a material headwind. Our focus on improved execution and cost should produce $200 million to $300 million of cost out, which includes the benefit of lower manufacturing and SG&A costs. We expect to reverse the negative take or pay impact in Ag Services from last year. We also anticipate less insurance proceeds in 2025. We currently expect approximately $60 million in 2025, with approximately 60% coming from reinsurance. This is compared to total insurance recoveries of $231 million in 2024 with approximately $133 million coming from reinsurance in 2024. Looking at our other guidance metrics, we anticipate corporate costs to be within the range of $1.7 billion to $1.8 billion. We expect the benefit of cost actions and a decline in net interest expense in corporate to be more than offset by the elevated legal costs and the reversal of performance based reduction in incentive compensation relative to 2024. In other, we expect lower results in ADMIS compared to the prior year due to lower interest rates. We expect capital expenditures to be in the range of $1.5 billion to $1.7 billion and we expect D&A to be approximately $1.2 billion. We expect our effective tax rate to be higher in 2025 in the range of 21% to 23% due to the sunset of the biodiesel tax credit, a shift in geographic mix of earnings and an expansion in the global minimum tax. Lastly, we expect diluted weighted average shares outstanding to be approximately 483 million shares and our leverage ratio to be approximately 2 for the full-year. To conclude, I want to take a moment to thank our ADM colleagues for their focus, adaptability and contributions through the close of 2024. These organizational efforts have been critical in driving progress and meeting challenges head on. As we navigate 2025, our focus will remain on what is within our control. A full commitment to remediating the material weakness and making strides to strengthen our internal controls, driving execution to improve operational performance and lower costs while sustaining functional excellence unlocking additional capital to drive value and position the company for long-term success. These efforts position us in our ability to navigate the current dynamic environment and reinforce our confidence in delivering on our commitment. Before I turn it back to Juan, I wanted to briefly mention a leadership transition we announced last week and that officially will take effect on March 1. Carrie Nichol is joining us as our new Vice President and Chief Accounting Officer. She joined us from Cargill, where she served as Senior Vice President, Chief Accounting Officer and Global Process Leader. I am excited to make this important addition to our leadership team, and I look forward to working with her. Back to you, Juan."
},
{
"speaker": "Juan Luciano",
"content": "Thanks, Monish. I'll briefly close by recapping our focus as we continue the path into 2025. With the uncertainty we've noticed in the external environment, ADM is prioritizing an internal focus on the areas we can best control. While administering this self-help we'll remain agile and ready for opportunities that may present themselves along the way. Our focus on execution and cost management will drive savings to the bottom line while ensuring that we're managing our assets and overall network as effectively as possible. Our focus on strategic simplification will deliver opportunities to optimize our portfolio and organization around those areas that deliver strongest returns and where we are the strongest operators. Our focus on strategic growth will allow us to organically invest in proven winners while also ensuring our business are ready for the future. And our focus on capital discipline will position us to continue the return of cash to shareholders through dividends and selective share repurchases. We are confident that this equation sets ADM up for success in 2025 and ensures we have necessary optionality in both the short and medium term while keeping our eyes on longer term opportunities ahead. With that, we'll take your questions now. Operator, please open the line."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Our first question for today comes from Tom Palmer of Citi. Your line is now open. Please go ahead."
},
{
"speaker": "Tom Palmer",
"content": "Good morning, and thanks for the question."
},
{
"speaker": "Juan Luciano",
"content": "Good morning, Tom."
},
{
"speaker": "Tom Palmer",
"content": "Just on the nutrition segment, I wanted to make sure I understood the expected profit recovery. It implies a pretty big inflection as the year progresses. You noted 1Q has some maybe heightened headwinds. It sounds like at least for the second quarter, I wasn't sure if it was second quarter or for the full-year, the start up at Decatur's noted as a headwind. And then, you've got the insurance headwind, especially in the second-half. So, just trying to understand what really drives that inflection. Is it the belief that end markets get better? Is this cost savings plan maybe more concentrated in this part of the business? Thanks."
},
{
"speaker": "Juan Luciano",
"content": "Yes. Thank you, Tom, for the question. Listen, nutrition has a big self-help story inside themselves as we have in ADM of course. But I think the main issue for Nutrition is you need to think about like three different buckets. There is one bucket that is the Decaturist plant, which is Specialty Ingredients, that is a big headwind and until we can bring the plant back that will continue to be. So, that is going to happen in the first quarter. Hopefully the plant will be back in the second quarter we expect, and that will naturally bring an improvement to the results. The other bucket is a bucket that it continues to go very well, which is, if you think about flavors and if you think about biotics, those businesses are going very well. They are growing. They have grown 7% and 10% respectively in revenue in 2024. So that's going to continue and that's basically execution of their pipeline, and their pipeline is very robust and very good. And I would say, the third bucket is you have this steady improvement month-over-month, quarter-after-quarter of animal nutrition, which is not a revenue story, but it's a margin improvement story. So, you have three different things, and when you put them altogether, we see a strong recovery in the last-half of the year for nutrition."
},
{
"speaker": "Monish Patolawala",
"content": "Tom, just to add, and I know you already picked it up, but just for math, when you look at it sequentially, so you're right, Q1 starts softer. Sequentially, after adjusting for the insurance recovery, which we have $46 million, we expect those results to be pretty much in line, Q1 equals Q4. And as Juan mentioned, the manufacturing cost, all the self-help starts kicking in, in the second quarter to fourth quarter."
},
{
"speaker": "Tom Palmer",
"content": "Understood. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Andrew Strelzik of BMO. Your line is now open. Please go ahead."
},
{
"speaker": "Andrew Strelzik",
"content": "Hey, good morning. Thanks for taking the question. I wanted to ask now that we've got the -- hey, how are you? I wanted to ask about your view on vegetable oil demand, soybean oil demand in particular. Now that we have the 45Z guidance kind of behind us to a certain extent and the imported UCO that's not going to qualify for tax credits. In kind of your first-half, back-half, a summary there slide, you gave what I would say is a reasonably constructive outlook for vegetable oil demanded. So I guess, I'm just curious for how you think about the puts and the takes around that because I know there's a lot of concern in the market. And then, kind of subsequent to that, as you think about all the uncertainty that's impacting the first quarter, is there a way to think about kind of the first-half, back half, earnings split relative to what is typical for you guys? Thanks."
},
{
"speaker": "Juan Luciano",
"content": "Yes, thank you, Andrew. A lot to unpack there, so yes, we received guidance from 45Z in January and I think it was constructive, but it's still a lot is in the air. We still need to get finalized that guidance. Probably, it's not going to happen until the end of Q1 and by that time we might have sold already Q2. So we have to see how that evolves. So we have to be cautious with that. On the other hand, when you do the math that probably implies an extra maybe 0.5 million tons of oil demand by Yuko that's not going to qualify for this. Our team anticipates that soybean oil share will be up from 35% to 40% and maybe Yuko down from 20% to 14%. So, I think that this is a year in which right now the Ag Services and Oilseeds Industry is trying to digest this extra capacity, if you will, extra production because we have North America, we have Brazil and we have Argentina producing -- crushing a lot and also this big uncertainty not only on tariffs for imported products, but also the policy uncertainty around biofuels. We think that as these policy uncertainties start to clear through the year, we're going to see margins improving and you can see that in the current in the market for crush going forward. We are excited about the manufacturing improvements we're going to have and we are excited about the fundamental demand that when these clouds of uncertainty regulatory will clear, you will see that the livestock area is very strong and soybean meal continues to be the most beneficial feeding material, so that's maximizing the rations at the moment. So, USDA is thinking meal growth probably 5.5%, maybe we have even some upside to that number potentially. And then you have this area of all the mandates that are coming around the world. I think Monish referred before in his previous remark about SAF in Europe, but also it's Indonesia, also it's Brazil increasing their biofuels mandate. So and when we clear 45Z, we're going to have that extra demand from the U.S. So, we see a first-half, second-half different pattern than other years and very hard to quantify what else on one and the other, because it will depend more on government and clarifying the regulatory environment, which we can only adjust to, but we cannot manage."
},
{
"speaker": "Andrew Strelzik",
"content": "Great. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Ben Theurer of Barclays. Your line is now open. Please go ahead."
},
{
"speaker": "Ben Theurer",
"content": "Perfect. Thank you very much and good morning. Just wanted to follow-up on your guidance cadence for Ag Service and Oilseeds, similar to what Tom had on Nutrition. But as we look at it, obviously, Q1 is very tough comp and you already indicated that to be 50% down. But then in order to get to just slightly below 25 levels as your guidance indicates, that would mean that 2Q onwards; we should see improving trends on a year-over-year basis. And I just would like to understand if you can help us reconcile that with lower insurance proceeds, but then at the same time you assume canola and soybean crush to be lower for the year? So, I just wanted to understand what is else in there that helps us to get those profits in line to below versus '24 with such a tough start in 1Q?"
},
{
"speaker": "Juan Luciano",
"content": "Yes, I think the -- then -- part of the tough start in the Q is because although you see some canola margins maybe rebounded recently, when we put our book, we put our book at lower numbers, because we put itthere in Q4. So, maybe our Q1 is even lower than maybe what current conditions may indicate. When we think about crush margins approximately around $40 in Q1, we are expecting full-year crush margins in the range of $45 to $55 per ton for soy. That's about $5 lower than the average of last year, and canola $50 to %70 that's probably 20 bucks lower than last year. And again, you have to include here all the improvements that we expected in manufacturing for the business. If you recall, last year we were doing a lot of project automation and digitization in the carb solutions area. And I mentioned before that we have run an experiment with the oil seed plant in Brazil. And now, we have the result of that experiment. And we are bringing some of those learning. So, we expect a lot of self-help coming to Ag services and oil seed. And we also expect destination marketing to grow our internal -- our direct farming procurements also to improve or to grow this year. So, -- and as I said, mill is going to be strong. And soybean oil should become significantly better in the second-half of the year so."
},
{
"speaker": "Monish Patolawala",
"content": "And Ben, I would add to Juan's comments. Just when you think about RPO or biofuels and what clarity that gets. That should allow the second-half to be far stronger than the first-half. And Juan already mentioned, when you look at the forward curve that carries is pretty strong in the second-half. And we are open for business quite a lot in the second-half. So, hopefully, we are positioned to take advantage--"
},
{
"speaker": "Juan Luciano",
"content": "To capture that, yes."
},
{
"speaker": "Monish Patolawala",
"content": "To capture as that goes, so, all that put together, why you start pretty soft in Q1. And then, you move yourself up. But you're right. It's a second-half story. And that's what we'll have to watch. Multiple factors -- as you're watching, we are watching the same. Whether it's weather whether it is the crop yields et cetera. So, as we know more, we'll keep you posted. But that's how we see it right now."
},
{
"speaker": "Juan Luciano",
"content": "One of the things also, Ben, as I forgot is we don't have the negative takeoff pace that we had last year in Brazil. So, we don't expect them this year. So, that would be a positive also for this year."
},
{
"speaker": "Ben Theurer",
"content": "Okay."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Heather Jones of Heather Jones Research. Your line is now open. Please go ahead."
},
{
"speaker": "Heather Jones",
"content": "Morning. Thanks for the question."
},
{
"speaker": "Juan Luciano",
"content": "Good morning, Heather."
},
{
"speaker": "Heather Jones",
"content": "I wanted to ask I -- good morning. Just wanted to first of all clarify that your guidance doesn't include any expected impact from tariffs, and then secondly, even if it doesn't include it, if you could just flesh out how that would look for you guys? How you have to be thinking about the impact from operations, particularly in North America? Thanks."
},
{
"speaker": "Juan Luciano",
"content": ""
},
{
"speaker": "a",
"content": "The China retaliatory measures doesn't include agricultural products at this point in time. So, it's difficult to know. I think in the short term, our teams are making sure that they are doing everything possible to avoid the short-term impact. I think medium-term and long-term trade flows seem to stabilize. But of course, we saw in 2018 how the corn imports from China were reduced by almost like 9 million tons from the U.S. Whether that's going to be something that's going to happen again or not, we'll have to see. Again, when you think about the power of ADM in terms of our origination in so many parts of the world and our destination marketing in so many parts of the world, it provides an optionality that few companies have in order to be able to capitalize on any environment. We don't know if net-net it will be a positive or a negative, but we will go through as we went in 2018."
},
{
"speaker": "Heather Jones",
"content": "Thanks so much."
},
{
"speaker": "Juan Luciano",
"content": "You're welcome."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Steven Haynes of Morgan Stanley. Your line is now open. Please go ahead."
},
{
"speaker": "Steven Haynes",
"content": "Hey, good morning, and thank you for taking my question. I wanted to come back to Argentina and their recent export tax revision across the soy crush complex, and if you could just briefly, I guess, talk about how you think that's going to impact your businesses and then how maybe you see that policy evolving after turn because I think that's kind of when they had framed the current revision period for. So, thank you."
},
{
"speaker": "Juan Luciano",
"content": "Yes, thank you for the question, Steven. So, let me -- this policy was implemented, as you said, effective until June 30. Very difficult what's going to happen after that, because it depends more on microeconomics of Argentina, so it will depend on many, many factors. I would say, until then, we haven't seen a big impact yet, mostly because they are still going through the harvest and through the planting. Second, because and I'm a farmer in Argentina, we're all worried about the weather in Argentina and the crop in certain places doesn't look terrific. We need rains that are expected to come, but those rains may just stabilize the yields but not being able to turn around that. And then, there are details about the implementation of this regulation that we need to be observing. Before all this, you needed to bring the dollars into Argentina 30 days after your shipment. Right now, if you want to qualify for this reduction in exports, you need to commit that you're going to bring the dollars of 95% of all the amount within 15 days of issuing the license. So, before you have 30 days from shipment, now you have to bring the money 15 days after you get the export license. So that's a big financing change in the thing that I don't know how it's going to impact. So we will have to see in April with the farmer's seeds on top of their harvest and they have from April to May to June to be able to play this how much it's going to be. At this point in time, we haven't felt much."
},
{
"speaker": "Steven Haynes",
"content": "Thank you."
},
{
"speaker": "Juan Luciano",
"content": "Welcome."
},
{
"speaker": "Operator",
"content": "Our next question comes from Pooran Sharma of Stephens. Your line is now open. Please go ahead."
},
{
"speaker": "Pooran Sharma",
"content": "Great. Thanks for the question. I wanted to see if we could unpack 45Z guidance a little bit. I know there's been, the situation's fluid. Biden provided interim guidance, but I think there's a little bit left with final guidance. To my understanding, the biofuels industry with interim guidance is able to accrue tax credits, but I think you need final guidance to have them paid out. So we've seen some smaller operators already seize shutter production. We just weren't sure about the larger producers. So I wanted to kind of get your take on 45Z guidance and then the State of the Union on the biofuels industry."
},
{
"speaker": "Juan Luciano",
"content": "Yes, let's see if I can provide some clarity to that. First of all, this is preliminary guidance and of course it needs to be ratified after the comment period and then we need to see what the Trump administration will decide on this. So this still needs to be played out. I would say with the removal the blenders tax credit, margins have been significantly impacted. And so, you may see some small producers that in the absence of all these, when they are not integrated and are isolated plants, they have shut down. We were expecting to do that. Our integrated facilities, all our facilities are integrated, have allowed us to continue to operate, although we see the impact in Q1 margins that we're going to have as we have Q4 margins. So the industry definitely needs to bring some margin back into it. More importantly, we need to bring clarity because lack of clarity has pulled people off the market. What we know is the administration of President Trump strongly supports the farmers and having an output for the farmers' production. And I think that in that sense, a strong biofuel policy, a strong export policy, a strong bio-solutions type of product are all going to be very supportive."
},
{
"speaker": "Pooran Sharma",
"content": "Great. I appreciate the color."
},
{
"speaker": "Juan Luciano",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Manav Gupta of UBS. The line is now open. Please go ahead."
},
{
"speaker": "Manav Gupta",
"content": "Good morning. I'm sorry I dropped off briefly. So if somebody has already asked this, I apologize. But Monish, your key priorities when you took over, your focus was one on operational rigor and second, ensuring there are no material weakness in financial reporting, and what's the progress been on those two fronts? Thank you."
},
{
"speaker": "Monish Patolawala",
"content": "Yes, thank you, Manav. I would say on both, and I'll start with the material weakness. As I said at the end of my prepared remarks, that is one item that we are very heavily focused on, which I am focused on. And the progress on that, and I'll start by just saying, when we talked to you three call, and you had asked the question, I said the company had enhanced the design and controls and documentation of inter-segment sales. So we have continued to do that this quarter. We have continued to provide a lot of training to our personnel around the reporting and recognition of inter-segment sales. We have enhanced and tested a lot of controls, and we need to continue to make sure that is sustained for a period of time before we can lift the material weakness. And that's what the teams are focused on. We also made an announcement where we've got Carrie Nichol who's joining us, the Chief Accounting Officer, who was from a similar role in Cargill. And I'm excited to have her on board and my partner to help me continue this journey that we have started on remediating our material weakness. To answer your question on operating rigor, you can see that we've made progress. In Juan's comments, you can hear that some of the items where we have done root cause in our manufacturing facilities have given yielded results. In December, we saw good outputs in some of our plants in North America. We also saw progress in EMEA, in our flavors business, in nutrition. And as a part of that whole thing, Manav, and as we look at the opportunities, Juan and I announced that we have a plan to get $500 million to $750 million of cost out over the next three to five years. It's going to come from multiple places. Number one is driving efficiencies in our manufacturing facilities. Number two is going after costs with our third parties. And number three is controlling SG&A and some of the actions we're going to take there. Adding on to that on the other side is the simplification agenda. So as we continue to drive portfolio simplification, we see an opportunity to continue to drive margin enhancement in there too. At some of these facilities, whether you talk about consolidations or targeted divestiture, should allow us also benefit in there. We are going to do all of this while at the same time battling a lot more around the inflationary environment, whether it's the energy complex, as well as labor inflation or general inflation that continues to stay. So, focused on it, Juan said it, I've said it, it's a big self-help agenda. We know the environment that we are going into 2025. And I think the team is quite confident that we can execute this cost-out plan that we have got over the next three to five years."
},
{
"speaker": "Manav Gupta",
"content": "Thank you so much for the update."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Salvator Tiano from Bank of America. Your line is now open. Your line is now open. Please go ahead."
},
{
"speaker": "Salvator Tiano",
"content": "Yes, thank you very much. I want to go back to nutrition specifically for Q4. So your commentary was pretty positive in that human nutrition had higher volume and pricing versus last year. But if we adjust for last year's write-down, I think you would have made 39 million human nutrition, whereas this year without the insurance, you would have made only 15 million. So it looks like the performance even with M&A was quite worse, so I cannot reconcile the two. Can you provide a little bit more color on why margins were so lower and perhaps quantify the impact of this contract cancellation in Q4?"
},
{
"speaker": "Monish Patolawala",
"content": "Yes, I think when you look at it, yes, we've made progress on the growth in human nutrition, but the biggest piece that still continues to be a headwind is the specialty ingredients business. When you look at the continued inefficiencies from the downtime at Decatur East, the higher insurance premiums that we are seeing, as well as the lower pricing for texturants and demand, all put together is where we landed up for the fourth quarter. And going into 2025, we look at the same and say, when you look at Q1 and we say it's sequentially flat when you adjust for the insurance proceeds, the biggest driver there again on a year-over-year basis is the specialty ingredients. And so getting that plant back online in Q2 2025 and then doing all the self-help actions that Ian and his team are doing in nutrition will help us continue to grow nutrition's P&L in 2025."
},
{
"speaker": "Salvator Tiano",
"content": "Thank you. Just to understand though here, the fire indicator happened I think August or September last year, meaning that you should have lapsed, at least in my understanding, you should have lapsed the inefficiencies and the problems already in Q4. So that shouldn't have been an issue versus Q4 of '24 or it shouldn't be an issue in Q1 '25 versus what you posted this year?"
},
{
"speaker": "Monish Patolawala",
"content": "Well, we had inventory going into Q4 of '23, and that allowed to reduce some of the impact that was there on a year-over-year basis. But also prices and the kind of tech spend that have come down, yes."
},
{
"speaker": "Salvator Tiano",
"content": "Okay, perfect. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. Due to time, we'll take no further questions, so I'll hand back to Megan Britt for any further remarks."
},
{
"speaker": "Megan Britt",
"content": "Thank you so much for joining the call today. If you have additional questions, please feel free to reach out directly to me. Have a wonderful rest of your day."
},
{
"speaker": "Operator",
"content": "Thank you all for joining today's call. You may now disconnect your lines."
}
] |
adm | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning and welcome to ADM's Third Quarter 2024 Earnings Conference Call. All lines have been placed on a listen-only mode to prevent any background noise. As a reminder, this conference call is being recorded. I’d now like to introduce your host for today’s call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin."
},
{
"speaker": "Megan Britt",
"content": "Hello and welcome to the third quarter earnings call for ADM. Our prepared remarks today will be led by Juan Luciano, Chair of the Board and Chief Executive Officer; and Monish Patolawala, our EVP and Chief Financial Officer. We have prepared presentation slides to supplement our remarks on the call today, which are posted on the investor relations sections of the ADM website and through the link to our webcast. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to numerous risks and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation and the materials. To the extent permitted by law, ADM assumes no obligation to update any forward-looking statements due to new information or future events. In addition, during today's call, we will refer to certain non-GAAP or adjusted financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are available on our earnings press release and presentation slides, which can be found in the investor relations section of the ADM website. Please turn to slide four. I'll now turn the call over to Juan."
},
{
"speaker": "Juan Luciano",
"content": "Thank you, Megan. Hello and welcome to all who have joined the call. We sincerely appreciate your patience as we work expeditiously to amend the company's fiscal year 2023 Form 10-K and Form 10-Qs for the first and second quarters of 2024. We are pleased to now be able to share more context about our 2024 year-to-date financial results and our outlook. Even that we are holding this call later than usual, we're also in a position to provide qualitative color on how the fourth quarter is progressing. To start, let's recap our financial results for the company. ADM reported third quarter adjusted earnings per share of $1.09 and a total segment operating profit of $1 billion. This brings adjusted earnings per share to $3.61 and our total segment operating profit to $3.2 billion year-to-date for 2024. Our trailing four-quarter adjusted ROIC was 8.8%. Although we made progress on several important initiatives in 2024, this results are not consistent with the high bar that we have set for our team. While we have seen a decline in our total segment operating profit and a decline in operating cash flow before working capital changes, due to lower net earnings relative to the prior year period, discipline management of our balance sheet continues to allow us to invest in our business and return cash to shareholders. In total, we have returned $3.1 billion to our shareholders with $744 million in the form of dividends and $2.3 billion in share repurchases year-to-date in 2024. Next slide, please. Entering 2024, we laid out key priorities for value creation based on the year we saw ahead of us. And as we moved into the fourth quarter, it's clear that certain expectations have not all play out as anticipated. The global commodity landscape has continued to shift. Stronger-than-expected supply has driven commodity prices down further than anticipated. Canola crash margins have been negatively impacted by regulatory uncertainty and higher seed prices. In addition, China has begun to increase local commodity production and has had a slower pace of demand recovery, negatively impacting the trade of certain commodities and uptake of animal nutrition solutions. We're also seeing the trailing effects of inflation in part of our business. Some new nutrition projects have been delayed as some customers look for opportunities to manage costs by simplifying their consumer offerings. We have also seen some softness in demand in other end markets such as pet treats and energy drinks where consumers are prioritizing their discretionary spending. The global regulatory environment has led to additional uncertainties. Programs such as EUDR and the U.S. producers tax credit are still not fully in place, which has left various stakeholders in the Ag supply-chain without the confidence of a clear path forward. Beyond these external factors creating downward pressure, we're also managing through a balance of both positive and challenging results across our own operational environment. In carbohydrate solutions, we've been able to improve production throughout the network, in part due to advancements in automation and digitization at the plant level, as well as by finding synergies across our milling network. We've seen similar improvements in our crush facilities in LatAm and EMEA, but this has been offset today by the fact that opportunities previously identified in some of our U.S. plants have been taking longer-than-expected to be completed. However, in October, we began to see improvements in unplanned downtime in our U.S. facilities. Nutrition has continued to manage through the downtime of our Decatur East facility, where our expected ramp up has been delayed from the end of 2024 to the first quarter of 2025 as safe restoration of operations is a top priority. And while the integration of our most recent Flavor acquisitions has driven positive results, we have experienced demand fulfillment issues due to the complexity of other integration efforts. We believe that our business is well-positioned to grow alongside enduring global trends such as the expansion of functional food and beverage alternatives, the replacement of petroleum-based products across multiple industries and the broader opportunity associated with decarbonization. As we look at the near-term in 2025, however, we anticipate that we could still be managing through a challenging cycle, and we have already begun taking necessary productivity actions with a clear focus on cost and cash management. This slide highlights several of the areas we have already taken action on in 2024, along with additional actions we are aggressively driving at the end of the year. As we manage through the current cycle, we've seen success in delivering expansion across strategic initiatives such as regen ag, BioSolutions and destination marketing, which achieved record volume handled in October, supporting supply and demand needs through increasing capacity. This is example in our Spiritwood facility, which has achieved near full run-rates in the month of October. And in ramping up the drive for execution excellence program, which has already begun to deliver toward our cost-saving goals. Moving forward, as we expand our focus on procurement and execution excellence, we believe that we can double this program's target cost savings over the next few years. In addition, the automation and digitization efforts that have already achieved millions in cost savings are being scoped and accelerated across the other plants in our footprint. Turning to Nutrition's recovery efforts. To-date we have strengthened our operational leadership, driven simplification and optimization opportunities and continued to expand our pipeline and win rates in part of the portfolio such as flavors. These efforts are now being supplemented to increase the pace of recovery. We have placed additional focus on demand generation, supply-chain improvement and rightsizing our production to better flex to the needs of the dynamic demand environment. And finally, from a strategic capital allocation perspective, we have already accelerated our return of cash to shareholders this year in the form of share repurchases and dividends. Going forward, we're being extremely prudent on focusing our attention on cash generation opportunities, while considering specific portfolio optimization efforts to simplify operations, enhance our focus and drive an improvement in ROIC. Along with all these actions, Monish joining as CFO has already brought new perspectives to the team. We are using his experience to help identify and accelerate paths for continuous recovery. With this, let me pass to Monish for a more detailed financial review. Monish?"
},
{
"speaker": "Monish Patolawala",
"content": "Thank you, Juan. First, I would like to take a moment to say how excited I am to be joining the ADM team at such an important point in the company's trajectory. While I've only been on the job for a few months, I have enjoyed the opportunity to personally engage with our teams and learn the company. I want to thank all my ADM colleagues for their warm welcome. Turning to Slide 6. On a year-to-date basis, AS&O segment operating profit of $1.8 billion was 42% lower versus the prior year period as ample supplies out of South America have driven lower commodity prices and margins across the segment. Ag services sub-segment operating profit of $461 was 52% lower versus the prior year, driven by lower South American origination margins and volumes, in part due to industry take-or-pay contracts. The stabilization of trade flows has also led to fewer opportunities in our global trade business, leading to lower results. Crushing sub-segment operating profit of $632 million was 30% lower versus the prior year period. Slower farmer selling and lower crush rates in Argentina, coupled with solid demand has supported soy crush margins leading to a year-to-date executed soy crush margin of approximately $50 per metric ton, which is lower, compared to the prior year. While year-to-date executed canola crush margins are lower by approximately $15 per ton, compared to the prior year, margins have moderated significantly in the second-half of the year so far, as higher seed prices and regulatory uncertainty drove lower margins. There were net negative timing impacts of approximately $120 million year-over-year. In the refined products and other sub segment, increased pre-treatment capacity at renewable diesel facilities and higher imports of used cooking oil has negatively impacted both refining and biodiesel margins, leading to sub-segment operating profit that was 58% lower versus the prior year. There were net negative timing impacts of approximately $360 million year-over-year. As we look forward, we anticipate AS&O fourth quarter results to be lower than the prior year quarter. The seasonal shift to our North American weighted footprint and strong North American crop should be supportive of volumes. But recent elevation margins are below the levels we expected when we put our guidance in place in November. In crushing, the ramp-up of our Spiritwood facility is expected to support high-single-digit volume improvement. However, we expect lower results due to lower soya and canola crush margins versus the prior year. The addition of new pre-treatment capacity has continued to weigh on margins within the RPO business and on the food oil side, margins for free-to-sell opportunities have been under pressure, due to increased competition. Based on the information available today, we also anticipate 100% reinsurance proceeds of approximately $50 million in the fourth quarter related to both Decatur West and East. We continue to monitor the impact of uncertainty related to regulation and trade flows on the operating environment as we look forward to the end of the year. Year-to-date, carbohydrate solutions segment operating profit of $1.1 billion in the year-to-date period was roughly in line with the prior year as lower margins in the EMEA region and ethanol were mostly offset by strong volumes and improved manufacturing costs. As we look forward, a strong North American corn supply and robust export demand is export expected to be supportive of VCP. However, North American ethanol production continues to outpace demand, driving lower margins. We expect to see solid demand and margins in North American starches and sweeteners as we finish the year. Wheat milling margins are expected to moderate from elevated prior-year levels. Based on information available today, we also anticipate 100% reinsured insurance proceeds in the fourth quarter related to both Decatur East and West incident of approximately $35 million. Taken together, we anticipate the carbohydrate solutions fourth quarter results to be in line with the prior year period. Year-to-date, revenues from nutrition were $5.6 billion, up 2%, compared to the prior year. On an organic basis, segment revenue was down 3%. Human nutrition was flat organically as headwinds related to Decatur East and texturants pricing offset growth in flavors and health and wellness. Animal nutrition revenue declined 5%, driven by unfavorable mix, negative currency impacts in Brazil and low volumes due to demand fulfillment challenges. Year-to-date nutrition sub-segment operating profit of $298 million was 32% lower versus the prior year. Human nutrition results of $265 million were 40% lower, compared to the prior year period, primarily driven by unplanned downtime at Decatur East. Animal nutrition results of $33 million were slightly higher, compared to the prior year, due to an improvement in margins. As we finish the year, we expect continued weak consumer demand, lower texturants prices and ongoing operational challenges to be a headwind. And as Juan previously mentioned, we now anticipate the start-up of our Decatur East facility to be delayed until the first quarter of 2025. We expect the impact of prolonged downtime at Decatur East to be partially offset by 100% reinsurance proceeds in the fourth quarter of approximately $50 million based on the information available today. We expect animal nutrition results in the fourth quarter to be better than the prior year with tailwinds from our turnaround efforts and as we continue to work through operational challenges in pet solutions. Taken together, we expect nutrition results for the fourth quarter likely lower than the third quarter of 2024, but to be higher than the prior year, which had negative impact of approximately $64 million in non-recurring items. Please turn to slide seven. Year-to-date in 2024 the company has generated cash flow from operations before working capital of approximately $2.3 billion, down relative to the same period last year, due to lower segment operating profit. Despite the decline, solid cash generation has supported our ability to invest in our business and return excess cash to shareholders. Year-to-date, the company has returned $3.1 billion in cash in the form of dividends and share repurchases. Allocated $1.1 billion to capital expenditures and nearly $1 billion to M&A announced in 2023 and completed in January 2024. Our capital structure continues to provide the financial flexibility to invest in our business and return capital to shareholders. We continue to see opportunities to drive enhanced cash generation through operating improvements both in our facilities and through better management of working capital. We believe investing in organic opportunities gives us the best return. While we will always look at opportunistic M&A as a way to enhance return, it is essential that we prioritize maximizing returns from the assets that we have already acquired and also ensuring that we are the best owners of all our assets. Now let's transition to a discussion of guidance for 2024 on slide eight. In early November, we announced that we lowered our full-year 2024 adjusted earnings per share guidance to the range of $4.50 per share to $5 per share. The lowering of our guide takes into account our year-to-date results and headwinds from slow market demand and internal operational challenges. Additionally, we now anticipate our corporate cost to be within the range of $1.7 billion to $1.8 billion, primarily due to lower incentive compensation and our corporate net interest expense to be in the range of $475 million to $525 million. We now expect capital expenditures to be approximately $1.5 billion. We are also increasing our effective tax-rate guidance to the range of 20% to 22%, due to the non-deductible impairment of Wilmar taken in the third quarter. Our expectations for our leverage ratio and D&A are unchanged. Let's turn to slide nine to close the call with a reflection on the key priorities that we are driving with our team to deliver improvement and enhance return. First, my top priority is ensuring integrity and accuracy in our internal controls and financial reporting. I echo Juan's earlier statement and add my particular thanks for the extraordinary efforts of our team to amend and file the restated financials for fiscal year 2023 Form 10-K and Form 10-Qs for the first and second quarters of 2024. We are continuing to focus on implementing enhancements to our internal controls to remediate the previously identified material weakness and are taking action to enhance the integrity and accuracy within internal controls and financial reporting related to intersegment sales. Among other things, the design and documentation of the execution of pricing and measurement and reporting controls for segment disclosure purposes and projected financial information used in impairment analysis have been enhanced and the testing of these controls will continue throughout the balance of the year. Further, training for relevant personnel on the measurement of intersegment sales and application of relevant accounting guidance to intersegment sales has been provided and remains ongoing. In the broader category of improving focus and execution, the team will remain adaptable and focus on items within our control. On the cost side, we are optimizing our cost structure and enhancing operational resilience initiatives. In this vein, we have the opportunity to create a more cohesive digital strategy. Today, we have invested in numerous efforts to improve our systems and enable a more digital footing for our business. However, we have the opportunity to connect these efforts to accelerate outcomes around how we serve our customers, operate our assets and run the enterprise, while also delivering structural cost improvement. Similarly, we have room in our portfolio and broader asset network to optimize through targeted divestitures or rationalization and we are evaluating numerous actions that we could take to improve our footprint performance and generate cash. We will also maintain a sharp focus on working capital management to further strengthen our cash position. Lastly, we'll remain disciplined in capital allocation, seeking opportunities to drive ROIC and enhance returns. I see maintaining our capital discipline as essential to value creation. We will work to ensure that we maintain a healthy balance sheet that continues to create strong cash flow and that we rigor investment opportunities appropriately by applying a stage-gated model to ensure that we are achieving key milestones and meeting our return objectives to continue to invest. In closing, I want to take a moment to thank our ADM colleagues for their hard work and dedication this quarter. I am optimistic that today we can successfully tackle the challenges and seize the opportunities as we continue to execute our strategy and focus on delivering value for our shareholders. With that, we look forward to taking your questions. Operator, please open the line for our first question."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] First question comes from Andrew Strelzik with BMO. Your line is open. Please go ahead."
},
{
"speaker": "Andrew Strelzik",
"content": "Hey, good morning. Thanks for taking the questions and I appreciate all the color you gave on the outlook and the strategy. I was hoping that you could help reconcile the decline in U.S. crush margins over the last several weeks. You have now a U.S. crush margin curve that's much lower in the nearby than in the spring, which is abnormal. You have soybean meal delivery certificates issued last week by some of the commercials, which I also believe is abnormal. So I guess the question is, what does all of this tell us about where crush margins are headed and how much visibility do you have on crush into next year compared to what you would typically have for this time of year? Thanks."
},
{
"speaker": "Juan Luciano",
"content": "Yes. Thank you, Andrew. As you said, board crash rallied steadily from the lows in Q3, but has come under pressure in November. And it's basically a combination of things. First of all, demand for the products have been very good. Demand for meal is good, demand for oil around the world is good. But you see during November, we have the Argentine farmers started to sell again. So we've seen higher crush rates in Argentina. There are high crush rates in Brazil and NOPA here in North America, all our plants have been running well, so we have high crush in October. When you combine that with the regulatory uncertainty now we have in the oil side, that has created the problems that we have. The U.S. is exporting oil, the U.S. is exporting mill, but there is more pressure in the system with more crush being put and less regulatory clarity. So that's why overall message, Andrew, is as we look forward here, we think that given the soft markets and the regulatory uncertainty, our focus in ADM is on the things that we can control on the double down on productivity, looking at all our efforts in trying to control cost and cash and certainly portfolio management. So that's kind of our priority for the year. The markets remain robust. Soybean meal is the most competitive feed out there. So demand is strong and oil is needed for the biofuels market and oil is needed for human consumption. So I think that when we clear the regulatory environment or regulatory uncertainty, if you will, I think you're going to see things normalizing a bit."
},
{
"speaker": "Andrew Strelzik",
"content": "Okay. And sorry, if I could just quickly follow up. Given all of the internal actions that you guys are focused on as you kind of navigate the cycle, and if I were to kind of exclude some of the insurance dynamics from this year and maybe from next year as well, do you think that this is kind of an earnings base from which you would expect those actions to drive earnings growth in 2025 or do you think about it as still kind of navigating through kind of a muddled environment as we get through the regulatory dynamics, how do you think about kind of this year and actions that you're taking in the ability to grow in '25? Thanks."
},
{
"speaker": "Juan Luciano",
"content": "Yes. I think it's important never to lose an opportunity to get yourself extra feet. So we are taking this decline in margins as an opportunity to review everything from ADM and accelerate all the decisions that were already ongoing. So I will, you know it's too early in the year. There are too many unknowns, Andrew, to especially on the regulatory front to make a forecast for the year. But we know that focusing on the things we can control continue to drive cash flows, that's an important thing for our shareholders and that will improve returns."
},
{
"speaker": "Monish Patolawala",
"content": "Andrew, I echo what Juan just said, it's back to the basics of cash cost and capital. And that's what we are focused on right now. Lot of opportunities head-down, get 2024 closed and we'll come back when we're ready to discuss 2025. But we know the environment is going to be soft and that's why the teams are controlling what they control."
},
{
"speaker": "Operator",
"content": "Our next question comes from Tom Palmer with Citi. Your line is open. Please go ahead."
},
{
"speaker": "Tom Palmer",
"content": "Good morning. Thanks for the question. I just wanted to enquire on the nutrition side of the business. We've seen some changes in terms of the animal nutrition business, I think from a cost-savings standpoint that's driven some improved profitability. What about on the human nutrition side? Is there just given some of the end-markets maybe haven't progressed the way you once anticipated thought to kind of resizing that business? And maybe how much of an opportunity might that be as we think about the coming year? Thanks."
},
{
"speaker": "Juan Luciano",
"content": "Yes, thank you, Tom, for the question. Listen, I think I will take it by pieces. If you take human nutrition, you have to separate. We have a big issue with the plant that is down. That plant is a significant cost. It was down for a full-year, now it's going to be down for the first quarter. And so that's an issue that is a little bit of extraordinary that we're fixing, and we thank all the engineers and everybody working expeditiously to bring it back safe. On the rest of the business is the flavors business and the health and wellness business, we continue to see opportunities. We've seen in the positive side, if you will, we've seen growth of flavors -- revenue flavors in Europe of about 7% like-for-like, so organic growth year-to-date. We have seen 5% in North America. These are not the growth rate that we were expected when we started the year because there has been some categories like energy drinks where although still growing, is growing at less -- at lower rates than we expected at the beginning of the year and our customers have expected at the beginning of the year. Some launches has been postponed, but still is a robust category and we still see growth. But as you said, we are adjusting a little bit our supply-chain to make sure we match the new realities. When you look at the other piece of human nutrition, which is health and wellness, the probiotics part, which is the part there that is the future, it is the growth part has grown so far 14% year-over-year on a revenue side, and even higher than that in operating profit side. So I think that there are good signs, but we continue to flex this. This is a year in which, as you understand, nutrition is not where we want them to be, and we are working hard to fix it. But there are on the customer side, there are positive signs that makes us believe that when we put some of these supply issues behind, we're going to see the results coming to the P&L in a bigger way."
},
{
"speaker": "Tom Palmer",
"content": "Okay. Thank you. And just on the capital allocation, it sounds like there was some mention in the prepared remarks of maybe some focus on discipline, but there was also some commentary maybe on the crush side about some unexpected downtime. Is there may be an elevated maintenance CapEx cycle needed in the crush operation to kind of get it to the operational levels that you desire? And if so, might we expect maybe less of a step-down in CapEx next year just given that or maybe I'm overstating it? A - Juan Luciano No, listen, CapEx for next year will be solid CapEx, if you will. We have many plants, we have grown the company and we need to make sure those plants stay in good shape. But also there are opportunities for automation and digitization that we are adding to that. If you look at the oilseeds plants, Europe and Latin America have been operating very, very well. We have a handful of plants in North America that have given us problems over the summer, and I'm happy to report that they are doing better in October, they are doing better in November. But we have some issues that took a little bit longer to fix than we thought and we put the resources to do so."
},
{
"speaker": "Operator",
"content": "Our next question comes from Ben Theurer with Barclays. Your line is open. Please go ahead."
},
{
"speaker": "Ben Theurer",
"content": "Yes, good morning, and thanks for taking question. Good morning. So just wanted to like kind of get a little bit maybe your sensitivities around the implied guidance for the fourth quarter and taking a little bit of an advantage that we're early in December and already two months have gone past. Clearly, if we look at it implied low-end versus high-end, it's very widespread? So maybe help us understand and frame a little bit what are the risks getting closer to the lower end, which would be implied a little less than $1 versus the higher piece closer to $140, just to kind of understand where we're shaking out and where you think things are going out considering that two months are in?"
},
{
"speaker": "Juan Luciano",
"content": "Yes. Thank you, Ben. So let me give you the puts and takes for the quarter and you can build it from there. I think in -- if you think about the grain business ag services, of course, this is the quarter in which the volumes come to North America for exports. And we see good volumes. China is buying for Q4, beans, Europe is buying corn for Q1. But we have -- although we have good volumes, we have not seen the margin expansion that maybe we have forecasted a couple of quarters or a couple of months ago. River logistics are good for December. We will have to monitor the weather for Q1, but so far so good. And calories in the market should help our interior assets. On a global trade perspective, volumes are strong and lower commodity prices are supporting feeding animals globally. So destination marketing margins are holding. On the crush side, I described before the decline in crush margins, you know, a lot of uncertainty about biofuels policy, of course. This margin compression could create timing depending on where prices are at the end of the year, we could see positive timing. So we will not be able to call that until we see the end of December. We have been selling our biodiesel book, but of course, it goes out to December. Unfortunately, with the lack of clarity over next year, you know, you could think that if we continue to crush at these levels, maybe oil inventories will climb and something we'll have to give for next -- for the first quarter. At this point, there is not a lot of margin for independent non-integrated plants to run in the first quarter. So you know, we may see a spike of RINs later in the quarter and we might have to maybe as industry slowdown crash in the first quarter. On a carb solutions perspective, it's kind of steady, if you will. Margins are good, volumes are good, manufacturing is operating well, so we get -- we are cranking on all the cost savings. We have implemented some of the automation projects that's given us benefits to that. So I would say we should see a little bit ethanol margins are always the variable here. They are slightly on the breakeven side. So hopefully, we finish the year strong there. And then on the nutrition side, we certainly, as Monish was saying in the outlook, we've seen improvements in animal nutrition, we've seen a balance of some revenue growth, but also some one-offs that we needed to address in the human side. So I will say better than last year, slightly lower than maybe the previous quarter, and we are putting all our efforts in finishing that plant, so we can have a 2025 cleaner of all those extra costs."
},
{
"speaker": "Monish Patolawala",
"content": "Just a couple more for you Ben is -- can I just add a couple more?"
},
{
"speaker": "Ben Theurer",
"content": "Yes, yes."
},
{
"speaker": "Monish Patolawala",
"content": "For insurance proceeds that is a partial settlement right now. If you add the three segments I gave you, in the fourth quarter, there is an assumption that we will get 100% reinsurance proceeds of $135 million. So that's the other variable. And then back on nutrition, what Juan said just for disclosure, currently based on where the team is seeing, we think with M&A, it's low-single-digit growth in the fourth quarter. And on an organic basis, it's low-single-digits negative growth. And so that's the other piece. I just wanted to add to what Juan said. Thank you."
},
{
"speaker": "Ben Theurer",
"content": "And to clarify, those insurance just similar as in the third quarter that will basically then be deducted in other, correct?"
},
{
"speaker": "Monish Patolawala",
"content": "No, these are all 100% reinsurance proceeds, Ben. So they will -- so our captive insurance has reinsurance cover. And so we expect to get $135 million as a partial settlement for the Decatur East. And this will continue into '25 and '26 as we -- yes, it's different than 3Q where the captive was paying for it. Now we are expecting reinsurance proceeds."
},
{
"speaker": "Ben Theurer",
"content": "Okay. Perfect. That explains a lot. Thank you."
},
{
"speaker": "Operator",
"content": "We now turn to Heather Jones with Heather Jones Research. Your line is open. Please go ahead."
},
{
"speaker": "Heather Jones",
"content": "Good morning. Thanks for the question."
},
{
"speaker": "Juan Luciano",
"content": "Good morning, Heather."
},
{
"speaker": "Heather Jones",
"content": "So you guys talked -- good morning. So you all have talked a lot about the challenging cycle we're in and as far as looking to '25, but wanted to get a sense of, I mean, what are some things that could be givebacks in '25. So I was just wondering if you could quantify how much take or pay hit you guys in '24? And then the cost impact of all the unplanned downtimes that presumably as you've gotten these plants running better, you should get back that's separate from the crush curve. So I was just wondering if you could first quantify those couple of things for me."
},
{
"speaker": "Juan Luciano",
"content": "Yes, I would say, I'm not sure I have all of them top of my head for the full year, Heather. But let me say the following. I agree with you. I think and on the take or pay, first of all, we learned our lesson. So we're going to act differently, I think as ourselves and you know maybe even the whole industry. I think also the weather in Brazil is very good. So we expect to have probably 170 million tons type of crop next year that will avoid these issues. I will say all these resets in 2025, so we still have very little exposure of our take or pay. But I don't have top of my head what was the whole thing. And then on the manufacturing side, we have issues mostly in the Q3, I would say. Some of the plans when we look at our capacity, when we were down, sometimes it was things like Paraguay because we didn't have margins, so we shut it down ourselves. And then sometimes it was Ukraine or other plants like that. We had a plant in Des Moines, Iowa that we were a little bit waiting for a permit, so we couldn't bring it back. So there are improvements there. I don't know if Monish you have some numbers in your head. I will hesitate to quantify them myself. But..."
},
{
"speaker": "Monish Patolawala",
"content": "Yes, so I would just on take or pay, Heather, it's year-to-date, it's approximately $40 million of impact. We'll have to see what 2025 brings and what the volume and what the revised take or pay contracts look like. And then on the downtime, again, it comes down to the teams are focused on trying to get that up. The cost has gone up per cost per ton, but I would not quantify that right now. I would just wait through as we get to, there should be upside as these plants start running, but I would not quantify because it's not like a systemic down of X over months, it's puts and takes of downtime."
},
{
"speaker": "Heather Jones",
"content": "Right."
},
{
"speaker": "Juan Luciano",
"content": "One thing, Heather, that you need to consider, sorry, in the manufacturing is we implemented our automation projects in the carb solutions business first because we run a pilot and it was good return. So we extended that. Now we have finished our first pilot in the oilseeds plant in one plant in Brazil, and the results are very encouraging. Based on those results, we might do the same thing than now that we did in automation in carb solutions into the oilseeds plant. That had given us improvements in not only yields, but also energy savings and you know, ex-same losses and things like that. So there is an upside there as well as we go into -- we're going to implement all of these in -- I think we have 15 projects going into 2025 for this. So I think that you should see that as a positive for us."
},
{
"speaker": "Monish Patolawala",
"content": "And Heather, I would add to Juan's piece on this is everyone looks at downtime and says cycle up or cycle down. What the team is actually doing is a very good lean-based approach. So they're actually going into deep root cause, looking at what equipment caused the failure, why did it caused the failure? Is there a way to automate? Is there a way to digitize? So in the long run, I put this under the pillar of operational excellence. Our factory should continue to run better in the longer term, and we'll put in the right appropriate of CapEx needed to make sure that we can over the long-term have sustained operating leverage from our factories."
},
{
"speaker": "Heather Jones",
"content": "Okay. Thank you. My follow-up is just, do you have an estimate of how much reinsurance proceeds will be in '25 and '26? I think you said it will continue into '26. So just give us a sense of what those just rough numbers, what those numbers will look like?"
},
{
"speaker": "Monish Patolawala",
"content": "Yes. So I'll start with just the overall possible loss that is there. And again, this is very preliminary. The teams are still working it through. But we believe Decatur West should be approximately in the $100 million of loss and Decatur East should be in the $300 million to $400 million of loss. We've got $95 million in Q3. We expect to get $135 million, give or take in Q4. We expect that in 2025, we should be somewhere in that $50 million to $100 million range and then and the rest will work over the next. Now all of this is based on information we have right now, all of this is based on still working through with the actuaries, with the insurance companies, et cetera. And our goal is to continue working it and we'll keep you posted as we get to know more, but this is truly based on what we know as of right now."
},
{
"speaker": "Operator",
"content": "We now turn to Manav Gupta with UBS. Your line is open. Please go ahead."
},
{
"speaker": "Manav Gupta",
"content": "My question specifically is to you, Monish. You have been in the seat for some time, but looking at the next 12 months to 24 months, Monish, what are your key priorities? What are you going to be most focused on for the next couple of years to make ADM a stronger company?"
},
{
"speaker": "Monish Patolawala",
"content": "Yes. First, Manav, I'll just say, yes, I've been here slightly over 90-days and it's been a blast to be here. It's a fantastic team. I've got a chance to go see some farms, I've got a chance to go see our operations. I've got a chance to go meet the teams in the field and it's a very exciting time to be here. I would tell you on my priorities, as I think about it, as I said in my prepared remarks, my first priority is the integrity and -- of our financial statements and remediating the material weakness. The team has already done a lot of work, but there's a lot more we can do in improving our processes, our internal controls and our systems. And that's what I'm focused in with the IT team and the finance teams to make sure that we have systems that can support all the reporting and all the revised pricing et cetera for intersegment sales. So that's one item. Then I come to the second piece, which is driving cash cost and capital. As Juan mentioned and I have said, there is a lot of opportunity here to control what we control and therefore, we are doubling down on our productivity efforts. And I'm working with the teams on multiple areas that we can simplify our business, reduce our cost, take advantage of our procurement savings as we should be getting into a slightly deflationary environment, while at the same time making sure that we are having functional excellence, which is we are delivering from the center what really the businesses need. So we are following a zero-based approach in certain of our functions. We are looking at all the cost and saying, what are we doing? Do we get the value for it or not. Similarly, when it thinks about capital, you've heard about capital allocation. When you think about CapEx, it's a stage-gate model. So making sure that we are investing in areas because there are tremendous opportunities for investment available to us, but at the same time, making sure that we're getting a return and we're going to follow a stage-gate approach, which means we'll fund you a little bit, we'll see what the return looks like at that point in time. If you hit the milestones, you get the next funding, otherwise, the money goes to somebody else. So create some internal tension to make sure that everyone is fighting for the last dollar of CapEx that's available. Then I go into digital and I think there's tremendous opportunity for you. The Kristy and team who's our CIO has done a really nice job. The company has done a nice job of improving the infrastructure that we have. We still have a long way to go in that, but I feel there's also a chance here to accelerate some of the ability to use data and data analytics to drive business outcomes. So that's another priority of mine. And then I would tell you back to portfolio. The company has always said they will look at portfolio. I've said that too in my prepared remarks in my three-month plus year, I've seen there are opportunities here that we are working on to make sure we simplify our portfolio. And I look at it from a simple lens of do I have a market and do I have a right to win first. And if I do, am I the rightful owner of that asset and what return are we getting. And Juan and I have spent quite some time together on talking about this. He has always been open to portfolio, and we are going to continue working on that. So Manav, I don't know if I answered your question, long answer to your short question, but lot of priorities. And then I'll end with where I started, which is back to the basics. You got to drive cost, cash and capital in this environment where we know that the commodity cycle may not be our best friend. So self-help is truly our best friend and that's what the teams are working on. So hopefully answered your question."
},
{
"speaker": "Manav Gupta",
"content": "No, you absolutely did. My very quick follow-up and this is more on the policy side. We saw some news that there are some changes to China export taxes as it relates to UCO and maybe Chinese UCO will make its way less to the global markets. There's a little bit of possibility that President Trump might impose some tariffs on anyways UCO coming into the U.S. So I'm just trying to understand from the perspective of ADM, if China exports less Yuko to the global markets, how does -- how can that help ADM?"
},
{
"speaker": "Juan Luciano",
"content": "Yes, thank you. Well, you see Manav what happened when the flood of UCO came into the U.S., so then basically soybean oil or canola oil lost percentage, it lost share as a percentage of feedstocks, if you will. And there were a lot of concerns on the origin of some of these UCO. And there have been a lot of questions by people about making sure we verify that origin, especially when you start seeing big palm oil producing countries being big exporters of UCO also. So I think part of that is to make sure that whoever is playing here is playing with the right rules. So I don't know about the regulation. There are a lot of speculation at this point in time about regulations. We just want a level-playing field. We just want to work on products that are real what they say they are. And I think that's what we aim for is transparency in the rules. Then we play by the rules."
},
{
"speaker": "Operator",
"content": "Our next question comes from Steven Haynes with Morgan Stanley. Your line is open. Please go ahead."
},
{
"speaker": "Steven Haynes",
"content": "Hey, good morning. Thanks for taking my question. Maybe just coming back to the cost side of things. I think your SG&A is up quite a bit this year and accelerating a bit, maybe more than kind of what would be implied by normal inflation. So I guess when we're thinking about that kind of ramp-up this year, what are some of the key drivers there? And then how are we supposed to think about that going into next year pairing with your comments about you know more focus on controlling cost. Thank you."
},
{
"speaker": "Juan Luciano",
"content": "So I'll just start with answering the question on what's driving the increase in SG&A, there are couple of drivers here. One is the higher litigation costs that we have in defending the or sorry, the higher litigation costs that we have with the material weakness that we have. So that's number one. Number two is the company has invested in digital transformation over the last few years and that's the cost that is increasing there to support the transformation of our ERPs. Number three is we got higher interest cost that we have, which is also reported -- sorry, you were just asking SG&A, not corporate. So those are my two big drivers that drive it, which is GT and then some litigation costs. We also have normal merit increase that goes into that, but that's partially offset by the lower incentive compensation that as we see the results of the company right now, you're going to see lower. So when you look at all of that back to your question also what are we going to do about all of this, as I said, a couple of things is, we need to continue investing in digital transformation as we go through that. Secondly, I would tell you that as we work through some of the zero-based budgeting exercises that we have here, we need to make sure that where there is opportunities, there is value being added for those activities, that's what we are working on. And then the third piece that is an add to the cost, which is M&A, so as we have bought four companies that closed in 2024, you get added cost that of course comes through into SG&A, but that's also where we have to keep looking at and saying making sure the synergies for those M&As are coming through too. So I would say in the long-run, when I look at this, this is where we clearly have an opportunity to continue driving our focus on cost. And I would do cost in two places. One is cost in SG&A. The second cost is our manufacturing cost, which Juan has already talked about and I've talked about where we should be able to keep driving efficiencies, which should help us reduce cost."
},
{
"speaker": "Steven Haynes",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "We now turn to Tami Zakaria with JP Morgan. Your line is open. Please go ahead."
},
{
"speaker": "Tami Zakaria",
"content": "Hi, good morning. Thank you so much. My question is on crush volumes. I think I saw on your slide you expect high single-digit percent type volume growth in the fourth quarter. So I'm just curious, is that a good starting point for next year barring any policy developments or can you share any initial thoughts on how you're thinking about volumes?"
},
{
"speaker": "Juan Luciano",
"content": "Yes, I would say, as you said, if you take the regulatory uncertainty out and what's going to happen with people adjusting their crush because of their blender tax credit to producer tax credit issue, whenever that's going to be solved, I think that, that level that we are disclosing is probably a reasonable level on normal conditions, if you will, yes. And that basically is just the addition of Spiritwood -- is the addition of Spiritwood that is running at full capacity basically, almost full capacity."
},
{
"speaker": "Tami Zakaria",
"content": "Understood. That's helpful. And then just following up on that tariff question from earlier, are you preparing for any either positive or negative impacts should the incoming new administration slap tariffs on foreign imports maybe starting in January, do you see any immediate opportunities or even risks to your business when initial tariffs go into effect?"
},
{
"speaker": "Juan Luciano",
"content": "Yes, of course, our business is running a lot of scenario planning for what could happen. Normally, what we see in these circumstances is the trade flows adjust. At the end of the day, you continue to have certain demand in the world, is just satisfied in a different way. So that's where in those situations is where the footprint, the global footprint and the team of ADM normally shines because it allows us with a lot of agility to repurpose those trade flows to take advantage of the conditions. So we are remaining agile, and again doing a lot of scenario planning to be ready."
},
{
"speaker": "Tami Zakaria",
"content": "Understood. Thank you."
},
{
"speaker": "Juan Luciano",
"content": "You're welcome."
},
{
"speaker": "Operator",
"content": "We now turn to Salvator Tiano with Bank of America. Your line is open. Please go ahead."
},
{
"speaker": "Salvator Tiano",
"content": "Yes, thank you very much. You did make a comment early in the call about China increasing production of certain commodities that is impacting trade. And I was just wondering if you can talk a little bit more about that, what are these commodities you're talking about, and whether this is something that's more cyclical like higher crop production because of favorable weather or something more structural certainly more policy, I guess driven that could impact global trade in the longer-term?"
},
{
"speaker": "Juan Luciano",
"content": "Yes, I think that China has shown this year that they wanted to encourage or incentivate their local corn production. And as such, they have reduced their -- they have to reduce their imports of corn. I think in -- that's probably what I was referring to, their imports of corn this year are going to be lower. I think in terms of soybeans, the situation is slightly different. I think they are preparing for the eventuality of having to or having to have, you know, tariffs or whatever. So they've been buying and they've been refreshing their reserves. So I think that in that sense the amount that they imported has been about the same. I would say it was more the corn comment."
},
{
"speaker": "Salvator Tiano",
"content": "Okay, perfect. And just want to follow-up a little bit on to ask about the depreciation in the Brazilian reis recently. And I'm just wondering what impact could this have most of your bottom line in Q4, but especially in 2025, given that's now under -- it's now over six."
},
{
"speaker": "Juan Luciano",
"content": "I think, Salvador, the biggest impact that happened with devaluations in Latin America is how they impact farmer selling. You see it in Argentina now that the currency and/or the spread with the you know the two exchange rates is just 10%, the farmer is a more normal seller, if you will, when they need cash and more a steady seller. In Brazil, now with the devaluation, the farmer has been more reluctant seller, if you will. So I would say when you look at Latin America, that's probably what impacts us the most is the ability of the farmer to be pressed to be a commercializer of grain."
},
{
"speaker": "Operator",
"content": "We have no further questions. I'll now hand back to Megan Britt for any final remarks."
},
{
"speaker": "Megan Britt",
"content": "Thank you so much for joining the call today and for your interest in ADM. Please feel free to follow-up directly with me if you have any additional questions."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, today's call has now concluded. We'd like to thank for your participation. You may now disconnect your lines."
}
] |
adm | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning and welcome to ADM's Second Quarter 2024 Earnings Conference Call. All lines have been placed on listen-only mode to prevent any background noise. [Operator Instructions] As a reminder, this conference call is being recorded. I now like to introduce your host for today’s call, Megan Britt, Vice President, Investor Relations for ADM. Ms. Britt, you may begin."
},
{
"speaker": "Megan Britt",
"content": "Thank you, Eliot. Hello and welcome to the Second Quarter Earnings Webcast for ADM. Starring to tomorrow a replay of this webcast will be available on our Investor Relations website. Please turn to slide 2. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to risk and uncertainties. ADM has provided additional information in its reports on filed with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. On today’s webcast, our Chairman and Chief Executive Officer, Juan Luciano will discuss our second quarter results and share recent accomplishment on our strategic priority. Our Chief Financial Officer, Ismael Roig will review segment level performance and provide an update on our cash generation and capital allocation action. Juan will have some closing remarks and then he and Ismael will take your questions. Please turn to slide 4. I'll now turn the call over to Juan."
},
{
"speaker": "Juan Luciano",
"content": "Thank you, Megan and good morning to all of who have joined for today’s call. Today, ADM report its second quarter adjusted earnings per share of $1.03 with an adjusted segment operating profit of $1 billion. Our trailing four quarter average adjusted ROIC was 9.7%. We delivered a strong cash flow from operations before working capital at $1.7 billion. Year-to-date, this equates to an adjusted earnings per share of $2.49 and an adjusted segment operating profit of $2.3 billion. Our team delivered solid results in challenging market conditions, highlighting the efforts of our teams across the business to manage through the commodity down cycle while putting our nutrition business on a path to recovery. Additionally, we saw signs of improving fundamentals within crush and ethanol later in the quarter, positioning us for a strong second half. We're also flexing our capital allocation strategy to return cash to shareholders, completing our planned share repurchases for the quarter and delivering our 370th consecutive quarterly dividend. Next slide, please. Let's start by reviewing the top-line results of our business units alongside our efforts to manage the cycle through productivity and innovation. Our service analysis results are significantly lower than the record results of prior years due to the ongoing rebalancing of the supply and demand environment and overall lower farmer selling. In anticipation of this year's challenges, we focus on driving stronger production volumes and actively leveraging our footprint to match supply to demand around the globe. We've also focused on differentiation opportunities, extending margins and growing volumes by more than 20% year-over-year in areas like destination marketing, achieving our targeted run rate in our Green Bison JV for renewable green diesel feedstocks, and bringing new solutions to our customers through innovations such as our recent EUDR-compliant fully traceable soybean program and the expansion of our regenerative agriculture partnerships and acreage. These regenec programs highlight our leadership in this space. ABM was named the finalist in Fast Company's world changing ideas in May. And just last week we released our second annual regenec report detailing the data backed results we are achieving across our global operations. Carbohydrate Solutions have continued the solid performance trajectory driven by strong margins for sweeteners, starches, and flour with higher volumes year-over-year. Ethanol margins also strengthened as industry production tried to keep pace with robust export and domestic demand. Along with this performance, we are continuing to drive innovation-based growth through the sustainability centered evolution of the business. We have delivered 7% year-to-date volume expansion across our BioSolutions platform, increased starch capacity in our Marshall, Minnesota facility to meet growing demand from food, beverage, and industrial customers, and in a milestone for our strategic partnership, Solugen recently broke ground on a 500,000 square foot biomanufacturing facility that will use ADM source dextrose for applications in water treatment, agriculture, energy, and home and personal care. Within our productivity agenda, the drive for execution excellence is continuing to deliver simplification and cost-saving opportunities across the enterprise. In Q2, we advance hundreds of projects that put us clearly on the path to the plan $500 million in cost reduction over the next two years. We are accelerating these efforts and expect to see a significant portion of these savings by the end of 2024. Our focus on returning nutrition to its growth trajectory is also taking hold, and we are seeing sequential top-line improvement as compared to our previous two quarters. While we are experiencing some downward pressure with texture and some protein demand, we draw strong growth in health and wellness sales, along with flavor sales growth, and excellent contributions from our recent acquisitions. In our targeted areas of focus, we are continuing to make progress. We continue to improve demand fulfillment for Flavors in our EMEA region, following the implementation of one ADM. We're optimizing cost across the Animal Nutrition portfolio, building the foundation to drive continued sequential improvement across the core of the segment. The use of our refined M&A playbook with our recent flavor acquisitions has proven to be an important accelerator to integration and the ongoing growth of our leading global Flavors business. And our innovation agenda is paying off, driving Human Nutrition revenues up 6% year-to-date, driven by flavors and our science-backed health and wellness portfolio. Our capital allocation efforts continued through the second quarter as we completed our planned shared repurchases and announced our most recent dividend. We have already returned $2.8 billion of capital to shareholders to date. The second quarter marked an important point in our efforts to manage through the market realities of 2024 and deliver on our priorities. Across all three businesses, we are evolving to drive new pockets of growth in the near term while positioning ADM to take full advantage of macro trends of sustainability, health and well-being, and food security in the longer term. As we continue to drive operational excellence and make progress on our key priorities, we have confidence in our full year expectations despite uncertainties in the external environment. Before I hand over to Ismael for a detailed review of our second quarter results, I would like to first thank him for his leadership and guidance as Interim CFO through the first half of the year. It's the hallmark of ADM leaders to step up when our organization asks for their support, and Ismael has shown that his experience, passion, and knowledge of our business set him apart as one of our best. We are excited to be welcoming Monish Patolawala to ADM as our new CFO in August, and know Ismael has important work to do as he returns to lead EMEA and Animal Nutrition's continued growth. Ismael, over to you."
},
{
"speaker": "Ismael Roig",
"content": "Thank you, Juan. Let me begin by sharing my own thanks and congratulations for what our finance team has accomplished over the first six months of this year. As a 20-plus year employee of the company, I have seen amazing things our colleagues can accomplish when we work collectively to achieve them. And this was, again, the reality as I stepped in as Interim CFO. I'm proud to have served the company in this capacity over the last several months, and I'm excited to welcome and support Monish as he joins the team. For the second quarter ended June 30th, 2024, earnings per share on a GAAP basis were $0.98. Segment operating profit on a GAAP basis was $1 billion and included charges of $7 million, or approximately $0.01 per share related to impairments. Adjusted segment operating profit was $1 billion for the second quarter, a 37% decrease versus the prior year period. Adjusted earnings per share were $1.03. Lower pricing and execution margins led to a decline of $1.03 per share versus the prior year period, largely reflecting the impact of lower crush and origination margins. Volume improvement represented a $0.19 per share increase versus the prior year period, primarily reflecting higher volumes in AS&O and Carbohydrate Solutions. Higher costs of $0.07 per share were primarily related to $0.06 per share of unplanned downtime at Decatur East. Share repurchases represented a $0.10 per share increase versus the prior year. During the quarter, there was approximately a $0.02 per share negative impact from mark-to-market timing in the AS&O segment. Please turn to slide 7. For the second quarter, the Ag Services & Oilseeds Team delivered $459 million in operating profit, reflecting on a challenging operating environment compared to the prior year. On a year-over-year basis, mark-to-market timing for the segment was relatively muted. As Juan mentioned, strong supplies out of South America have led to a rebalancing of the supply and demand environment, while also shifting export market competitiveness from North America to South America. These ample supplies have also pressured commodity prices compared to the past two years, resulting in slower-than-expected farmer selling relative to last year and the five year averages. From the demand side, inclusion rates for meal continue to be robust, supporting domestic and export demand. Oil values were pressured during the quarter as imports of used cooking oil as a feedstock for renewable diesel continue to grow. Ag Services results were lower than the prior year, primarily driven by lower results in South American origination, as lower farmers selling due to a smaller-than-expected crop in Mato Grosso and higher logistic costs related to industry take or pay contracts led to lower margins. North America origination saw lower volumes and margins as strong crop yields out of both Brazil and Argentina led to a shift in export competitiveness to South America, as well as limited carries and trading opportunities. As we began the quarter, global demand for both meal and oil remained strong. However, the return of Argentinian crush combined with the increased imports of used cooking oil also weighed on crush margins. As we progress later in the quarter, slower farmers selling in Argentina brought tighter S&D dynamics, driving an improvement in both crush. The team performed well in this environment, leading to an executed soy crush margin of approximately $45 per metric ton for the quarter. While fundamentals supported improving crush margins as we expected, the more balanced S&D environment led to lower margins versus the prior year, translating to lower results. During the quarter, there were approximately $15 million of negative timing impacts versus negative timing impacts of approximately $195 million in the comparable period. In refined products and other, results were lowered due primarily to the reversal of prior positive mark-to-market timing impacts. In North America, increased pretreatment capacity at renewable diesel plants and higher imports of used cooking oil caused refining margins to ease relative to the record levels of last year. The biodiesel margin structure has also come off of record levels versus the prior year as a result of lower LCFS credits and RIN values. During the quarter, there were approximately $90 million of negative timing impacts versus positive timing impacts of approximately $90 million in the comparable period. Equity earnings from Wilmar of $60 million were lower compared to the prior year quarter. Moving to slide 8, the Carbohydrate Solutions team executed well, delivering $357 million in operating profit for the second quarter, which was higher versus the prior year. Industry fundamentals in the Starches & Sweeteners space continue to be supported by strong sweetener demand and an improving starch market. Within ethanol, markets became more constructive as we advanced later in the quarter and stocks moved lower, firming up both domestic and export margins. Demand for ethanol remained robust, supported by summer driving season in the U.S., solid domestic blending rates and export demand. The Starches & Sweeteners subsegment results were higher year-over-year as strong margins and volumes in North America were partially upset by lower margins in the EMEA region as they came off historically high levels. And our operational excellence efforts have helped streamline our processes and overall efficiencies, leading to improved cost positions. In the Vantage Corn Processing subsegment, strong export demand for ethanol supported solid ethanol margins, leading to higher year-over-year results. Moving to slide 9. Nutrition revenues were $1.9 billion for the second quarter, up 3% on a year-over-year basis and sequentially improved from the first quarter. Our Human Nutrition subsegment grew 10% year-over-year, as strong M&A revenue contributions as well as improved volumes and mix and flavors, combined with strong growth in our health and wellness business, more than upset headwinds from lower pricing in the texturants market and lower plant-based protein demand. Our Animal Nutrition subsegment had lower revenues versus the prior year, as lower pricing and mix was partially upset by improved volumes in the base business. Please turn to slide 10. The second quarter marked another quarter of progress with sequential improvement in operating profit for the Nutrition business, when comparing to the prior year quarter, Human Nutrition results were lower, primarily driven by unplanned downtime at Decatur East and lower texturants pricing in the specialty ingredients business. Within Flavors, we have continued to improve operations, which has led to higher shipments sequentially. In Animal Nutrition, results were higher versus the prior year, as improved execution in the base business has led to higher volumes, and cost-optimization actions and lower commodity prices helped support margins, partially upset by lower pet solutions performance in North America and Brazil. Turning to slide 11. For the second quarter, Other segment operating profit was $96 million, up 12% compared to the prior year period, supported by higher captive insurance results due to lower claim activity. ADM investor services results decreased on lower interest income. In corporate for the second quarter, an allocated corporate cost increased on higher global technology investments to support digital transformation efforts, increased legal fees, and increased securitization fees. Turning to our balance sheet and cash flows on slide 12, through the second quarter, the company has continued to generate healthy cash flows with $1.7 billion of operating cash flow before working capital. Our current leverage ratio is now within our targeted range, reflecting our disciplined approach to balance sheet management and robust cash flow generation. With robust financial flexibility, we have been able to support both strategic initiatives to support long-term growth and also leverage excess cash for enhanced shareholder returns. During the quarter, we repurchased over 16 million shares through our open market repurchase program, returning approximately $1 billion of capital, thus making the completion of our targeted $2.3 billion of share repurchases for the year. In total, we have returned $2.8 billion of capital to shareholders through repurchases and dividends so far in 2024. We also continue to invest in the business with an enhanced focus on the reliability of our asset performance, allocating $700 million to capital expenditures. Now breaking down our expectations for the third quarter by segment on slide 13, in AS&O we anticipate the third quarter to be lower versus the prior year, but improved from the cyclical low margin environment from the second quarter. We anticipate demand for both meal and oil to remain robust and support crush margins, however, likely lower than the levels in the prior year. We anticipate improved process volumes in the third quarter as we enhance our focus on operational excellence across our network, and as our Green Bison JV achieves full run rates. It is also important to note the prior year period also included a $48 million insurance recovery related to damages from Hurricane Ida. In Carbohydrate Solutions, we anticipate a strong third quarter, but lower than the prior year as wheat milling margins moderate off elevated levels. Network optimization and operational excellence will continue to support strong earnings in the second half. We anticipate solid demand for ethanol both domestically and in the export markets, and upside opportunities could be presented if fundamentals hold. In Nutrition, we expect the third quarter to be higher than the prior year period. The team is systematically optimizing the organizational and operational structure across both Human and Animal Nutrition, which are expected to continue to yield cost benefits throughout the year. Coupling this with our efforts to convert pipeline opportunities and drive improved volumes, we anticipate to see continued sequential improvement in the Nutrition business throughout the year. Turning to slide 14 to discuss our full year guidance assumptions. We anticipated increased crop production in South America would lead to lower margins across the AS&O segment in 2024. And the global soybean crush margins would likely be in the range of $35 per metric ton to $60 per metric ton for the year, with performance around the midpoint determined by the strength of soybean meal and oil demand. Though the larger crop production in South America did materialize, we experienced slower than average farmers selling in that region, as well as fewer merchandising opportunities in North America through the first half, which weighed negatively on margins in act services. We expect these dynamics to continue to pressure margins in our third quarter. On soybean crush margins, we continue to see robust soybean meal demand based on solid livestock margins and some supply tightness among competing feedstuffs. From the soybean oil side, we expect that as renewable diesel production continues to grow in the second half, the demand for vegetable oil will remain well supported. And with the prospects of a large crop in North America, we perceive increased opportunities for our interior elevator network and processing plants within Oilseeds and Carbohydrates Solutions in the second half. Taking this all together, our expected crush margin remains unchanged from $35 per metric ton to $60 per metric ton, with recent fundamentals supporting margins above the midpoint. With the first half results largely in line and balancing an improving crush environment with less opportunities and merchandising in the second half, our 2024 earnings per share range remains unchanged. Looking at the other metrics included in our total consolidated guidance, our full year 2024 indications remain unchanged. Back to you, Juan."
},
{
"speaker": "Juan Luciano",
"content": "Thank you, Ismael. As we think about the rest of 2024 and the lead-up to 2025, we remain optimistic about ADM's ability to execute against our priorities while remaining agile in an evolving environment. The pressures of the current commodity cycle do not seem to be demand-driven, as we see continued robust demand for meal and oil. We will continue to focus on how we can actively manage our global footprint to best match these realities moving through the remainder of the year. Our processing capacities are improving through the year across our production operations, including the ramp-up of Green Bison to full capacity and growing production in Ukraine. And our forward book indicates that ADM is well-positioned to drive value through improved margin opportunities as we move into the back half of the year. AS&O results have remained robust, and we expect solid demand through 2024. Assuming fundamentals hold, we have an opportunity for upside in this part of the business through the year. Our initiatives to manage through the current cycle are expanding additional margin opportunities and opening up new channels to our customers, whether in the growth of destination marketing, the expansion of digital technologies focused on farmer needs, the extension of our Regen Act programs and partnerships, or the growth of our BioSolutions platform. So as market conditions improve, ADM has even more exciting platforms for growth and differences. As noted, we expect to see a significant portion of the planned $500 million cost savings driven by the drive for execution excellence to be realized by the end of this initial year of the program, setting up for potential upside in 2025 as more projects are identified and executed. Our Nutrition business have move beyond green shoots of positive momentum. We now see cyclical improvement across the broader portfolio, flavors, health and wellness, animal nutrition. As this continues through year end, we expect a return to growth that will continue and expand in 2025. In short, progress against our priorities, along with our experienced team's ability to pivot in response to an ever changing external environment, give us confidence in a solid close to the year and set ADM up well for a continued growth trajectory for our full business in 2025. Thank you. Operator, please open the line for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from Andrew Strelzik with BMO."
},
{
"speaker": "Andrew Strelzik",
"content": "Hey, good morning. Thanks for taking the questions. I guess I wanted to ask about the guidance. It seems like you tempered a little bit the language on the AS&O side. And nothing else really was changed, and you kept the EPS guidance. And so I guess I'm curious if there are kind of any other underlying offsets, or if you're thinking about kind of the range differently at all. And maybe, as we've seen more crush margin strength materialized through the year, how much visibility you have to that?"
},
{
"speaker": "Juan Luciano",
"content": "Yes, thank you, Andrew. Listen, as you know, we have three businesses. Ag Services, I know it is in this, what we call a transition year, if you will, a rebalancing year from tight supplies to more comfortable S&D. So we expected to have a Q2 that was facing challenging conditions, which we did. And I think we navigated well. As we look at the rest of the year and the improvements we have over the quarter in terms of crush margins, we are executing at this point in time, even outside the range of $35 to $60 per metric ton that we gave so. But of course, when you think about our forecast for Ag Services & Oilseeds was heavily weighted on Q4. So to a certain degree, until we can put more businesses into Q4, it's probably that we have the same kind of visibility we had before. That's where we decided not to touch the range. On the other hand, Carb Solutions continue to be improving. And I think that as Ismael said in his remarks, if current ethanol margins that have improved over the quarter continue to stay that way, we could have an upside there. And certainly Nutrition continues to make significant improvements year-over-year now versus just being sequential before. So we're optimistic about the second half. We just didn't want to change the guidance at this point in time since it's heavily loaded towards Q4."
},
{
"speaker": "Operator",
"content": "We now turn to Tom Palmer with Citi."
},
{
"speaker": "Tom Palmer",
"content": "Good morning, and thanks for the question. I wanted to ask on the Nutrition side, you reiterated the outlook for a second profit to increase year-over-year for the full year. I first just wanted to confirm that this is after adding back the write-down in the fourth quarter, so off I think kind of a $495 billion base. And then second, I wondered if you could elaborate a bit on the key drivers of these improvements over the next couple of quarters. The implication would seem to be that 3Q is up year-over-year. And sorry, the implication of 3Q being up year-over-year, would it seem to imply like a pretty meaningful increase between 2Q and 3Q. I think historically we've seen the opposite where 2Q is a bit more reasonably strong. So just any help on that sequential improvement and then off just the base that we're looking to grow as we look at this year. Thank you."
},
{
"speaker": "Juan Luciano",
"content": "Yes, Tom. Yes, the base is what you describe, you are correct in your assumption there. Let me give you some feel here. The sequential improvement continues in the business, as we said, and that's when we start looking at Q3, it looks like it's going to be year-over-year improvement, which marks a significant improvement in Q3 versus Q2. If I go through the different segments, if you will, Flavors continues to do well. I think the business is up in sales 6%, excluding M&A. Of course, it's still reeling with some higher cost because of all the demand fulfillment improvements we needed to make. But demand is coming back to normal, recovering after this tuck-in period. So we feel good about our pipeline there. We feel good about our prospects for Flavor. Specialty ingredients continue to have a challenge in time. Demand is often we are working through our plant issues. Also, we have the issue of texturants or more specifically emulsifiers in that area are coming down after significant record prices last year, if you will. Health and wellness continue to be very strong. Biotic sales growth is up to 22%. And I think that the pipeline there and the prospects continue to be very strong. When you think about Animal sector, in Animal Nutrition, excluding pet, improvement continues. And based on a strong self-help plan, so it's pretty much under our control, so we feel good about that. Pet Solutions is finding mixed results around the globe. If, I would say, Brazil market conditions continue to be challenging, North America, specifically the US, is still having some demand fulfillment issues. But we are looking good in terms of the improvements we are making towards Q3. And Mexico, our B2C business continues to be very strong. So I would say, overall, with the exception of specialty ingredients, which is the weak part, the rest of the business is looking good. So we expect significant improvements sequentially. And I will start making them improvements year-over-year."
},
{
"speaker": "Operator",
"content": "Our next question comes from Heather Jones with Heather Jones Research."
},
{
"speaker": "Heather Jones",
"content": "Good morning. Thanks for the question. I just wanted to ask about oilseed process volumes. So they were up 1% for the quarter. But in Q1, they were up nearly 9%. And you remarked that utilization of Spiritwood was full for the quarter. So, I was just wondering if there were one-time issues during the quarter and if so, there's been rectified in order to reach all mid to high single-digit growth outlook for the year."
},
{
"speaker": "Juan Luciano",
"content": "Yes. Thank you, Heather. As you said, yes, Spiritwood is performing very well, so is coming up in volumes. Traditionally, I would say in North America, when we have our low part of the cycle in North America, where South America has all the capacity, we take shutdowns in anticipation of demand not being very strong and we want to have our plants ready for the harvest. So, I think that's a traditional seasonal slowdown that we do. So, nothing unusual in that regard."
},
{
"speaker": "Operator",
"content": "Our next question comes from Adam Samuelson with Goldman Sachs."
},
{
"speaker": "Adam Samuelson",
"content": "Yes, thank you. Good morning, everyone. I was hoping to maybe drill in on some of the cost and productivity initiatives that you have underway right now. And I think, one, there's a target of $500 million savings by the end of 2025, kind of split between the two years. Can you maybe provide an update on what you've realized to date in 2024, what the 2024 savings kind of are expected to be on a net basis and maybe any additional color in terms of where within the portfolio those are actually hitting the P&L? I really appreciate it. Thank you."
},
{
"speaker": "Juan Luciano",
"content": "Yes, thank you, Adam, for the question. Yes, we're very proud of how this initiative that we put together at the beginning of the year has continued to accelerate. So far, we are on track. If you think about $500 million in over two years. That's about %125 million per half. We delivered about $127 million in the first half. So we're pretty much on track there. But this group of activities and projects and ideas continue to accelerate. So that's not going to be linear. It's going to be an accelerated bringing up to the P&L and to the bottom line. So we feel very good about it. We are very confident that our forecast shows that we're going to deliver on the $500 million way before the two year mark. With regard to what's the distribution of that, of course, sometimes when you have more bigger manufacturing units or bigger energy consumption, like in Carb Solutions, you have more opportunities to bring that. So I would say, if I were to name a ranking today. Initially, out of the gate, we see more in Carb Solutions and Nutrition because of some of the improvements we needed to make in demand fulfillment, and maybe Ag Services & Oilseeds having to pick a momentum during the second half, so we will see that. So but overall, I think good distribution of projects around the four geographies and the three businesses, and again, catching momentum when you have a big organization that you need to promote all these activities, so not everybody starts at the same time, so we feel very good by being on track, and again, we think ahead of schedule for our $500 million over two years."
},
{
"speaker": "Operator",
"content": "Our next question comes from Ben Theurer with Barclays."
},
{
"speaker": "Ben Theurer",
"content": "Hi, yes, good morning, Juan, Ismael. Thanks for taking my question. I wanted to go back to the Nutrition business and just understand a little bit what your cadence is into the back half as the Decatur East plan is going to come back in. You've selected the $25 million higher fixed cost observation. We just wanted to understand how immediately are you going to be able to gain this back, so as we move into the ramp-up of this, the East part of Decatur, how should we think about those cost headwinds that we've seen over the past? Is that to be recovered in ‘24, or is that more of the ‘25 thing? Thank you."
},
{
"speaker": "Ismael Roig",
"content": "Yes, thank you for the question. From the point of view of plant protein, we do expect the plants to come online again in Q4, so we will see some of that recovery coming in. I think as we look at the second half, we significantly pulled quite a bit of volume out in 2023 as a result, obviously, of the Decatur East facility, but also, we had in demand fulfillment. So I did report -- we did report a 3% revenue growth, as we look into the second half, we are seeing an acceleration of that, and we expect to grow, to be on track to deliver roughly in the mid-single digit growth when we bring back some of these facilities and demand fulfillment capabilities that we had lost in the second half of ‘23."
},
{
"speaker": "Juan Luciano",
"content": "I would say that maybe complimenting Ismael, I think is a ’25 impact not very much ’24 impact given in the Q4 so."
},
{
"speaker": "Operator",
"content": "Our next question comes from Manav Gupta with UBS."
},
{
"speaker": "Manav Gupta",
"content": "Hi. A quick question. We are seeing a very strong rebound in ethanol margins, and it's just seasonal. Is it what's else going out there? Do you think this sustains itself in the second half, and then how does that position you well in the Sweeteners and Starches business across in the second half? Thank you."
},
{
"speaker": "Juan Luciano",
"content": "Yes, thank you, Manav, for the question. We have been seeing for a while that exports have been increasing year-over-year, so ethanol continues to be one of the cheapest alkoxylates out there, and it's very competitive with gasoline in many parts of the world. So we have seen a strong domestic demand because of miles driven in the U.S., especially now with the summer. We have been seeing good blending in the U.S. I think the price of ethanol is very competitive to encourage blending. And we have seen exports at levels that we've never seen before, probably north of 1.7, maybe even 1.9 billion gallons per year. So I think that was a very logical kind of when you see that the strong demand was very logical, that prices will rebound. And, again, we don't see any change for now. It will depend on how much the U.S. produces, of course, of ethanol. But at this point in time, margins are holding, and we think that it bodes well for a strong Q3. In terms of Sweeteners and Starches, that business continues to have very robust volumes and very good margins. If anything, you can see a little bit of a pullback of the energy complex, if you will. That bodes well for manufacturing costs, because these are big facilities that consume a lot of energy. So natural gas prices being close to $2 is a little bit of a tailwind for us. So, Carb Solution is having a very good year so, and we expect that to continue."
},
{
"speaker": "Ismael Roig",
"content": "I'd like to compliment on the Sweeteners & Starches side, as you know, there's been a fairly low corn crop in Mexico, and that has certainly helped with exports of sweetener and starches products into Mexico. So it's created a demand pool into Mexico that has helped the overall market structure for our business in North America."
},
{
"speaker": "Operator",
"content": "We now turn to Salvator Tiano with Bank of America."
},
{
"speaker": "Salvator Tiano",
"content": "Thank you very much. I just wanted to clarify a little bit on the crush margins. So again, I think you made in your prepared remarks a comment that soybean crush margins were $45 per ton in Q2, and at least based on the report, EBITDA, I don't know if I'm missing something, and I may not be fully comparable, but it looks like your crush margins per ton were much, much lower than that. So what am I missing here? Are you easier, I guess, benchmarked the way you're presenting the $35 to $60 material different from what we would see, for example, on Bloomberg synthetic margin? And you made also the comment that you recently executed the trades, I guess, above the top end of the range, above $60. So can you elaborate a little bit on that? Are we talking about just one of trades, or is it something that you're actually consistently generating so far in Q3?"
},
{
"speaker": "Juan Luciano",
"content": "Sure. Let me clarify for you. First of all, the $45 per ton is the $45 per ton we made this year. So we can work offline to walk you through the arithmetic, if you will, but there's nothing strange on that. If I go around the world, if you will, on crush margins, at this point between $60 to $70 in the US, that's where we are making businesses, about similar margins for soy in Europe, Brazil may be something between $10 and $50 depending on their domestic plants or export plants, China, $20 to $25, that kind of the margin environment. I would say when we started the quarter, we were doing margins in the low end of our range and as maybe Argentine farmers did not sell, as maybe the industry was expecting, we saw more demand for soybean milk coming into North America that make an improvement in our crush margins, so we finished the quarter a little bit better than maybe we thought, about the $45 per ton. We are selling, we said before that we were relatively open going out. We have some of the Q3 sold, what we don't have sold, we are selling at about $60 to $70 per ton. So that's the crush realities at this point in time. So I think that then we're going to leap into Q4 where we have hopefully a very large crop here in the US. Crops look terrific so far in the US, so we expect to have plenty of raw materials in that. And demand for soybean milk continues to be strong around the world and I think low prices have incentivated demand. Demand is driven a lot by poultry, as you know, and soybean milk has been increasing in the Russians. And then on the oil side, we continue to see a little bit more RGG plants coming on the stream on the second half, so that will bode well as well. So we are positive about crush margins for the rest of the year for North America."
},
{
"speaker": "Operator",
"content": "We now turn to Dushyant Ailani with Jefferies."
},
{
"speaker": "Dushyant Ailani",
"content": "Hi. Can you hear me? Yes. Thank you for taking my question. I just want to talk on the CapEx guide. I think it's improved or it’s increased by about $300 million. I just wanted to see what's driving that."
},
{
"speaker": "Ismael Roig",
"content": "Yes. I think CapEx is always, the prioritization of CapEx is always NDE, so maintenance and safety and quality we do first. So whatever the plants need at any point in time. So that's a bottom up, roll up of their respective needs. Then we fill it up with cost projects, which the execution excellence challenge that we have to deliver $500 million and bring in more ideas, some of those ideas require CapEx. So you can see that growing and then there are growth projects around the world. So I would say nothing specifically is a little bit of everybody else executing on their plans. So I would say nothing. There is a little bit of CapEx inflation as well in our numbers because things are a little bit more expensive than maybe they were two years ago."
},
{
"speaker": "Operator",
"content": "Our next question comes from Steven Haynes with Morgan Stanley."
},
{
"speaker": "Steven Haynes",
"content": "Hey, good morning. Thanks for taking my question. I wanted to come back to Argentina. You mentioned it's kind of been a bit of a tailwind kind of towards the end of the second quarter on some slower than expected farmer selling. So how are you kind of thinking about how that evolves over the balance of the year and what's you kind of helps us think about the risk Argentia kind of coming back into the market in a more meaningful way going forward? Thank you."
},
{
"speaker": "Juan Luciano",
"content": "Yes. So what happened in Argentina, there was a big expectation for the unification of the exchange rate. And of course that hasn't happened so far. On the contrary, the GAAP has increased to about 50% or 55%. So at this point in time, when you combine low commodity prices because of all the abundant production and then the exchange rate, it's not very favorable for the farmer to sell. So the farmer in Argentina is selling a little bit more corn but trying to hold the beans. Will the government, so the question is, will the government be able to unify the exchange rate? I think the government's priorities right now is to fight inflation. And that was the whole plan. So they don't have a lot of room to maneuver to change something because the moment you divide, you change the exchange rate, everything is translated into prices. And the priority right now is to control prices. So I think this is for the good of Argentina long-term as a country, but I think short term will present a problem for the farmer to sell. So I think the farmer will hold as much as possible unless there is a special program that the government rolls out that they don't seem to have a lot of latitude to do so at this point in time. So I think we need to be cautious about the thinking that a lot of the crop will come as a glut to Argentina. It hasn't happened so far."
},
{
"speaker": "Operator",
"content": "We have a follow up question from Heather Jones with Heather Jones Research."
},
{
"speaker": "Heather Jones",
"content": "Thanks for taking the follow up. I wanted to ask about the Chinese UCO into the U .S. situation. So our understanding is those are slow some and then there is an expectation that with Europe imposing anti-dumping duties on Chinese biodiesel that China may shift more of their UCO to that market and not as much as the U.S. And just wondering what you all are seeing there and how you are expecting that to evolve throughout the year?"
},
{
"speaker": "Juan Luciano",
"content": "Yes, thank you, Heather. So of course there was a lot of noise by the industry about the prospects of maybe some adulterated or not quite truly UCO coming into the U.S. and checking for that. So we have seen some significant moderation of that coming. I don't want to pinpoint a particular reason, but part of that what you mentioned maybe in Europe is true as well. Europe will not allow raw crops to be part of that. So as they start to build SIF, they will have to use more UCO. So it's naturally that some of those flows would move to Europe. The current North American feedstock market is better balanced after the situation we have in Q1. So I think also we saw palm oil going up in prices. So I think that it's bodes better for soybean oil going forward for the U.S."
},
{
"speaker": "Operator",
"content": "We have another follow-up from Salvator Tiano with Bank of America."
},
{
"speaker": "Salvator Tiano",
"content": "Yes. Thank you very much. I just want to ask about the ethanol outlook, and I know you talked about a lot of factors here, but clearly your commentary on the starches and sweeteners, which include, I guess, the wet meals, was more negative, saying about lower ethanol margins year-on-year, whereas VCP, being the dry meals, it was much, much higher year-on-year. So can you discuss a little bit the differentiation there, and it seems like a lot of the delta is from the export side. So essentially, are you seeing different pricing, different margins from the exports, and as they become a much more important part of the ethanol mix, which we weren't used to in the past, is this something that besides being a driver of demand and operating rates, is it something that's margin accretive, or do the netbacks tend to be lower for export ethanol?"
},
{
"speaker": "Juan Luciano",
"content": "Yes, there are several factors, Salvator, here in place. So first of all, the ethanol margins are the ethanol margins, and they are better right now. They are probably twice as big as they were at the beginning of the quarter. There are some particular export markets where we can export as a premium, and we're taking advantage on that. I don't have top of my head where we export those from in terms of plants. But at this point in time, I would say the challenge, not the challenge, but maybe the activity has been on the logistics side to make sure that we can fulfill all the exports and we can get the materials to the ports, because, as you said, and I said before, demand has been very strong, and margins are very good, so we need to take advantage on that. Plants are running well. As I said, costs are coming a little bit lower, so this all bodes well for the forecast. And there's no reason for demand to change significantly outside of the world. We have a basket of countries where we are exporting is very well balanced. So at this point in time, we're looking at Q3 with optimism."
},
{
"speaker": "Operator",
"content": "We have another follow-up from Andrew Strelzik with BMO."
},
{
"speaker": "Andrew Strelzik",
"content": "Great. Thank you. I wanted to just get your perspective on broader biofuels policy. As we get deeper into the back part of the year here, we're getting close to some upcoming upcoming changes obviously the PTC maybe decisions around the RBO import export dynamic so just was curious for some updated thoughts about how those policy shifts will impact your business and whether you think there's risk on the timing of some of those things getting done. It feels like some of the timing around biofuels policy has been a moving target in a number of different ways. So just curious for how you're thinking about that progressing and impacting your business from here? Thanks."
},
{
"speaker": "Juan Luciano",
"content": "Yes. I think all these regulatory frameworks creates movements and uncertainty, the more clarity the industry can have of course the better. I think you have to think about the message around biodiesel blenders credit to a producer credit is, at the end of the day we still have a higher mandate for 2025 and a real deficit in 2024. So I think that you have to think that vegetables oil will be part of the solution to filling that mandate, ultimately the pie is getting bigger here and not the vegetable oil should be gaining on the low CI products especially now that California's CFS credits have come down a little bit. So I think that the problem with these are the short terms gyrations of that is very difficult to know what's going to happen Q4 so maybe we have accelerated buying in Q4 maybe we have a little bit of a slowdown in Q1. But I think overall as we look at that overall policy is constructive for all these and we see more demand and the pie getting bigger. So I think it's all positive for crush margins in the medium or long term calling it by quarter is more difficult."
},
{
"speaker": "Operator",
"content": "We have no further questions, so I'll now hand back to Megan Britt for closing remarks."
},
{
"speaker": "Megan Britt",
"content": "Thank you for joining us today. Please feel free to follow up with me if you have additional questions. Have a good day and thanks for your time and interest in ADM."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, today's call is now concluded. We'd like to thank you for your participation. You may now disconnect your lines."
}
] |
adm | 2,024 | 1 | [
{
"speaker": "Megan Britt",
"content": "Hello and welcome to ADM's first quarter 2024 earnings conference call. Our prepared remarks today will be led by Juan Luciano, our Board Chair and Chief Executive Officer, and Ismael Roig, our Interim Chief Financial Officer. We have prepared presentation slides to supplement our remarks on the call today, which are posted on the investor relations section of the ADM website and through the link to our webcast. Some of our comments and materials may constitute forward-looking statements that reflect management's current views and estimates of future economic circumstances, industry conditions, company performance, and financial results. These statements and materials are based on many assumptions and factors that are subject to risk and uncertainties. ADM has provided additional information in its reports on file with the SEC concerning assumptions and factors that could cause actual results to differ materially from those in this presentation. To the extent permitted under applicable law, ADM assumes no obligation to update any forward-looking statements as a result of new information or future events. I'll now turn the call over to Juan."
},
{
"speaker": "Juan Luciano",
"content": "Thank you, Megan. Today, ADM reported first quarter adjusted earnings per share of $1.46, adjusted segment operated profits of $1.3 billion, and a trailing fourth quarter average adjusted ROIC of 11.2%. Our first quarter operating cash flow before working capital was $900 million. In a year where the buildup of grain and oil seeds supply is expected to create pressure on margins, our teams are proactively taking action to manage through the cycle, driving structural earnings, ROIC, and cash flow generation. Our strong performance and disciplined management of our balance sheet continue to allow us to invest in our business and return cash to shareholders. Next slide, please. Last month, we laid out three priorities for value creation in 2024. One, managing through the cycle. Two, nutrition recovery. And three, enhanced return of cash to shareholders. We made progress on each of these priorities in the first quarter. Our efforts to manage through the cycle highlight ADM's ability to mitigate challenging headwinds while building structurally on enduring global trends, such as sustainability. To share a few examples of progress in the first quarter, we have been ramping up production at our Green Bison joint venture with Marathon, with increased volumes and utilization in [indiscernible]. And we're expecting to be at sustained full run rates for harvest this fall. We're continuing to evolve the carbohydrate solutions business through decarbonization, driving nearly 10% volume growth in bio solutions in Q1, while managing solid demand across the core business. Driven by increasing demand for sustainable resource feedstocks and solutions, we are announcing today that we're not only exceeded our 2023 goal of 2 million acres in our regenerative ag programs, we have also increased our 2025 acreage goal from 4 million to 5 million acres. This growth highlights the leadership role ADM is playing across the regenerative ag landscape, which is built upon the longstanding relationships we have with our more than 200,000 farmers partners. The Drive for Excellence program is focused on uncovering efficiency and effectiveness opportunities across ADM, taking action to improve outcomes and deliver cost savings. To-date, we have generated a pipeline of nearly 1,200 validated proposals. Many of these are already delivering results. For example, colleagues in Thailand had developed Chatbot to automate processing of thousands of logistic transactions previously done with a manual process, reducing errors and dramatically improving operating performance. Colleagues in Spain have released capacity in our Valencia extract facility by more than 35% by adjusting the extraction time. These projects and more like this will support us in achieving our aggressive cost savings objective of $500 million over the next two years. Moving to nutrition, the team is focused on actions across all areas of planned recovery, and we've seen expected sequential improvement coming out of the fourth quarter. The impact of these actions will accelerate in the back half of the year, consistent with what we mentioned in the last earnings call. Let me provide a few examples of progress we're making across the targeted areas. Our focus on operations and supply chain has helped us debottleneck some of our demand fulfillment challenges, particularly in EMEA Flavors, where the team has rallied to adjust our fulfillment processes following the go-live of 1ADM and improved volumes delivered sequentially. We're leveraging our improved M&A playbook to support the integration of our most recent Flavor acquisitions and now forecast better results than the initial deal model estimates. To increase speed, agility, and responsiveness to customer needs while delivering more wins across each market segment, we have fine-tuned our go-to-market and COE organizations to best align to demand. Looking to our capital allocation efforts, we have maintained our balanced capital allocation approach while leveraging excess cash flow for enhanced returns to shareholders. We returned a significant amount of cash to shareholders to date as we repurchased more than 20 million shares. As mentioned last month, our focus for excess capital deployment will remain centered on the shareholders. In summary, we are making measurable progress across each of our three major priority areas in 2024, which is setting us up well to navigate the market headwinds we are facing this year and delivering in line with our expectations. I would now like to turn the call over to Ismael for more detail on the first quarter financial results. Ismael?"
},
{
"speaker": "Ismael Roig",
"content": "Thank you, Juan. Let's start on Slide six, which provides overall segment operating profit and EPS for the first quarter of 2024. Adjusted segment operating profit was $1.3 billion for the first quarter, a 24% decrease versus the prior year. At a high level, operating profit was primarily down year-over-year in ag services and oil seeds and nutrition. In the other segment, which includes ADMIS and Captive Insurance, we had a 25% increase in operating profit. Adjusted earnings per share were $1.46 for the quarter. Lower pricing and execution margins primarily driven by margin normalization in the AS&O business led to a $1 per share decrease. This includes lower mark-to-market impact in AS&O of approximately $0.38 per share. Our enhanced focus on operational excellence and improving the reliability of our assets, as well as the ramp-up of our Green Bison JV, led to volume improvement in the AS&O segment, resulting in a $0.20 per share increase in EPS versus the prior year. Lower manufacturing costs and input costs led to a $0.15 per share increase versus the prior year, partially offset by negative impacts associated with unplanned downtime at our Decatur East facility. Higher equity earnings, primarily related to Wilmar, attributed a $0.07 per share increase versus the prior year. Increased corporate costs related to the 1ADM implementation and legal fees drove a decrease of $0.11 per share versus the prior year. In other, benefits from share repurchases more than offset negative impacts related to a higher adjusted income tax rate, leading to a $0.06 per share increase versus the prior year. Moving to Slide seven, let's look at our segment performance for AS&O. For the first quarter, the AS&O team delivered $864 million in operating profit, reflecting increasing headwinds from lower commodity prices and ample supplies, partially offset by improvements in process volumes and manufacturing costs, as we enhanced our focus on items within our control. The Ag Services subsegment operating profit was lower versus the prior year, primarily due to the stabilization of trade flows leading to lower global trade and risk management results. Slower farmer selling also negatively impacted export volumes and margins in South America. Crushing subsegment operating profit for the quarter of $232 million was lower versus the prior year. Increased imports of used cooking oil and the anticipation of large South American supplies negatively impacted North American soy crush margins, more than offsetting the benefits from improved process volumes and lower manufacturing costs. There were positive mark-to-market timing impacts during the quarter of approximately $40 million versus positive timing impacts of approximately $240 million in the first quarter of 2023. Refined products and other subsegment results were $157 million. Results were driven by weaker North American refining margins due to the increased imports of used cooking oil, as well as negative mark-to-market timing impacts of approximately $30 million versus positive impacts of approximately $40 million in the prior year. Equity earnings from Willmar were $149 million during the first quarter, higher than the prior year. Moving to Slide eight, let's look at carbohydrate solutions. For the first quarter of 2024, carbohydrate solution segment operating profit was $248 million. The team executed well in a solid demand environment, as well as advance our BioSolutions platform with strong volume growth. Turning to the subsegments. In the starches and sweeteners subsegment, strong starches and sweeteners margins in North America were offset by pressured domestic ethanol margins due to strong industry production and elevated stocks, as well as moderating margins in the EMEA region. In the vantage corn processing subsegment, strong export demand for sustainably certified ethanol supported both volumes and improved margins, leading to an improvement in year-over-year results. Please turn to Slide nine. Nutrition revenues were $1.8 billion for the quarter. In the human nutrition subsegment, strong M&A revenue contributions from our recent acquisitions, as well as price and mixed benefits in flavors, were partially offset by lower volumes in plant-based proteins and normalizing pricing in the texturants markets. Our animal nutrition subsegment had lower revenues versus the prior year, driven by lower pricing and mix. Demand creation has remained strong and provided significant revenue pipeline opportunities. We anticipate steady improvement in demand fulfillment throughout the course of the year, recovering a significant portion of volumes in the second half of the year. Please turn to Slide 10. While we have room to go on our commitment to restore the growth trajectory of the nutrition business, we believe Q1 was an important first step, showing sequential improvement from a challenged fourth quarter, evidencing progress in our operations. For the first quarter, nutrition segment operating profit was $84 million. Human nutrition subsegment results of $76 million were lower than the prior year, driven primarily from headwinds in the specialty ingredients business due to higher fixed cost absorption at Decatur East and normalizing texturants pricing. Animal nutrition subsegment results of $8 million were higher compared to the prior year, primarily driven by cost optimization efforts and lower commodity prices supporting margins. Please turn to Slide 11. For the first quarter, other segment operating profit was $121 million, up 25% compared to the prior year. The improvement was largely driven by improved Captive Insurance results on higher program premiums and lower claim losses. In corporate, unallocated corporate costs increased versus the prior year on higher global technology investments to support digital transformation efforts, as well as increased legal fees. Other corporate was unfavorable compared to the prior year due to an investment valuation loss of approximately $18 million. Please turn to Slide 12. With healthy cash flows and a strong balance sheet, we have maintained our balanced capital allocation approach while leveraging excess cash flow for enhanced returns to shareholders. We entered 2024 with momentum, which has allowed us to return $1.3 billion to shareholders via repurchases during the quarter, with $1 billion being executed through an accelerated share repurchase program. We intend to actualize the additional $1 billion of share repurchases approved last quarter throughout the remainder of the year. We still anticipate capital expenditures will be held at a level aligned with depreciation and amortization, focused largely on investments to secure reliability of asset performance through modernization and digitization efforts. Now, let's transition to a discussion on our full year guidance on Slide 13. Our first quarter results were largely in line with expectations, and in turn, our 2024 planning assumptions and EPS guidance remain unchanged. We are raising our corporate net interest expense guidance from approximately $500 million to approximately $525 million, as the Federal Reserve has signaled that the probability of interest rate cuts in 2024 has decreased. Last month, we mentioned that the global grain and oil seeds supply is expected to increase as anticipated improvements in weather would support larger production levels in key South American countries. With this, we anticipate that commodity prices will continue to ease from the recent highs of the past two years and that trade flows will adjust at the dislocations. As a result, we anticipate the global soybean crush margins would moderate in 2024, likely moving into a range of $35 per metric ton to $60 per metric ton. During the first quarter, the team executed well on a strong forward book supported by meal demand, leading to executed soy crush margins of approximately $55 per metric ton. As we look today, we see that the forward curves reflect the assumption of ample South American supplies and the return of Argentinian production, specifically in Q2 and Q3. While the supply side certainly has pushed forward curves to the lower end of that range in the near term, we remain constructive from the demand side. We continue to expect vegetable oil demand growth from renewable diesel as large facilities ramp up in Q2 and Q3, despite the increase in imports of used cooking oil. From the soybean meal side, lower soybean meal prices are incentivizing demand, supporting producer profitability and, in turn, leading to higher inclusion rates. Now moving to the breakdown of expectations by segment for Q2 2024 on Slide 14. In AS&O, we anticipate the second quarter to be significantly lower versus elevated prior year levels. We anticipate our average global soy crush margin to be towards the lower end of the guided range during the second quarter as the market balances strong soybean availability against increased crush capacity. We still remain confident in our full year planning assumptions as we move through the seasonally lower middle of the year as the world pivots to South American production. In carbohydrate solutions, we anticipate the second quarter to be higher versus the prior year, driven by solid demand and margins in North American starches and sweeteners, partially offset by moderating margins in wheat milling and international corn milling after elevated results in the prior year period. We anticipate solid demand for ethanol, both domestically and in the export markets, similar to the prior year. For nutrition, the second quarter is expected to be lower versus the prior year as we face headwinds in specialty ingredients. We anticipate to see another quarter of sequential improvement as we continue to make progress in demand fulfillment. Back to you, Juan."
},
{
"speaker": "Juan Luciano",
"content": "Thank you, Ismael. Please turn to Slide 15. As you can see, our team is continuing to improve execution excellence across our strategic and operational priorities, which requires a level of agility that is a hallmark of ADM's workforce. We're focusing the organization on a combination of productivity and innovation to help offset increasingly challenging market conditions based on growing commodity supply. Our teams are looking for every opportunity to manage what we can control, remaining nimble to adjust quickly to external circumstances while advancing our strategy. When we look ahead to the rest of the year, our business priorities in 2024 put us in a position to manage through this cycle. Through the differentiation and evolution of our business models in ag services and oil seeds and carb solutions, our drive for excellence program, the recovery of our nutrition business, and continued focus on shareholder returns, we have confidence in our outlook for the full year. Thanks for your time today. We look forward to taking your questions. Operator, please open the line for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Our first question for today comes from Andrew Strelzik of BMO. Andrew, your line is now open. Please go ahead."
},
{
"speaker": "Andrew Strelzik",
"content": "I guess I wanted to ask about the interplay. I wanted to ask about the interplay between US and South America crops and timing and farmer selling in terms of the implications for crush margins and how you're thinking about that. It seems like we've got some delayed farmer selling out of South America that could push out the timing to which that crop comes to market. And so I guess I'm just curious how you're thinking about the balance there and ultimately kind of the confidence that you have as we get into the back part of the year that you see crush margins consistent with your expectations. Thanks."
},
{
"speaker": "Juan Luciano",
"content": "Yes. Thank you, Andrew. So what we're seeing in South America at the moment, Brazil has had a little bit of a better selling last couple of weeks from the farmer perspective, given that with the harvest and also some of the devaluation of the real. So we've seen the crush margins there for Q2 improving a little bit around our portfolio of products. In Argentina, a little bit more difficult to read, Argentina with the economic plans and the uncertainty about how the government navigates through the difficult times. There are also a lot of, even when the farmer may agree to sell, there are some strikes, like right now, there are some strikes in Argentina that are popping through every sector of the economy. So a little bit more difficult to predict, but the reality is all that crop will come to the market. And we're starting to see that in crush margins, and you can see that. So what Ismael was reading in his remark is that, we highlighted a range of crush for the year. We operated in the first quarter, mostly in the higher part of that range, we will move in the second and third quarter, as traditionally happened when South America has a big crop, toward the low end of that range. And then we see at the end of the year, September onward, when we have a crop here in the U.S., where our margins will recover. So that's the way we see the year. We continue to see a strong meal demand as soybean meal becomes cheaper, and it gets more favor in the inclusions, especially when we see some maybe bottom out of profitability from the poultry sector. So that bodes well for our demand. And we have new RGD plants coming in on the stream in the U.S., whether it's Q2 or Q4, that will bring like another half a million ton more of soybean oil demand for the U.S. And don't forget that Brazil increased their mandate to B14, which represents another half a million tons of soybean oil. So all in all, I think that all that oil demand and meal demand will be important to bring back crush margins to the higher part of the range at the end of the year."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Ben Bienvenu of Stephens Inc. Your line is now open. Please go ahead."
},
{
"speaker": "Ben Bienvenu",
"content": "So I want to ask in the carbohydrate solution segment, you point to a pretty robust outlook for the remainder of the year for starches and sweeteners. In particular, you call out strong volumes. That's a bit of a recovery from what we saw last year. Can you talk about some of the dynamics that you're seeing around volume and the pace of recovery that you're seeing in volume that makes you call out this year?"
},
{
"speaker": "Juan Luciano",
"content": "Yes. I would say we've seen strong demand, I would say, I don't know, strong or solid demand across all our segments. Margins have been good. We continue to get a lift on margins by the reduction in chemicals, the reduction in energy prices, a little bit better operations of our facilities. And I would say the main difference maybe versus last year was the last year we have exceptional margins in international milling and also in the corn business in Europe. Those have moderated a little bit, but still the business remained very strong. So I would say all the sweeteners and starches contracted for the year, we're pleased with it. And we expect strong exports to Mexico, other countries pulling well. So I would say, we feel strongly about having a Q2 that's going to be better than last year. So all in all, the uncertainty continues to stay on the ethanol side in which we are cautiously optimistic that, the maintenance systems will balance inventories, if you will, and lift a little bit of margins there. But for the rest of the business, rest of the business is operating very solidly."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Tom Palmer of Citi. Your line is now open. Please go ahead."
},
{
"speaker": "Tom Palmer",
"content": "I wanted to maybe dive in a little more on refined products. You noted lower biodiesel margin expectations for the year and then in prepared remarks and pressure from imported used cooking oil. I guess, what do you see on more of a regional basis when we think about those refined spreads and more pressured U.S. and other places? And then you did have some timing gains a year ago. We saw a bit of an unwind in 1Q. Just any help on the expected progression of those as we move through 2024? Thanks."
},
{
"speaker": "Juan Luciano",
"content": "Yes. So let me deconstruct a little bit the RPO part. The difference in Q1, so results were lower significantly than last year where we had the record year. Main reason for that is North America, as you described, the imports of used cooking oil negatively impacted North America refining margins. Actually, in EMEA, our results were higher. We executed on the strong biodiesel margins. And I would say refining there is in line with the prior year. I would say we have additional volumes that offset a little bit lower refining premiums. South American results in biodiesel and packages, margins are stronger in the current year, supported by, as I said, increased biodiesel mandate. That's half a million tons per year of new demand that really impacted that. So overall, I think the dynamic will be similar for second quarter in which you will see refining margins lower in North America and crush margins and refining margins a little bit better in South America."
},
{
"speaker": "Tom Palmer",
"content": "Thanks. And just any help on the timing, Juan?"
},
{
"speaker": "Juan Luciano",
"content": "Oh, yes. Well, year-over-year, there was a $72 million negative of net timing impacts in Q1. So we had a negative mark-to-market this quarter of $30 million versus the previous year where we had a positive of 42. So that's the arithmetics, if you will, of that."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Manav Gupta of UBS. Your line is now open. Please go ahead."
},
{
"speaker": "Manav Gupta",
"content": "Good morning. My only question is, can you provide the path to the full restart of the Decatur East plant? Like where are we in the restart regulatory or construction, if you could help us out with that? Thank you very much."
},
{
"speaker": "Juan Luciano",
"content": "Yes, Manav. Good morning. Listen, there's a lot of activity going on there. But we have said, I think this is something we've got nutrition is going to carry as a headwind during the whole year. We expect that plant reasonably to be operating in Q4. I cannot provide any more details or granularity on that as we're going through all the projects, but I would say as soon as we have more specifics, we will be updating all you guys on that. But at this point in time, I think you need to think that the headwinds for nutrition in specialty ingredients and a lot of that driven by this will carry through the year."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Heather Jones of Heather Jones Research. Your line is now open. Please go ahead."
},
{
"speaker": "Heather Jones",
"content": "I was just hoping you could help me. I just want to discuss the crush margin outlook a little more specifically on the soy side. So thank you for the cadence information you provided earlier. But I just wanted to dig in a little bit more. So at present, the curve for the U.S. has margins below the range. And then on a cash basis, in certain regions, they're materially below that 35. So when I think about the rest of the year, are y'all assuming that regions like Brazil and Europe are going to provide a material uplift to offset the U.S.? Or is it you think the increased soybean oil demand, et cetera., will make U.S. margins materially better than the curve is indicating at present? So just trying to think about how you all are thinking about that."
},
{
"speaker": "Juan Luciano",
"content": "Yes. Heather, good to hear from you. Listen, the way we're seeing it at the moment, so North America, as we said, Q2 and probably Q3 will move to the lower part of the range. Then as we come through the year and we get more beans here in the U.S. and we get more renewable green diesel volume coming from probably 1 billion gallon more of capacity that's coming, we think that, that and inclusion rates will drive Q4 higher. In the Q2, Q3 area, if you will, we see right now, crush margins in Brazil have gotten better across all our plants, not only the domestic ones, but also the export ones. So as the farmer has been selling a little bit more, as you get more through the harvest there in Latin America, farmers start to move a little bit more volume. In Brazil, it was helped by the devaluation. So we saw that easing the pressure that we have in getting beans and helping crush margins. Europe, we expect it to be around $40 per ton, so it's a little bit in the middle of the pack. China, we don't have a lot of visibility in China, but it seems to be very spot in China at the moment. So it's a little bit hand to mouth over there. So in general, as I said, we see for ADM, at least, a big correction going into the second quarter, also a soft third quarter, and then we start to see coming back up in the Q4. But mostly, the curve of the U.S., if you will, with a little bit moderation provided by the other areas."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Salvator Tiano from Bank of America. Your line is now open. Please go ahead."
},
{
"speaker": "Salvator Tiano",
"content": "I wanted to ask a little bit about ethanol. And specifically, it seems like your commentary on ethanol was a little bit different between starches and sweeteners and VCP. It seems like you talked about lower ethanol margins in the former and better ethanol demand margins, et cetera, in VCP. So can you clarify why this, I guess, ethanol margins from the 2 different types of mills diverged? And also specifically, what are you seeing on the ethanol export front, and why is that benefiting VCP more than Starches and Sweeteners?"
},
{
"speaker": "Juan Luciano",
"content": "Yes. The reference we made to that is because VCP results were helped by stronger export demand for sustainably certified ethanol, and we get a premium for sustainably certified ethanol. So that supported volumes and margins. In general, Salvator, ethanol is a very cheap oxygenate, so it's getting a lot of demand from the rest of the world. So exports are expected to be north of 1.5 billion gallons. And blending demand inside the U.S. domestically has been good. It's just that this is the time of the year in which the plants have produced a lot. I always said the plants are exothermic. So in a time of cold temperature, they produce a lot, and that's a time where we drive the least. So now we're going into more the maintenance period of those plants. And I think that inventories for the industry, we hope will come a little bit more into balance, and we expect that to higher driving miles during the summer to balance margins a little bit better. But we expect for the whole year for exports to remain very healthy."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Ben Theurer of Barclays. Your line is now open. Please go ahead."
},
{
"speaker": "Ben Theurer",
"content": "Just wanted to follow up on some of the initiatives you're doing within the Nutrition business. And Juan, you talked about it at the beginning as it relates to like just simplification, portfolio optimization. So as you've looked through the assets and obviously, it's been volatile here and somewhat soft, obviously impacted by some of the onetime items. But as you think about Nutrition going forward and past some of the issues with the plant downtime, et cetera. How do you want to structure this business? Where do you want to take it to? What do you think is going to be the Nutrition, call it, maybe 2.0 version in 2 to 3 years time? What's the contribution, animal, human? How should we think about this?"
},
{
"speaker": "Juan Luciano",
"content": "Yes. Good question. Listen, if you see the sequential improvement that we have had right now, is we're taking a lot of the one-offs we received last year or even in Q4 out of the picture, if you will. Some of them completely. Some of them, they're going to continue to improve as the business improve the reliability of our supply, if you will. I would say, in the short-term, you need to be able to see through some of the headwinds that we will get in revenue because of the correction of raw materials. So there are some parts of the Nutrition business, what we call Specialty Ingredients, if you will, that were either related to proteins or emulsifiers. Those things tend to correct revenue because they are related to soy or corn at the end of the day, so they moderate. And that business is a business that from a volume perspective, there is a reshuffle of the demand in terms of plant-based proteins. And there's a lot of exciting stuff that the industry is doing. Listen, there is a lot of emerging technologies, novel ingredients and new culinary techniques that will come to revitalize that demand over time, but that's a shift that we're going through and you're not going to see that in 2024. But that's something that, long term, we still believe in that piece. Right now, in the present time, flavor, we continue to see strong demand for flavor, whether it's in North America or whether it's in Europe. To the extent that we can release our supply constraints, we will be able to capitalize more on that. And U.S. has been doing better, faster than maybe Europe, and we're correcting those things in Europe but we feel strongly about that. On the Health & Wellness perspective, biotics continues to excel. Biotics have increased OP by like 100% in the first quarter. So we're doing very well. We're getting some headwinds from the fibers perspective, but I think that's a matter of competitive materials. But over time, fibers has a very positive prognosis as all of us are trying to incorporate more protein and fibers in our diet and reduce fats and sugar that's where the world nutrition trends are moving. And then when you think about the Animal Nutrition side, Animal Nutrition is probably the most undervalued, if you will, story given their potential. Because we are doing a lot of self-help, and that self-help continues to be seen in the P&L. But some of the protein sector issues have impacted the demand there. I would say there in the Animal Nutrition area is where we're probably going to see more of the refinement of the portfolio, if you will, just because there are unevenness across sectors in terms of our ability to achieve the right returns on the long-term. So in some part of the sectors, it's more like self-help. In other parts, it's more innovation driven. And even if you go to things like pet, where the demand is very strong, there are pieces of the world that are doing exceptionally well for us like Mexico. There are pieces where demand is very strong, like in North America, so maybe we need to fix some supply issues. And there are parts of the world, like maybe like South America, where structurally it becomes a little bit more difficult to make money. So we are applying different recipes to the different parts of the world. But I still see a very complete Nutrition business, if you will, going forward, more focus on the maybe fewer platforms, fewer customers to be able to execute our pipeline faster. Maybe in the past, we have a big pipeline with a percentage of conversion that we expect it to be higher on a maybe a more focused, concentrated pipeline. That's the way I tend to think about it."
},
{
"speaker": "Ismael Roig",
"content": "Can I offer a complementary view? I just wanted to offer you a complementary view on Juan's comments with regard to Animal Nutrition, but I think it also applies to the broader portfolio, which is I fully agree with Juan in the sense that the base business in Animal Nutrition is now experiencing the benefits of the cost improvement programs that we put in place, and we've seen that evolution quarter-on-quarter. But to Juan's observations on a going-forward basis, you will see a business that is looking to become more focused on the specialty side of its portfolio. As Juan alluded to at the beginning, part of the revenue calculation for the platform is partly impacted by the fact that there is a soy mill commodity component to some of the products that are produced. Over time, it's a business that will evolve to become more specialty focused, more higher margin focused. I think it bodes well for the growth and margin structure of that business as we look forward into 2025."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Steven Haynes of Morgan Stanley. Your line is now open. Please go ahead."
},
{
"speaker": "Steven Haynes",
"content": "Maybe just two quick follow-ups on Nutrition. So I think your income was down slightly and based on your kind of prior comments about there being some price component, were your volumes, I guess, organic volumes, positive in the quarter? That would be the first one. And then the second question is on the full year, you mentioned that the recent M&A is kind of coming in ahead of your kind of deal model expectations. How much operating profit contribution are you baking into the full year guide from M&A? Thank you."
},
{
"speaker": "Juan Luciano",
"content": "Yes. Thank you, Steven. So let me tell me that we are very pleased with the 2 M&As. The 2 M&As contributed to revenue in the first quarter and not yet to OP because of start-up costs and all that. But we still expect revenue, even despite the headwinds that I mentioned before relative to commodity prices, moderating in some of our less specialty categories. We expect revenue growth to be in the range of mid-single digit for full year. We expect probably operating profit to be a little bit better than that given that our cost should be down year-over-year. So what was the other question there?"
},
{
"speaker": "Ismael Roig",
"content": "Yes. So in terms of overall volume, volume was a complementary question. Overall, we've seen volume hold up well. The exception to that would be, obviously, the Specialty Ingredients business and specifically, the impacts of the Decatur East plant. But all of the other elements of our business have generally performed well volume-wise. So you've seen a bit of a deterioration of the volume on a revenue basis, but you have seen a general improvement except for the SI business when it came to volume."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Adam Samuelson of Goldman Sachs. Your line is now open. Please go ahead."
},
{
"speaker": "Adam Samuelson",
"content": "So I guess I got two questions. Maybe first, as we think about the outlook for the year where you talked about improvement in soy meal demand and inclusion ratios later in the year. Can you maybe help us be a bit more specific? Just that doesn't seem to you as implied by the curves. Most forecasts on poultry supply in different parts of the world don't really project a sizable uptick in production. So could you just help us a little bit on the areas where you're actually seeing that or getting that signal from your feed customers? And then an unrelated question, as I think about some of the cost actions and productivity savings that you've targeted for this year and next. Would love if you could maybe a bit more specificity to the areas where the $500 million are really coming from, both in terms of the category of spend, but also whether they're in the operating segments or in corporate unallocated as we think about the outlook for the next couple of years. Thank you."
},
{
"speaker": "Juan Luciano",
"content": "Yes, sure. Adam, listen, I think what you need to realize, so first of all, we are early in the year, of course, and we are making predictions on Q4. So this is a transition period for the industry, if you will. We're going from a couple of years of tight supplies to ample supplies. So we're seeing here a customer base that is very uncovered, if you will, farmer selling that is a little slow. And we're going to go through that transition. On top of that, you have a proteins industry that was in the unprofitable territory, if you will, and still is for certain for, if you will, beef or some parts of pork, but now it seemed to have based and seeing growth trends in poultry. So we see that in different parts of the world, whether it's in Thailand, in Turkey, in other parts of the world. But I think the main issue is that pricing is doing its effect. So you see some trade flows changing. We see some soybean oil being exported out of the U.S., as we see used cooking oil coming into the U.S. We're starting to see maybe Brazil becoming less of an exporter of soybean oil, maybe more competition in mills, but the U.S. is still very competitive in mill. So I think that we will have to see all that shift during the year. What we are seeing is we're looking at our customers, we're looking at our book. And we just think that, again, with 1 billion gallon more of RGD capacity in the U.S. with 500,000 tons more soybean oil coming from the biodiesel mandate in Brazil, that will be a very big determinant of crush margins for the year. With that, I think Ismael will cover the drive for excellence profitability."
},
{
"speaker": "Ismael Roig",
"content": "Yes. Adam, on the drive for excellence, we're actually quite encouraged by the progress. As Juan mentioned during the remarks, we have more than 1,200 initiatives, but they can be grouped into substantial areas or themes of effort and focus, working on plant process optimization, working on business process optimization, also very important on supply chain and demand fulfillment , which is part of the challenges that we've had in Nutrition. So these would be the large buckets that we're working on. And we've seen the platform progress very well. And we have at least about 1/3rd line of sight of the $500 million already for 2024. So we're very encouraged about the ability of this drive for excellence impacting 2024 already in the measures that I've just outlined."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Ben Kallo of Baird. Your line is now open. Please go ahead."
},
{
"speaker": "Ben Kallo",
"content": "Just how do we think about or you think about the dynamic of the blenders tax credit changing over to a producers tax credit and the carbon intensity being a factor for overall soy oil demand in the U.S. next year?"
},
{
"speaker": "Juan Luciano",
"content": "Yes. Thank you, Ben, for the question. So as you know, the $1 blenders tax credit will expire at the end of '24 and transition to a production tax credit. And this will be administered by the US Treasury. They issued guidance on, I think, at the end of last year that will allow the use of grid CA modeling in addition to CORSIA. Of course, we favor including grid. We're successful in grid being officially included. We're still delayed in the EPA ruling on that. So I think that we have been doing a lot of advocacy in encouraging government officials to make sure that we remove this uncertainty out of the equation here. I think that a transition without guidance of whether the crop-based biofuels will generate credits will create a very difficult price discovery mechanism in the coming months, as participants are trying to begin locking 2025 volume. So I think that's an important clarification that needs to happen. These are industries that are investing in the U.S., and I think that providing regulatory certainty are very important for those investments to come to fruition on time and as expected."
},
{
"speaker": "Ben Kallo",
"content": "Just a follow-up there. What are you seeing with the renewable diesel refiners, producers in terms of them transitioning to using waste fats or other materials?"
},
{
"speaker": "Juan Luciano",
"content": "Yes. Listen, there is a reality in the world that palm oil production is flat and not being able to cope with demand. So we know that the U.S. and renewable green diesel was going to have to be met with a lot of feedstocks, of which soybean oil is an important component. But of course, the industry is trying to gather every kind of feedstock that they can find. And there was inventory of used cooking oil. The U.S. has imported a lot of that, but still is not going to be enough because how much are you going to grow the used cook oil inventory around the world to supply, as I said, an industry is going to have 1 billion gallon more capacity this year. So we still expect that we are adjusting to these temporary imports of used cook oil. But we still expect that soybean oil will recover their percentage of the used from maybe 30% to again, the 40% we used to be."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Salvator Tiano of Bank of America. Your line is now open. Please go ahead."
},
{
"speaker": "Salvator Tiano",
"content": "I just had a follow-up. So as we look a little bit into a couple of items, can you help us understand the Green Bison contribution now? So for example, the process volume growth that you showed, roughly how much came from that? And also, I believe you had the $10 million non-controlling interest loss. Well, I guess, the JV, among others, are the loss. So how much, I guess, of that was the Green Bison JV, and at which point do you expect it to turn into a profitable JV on a net income basis, so for that NCI line?"
},
{
"speaker": "Juan Luciano",
"content": "Yes. Salvator, maybe I give you what I have at the top of my mind. But we were very pleased with the increase in volumes in oilseeds or in crush during the first quarter. It was 9% increase. Part of that was Spiritwood coming online, part of that were our plants improvements in general across the footprint. Part of that was Paraguay and Ukraine also coming to crush. So that all happened at different points in the quarter. So I don't have a full recollection of what happened to what volume at any part of the quarter. The Green Bison joint venture will be a contributor to profit during 2024. So it's ramping up. It's going to get to full capacity very soon. So it will be a meaningful contributor. I don't have top of my head what was the contribution on first quarter, to be honest."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Heather Jones of Heather Jones Research. Your line is now open. Please go ahead."
},
{
"speaker": "Heather Jones",
"content": "Just wanted to ask really quickly what exactly you're doing for the dry mills as far as sustainability sourcing? And the doubling of your region acreage, is that related to like proactively getting ahead of this EU deforestation regime or more stringent carb requirements? Just wondering what's driving that?"
},
{
"speaker": "Juan Luciano",
"content": "Yes. So Heather, in carb solutions, we have a whole decarbonization strategy. Actually, across ADM, we have a decarbonization strategy, driven partly by our Strive 35 goals that we need to decarbonize ourselves, part driven by our customers and the need for either awaiting Scope 3 emissions from the side of our customers, but also by providing some low carbon intensity characteristics of some of our products that has also commanding a premium out there. So what are we doing? We are working on increasing our carbon capture sequestration. We're going to go from 2 wells, 1 well and 1 experimental well, but let's say 2 wells to 7 wells, so we're going to be able to increase significantly our capacity. And let me remind you, we have already captured 4.5 million tons of CO2 in the last 10 years that we've been operating. So that has been successful. For the dry mills specifically, what we're doing is we are building pipelines to bring that to our carbon capture and sequestration units indicator. We have 1 pipeline that has been ongoing, the project, and we are looking for solutions for the other dry mills. So that's what is happening. The second part of the question, Heather, I'm not remembering exactly what..."
},
{
"speaker": "Heather Jones",
"content": "I was just wondering about the region."
},
{
"speaker": "Juan Luciano",
"content": "Oh, yes."
},
{
"speaker": "Heather Jones",
"content": "Yes, on the region acreage, just wondering, is that doubling in anticipation of like the EU deforestation regime or more stringent carb standards? Just wondering what's driving that. Or is it all voluntary market-driven growth?"
},
{
"speaker": "Juan Luciano",
"content": "Yes. I would say there is excitement on both sides. There is excitement on the farmer side to adhere to all these practices, but there's also a lot of demand pull from the customer side in terms of we continue to sign contracts for more of these as people need to, again, have an answer to their Scope 3. So we have been setting goals, and we have been beating those goals and increasing those goals. Now we have expanded that to Europe and Latin America, and we continue to see demand for these activities around the world. And to be honest, the team has been doing an excellent job. So I think that this program is perceived as the leading program in the world there."
},
{
"speaker": "Operator",
"content": "Thank you. At this time, we currently have no further questions. So I'll hand back to Juan Luciano for any further remarks."
},
{
"speaker": "Juan Luciano",
"content": "Okay. Thank you. Thank you, everyone, for joining us today and for your interest in ADM, and have a great day."
},
{
"speaker": "Ismael Roig",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you for joining today's call. You can now disconnect your lines."
}
] |
adp | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good morning. My name is Michelle and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Fourth Quarter 2024 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the conference over to Matt Keating, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Matthew Keating",
"content": "Thank you, Michelle, and welcome, everyone to ADP's Fourth Quarter Fiscal 2024 Earnings Call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you also find the Investor Presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. The description of these items, along with a reconciliation of non-GAAP measures to the most comparable GAAP measures, can be found in our earnings release. Today's call will contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from current expectations. I'll now turn it over to Maria."
},
{
"speaker": "Maria Black",
"content": "Thank you, Matt and good morning. Before we get started, I'd like to take a minute to thank Danyal Hussain for leading Investor Relations for these past several years. He helped lead us through the pandemic and helped Shepherd our CFO and CEO transitions during his time. With Danny moving on to a broader role, it is my pleasure to officially welcome Matt Keating to his first call. Congratulations to you both. We closed out the year with a strong fourth quarter that included 6% revenue growth, 80 basis points of adjusted EBIT margin expansion and 11% adjusted EPS growth. For fiscal 2024, we delivered 7% revenue growth, 70 basis points of adjusted EBIT margin expansion, and 12% adjusted EPS growth, representing another great year for ADP. I'm excited to share the progress we've made across our three strategic priorities, but first I'll start off with some additional highlights from our results. Our sales and marketing team delivered exceptional employer services, new business bookings in Q4, on top of a strong Q4 last year. This performance was broad based, showing continued strength in our small business portfolio, as well as our mid-market enterprise and international businesses. In fact, we sold and started more than 50,000 new small business clients during the quarter, which not only reflects the strength of our run solution, but also our reputation for commitment to strong service. Similarly, in the enterprise space, client interest in our next-gen HCM solution has exceeded expectations and resulted in strong Q4 sales, and we are excited to continue this great momentum. As a result of this exceptional performance, our fiscal 2024 employer services bookings growth came in at 7%, the high end of our 4% to 7% guidance range. This growth speaks to the power of ADP's unmatched distribution model, which remains a clear competitive advantage for us. With our new business pipeline even stronger than this time last year, we look forward to building on that momentum. Overall, our employer services retention came in better than expected for the year at 92%. We drove record level retention in our mid-market business for the second consecutive year in fiscal 2024. I'm also extremely proud to share that our client satisfaction scores for our total business reached new all-time highs for both the fourth quarter and full year. These results are a testament to the strength of our entire product portfolio and our commitment to supporting our clients. We are confident that these client satisfaction gains will support our retention results moving forward. Our employer services pays per control increased 2% both for the quarter and the full year. We were happy to have seen the resilience of the US Labor market, as our clients continued to hire employees at a moderate pace. Finally, our fourth quarter PEO revenue growth of 6% exceeded our expectations despite continued pressure from slowing client hiring activity. Our fiscal 2024 accomplishments extend far beyond our strong financial results. One year ago, I laid the foundation for our three strategic priorities that will guide our future growth. Now, I'd like to recap some of the great progress we made in each of these areas. Our first priority is to lead with best-in-class HCM technology. We had a very busy year on this front as we launched ADP Assist, our cross-platform solution powered by generative AI that transforms client data into actionable insights. This isn't just another technical solution, it's an experience that combines ADP's deep data set and expertise to empower HR professionals, leaders, and employees. We deployed ADP Assist across several of our platforms, including [Roll] (ph), RUN, Workforce Now, and next-gen HCM, with enhanced capabilities ranging from report creation to natural language search to initiating HR actions. These tools streamline daily tasks and are all powered by an easy-to-use search interface that is already receiving meaningful recognition in the field of generative AI. We are very proud to share that ADP Assist earned the Generative AI Innovation Award in the 2024 AI Breakthrough Awards, and we look forward to rolling out even more features in fiscal 2025. In addition to embedding generative AI in our products, we continued to advance our next-gen initiatives. Our active next-gen payroll client count increased by nearly 50% in fiscal 2024, and we grew our number of live next-gen HCM clients by more than 30% as we continued to improve implementation times. Our next priority is to provide unmatched expertise and outsourcing. Our approach to supporting our clients has been key to our winning formula for decades. And in fiscal 2024, we focused our efforts on implementing new technology that will help make an even greater impact for our clients. To further unlock the value of our expertise, we deployed generative AI tools like call summarization and real-time guidance to support our service associates. We also invested in generative AI and other automation capabilities for our implementation teams to reduce manual data entry and minimize the risk of error during implementation. For example, out of the 50,000 new RUN clients we sold and started during the fourth quarter, about half were digitally onboarded compared to a third of our new client onboarding and run this time last year. And as generative AI capabilities advance, we are excited to further accelerate this progress. Finally, we plan to provide additional tools to help our associates deliver better, faster service and allow our client satisfaction scores to continue reaching new record levels. Our third strategic priority is to benefit our clients with our global scale. Globally, we bring together an unmatched footprint, best-in-class integrated solutions, and industry-leading service and expertise to help our clients and their employees navigate the changing world of work. In fiscal 2024, we continued to leverage this global scale to strengthen our business. We extended our global footprint, acquiring the payroll business of our partner in Sweden, expanding the scope of our Celergo payroll offering to include Iceland, and further growing our on-the-ground presence in the APAC region. Our iHCM platform also continued to scale in several European countries and now serves more than 5,000 clients and pays more than 1 million client employees. Finally, we deepened our existing partnerships with several other leading technology providers to further simplify HCM processes and broaden the spectrum of support we can provide our clients. Next, I'd like to share some new client wins from Q4 to highlight how we're leading in workforce innovation and delivering value for our clients. In US Small business, we continue to successfully onboard new retirement services clients across multiple industry verticals. During the quarter, we added the plan of a Texas-based insurance agency, which was challenged by manual processes and the management of multiple providers. ADP's advanced technology and planned [fiduciary] (ph) solutions simplified the client's plan administration, reduced its manual oversight, and lowered its plan fees. The ADP team made the transition easy and stress-free by providing the client with critical management of the transfer process, as well as regular briefings on the plan set up. This is just one of the thousands of new clients who turn to our retirement services solution every year. In fact, we recently took the top spot as the nation's largest 401(k) record keeper by Total Plans and Total 401(k) Plans in the Plan Sponsor Magazine 2024 defined contribution Record Keeping Survey. We serve over 170,000 retirement services clients and it brings me great joy to see how ADP is helping employers address the retirement savings needs of so many Americans. We look forward to continuing the momentum in our retirement services business in fiscal 2025. In our HR outsourcing business, an orthopedic device company who had grown extensively through acquisition recognized it needed a deeper HR and technology infrastructure to support its future growth. So it turned to our comprehensive services support model to integrate its acquired companies onto a common platform. We look forward to supporting this client's current needs and helping it expand in the future. Additionally, comprehensive services cost a major milestone in fiscal 2024, generating more than $1 billion in revenue for the year. This business has come a long way since its launch in 2008, and we look forward to leaning into our outsourcing business as a differentiator. In US Enterprise, we welcomed one of the largest automotive dealers in the Midwest to our next-gen HCM platform. Following several years of rapid growth, this client wanted to reimagine their HCM strategy. To help, our team went on-site and conducted a deep review of its current practices and pain points. We developed a plan that would leverage our next-gen HCM platform, flexible position management structure and other advanced HCM tools to address the organization's current and future HR strategy. Our initial solution included HR, payroll, time, and benefits, and the client later added recruiting and talent management. We look forward to helping shape the future of their workforce together. Overall, we were extremely pleased with our strong financial and strategic outcomes this past year. In fiscal 2024, ADP was recognized as the world's most admired company by Fortune magazine for the 18th consecutive year, and we also celebrated our 30th straight year on the Fortune 500. As some of you may know, 2024 is also our 75th anniversary. As I reflect on ADP's enduring impact on the world of work, the one constant on our journey is our talented associates, be it the recent accolades we received or the 75 years of support for our clients, we owe our recognition and strong financial performance to our 64,000 dedicated associates who deliver the great products and exceptional experiences and continue to drive our client satisfaction scores to new highs. I want to take a moment to recognize them for their incredible contributions. Thank you for all you do for ADP and for our clients. And now I'll turn the call over to Don."
},
{
"speaker": "Don McGuire",
"content": "Thank you, Maria. And good morning, everyone. I'll start by expanding on Maria's comments around our Q4 results and then cover our fiscal 2025 financial outlook. Q4 performance was very strong overall, helping to drive fiscal 2024 revenue and earnings growth towards the high end of our expectations. As previously mentioned, we benefited from broad-based strengths in employer services with exceptional new business bookings, better than anticipated retention, and stable pays per control growth. PEO revenue growth in the quarter also came in better than expected. Our strong Q4 results contributed to our full year revenue growth of 7%, bringing our fiscal 2024 revenue to $19.2 billion. For our employer services segment, revenue in the quarter increased 7% on both a reported and organic constant currency basis. These results were bolstered by a slightly better than expected contribution from client funds interest. Our ES margin expanded 220 basis points in the fourth quarter, which exceeded our expectation. For the full year, our ES revenue grew 8% on a reported basis and 7% on an organic constant currency basis, and our ES margin expanded 210 basis points. For the PEO segment, revenue increased 6% for the quarter as growth accelerated from Q3. Average worksite employees increased 3% on a year-over-year basis in the fourth quarter to 742,000. PEO margin contracted 240 basis points, slightly more than we anticipated due to higher operating expenses and unfavorable actuarial loss development in workers' compensation reserves. For the full year, PEO revenue grew 4%. Average worksite employees increased 2% and our margin contracted 150 basis points, with the margin contraction mostly due to less favorable actuarial loss development in workers' compensation reserves versus the prior year. Our fiscal 2024 PEO new business bookings growth rate also moderated from the prior year. I'll now share outlook for fiscal 2025. While the macro backdrop remains uncertain, we believe we are well positioned to deliver solid overall financial results while continuing to invest in our future growth consistent with our strategic priorities. Our fiscal 2025 outlook assumes some moderation in economic activity over the course of the year. Beginning with the ES segment, we expect revenue growth of 5% to 6%, driven by the following key assumptions. We expect ES new business bookings growth of 4% to 7%, representing solid growth after coming in at the high end of the same guidance in fiscal 2024. For ES retention, we forecast a 10 basis point to 30 basis point decline from the 92% result for fiscal 2024. We are encouraged by our recent record client satisfaction scores, but we think it's prudent to continue to expect some retention pressure from higher small business out of business levels and slightly slower economic growth overall. As we mentioned at our prior earnings call, we see the potential for below normal US pays per control growth in fiscal 2025. And our outlook assumes 1 to 2% growth for the year. This view is consistent with most economists forecast for continued moderation in US private sector payroll growth. After price contributed around 150 basis points to ES revenue growth in both fiscal 2023 and fiscal 2024, we anticipate a benefit closer to 100 basis points in fiscal 2025, which is in-line with the moderation in overall inflation. We also expect FX to transition from a modest tailwind to ES revenue growth in fiscal 2024 to a slight headwind in fiscal 2025. And for client funds interest revenue, the interest rate backdrop remains dynamic. And it's important to remember our client funds interest revenue forecast reflects the current forward yield curve, which is likely to continue to evolve as we move through fiscal 2025. At this point, we expect our average yield to increase from 2.9% in fiscal 2024 to 3.1% in fiscal 2025, which contemplates the market's expectations for short-term interest rates to decrease during the year. We expect our average client funds balances to grow 3% to 4% in fiscal 2025. Putting those together, we expect our client funds interest revenue to increase from $1.02 billion in fiscal 2024 to a range of $1.13 billion to $1.15 billion in fiscal 2025. Meanwhile, we expect net impact from our client fund strategy to increase to a range of $1 billion to $1.02 billion in fiscal 2025. We expect ES margin to increase 100 to 120 basis points in fiscal 2025, driven by operating leverage as well as continued contribution from client funds interest revenue partially offset by ongoing investments to advance our key strategic priorities. Moving on to the PEO segment, we expect PEO revenue to grow 4% to 6% and PEO revenue excluding zero margin pass-throughs to grow 3% to 4% in fiscal 2025. Our PEO revenue growth outlook assumes average worksite employee growth of 1% to 3%. This reflects our expectation for continued new business bookings growth and modestly better retention to be offset by declining PEO pays per control growth that remains below our historical experience. We expect PEO margin to decrease 90 to 110 basis points in fiscal 2025. This anticipated margin decline reflects our forecast for zero margin pass-throughs to grow faster than PEO revenue and increase in our workers' compensation costs and higher PEO selling expense from accelerating new business bookings growth. Adding it all up, our consolidated revenue outlook is for 5% to 6% growth in fiscal 2025. And our adjusted EBIT margin outlook is for expansion of 60 to 80 basis points. We expect our effective tax rate to be around 23%. And we expect fiscal 2025 adjusted EPS growth of 8% to 10% supported by buybacks. One quick note on our margin cadence. We anticipate adjusted EBIT margin expansion on a year-over-year basis to be more modest in the first half of the year before trends ramp in the second half of fiscal 2025. Thank you. And I'll now turn it back to Michelle for Q&A."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Our first question comes from Bryan Bergin with TD Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"content": "Hi. Good morning. Thank you. I want to start with bookings here. So, sounds like a pretty solid close to the year. Can you provide more color on the attribution of that bookings performance across the business? And in general, I guess when you're looking at demand into July, just any changes based on employer size or geography?"
},
{
"speaker": "Maria Black",
"content": "Sure, good morning, Bryan. Great to hear from you. I love talking about bookings, especially on the heels of what was truly an exceptional performance by the overall team in the fourth quarter. To answer the first part of the question, it was broad-based. So we did see strength across our growth in small business, mid-market, enterprise, and international. So we are really pleased with the momentum that we see as it relates to the overall receptivity to the offerings, to the product, to the execution, and really proud of how the team moved through the quarter, which led to the exceptional results at 7% for the year. In terms of the demand environment overall and what we see, what I would offer is that the HCM demand environment remains strong. One of the things that's unique about HCM is what we do, it's not a nice to have, it is actually an imperative for a company to run their business. They need to have their associates pay, they need HR tools, and certainly it's not getting any easier. Whether you're in the down-market, mid-market, up-market, to navigate being an employer. And as such, we fit squarely into that. So we feel good about the momentum stepping out of the quarter. We feel good about the demand environment stepping into the quarter. Pipelines from a year-on-year perspective look strong. So we're very optimistic and proud of the performance."
},
{
"speaker": "Bryan Bergin",
"content": "Okay, I appreciate that. And then my follow-up, just on kind of pays per control performance here, can you compare and contrast the pays per control performance in ES versus what you're kind of seeing on the same store sale, PPC and PEO. And any cadence assumptions here as you go through 2025?"
},
{
"speaker": "Don McGuire",
"content": "Yeah, Bryan, I'll take that one. So as we look at pays per control, we do think that the labor market is still pretty resilient. I mean, there are a number of factors that we look to. And, you know, if you look at the BLS, you look at the unemployment rate, JOLTS Report came in the other day, it was down, but better than expected. Labor force participation still got some room to go, et cetera. So jobless claims are kind of neither here nor there. They're benign. So we think there's still continued good strength in the market. Having said that, we do think that pays per control is going to moderate. And we have said we're thinking 1% to 2%, as we go forward into 2025. I would say that we do expect that the pays per control growth in the PEO will be lower than it is in ES, but we are still optimistic that there's growth to be had, but certainly we expect ES to be somewhat stronger than we expect PEO."
},
{
"speaker": "Bryan Bergin",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Dan Dolev with Mizuho. Your line is open."
},
{
"speaker": "Dan Dolev",
"content": "Oh, thanks guys for taking my question. You know just to touch again on ES, like I kind of want to know like how much of that strength is idiosyncratic and things that you're doing internally versus the macro. And then maybe the follow-up is again asking about the guidance and like maybe you can layout you know what could go well and what could go wrong in terms of the macro -- the underlying macro for the guide that would be it. Thank you."
},
{
"speaker": "Don McGuire",
"content": "Yeah Dan. So you know just to follow up on that I would say that you could will unemployment remain as low as it has been? I think there's no indication that it's going to worsen. It's still at, you know, decade lows or comparable to decade lows. There is good strength, there seems to be good strength across the broader spectrum of new jobs. So the NER report came out earlier today and we're [continuing] (ph) to see new jobs. So I think that we put out there a PPC growth number that's realistic. What could change that? We could imagine all kinds of macro issues, but I prefer not to do any imagining. I think we're trying to do what we can based on what we know today. So I think that what we have today is pretty good. But as I mentioned earlier to Bryan's question, we certainly recognize that ES is likely to be stronger than PEO."
},
{
"speaker": "Maria Black",
"content": "And Dan, if I can just add on the sales side, just with respect to -- are we driving the results as it being driven by Macro? My answer to you would be both. And so I think we have a strong demand environment. I touched on that during Bryan's question in terms of our offer and how squarely it fits into that demand environment. And that's really a broad-based execution across the entire business. So it is the investments we've made into our products. It is the best-in-class service that we have. We see that in the NPS results, by the way we see that in our retention results as well. And so I think we've been getting stronger and stronger. I think the value proposition of what we offer is an imperative for businesses. And then once again, I would say, yeah, we are executing incredibly well across the full spectrum of our sales differentiation. I mentioned in the prepared remarks, I consider it to be one of the greatest competitive advantages that ADP has. Part of that is our ability to canvas the entire market. So whether buyers trying to buy digitally, or they're trying to buy through a channel, or they're trying to buy the traditional way, like we show up at every single turn, and we lean right into that with the best product and the best service out there. And as a result of all of those things, I think we are executing very well."
},
{
"speaker": "Dan Dolev",
"content": "Great results, Thank you."
},
{
"speaker": "Maria Black",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "James Faucette",
"content": "Great. Thank you so much. I wanted to ask on competition. Some of our recent conversations with those in the industry have kind of indicated that there's been some meaningful price compression from some of your competitors, particularly in the mid and down market segments. Have you observed others getting more competitive on price or from your perspective, is it fairly status quo right now?"
},
{
"speaker": "Maria Black",
"content": "Good morning James. What I would offer is it is pretty status quo. We haven't really observed any of those meaningful price compression, things of that nature. Given how much we do compete, I think we would see – I’d say, that there is always some of that in terms of whether it is promotions and things that all of us run at various times throughout the year. But it doesn't seem atypical for me. And obviously, I've spent a lot of years watching the competitive landscape and the sales environment. So I haven't seen anything anomalous. I think the one thing that's changed, specifically in the competitive landscape is us. And so when I think about our ability to execute, and everything I just mentioned, best product, record retention, record NPS, incredible execution by sales. I think we are stronger than we've ever been. So I'd say, that's the shift. But from our purposes, it is still a competitive environment and we lean into it every single day."
},
{
"speaker": "James Faucette",
"content": "Great. Glad to hear that. And then wondering if you can give a little bit more color on the composition of bookings, especially between enterprise, mid-market and down market. And also, what are you seeing in the international business? And how should we think about the potential uplift there over time, as price points in lower-cost regions continue to improve?"
},
{
"speaker": "Maria Black",
"content": "What I would offer is that the down market had incredible strength by the way on top of incredible strength last year. I think I mentioned -- or I did mention during the prepared remarks, we onboarded, we sold and started 50,000 new clients in small business in the fourth quarter alone. So we are officially got 890,000 of our 1.1 million clients are in that down market space. And so we continue just to see broad-based demand. And again, we’re executing very well on that. Our mid-market sales results were phenomenal. Just an incredible execution by the team. Again, our product has been getting newer and stronger, so feel really good about that. I mentioned also in the prepared remarks what we saw in the enterprise space, specifically with respect to our next-gen HCM offering. One of the reasons I'm so excited about this is that we are seeing record results, we are seeing more than we anticipated, quite significantly more than we anticipated. And we are not even at general availability yet. And what that suggests to me is that the market is ready for this offering -- the market is excited about this offering. We see clients wanting to buy in the enterprise space from ADP, and we are stepping into that opportunity. So that's kind of the distribution. Very strong strength. You asked about international specifically. International had a fantastic year overall. So it was really the story of four quarters. I think first quarter of last year was strong over year-on-year first quarter of 2023. Second quarter got even stronger. Third quarter got even stronger than that. And fourth quarter, you'll probably guess got even stronger than that. So overall, our international business had just a fantastic year as well."
},
{
"speaker": "James Faucette",
"content": "That’s great. I appreciate all the color Maria."
},
{
"speaker": "Maria Black",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"content": "Hi, thanks for taking my question. I wonder if you could comment on how you're thinking about the balance -- striking a balance between pricing and retention and just sort of also speak to your confidence level about being able to take that 100 basis points of pricing, which I think is more than you took sort of pre-pandemic, although less than you've been taking in this really inflationary environment. How are you -- how confident are you that you can take that without tipping retention in the wrong direction?"
},
{
"speaker": "Don McGuire",
"content": "Thanks for the question Ramsey. Yes, it is a great question because we always think really, really hard about pricing decisions and making sure that we don't get greedy. As we've shared on many occasions, what we are interested in is long-term clients and the lifetime value of those clients. So we are always very, very careful not to over rotate on price. And you are right, we have been able to take about 150 basis points in '23 and '24. And as we look to '25 and we looked at the moderating inflation environment, we thought that 100 basis points is realistic. If we go back pre '23 and back into the teens we were more on the 50 basis points range, but the inflation environment was very, very different then it was virtually not existent. So we are confident that we can get 100 basis points. We are confident that we can target it in the right places. So it is something that we think is a reasonable expectation for us to target."
},
{
"speaker": "Ramsey El-Assal",
"content": "Okay. And a follow-up for me is about generative AI. And just if you could talk about how we should think about the long-term kind of opportunity there in terms of monetization. Is this ever something that could contribute to revenue directly? Or is this -- is generative AI sort of more something that will drive soft dollars to retention, new bookings? Obviously, there is an expense benefit internally. But I'm just curious about how you're framing it up over the long term."
},
{
"speaker": "Maria Black",
"content": "It's a great question. My answer to you would be both. And so from a generative AI perspective, I know you know that I love to speak about it. I talked about it again at length just this morning during the prepared remarks. What I’d offer is that all across, whether it is the focus we have of putting generative AI, ADP Assist across and into each one of our products, or it is the work that we're doing with putting ADP Assist into the market to help practitioners, or help our own service associates and our sales associates, the way I think about it, first and foremost is exactly what you suggested, which is it should feed the ADP model. And in its most simplistic form when I think about this company and driving the recurring revenue model that we have, it is about sales, it is about retention, it is about product efficiency and it's about NPS. And those four metrics generative AI and everything that we are offering as it relates to ADP Assist should feed, call it the machine of our model, right? So we should have more sales, we should be able to keep clients. Why? Because they are happier and they have a better experience as it relates to NPS. And then in turn, we also drive efficiency. So I think that's the output and the outcome of a lot of the investments we are making. That said, as we look at all the use cases and both the short-term stuff that we're working on, as well as the long-term vision of what ultimately generative AI could look like in the coming years, we do see monetization opportunities. And each one of our business cases, as you can imagine, has clear goals of what it is that we are trying to accomplish, inclusive of revenue growth. I think it's too early to start sharing some of those broadly across the market. But certainly, that's a big piece of our strategy, as is making sure that we continue to drive the transformation type of opportunities that we've been driving for years as a company."
},
{
"speaker": "Ramsey El-Assal",
"content": "Fantastic, thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"content": "Hi, good morning. Thanks for taking my question. Don, maybe one for you. Just on the PEO guidance, and I apologize if this question is kind of a dumb question, but I just want to make sure I understood it. If I look back to last year, you had actually a slightly better WSE assumption, and you guided to 3% to 5%. And this year, you are assuming lower WSE growth but actually slightly better revenue growth. And I was just trying to reconcile those two things. Is retention assumptions the big difference there? Or is there some other mechanical thing, it is easier comps? I'm just trying to understand the PEO guidance this year versus last year."
},
{
"speaker": "Don McGuire",
"content": "No, Samad, it is a great question. So there are a few things happening if you look forward to 2025, revenue is growing, but the biggest contributor to the revenue growth is zero margin pass-throughs. So that's the largest component, and that's what's happening there. And then, of course, we have mentioned earlier that pays per control are under pressure. So as I said in an earlier answer, 1% to 2% for ES, and we think more towards the low end of that for the PEO area. And then we have a little bit of pressure from workman's compensation on the margin. And I guess the third thing is we do continue to focus on the area to get sales reaccelerating. So we certainly have more selling expense baked in to that business to help drive the top-line and make sure we get to continue to grow our worksite employees."
},
{
"speaker": "Samad Samana",
"content": "Understood. And Maria, if I take just one huge step back, the business is very strong right now, and it seems like that's happening in what is a backdrop that is slowing. And so I just was wondering, you've been at ADP for a long time, you've seen multiple cycles, can you just remind us that when you see a broader slowdown in the backdrop, just kind of how you still are able to drive value and what the performance of the business has historically been in these slowdown periods, because I think we are all impressed by the durability of the strength even as things may be slow in the backdrop?"
},
{
"speaker": "Maria Black",
"content": "Yes. Thanks, Samad. And you are right. I think the durability of what it is that we offer, I spoke to it a bit earlier in terms of the imperative of HCM, I think that durability also lends itself to a different environment should the macro change. So the sales force of ADP, if you will our offering is great in times of growth, it is great in times of steady, and it's also great as a conduit as there might be pressure in the employer environment. And so the value proposition, we have a playbook. We can adjust very, very quickly in terms of what it is that we offer and the demand environment -- as the demand environment shift. Now that said, should there be a huge decline in the macro, of course we will be impacted. One of the things that does end up getting impacted is bookings. But at the same time, from a standpoint of the self-adjustment of that value proposition, it’s very durable, and it is very durable, as a result of HCM being an imperative. And so we feel good about our ability to flex. And I've seen that, to your point Samad, I've been here a long time, as a student of ADP's great distribution, and I've seen that flex over time and have all the confidence that the team would do the same. I think maybe Don could also talk about the -- how that financial model, should something shift in the market, the financial model also self-adjusts as it relates to the playbook, if you will in a different macro."
},
{
"speaker": "Don McGuire",
"content": "Yes, certainly. We've talked about this before. But if we go back a year or so, I think -- or maybe 18 months, the word recession was on people's lips a lot more frequently than it is today. I think the latest survey I've seen says that there is about a 28% probability of recession in the next 12 months. I'm sure that's some survey that the rest of you have read somewhere as well. So the good news is, it looks very unlikely that we are going to have a recession over the next 12 months. But certainly, as an all-weather company, what we do isn't discretionary. You have to do it. The levers we have, if sales slow commissions slow, if implementations slow, we don't need as much headcount, et cetera, et cetera. But I think, as we saw in 2008, it took a long time for ADP to find itself in a place that looked like a lot of adjustment. So we think that we can use those tools again should we need to. But I'll just finish with hopefully, that survey is correct and nobody is thinking about a recession in the next 12 months."
},
{
"speaker": "Samad Samana",
"content": "Great. Appreciate. Have a good day. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"content": "Hi, good morning. And thanks for taking my questions. Congrats on the strong bookings in the fourth quarter as well as the really strong retention. I wanted to dive a little bit deeper into both. With regards to the strong bookings, Maria you cited on the small business side, RUN doing extremely well, getting 50,000 new clients. Can you talk a little bit about what the source of those clients are? Were those clients that were using competitive solutions? Were they brand-new business formations? How would you characterize that? Where are you seeing the strength and the takeaways from?"
},
{
"speaker": "Maria Black",
"content": "Sure. So on the down market specifically as it relates to bookings, the bookings again are broad-based, right? So where are we getting them? We are getting them from digital inbound, we're getting them from new businesses, we are getting them through the ecosystem of our channels, so clients that are engaging with banks, CPAs. Again, we canvass the entire market. That said, some of the things that we have seen, Mark year-on-year new business formations, it is still at an elevated rate, but it is pressurized. So sorry, year-on-year, it is minus 3%, but it's still elevated compared to norm. And so as a result of that, we did see less coming this time from new business formations. Now we had a lot come from new business formation, but we also saw an increase in balance of trade, some more coming from the competition. So what I would say is mix shifted a little bit in terms of how we broadly canvass the down market. All that rolled up to this incredible result of 50,000 units in the fourth quarter. So it is broad-based, but there are tiny bit of shifts within that to answer your question specifically."
},
{
"speaker": "Mark Marcon",
"content": "Great. And then on next-gen HCM, you also mentioned a 50% pickup there in terms of new sales. And this is before you are fully GA. Can you talk a little bit about what the source of the wins are in terms of -- are these clients that are transitioning from older ADP platforms? Or are they coming from competitors? And if it's from competitors, what sort of competitors?"
},
{
"speaker": "Maria Black",
"content": "Sure. The answer is both and also head-to-head against competition. So some of them are ADP upgrades. We did see more new logos than we've seen before. So we are really excited about the net new wins to ADP. Some of those were wins and takeaways from enterprise competitors. Some of them were wins head-to-head against the same said enterprise competitors, which again is probably why I'm so optimistic about it, because it appears that the offer that we have is competing incredibly well in the market and clients are choosing ADP."
},
{
"speaker": "Mark Marcon",
"content": "That's great. And then with regards to client retention, I know you are guiding prudently for a normalization. But it seems like your client satisfaction scores continue to trend up. How would you characterize the primary drivers of the improved client satisfaction? Is it the solution set? Or is it the service underlying, or a combination of both?"
},
{
"speaker": "Maria Black",
"content": "It is a combination of both. NPS is fantastic. So NPS for the quarter as well as the full year was a record. Almost every single business is at a record NPS. So what drives NPS? It is that both, right? So it is the investments we've made into our best-in-class products. And this is years that we've been making these investments and making our products newer and more modern taking friction out, making them more self-service. All of these things that go into having best-in-class HCM technology, those investments coupled with best-in-class service, is driving the broad NPS record that we have across the business. So as such, that is a direct correlator to a record retention. And so we are really proud of the 92%. You are right. We're prudently guiding into the year again. And the reason behind that is, as you know we've had this conversation many times, is that there is still perhaps some normalization that could happen, and also because we are executing at all-time highs almost across every single business. We just want to be thoughtful as we step into the year to make sure that the retention guide is prudent."
},
{
"speaker": "Mark Marcon",
"content": "Got it. Thank you."
},
{
"speaker": "Maria Black",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Tien-Tsin Huang with JPMorgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Hi. Perfect. Just want to extend on the retention, but more on the outlook side, if that's okay. Just any callouts expectation-wise across the segments, small, mid and large? I know you've commented on balance of trade already, but I didn't know if you are seeing anything different in terms of expectations on retention."
},
{
"speaker": "Maria Black",
"content": "Yes, fair. What I would offer is it is the same reason that we guided into the year, this year the way that we did, this year that we just closed, it is expected potential normalization in the down market. Now I've been saying that for the last couple of years. It isn't -- yes I know. The down market isn't entirely normalized back to where it was pre-pandemic. Now I get that that's five years ago and it may be at some point, we all have to just suggest that it is the new normal. But we haven't seen an uptick in bankruptcies, out of business at the levels that we used to see in that business. And as such, we believe it is prudent that there could still be some of that normalization. So it's really the same thing that we've been suggesting. It just hasn't happened yet. And our goal would be of course, to not have it happen again."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Yes. And you did outperform, obviously the guidance you set last year this time, so okay. No, I just wanted to check. I think this -- again, you've said prudent and totally agree with that. Just my quick follow-up just is on the margin front. I know it is very typical margin expansion. I think you did call it last quarter, maybe a little bit more investment in G&A. Anything different in terms of incremental margin outlook for fiscal 2025? It does look like you have a workforce rebalancing in the fourth quarter as well. So I just want to make sure we call it the puts and takes there on the margin front. Thank you."
},
{
"speaker": "Don McGuire",
"content": "Yes. So Tien-Tsin, thanks for the question. I think that we are always -- I'll start with where you ended there. We are always looking at the workforce and making sure we're -- we've got the right people in the right places and the right numbers of people in the right places. So we're always looking at that. I don't think there is any real specific callouts on the margin. I think that there are some Gen AI investments. These are modest, but they do attract 10, 20 bps here and there, so to speak. But they are modest all things considered. Certainly, the margin next year would get a little bit of pressure from lower pays per control from lower pricing increases and from lower client fund interest, specifically -- most specifically in the back half. But I think those are all things that we've called out and you can read through. So nothing abnormal."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Yes. No, glad to see it's typical. And congrats to Danny and Matt as well. Thanks guys."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open."
},
{
"speaker": "Bryan Keane",
"content": "Hi guys. Congrats on the quarter really strong in ES. On PEO, the bookings were accelerating and recovering in fiscal year '24 but moderated towards the end of the fiscal year. So just want to understand what changed in the marketplace there."
},
{
"speaker": "Maria Black",
"content": "Sure. Thank you by the way. I appreciate the congrats. PEO bookings did moderate a bit in the back half. And from a year-on-year perspective, it did moderate as well. That said there was still strong growth in PEO bookings. And so from my vantage point, the demand equation is still incredibly strong for the PEO. It was a slight moderation year-on-year. We feel really solid about the demand for the offer, the value proposition of the offer, and we feel solid about pipelines in the PEO. And as you know, with pipelines in the PEO, it is more about activity in the market, new appointments, requests for proposals, things of that nature. So all the bellwether signals show that the PEO strength is still there, but it did moderate a bit in the back half."
},
{
"speaker": "Bryan Keane",
"content": "Yes. And just a follow-up just with thinking what would it take to get PEO back to high single-digit or double-digit revenue growth that was targeted previously?"
},
{
"speaker": "Don McGuire",
"content": "Yes. Hi Bryan, I think it's going to take a little bit of time. And we were working, and as I mentioned earlier, we are seeing some more margin pressure in PEO, and some of that is because of the investments we are making in the sales force to make sure we can get those bookings going. But realistically, to get to kind of Investor Day guidance that we provided three years ago, it is going to take some time to build that back. So we are definitely focused on that, and we are definitely focused on getting there. Of course, if we were to see some reacceleration in the pays per control, that would put lots of wind in the sails, but it's going to take a little bit of time to get back to where we want to be."
},
{
"speaker": "Bryan Keane",
"content": "No, that makes sense. And congrats again."
},
{
"speaker": "Maria Black",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Scott Wurtzel with Wolfe Research. Your line is open."
},
{
"speaker": "Scott Wurtzel",
"content": "Good morning guys. Thank you for taking my questions. I wanted to go back to the margin guidance and just the context of seems like slower expansion in the first half versus second half. Wondering if you could maybe walk us through the drivers there. Is that more on the shape of revenue, or does it have anything to do on the cost side? Thank you."
},
{
"speaker": "Don McGuire",
"content": "No. Good question, Scott. More on the shape of expenses. Revenue expectations throughout the year are pretty consistent quarter-to-quarter. It is really some spending patterns we have in the first half of the year, but really nothing specific to call out. Just want to give folks a heads up that we think we are going to be stronger in the back half than the first."
},
{
"speaker": "Scott Wurtzel",
"content": "Got it. That makes sense. And just as a follow-up on the international side. I mean it seems like you're making some good traction on incremental countries and geographies. And we'd love to just kind of hear about your sort of expectations for international heading into this year, how much of it is a priority for you relative to maybe other investments in the business and where you're maybe seeing opportunities internationally."
},
{
"speaker": "Maria Black",
"content": "Yes, fair, Scott. It is a very large priority for us. As you may remember, our third strategic priority is to benefit our clients with our global scale. International fits squarely into that strategic priority. We've been building this business for 50-some odd years. We are well ahead of the competition, as it relates to the number of countries that we serve on behalf of our clients, and moreover the infrastructure in those countries that we've built out. So we often speak to the final mile and all the things that we do to ensure that our clients have the ability to pay across very complex, sometimes large complex clients or countries, and sometimes very small complex countries. But certainly, it is a big piece of our offer. I think companies continue to want to think about their system of record from a global perspective, as they continue to have distributed workforces across the globe, as they continue to move supply chains in this world of globalization, as they have remote employees in smaller countries and around the world. We have this incredible network and ability to support clients today in what is 141 countries, and we continue to add more, as they become prudent in terms of the -- again, if it is the growth economies or where our clients are heading. But it is a big piece of our growth story. It's a big piece of our differentiation in the marketplace. And our multi-country MNC business is a clear competitive advantage for us in the international space."
},
{
"speaker": "Scott Wurtzel",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from Jason Kupferberg with Bank of America. Your line is open."
},
{
"speaker": "Caroline Latta",
"content": "Hi. This is Caroline on for Jason. Thanks for taking our question. Can you talk about the duration of the portfolio? We were a little surprised to see that the F’25 average yield is expected to be up year-over-year based on the number of rate cuts being forecast. And maybe how you might be adjusting your investment strategy for the portfolio based on the interest rate outlook for the next 12 months."
},
{
"speaker": "Don McGuire",
"content": "Caroline, thanks for the question. So we do have a laddered strategy. So if you actually refer to the -- I think, the last page of the earnings release, I think you can see the maturity schedule for our investments. And you can see that, for example in 2025, we have $6 billion that's maturing at roughly 2.2%, and our reinvestment at this point in time is 4.2%. So there's still lots of opportunity, and this is a place where ADP's laddering strategy shows its strength. It is fair to say that over the last couple of years, because of the inverted yield curve, we did have some opportunity cost by having this strategy. But I think we are very much seeing that as yield curves start to normalize, that we still have lots of opportunity for client funds interest growth. I’d just add to that that the portfolio is continuing to grow. It's growing 3% to 4% again next year, maybe not as much as it has in the past couple of years because wages have moderated a little bit, pays per control moderated a little bit. But we are still seeing good growth in that area. So we still have lots of opportunity. And the most important thing here, the most important comment I can make on this whole fund strategy, is that we base all of these commitments or all of these expectations on the current yield curve. We're not trying to outguess the market. We're looking at what the market in general has to say. And we are using those yield curves to put together our forecasts and our guidance on interest rates."
},
{
"speaker": "Caroline Latta",
"content": "Okay, that’s helpful. Thank you so much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Ashish Sabadra with RBC Capital Markets. Your line is open."
},
{
"speaker": "David Paige",
"content": "Hi. This is David Paige on for Ashish. Thanks for taking our question. I just wanted to circle back to the workforce optimization charge that we had in the quarter of $42 million. Should we expect further workforce optimization in 2025? And if yes, how much of that there, what's the benefit to the EPS guidance for '25 as well? Thank you."
},
{
"speaker": "Don McGuire",
"content": "David, as Maria has shared earlier, I mean, we're always looking to make sure that we've got the workforce at the size it needs to be and in the places it needs to be. So we made those difficult decisions that we had to make on behalf of some of those employees. But we always look at this. And if you look at ADP over the years, we've always done what needed to be done to go forward. So I would just leave it at that and say that we're very happy with the guidance we put out here and the margin guidance as well. So we will make sure that we do what we need to do to execute, and we'll see what the future brings. But as we sit here today, we've done what we need to do, and we are looking forward to the future."
},
{
"speaker": "David Paige",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"content": "Good morning. I know you've talked about the strength in bookings quite a bit. And I'm just wondering from an enterprise sales standpoint if there is been any change. Is the sales cycle lengthening at all? Are enterprises maybe asking to buy less modules they have in the past? Any kind of change or has it been pretty much status quo and really no change from a demand or a sales cycle standpoint?"
},
{
"speaker": "Maria Black",
"content": "Fair. It is a great question. I think we talked about it a bit last quarter and perhaps throughout the year, which is that we're really at a new normal, as it relates to the overall sales cycles. It is reminiscent of what it used to look like pre-pandemic. But arguably, there are more decision-makers involved. The process has elongated a bit from where it was during the height of the pandemic. But the deals are moving through the motions. I would say that they are moving through the motions pretty typically. But certainly, it's not as fast as it was at one point in time. But we're not seeing less modules. We are seeing a big conversation around global, a big conversation around global system of record, things of that nature, which again is where this next-gen HCM fits squarely into that demand. So the conversation shifted a bit, but that is not necessarily new news, Kartik. It's really what we've seen over the last couple of years, as a byproduct of how clients in that enterprise global space operate. So certainly, that's how we are leading what that best offer kind of across the enterprise and international space. But from a deal cycle standpoint, it is pretty similar to what we've seen throughout this year, which is more decision-makers involved and prudency, as it relates to the decisions that are being made, but not necessarily less modules or anything of that nature."
},
{
"speaker": "Kartik Mehta",
"content": "And then just on the small business side, I mean as you look at the health of the small business, anything that is changing or anything that would give you concern just as people get worried about the economy, or change in behavior?"
},
{
"speaker": "Maria Black",
"content": "Yes. Great question. So we monitor so many of these things, right? So I spoke to one of them earlier, which is the pace of new business formation. That tends to be a bit bellwether. Again, it is still elevated from norms, but it is down year-on-year. We are also monitoring our own out of business. We are looking at clients that call it suspend payroll and how many are sitting in that type of capacity. These are all things and metrics that we've monitored for years to ensure that we are kind of seeing what is happening real time, if you will. What I would say is there are little pockets, very similar to the new business formation of kind of watch items that we have our eye on. None of it at this juncture gives us great pause. Quite the opposite. But at the same time, we are monitoring these things to make sure that we don't get surprised as it relates to the shift should there be one. But there hasn't been one yet."
},
{
"speaker": "Kartik Mehta",
"content": "Perfect. Thank you so much. I really appreciate it."
},
{
"speaker": "Operator",
"content": "Thank you. There are no further questions. I'd like to turn the call back over to Maria Black for any closing remarks."
},
{
"speaker": "Maria Black",
"content": "Great. Thank you. So I will end where I started, which is I'd like to take this opportunity to thank our 64,000 associates. All of the results that Don and I have the pleasure of getting on this call to represent, they are a byproduct of 64,000 associates that are all incredibly committed to having the best-in-class technology, the best service, and the biggest, broadest global scale. And everything we do, whether it is from product innovation to our contracting process, to our sellers, to our service associates, it really takes the entire company being aligned on what I would suggest is a commitment to client and client centricity. In that spirit, I'd also like just to take a minute to thank our 1.1 million clients. I will tell you, as we celebrated the 75th anniversary of ADP, it was quite a remarkable moment to think about all the clients that we've impacted over 75 years and had the honor of contributing to their journeys of success and navigation. So definitely want to take a minute to honor all of our clients. And then last but not least, all of you who dialed-in today. I appreciate you joining us. I appreciate your interest and your investment in ADP. And I look forward to speaking with you soon."
},
{
"speaker": "Operator",
"content": "Thank you for your participation. You may now disconnect. Everyone have a great day."
}
] |
adp | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning, my name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Third Quarter Fiscal 2024 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the call over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danny Hussain",
"content": "Thank you, Michelle, and welcome everyone to ADP's third quarter fiscal 2024 earnings call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risks. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria."
},
{
"speaker": "Maria Black",
"content": "Thank you, Danny, and thank you everyone for joining us. This morning, we reported strong 7% revenue growth and 14% adjusted diluted EPS growth for the third quarter as we continued to make progress delivering against our strategic priorities and as the labor market and the overall HCM business environment remained stable. I'll begin with a review of the quarter's results and provide a brief update on our strategy before turning it to Don to update you on our outlook and share some early considerations for next year. In Q3, we delivered solid Employer Services new business bookings growth reaching record bookings for our Q3 period and keeping us on track for our full-year outlook. We maintained momentum in our small business portfolio with particularly strong growth in our retirement services offering, and in Q3, we also delivered strong bookings results in our midmarket, enterprise and international businesses. With a steady demand backdrop and a healthy new business pipeline, we are focused on continuing to execute for the remainder of the year. Employer Services retention was very strong in the third quarter and once again exceeded our expectations also reaching a new record level for our Q3 period led by our midmarket business. Our overall retention continues to benefit from ongoing investments in our key platforms and from our commitment to delivering an exceptional client experience, which together helped our client satisfaction scores reach a new all-time high for our Q3. Our Employer Services pays per control growth was steady at 2% reflecting the resilient overall U.S. labor market and the fact that our clients continue to add to their workforces at a moderate pace, and our PEO revenue growth of 5% for the third quarter was in line with our expectations despite continued short-term pressure from below normal hiring activity we've been experiencing among those clients. Moving on to a broader update, we continue to push forward on our three strategic priorities, leading with the best HCM technology, unmatched service and expertise in a broader scale to ultimately deliver the best possible experience not just to the buyers of our products but everyone that engages with ADP. We are investing with purpose to deeply understand and deliver value to a vast set of personas from small business owners that count on us to HR professionals and executives of the largest global enterprises to millions of employees and gig workers around the world who engage with our solutions through CPAs, banks, brokers and other key partners to our thousands of dedicated service and implementation associates and to our sellers who represent ADP in the market every day. It's with these personas in mind that we continue pushing forward on our strategic priorities, and in Q3, we made steady progress. Our first priority is to lead with best-in-class HCM technology. We've been rolling out ADP Assist these past couple of quarters, which as a reminder will be embedded in our key platforms and utilizes GenAI to surface insights, aid decision-making and streamline day-to-day tasks for our clients and their employees. In Q3, we were very excited to begin piloting a new feature that enables our small business clients to not only leverage GenAI to answer questions and better understand how to initiate an HR action which we outlined in recent quarters but to actually allow them to issue commands to complete that HR action. For example, users can now type I need to rehire Alex or I would like to give Alex a leave of absence and are expedited through that workflow. Our second priority is to provide unmatched expertise in outsourcing. We continue to extend GenAI capabilities to a broader portion of our service associates, and in Q3, we started rolling out a new tool for some of our implementation teams. Now they can use GenAI to take in unstructured client employee data reducing manual data entry and minimizing errors during the implementation process. While it's still early, we are excited about its potential benefits. Our third priority is to benefit our clients with our global scale. The ADP marketplace remains a differentiator for us and is a perfect example of a benefit our clients receive from partnering with the leader in HCM. As a growing number of our hundreds of partners offer AI-enabled solutions, in Q3, we established ADP marketplace AI principles that require our partners to commit for the same type of responsible AI principles that govern our own products including human oversight, monitoring, explainability and mitigating bias. Our clients put a huge amount of trust in us and this is another example of how ADP strives to ensure the responsible use of AI throughout the ADP ecosystem. We also continued to extend our market-leading global scale, and in Q3, we reached 1 million paid employees on our I-HCM platform, which continues to scale in several countries in Europe and we made further progress in growing our presence in the APAC region, where we have recently been expanding our in-country payroll and workforce management presence in a number of markets. In 2024, we are celebrating our 75th anniversary and we pride ourselves on having built ourselves into a brand that truly matters to employers, their employees and the broader world of work. Our focus on our strategic priorities positions us to deliver more value than ever for our over 1 million current clients and to the tens of thousands of new clients we welcome to the ADP family every quarter. I'd like to highlight just a few of these new client wins from Q3 to give you an appreciation for the variety of ways in which we deliver value for them. In U.S. small business, we had a new Boutique Donut Shop referred to us from one of our CPA partners. The client chose ADP for the strength of our run platform, our reputation for great service, our strong relationship with our CPA and our ability to provide retirement services. Since this was a first time small business owner, our sales team even took the time to help the business owner set up their business the right way from guiding the client on obtaining a state tax ID to making sure the client obtained the appropriate workers compensation insurance. In U.S. midmarket, we won a multistate operator of rehabilitation centers, this client wasn't happy with our prior HCM provider and Workforce Now proved a much better fit. What makes me the most proud in this example is how one of our ADP marketplace partners played a key role in the decision to switch to ADP by independently highlighting the advantages we offered in terms of ease of integrations, a capability we have invested in over the years. In U.S. enterprise, we welcomed a large luxury resort that operates multiple hotels, restaurants and retail stores on site and was dissatisfied with the prior provider's level of client service. The client was so happy following their seamless ADP implementation, which included onsite training for their HR team that they accelerated their plans to add-on features like benefits, recruiting, onboarding, wage garnishment and tax credits. In our International business, one recent win was a leading airline that utilized ADP in certain countries and asked us to help better define their global payroll strategy. Ultimately, they expanded the scope of our services to include in additional 18 countries and started that rollout in the third quarter with plans to add other countries over the next year to enable true consolidated global reporting and analytics. And as a final example, our HRO team started a New York-based design firm after its leadership team recognized the company lacked the HR infrastructure required to adequately attract and retain the right talent. They turned to our PEO offering for truly comprehensive support, attracted by the breadth of our offering including features like the MyLife Advisors program, which supports employees as they make benefit in other important life decisions. We also advise this client in the development of a comprehensive benefits strategy to support their multigenerational workforce and help them attract the talent that they need to grow. As you can tell from these examples, it's often a combination of our technology, expertise and overall breadth that resonated with these businesses, and the result is incredible diversity in our client base and a resilient overall business model. We look forward to leaning in and delivering even greater differentiation in the market going forward. Overall, we were pleased with the strong financial and strategic outcomes in the third quarter. I'd like to thank our associates who continued to deliver exceptional products and service to our clients, in whose efforts drive these client wins and retention. Thank you again for all you do for ADP and for our clients. And now, I'll turn it over to Don."
},
{
"speaker": "Don McGuire",
"content": "Thank you, Maria, and good morning, everyone. I'll provide more color on our results for the quarter and our updated fiscal 2024 outlook. Overall, we reported a strong third quarter with our consolidated revenue growth and our adjusted EBIT margin coming in a bit above our expectations. The interest rate backdrop has improved since we last provided our full year outlook, so we are updating our outlook for that as well as making a few other changes, which I'll detail. I'll start with Employer Services. ES segment revenue grew 8% on a reported basis and 7% on an organic constant currency basis. As Maria shared, we had a good quarter in ES new business bookings with broad-based growth across our client segments. We have a tough compare in Q4 following last year's strong finish but with a steady HCM demand environment and healthy pipelines, we feel on track to deliver our 4% to 7% new business bookings growth outlook for the year. Also, as Maria mentioned earlier, our ES retention exceeded our expectations and increased slightly from last year. Given our continued strong retention performance, we are increasing our full-year retention outlook slightly, we now anticipate a 20 to 30 basis point decline in full year retention which is better than our prior forecast. ES pays per control growth held steady at 2% in Q3 and we now expect growth to round to 2% for the year, the high end of our prior 1% to 2% growth outlook, and client funds interest revenue exceed our expectations in Q3 due to higher average client funds balances and a slightly better average yield. We are revising our full-year client funds interest outlook to reflect our Q3 results and the increase in prevailing interest rates since our last update. We now expect fiscal '24 average client funds balance growth of about 3% and we are raising our expectations for client fund's interest revenue and net impact from our client fund's extended investment strategy. In total, there is no change to our fiscal '24 ES revenue growth forecast of 7% to 8%, although we are now likely to come in towards the higher end of that range. Our ES margin increased 230 basis points in Q3, driven both by operating leverage and the contribution from client funds interest revenue growth. With our strong Q3 results and the slightly more favorable client funds interest rate backdrop, we are raising our fiscal '24 ES margin outlook and now anticipate growth of 180 to 190 basis points. Moving onto the PEO. We had 5% revenue growth driven by 3% growth in average work site employees in the third quarter, representing slight acceleration from the first half of the year. These results were largely in line with our expectations and we were encouraged by the gradual stabilization in our PEO's pays per control growth which decelerated but only slightly from the prior quarter. We continued to anticipate soft pays per control growth through the end of the year and expect work-site employee growth to hold steady at about 3% keeping us on track for our full-year outlook for work-site employee growth of 2% to 3% and revenue growth of 3% to 4%. PEO margin decreased 220 basis points in Q3. As we shared last quarter, we expect this year's workers' compensation reserve release benefit to be significantly lower than what we experienced these last few years, and in particular, last year's $73 million benefit. We are updating our fiscal '24 outlook to now assume a minimal release benefit, and as a result, we are further revising our overall PEO margin expectation to be down 120 to 140 basis points in fiscal '24 versus our prior expectation for a decline of 80 to 100 basis points. Putting it all together, there is no change to our fiscal '24 consolidated revenue growth of 6% to 7%. With the two changes to segment margins, largely offsetting one another, we continue to expect our adjusted EBIT margin to increase by 60 to 70 basis points. We still anticipate an effective tax rate of around 23% and we continue to expect fiscal '24 adjusted EPS growth of 10% to 12% with the middle of that range still the most likely outcome. As we look ahead to fiscal '25, I wanted to share a couple of early thoughts at this point. First, give them the fullness of the labor market, we are planning for pays per control growth to once again be below normal levels next year and to decelerate modestly from this year's growth level in both ES and our PEO segments with the resulting revenue pressure more apparent in the PEO segment given its more direct revenue sensitivity to work-site employees. We will of course share those exact assumptions with you when we give our formal guidance in a few months. On the expense side, we are also planning to continue growing our GenAI related spend next year. As you've heard from us all year long, there are many ways we can put GenAI in the hands of all of the different stakeholders that work with or on behalf of ADP, including our client practitioners, their employees, our service and implementation teams, our sellers and our developers. These are critical investments and they are the right investments for ADP, but we expect the associated benefits and productivity of growth to phasing gradually over time likely representing overall margin pressure for the year. At the same time, we appear positioned for continued tailwind from interest rates, though the extent of this benefit will of course depend on how the yield curve continues to develop. As usual, we're focused primarily on maintaining good momentum in our new business bookings and maintaining our strong client satisfaction and retention and we remain upbeat about our strategy for the years ahead. And now over to Q&A."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Our first question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Owen Callahan",
"content": "Hi, this is Owen on for Ramsey. Thanks for taking our question this morning. So, you're currently entering your open enrollment season for client benefit elections within the PEO. I was wondering if you could talk about trends you're seeing there thus far, you called out some stability in regard to insurance price inflation driving more attached rates, are you seeing any of this follow through? Any thoughts there might be helpful. Thanks."
},
{
"speaker": "Maria Black",
"content": "Good morning. I was going to say good morning, Owen. How about I start and I'll let Don chime in. I think the comment would be, just to start, we are smack in the middle of our open enrollment season exactly as you suggested, and so, it's probably too early to make a call in terms of what that's going to look like from a full year perspective on the retention side. But overall, we have seen a bit, a tiny bit of PEO retention improvement this year and the compares are getting a bit easier and we do expect some improvement for the full year. So with that, I'll let Don chime in."
},
{
"speaker": "Don McGuire",
"content": "Sorry, I jumped again there. So, Maria, thank you. Perfect answer. Thank you."
},
{
"speaker": "Owen Callahan",
"content": "Great. Super helpful. And then, if I may, just on client retention continues to sort of surprise to the upside, I was wondering drivers there, I previously thought potentially fewer bankruptcies in the down market but any expectations more longer term might be helpful there?"
},
{
"speaker": "Maria Black",
"content": "Yes, absolutely. We're very pleased with the overall retention results. I think you see that in our revised outlook, you see that in the revision we made last quarter as well. And so, just to remind everybody just how well retention is going, fiscal '23 was a record, that record was really driven by the mid-market and international and the down market actually did decline a bit in fiscal '23 and we expect pretty much the same outlook, if you will, for full year '24, which is why we still have a down year-on-year retention result, but we're incredibly pleased with overall what we're seeing with client retention, that's really being led by a combination of things, one of which is the investments we made into product, the record results we have in terms of client satisfaction, that in and of itself was a record in the third quarter, along with retention. So, we're very, very pleased with that. As mentioned, there's still down market variability and there's down market out of business. We haven't seen it thus far this year but we still expect it to normalize a bit further. And then there's always normal variability in retention. So, we believe the retention guide is the appropriate one, but certainly we're very pleased with the record quarter and where we sit with retention thus far this year."
},
{
"speaker": "Owen Callahan",
"content": "Great. Super helpful. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Bryan Bergin with TD Cowen. Your line is open."
},
{
"speaker": "Zack Ajzenman",
"content": "Hi, thanks. This is Zack Ajzenman on for Bryan. First question, just want to dig in on the ES revenue growth affirmation despite the higher retention at PPC views, heard that you might come in towards the higher end of the range, but perhaps you can elaborate on some of the underlying assumptions and any offset?"
},
{
"speaker": "Don McGuire",
"content": "Yes, so a couple of things, Zack. Maria already mentioned that retention is in very good shape for us, so certainly that's been helping and contributing to the revenue growth. And of course what's changed since last time around which is making us even more comfortable with saying we're going to be towards the higher end of the range is that client funds interest impact is very good. So, I think those are the two primary drivers to why we're more confident that we're going to see revenue come in towards the higher end of the seven to eight than we perhaps worth 90 days ago."
},
{
"speaker": "Zack Ajzenman",
"content": "Got it. And a follow up on demand ES new business bookings affirmed at 4% to 7% growth, what are the strongest segments of the market and any notable changes to call out versus the second quarter?"
},
{
"speaker": "Maria Black",
"content": "Sure. So, first and foremost, we feel good about the overall demand environments. Companies are still hiring as we saw today and they're still investing as such in people, in HCM. The call outs, I made a few of them during the prepared remarks, but it's really -- the down market continues to impress us this quarter specifically in retirement services, so I'd make a call out there, it's quite fantastic to see that story and retirement services come together. We talked quite a bit about secular tailwinds in that space based on legislation that coupled with the investments we've been making, an incredible distribution execution, really great to see the retirement services leading the way. I think other areas that I would call out that have been remarkably strong is our mid-market as well as international. And so, again, similar story to retirement services, and that it's really a great story coming together between investments and execution, and enterprise also was strong for us for the quarter. And in terms of anything changing broad-based, we haven't really seen anything change in the demand environment. Quite candidly, we feel really strong as suggested by the overall hiring landscape and the labor demand."
},
{
"speaker": "Zack Ajzenman",
"content": "Thanks very much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"content": "Hi, good morning, and thanks for the terrific updates. Client retention obviously really strong, obviously your scores continue to go up. Are there any areas that you would call out that are standing out in terms of driving the higher NPS scores and the higher client retention? Anything that you would particularly note?"
},
{
"speaker": "Maria Black",
"content": "Good morning, Mark. I would say to you mid-market on both of those. So, mid-market is driving the strong NPS scores to record highs. The mid-market is driving incredible retention. So that's the one call out. You can probably hear the optimism in my voice there because it's a fantastic story coming together, but I think overall retention is incredibly strong. The mid-market international in fiscal '23 were very strong, they continue to be strong, but that's really the one call out I would make is the mid-market."
},
{
"speaker": "Mark Marcon",
"content": "Great. And then Maria there's one area that investors have been asking more about and you have -- you and ADP have the broadest outlook with regards to the space, so I'm asking this on the call, but some people wonder a little bit about saturation, your new bookings continue to grow but investors are asking a little bit more about like how much room do we have for new solutions or how many clients have already upgraded, things of that nature? Your results and the results of some of your peers continue to blow their concerns, but I'm wondering if you could address those?"
},
{
"speaker": "Maria Black",
"content": "Yes, absolutely, Mark. I'll give it a shot and certainly happy to have Don chime in. Maybe he can talk a little bit about our growth opportunity in international, but I think, broadly speaking, when you think about the total addressable market of the HCM space and where we all play and we all compete and it's highly competitive and there's been a lot of investments coming into the space over the past few years. What I would suggest is there's still tremendous amount of growth and growth upside for all of us, and as you mentioned, we continued to deliver that and the results that we see on the new business booking side. And so, I think overall there is still runway, there's still plenty of space. I think the part for us outside of our incredible distribution organization which has always been a competitive advantage in how we go to market, that distribution is also anchored to our ability to upsell to the base. So you mentioned this ability to upgrade and how much has upgraded and are we all the way there? What I would suggest to you is, we're still at about 50% as it relates to new business bookings coming from, call it, new business, net new business versus upgrades, which suggests to me that we still have a tremendous amount of opportunity even within our base. And that's a lot of the focus that we have as an organization, whether it's in the PEO getting smarter about which clients within employer services that we target to offer to the PEO or it's the work that we're doing on generative AI to try to get upsell and offering the right product to the right client at the right time. And in my mind, bending the curve and continuing to focus on attach rates whether that's on the point of sale or omni-attach at a later time is definitely an opportunity for us to continue to deliver bookings in a very broad market that still has a tremendous amount of opportunity for all of us, but moreover, where we continue to execute and deliver on that. So, I don't know, Don, if you want to comment a little bit on international in terms of the opportunity there?"
},
{
"speaker": "Don McGuire",
"content": "Yes, perhaps to add a little bit more color, I think we're very still very optimistic about growth opportunities beyond the U.S. or the North American market. So, Mark, I think we've talked before we're on the ground in 40 plus countries outside of the U.S. We're present in multiple segments in those markets as well. We've got some great things happening in Southeast Asia where we're rolling out a single platform across beginning in India but many countries surrounding India and the Southeast Asian market. We're excited, we often talk about the fact that we pay over a million people in India, every payroll, every payday. Price points are still a bit low, but we expect those things to work for us and work in our favor in the future. So, I think still lots and lots of opportunity for ADP from a growth perspective and certainly we don't worry about saturation being a limiter to our future."
},
{
"speaker": "Mark Marcon",
"content": "That's what I thought. Thanks for -- appreciate the complete answers."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Scott Wurtzel with Wolfe Research. Your line is open."
},
{
"speaker": "Scott Wurtzel",
"content": "Hi, good morning, and thanks for taking my questions. I just wanted to go back to some of the early thoughts Don that you provided on fiscal '25 and talking about the GenAI investments and I think you had mentioned that there could be some margin pressure associated with that, and just wanted to clarify were you talking about potentially leading margin to be down year-over-year or are there other offsets with general operating leverage and interest income that can potentially offset the margin pressure from those investments? Thanks."
},
{
"speaker": "Don McGuire",
"content": "Yes, Scott, thanks for the question. I think it's still early. I think the intent here was to give some very early guidance on what '25 could look like. So, we still expect to see some improvements in margins. It's just, do we expect to see as much of an improvement given some of the GenAI pressures, expense pressures that we may see. Of course, CFI, at this point in time, depending what the yield curve does, once again things have changed a fair bit in the last 90 days, and if I was to, not that I have a crystal ball, but I don't think many folks right now are expecting anything to change from the rates perspective in the U.S. before September, so I think we're going to get some tailwinds from that. So, we're not really trying to signal here -- not signaling a decline in our margins, what we're signaling perhaps is perhaps a slower growth in the margins as we look into '25."
},
{
"speaker": "Scott Wurtzel",
"content": "Got it. That's super helpful. And then just wanted to go onto the PEO segment and going back to some of the verticals that we've talked about over the last year in technology and professional services, just wondering if you can update us on some of the trends you've seen there with pays per control growth. I mean, even looking at the employment report that you guys released this morning, it looks like professional services is stabilizing and increasing, but technology information seems a little bit choppy. So, just wondering if you can talk about trends in the PEO with respect to those verticals?"
},
{
"speaker": "Don McGuire",
"content": "Sure, so if I, you know, Maria talked a little bit about bookings, I think, so we've been, we were happy with our bookings. They softened a little bit in Q3, but we had a very, very strong Q2 on PEO bookings. We can move on kind of to the PPC growth. Back in Q1, it decelerated a little bit more than we anticipated, and a significant amount of that deceleration was attributed to the technology and professional services sector. And in Q2, that stabilized. So that was good for us. While there's still some headwinds in PPC, including from technology and service sectors, there were no surprises in Q3. So it's important to note that worksite employee growth accelerated, about 1% over Q2, despite the modest incremental pressure we had from PPC pressure. And so, and that, of course, is a function of the year-to-date booking success that we've had. So nothing really to call out. More stability, if you will, in PPC pressure than we've talked about previously."
},
{
"speaker": "Scott Wurtzel",
"content": "Great, thanks, guys."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Tien-Tsin Huang with JPMorgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Thanks, good morning. Thanks for going through all this. Anything on the pricing side worth sharing, Maria? Just thinking about some of the peer commentary out there. Any call-outs or interesting observations?"
},
{
"speaker": "Maria Black",
"content": "In terms of, from a standpoint of our price, or pricing in the market from a demand?"
},
{
"speaker": "Tien-Tsin Huang",
"content": "Yes, your pricing, or as you're thinking about resetting prices as you go into the usual seasonal time changes, price changes, any thoughts there? So both for new renewals as well as new deal bids?"
},
{
"speaker": "Maria Black",
"content": "Yes, absolutely. So I think my general sentiments, and then Don can give the kind of a little more directional, but my general sentiments around price remain that we're very thoughtful, and very measured as it relates to how we think about price, whether that's on the new business side, or it's on the renewal side, as you mentioned. And so for us, it's about understanding kind of by segment. So you heard my commentary in the prepared remarks, just how broad and deep and diverse ADP is, with respect to our client base. As you can imagine, we think about a down market, price increased differently than perhaps an enterprise. Some of those are also long-term contracts that have indexes attached. And so all of that lends itself to a very surgical approach, right? To ensure that the price value equation remains the right one, for the market and for our clients. And obviously at the same time, what we're doing is also monitoring what's happening in the HCM space with respect to the peer group and pricing overall. And I would say from a competitive lens, we haven't seen anything unusual as it relates to price from us or the others, even though it continues to be a highly competitive environment. And so as such, our approach this year to price, which I'll let Don comment on, has been very thoughtful and I would expect us to take that same measured approach as we had into '25."
},
{
"speaker": "Don McGuire",
"content": "Yes, so the price increase this year was relatively well-received. We're in the 100, 150 basis point range. We're closer to the 150. So happy with where we're at. But back to Maria's comments, we're in the middle of our planning cycle right now, and we'll look very carefully at that whole value equation, making sure that we keep our retention up. Our NPS is supporting that, and we'll make sure that we're mindful and thoughtful about what we do with pricing going forward."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Yes, no I'm sure it'd be thoughtful about it. Thank you for that. Just on the GenAI front, I respect the investments there. I'm curious if you were to classify it as either driving expense efficiency versus driving better sales efficiency, what are you really aiming for with some of these investments here for fiscal '25?"
},
{
"speaker": "Maria Black",
"content": "Oh. The answer is both. So I think it's really about solving for, again, all of the users that interact with ADP, right? So if you think about all the personas, our clients, our clients' employees, and our service agents, our sellers, it's really about putting GenAI in every part of our ecosystem. So in terms of what are we solving for, the answer is both. We're trying to drive greater service efficiency. I think, we've proven out that through digital transformation and taking friction out of our products and making those investments, we have the ability to drive up our NPS results and record client satisfaction tends to lead to similar record retention. So definitely working on ensuring that we're driving up retention. Obviously, the more happy clients we have, the easier it is for our sellers. We're also investing into generative AI for our sellers, to become more productive. So it is about service productivity. It's about seller productivity. It's about client experience. Client experience lends itself to retention. So I guess it's just one happy virtuous cycle, but I think - my answer is both, and all of it is what we hope to gain. Now, again, kind of back to the investments we're making and what Don alluded to in terms of any pressure we would have with respect to margin on those investments. Some of these investments, we know they're the right thing for ADP, but they will take time to ultimately garner all of the results, in all of these categories that I just mentioned. And so, as it stands today, we have some really exciting things that we're seeing. If you think about something, like call summarization that I've spoken about in the past. And we're shaving off roughly a minute per call, that doesn't probably sound that exciting. But you think about a minute per call over time, and you think about how many calls we take broadly across ADP in a given year. The math lends itself to over time, tremendous efficiency, and again, hopefully a better experience, right? So I think the answer is all of it. We're solving for all of it."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Understood. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "Unidentified Analyst",
"content": "Hi, everyone. It's [indiscernible] for James. Thanks for taking our question. Just one for me today. You mentioned coming in at the higher end of the range on ES for the full year, which makes sense given some of your commentary on booking strength, better retention, pace for control, improvement in the float benefit that we're seeing. But given all of those factors, it looks like ES in the quarter came broadly in line with our expectations, despite all of those tailwinds. So I'm curious, given your commentary about price coming in towards the higher end of your historical range, what does that imply just in terms of what you're seeing on the net new side, as well as cross-sell and upsell? Thanks."
},
{
"speaker": "Don McGuire",
"content": "Yes, Michael, thanks for the question. I think that, first of all, the price, there's no change in that. I think we've been calling that out for most of the year, certainly in the one to 150 range. So not much of an incremental impact, if you will, for Q4 and therefore for the year in total. So not a lot of change from that. Yes, I mean, bookings, we called out, we're still in the hunt for delivering on the range as we declared, so we're still in that so. But not really a lot to drive incremental revenue, other than some of the float, but as the year shortens or we have fewer months, days left in the year, the impact from higher CFI is going to be somewhat muted as we look to finish the year."
},
{
"speaker": "Danny Hussain",
"content": "Hi Michael, it's Danny. If you're wondering whether there is some offset somewhere else, there's a little bit from FX moving adversely relative to our prior expectations."
},
{
"speaker": "Unidentified Analyst",
"content": "Got it. Thank you both."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Pete Christiansen with Citi. Your line is open."
},
{
"speaker": "Pete Christiansen",
"content": "Good morning. Thank you for the question. Maria, you gave great explanation of the wallet share opportunity that still left earlier, PEO, propensity modeling with GenAI and then international. I want to dig into the international side a little bit, particularly some of the newer markets that you're getting into. I'm just hoping you can give us a bit of a progress report on a lot of the last mile infrastructure that, you've been putting in place, go-to-market, ramping that up. And I'm just curious, should we think of like the deployment of PI, the next-gen payroll engine in the international, as a real catalyst - for the next leg of booking growth? Thank you. I appreciate it."
},
{
"speaker": "Maria Black",
"content": "Yes, thanks, Pete. I think that was a solid like three, four questions in one. So I will, I'll do my best to weave through it here. But as Don mentioned, we're on the ground in 40 countries. We do payroll across 140 countries, inclusive of our partner network. In terms of the final mile or the last mile, as you referenced, the first thing I would comment on is we've building that 50 years. So when I think about international and everything we've done over the course of decades to build that infrastructure, it's a tremendous lead is what I would suggest. And you see that in our international bookings results, right? So we had a nice first quarter in international. We accelerated that in the second quarter. We had an even better Q3. A lot of that is being driven by our multinational growth. So think about our Celergo offering, our GlobalView offering. These were especially strong for us in the third quarter. And I do believe it's the overall demand environment coupled with - on the ground strategy, if you will, if you will. And by the way, the international pipelines remain healthy. And we believe it's going to position us for a solid Q4, but also next year. In terms of, where we continue to expand. I mentioned it in my prepared remarks. Asia-Pac or APAC is something that, our Asia business has been relatively modest, but we see significant growth over time. Obviously, that growth is a direct byproduct of our clients demand growth, as it relates to the activities of our clients and where they're moving associates, and where they're moving business. So, we believe that continuing to lean into Asia-Pac is important for us. And so as a result of that, we kind of are continuing to lean in there. I think we mentioned last quarter, the acquisition of a company in the Nordics, specifically in Sweden. So that's an area that also is a high growth area from a client perspective. And so I think, our strategy over time has been as we get further into a country and we see the demand, at times we will fold in our partners. And you've seen that obviously in the Nordics, and you've seen that in many countries prior to that. But that ecosystem is vast across 140 countries. Its decades of building that final mile. It's a clear competitive differentiator in the market. You can feel see and it's really palpable on the heels of the last earnings call. I was actually over at our rethink event, which is where we bring together a few hundred of our very largest global MNC clients. And the spirit of how we're executing in that market is really palpable, when you hear it directly from our clients. And I believe it's a tremendous opportunity for us to continue to drive growth. So I think, I covered all of that, Pete."
},
{
"speaker": "Pete Christiansen",
"content": "Thank you, Maria. Just quick follow-up. Do you think that the deployment of next-gen payroll is a catalyst for going-to-market and some of those newer markets?"
},
{
"speaker": "Maria Black",
"content": "Yes, of course. So next-gen payroll, for sure, our intent is to continue to drive next-gen payroll, across various international markets. We have it deployed in a few of our markets today. And that coupled with these offers that again have the lead of Celergo going GlobalView over time, will just further the growth narrative and the story over there. But that is absolutely the intention and the strategic direction of next-gen payroll."
},
{
"speaker": "Pete Christiansen",
"content": "Thank you for the comprehensive call."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Ashish Sabadra with the RBC Capital Markets. Your line is open."
},
{
"speaker": "David Paige",
"content": "Hi. This is David Paige on Ashish. It was great to hear about your results and growth in the mid-market particles. I was wondering if you could just give a little bit of an overview on the competitive landscape there. Are you guys taking share or the entire market or just what's the outlook or the environment in terms of competition in the market? Thank you."
},
{
"speaker": "Maria Black",
"content": "Yes, absolutely. So the mid-market is a great segment for us. It's certainly not getting any easier to be an employer in the mid-market. It's littered with complexity and all sorts of challenges to navigate, just even if you look at the last 30 days, you can see legislation that mid-market employers are having to navigate. And so it's a strong market. It is a highly competitive space. That's not new. I think for - from a competitive landscape perspective, it's always been competitive. And I don't know that we've seen a noticeable changes in the competitive landscape. What we have seen is incredible distribution, execution, incredible satisfaction, execution on our end. We've made great investments into the product set. It's winning in the market. You marry that strategy with great execution on the seller side and great execution on the retention side. That, to me, is what's changing in the mid-market is that we've gotten stronger."
},
{
"speaker": "David Paige",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Jason Kupferberg with Bank of America. Your line is open."
},
{
"speaker": "Unidentified Analyst",
"content": "Hi. This is [Caroline Lada] on for Jason. Thanks for taking our question. Sorry to double down on price, but just given the way inflation isn't dropping off, maybe the way the market was hoping or expecting recently. Do you have any updated expectations about ADP, and like the broader peer group's ability to raise pricing heading into the fourth quarter, and 2025 without like significant pushback?"
},
{
"speaker": "Don McGuire",
"content": "Caroline, thanks for the question. I think it just comes - continues to come back to the same concepts, and that's making sure that we offer good value to our customers over a 10-plus year lifespan. So, we're always mindful of making sure that clients are getting good value, and that we keep those clients for a very, very long time. So it's that client life cycle of the total return on the entire life of a client. So, we're always very, very careful not to overstep on pricing. Having said that, we, of course, watch what the competition is doing. We have our ear to the ground. Our salespeople have their ear to the ground. We're trying to make sure and understand what's happening from the competition. So, we will continue to look at it. We'll continue to knock around some ideas, and some models and see what the impact could be. But I don't want to signal exactly what we think we're doing, because we're still, as I said earlier, in the midst of our planning cycle here. But we always look at it. We take price usually every year where we can, not including some of the contractual commitments we have with some of our larger clients, but just something we're very, very careful and cautious about doing shots a lot of color."
},
{
"speaker": "Unidentified Analyst",
"content": "Awesome, thank you. That adds a lot of color."
},
{
"speaker": "Operator",
"content": "Thank you. And our last question comes from Kartik Mehta with Northcoast Research. Your line is open."
},
{
"speaker": "Kartik Mehta",
"content": "Good morning. Maria, as you look at the mid-market and the success ADP is having, who are you winning market share from? Is it traditional payroll companies? Are there companies that are maybe using other software products that you wouldn't consider payroll companies? I'm just wondering where the success is coming from?"
},
{
"speaker": "Maria Black",
"content": "Everywhere. Candidly, listen, from a mid-market perspective, again, the demand is healthy. The competitive environment is competitive, and we continue to remain laser-focused on all of the competitors specifically. The ones that have been talking a lot about us over the last few years. And I think the way that we've been focused is really about the investments we've made, investments into a best-in-class product. Investments into focus on distribution investments into a digital transformation that's driving great client satisfaction. And so, that really has allowed us to have a winning story, as it relates to really all of the players."
},
{
"speaker": "Kartik Mehta",
"content": "And then just one follow-up. Just on the PEO business, as you look at the long-term growth perspective of that business, obviously, there's been - a couple of things that happened that maybe have slowed the growth down in the last year or so. I'm wondering just your outlook on the PEO business and if you think anything has changed in that business, or demand for the product?"
},
{
"speaker": "Maria Black",
"content": "Yes. So I'm happy to start and certainly happy to have Don chime in too on the PEO. I'm always very, very bullish on the PEO value proposition. I've been close to that business for a long time, and I will tell you it's stronger than it's ever been. So despite the strangeness that we've had in the PEO, from a kind of the componentry heading into the pandemic, during the pandemic after the pandemic and then now, call it, a little bit post, post pandemic. What I would suggest to you is it has nothing to do with the fundamentals of that business, and what we would expect over time from a growth perspective long-term. And so the value proposition is strong. Nothing from our end has changed there, as it relates to the overall demand from the business. And we see that just in the - we continue to have 50% of our clients into the PEO coming from the base. So it's resonating with our existing clients. It's resonating with the open market, and it continues to be a very strong offering for us. So I don't know, Don, if you want to add anything there?"
},
{
"speaker": "Don McGuire",
"content": "Nothing to add then the value proposition is as strong as ever, and the fundamentals in the business are continue to be quite strong."
},
{
"speaker": "Kartik Mehta",
"content": "Thank you very much. I really appreciate it."
},
{
"speaker": "Operator",
"content": "Thank you. We have one more question from Dan Dolev with Mizuho. Your line is open."
},
{
"speaker": "Dan Dolev",
"content": "Hi guys, thank you for taking my question. And apologies, I was on a different call. But I know it's kind of maybe early, but do you have any news about - your next fiscal year, maybe something like early views as we head into the fourth quarter? Thank you."
},
{
"speaker": "Don McGuire",
"content": "Yes. Dan, just a couple of things, thinking about next year. We do think that it's early, so we didn't share too much, although we did say that the pace per control will continue to be under a little bit of pressure, given the fullness of the labor market. So that's kind of continuing story that we've been telling. We will continue some of our GenAI spending related spending, making the right investments for ADP. And of course, we're going to get some tailwind from interest rates. So I think those are the three primary things. And of course, we always remain very, very focused on bookings and our strong client retention and client experience. So, I think those would be the highlights for '25."
},
{
"speaker": "Dan Dolev",
"content": "Okay. Appreciate it. And apologies again if this was already addressed. I was on a different call. I appreciate it."
},
{
"speaker": "Operator",
"content": "Thank you. There are no further questions. I'd like to turn the call back over to Maria Black for any closing remarks."
},
{
"speaker": "Maria Black",
"content": "Yes. Thank you, and thank you once again to everyone who joined us today, whether the full time or late. We always appreciate the questions, the interest, and we certainly look forward to speaking with all of you again soon, and look forward to the close of the year. Thanks."
},
{
"speaker": "Operator",
"content": "Thank you for your participation. This does conclude the program, and you may now disconnect. Everyone have a great day."
}
] |
adp | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's Second Quarter Fiscal 2024 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session. Instructions will be given at that time. I will now turn the conference over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danny Hussain",
"content": "Thank you, Michelle, and welcome, everyone, to ADP's second quarter fiscal 2024 earnings call. Participating today are Maria Black, our President and CEO, and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com, where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items, along with a reconciliation of non-GAAP measures to the most comparable GAAP measures, can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria."
},
{
"speaker": "Maria Black",
"content": "Thank you, Danny, and thank you, everyone, for joining us. This morning, we reported strong second quarter results, including 6% revenue growth and 9% adjusted EPS growth. I'll begin with a review of the quarter's financial highlights, before providing an update on the progress we are making across our strategic priorities. We delivered solid Employer Services new business bookings in the second quarter, reaching a new record bookings volume for Q2, and keeping us on track for our full-year outlook. Growth was especially robust across our small business portfolio, and we also experience healthy growth in our mid-market and international business. With steady demand in HCM and a healthy new business pipeline at the end of the quarter, we look forward to the important selling season ahead. Employer Services retention was strong in the second quarter. Although it declined slightly compared to the prior year, we once again exceeded our expectations as we continue to benefit from a healthy overall business environment, and from our very high client satisfaction levels. Our Employer Services pays per control growth remained at 2% for the second quarter. The overall labor market remains resilient, and our clients continue to add employees at a moderate pace, which is resulting in a very gradual deceleration and pays per control growth. And last, our PEO revenue growth of 3% for the second quarter, was in line with our expectations, and we are very pleased to have delivered strong PEO new business bookings that were ahead of our expectations. Based on continued healthy activity levels, we feel good about our PEO bookings momentum, and we look forward to seeing a gradual re-acceleration of our PEO business in the second half of this fiscal year. Moving on to a broader update. During the second quarter, we launched a new brand advertising campaign themed, the next anything. The campaign highlights how the world of work is always changing, sometimes gradually, sometimes suddenly, and trusted business solutions must evolve with it. The theme aligns with our strategic priorities to give our clients the advantage of our leading technology, expertise, and scale. In Q2, we continue to push forward on our first strategic priority to lead with best-in-class HCM technology. A key part of that is the rollout of ADP Assist, our cross-platform solution powered by GenAI that proactively delivers actionable insights in plain language to enhance HR productivity, aid decision-making, and streamline day-to-day tasks for our clients and their employees. ADP Assist seamlessly integrates with ADP products across multiple platforms. Using an intuitive conversational interface, it provides valuable and contextual insights which touch every aspect of HR. For example, in addition to the features we shared with you last quarter, including our natural language reporting capability, in Q2, we integrated natural language search capabilities into our run platform, which allows it to understand intent behind the search terms and use GenAI to mine ADP's deep knowledge base to deliver easy to use and effective content. ADP Assist also helps clients validate payrolls and solve common employee challenges across HR, payroll, time, and benefits. It's a comprehensive experience that is trained on the industry's largest and deepest HCM dataset and our deep knowledge base to surface highly credible and actionable insights so that clients can make smarter decisions. We are excited about the roadmap ahead for all of our major solutions, and we expect it to help us build on the recognition we continue to earn in the market. In Q2 alone, we were pleased to be recognized for product leadership by three major industry analyst rankings. Everest Group named ADP the highest leader out of 27 providers in its multi-country payroll solutions PEAK Matrix report. NelsonHall identified ADP as a leader in its Payroll Services Vendor Evaluation and Assessment tool in all markets. And Ventana Research named us an exemplary leader across its North American, global, and payroll management buyers guide for performing the best and meeting overall product and customer experience requirements. Our second strategic priority is to provide unmatched expertise and outsourcing solutions. We shared last quarter that we were beginning to equip our associates with GenAI capabilities through our Agent Assist technology. In Q2, we expanded our call summarization deployment to a greater portion of our service associates and started to see productivity gains with shorter handle time and improved service quality. With our global service associates fielding millions of calls annually, we are incredibly excited to test ways to optimize those client interactions. Our third strategic priority is to benefit our clients through our global scale, and we continue to lean into this advantage. In Q2, we announced a strategic collaboration with Convera, a global business to business payments company to help our multi-country clients manage the complexity of global payroll and cross-border payments through an integrated platform. By combining Convera’s payment solutions with our global payroll expertise, we're enhancing the client experience by minimizing the need to access various banking platforms and improving payment accuracy, compliance, and security. We also announced the launch of ADP retirement trust services to support our growing retirement services business. Standing up our own trust services entity demonstrates our scale and commitment to our retirement clients, positioning us on par with financial industry leaders and ahead of HCM competitors that rely on third parties. This commitment can really matter to financial advisors, keeps data within ADP's trusted ecosystem, and provides a cost and price benefit to ADP and our clients over the long term. Our scale also affords us the opportunity to partner with other leading technology providers in innovative ways, and we continue to expand on many of those partnerships to provide our sales implementation and service teams with client-specific insights to quickly address market shifts, drive more personalized interactions, and deepen our overall client engagement. Overall, our second quarter represented strong outcomes on the financial front and with respect to our key strategic priorities. I'd like to thank our associates who continue to deliver exceptional products and outstanding service to our clients, particularly now, as many of them are in the middle of our most hectic time of year completing year-end work. I'm proud to share that their efforts help drive our overall Net Promoter Score to its highest level ever in the second quarter. Thank you again for all that you do for ADP and for our clients. And now, I'll turn it over to Don."
},
{
"speaker": "Don McGuire",
"content": "Thank you, Maria, and good morning, everyone. I'll provide more color on our results for the quarter, as well as our updated fiscal 2024 outlook. Overall, we reported a strong second quarter, with our consolidated revenue growth moderating in line with our expectations, and our adjusted EBIT margin coming in slightly better than expected. However, the interest rate backdrop has changed since we last provided our full-year outlook, and we are lightly tweaking our outlook, which I'll detail. I'll start with Employer Services. ES segment revenue increased 8% on a reported basis, and 7% on an organic constant currency basis, coming in slightly ahead of our expectations. As Maria shared, we continue to grow our ES new business bookings, resulting in a record second quarter bookings volume. Our small business portfolio and international business provided outsized growth contributions this quarter. And with a steady HCM demand environment and healthy pipelines, we feel on track for our 4% to 7% new business bookings growth outlook for the year. As mentioned earlier, our ES retention declined slightly in Q2 versus the prior year, but again exceeded our expectations. Given our first half retention outperformance, we are increasing our full-year retention outlook slightly. We now anticipate a 40 to 60 basis point decline in our full-year retention, which is 10 basis points better than our prior forecast. ES pays per control growth of 2% in Q2, was in line with our expectations, and we are maintaining our 1% to 2% growth outlook for the full-year. And client funds interest revenue increased in line with our expectations in Q2, as a slight decline in our average client funds balance, which we discussed last quarter, was more than offset by an increase in our average yield. However, we are revising our full-year client funds interest outlook lower to reflect the change in prevailing interest rates since our last update. We now expect fiscal 2024 client funds interest revenue of $985 million to $995 million, and we expect a net impact from our client funds extended investment strategy of $835 million to $845 million, representing a reduction of about $20 million at the midpoint. In total, there is no change to our fiscal 2024 ES revenue growth forecast of 7% to 8%. Our ES margin increased 170 basis points in Q2, driven by both operating leverage and contribution from client funds interest revenue growth, but reflecting the impact of a reduced client funds interest revenue forecast, as well as a slight increase in expected GenAI related spend, we are tweaking our fiscal 2024 ES margin outlook and now anticipate the lower end of our prior margin range. Moving on to the PEO, we had 3% revenue growth, driven by 2% growth in average work site employees in the second quarter. These metrics were in line with expectation, and we are encouraged to see signs of stabilization in our PEO pays per control growth. As Maria mentioned, our PEO new business bookings were very strong in Q2. With continued healthy activity levels, we continue to anticipate a gradual ramp in our work site employee growth in the back half of fiscal 2024, and we are maintaining our full-year growth outlook of 2% to 3%. PEO margin decreased 50 basis points in Q2. As we shared last quarter, we assume this year's workers' compensation reserve release benefit will be lower than last year's benefit, and we are further narrowing our PEO margin expectation to be down 80 to 100 basis points in fiscal 2024 versus our prior expectation of decline of 50 to 100 basis points. Putting it all together, there is no change to our fiscal 2024 consolidated revenue growth outlook of 6% to 7%. With the two changes to segment margin, we now expect our adjusted EBIT margin to increase by 60 to 70 basis points versus our prior outlook, for an increase of 60 to 80 basis points. We continue to expect an effective tax rate of around 23%, and we still anticipate fiscal 2024 adjusted EPS growth of 10% to 12%, with the middle of that range the most likely outcome given current assumptions. Thank you, and I'll now turn it back to the operator for Q&A."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] We'll take our first question from Mark Marcon with Robert W. Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"content": "Hey, good morning, and congratulations on all the accolades that you've gotten from the third-party reviewers. I'm wondering if you can talk a little bit about some of the initiatives. And specifically, one that stood out was the - was setting up your own trust. Can you talk a little bit about the investment there and how we should think about how that would end up unfolding? And what do you think some of the reactions would be with some of your third-party partners? Like, you've got bank partnerships and CPA partnerships and obviously benefit administration partnerships. How do you think they'll end up reacting? Thank you, Maria."
},
{
"speaker": "Maria Black",
"content": "Thank you, Mark, and good morning. Appreciate the question and appreciate your well wishes on all of our recognition. Certainly excited to see across the board the recognition we mentioned during the prepared remarks, but also the continued momentum across all of our initiatives. Happy to comment on retirement trust services. It is really a demonstration of our scale. And so, when I think about what it means to our clients, what it means to the ecosystem that you mentioned, banks, CPAs, I think it's all incredibly positive. And trust services are a core component of any 401(k) plan. Given the size and scale of our retirement services business, what we found is that the pool of what's known as third-party trustees, if you will, that are capable of handling a business just of our size, is actually becoming shrinkingly more difficult, if you will, in terms of the number of providers that are able to offer standalone trust services to a retirement offering of our size. So, in terms of that, we made the decision to launch our in-house trust services. We believe that this is a great value to our clients, to the ecosystem. It puts us on par with other industry leaders and the financial services, and really a competitive advantage against some of our HCM competitors that continue to leverage these third-party trustees. So, for us, I think it's a big commitment to the business that we have, the retirement business that is, which really can matter to financial advisors, and as you said, CPAs and banks. Really by taking the trust services in-house, the implication is that we have better control over our costs. Ultimately, that yields a better price for our clients, a better service. We also have the ability to maintain all of the data inside of ADP's ecosystem, which as you know, is a big component of who ADP is in terms of data integrity and all those things. So, that's kind of the retirement trust services in a nutshell, Mark."
},
{
"speaker": "Mark Marcon",
"content": "Terrific. thanks for that. And then just, it was noticeable that you basically are anticipating a lower level of decline in terms of the ES retention, which is coming off of record levels. To what extent is that due to an anticipation of lower levels of bankruptcies as opposed to just the improvement that you've been seeing in terms of your client service scores?"
},
{
"speaker": "Maria Black",
"content": "So, retention is going incredibly well, right? And we mentioned that in the remarks. Year-to-date retention has definitely been better than we expected. And so, I think things are fundamentally really healthy right now. One thing to keep in mind as kind of think about the outlook, is that we are, as you mentioned, we are coming off of some of the record highs that we've seen over the last several years. And while we believe that from specifically a down market perspective, we're close to being normalized back to fiscal 2019 trends, we do also anticipate some pressure in the back half from perhaps out of business and bankruptcies having more of a material impact. We haven't seen it to date, but we certainly want to ensure that we're cognizant of the fact and we believe it's prudent - given that we have retention running at such record levels, we believe it's prudent to plan for it in the back half to have some pressure. And obviously, just like any year, Mark, retention is always noisy until we have some normal variability and conservatism in the back half. Just like you, I'd like to think that there's opportunity there. I think only time will give us the answer to that, but that's kind of how we're thinking about the back half."
},
{
"speaker": "Mark Marcon",
"content": "Really appreciate that, Maria. Thank you, and congratulations."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from James Faucette with Morgan Stanley. Your line is open."
},
{
"speaker": "James Faucette",
"content": "Great. Thank you very much. Appreciate all the detail this morning. I wanted to quickly just touch on PEO. You called out a strong acceleration in the business, but it looks like outlook for revenues was changed - you may have mentioned that, but I'm just trying to capture how much of that is timing issue versus the concentration you have in professional services and technology, which still seem a little bit soft, at least in the employment reports."
},
{
"speaker": "Don McGuire",
"content": "Yes, James, thanks for that question. We've been happy to see the stabilization in the pays per control in those sectors, the financial services and technology sector. So, although there's still a little bit of noise there, it's certainly stabilized from what we saw in the prior quarter. So, that's positive. I do think that as we looked at our sales results, our bookings for PEO, we were very happy with the bookings. Maria mentioned that already very good. I think as we kind of put those together, the improvement in the pays per control and the improvement in our bookings, I think we're going to be heading towards that re-acceleration that we've been pointing to over the last couple of quarters in the PEO. But really just trying to get the impact of those two components, those variables, is really what's going to help us get that re-acceleration going."
},
{
"speaker": "Danny Hussain",
"content": "And James, just to clarify, the pays per control, although it’s stabilizing, it's not providing any sort of upside versus our prior forecast. So, bookings are going well. It takes a quite a bit in terms of bookings to really drive a material change to the current year revenue, which you well understand. With pays per control still providing sequential, gradual drag, those two are sort of netting out to an inline outlook."
},
{
"speaker": "James Faucette",
"content": "Got it. Thanks for that, Danny. And then quickly on AI, it seems like there's a little bit of incremental investment there and certainly a big focus on this call, but wondering about how we should think about the - how you're anticipating a return on that investment and over what kind of timeframe. And maybe more qualitatively, what kinds of paybacks, whether it's increased customer satisfaction or internal operations, et cetera. Thanks."
},
{
"speaker": "Maria Black",
"content": "Yes, so I'll start on the on the AI side and tell you all the reasons again that I'm so excited about it. Maybe Don can give you a little bit about how we're thinking about the return on investments that we're making. So, just to remind everyone how we're thinking about AI, in its most simplistic way, I think about it really in three buckets, the first of which is product and innovation. So, putting generative AI into all of our innovation cycles. So, that's everything from product development to the features and functionality that I mentioned in the prepared remarks. And by the way, later this morning, we're actually issuing a press release that goes through some of our product and innovation, call it, philosophy and launches of products, right? So, some of what this press release speaks to is how we're thinking about and our design principles around making things easy, smart, and human within our product and innovation cycles to really drive things like payroll assist, things like ADP Assist into the market in a meaningful way. So, product is really kind of the first bucket. And as you'll see, we're making significant investments there. We do have ADP Assist now more broadly deployed across the product set, and we're seeing meaningful impact as it relates to our client experience on that. The second bucket is what I call efficiency and service efficiency. And this is really about giving all the same things that we're looking to give our clients to make their jobs easier and more effective and efficient, and giving those same tools to our associates. And so, we have Agent Assist. I'm pleased to say that from an Agent Assist perspective, we've more than doubled the number of associates today that are engaging in AI tools overall. Specifically, a big piece of that is anchored in Agent Assist and the things we're doing around call summarization. Again, I'll let Don comment on investments and return, but just to kind of give you a flavor of what we're talking about here, the feedback we're getting from our associates is, there are times we're shaving off a minute or two minutes by aiding things like call summarization. And while that probably seems minuscule, what I would offer to you is we have thousands of service associates, and we also have millions and millions of calls that we take every single year. And so, we're pretty optimistic and excited about a minute here and a minute there, and what that means from an incremental opportunity for us over time, right? So, we continue to lean into our service efficiency and really getting all of our associates more effective as it relates to their ability to engage with our clients. And then last but not least - by the way, I could go on and on and on all day on this topic, but last but not least and very, very important is how we're thinking about generative AI in our go-to market motions. And so, we have for years been at the tip of the spear of sales modernization. We have partnerships that are two decades old where we've always been leading the way with what it looks like to have a best-in-class modern distribution and sales force, and this is no different for us. So, we already have a broad set of our sellers leveraging tools along the lines of Generative AI, many of which are through our best-in-class vendors and partners that we have, and we're seeing great impact there. Things that I used to do myself at a personal level manually, such as pre-call planning, by the way, things like call summarization for prospecting, these are big items for us as it relates to our go-to-market motions, and we've just started scratching the surface. So, all in, really excited again. Just to kind of wrap it all up, I think it's about product, service efficiency, and our go-to-market motions. We are making active investments. Some of those investments are things that we've shifted that we were already working on in digital transformation. Some of it is incremental investments. And so, I think with that, I'll turn it over to Don who can kind of talk about how we're thinking about our incremental investments and moreover the return on that."
},
{
"speaker": "Don McGuire",
"content": "Yes, so I think Maria just outlined some of the exciting areas that GenAI will have for us and some of the things that'll change, how they'll make the client experience better, how they'll help our associates, how they'll help us sell more, et cetera. But I would say at this point in time, what we're really talking about is some modest investments in GenAI. I think it's going to be a little while before we start to see returns from those things, but we certainly do anticipate returns. But in the near term right now, it's really a time for investing in these tools, et cetera, and we'll see those outcomes, those financial outcomes somewhere down the road."
},
{
"speaker": "James Faucette",
"content": "That's great. Thank you both very much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Ramsey El-Assal with Barclays. Your line is open."
},
{
"speaker": "Ramsey El-Assal",
"content": "Hi there, and thanks for taking my question this morning. You guys called out higher seller expenses as just one component of the margin headwinds in PEO. I guess the question, is this just the cost to compete in PEO at this point? In other words, is it becoming more expensive to compete in PEO, or do you expect expense levels related to selling to sort of abate in a more normalized time period?"
},
{
"speaker": "Don McGuire",
"content": "Yes, I don't think there's - just to answer the question, there's nothing really unusual or fundamentally different about our selling expenses and how we go-to-market in the PEO. I think certainly as we see higher sales, as you know, we get a lot of our sales, half of our sales, give or take, from internal. So, some of that's a little bit of our internal housekeeping if you will, how we allocate expenses between business units, et cetera. But higher sales generally translate into higher selling expenses. So, really nothing fundamentally different in how we go-to-market. Certainly, not seeing any fundamental differences in the competitive landscape that's driving those expenses."
},
{
"speaker": "Ramsey El-Assal",
"content": "Got it. Okay. And then one follow-up for me. In the context of the international product launches like Roll in Ireland, and also I guess the partnership you guys just announced with Convera, can you comment on the international value proposition itself, whether it's sort of largely the same as it is in the US, or are there distinctive products, needs, partnerships required in these markets that you guys sort of still need to build out to more fully execute on the international opportunity?"
},
{
"speaker": "Don McGuire",
"content": "Yes, I'll start, and Maria can add here in a second. So, as you know, you look at our revenue as - international revenue as a percentage the total, and it’s not where we'd like it to be, even though roughly 40% of the people we bear around world are in international. So, and the reason for that is that we have fundamentally different offers in the US. We have things like PEO. We also have money movement services, tax services, pretty much broadly distributed. Some of those offers don't have the same value proposition outside of the US market. So, our opportunity there is not quite the same. Perhaps it will be as time goes on, some of those services may be available in other markets, but as we speak today, they're not there. The value prop isn't the same. With respect to Convera as a partner, just to speak to that one a little bit, we have thousands of clients, and those thousands of clients have thousands of entities spread across multiple countries around the world. And if you think about the complexity and the difficulty of paying their people in some of these small countries and then getting the payments to the various social security providers in those countries, having somebody like Convera who can help a large European or a large US multinational manage the treasury function in those small countries around the world without having to set up all the banking, et cetera. So, someone like Convera acts as a great partner for us to facilitate those cross-border payments in a very - in a compliant way, et cetera. So, I think that's very positive for us. So, we do have some partners in international like Convera as I just mentioned, but we still see it as a great opportunity for us to continue to grow."
},
{
"speaker": "Maria Black",
"content": "That's right. If I may, one of the things, I think what Don is suggesting is really the opportunity we have with international. And so, when you put it in the context of the business that we have in the US there, there is a tremendous opportunity for us to think more broadly in international partnerships as the one Don just outlined with Convera, is a big piece of that. What I would also add is that from an international perspective, we did call out the performance specifically in Q2 on international. That's, by the way, bookings. That's on the heels of a solid Q1. What I would offer as well, we have record retention. We have record customer experience and client experience in international. So, I think we have a tremendous value proposition in international. By the way, some of the recognition I cited during the prepared remarks is really about how best-in-class our offer is with respect to the international offering we have. So, that said, as Don mentioned, we're not satisfied. I think there's more opportunity to us to scale and grow our beyond payroll offerings, partnerships that are a big piece of that, but undoubtedly, we're performing and competing very, very well internationally."
},
{
"speaker": "Ramsey El-Assal",
"content": "Fantastic. Sounds like good things ahead. Appreciate it."
},
{
"speaker": "Maria Black",
"content": "Oh, you know what, let me just comment because you mentioned Roll in international, so I just thought I'd mention that really quickly, which is, we are very excited about the down market in international. Roll is one way that we're getting after that. And the pilot programs that we're running are teaching us a lot as we think about the down market and international."
},
{
"speaker": "Ramsey El-Assal",
"content": "Okay, perfect. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open."
},
{
"speaker": "Bryan Keane",
"content": "Hi guys, congrats on the solid results. Don, I just wanted to ask about average balances. I know we were expecting a little bit of a headwind from the payroll tax deferral. Maybe you can quantify that as part of the reason for the drop of balances down 2%. And then what's the go forward there we should expect? Is there a more of a headwind from the payroll tax deferral for balances and maybe expect a similar decline in the back half of this year?"
},
{
"speaker": "Don McGuire",
"content": "No, I think you were right to call out the payroll deferral, payroll tax deferral. That definitely was behind the decline quarter-to-quarter. We don't - that's now behind us. So, that's not going to be there. So, we are expecting 2% to 3% balanced growth throughout the balance of the year. So, we think that's very positive. I think the big callout though on the whole CFI program is just the fact that since we spoke last, five-year and 10-year interest rates are down about 80 bps on both of those. And so, I think that's a little bit of the headwind and that's roughly the $20 million or so that we're calling down the float number for the balance of the year. But still very optimistic about growth. Certainly, the reason that it's not growing as quickly perhaps as it did last year, we've certainly seen some moderation in wage growth, and we've talked about even though pays per control are behaving as we expected, they are certainly lower - pays per control growth is lower than it was in the back half, but will be lower in the back half of this year than it was in the back half of last year. So, those would be the major influencers, if you will, to the full balance as we go forward to the back half."
},
{
"speaker": "Bryan Keane",
"content": "Got it. And is that part of the moving of the ES margins to the lower end of kind of the range you talked about? I think you talked about rates there. Just what was the surprise from three months ago on rates that that maybe caused you to push the margins towards the lower end or where you think the lower end, the new margin range?"
},
{
"speaker": "Don McGuire",
"content": "Yes, so, you're right. I think the float certainly is a component of us guiding to the middle of our range, for sure. So, that's a component. We don't try to second guess the markets. We use yield curves that are out there in the market to estimate what we think our returns are going to be. So, no real surprises, other than seeing what's happening in the overall market. And then we're taking the forward yield curves and applying those to our balances, and that's where we land."
},
{
"speaker": "Bryan Keane",
"content": "Great. Thanks for taking the questions."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Scott Wurtzel with Wolfe Research. Your line is open."
},
{
"speaker": "Scott Wurtzel",
"content": "Great, thanks. Good morning, guys, and thank you for taking my questions. Maybe just wanted to start off on some trends that we've seen so far in the selling season. Seems like through 2Q it was pretty positive on the booking side, but maybe wondering how we've sort of tracked into 3Q, and then also what you've seen maybe from competitors, any changes in pricing, go-to-market strategy and all that would be helpful."
},
{
"speaker": "Maria Black",
"content": "Yes, good morning, Scott. We feel good about the demand environment overall at this point. I think companies are still hiring. We saw that this morning actually as well. And companies are still investing in their people, their talent. They're investing in HR. I think there are a couple things I'd highlight to you. The down market, definitely companies are continuing to hire and they're continuing to buy. We had tremendous second quarter results. By the way, that business has been executing incredibly well really for many, many quarters. And that's our run offering, but it's also all the things that are attached to run. So, think insurance services, retirement services. All of the down market is doing incredibly well. To give you a little bit of a line of sight, because it is the 31st of January, so we do actually have a tiny bit of visibility specifically to the down market. And you asked about trends into the third quarter. What I would offer to you is January looks good. I think we're actually on track to onboard something close to like 30,000 units in that business alone in the month of January. And so, that's the size of some companies, if you will. So, it's pretty incredible to see the execution in the down market. We have solid pipelines really across the mid-market as well as off-market. The mid-market did incredibly well in the second quarter. From a competitive standpoint, I think we get a lot of questions around the competitive landscape. Has it shifted in the mid-market? What I would offer to you, it hasn't really shifted. It's been a competitive space per us for a long time. It's an area for us that we're executing very, very well. We have best-in-class products. We continue to take friction away from our clients, make it easy for our clients to engage with us. We know this based on our results and retention. We know this based on our results and record NPS. We had good bookings in the mid-market. So, I think the mid-market is solid and certainly not getting any easier for our clients to be employers in the mid-market. As it relates to the international space, I think I covered that already, so I won't touch much more on international, but a good Q2 on the heels of a good Q1. And then in our enterprise and upmarket space, this is an area that has normally, I think it's kind of the new normal on longer deal cycles that have more individuals involved in those cycles. We're paying close attention to it and certainly all the things that are happening kind of across that space. But I would suggest to you that we feel relatively solid about our pipelines and our ability to bring that business in the back half."
},
{
"speaker": "Scott Wurtzel",
"content": "Great. That's helpful. And just a follow-up for Don, just on the float income guidance, sort of noticed a pretty notable increase on your outlook for the client short portfolio. So, just wondering if you can maybe give a little bit of color on sort of the changing geography on those investments for the balance of the year. Thanks."
},
{
"speaker": "Don McGuire",
"content": "Yes, so maybe let me clarify that for you a little bit. So, really, we haven't changed our investment strategy at all. What we have done is we've tweaked a little bit the way we're going to - we were borrowing funds in the market day in, day out. So, what you're seeing is, we're actually entering the market a little bit early. So, instead of borrowing everything we need to on a peak borrowing day, we've simply spread the borrowing out over two, three days so that we can tap the market in a more - in a smoother way, if you will. And I think if you're looking at the average balances on that - on the appendix sheet that's in the release, you'll notice that that number's gone up in the short fair bit, but that's the driver. So, it's not a change in our investment strategy at all. It's just a change in a bit of a tweak in the way we're actually borrowing funds in the market when we need larger amounts of - when we have larger amounts of borrowing."
},
{
"speaker": "Scott Wurtzel",
"content": "Great. Thanks, guys."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Bryan Bergin with TD Cowen. Your line is open."
},
{
"speaker": "Bryan Bergin",
"content": "Hi, good morning. Thank you. First question I had is on EBIT margin. Can you comment on what drove the outperformance versus your view for that to be down I think in 2Q? I'm curious if that was an aspect of timing within the year versus better-than-expected efficiency. And I think, Don, I heard you mentioned some GenAI investments to come. Is that incremental spend versus the prior plan?"
},
{
"speaker": "Don McGuire",
"content": "So, yes, let me start - Bryan, let me start with the first part of your question. So, there was a little bit of modest revenue outperformance in the quarter. So, I think that was a contributor to the margin. And then we had some expenses. We always have focus on expenses. There's a few things, a little bit of bad debt, a little bit of headcount, et cetera, and perhaps a little bit of timing, but nothing significant to really call out as a contributor. In terms of the GenAI spend, yes, we are spending a little bit more than we said we were going to last quarter. So, we do have a bit of incremental spend. It's not a huge amount, but I know that lots of folks like to measure things in 10 bps. So, we are calling it out. Not an incredible amount, but a little bit more than we had said in the prior quarter."
},
{
"speaker": "Bryan Bergin",
"content": "Okay. And then just I guess a follow-up then on GenAI and ADP Assist here. Is that a feature you're able to monetize directly or more so kind of an enhancement you're offering for free to drive the CSAT stores higher? And I guess understanding you're leaning into these developments, do you kind of view it - when you think about the monetization of GenAI products, is this a near-term dynamic or more so kind of feature and product differentiation that's a longer term monetization dynamic?"
},
{
"speaker": "Maria Black",
"content": "So, Bryan, ADP Assist is really the overarching, call it, brand, if you will, that we're leveraging to talk through all the things that we're putting into our product to make things easier. The way that I think about it is it’s really just the next phase of digital transformation for ADP using new tools and technology. So, said differently, our intention is not to charge to make things easier for our clients to do business. That is our commitment to our clients, always has been, is to make it as easy as possible to process payroll, to have accurate payrolls. And so, it's not a monetization effort as it stands. It's really about just leveraging the new technology to step change the digital transformation that we've had underway candidly, for many, many decades since the dawn of the computing era. So, that's kind of how we're thinking about ADP Assist. In terms of monetization in general, do I believe there's monetization as it relates to GenAI? Of course. I think it’s more about the dollar long term, right? So, I think about it - the dollars that we're putting in today will yield multiple dollars for us in years to come. So, there will be distinct monetization opportunities as we create new products into the market, as we think about various things of that nature, perhaps features and functionality. There will also be gains in sales and retention that will lead, in my mind, to investments that are proven today in GenAI to drive incremental bookings and retention over the long term. So, I think it's about putting a dollar in today with the belief that it will yield many dollars of margin to come, if you will, as well as bookings, et cetera."
},
{
"speaker": "Bryan Bergin",
"content": "Okay, understood. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Samad Samana with Jefferies. Your line is open."
},
{
"speaker": "Samad Samana",
"content": "Hi, good morning. Thanks for taking my questions. Maybe on the PEO business, I was curious, I know you guys called out some of the bigger verticals inside of the PEO business and that there's maybe some more softness there than you'd expected in technology and professional services. Any change in the exposure rather inside the PEO business or within like the big verticals? Are you guessing any change in the trends that you saw maybe over the last couple of quarters?"
},
{
"speaker": "Maria Black",
"content": "The trend in specifically professional services has stabilized. And so, I think Danny made the comment earlier, it's no longer contributing to the deceleration. So, it used to - the professional services cohort used to contribute to the acceleration of pays per control, then we found ourselves where it was contributing to a deceleration, and it's largely stabilized at this time."
},
{
"speaker": "Samad Samana",
"content": "Got you. And just as you think about the pricing environment, I know that we're still not at when the company does the annual price increases, but as you think about maybe for new deals or for new customers that are onboarding, any change in the kind of price pressure or competitive nature of what your competitors are offering in terms of discounts or what ADP's is having to offer? And just as we look ahead to price increases, how are you thinking about this year's price increases?"
},
{
"speaker": "Don McGuire",
"content": "Yes, we're not really seeing any changes, Samad, in the price environment, the competitive environment. We think we're priced appropriately, and we've always acknowledged that we're a little bit of a premium to others. But we're happy with that because we think we offer better service and stability, et cetera. So, no real changes. You're right. It is a little bit early. The budget cycle kicks off here in the next six, eight weeks or so, and we'll certainly be looking at the pricing increases for next year and weighing all the regular factors, what's inflation been? We thought our price increases were very well received last year. We thought they were in line. So, we'll keep that in mind. But as always, we're always interested in the long-term value prop with our clients and being competitive in the market. So, we're always measured, I believe, when we think about the price increases that we do hand out to our clients."
},
{
"speaker": "Samad Samana",
"content": "Great. Appreciate you taking my questions."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Kevin Mcveigh with UBS. Your line is open."
},
{
"speaker": "Kevin Mcveigh",
"content": "Great. Thanks so much. Maria, I think you talked to kind of implementations a little bit. Can you remind us maybe what percentage of the revenue is done internally on implementations today, and if that's a shift philosophically, what that can be over the course of time? If I heard the remark right. Maybe I picked it up wrong, but just any incremental thoughts on that?"
},
{
"speaker": "Don McGuire",
"content": "Yes, I'll maybe - Kevin, you're a bit soft by the way, but you're a little bit hard to hear, but I think the question was what kind of revenue we derive from implementation, and is that …"
},
{
"speaker": "Kevin Mcveigh",
"content": "Yes."
},
{
"speaker": "Don McGuire",
"content": "Yes, so it's not a substantial. Sub 10% of our overall revenue comes from setup - we internally call it setup fees. So, it's not a substantial amount."
},
{
"speaker": "Kevin Mcveigh",
"content": "And then do you see that - Don, over time, does that become less if you outsource that? And is there any way to think about the margin impact from that initiative?"
},
{
"speaker": "Don McGuire",
"content": "Well, I mean, you also - so, no, I don't think there's a big opportunity there. We certainly have had conversations. We certainly have lots of folks who would like us to outsource our implementation because they think it's a revenue stream for them. We like to have that control over the client from sale-through to go live in service. Not to say that we won't work with third parties to help us from time to time, which we do. But it's really not that large a factor. Certainly, there's some money there to be had, but it's not that large a factor in the overall scheme of things. There's also some interesting accounting, of course, around implementation and setup fees and the deferral over the terms of the contract. So, once again, it would take a lot of changes to do anything, make any changes to the bottom-line financials in the near term."
},
{
"speaker": "Kevin Mcveigh",
"content": "Helpful. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Tien-Tsin Huang with J.P. Morgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Thanks so much. Good results here. Just want to dig in on your prior comments. I know a lot of people asked on PEO and the healthy activity there and the confidence in the acceleration. Is ADP doing anything differently, or is industry demand changing? I understand it’s not - it doesn't sound like there's a cost of pricing change there. So, I just want to make sure I understood that. Thanks."
},
{
"speaker": "Maria Black",
"content": "Yes, good morning, and thank you. I am happy to talk about PEO bookings. I think as mentioned in the prepared remarks, we're very pleased with our PEO bookings. This really is the fourth quarter that we've seen positive PEO bookings momentum, and the Q2 specifically exceeded our expectations. Most of the pressure that we felt in the PEO has been a byproduct of kind of the pressure on pays per control and having to overcome that, which is why the focus on bookings has been so paramount for us. And certainly, we deliver that in the second quarter. In terms of from a demand perspective, I speak about the PEO all the time, as you know. I think the demand continues to be incredibly strong. I wouldn't suggest that there's anything unnatural that we are doing outside of a tremendous amount of focus across the enterprise to ensure that we're executing on the PEO booking side. But in terms of anything unnatural or demand changing, I think the value proposition, as I always say, is stronger than it's ever been. I think clients in that space are looking toward ADP to help them from a PEO value proposition. So, everything from payroll to benefits to navigating the complexity of being a business and having the ability to execute on a co-employment relationship. So, I would say the value proposition is as strong as it's ever been. I think it remains strong. The demand is there. The organization is focused on PEO bookings as an execution lever for us. And I'm pleased to see that we did just that in Q2, and we've really had - this marks the fourth quarter of positive bookings momentum from the PEO."
},
{
"speaker": "Tien-Tsin Huang",
"content": "No, that's great. Thank you, Maria."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Jason Kupferberg with Bank of America. Your line is open."
},
{
"speaker": "Unidentified Analyst",
"content": "Hi, this is Caroline (indiscernible) on for Jason. Thanks for taking our question. So, pays per control growth has been 2% quarterly through the first half, but the guide for full-year 2024 is still 1% to 2%. So, what are the drivers of the second half deceleration, or do you think that the high end has become more likely?"
},
{
"speaker": "Don McGuire",
"content": "Caroline, thanks for the question. We said we would go to - we'd be 1% to 2% for the year, and we certainly have that 1% to 2% range still in the back half. We're not really anticipating any slowdown in pays per control, but we certainly have it built in. So, perhaps we're a little bit conservative there. But as we sit here today, the employment demand continues to be robust, although still declining somewhat, but I think we're confident that in the back half, we're going to be declining a little bit, but still coming in on that 1% to 2% range for the year. Not really much more to say there other than employment demand, labor markets continue to be maybe a bit softer than they were, but as we saw this morning in our NER report, hirings still out there, still good growth. So, not a lot of extra color, I don't think, to add around pays per control."
},
{
"speaker": "Unidentified Analyst",
"content": "Okay, great. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Dan Dolev with Mizuho. Your line is open."
},
{
"speaker": "Dan Dolev",
"content": "Hey, guys, great results here. Just a strategic question, obviously if you look over the next 12 to 18 months, interest rates are coming down. There is a big debate out there on the ability to offset some of those headwinds in terms of revenue. Can you talk about maybe some idiosyncratic initiatives that you could do to offset the headwind from declining interest rates? Thank you so much."
},
{
"speaker": "Don McGuire",
"content": "I think that's really a macro question. I guess the macro answer to that would be that if interest rates start to decline, we'll see an offsetting increase just in economic activity. And if we see that increase in economic activity, we should see revenue go up. We should see bookings opportunities go up, et cetera. So, I think that if interest rates come down - and there's lots of debates, whether it's two cuts or four cuts, et cetera, who knows, but if they do come down, we should certainly avoid the recession. Nobody's asked about a recession on the call today, so thank you. I think the consensus is that there's not going to be a recession. So, certainly any of the polls suggest that the economy's healthy with 3.3% GDP growth in the last report. So, if rates come down, the economy should remain healthy, and a healthy economy should help continue to contribute to our growth."
},
{
"speaker": "Danny Hussain",
"content": "Dan, I'll just add also, our model involves reinvesting further out in the yield curve, and as you know, we're still reinvesting at higher rates than what's embedded in the securities that are rolling off. So, even if we do start to see short-term interest rates fall next year, which is obviously consensus at this point, a lot of that will be offset by the reinvestments that we have further out in the yield curve. And so, it's too early to be talking specifically about the interest rate outlook for next year, but we would just recommend you keep that in mind."
},
{
"speaker": "Don McGuire",
"content": "Yes, that's fair. I think if you look at our reinvestments, our current reinvestments are still at 4%, which is higher than our average yield today. So, there still are opportunities. Our float is expected to continue to grow over the next 12, 24 months. Certainly, it's going to grow a little more slowly than we would've expected at the end of last quarter, but there's still upside from float, which is perhaps not as much upside."
},
{
"speaker": "Dan Dolev",
"content": "Great. Great results, again. Thank you so much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Pete Christiansen with Citi. Your line is open."
},
{
"speaker": "Pete Christiansen",
"content": "Thank you. Good morning. Two questions. Now that we fully lapped ERTC, I'm just curious if you've noticed any changes in client demands or competitive tactics, particularly in the down market?"
},
{
"speaker": "Maria Black",
"content": "Yes, good morning, Pete. The ERTC, as you know, and I think what you're referencing is the new deadline that was pulled forward five quarters actually. So, the deadline actually as it stands is potentially today. I think we're still waiting for the final kind of execution, if you will, of that new deadline. But arguably, we're having to execute on behalf of our clients with today in mind. And so, there's a tremendous amount of volume that we are pushing through on behalf of our clients, and it has put pressure into the system, which is hard to watch and witness, by the way, as it relates to the very clients that are supposed to be helped by this and the challenges that they're facing trying to navigate it. So, we're doing everything we can in our power to help and process these claims. In terms of financial impact for us as it relates to ERTC, it isn't a financial impact to us. I think it's very de minimis as it relates to our overall revenue, as it relates to our overall incremental. We really, from a standpoint of what we're looking toward, it's about supporting our clients. And so, I think some of our competitors have used it more as a business and a revenue than us as it relates to how we're thinking about it. But undoubtedly, the advancement of this deadline to today has not been ideal for really anyone engaged in it."
},
{
"speaker": "Pete Christiansen",
"content": "That's helpful. And then I'm curious, the combination of HCM and payments functionality, has certainly been a theme. EWA is obviously a big portion of that and now cross border. Do you see opportunities to increase penetration there or to add more capabilities either through partnership, M&A, furthering payments, and I'm thinking perhaps even like in disbursements, those sorts of things? Thank you."
},
{
"speaker": "Maria Black",
"content": "From a strategic standpoint, Pete, what I would offer is continuing to solve for our clients and employees and how they engage with us. If you imagine across ADP, we pay 41 million wage earners in the US. That's 25 million. I think last time we talked about our Wisely offering, what we disclosed was that we had 1.5 cardholders or something like that. So, to just kind of give you the opportunity scale of it, we believe there's tremendous opportunity to increase how we're engaging with our clients, whether that's through the likes of Wisely, it's through the likes of EWA, as you're suggesting, or it's any other type of payments and things that we can do to make it easier for our clients and employees to move through the world of work, right? And so, the way I think about it and the partnerships that we're actively out there in the market talking to and thinking about, anywhere we can add value in our clients and employee life and flow. So, as they move through their day and they clock in through ADP's mobile app, which by the way, we have 10 million users that are actively using our ADP mobile app, so as they're engaging with ADP, are there opportunities for us to insert value there? Whether that's things like EWA, it's things like payments, it's things like financial and wellness apps like the companion app we have through Wisely. These are all top of mind for us as we go through our strategic discussions and as we think about partnerships in the future for ADP."
},
{
"speaker": "Pete Christiansen",
"content": "Thank you so much. Super helpful."
},
{
"speaker": "Operator",
"content": "Thank you. We have time for one last question, and that question comes from Ashish Sabadra with RBC Capital Markets. Your line is open."
},
{
"speaker": "Ashish Sabadra",
"content": "Thanks for taking my question. So, just a multipart question on PEO and following up on some of the commentary earlier on solid bookings and moderating PPC, sorry, paper control headwinds. As we look at the WSC growth, we have continued to see a sequential improvement there, better than what we saw last year. And just given the commentary, is it fair for us to assume that we should continue to see that improve as we go through the year? And then on revenue per WSC, I was wondering if you could comment on, looks like pricing trends are positive, but if you could comment on any other puts and takes participation, anything else that could help drive better revenue per works at employee. Thanks."
},
{
"speaker": "Maria Black",
"content": "So, the answer to your question is, yes, we do expect that the booking contribution, coupled with a bit of stability on the pays per control side, coupled with retention getting more favorable on the back half, all of those things should lead to the re-acceleration that Don mentioned earlier, that we've been pointing to in the back half. I think in terms of other componentry within the PEO, you mentioned a few of them. There's payroll per works on employee. There's workers' compensation. There's State unemployment. Some of these things are things that we're still waiting to really see the outcomes. I'll give you an example. One of those is State unemployment in terms of - obviously, we sit here today forecasting what that looks like. Most of those rates are issued throughout this quarter. And so, while we have some line of sight, in the end, we don't know entirely what the State unemployment outcome - we do expect that it creates a little bit of a - rates are going down year-on-year again this year. But again, only time will tell. Sometimes the States, as an example, make very strange decisions that aren't always in line with what's happening from a broader labor and unemployment perspective. So, all that to say, I think - I don't know that I could sit here today and give you any componentry that seems strange or out of the norm. I think they're all things we're watching as we look toward the re-acceleration in the PEO in the back half."
},
{
"speaker": "Ashish Sabadra",
"content": "That's very helpful color. Congrats on the solid results."
},
{
"speaker": "Operator",
"content": "Thank you. I'd like to turn the call back over to Maria Black for any closing remarks."
},
{
"speaker": "Maria Black",
"content": "Yes. So, really quickly, I think I'll end with how I ended my prepared remarks, which is a huge shout-out to all of the associates and the entire ecosystem across ADP. So, that's ADP associates, partners, channels, all of the stakeholders that really contributed to what was a good, solid Q2, but also a good, solid first half. I'm really excited about the back half and what we'll accomplish, not just in fiscal 2024, but moreover in calendar 2024. It's a time and it's an exciting year for ADP. This year is the year that we actually round our 75th anniversary. And then when I think about who this company is over the last seven decades and 75 years, I can't wait to see what we're going to do in the next 75. So, look forward to sharing in that celebration with all of you as we head into 2024 together. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you for your participation. This does include the program and you may now disconnect. Everyone, have a great day."
}
] |
adp | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning. My name is Michelle, and I'll be your conference operator. At this time, I would like to welcome everyone to ADP's First Quarter Fiscal 2024 Earnings Call. I would like to inform you that this conference is being recorded. After the prepared remarks, we will conduct a question-and-answer session, instructions will be given at that time. I will now turn the conference over to Mr. Danny Hussain, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Danyal Hussain",
"content": "Thank you, Michelle, and welcome everyone to ADP's first quarter fiscal 2024 earnings call. Participating today are Maria Black, our President and CEO; and Don McGuire, our CFO. Earlier this morning, we released our results for the quarter. Our earnings materials are available on the SEC's website and our Investor Relations website at investors.adp.com where you will also find the investor presentation that accompanies today's call. During our call, we will reference non-GAAP financial measures, which we believe to be useful to investors and that exclude the impact of certain items. A description of these items along with a reconciliation of non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. I'll now turn it over to Maria."
},
{
"speaker": "Maria Black",
"content": "Thank you, Danny, and thank you, everyone for joining us. This morning, we reported strong first quarter results, including 7% revenue growth and 12% adjusted EPS growth, and we made significant progress on the three strategic priorities we shared with you last quarter. Let me begin by quickly reviewing some of our financial highlights from the first quarter. We had a solid start to the year in Employer Services new business bookings with record-level volume for first quarter which was supported by a particularly strong September. Among our best performers were our small business portfolio and our compliance-oriented solutions. Overall demand in HCM has remained steady and we maintained a healthy new business pipeline at the end of the quarter across our business. Our Employer Services retention rate once again exceeded our expectations. Although, retention declined slightly versus the prior year, including in our small business portfolio, we continued to see resilience among our clients. More importantly, our overall NPS scores reached a new all-time high, positioning us to stay near these historically high retention levels. Our Employer Services pays per control growth was 2% for the first quarter as our clients continued to add employees at a pace that is gradually slowing. And our PEO revenue growth of 3% in the quarter was relatively stable versus last quarter, reflecting solid PEO bookings performance offset by deceleration in PEO pays per control growth. Don will speak to our updated guidance in a moment, but the demand environment for PEO as well as our other outsourcing services remains healthy. Moving on, we made meaningful progress across all three of our strategic priorities that we outlined last quarter. Let me start with an update on some actions we took in Q1 to lead with best-in-class HCM technology. First, we began embedding Gen AI features into our products. In Q1, we integrated Gen AI into Roll to further enhance its conversational UI and make it even easier for small business owners to quickly obtain customized Payroll and HR guidance. We also began rolling out ADP Assist, which delivers insights and recommendations to make complex HR work simple. We've enabled ADP Assist for select Workforce Now clients, beginning with a Report Assist feature that allows practitioners to easily extract the insights they're looking for. We look forward to continuing to build on the live feature set of ADP Assist to further enhance the experiences of both HR practitioners and employees. We also had some exciting product developments beyond AI. Our clients tell us they need personalized experiences and deep integrations to help them manage the complexity of running a business today. To help address this, we recently launched a new product called API Central, which enables businesses to easily and securely connect their ADP workforce data across systems using pre-populated APIs and tools. This is a feature our clients have increasingly asked for and we have already seen a strong uptake. In Q1, we complemented the launch of API Central with the acquisition of Sora, an intelligent workflow automation and data integration tool. Sora's unique capabilities will allow our clients to automate people processes by unifying various applications such as HR, IT, CRM, and more, creating a smarter and easier-to-use experience for our clients. In Q1, we also launched ADP Workforce Now for construction, a comprehensive offering designed to help clients with the unique payroll and HCM needs of the construction industry. This verticalized offering combines tailored Workforce Now capabilities and reporting with a team of dedicated specialists for the construction industry. While ADP has always served clients across the full spectrum of industries, construction stood out to us as a vertical with enough complexity to warrant a more tailored solution, and we're excited to further strengthen our offering in the mid-market. We also announced the launch of our corporate venture capital fund earlier this month, leading with best-in-class HCM technology requires that we stay attuned to the frontier of HCM innovation. And now, in addition to the organic efforts we are developing in ADP Ventures, we will invest in and partner with early-stage startups to strengthen our core business our core business and to extend into natural adjacencies. Two of our early investments focus on improving lifestyle benefits to drive associate engagement in simplifying the incredibly complex leave management process that businesses and their workers have to address. We're excited to build on these partnerships and develop new ones. Overall, Q1 was a very busy quarter on the product front with much of the work we're doing representing seeds of innovation that will position us to continue shaping the future of work. Our second strategic priority is to provide unmatched expertise and outsourcing solutions. In addition to launching the pilot of ADP Assist for our clients, we also launched the pilot of our new Agent Assist embedding Gen AI in the flow of work for ADP Associates. So far, we have enabled our call summarization capability to select associates. Thanks to this Agent Assist feature, those service associates no longer need to spend time writing up case notes after client calls, which should make our associates more effective and also allow us to quickly aggregate real-time client feedback to continuously improve our products. We are also piloting Agent Assist real-time guidance for our associates to help them with support content and guided workflows and to more easily share their accumulated knowledge in a way that's customized to individual client cases. We are excited to continue working toward additional Agent Assist features to help our implementation and service associates deliver better, faster service and to help our client satisfaction scores continue to reach new record levels. Our third strategic priority is to benefit our clients through our global scale, and in Q1, we expanded on this advantage. In August, we extended our leading global footprint by acquiring the payroll business of BTR, our longtime partner in Sweden. Acquisitions like this strengthen our multi-country payroll ecosystem while also positioning us to grow a local HCM business in countries with attractive growth prospects. In Q1, we launched Roll in Ireland, representing the beginning of an expansion into the European market, where we believe an AI-based payroll app coupled with our existing on the ground ecosystem will allow us to expand our SMB business outside the U.S. And during Q1, we also announced plans to deepen our existing partnership with Workday to deliver enhanced global payroll compliance and HR for the many clients we jointly serve around the world. Partnerships like this reflect our long-standing commitment to provide the personalization and overall experience our clients desire. Before turning it over to Don, I wanted to highlight a couple milestones in two of our businesses. Our suite of workforce management solutions, sometimes referred to as time and labor management, reached more than 125,000 clients in the first quarter, benefiting from a double-digit growth rate these last few years. Scheduling and precisely tracking time has become more important for employers over recent years in order to meet evolving legislative requirements, and we look forward to continuing to invest in our workforce management solutions to drive higher client attach rates. We also now serve more than 150,000 retirement services clients, which is up more than 20% from the 125,000 clients we served at the end of fiscal 2022. We anticipate growth for our retirement services business will remain strong in the years ahead as the provisions of the SECURE Act 2.0 and additional state mandates continue to phase in and as companies of all sizes continue to recognize the importance of positioning their workers well for their eventual retirement. I'm proud of our start to fiscal 2024 with both strong financial results and meaningful strategic progress. Our roadmap for the months ahead is keeping us incredibly busy. And with this in mind, I'd like to take a moment to recognize our associates across sales, service, implementation and technology whose efforts and outstanding performance are positioning us to consistently deliver for our clients and our shareholders. Thank you, all. With that, I'll turn it over to Don."
},
{
"speaker": "Don McGuire",
"content": "Thank you, Maria, and good morning, everyone. I'll provide some more color on our results for the quarter and update you on our fiscal '24 outlook. Overall, we had a solid Q1 and are not making changes to our consolidated outlook, but there are some moving pieces I'll cover. Let me start with Employer Services. ES segment revenue increased 9% on a reported basis and 8% on an organic constant currency basis, ahead of our expectations. As Maria shared, ES new business bookings had a solid start with especially strong growth in September. The demand environment is stable, our pipelines are healthy, and we are on track for our 4% to 7% growth guidance. Our ES retention did decline slightly in Q1 versus the prior year, but that was slightly better than we expected. At this point, we are maintaining our outlook for a 50 basis point to 70 basis point decline in full year retention, which continues to embed an expectation for small business losses to increase due to higher out of business rates. But if recent trends continue, then we would hope to outperform that range. ES pays per control growth was in line with our expectation in Q1. It decelerated modestly to 2%, and we expect this very gradual deceleration to continue in the coming quarters and are maintaining our outlook for 1% to 2% growth for the full year. Client funds interest revenue increased in line with our expectation in Q1, but we're raising our full year outlook based on the latest forward yield curve, which result in a modest increase in average yield to 2.9% from our prior expectation of 2.8%. We now expect client funds interest revenue as well as the net impact from our client funds extended strategy to be up $35 million from our prior outlook. Meanwhile, the U.S. dollar strengthened, representing a drag relative to our prior fiscal '24 revenue outlook. In total, our strong Q1 ES revenue growth combined with higher than expected client's funds revenue for the rest of the year effectively offset the adverse FX movement and we're maintaining our fiscal '24 ES revenue growth range of 7% to 8%. Our ES margin increased 220 basis points in Q1, driven by both operating leverage and contribution from client's funds interest revenue. For the full year, we are raising our fiscal '24 outlook to now anticipate an increase of 150 basis points to 170 basis points, which reflects the benefit of higher yields, partially offset by higher spend on Gen AI projects and usage, as well as a small amount of dilution from our recent acquisitions. Moving on to the PEO. We had 3% revenue growth driven by 2% growth in average worksite employees in Q1. As Maria mentioned earlier, our PEO bookings growth was solid, but pays for control growth continued to slow and was lower than expected, particularly for clients in the professional services and tech industries. This resulted in a slightly softer Q1 worksite employee count than we were anticipating. As a result, we now expect fiscal 2024 PEO revenue growth of 3% to 4% with growth in average worksite employees of 2% to 3%. Our PEO sales pipelines are healthy and we continue to forecast their worksite employee growth gradually ramping in the back half of fiscal '24. PEO margin decreased 90 basis points in Q1 which is more than we had planned. The decline was primarily driven by a lower workers' compensation reserve release benefit as well as higher selling expenses. We now expect PEO margin to be down between 50 basis points and 100 basis points in fiscal '24 with the continued assumption for higher selling expenses as well as year-over-year headwind from a lower workers' compensation reserve release benefit than we experienced in fiscal '23. Putting it all together, there is no change to our consolidated outlook, but I would like to share some color on cadence. In Q2, our client funds balanced growth will lightly impact the payroll tax deferral that we had in our average balance for the past two years, which creates some grow over pressure on our client's funds balance and will result in more modest ES margin expansion in Q2 than other quarters this year as well as a modest revenue impact. As a result, we expect consolidated revenue growth to moderate before accelerating slightly in the back half. And we expect adjusted EBIT margin to be down slightly before ramping in the back half of the year. This was already contemplated in our guidance at the outset of the year. So again, no change to our consolidated guidance. We continue to forecast fiscal '24 consolidated revenue growth of 6% to 7% with our adjusted EBIT margin expanding by 60 basis points to 80 basis points. We still expect our effective tax rate for fiscal '24 to be around 23% and we anticipate adjusted EPS growth of 10% to 12%. Thank you. And I'll now turn it back to Michelle for Q&A."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] We'll take our first question from the line of Samad Samana with Jefferies. Please go ahead."
},
{
"speaker": "Samad Samana",
"content": "Hi. Good morning. Thanks for taking my questions. Maybe first just want to double-click on the PEO side. I think that, the information you gave helps to understand some of what happened in the revised guidance, but maybe just help us understand what's giving that back half ramp confidence, especially, as you expect pays per control in the kind of broader macro to continue to decelerate. Where should we get the acceleration in the PEO WSEs? Is it purely based on bookings ramping? Is it based on an expectation that the base will stabilize? Maybe just dig into that a little bit further because they're moving in different directions."
},
{
"speaker": "Maria Black",
"content": "You bet. So, good morning, Samad. It's Maria here. I thought I'd kind of break down your question with respect to the PEO, call it, double-click. So I'll start by commenting on the first quarter. So, I've mentioned, we did see deceleration in PEO pays per control. So as Don mentioned in the opening comments, that is a byproduct of what we're seeing in the pressure with respect to, as you know, that business tends to skew more into professional services technology. The pays per control deceleration is happening at a faster clip in those cohorts than the broader base. And so said differently, the pays per control growth in the PEO is decelerating faster than we expected and faster specifically in those cohorts. So in terms of the contributions, that is the contribution to the deceleration or the new guide to worksite employee growth that we're seeing in the first quarter. We did have strong bookings in PEO in the first quarter. That said, it did come in slightly below where we had hoped for, so it was still higher than overall employer services. It was a good quarter for the PEO and this is now the third quarter in a row that we've seen strength in bookings in the PEO. And that's important to note because really the strength in PEO bookings is what ultimately will yield the reacceleration that you're asking about in the back half. That coupled with kind of what we're seeing in retention. So while retention is stable and stabilizing inside the PEO, it isn't back to the high growth levels that we saw, call it, a couple of years ago in the last year or so, and as such as those compares continue to lap coupled with retention continuing to accelerate, if you will versus stabilize. We will see contributions from retention, we'll see more contributions from bookings and that's really why we anticipate the worksite employee guide for the year that we've given."
},
{
"speaker": "Samad Samana",
"content": "Great. And Maria, I actually had a follow-up for you as well on the international side."
},
{
"speaker": "Maria Black",
"content": "Yeah."
},
{
"speaker": "Samad Samana",
"content": "After seeing the rollout of the product into Ireland. And I'm just curious, how should we think about the expansion beyond the U.S.? I know ADP already has a presence and it's a meaningful contributor to revenue, but just should we think about international maybe being an offset to some of the slowdown that we're seeing in U.S. revenue? Just how should we think about the cadence and impact as you move more international with your core HCM solutions versus just helping U.S. employers that already had an international presence?"
},
{
"speaker": "Maria Black",
"content": "Yeah. Absolutely. So I'll speak to Roll, which is what I commented on in the opening comments. So we did roll out, no pun (ph) unintended, our roll offering into Ireland. And it is an exciting bit for us, albeit it's very early days, right? It's actually only been a couple of weeks. But we're excited about it because it's the first of many countries where we intend on taking the, call it, very down market offering into our various countries throughout international. And it's really about marrying that product with what we see as still potentially greenfield opportunity within our international space and really leveraging the ecosystem that we have, that's everything from distribution to all the services call it around, the offers in various countries. So we're very excited about that. Now, in terms of the overall growth contributions in the short term of rolling out Roll into Ireland, I would say they're negligible. I would say even Roll over time this year, I think it would be, not a meaningful contributor to bookings. To me, I think this is really about a long-term investment that we're making across international and what we see as a continued opportunity for us. So you kind of mentioned is this companies that have a presence in Europe, that exist in the U.S. with folks working in or call it in international? And the answer is, this is both of that coupled also with a lot of our, what I would say, best-of-breed offerings in international. So we see growth opportunity really across the board in international and that's everything from the down market, which we're going after now with this new product offering of Roll. So we see it in the SMB space, we see it in our best-of-breed space and we also see it in our global MNC space. So really excited about the long-term growth opportunity that continues to be international. And while on international, I thought I would just mention because it's important to note, we did have a very strong quarter with respect to international, albeit that quarter is obviously off of a compare Q1 of last year that was less favorable, but it is on the heels of what was a very strong fourth quarter finish in international. And so, all the way around, I continue to be incredibly excited and optimistic about what it is that we can go accomplish and continue to build in our international offering."
},
{
"speaker": "Samad Samana",
"content": "Great. Thanks so much for taking my questions."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Bryan Bergin with TD Cowen. Please go ahead."
},
{
"speaker": "Bryan Bergin",
"content": "Hi. Good morning. Thank you. So, Maria, I was hoping if you can comment on just how you're seeing the overall macro situation evolve and maybe how that may affect demand? And if you can specifically unpack that within the ES segment, maybe talk about some of the areas that came in better than you expected versus any areas that may have been lighter or downtick versus the prior quarter."
},
{
"speaker": "Maria Black",
"content": "Absolutely. Good morning, Bryan. So happy to comment on what we saw in the first quarter with respect to the overall performance of bookings, but also the demand. So I'll kind of start with the overall performance. I mentioned in the opening comments, we did see strength, continued strength in our down market, so really excited about that. Also saw tremendous strength in our compliance solutions offering. So think of it as all the stuff that hits compliance tax, things of that nature. So we're pleased with what we saw with respect to new business bookings. Those are the two that really outperformed. And it's exciting to see because really that entire down market offering and that's everything from our run offering to retirement services, insurance services, we continue to see tremendous strength there. We saw that all of last year and definitely the finish last year, and it makes me happy because it's a lot of the places that, well, good performance makes me happy regardless, but it's a lot of the places where we've been making meaningful investments both in the product as well as the distribution. So excited to see the continued performance there and the outperformance. The overall results do keep us in line with our full year guide. So excited to confirm that again here today. In terms of the overall demand environment and I feel like I've been saying this quarter-to-quarter, but we're not really seeing any major changes in demand. Demand is still strong, demand is still healthy. We see that in our bookings results. There are all sorts of other indicators that we look at in terms of pipelines, in the up-market, in the mid-market, certainly in the down-market. We're looking at things such as new appointments and kind of activity, excuse me, activity measures to really give us a guide on whether demand is strong. And I would tell you pipelines are healthy year-on-year and certainly activity is healthy. And so we don't see a big demand change again this quarter. In fact, it’s kind of the opposite stepping into the quarter on the heels of a strong September. We feel really good about where our pipeline sit year-on-year, which again is giving us the confidence in the full year guide. As always though, Bryan, we continue to keep an eye on the macro. We continue to keep an eye on our global space and international and making sure that we're understanding both any macroeconomic changes coupled with any demand environment that could shift given everything kind of going on in the world, if you will. So that's the current story on kind of pipelines demand in the quarter."
},
{
"speaker": "Don McGuire",
"content": "Yeah, maybe.."
},
{
"speaker": "Bryan Bergin",
"content": "Okay."
},
{
"speaker": "Don McGuire",
"content": "If I could add a couple of comments on the macro, certainly macro continues to be pretty positive. Unemployment rates continue to be near decade lows here in the United States. Unemployment rates around the world continue to be quite low. The discussion about whether or not we're going to be in a recession, I think the odds are now not for a recession. So soft landing is pretty much what is being anticipated. Interest rates are expected to have peaked here in the US. So I think all things considered, things are pretty positive. I think the one area that we put in our original guidance for the year and that we continue to look at is our guidance had in fact contemplated a slowing and pays per control growth. Maria mentioned that and talked about that in the PEO business, but we are confident. We are still seeing growth, albeit, we are seeing growth at a slower pace than we had previously. But once again, that was fully contemplated in our original guide for the year."
},
{
"speaker": "Bryan Bergin",
"content": "Okay. That's helpful. Thanks, Don. My follow-up on the PEO. So heard you, the bookings are a little bit lighter than you expected to start, but you're also calling out, I think higher selling expenses impacting the PEO margins here year-over-year. So can you -- maybe talk about the puts and takes there driving that dynamic?"
},
{
"speaker": "Maria Black",
"content": "Specifically on PEO margins? I will let Don…"
},
{
"speaker": "Don McGuire",
"content": "No. But I think originally, Bryan, you mentioned bookings were lighter than expected. I think our bookings came in – our bookings came in pretty good, as Maria has mentioned."
},
{
"speaker": "Maria Black",
"content": "Yeah. I think he's referencing the comment I made around PEO bookings was slightly lighter than expected. By the way, still higher than ES, which we expect to be the case throughout the balance of the year. So that's the kind of nuanced [Multiple Speakers]"
},
{
"speaker": "Bryan Bergin",
"content": "So the question there, you're also citing higher selling expenses impacting the PEO margin. So it seems like there's a bit of a disconnect there. Just trying to understand that."
},
{
"speaker": "Don McGuire",
"content": "Yeah. So we had planned the year, we talked about the growth being stronger in the second half in bookings, sorry, in margins than in the first half. And certainly we have seen some investment and some higher selling expenses and we'll see in the first half than we will in the second half, but nothing really surprising. A little bit off, but certainly we're in line with what we expected."
},
{
"speaker": "Bryan Bergin",
"content": "Okay. Thanks."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from James Faucette with Morgan Stanley. Please go ahead."
},
{
"speaker": "James Faucette",
"content": "Great. Thanks. I wanted to ask just a couple of quick follow-up questions. First, I think the comment was made that you're still anticipating a bit worse performance in terms of out of business rates on a go-forward basis, but to-date those have been a little bit better than you had anticipated. Can you help provide some detail as to what you're seeing, why you think we're seeing better, survival rates, and kind of the things you may be looking at as indicators that could get worse on a go-forward basis."
},
{
"speaker": "Don McGuire",
"content": "Yeah. Demand continues to be strong in the economy overall, and I think that's supporting what tends to be this view that we're not going to enter into a recession. At best, there's going to be a soft landing. So I think that strong demand environment, particularly consumer demand is keeping small business afloat. So when you also look at what we're seeing in terms of new business formations, there seems to be continued strength in new business formations. So generally I would say that the environment, irrespective of the higher interest rates, the environment continues to be favorable for small business, and I think that's translating itself into what looks to be lower out of business than contemplated now. We have continued, as we said in our original guide, and as we will reiterate or update here today, we have continued to think that we will see a little bit more normalization in other business. So we'd have contemplated that, but we think we are getting closer to where we think we're going to plateau or hit the bottom there. So I think we're very close, and once again, I think it just comes back to demand environment. It tends to be supporting the economy more broadly and more generally and small businesses benefiting from that as well."
},
{
"speaker": "Maria Black",
"content": "Yeah. I think if I may, I think the only thing I would add is that it's still very early in the year, right? So when I think about retention, we did have a record level in fiscal '23. We were near that record level a year before, we were at that record level the year before that. And so we've had this tremendous strength. And I think Don is spot on in terms of all the reasons from a macro perspective that we've had that strength in terms of client retention. And so as that normalizes, we believe it's still prudent for us to have the retention guide that we have, which is really a byproduct of how we planned the year in the back half. So I think I got the question last quarter and so I'll answer it proactively this quarter, which is, are we just being conservative? And I think the answer to that question is, it's still early in the year. And so, if we do continue to outperform retention in the way that we outperformed in the first quarter, we hope that we will outperform for the full year. It's just early to take away that conservatism sitting here just, three short months into a very long year."
},
{
"speaker": "James Faucette",
"content": "Yeah. And then, I want to go back to kind of a headline related question. You saw that -- you saw or you indicated that you'd seen kind of a 25,000 sequential improvement in retirement services and -- for clients, you alluded to some state mandates there, particularly around SECURE Act 2.0. Can you talk a little bit about what state mandates you've seen or that may be impacting that business or how long before we start to see benefit in their retirement services, post a new state mandate? So maybe we can help track headlines and anticipate like, how big of an impact any new requirements may have?"
},
{
"speaker": "Maria Black",
"content": "Absolutely. So I think I've spoken quite a bit to retirement services as well as the SECURE Act over the last year or so. And I will tell you, I was excited to report the new milestone today in part because that business continues to show strength, but also because it's a business that I know is adding tremendous value into the world of work. And so, it is an exciting time. It does come as a byproduct of the offering, the investments we've made into the offering, and also these state mandates, some of which are anchored into the SECURE Act at the federal level, some of which are anchored state by state. Candidly, I could probably spend an hour with you and go state by state in terms of all the various mandates. What we see over the next year or so is the threshold of companies that need to comply with the state mandates starts to creep into, call it, the further down market, if not the micro market. And so, as all these states, a lot of them being on the West Coast, if you're looking for headlines tracking states like California, as they continue to pull down at what level do you need to comply with the state mandates and/or the SECURE Act, the more opportunity we will have to ensure that we're helping our clients to solve for this piece, keep them compliant. But again, back to doing good in the world, it's also something that's bringing the value to each one of these employees that are engaging with these clients, so."
},
{
"speaker": "James Faucette",
"content": "Great. Appreciate that color."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open."
},
{
"speaker": "Bryan Keane",
"content": "Hi, guys. Good morning. Just want to ask about the decline in PEO. Looking at the employee base of PEO declining versus not necessarily the case, looks like almost the opposite in the employer services. So just trying to think about the trends. And does, typically the trend you see in PEO bleed into employer services and why maybe it's been a little bit weaker for pays per control there in PEO versus employer?"
},
{
"speaker": "Maria Black",
"content": "Yeah. So just to clarify, pays per control in PEO is actually higher. We don't give that number, but it is actually higher than employer services. So I think the first piece suggests is that the bases are actually just different, right? So if you look at the pays per control across the broader ADP, it's really a reflection of a mix of industries. As I mentioned earlier, the PEO tends to skew, by design, by the way, for the offering. It's really -- the offering is the most valuable if you will to the cohorts that we offer it to, which tends to be more professional services, tech-oriented companies that want to offer employers or their employees benefits of choice, if you will, to be employers of choice. And so that skews that base slightly differently than the overall. And what we're seeing within the PEO base is a delineation between those cohorts and the rest of the base, if you will. So we cited it in the prepared remarks, but the deceleration that is happening at the PEO is still a byproduct of within that base having professional services and tech decelerating at a faster clip than the rest of the base. So to answer your question, does it bleed across? I think, we're already hearing these headlines in the market in terms of -- and we see it within our own ADP Research Institute data with respect to professional services and tech hiring being in a different position than the rest of the market. So I think I would suggest it's already been bleeding across. If you look at the last couple of quarters of that, by the way, that also tracks BLS data shows the same thing. You see it in wages. And so all of that to suggest, I would say, the trend we're seeing in the PEO is already in the macro, but the bases are slightly different, which is why you would feel it, the impact of it perhaps more significantly in the PEO PPC than you would in the broader PPC. That was a mouthful, by the way."
},
{
"speaker": "Bryan Keane",
"content": "No that was helpful though. Thanks for that clarification. And then the other question I just had is the strength you saw in the ES new bookings especially in September and the way the pipeline looks, but you're not changing the total outlook of 4% to 7%. Just trying to figure out -- do you feel like you guys are maybe trending if things hold trending above the guidance range for bookings given the strength you saw in September in the pipeline and for SMB strength in the quarter?"
},
{
"speaker": "Maria Black",
"content": "Yeah. What I would offer is that I'm incredibly pleased with the results in the first quarter, especially on the heels of what was an incredible finish last year. And so the pattern that we saw in the first quarter and the strength in September is not a typical of the pattern we see in this -- the first quarter on the heels of an incredibly strong fourth quarter. And so I am excited about the first quarter results, I am excited about the strength in September. But the excitement is actually less about, call it, the finish in September and more about what we see on the year-on-year demand environment, what we see in activity, what we see stepping into this next quarter. And that does give us confidence into our full year guide at that 4% to 7%. What I would also offer though is it's a long year, and when you think about where the skewing, if you will, or the contribution of new business bookings happens for us on a full-year basis, it is in that third and fourth quarter. I'll much call it larger than the first and second quarter. And so we believe it's prudent to given the line of sight that we have today, just a quarter in. But we feel confident in the guide, we're excited about the performance, we're excited about how we're stepping into the quarter. The second quarter that is but we also still have an entire year ahead of us."
},
{
"speaker": "Bryan Keane",
"content": "Got it. Thanks for taking the questions."
},
{
"speaker": "Maria Black",
"content": "You bet. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Ramsey El-Assal with Barclays. Please go ahead."
},
{
"speaker": "Ramsey El-Assal",
"content": "Hi. Thanks for taking my question. Could you give us your latest thoughts on the competitive environment in PEO and how that's sort of evolving over time? I think there's somewhat slower than historical growth across the industry. Are there any signs that the market is, saturated with providers or is there any competitive overlay to PEO performance?"
},
{
"speaker": "Maria Black",
"content": "I would suggest that the PEO ASO conversation, if you will, or PEO HR outsourcing offerings kind of continues. I don't know that there's anything new to report, Ramsey. I think from my vantage point, it's always been a very competitive environment. We all have slightly different PEOs from one another. I think we talked a lot about ours today and the way that it skews to professional services and tech. I think you have others that skew to different types of industries. You also have other PEOs that perhaps are a bit more down market. We tend to skew a little bit more upmarket than some. And so I think all the PEOs look slightly different. I think we all know our models are also not identical in terms of how we actually go-to-market, whether it's through the strength that we have in the competitive advantage of being able to have ADP's client base contribute about 50% of those upgrades. So I think how we go to market, our models, never mind the models of, you know, fully insured to self-insured, et cetera. I think similar trends are within the ASO offerings, or some refer to them as HRO offerings. And so I think within there, you also have various models and various go-to-markets in terms of the, some competitors perhaps some -- have some flexibility or more movement between ASO and PEO than I think we've cited in the past. And so, I think all that to suggest I think the competitive environment is about the same and remains. I think I’m optimistic and expect growth in both our PEO bookings as well as our HRO and ASO offerings throughout the balance of this year. And so I think we remain very, very excited and optimistic about the growth of those -- all of our HR outsourcing offerings, both in this year as well as the long term."
},
{
"speaker": "Ramsey El-Assal",
"content": "Got it. Okay. And a follow-up for me. Could I ask you to revisit those comments you made about higher selling expenses in PEO? What does that mean exactly? And also just I wanted to make sure I understood that, Don mentioned that, there's some expectations those may continue, but they're still, in essence, sort of a non-recurring step up in expenses. It's not a permanent step up in, in expenses in the segment."
},
{
"speaker": "Don McGuire",
"content": "Yeah. We saw higher selling expenses in Q1 for the PEO, and we expect to see higher selling expenses year-over-year in the first half, but we do think that that's going to settle down into the second half. So we're not looking at the kind of growth that we saw last year. I think we commented quite extensively on the many, many salespeople we added into the business last year and had great success and allowed us to finish the year the way we did. So those folks are in place. So we are continuing to add some sellers. We will add though, most of those sellers in the first half and it's important to also, I think, call out here that, what we are seeing with our sellers is that we are getting much better retention within the seller community. So we are hoping and expecting to benefit from the improved tenure that we should see from the selling organization as we go through the balance of this year."
},
{
"speaker": "Ramsey El-Assal",
"content": "I got it. So it's headcount-related primarily. That makes a lot of sense. Thanks so much."
},
{
"speaker": "Maria Black",
"content": "Yeah. I think it's a timing thing. I think that's the…"
},
{
"speaker": "Ramsey El-Assal",
"content": "Got it."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Jason Kupferberg with Bank of America. Please go ahead."
},
{
"speaker": "Jason Kupferberg",
"content": "Good morning, guys. Just staying on PEO for a second and maybe if we can just refresh a little bit here. I'm just thinking back to the Analyst Day two years ago, we thought it was a medium-term 10% to 12% grower. Now it's 2% to 3% at the moment. There was definitely some post-COVID normalization. But maybe just, Maria, if you want to take us back through the dynamics in terms of just how the business has evolved from your perspective? And is there a potential path back to double-digit growth for this business if the macro is a little bit more cooperative?"
},
{
"speaker": "Maria Black",
"content": "Yeah. So I'll let Don kind of speak to the medium-term targets and kind of the path back. But I think, from my vantage point, and I said it earlier today, that step one is the continued reacceleration of bookings. And so this is the third quarter that we're pleased and we did have a solid contribution of PEO bookings to the overall bookings picture in this quarter. That was the case last quarter, it was the case the quarter before. And I think the reason that I go to that is not just because it's the piece that will accelerate the growth and path us back to what our long-term goals and medium-term targets are with -- for that business. I think it's also because it speaks to the demand environment. It speaks to the value proposition and the strength of that offering that still exists in the market. And so I think that's a big piece of it. I think step two is the continued acceleration -- reacceleration of retention. So I mentioned that retention has been stable and as we reaccelerate retention back into that growth, that also will contribute to obviously the revenue. And then last but not least, Jason, you mentioned it, the macro headwinds, and I think I talked about the last couple quarters, how that's been the post-pandemic, call it, nuances that impacted that business. I think we talked a lot about the renewal over the last couple of quarters. Now we're seeing these trends in PPC. My view would be that all of the post-pandemic waves that have been, call it, flowing through the PEO and all the variables that make up that model. We're still seeing some of those case in point being really call it the reversion of what we saw several quarters ago, which was when professional services and tech was in a massive hiring boom, now we're seeing the opposite of that, right? So I think we still have some of these waves, kind of shuffling through or whether or going through -- flowing through the PEO. And if and when the macro changes with respect to that, that certainly will help reaccelerate that business as well. So in terms of the path back, I'll let Don kind of speak to the medium-term targets."
},
{
"speaker": "Don McGuire",
"content": "Yeah. I think Maria covered it very comprehensively there. I would say that when we established the mid-term targets, I think a lot of things have changed since then, certainly the inflation environment and that we've seen in particular and Maria just mentioned professional services and technology, we saw incredible growth in those sector -- in those segments and growth beyond what we thought we -- or what we had predicted in the mid-term targets or spoken to. I think now we're seeing some reversion. We do, though, continue to be incredibly positive about that business. We think it definitely has a place, and we think that we will make our way back. But as Maria also said, it's a little bit early to forecast when we think we're going to get back to some of those mid-term target growth areas that we had discussed."
},
{
"speaker": "Jason Kupferberg",
"content": "Understood. That's good color. Just a follow-up on float yield. It looks like it was actually a tick down slightly quarter-over-quarter here in Q1, amid a higher rate environment. But just curious what the callouts might be there."
},
{
"speaker": "Danyal Hussain",
"content": "Hey, Jason. That just relates to the mix between short-term and extended in long. So in Q4, we were a little more levered to overnight partly because of this debt ceiling issue. We had to be deliberately skewed shorter duration. But in a typical Q1, we would generally have a lower short portfolio. And so there is seasonality in the average balance wouldn't read much into it. The year-over-year number is a much more relevant metric."
},
{
"speaker": "Jason Kupferberg",
"content": "Thanks, guys."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Tien-Tsin Huang with JP Morgan. Your line is open."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Hi. Good morning. Forgive me, if I'm asking another clarification on the PEO side. Just --what the -- was the slight softness in the bookings also related to the PS and tech sectors and also with the pays per control within PEO, is that more of a healthcare participation issue or just labor weakness in those sectors?"
},
{
"speaker": "Maria Black",
"content": "I really apologize, you actually blipped out during the first part of your question. Would you mind just repeating -- yeah, there was a word missing so."
},
{
"speaker": "Tien-Tsin Huang",
"content": "No, I probably didn't ask it very well. Just wanted to make sure the bookings softness on the PEO side, was that also in the professional services and tech sectors. And then also just on the pays of control, was is a labor weakness or health care participation?"
},
{
"speaker": "Maria Black",
"content": "Yeah. Listen, so I'm glad you're asking this question actually because I just want to reiterate, we were very pleased with our PEO bookings. And so there wasn't softness, there was strength and growth in the PEO quarter bookings. In terms of how we skewed the year, it was slightly lighter than we had positioned our planning, which is why it contributes the way that it does to the overall worksite employee growth. But, it's -- again, the worksite employee deceleration is really about the PPC story. And so I just want to reiterate, we were actually very pleased with the quarter from a PEO bookings perspective. In terms of the industries, I think it's a mix. I think we continue to see the PEO execute with respect to the industries that we target which tend to be into those categories. As it relates to, this comment around kind of within the PEO, the deceleration that is happening faster in professional services and technology versus the broader base of the PEO. Again, I don't want to give kind of the numbers of what that is, but it isn't like the entire base is sitting in professional services. It's just that subset, if you will, of the base. And it is really, again, kind of triangulate to the macro that we're seeing and the same type of data coming out of ADP Research Institute, out of the BLS and it's really about hiring. So it's less about, call it, layoffs and it's really where the professional services and tech industries, we're doing massive hiring, call it, a year ago, six quarters ago, it's really a lack of hiring that's happening in those businesses. Did I answer that question?"
},
{
"speaker": "Tien-Tsin Huang",
"content": "Yeah. [indiscernible]"
},
{
"speaker": "Danyal Hussain",
"content": "Tien-Tsin, just on the participation piece of it, the pay per control wouldn't be impacted by participation rate, but the reported revenue would be. So to the extent, workers are taking plans, cheaper plans or fewer plans. And there's a little bit of that. You do see it in the revenue per WSE, but the WSEs themselves wouldn't be impacted."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Thank you, Danny. I didn't ask it. Well, that's perfect. That's what I was looking for. On the -- we get questions around pricing as well. That's why I was asking about the participation side of things and if there's a difference there, it sounds like it isn't. On the international front, just my quick follow-up. Just I think Sweden was the call-out in terms of acquisition. Why is Sweden important to own? Just I'm not as familiar with some of the specific countries that you're targeting. And I'm curious if this is just part of a -- maybe a broader plan to aggregate international payroll."
},
{
"speaker": "Maria Black",
"content": "Absolutely. So listen, I have to take this question because I think you may know that I'm actually -- I was born and partially raised in Sweden. So I thought it was prudent to make it the very first country that I announced. I'm actually completely kidding. This was obviously well in motion before my time. But I -- it sounds like I might be closer to Sweden than you are. And for us, it is an exciting time for us. We have had this partnership with BTR for quite some time for us to be able to acquire the payroll business of BTR is exciting because the Nordics are growing, and this does give us a physical footprint into Sweden, which allows us to expand further into the Nordics and really take advantage of the growth trajectory of those economies. So this is obviously payroll, but also in the beyond payroll opportunities that we will have in years to come. So really excited about the acquisition not just because it's near and dear to my heart, but moreover because the Nordics represent growth, and it's exciting to think about us having a physical presence there."
},
{
"speaker": "Tien-Tsin Huang",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from David Togut with Evercore ISI. Your line is open."
},
{
"speaker": "David Togut",
"content": "Thank you. Good morning. You called out strength in ES bookings, particularly in the small business market with RUN. Could you provide some texture into the bookings trends you saw in mid-market with Workforce Now and then up-market with enterprise? And any insights you have into international bookings in the quarter would also be appreciated."
},
{
"speaker": "Maria Black",
"content": "Absolutely. So yes, we did have great strength in the down markets, kind of moving on up in the mid-market. Certainly, we have continued solid demand in the mid-market. That's inclusive of our Workforce Now platform. It's also inclusive of our HR outsourcing offering. So I spoke a bit about the ASO models, the HRO models earlier in that mid-market also support -- is supported by the PEO. So we do see continued demand from the mid-market. I think the way I always think about it is not getting any easier for companies in that mid-market to navigate being an employer today. And so we expect continued strong mid-market growth. I think in the up-market, since you asked about the enterprise space, one of the call-outs we made last quarter was about the strength that we saw in our next-generation HCM offering, and we did see that strength continue into this quarter, which we think is fantastic. We also see strength in the pipeline in that space year-on-year. So excited about what we're hearing from our clients, the sentiments around the offerings that we have in the enterprise space. And then I think I touched a little bit on international earlier, but our international business did grow nicely in the first quarter. Again, it was a benefit of a little bit of an easier compare year-on-year. But we also had, as I mentioned, a really strong finish and a strong fiscal '23 in our international business. Again, what I measure is partly the results. But as I think about the look forward, it's really about pipelines and what I would say, our international pipeline year-on-year have a fair amount higher than they did a year ago, which gives us the strength to really feel good about our international bookings to remain healthy through fiscal '24."
},
{
"speaker": "David Togut",
"content": "Thanks for that. Just as a quick follow-up, Don, you called out part of the 90 basis point margin decline in PEO being traced to a difficult comparison on workers' compensation reserve adjustments a year ago. Can you quantify for us how large those were as we think through the margin comparisons for Q2, Q3 and Q4 of FY ‘24 in PEO?"
},
{
"speaker": "Don McGuire",
"content": "Yeah. So as we've had very favorable reserve releases over the last number of years and somebody called out last year in the K, you would have seen the favorability there. So just to be clear, we are still seeing favorable reserve releases, but we are not seeing -- we didn't see the reserve release to the extent that we did Q1 to Q1 of the prior year. So the numbers will be in the Q, but it's about $6.2 million less than it was in the prior year. So that's the quantification of it. And if you kind of translate that into the margin, it's about 60 bps to 90 bps -- 60 bps of the 90 bps decline comes from the lower reserve release. Now once again, we think that we're going to continue to see reserve releases and were favorable as the actuaries get back to us and let us know what's happening, but we're not seeing any underlying changes or large changes that would lead us to be any less optimistic about seeing continued releases in the reserve."
},
{
"speaker": "Danyal Hussain",
"content": "And David, sorry, just to clarify, it was a $6 million benefit in Q1, which is about $8 million less than the prior year."
},
{
"speaker": "David Togut",
"content": "Got it. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Mark Marcon with Baird. Your line is open."
},
{
"speaker": "Mark Marcon",
"content": "Hey. Good morning, and thanks for taking my question. At HR tech, you got to see a lot of your new solutions, particularly focused on, the AI Assisted solutions. Maria, I'm wondering if you can talk a little bit about your philosophy with regards to, which solutions you would charge additional for -- how are you thinking about monetization? And then I've got a follow-up in terms of process improvement."
},
{
"speaker": "Maria Black",
"content": "Sure. Good morning, Mark. I'm pretty excited about all of our new solutions that you would have seen at HR tech. So I think I'll take a minute to kind of think or talk through how I'm thinking about Gen AI in general, and then I'll tell you how I'm thinking about monetization because I think it'll make more sense on the other side. But when I think about Gen AI, I think it will impact everything. So the answer is it's going to be everywhere impacting everything that we do across the entire client life cycle. So it's about how we develop products. That's everything from developer co-pilot types of tools that everyone is talking about. It's about how Gen AI will be embedded into our product, it's about how we go-to-market and modern seller stuff that I've spoken about for years and how we actually have the ability now leveraging Gen AI to actually acquire clients. And then the most obvious being how we serve them, how we implement them, how we become more productive and make our clients more productive as we serve our clients. And so when I think about Gen AI, and I think most -- everyone has probably likened it to things like whether it's software or the Internet, I think my answer to you is, it will be in everything that we do and in the fabric of who we become. And so in terms of the monetization side, I think it's less about, charging a PEPM (ph) on a per feature. So let's say, you know, some of the things I talked about today, which probably doesn't sound that exciting, like report writing or if you look at the earnings release document, you'll see in there a job description that's pulled in the screenshot showing roles. So these things probably don't sound that exciting, but they're pretty exciting because they are the seeds of innovation, as I used earlier to really show what -- how Gen AI will interact with everything that we do kind of in the fabric. So said differently, Mark, like, I don't think we're going to be charging separately to get Gen AI job description written or Gen AI report written. I think it's really about continuing our innovation journey to do all the things we've always done, which is really about becoming more productive. It's about solving things for our clients and making them more productive. And I think that, to me, the fruits of that labor really end up in new business bookings, and they end up in retention. And so that's not to suggest that there may not be things. But I don't think it's really to me about $0.50 PEPM (ph) here and there. To me, it's really about the innovation journey we've been on. This just allows us to do it at a faster clip. And I'm really optimistic and excited about the things that we're seeing. In terms of other things that we're measuring, we actually have the entire organization rallied to engage in these tools. We actually have some goals that we put out there in terms of -- by the end of the year, how many of our associates that set across sales and implementation and service and technology that are engaging with these tools. Right now, they're sitting at already above 10% of our base of associates that have the ability to touch these tools are already playing with them. I would tell you our entire sales organization are comping up a bit because the digital sales or inside sales where we've deployed a lot of these modern tools over years, have an ability to become that much more productive, engaging our new prospects and new sales. So as you can probably tell, like, I literally could go on and on and on, but I think my answer to you is, it will be everywhere across the entire client life cycle that we have, and I'm very optimistic about the long-term implications of this on all the major metrics that make up this great business model."
},
{
"speaker": "Mark Marcon",
"content": "That's terrific. And then with regards to just the productivity enhancement. I mean, particularly when we think about service and implementation, from a longer-term perspective, can you describe how much more efficient you think your service personnel could become? And how much efficiency you could end up gaining there and the implications from, continuous margin improvement as you continue to go along that journey? I know it's early days, but just how are you thinking about that?"
},
{
"speaker": "Maria Black",
"content": "Yeah. Listen, Mark, it is early days, right? And that's not for a lack of scoping it, right? So we have had because it's not as though we haven't had all of these business cases over many years on how to become more productive, and we've had machine learning and regular AI in our house for a long time. And this does give us a step change to that innovation. But it's still too early. I think to sit on an earnings call and commit numbers, but that's not for a lack of internally having scoping and line of sight to what we believe are pretty exciting goals for us to go chase. And again, some of those goals have existed for a long time, but now we have technology that I'm hopeful that we can actually finally crack the code on some of these really big enhancements that we see. But certainly, productivity is a big piece of it. I know I talked today about Agent Assist and this idea of call summarization. Again, it probably doesn't sound that exciting. But for someone who used to sit on the other side of that, you see whether it's a prospect call or a client call gets summarized and recapped into a very quick format that's usable. These are, hours and minutes of time. even on the seller side, we actually are launching something called rapid pre-call planning, and I think about the hours I used to spend 27 years ago, researching a company to get myself ready to go in and have a conversation with a prospect that brings value, enabling our sellers to have all of that productivity. So I think it's -- again, it's too early to give you exact hundreds of millions of dollars of types of quantifications. But arguably, we are actively looking kind of case by case and really picking the ones that we believe sequentially will be the most accretive to drive the most amount of productivity, the most amount of value back to our shareholders, but candidly, the most amount of value to our clients."
},
{
"speaker": "Mark Marcon",
"content": "Terrific. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. We have time for one more question and that question comes from Scott Wurtzel with Wolfe Research. Your line is open."
},
{
"speaker": "Scott Wurtzel",
"content": "Great. Good morning, guys, and thanks for squeezing me in here. Just on the launch of the construction vertical software. I'm just wondering, is this sort of part of a bigger shift to develop more vertical specific HCM solutions for your clients? I understand, construction may be a more complex vertical, but wondering if there's more of a vertical specific strategy that could develop beyond the construction vertical. Thanks."
},
{
"speaker": "Maria Black",
"content": "So I'd like -- what you're suggesting, and I think the answer to that could be yes. And I think when I think about -- back to selling 27 years ago, I used to sell construction companies and the complexity that they have has always existed and candidly, a lot of the features and functionality that we have and are now pulling together to make it an actual solution for that vertical existed many years ago. And that's everything from things like job costing, obviously, compliance and reporting, think about certified, compliance type of reports for payroll, things of that nature. And so it's really about pulling it together and marrying it with a service organization that can support the complexity of that vertical. I think that, to me, is a big change, so we did add some features. But a lot of these things we've had, and we pulled them together and we're marrying it with the ecosystem of a dedicated service org that can actually really help the construction industry and this vertical saw the complexity of being in that industry. So I think what I would offer is that, it's an exciting time for the construction industry, specifically for our Workforce Now clients, and I see this, just as you suggested at the beginning of other places that we could pull together our existing tech with a dedicated type of service model and solve real challenges in the business for various verticals."
},
{
"speaker": "Scott Wurtzel",
"content": "Got it. That's helpful. And just a quick follow-up. Just wondering if you can give an update on sort of Next Gen HCM and Next Gen Payroll, attach rates and how we're sort of trending there, relative to expectations?"
},
{
"speaker": "Maria Black",
"content": "So Next Gen Payroll. That was the question?"
},
{
"speaker": "Scott Wurtzel",
"content": "Both."
},
{
"speaker": "Maria Black",
"content": "Both. Okay, just making sure I heard it right. So I think I touched base really quickly on Next Gen HCM. And I think I noted to the excitement that we have that we continue to see the strength in the Next Gen HCM offering into Q1. So we had a strong fourth quarter. What I would suggest is that we actually brought in more Next Gen HCM in the first quarter than we saw all of last fiscal year. But again, one quarter these things can sometimes be lumpy. But I think for me, it's really about the sentiment. And so we recently had an Analyst Day. We had a handful of our clients up on stage that, shared with us the impact, the platform is making for them. And as you would remember, we spent a lot of our discussions over the last year talking about scaling implementation, on-boarding the backlog. So pretty exciting to see some of that backlog that's no longer backlog on stage, speaking to the value proposition, and that's supported by continued strength which means our sellers are excited to continue to sell the Next Gen HCM offering. So I think that's all very, very positive. Similarly, we have continued focus in the Next Gen Payroll. And so what I would offer there as we continue to make headway. So as it's not deployed across the entire mid-market. We continue to make headway to solve for more complex features, things of that nature, that will pull it further into the upmarket of the mid-market. But as you know, that Next Gen Payroll engine is also what's attached to the Roll offer. So the other exciting part about that engine is it is the thing that's taking us into the SMB space internationally. So I feel really excited about the road map for that offering and the contributions that it's making into the mid-market today, but also into the long-term growth of the company internationally."
},
{
"speaker": "Scott Wurtzel",
"content": "Awesome. I appreciate the color. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes our question-and-answer portion for today. I'm pleased to hand the program over to Maria Black for closing remarks."
},
{
"speaker": "Maria Black",
"content": "Yeah. So thank you, Michelle. And listen, it's hard for me not to sit here and reflect on a year ago. And so I was driving in this morning and feeling candidly a bit nostalgic because it's exactly one year ago that Carlos and I sat here and announced the transition of me becoming CEO of this amazing company. And so I'm incredibly nostalgic and proud today. I'm proud of our first quarter results. I'm really proud of the execution of the team, both with respect to the results, but also with everything that you heard in terms of the progress we are making on a very cohesive and strong strategic outline and priorities. But mostly what I would offer is that I remain incredibly humbled by the -- over 60,000 associates that I've had an opportunity to engage with over the last year who continue to make this company everything that it is and absolutely amazing. And I just wanted to say that I'd like to thank each and every one of them for inspiring me every day. So with that, that is the conclusion of our call and until we meet again."
},
{
"speaker": "Operator",
"content": "Thank you for your participation. This does conclude the program and you may now disconnect. Everyone, have a great day."
}
] |
adsk | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Thank you for standing by. And welcome to Autodesk's Fourth Quarter and Full Year Fiscal 2024 Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to Simon Mays-Smith, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"content": "Thanks, operator. And good afternoon. Thanks for joining our conference call to discuss the fourth quarter and full year fiscal 2024 results. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. During this call, we will make forward-looking statements including outlook and related assumptions, products and strategy. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today's press release for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will quote several numeric or growth changes during this call as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel financials and other supplemental materials available on our Investor Relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"content": "Thank you, Simon. And welcome, everyone, to the call. We finished the year strongly, delivering 40% constant currency revenue growth in the fourth quarter of fiscal 2024. Resilience, discipline and opportunity again underpinned our robust financial and competitive performance. Autodesk's resiliency comes from its subscription business model and its product and customer diversification, which balances growth across different regions and industries. Renewal rates remained strong. And new business growth and leading indicators were consistent with recent quarters. Despite ongoing macroeconomic policy and geopolitical headwinds, we saw growing usage, record big activity on BuildingConnected and cautious optimism from channel partners. Disciplined and focused execution and strategic capital deployment through the economic cycle enables Autodesk to realize the significant benefits of its strategy, while mitigating the risks of having to make expensive catch-up investments later on. With the new transaction model, we are approaching the final phase of modernizing our go-to-market motion, which has involved updating our infrastructure, retiring old system to end business models, and building more durable and direct relationships with our customers and ecosystem. At the same time, we are advancing a multi-year process to develop lifecycle solutions within and between our industry clouds, powered by shared platform services and with Autodesk's data model at its core. Together, these will enable Autodesk, its customers, and partners to create more valuable, data-driven and connected products and services. Having led the industry in general design, we are leading again in 3D generative AI. Autodesk is getting closer to a transformational leap where Autodesk AI is to [three] (ph) design and make where ChatGPT is to language. Our new multimodal foundation models will enable design and make customers to automate low-value and repetitive tasks and generate more high-value complex designs more rapidly and with much greater consistency. We can already generate 3D representations from images 10 times faster and with faster higher-quality and currently available through the AI. We're bolstering our homegrown capabilities and data with partnerships and acquisitions in existing and adjacent verticals. Our recent bidirectional integration of fusion with cadence and the acquisition of payouts are good examples. Discipline and focus on executing our strategy and deploying capital also underpin our opportunity. Our go-to-market and platform initiatives will drive even greater operational velocity and efficiency within Autodesk, which will free up further resources to invest in our industry clouds and capabilities, including AI and sustained margin improvement. And with a modernized go-to-market motion, lifecycle solutions and platform services, Autodesk will fulfill its potential to break down the silos within and between manufacturing, AEC and media entertainment, enabling our customers to unleash their data and design a better world built for all. I will now turn the call over to Debbie to take you through our quarterly financial performance and guidance for fiscal 2025, I'll then come back to update you on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"content": "Thanks, Andrew. Our financial performance in the fourth quarter and for the fiscal year was strong, particularly in our enterprise business. Early renewals and strong upfront revenue from enterprise business agreements or EBAs and federal governments drove some of the outperformance relative to our expectations in both Q4 billings and revenue. Overall market conditions and the underlying momentum of the business were consistent with the last few quarters. Total revenue grew 11% and 14% in constant-currency with upfront revenue driving 2 percentage points of that growth. By products in constant currency, AutoCAD and AutoCAD LT revenue grew 7%, AEC revenue grew 18%, manufacturing revenue grew 16% and M&E revenue was up 8%. AEC and manufacturing benefited from EBA true-up and upfront revenue. By region in constant currency, revenue grew 19% in the Americas, 11% in EMEA and 8% in APAC. Direct revenue increased 19% and represented 39% of total revenue, up 3 percentage points from last year, benefiting from strong growth in both EBAs and the Autodesk's store. Net revenue retention rate remained within the 100% to 110% range at constant exchange rates. Billings declined 19% in the quarter, resulting from the transition from upfront to annual billings for multiyear contracts as expected. So, slightly offset by some early renewals in North America. As part of our implementation sequencing for the new transaction model, we shifted our North American price increase from the end of March to the beginning of February. This resulted in some renewals moving from Q1 fiscal 2025 to Q4 fiscal 2024 which modestly boosted billings in January. Total deferred revenue decreased 7% to $4.3 billion and expected result of the transition from upfront to annual billings for multiyear contracts. Total RPO of $6.1 billion and current RPO of $4 billion grew 9% and 13% respectively. Early renewals drove about 1 percentage point of current RPO growth. Total RPO growth decelerated in Q4 when compared to Q3 when we closed our largest-ever EBA. The year-over-year deceleration was due to the lower mix of multiyear contracts in fiscal 2024 when compared to fiscal 2023, which I mentioned last quarter. In line with recent quarters and our expectations, we again saw some evidence of multiyear customers switching to annual contracts during the quarter. Turning to the P&L, GAAP and non-GAAP gross margin were broadly level, while operating margin was modestly lower in the fourth quarter, primarily due to the timing of Autodesk University costs shifting from Q3 to Q4, which we flagged last quarter. As expected, full-year non-GAAP operating margin was level year-over-year but up about one 1 percentage point at constant exchange rates. Fourth-quarter GAAP operating margin was up 40 basis points year-over-year and about 1 percentage point at constant exchange rates, partly due to a reduction in stock-based compensation as a percent of revenue. At current course and speed, the ratio of stock-based compensation as a percent of revenue peaks in fiscal 2024. We expect it to fall to 10% or lower over time. Free cash flow for the quarter and full year was $427 million and $1.28 billion respectively with early renewals, providing a modest tailwind in the fourth quarter. The most significant free-cash-flow headwinds from our transition from upfront to annual billings for multiyear contracts are now behind us, which means our free-cash-flow through during fiscal 2024 and will mechanically rebuild over the next few years. Turning to capital allocation. We continue to actively manage capital within our framework and deploy it with discipline and focus through the economic cycle to drive long-term shareholder value. As you heard from Andrew, we continue to invest organically and through complementary acquisitions to enhance our capabilities and the industry clouds and platform that underpin them. During the quarter, we purchased approximately 300,000 shares for $63 million at an average price of approximately $217 per share. We have now offset estimated dilution from our stock-based compensation program well into fiscal 2026. We will continue to repurchase shares opportunistically to offset dilution from stock-based compensation when it makes sense to do so. Now let me finish with guidance. Overall, end-market demand has remained pretty consistent over the last few quarters. Macroeconomic and one-off factors like the Hollywood writer strike dragged on the new business growth rate during fiscal 2024 and will modestly drag on revenue growth in fiscal 2025, but Autodesk's resilience and robust underlying demand for its products and services reinforce its long-term growth potential. Turning to revenue. I want to highlight four key puts and takes impacting growth in fiscal 2025. First, let me talk about the new transaction model. We've added some slides to the earnings deck to help illustrate how to think about this shift, which I'll briefly summarize. The new transaction model enables Autodesk to build closer, more direct relationships with its customers and partners and to better understand and serve them with more data, more self-service and greater predictability. It will be a cornerstone of the data services that Andrew talked about earlier. As you can see from Slide 11, the transition mechanically drives higher revenue and costs is broadly neutral to operating profit and free-cash-flow dollars and is a headwind to operating margin percent. About $600 million of payments made the resellers and developed markets in fiscal 2024 were accounted for as contra-revenue. As this business moves to the new transaction model, these payments will shift to marketing and sales expense over the next few years, all else equal, with the timing of cost recognition not materially different than before. The change affects a substantial majority of our business, but note that emerging markets and our federal government business will remain on the buy-sell model for the foreseeable future. The pace of the shift will primarily be determined by the mechanical build from ratable subscription revenue accounting and the rate of regional rollout of the new transaction model. While the former is relatively easy to predict given the ratable revenue recognition of our subscription business model, which fills over time, the latter will in part be determined by what we learn as we roll out the model further. We gained useful insights from the successful rollout in Australia, and we're expecting to learn more as we roll out with much higher volumes in North America this year. We will be able to apply those learnings when we launch in EMEA. Our fiscal 2025 guidance assumes the new transaction model is deployed in North America in Q2 of fiscal 2025 and provides about a 1 percentage point tailwind to Autodesk's revenue growth and a 3 points to 4 point tailwind to billings growth. Second, the acquisition of payouts, which closed on February 20th, is expected to contribute about 0.5 point of revenue growth in fiscal 2025. Third, token consumption for the fiscal 12021 EBA cohort exceeded consumption predictions made during the pandemic which resulted in true-up payments in fiscal 2024. Token consumption and the smaller post-pandemic fiscal 2022 EBA cohort is tracking more in line with predictions, which means we expect fewer true-up payments in fiscal 2025. This pandemic echo effect is about a point of headwind to fiscal 2025 revenue growth. And fourth, our rolling four-quarter foreign-exchange hedges means that FX is expected to be about a 1 percentage point headwind to reported revenue growth in fiscal 2025. Bringing this altogether, we expect revenue of between $5.99 billion and $6.09 billion in fiscal 2025, which translates into a revenue growth of about 9% to 11% compared to fiscal 2024. Adjusting the midpoint of our guidance to exclude noise from the new transaction model, acquisitions, the absence of EBA true-up revenue and FX, we expect underlying revenue to grow more than 10% in fiscal 2025. Moving on to margins. We're going to manage our non-GAAP operating margins between a range of 35% and 36% in fiscal 2025, with the goal of keeping them roughly level with fiscal 2024. This means we expect a roughly one-point underlying margin improvement will be broadly offset by the margin headwind from the new transaction model. As we transition to the new transaction model, we'll see operating margin headwinds from the accounting change of moving reseller costs from contra-revenue to sales and marketing expense. We'll also have incremental investment in people, processes and automation. But over the long-term, we expect that this transition to the new transaction model will enable us to further optimize our business, which we anticipate will provide a tailwind to revenue, operating income and free-cash-flow dollars, even after the incremental costs we expect to incur. Moving on to free cash flow, we expect to generate between $1.43 billion and $1.5 billion of free cash flow in fiscal 2025. In Australia, some channel partners accelerated renewals ahead of the transition to the new transaction model to derisk month one of the transition. Because the new transaction model will be rolled out in Q2 in North America, it may be that the behavior we saw in Australia occurs also in North America, which may accelerate billings and free cash flow to earlier quarters, but should not materially change the outlook for the year. Excluding $200 million from fiscal 2024 free cash flow from multiyear upfront billings, which are now billed annually, in fiscal 2025, we expect free cash flow growth of about 35% at the midpoint of our guidance. We expect faster free-cash-flow growth in fiscal 2026 because of the return of our largest multi-year renewal cohort, the mechanical stacking of multiyear contracts billed annually and a larger EBA cohort. As we navigate the new transaction model transition, the pace of the rollout will create noise in the P&L. So we think free cash flow is the best measure of our performance. At current course and speed, our free cash flow estimate for fiscal 2026 at the midpoint is approximately $2.05 billion, which is in line with consensus estimates. In the context of significant macroeconomic, geopolitical, policy, health and climate uncertainty, the mechanical rebuilding of our free cash flow as we transition to annual billings for multiyear contracts gives Autodesk an enviable source of visibility and certainty. We continue to manage our business using a Rule-of-40 framework with a goal of reaching 45% or more over time. We are taking significant steps toward our goal this year and next. We think this balance between compounding growth and strong free-cash-flow margins, captured in the Rule-of-40 framework is the hallmark of the most valuable companies in the world and we intend to remain one of them. The slide deck on our website has more details on modeling assumptions for Q1 and full-year fiscal 2025. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"content": "Thank you, Debbie. Let me finish by updating you on our strong progress in the fourth quarter. We continue to see good momentum in AEC, particularly in infrastructure and construction fueled by customers consolidating onto our solutions to connect and optimize previously siloed workflows through the cloud. The cornerstone of that growing interest is our comprehensive end-to-end solutions, encompassing design, preconstruction, field execution through handover and into operations. This breadth of connected capability enables us to extend our footprint further into infrastructure and construction and also expand our reach into the mid-market. As a sign of that growing momentum, we closed a record number of deals over 100,000 and $1 million in construction accounts in the United States and worldwide during this quarter. Let me give you a few examples. First, Vinci, a world leader in concessions, energy and construction has been leveraging Autodesk solutions to streamline its operations and drive international expansion. With a platform approach, Revit customization and BIM as a standard practice, Vinci has achieved significant time savings annually and captured more business abroad. In Q4, Vinci renewed its fourth enterprise business agreement with Autodesk, expanding the deployment of Autodesk Construction Cloud on major projects to further integrate its data and workflows, and ensure a seamless transition from design through construction. Second, after a competitive RFP process early in the year, Fortis Construction, an ENR 400 firm based in Oregon ran a thorough peer assessment and selected Autodesk Construction Cloud for a six-month pilot. With the confidence gained during the pilot and close alignment between the construction technology vision and Autodesk roadmap to a connected design-build-operate platform, Fortis committed in Q4 to a multi-year agreement across preconstruction and construction. And third, the Pennsylvania Department of Transportation recently chose Autodesk Construction Cloud as the primary tool powering its project delivery collaboration center, which will manage the project delivery of infrastructure projects in the state, in large part due to our software-inclusive open ecosystem. Again, these stories have a common theme, managing people, processes and data across the project lifecycle to increase efficiency and sustainability, while decreasing risk. Overtime, we expect the majority of all projects to be managed this way and we remain focused on enabling that transition through our industry clouds. With the acquisition of Payapps, Autodesk will embed payment and compliance management into the project lifecycle. It can take an average of 83 days for subcontractors to get paid after putting work in place. And because of the risk, many will not bid on a project if a general contractor or an owner has a reputation for slow payments. Our goal is to leverage technology that eases the burden of construction payment management in a simpler, faster and more efficient process for all construction project stakeholders. Moving on to manufacturing. We made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and consolidate our design and make platform to grow their business and make it more resilient. In automotive, we continue to grow our footprint beyond the design studio into manufacturing and connected factories as automotive OEMs connect data and shorten hand-off to the design cycle. In the US, a leading manufacturer of leveraged AEC Solutions Fusion and Autodesk platform services to develop a connected factory, it delivered a much greater ROI to significantly faster design durations, product prototyping and data federation. Due to expanded EBA signed in Q4, it is exploring using VR studio tools in customization and increasing its adoption of Autodesk Construction Cloud to bring its new factories to life. We continue to serve some of the largest manufacturers in the world with a full breadth of our portfolio, as they design and make both products and factories. One of the largest private manufacturers in the US leverages our advanced manufacturing portfolio including Fusion, PowerMill and Moldflow, which has helped reduce rework in plastic designed by 20%. To build clean-energy solutions, it utilizes our AEC collection, including BIM metadata, assembly breakout and installation instructions for its building products. In Q4, the customer increased its EBA with Autodesk, and plans to expand our partnership beyond Revit and Autodesk Construction Cloud to support the digitalization of its factories. Fusion remains one of the fastest-growing products in the manufacturing industry and ended the quarter with 255,000 subscribers, driven by the growing number of customers who recognize the value of cloud-based workflows, enhancing efficiency, sustainability and resilience within their organization. As the breadth and depth of Fusion features and capabilities expand, we're beginning to drive adoption by larger companies and sort of higher-value segments of the professional market through expansion. As we do this, commercial subscriptions will become less complete indicators of Fusion's performance relative to the value we can realize in our reporting or change to reflect that. In education, we are preparing future engineers to drive innovation through next-generation design, analysis and manufacturing solutions. In the fall, the University of Delaware selected Fusion for more than 600 students to use in its introduction to engineering class, replacing a competitor's solution. Fusion was chosen because it facilitated better team collaboration, was easily adopted thing to available teaching resources and provided a single integrated platform to learn CAD, stimulation and CAM. And lastly, we continue to work with our customers to ensure they are using the latest and most secure versions of our software. In Q4, an American pharmaceutical company looked to understand its own usage better and ensure remains compliant in the transition to our named user model. In collaboration with our license compliance team, a preventative audit was conducted to identify risk areas and construct the combination of subscriptions and Flex tokens for continued access. It is also taking the opportunity Flex enables us to trial new products from our portfolio, resulting in an annual spend increase of more than 30%. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. Time and again, our success in executing strategic transformation and added new growth vectors, built a more diverse and resilient business, forged broader, trusted and more durable partnerships with more customers and given Autodesk a longer runway of growth and free-cash-flow generation. We are building the future with focus, purpose and optimism. Operator, we would like to open the call up for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Your question, please Saket."
},
{
"speaker": "Saket Kalia",
"content": "Okay. Great. Hey Andrew, hey Debbie. Thanks for taking my questions here and nicely done."
},
{
"speaker": "Debbie Clifford",
"content": "Thanks, Sakit."
},
{
"speaker": "Andrew Anagnost",
"content": "Thanks, Sakit."
},
{
"speaker": "Saket Kalia",
"content": "Hey, guys. Andrew, maybe just to start with you, you talked a little bit more about generative AI on this call, which was great to hear. Maybe just to make sure the question is asked, can you just talk about what your sort of core engineering customers are saying about generative AI? And I'm sure it's a very long discussion, but how do you think about the value that Autodesk can provide sort of on that journey?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yeah. So first off, Saket, let me make it clear that, it’s our intent to be the market leader in generative AI, just like we were in generative design over 10 years ago. So we intend to lean into this pretty heavily. Our AI lab has been in existence since 2018, it's been where some of the core research that's contributing to some of the things I talked about in the opening commentary came from. But also, we've been delivering AI in our products for several years now -- we just released drawing automation into Fusion, which allows people to automate manufacturing drawing stacks, which is a very labor intensive effort, and it's a high productivity driver for our customers. So, in terms of what our customers are saying to us. One, they're looking for the productivity increases. They're asking what are they going to look like, what kind of productivity increases are you going to deliver to this, and how are you going to use our data to deliver those productivity increases. Now, in terms of how we're going to do this is, there's two avenues that we're going to be approaching here. One is going to be more disruptive to how our customers work and the other one is going to be basically automating the capabilities and workflows they have today. We have to do both. Both have different value levers, both will have different adoption curves. Some of the things I talked about in the opening commentary about some of our new tools for generating 3D models from photographs or for incomplete 3D models, those are disruptive approaches that set up initial model ideas for our customers and allow them to do things initially with a blank slate kind of concept, where they create a model from specifications and requirements. We haven't released any of that yet, we will at some point release that to a private beta. But right now it's just something we're really proud of and we think is really important. That's an important disruptive technology. The other technologies are also going to look a lot like what we did with Fusion drawing automation. There are going to be tools that take the complexity of delivering and creating a 3D model and all of its outputs to a process and take it from months to weeks or sometimes even days and that's going to make customers who are currently using these tools maybe slower in the adoption of more disruptive tools, incredibly more productive. Both avenues are valid, both are important, and both are areas that we're focusing on."
},
{
"speaker": "Saket Kalia",
"content": "Got it. That makes a lot of sense. Debbie, maybe for my follow up for you, Autodesk obviously provides a lot of value to its customers, which you're also able to capture as well. Maybe the question is, can you just talk a little about some of the recent pricing actions that have been out there? And what sort of customer behavior that might drive as a result? I think there was a little bit of difference in pricing, sort of between one year and multi-year subscriptions. How do you think about that impacting the model, if at all, going forward?"
},
{
"speaker": "Debbie Clifford",
"content": "Sure. So let's start first with what we did. So there's a couple of things that are going on. We did about a 3 point increase for market factors and then we did a 5% increase for renewals. With market factors this was something that we've been talking about for a while. Our goal is to streamline pricing around the world. And then for the renewals price change before the increase, we had a 10 point price differential between new and renewal and with this move to agency or the move to the new transaction model, we don't see as much of a need for that delta. In Q4 what we did was, we moved up the timing of the price increase so that we could better sequence things with the new transaction model coming and that led to some early renewals down the stretch. That's part of what gave an extra point of growth to current RPO. But the price increase overall was most helpful to billings, but it wasn't material to revenue and free cash flow."
},
{
"speaker": "Saket Kalia",
"content": "Got it. Very helpful. Thanks, guys."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Adam Borg of Stifel. Your question please, Adam."
},
{
"speaker": "Adam Borg",
"content": "Great. And thanks much for taking the question. Maybe on the transactional model and thanks guys for all of the disclosures around it. Maybe talk a little bit more about the learnings you have from the early customer and partner feedback in Australia and even now that you have the early days of this direct relationship, anything interesting there that you're learning from your more direct relationship with customers, be it usage or adoption or expansion that you clearly didn't have before with the prior model? Thanks."
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. Thanks, Adam, for that question. First off, let me just reinforce something here, because I want to make sure that we're all on the same page here about why we're doing this, right? This is a critical part of a relentless, ongoing modernization of Autodesk business, getting us ready for the long term success we expect in a world of AI driven, cloud-based solutions for design to make lifecycles, right? It's a necessary step in this. It's the last big one in our journey of all the ones we've done at this point, and it really has some big benefits for our customers, long term. One, it's going to allow us to understand them a lot better in ways that we can't currently understand them because don't have the full account record of what the customer is doing. Two, it's going to allow us to deliver a lot more self service capability to these customers. And three, it's going to turn our partner channel into design made collaborators and consultants for our customers with their own unique IP and their own services and away from transaction partners. So it's critical that we kind of get on the same page of that. With regards to Australia, we actually did learn a lot, right? Mostly about the transactions at this point because it was only for a quarter and a little bit. It didn't necessarily have direct impacts on customer behavior. But what we did learn we've now put into the process. In fact, we actually delayed our US rollout by 30 days based on some of the learnings during the Australian process. We changed our roadmap for some of the capabilities, updated and upgraded some of the capabilities in the transaction systems to kind of correspond with some things we saw in Australia. And we also kind of delivered some new enablement materials for partners and frankly for customers as well, so they understand how this transaction model impacts their relationship with Autodesk. So we definitely took the learnings to the bank to make sure that we were better prepared and we even gave ourselves a little bit more time, based on what we learned to finish up a few things that we think are going to be impactful."
},
{
"speaker": "Adam Borg",
"content": "That's great. And maybe just as a quick follow up, you talked about some success with state DoT, as you think about kind of the infrastructure bill and the stimulus that continues to be deployed. Maybe just give a quick update on Innovyze and just a quick State of the Union there and the opportunity as part of the broader infrastructure push. Thanks so much."
},
{
"speaker": "Andrew Anagnost",
"content": "Yea, so you'll probably hear us use the word -- name Innovyze a lot less and talk a little bit more about Autodesk Construction or water solutions moving forward, all right. So I just want to be clear about that. Water is and has been a big part of our EBA successes. Larger customers are adding water solutions. I think there's an obvious reason for that. Water is just as important as it was before, if not more so. I think you're probably aware that in California, we just had yet another kind of flood where people didn't expect to have floods in San Diego and that's all because water management infrastructure is moving water in the wrong places. So people need to build and rebuild water infrastructure of all types, water scarcity, water purity, all of these things. Water is going to be a big business moving into the future and it's continued to enhance some of our EBAs with that respect. Since you mentioned infrastructure in general, I just want to kind of point a little bit to something that you heard in the opening commentary about PennDOT, all right. I think that's a really important story about what's going on there. Why is PennDOT choosing our solutions? What's going on? Because of the infrastructure bill and some of the money that was put in the infrastructure bill to help some of these Departments of Transportation understand how to invest in the future, PennDOT looked at its portfolio of tools, they looked at the future, they looked at what they need going out 10 years, 20 years in the future, what kind of modern stacks they want to work on, and they chose to move to our solutions and incorporate more of our solutions in their environment. That's an important first step in what we're trying to do. We want to be part of modernizing these Departments of Transportation with the kind of modern staff that we've created in the end-to-end design to make solutions. That's another vector here to pay attention to as the infrastructure boom kind of continues to roll out into the United States."
},
{
"speaker": "Adam Borg",
"content": "Great. Thanks for all the details."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Jay Vleeschhouwer of Griffin securities. Your question please, Jay."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Thank you. Good afternoon. Andrew, first question concerns the transaction model and what I'd like to ask about is relating the operational and transactional and accounting systems and compensation systems that you've put in place relative to the scale of your volume. You added well over 700,000 subscriptions in fiscal 2024, more than you added in fiscal 2023. You've spoken of certain growth expectations for volume over time. So, maybe help us understand the capacity that you have in place now to support the long term volume growth expectations that you have, because undoubtedly you're looking to do substantially more subscription additions than you did in fiscal 2024."
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So Jay, obviously the modernization of Autodesk and its back office infrastructures isn't just about rolling out the new transaction model and the kind of the nuts and bolts of that. It's actually about increasing our internal capacity to do these things at scale, which is exactly what we were trying to test in Australia, in the various environments and that we've been testing since then. So, we are very confident that we've not only built a transaction environment, but a cascading set of capabilities that allow us to scale significantly as we move forward. Because you're right, we intend to get deeper and deeper into people's design and make processes and that's going to increase the amount of subscriptions that are being used downstream in other types of make processes and we have to be able to operate at scale. So this is not just a new transactional model modernization effort. It's a full scale modernization effort inside of Autodesk that captures all aspects of this. And the good thing about the cascading rollout, the way we're doing it this year with the US first, is again we're going to get yet another test on the volume and capacity of the systems that allows us to understand where we're at before we go live with the next level of rollout and volume capture. But just know that this is more than just a transaction model. It is a full scale modernization of what's going on under the hood at Autodesk."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Yes. Understood. Second question concerns products and technology. When we think back to the various product sessions and roadmap sessions that you talked about at AU a few months ago, what do you think are the critical executables -- product deliverables that you're aiming for, for this year either in terms of improving upon or expanding the existing products, such as Revit or other new tools?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes, so I'll just hit a few here okay. First off, in manufacturing, the critical thing that really needs to happen this year for Fusion, for example, is we have to improve our capability to help move Fusion from small teams in the design and make part of the business, all the way up to supporting full scale engineering team. So basically scaling the size of installations inside of our customer base with Fusion. That's going to be through a combination of things we do with our cloud based data management solutions as well as some of our AI-based solutions which basically attract people to the product because of the productivity enhancement. But that is definitely an important effort. There's a second ancillary effort with regards to the Fusion around ensuring that our partnerships with companies like Cadence and the internal EDA capabilities we built in the Fusion set us up for a boom in smart products. We want to be the solution that people choose for smart products. We built enough capability into Fusion that people can get a certain way end-to-end with Fusion and we're partnering to make sure that when things get more sophisticated, we're able to move up into the more sophisticated processes associated with these smart products. Now, when it comes to Forma, Forma and Fusion kind of dance together here and one of the things that -- it's really important to do as we move into this year is make sure that Forma and Revit play together as our customers try to move forward as they adopt Fusion and also as they use Revit more collaborative in the cloud, that these two products work together in some way, that they exchange data and interoperate in ways that nobody else can achieve. Because the truth of the matter is, the work that people are doing with Revit isn't going away. It's a huge amount of what they do and we need to make sure that, that work is more efficient in a formal world. So, look for us to not only increase the capabilities of Forma, but increase its relationship with Revit as well, which I think is really important. The last thing I'll say, just around media and entertainment is, we have to continue to take what we're doing with regards to moving beyond post production special effects into full production management, script-to-screen capabilities for our customers in the filmmaking industry and make some of that real with the flow platform and that's really the big goal for the media entertainment team, is to make flow real this year and help our customers really see possibilities of integrating new types of complex solutions on top of a single production management environment."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Very good. Thank you Andrew. Thank you Debbie."
},
{
"speaker": "Andrew Anagnost",
"content": "You're very welcome."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Joe Vruwink of Baird. Please go ahead Joe."
},
{
"speaker": "Joe Vruwink",
"content": "Great. Hi everyone. Thanks for taking my questions. I wanted to ask -- so Autodesk has framed growth rates over the long arc of time in that 10% to 15% range. 2025 guidance is obviously holding to the 10%. When you think about 10% conceptually, is that ultimately, as you would expect, just given the nature of your businesses being exposed to certain end markets that are perhaps now closer to their bottoming or troughing point in a given cycle? And if that maybe is the case and this is the bottoming point, what indications are you watching over coming quarters to maybe set the stage for a recovery scenario, which, of course, your markets typically do after they reach that bottoming point?"
},
{
"speaker": "Debbie Clifford",
"content": "Thanks. So, we continue to target that 10% to 15% revenue growth algorithm and you're right, the midpoint for fiscal 2025 was right at that 10% coming off a year where we did 13% growth in constant currency. And really what we've said is that where we end up in that 10% to 15% range is going to be contingent upon the macroeconomic backdrop that we operate in, as well as our ability to harvest the opportunities that we have before us across AEC, manufacturing and so on. And so, the things that we're watching as we proceed through this year with that 10% midpoint are some of the things that we've been talking about for a while now. So, new business growth is really important indicator of future revenue performance for the company and we said in this last quarter that new business growth grew, but it was relatively soft, consistent with what we had seen over the previous several quarters. So, definitely being impacted by macro and that's one of the factors that's driving the 10% revenue growth midpoint in fiscal 2025, so we'll continue to watch that closely. We also watch product usage, we watch bidding activity on our BuildingConnected platform, and we stay close to our channel partners, try and understand what they're seeing in terms of their demand. So those are the things that we're going to be watching to see how this year progresses and beyond."
},
{
"speaker": "Joe Vruwink",
"content": "Okay thanks. That's helpful. And then I wanted to follow-up on the free cash flow. I think I heard $2.05 billion for fiscal 2026. At one point there was a comment that the progression between FY 2024 and 2026, that was going to be linear, of course, if you normalize for that $200 million effect benefit last year and then comes out this year. I guess as I look at that and the $2.05 billion, it's not quite linear. It would seem like FY 2026 is actually maybe a bit stronger. Did something change in kind of the modeling out of the progression? Just any color there?"
},
{
"speaker": "Debbie Clifford",
"content": "Nothing's changed Joe. So we said that we anticipate that cash flow would grow greater in fiscal 2026 than what we saw in fiscal 2025. And when you think about modeling the growth rate, just remember that you have to remove the $200 million in fiscal 2024 before we stopped selling multi-year contracts upfront."
},
{
"speaker": "Joe Vruwink",
"content": "Okay, I'll leave it there. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Jason Celino of KeyBanc Capital Markets. Your line is open, Jason."
},
{
"speaker": "Jason Celino",
"content": "Great. Thanks for taking my question. Maybe first for Andrew, just on the acquisition of Payapps and they were a great partner of yours. Just curious on what drove the decision to acquire them outright versus just extending the partnership? Thanks."
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. All right, so since you opened up the door there, let's talk a little bit about construction in general, because I think it's important to kind of highlight what's been going on there. We had a great EBA quarter for construction. Construction saw strong growth in our largest accounts, which is really important for the long term health of construction. And at a really high level we also saw an increase in $100,000 deals and $1 million deals both in the US and internationally and that's really important. And this is where -- one of the things where Payapps comes in, right? Remember, we're going end-to-end with our solutions here from design all the way to make. And we want to make sure that we get into the preconstruction planning and other types of our customers processes. It takes 83 days for our customers to process payments in their environment that's just too long. Now, we're not getting into the transaction business. What we're doing is, we're getting into the business of helping them automate and track those payments across their entire life cycle so that they can get, quicker return, reduce that 83 days to be faster, and increase their cash flows. This has to be something we tightly integrate into our solution. So, we intend to tightly integrate this in just like we rebuilt some of the other solutions we acquired previously into what is today Autodesk Build, which is a new modern platform for doing some of these things. So we thought it was very important to own this so that we can integrate it. And then we went out there and we bought a premium asset. It's a leader. It's a global leader in payment processors. It's not a small company, it's not what we could afford, it's what we needed. And I think that's really important. So, when we look forward at construction right now, we see tools like this being critical as well as our pre-construction tools and we actually see the deal cycles maybe getting a little longer, but we're competing head-to-head a lot more. And I want to again highlight that Fortis deal out of Oregon, which was a head-to-head competitive deal with a pilot period that ended up going fully to Autodesk. So what we see right now in our business is building momentum driven by the end-to-end solution and kind of acquisitions, like Payapps as well. So, when we look forward into next year, we don't see deceleration of the business, we see acceleration."
},
{
"speaker": "Jason Celino",
"content": "Okay. No, that's very helpful. And then my quick follow up for Debbie. Sorry if I missed it, but the 13% constant currency growth we did this year, did you mention how much was from the strong renewal cohort and then maybe any upfront revenues? I'm just trying to understand the several points of decel embedded in the 2025 guide? Thanks."
},
{
"speaker": "Debbie Clifford",
"content": "Yes. So the early renewal cohort didn't have any impact to revenue really, that had more of an impact on billings than it would have on revenue. And then the strength that we saw in enterprise represented about 1 point of growth."
},
{
"speaker": "Jason Celino",
"content": "Okay, great. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Tyler Radke of Citi. Please go ahead Tyler."
},
{
"speaker": "Tyler Radke",
"content": "Yes. Thanks for taking the question. Along the similar lines of Jason's question on construction Andrew. I'm just wondering if you could provide us an update on the go-to-market changes that you made, I believe last year and how you're expecting that business and you talked about acceleration, obviously make revenue is growing in the teens. Is this a business you think can be 20% over the medium term? Just help us frame what you're seeing both from the go-to-market and pipeline perspective? Thank you."
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So, as you know, last year was the full year of integrating the sales force back into the mainline sales force. We went through some of the integration efforts to do that. There were obviously some slowdowns in the business related to integration of those things. Those things are past us now, the business is fully integrated. It's starting the year off, not only fully integrated from the get-go, but with all of the processes, plans and capabilities all lined up according to how we want to grow the business heading into the year. And one of the things I wanted you to notice in my previous commentary is that, we're seeing deal activity going up. So, the pipeline is actually firming up really well and we're in more deals and some of these deals are more competitive, but we embrace that because when we're in a competitive deals, that means we're showing up in places we weren't showing up before because people are calling us in. That's a really important part of this whole entire process. People are starting to ask themselves what solution do they need for the next 10 years, 15 years versus what's available out there today. And the end-to-end capabilities we're delivering, especially leaning more heavily into our preconstruction capabilities, which lock in a lot of the cost and complexity and risk of a construction project, this is where we're leaning into this year and this is where we're going to be driving the growth. So I think we're past integration issues moving forward into pure execution at scale inside the mainline salesforce. The EBA success is a great example of that."
},
{
"speaker": "Tyler Radke",
"content": "That's helpful. And maybe a follow up for Debbie and apologies I've been jumping around calls, but can you just frame how you're thinking about the relative drivers of the top line growth outlook for FY 2025 between subs growth and pricing and the usual factors that build up to that? Thank you."
},
{
"speaker": "Debbie Clifford",
"content": "Sure. So, we typically are trying to target roughly 50-50 split of growth coming from volume and it's either price mix or margin basically, partner margin is how we think about it. So, across volume and price, again, our target is to do roughly 50-50 in fiscal 2025 that would continue to be our goal. Now there's certainly years where it's going to vacillate between one or the other and we've talked about how this past year our new business was growing slower than we would anticipate in a more normal macroeconomic environment. As we look ahead, we're hoping to get that growth coming from roughly equally across those two, volume and price. So that's how we're thinking about it."
},
{
"speaker": "Tyler Radke",
"content": "Thanks, Debbie."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Michael Funk of Bank of America. Your question, please, Michael?"
},
{
"speaker": "Michael Funk",
"content": "Yes. Thank you for the questions. So first, one of your competitors mentioned pressure on projected seat growth due to the declining ranks of engineers. Are you seeing a similar impact or is that not impacting your customers?"
},
{
"speaker": "Andrew Anagnost",
"content": "We are not seeing a decline in our growth rates because of any pressure out there associated with engineers. As a matter of fact, one of the things that's really important because we're moving into design and make processes, we have a pretty broad swath of people that we're able to touch. Also, we continue to displace competitive products, especially with Fusion in the manufacturing space. So, we're not seeing that kind of effect declining bases. We do see customers at times optimizing their installations with Autodesk to try to right size things, but not because they're downsizing their employment base."
},
{
"speaker": "Michael Funk",
"content": "Thank you for that. Then one for you Debbie, and thank you for the clarity and moving pieces in 2025. In the press release, you mentioned that the guidance for growth in 2025, you said adjusting for FX, EBA acquisitions, transaction model you gave additional data points on the call, is the right way to think about it that guidance, constant currency ex-EBA transaction model and acquisitions is basically 9.5% to 11.5% growth rate in 2025, is that the right very basic math?"
},
{
"speaker": "Debbie Clifford",
"content": "So what we talked about was a point of headwind from FX, a point of headwind from the absence of EBA true-ups, half a point of tailwind from acquisitions, and a point of tailwind from the new transaction model. So the net effect of that is half a point. So, yes."
},
{
"speaker": "Michael Funk",
"content": "Great. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Stephen Tusa of JP Morgan. Your question please, Stephen."
},
{
"speaker": "Stephen Tusa",
"content": "Hey, guys. Congrats on a good quarter. What would do you think is in the kind of crystal ball to drive you to the low end of the range? Like what are you concerned about that you can see today? I assume that's part of the macro, but what within the macro would get you to the low end of the range?"
},
{
"speaker": "Debbie Clifford",
"content": "We'll continue to watch that new business grow. That's something that we're laser focused on and if macroeconomic conditions were to shift, then that would be probably one of the first things that we'd be impacted and that can take us to the lower end of the range. We're watching end market demand pretty closely so that's why we talk about bid activity on BuildingConnected and it continues to be at record highs. But of course, if that were to take a turn, that can have an impact on us. And then we monitor these sentiment that we're hearing from our channel partners to understand how they're seeing end market demand and what the impacts might be for our business. So, those are the types of things that could inform whether or not we would be at the lower end of the range."
},
{
"speaker": "Stephen Tusa",
"content": "Okay and just to be clear, I thought it was when you went through some of the other moving parts on guidance that it netted out to kind of a point of tailwind. I guess you're throwing in the EBA true ups, or at least adjusting those out to get to an underlying rate. Is that part of the calc there?"
},
{
"speaker": "Debbie Clifford",
"content": "Yes. And sorry to go back to the last question, because there's a lot of moving parts here, and it has been confusing. So for revenue in the guide, it's 1 point of headwind from FX, 1 point of headwind from the absence of EBA true-ups, 0.5 point of tailwind from the acquisitions, and 1 point of tailwind from the new transaction model, which is a net negative. So net 0.5 negative headwind as we look into the guide for fiscal 2025."
},
{
"speaker": "Stephen Tusa",
"content": "Okay. And then just one last quick one on the subs. I guess they're up 12 for the year, if I have that number right. Your constant currency was 13 can you maybe explain what you mean by half coming from volume and half coming from price? It seems like that's a lot from -- much more from volume there maybe there's some mix or something like that?"
},
{
"speaker": "Debbie Clifford",
"content": "Yeah, there's definitely mix effects. And like I said, our target is to have it be roughly 50-50 between volume and price. But in any given year, we're going to have some puts and takes between that. But when we think about our guidance for fiscal 2025, we're targeting that 50-50 mix again."
},
{
"speaker": "Stephen Tusa",
"content": "Okay, great. Thanks a lot."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Nay Soe Naing of Berenberg. Your question, please Nay."
},
{
"speaker": "Nay Soe Naing",
"content": "Hi, everyone. Thank you for taking my questions. I've got two, if I may. Starting with you mentioned a lot of positive developments in the products like ACC BuildingConnect and the Fusion 360. I was wondering how we should think about that when it comes to your make revenue. And if we look at the growth rates in make segment, it's been consistent around 17% on constant currency for the past three quarters. Is there a possibility with all the positive developments that the make revenue will go back to growth rates in the 20s going forward? That was my first question. And the second question is on the new transaction model, please. I think Debbie, you mentioned that you're expecting 1 percentage point of growth tailwind from the new transaction, FY 2025, which will equate about $55 million and then the slide deck you mentioned there's about $600 million of reseller commission in total. So the remaining $450 million or so -- sorry, apologies, $550 million or so, will that all come through in FY 2026, or will it take longer for all the contra revenue to flush through in your P&L? Thank you."
},
{
"speaker": "Debbie Clifford",
"content": "So a couple of things. So first sorry, you were a little bit garbled and coming through, so we didn't quite get the first question and we'll go ahead and try and take those in the callbacks. But when we think about the new transaction model and the $600 million, I think the most important things to take away are the $600 million is a good number to model with. As you think about how to model the business during the transition and the pace at which you'll see the new transaction model cost, that $600 million bleed into revenue and expense over time is really going to be dictated by the pace of the rollout. And so, think of it as something that's going to be bleeding into revenue and expense over the next couple of years."
},
{
"speaker": "Nay Soe Naing",
"content": "Right. I think at the previous quarter you mentioned it would take about two years to implement this new transaction model. So, presumably this total $600 million bleeding into revenue and cost will take longer than two years to complete in totality?"
},
{
"speaker": "Debbie Clifford",
"content": "So the act of transitioning, the invoicing will take approximately two years to complete. But remember that we recognize revenue over approximately one year. So it's going to be a little past that when the invoices at the higher amount bleed into revenue."
},
{
"speaker": "Nay Soe Naing",
"content": "Right. Okay, understood. Thank you. My first question is around the make revenue. The growth rates has been consistent around 17% past three quarters. Should we expect that to go back to the 20% plus that we had in the past given the positive developments around the products like BuildingConnect or ACC or Fusion 360?"
},
{
"speaker": "Debbie Clifford",
"content": "Our goal would be to drive greater growth from the make revenue line. That's going to be an important aspect of our ability to achieve our target 10% to 15% growth algorithm over time and it's an area where we've been making incremental investments. So, we anticipate that, that revenue growth rate is going to be higher than the core business."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, as that is all the time we have for Q&A today, I would now like to turn the call back to Simon Mays-Smith for close remarks. Sir?"
},
{
"speaker": "Simon Mays-Smith",
"content": "Thank you everyone for joining us. We look forward to seeing many of you on the road over the coming weeks and at our Q1 conference call later in the year. Thanks very much."
},
{
"speaker": "Operator",
"content": "This concludes today’s conference call. Thank you for participating and you may now disconnect."
}
] |
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{
"speaker": "Operator",
"content": "Thank you for standing by, and welcome to Autodesk's Third Quarter Fiscal Year 2024 Earnings Conference Call. [Operator Instructions] I would now like to hand the call over to VP of Investor Relations, Simon Mays-Smith. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"content": "Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the third quarter results of Autodesk's fiscal 2024. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. Following this call, you can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, products and product capabilities, business models and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today's press release for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will quote several numeric or growth changes during this call as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel Financials and other supplemental materials are available on our Investor Relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"content": "Thank you, Simon, and welcome, everyone, to the call. Resilience, discipline and opportunity again underpinned Autodesk strong financial and competitive performance despite continued macroeconomic policy and geopolitical headwinds. Renewal rates have remained strong and new business trends have been largely consistent for many quarters. Our subscription business model and our product and customer diversification enable that. It means that accelerating growth in Canada has balanced decelerating growth in the United Kingdom. The growing momentum in construction has balanced deteriorating momentum in media and entertainment. And that strength from our enterprise and smaller customers has balanced softness from medium-sized customers. Our leading indicators remain consistent with last quarter with growing usage, record bid activity on building connected and cautious optimism from channel partners. Disciplined and focused execution and strategic deployment of capital through the economic cycle, enables Autodesk to realize the significant benefits of its strategy while mitigating the risk of having to make expensive catch-up investments later. As Steve said at Investor Day, we introduced a new transaction model for Flex, which gives Autodesk a more direct relationship with its customers and more closely integrates with its channel partners. We began testing the new transaction model across our product suite in Australia a couple of weeks ago. Assuming the launch proceeds is expected in fiscal '25 and '26, we intend to transition our indirect business to the new transaction model in all our major markets globally. In the new transaction model, partners provide a quote to customers, but the actual transaction happens directly between Autodesk and the customer. The new transaction model is an important step on our path to integrate more closely with our customers' workflows enabled by, among other things, Autodesk platform services and our industry cloud's fusion, forma and flow. Autodesk, its customers and partners will be able to build more valuable, data-driven and connected products and services in our industry cloud and on our platform. The new transaction model is consequential. Many of you will have seen other companies adopting agency models and will already understand the math. In the near term, the new transaction model results in a shift from contra revenue to operating costs that provide a tailwind to revenue growth, while being broadly neutral to operating profit and free cash flow dollars and mechanically result in percent operating margins taking a step or two backwards. Over the long term, optimization enabled by this transition will provide a tailwind to revenue, operating income and free cash flow dollars even after the cost of setting up our building platform. Finally, there is opportunity from developing next-generation technologies and services that deliver end-to-end digital transformation of our design and make customers and enable a better world designed and made for all. I was at Autodesk University last week, alongside more than 10,000 attendees, where we announced Autodesk AI, technology we've been working on and investing in for years. We showed how our design to make platform will automate noncreative work, help customers analyze their data and surface insights and augment their work to make them more agile and creative, but there is no AI without actionable data. And that's why we're also investing in Autodesk platform services, which are accessible, extensible and open via our APIs. Autodesk Platform Services offers several critical capabilities, but data services are the most impactful. These provide the tools that make data actionable. And at the core of our data services is the Autodesk data model. Think of the Autodesk data model is the knowledge graph that gives customers access to the design, make and project data in granular bite-sized chunks. The data chunks are the building blocks of new automation, analysis and augmentation that will enable our customers and partners to build more valuable, data-driven and connected products and services. Autodesk remains relentlessly curious propensity and desire to evolve and innovate. Time and again, well-executed transformation from desktop to cloud from perpetual license and maintenance to subscription has added new growth factors, built a more diverse and resilient business, forged broader trusted and more durable partnerships with more customers and given Autodesk a longer run rate of growth and free cash flow generation. With our transformation from file to data and outcomes from upfront to annual billings and from indirect to direct go-to-market motion, we are building an even brighter future with focus, purpose and optimism. Our customers are also committed to transformation and Autodesk is deploying automation to increase their success in an environment with ongoing headwinds from material scarcity, labor shortages and supply chain disruption. That commitment was reflected in Autodesk's largest-ever EBA signed during the quarter and record contributions from our construction and water verticals to our overall EBA performance. I will now turn the call over to Debbie to take you through our quarterly financial performance and guidance for the year. I'll then come back to update you on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"content": "Thanks, Andrew. Overall, market conditions and the underlying momentum of the business remained similar to the last few quarters. Our financial performance in the third quarter was strong, particularly from our EBA cohorts, where incremental true-up and upfront revenue from a handful of large customers drove upside. As expected, the co-termed deal we called out in our Q1 results renewed in the third quarter with a significant uplift in deal size. Total revenue grew 10% and 13% in constant currency. By product in constant currency, AutoCAD and AutoCAD LT revenue grew 7%, AEC revenue grew 20%, manufacturing revenue grew 9% and in double-digits, excluding variances and upfront revenue, and M&E revenue was down 4% and up high single-digits percent, excluding variances in upfront revenue. By region in constant currency, revenue grew 19% in the Americas, 11% in EMEA and 3% in APAC, which still reflects the impact of last year's COVID lockdown in China. Direct revenue increased 19% and represented 38% of total revenue, up 3 percentage points from last year, benefiting from strong growth in both EBAs and the eStore. Net revenue retention rate remained within the 100% to 110% range at constant exchange rates. The transition from upfront to annual billings for multiyear contracts is proceeding broadly as expected. We had the second full quarter impact in our third fiscal quarter, which resulted in billings declining 11%. Total deferred revenue increased 6% to $4 billion. Total RPO of $5.2 billion and current RPO of $3.5 billion both grew 12%. Excluding the tailwind from our largest ever EBA, total RPO growth decelerated modestly in Q3 as expected when compared to Q2, mostly due to the lower mix of multiyear contracts in fiscal 2024 when compared to fiscal 2023. Turning to the P&L. Non-GAAP gross margin remained broadly level at 93%. GAAP and non-GAAP operating margin increased driven by revenue growth and continued cost discipline. I'd also note that costs associated with Autodesk University have shifted from the third quarter last year to the fourth quarter this year due to the timing of the event. Free cash flow was $13 million in the third quarter, primarily limited by the transition from upfront to annual billings for multiyear contracts and the payment of federal taxes we discussed earlier this year. Turning to capital allocation. We continue to actively manage capital within our framework. Our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. We remain vigilant during this period of macroeconomic uncertainty. As you heard from Andrew, we continue to invest organically and through acquisitions in our capabilities and services and the cloud and platform services that underpin them. We purchased approximately 500,000 shares for $112 million, at an average price of approximately $206 per share. We will continue to offset dilution from our stock-based compensation program to opportunistically accelerate repurchases when it makes sense to do so. Now, let me finish with guidance. The overall headline is that our end markets and competitive performance are at the better end of the range of possible outcomes we modeled at the beginning of the year. This means the business is generally trending towards the higher end of our expectations. Incrementally, FX and co-terming have been slightly more of a headwind to billings than we expected. EBA expansions have been slightly more of a tailwind to revenue and interest income has been slightly more of a tailwind to earnings per share and free cash flow. Against this backdrop, we are keeping our billings guidance constant, while raising our revenue, earnings per share, and free cash flow guidance. I'd like to summarize the key factors we've highlighted so far this year. The comments I've made in previous quarters regarding the fiscal 2024 EBA cohort, foreign exchange movements, and the impact of the switch from upfront annual billings for most multiyear customers are still applicable. We again saw some evidence of multiyear customers switching to annual contracts during the third quarter, as you'd expect, given the removal of the upfront discount. We're keeping an eye on it as we enter our significant fourth quarter. All else equal, if customers switch to annual contracts, it would proportionately reduce the unbilled portion of our total remaining performance obligations and negatively impact total RPO growth rates. Deferred revenue, billings, current remaining performance obligations, revenue, margins, and free cash flow would remain broadly unchanged. Annual renewals create more opportunities for us to drive adoption and upsell and are without the price lock embedded in multiyear contracts. Putting that all together, we now expect fiscal 2024 revenue to be between $5.45 billion and $5.47 billion. We expect non-GAAP operating margins to be similar to fiscal 2023 levels with constant currency margin improvement, offset by FX headwinds. We expect free cash flow to be between $1.2 billion and $1.26 billion to reflect higher revenue guidance we're increasing the guidance range for non-GAAP earnings per share to be between $7.43 and $7.49. Our billings guidance remains unchanged, given incremental foreign exchange headwinds and the potential for further EBA co-terming in the fourth quarter. The slide deck on our website has more details on modeling assumptions for Q4 and full year fiscal 2024. We continue to manage our business using a Rule of 40 framework with a goal of reaching 45% or more over time. We think this balance between compounding growth and strong free cash flow margins captured in the Rule of 40 framework is the hallmark of the most valuable companies in the world, and we intend to remain one of them. As we've been saying all year, the path to 45% will not be linear. We've talked about all of the factors behind that over the last three quarters, and I think it's useful to put them all in one place here, particularly as we look into fiscal 2025 and 2026. First, the macroeconomic drag on new subscriber growth, a smaller EBA renewal cohort with less upfront revenue mix, and the absence of EBA true-up payments are headwinds to revenue growth in fiscal 2025. Slightly offsetting that, we expect our new transaction model, which Andrew discussed earlier, to be a tailwind to revenue growth in fiscal 2025 and beyond. Assuming no material change in the macroeconomic, geopolitical or policy environment, we'd expect fiscal 2025 revenue growth to be about 9% or more. In other words, at least around the same or more growth as we are now expecting in fiscal 2024. And second, the transition to annual billings means that about $200 million of free cash flow in Q1 fiscal 2024 that came from multiyear contracts built upfront will not recur in fiscal 2025. This will reduce reported free cash flow growth in fiscal 2025. And make underlying comparisons between the two years harder. If you adjust fiscal 2024 free cash flow down by $200 million to make it more comparable with fiscal 2025 and fiscal 2026 on an underlying basis, the stacking of multiyear contracts build annually will mechanically generate significant free cash flow growth in fiscal 2025 and fiscal 2026. The progression from the adjusted fiscal 2024 free cash flow base, will be a bit more linear, although fiscal 2026 free cash flow growth is expected to be faster than fiscal 2025 as our largest renewal cohort converts to annual billings in that year. As you build your fiscal 2025 quarterly and full year estimates, please pay attention to what we've said each quarter during fiscal 2024. As Andrew said, our new transaction model will likely provide a tailwind to revenue growth be broadly neutral to operating profit and free cash flow dollars and be a headwind to operating margin percent. The magnitude of each will be dependent on the speed of deployment. Excluding any impact from the new transaction model, we are planning for operating margin improvement in fiscal 2025. Overall, we expect first half, second half free cash flow linearity in fiscal 2025 to be more normal than in fiscal 2024. And we still anticipate fiscal 2024 will be the free cash flow trough during our transition from upfront to annual billings for multiyear contracts. Per usual, we'll give fiscal 2025 guidance when we report fiscal 2024 results, so I don't intend to parse these comments before them. As I said at our Investor Day last March, the new normal is that there is no normal. Macroeconomic uncertainty is being compounded by geopolitical, policy, health and climate uncertainty. I'm thinking here of generational movements in monetary policy, fiscal policy, inflation, exchange rates, politics, geopolitical tension, supply chains, extreme weather events and, of course, the pandemic. These increased the number of factors outside of our control and the range of possible outcomes, which makes the operating environment harder to navigate both for Autodesk and its customers. In this context, the mechanical rebuilding of our free cash flow as we transition to annual billings for multiyear contracts, gives Autodesk an enviable source of visibility and certainty. I hope this gives you a better understanding of why we've consistently said that the path to 45% will not be linear. But let me also reiterate this. We're managing the business to this metric and feel it strikes the right balance between driving top line growth and delivering disciplined profit and cash flow growth. We intend to make meaningful steps over time toward achieving our 45% or more goal, regardless of the macroeconomic backdrop. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"content": "Thank you, Debbie Let me finish by updating you on our progress in the third quarter. We continue to see good momentum in AEC, particularly in transportation, water infrastructure and construction. Fueled by customers consolidating on our solutions to connect and optimize previously siloed workflows to the cloud. Market conditions remain similar to previous quarters. In Q3, WSP, one of the world's leading professional services firms closed its sixth EBA with Autodesk, a testament to our strong and enduring partnership. Leveraging the breadth of our portfolio, WSP has delivered the comprehensive range of services demanded by its clients, generate millions of dollars in pipeline across the AEC and manufacturing industries, secured bridge and groundwork contracts through automation capabilities, reduce costs through increased efficiency and most importantly, delivered impactful results for its customers. TCE, a global engineering and consulting firm, which supports all types of infrastructure is harnessing Autodesk solutions to bolster its sustainable development goals around clean water and sanitation. Industry innovation, infrastructure and responsible consumption and production, utilizing Autodesk's BIM Collaborate Pro, TCE plans to improve team collaboration through easier data exchange, fewer classes and more effective designer years. Autodesk solutions are empowering TCE to manage, coordinate and execute projects more efficiently, thus contributing to a better quality of life through improved infrastructure. We are seeing growing customer interest in our complete end-to-end construction solutions, which encompass design, preconstruction and field execution through handover and into operations. Encouragingly, Autodesk Construction Cloud MAUs were again up well over 100% in the quarter. In Q3, LFD, Inc., an ENR top 200 general contractor based in Ohio, selected Autodesk Construction Cloud over directly competitive offerings as its end-to-end construction platform. With our preconstruction and cost capabilities of standout differentiator, it ultimately chose Autodesk based on our level of partnership, our aligned vision and commitment to serve the evolving needs of the construction industry and the momentum our solution has demonstrated in the marketplace. Again, these stories have a common theme: managing people, processes and data across the project lifecycle to increase efficiency and sustainability while decreasing risk. Over time, we expect the majority of all projects to be managed this way, and we remain focused on enabling that transition through our industry clouds. Moving on to manufacturing. We made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and to consolidate on our design and make platform to grow their business and make it more resilient. For example, a global industrial company based in the U.S. is partnering with Autodesk to innovate more rapidly in its business. The customer had already standardized on Autodesk's up chain to streamline its data and process manager within their molding technology solutions and modernize its CAM process by adopting Fusion to significantly reduce programming time and eliminate risks from legacy software. During Q3, it renewed its EBA with Autodesk and plans to broaden its use of up chain, vault infusion. It is exploring Fusion's ability to enhance process management and its digital threat initiatives, which focus on product life cycle management, closed-loop quality, sustainability design, service life cycle management and supplier insight. Fusion continues to provide an easy on-ramp into our cloud ecosystem for existing and new customers. For example, a leading manufacturer for the agriculture industry is migrating from network licenses to named users and complementing those subscriptions with Flex tokens to maximize value and access for occasional users. As it digitizes its factories and create digital twins for its global facilities, it will use Flex to explore Autodesk's most advanced technology for Fusion, for CAM tool path automation and generative design. Flex provides the customer with the flexibility to scale its usage based on its needs, making sure its users have access to the right products at the right time. Fusion continues to grow strongly, ending the quarter with 241,000 subscribers as more customers connect more workflows in the cloud to drive efficiency, sustainability and resilience. In automotive, we continue to grow our footprint beyond the design studio into manufacturing and connected factories. In Q3, a leading automotive manufacturer renewed and expanded its EBA by more than 50%. In addition to its existing usage of alias for concept design modeling and design evaluation, the customer is replacing an internal tool with Red for lighting simulation. In the future, it will implement flow production tracking to improve and accelerate project communication and collaboration across departments and expand its use of Autodesk's integrated factory modeling to optimize factory layouts and enhance operational performance. In education, we are preparing future engineers to drive innovation through next-generation design, analysis and manufacturing solutions. For example, our partnership with PanState is making a positive impact in design classes and car CMC activities across the PanState, Barron's, Burks, Terresburg and University Park campuses. PSU Harrisburg has recently adopted Fusion in its core design class and plans to integrate it into its mechanical engineering curriculum. Fusion's accessible platform allows students to seamlessly transition from car to CAE and CAM enabling them to make a different outside the classroom and in industrial applications. They have already collaborated with NASA on a generative design project for spaceflight applications, inspiring numerous projects at NASA. And finally, we continue with our customers to ensure they are using the latest and most secure versions of our software. A publicly traded construction company in Japan thought to streamline software management processes and minimize compliance risks by leveraging single sign-on FFO and directly sync features available in our premium plan. Through a collaborative analysis of the client software usage logs, we identify instances of noncompliant usage and recommended an appropriate number of subscriptions based on usage frequency and actual requirements. This proactive approach ensures that the client has the necessary access to meet their needs while maintaining compliance. We've been laying the foundation to build enterprise-level AI for years with connected data, teams and workflows in industry cloud, real-time and immersive experiences, shared extensible and trusted platform services and innovative business models and trusted partnerships. Autodesk remains relentlessly curious with the propensity and desire to evolve and innovate. We are building the future with focus, purpose and optimism. Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays."
},
{
"speaker": "Saket Kalia",
"content": "Okay. Great. Hi guys, thanks for taking my questions here. How are you?"
},
{
"speaker": "Andrew Anagnost",
"content": "Great, Saket."
},
{
"speaker": "Saket Kalia",
"content": "Andrew, maybe for you. Lots of talk about here, right, particularly with the new transaction model. Maybe the right first question here would be. Why is this new model, I guess, as consequential as you said in your prepared remarks. Any color there you can add?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes, absolutely. Let me start Saket by saying First, the business is super resilient where we're built through resilience, and this is really showing up in these results this round as well. And that's going to continue into the future. When we talk about this new transaction model, I think it's important to back up and talking about what we're trying to do with our customers and the journey we've been on. We are trying to do no less than move all of our customers to cloud-based life cycle solutions powered by AI that connect their design and make processes in a way that they've never had connected before. Now to do that, you absolutely cannot use 40-year-old systems and business models. So we've been on this relentless journey to modernize the company. We started moving from developing cloud-based products to subscription models, to annualized billings. I mean you've seen journey after journey here to modernize the company. This is the next step and one of the most important steps in modernizing the company so that we have the kind of relationship with our customers that actually matches the kind of technology we're delivering to them. So through this, we're not only going to have direct engagement with our customers through the products they use in the cloud, we're going to have direct engagements with them as a customer as an account. We're going to understand them at the account level and as an entity, not just as a collection of transactions passed through several tiers. And that's really important. Because that will not only give us more information about our customers, it will help us give more information to our partners about our customers and understand them significantly better. And it will wrap up the whole solution and business model and capabilities in one package. The other really consequential thing here is our partner network has to move transaction-focused partners to solution-focused partners. They are going to be incredibly important on the front lines in helping our customers deploy and integrate new design to make solutions in the cloud. And this is going to be part of that transition for them. So yes, it is very consequential. And it's part and parcel of a long stream of modernizations we've been working on for a while, and I do think it's very significant."
},
{
"speaker": "Saket Kalia",
"content": "Got it. No, absolutely. It sounds very strategic. Debbie, maybe for my follow-up for you. I know you said you wouldn't parse out your comments on fiscal 2025. But -- could we maybe parse out those comments for fiscal '25 just a bit kind of given some of the moving parts sort to ask, but..."
},
{
"speaker": "Debbie Clifford",
"content": "There are indeed a lot of moving parts, Saket. So thanks for the question. I know that's the question that everyone wants to ask. I'm not going to parse all the details, but I'll just highlight some of the things that we called out in the opening commentary. Those things are the non-recurrence of EBA upfront and true-up revenue, FX and the macro drag on new subscriber growth, these are all things that are headwinds to revenue growth next year. We also talked about the impact depending on the timing of this move to a new transaction model. That's going to be a tailwind to revenue. It will be margin and cash flow dollar neutral and is a headwind to margin percent. We'll give you all the details on this in February for the usual. But remember, what we're really trying to do is set ourselves up for success over the long term."
},
{
"speaker": "Saket Kalia",
"content": "Makes a lot of sense. Thanks, guys. I’ll get back in queue."
},
{
"speaker": "Operator",
"content": "Thank you. Please standby for our next question. Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Thank you. Good evening. So on fiscal 2025, following up on Saket's question, at the analyst meeting earlier this year, Debbie, you showed a chart depicting sustainable double-digit growth for Autodesk of 10% to 15%. And based on a combination of various price and volume components, are you still adhering to that plethora of price and volume sources of growth? Or have you changed your thinking in terms of the magnitude or mix of those sources of growth over time?"
},
{
"speaker": "Debbie Clifford",
"content": "We are still targeting those sources of growth, Jay, as well as targeting the growth parameters of 10 to 15 points of revenue growth. Really, what we're dealing with is this uncertain environment. And based on what we know today and assuming that market conditions are similar to what we've seen over the last several quarters, we do see revenue growth next year of about 9% or more. And what's driving that is really all those puts and takes that I talked about in the opening commentary. It's really important to remember that what we're trying to do is set ourselves up for success over the long-term."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Okay. Andrew, for you, following up on AU last week. There were a number of quite interesting and useful sessions on our roadmaps and product plans, particularly on AUC and more broadly with regard to the data model. So, let me ask you an unavoidably complex question about that. So, when you -- so when you think about the role of what you call granular data, does that ultimately affect as you implement that the packaging or composition or consumption of the software? And you also gave quite detailed description of where you're going with ACC and Bill and AC generally. But there's no timeline in any of those presentations. So, how are you thinking about the GA of much of what you talked about last week at AU in terms of making commercial a very large set of new technology features, particularly for AC?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. Okay. So, let me tackle that with the first thing around the granular data. So, ultimately, as you journey down this path, what does happen is the way the product operates all the products Forma in particular in terms of how it interacts with Revit and ultimately how those two blend together, they do become an environment that looks very much like the fusion environment. And that environment is very different, as you know, than what it currently exists in most of the wide -- the mainstream usage of our AC products. So, yes, granular data ultimately leads to a different way that people consume and use the products in a different paradigm for which they actually engage with the product every day. So. that's clear, okay? Timeline, I don't know exactly which presentation you're in. I suspect given your questions, you are in the more longer term timeline presentation. So, a lot of stuff you saw there was over a two to five-year time frame, but a lot of that is going to show up in the two to three-year timeframe associated with some of the things you heard. Now, I think it's kind of obvious to tell which ones we're towards the earlier part of that spectrum rather to the later part of that spectrum. Turning some of these solutions over into infrastructure solutions and combining them with some of our infrastructure stuff. Probably towards the later end, getting the data more granular, uniting detailed design and conceptual design in Forma, probably much more closer. That kind of expectation you can have with those road maps."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Great, great. Thank you both."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Adam Borg of Stifel."
},
{
"speaker": "Adam Borg",
"content": "Awesome. Thanks so much for taking the question. Maybe for Debbie, just on the multiyear to annual billings transition. Maybe just if you could just remind us kind of where we are overall in the process relative to expectations. And I do know that there are still some smaller cohorts that have yet to transition and just curious kind of where we are for those and if that's going to take place next year? Or is that still kind of in process?"
},
{
"speaker": "Debbie Clifford",
"content": "Sure. Thanks. The rollout is going well. We're a couple of quarters in the systems are working. Customers and partners are behaving pretty much as we expected. So overall, the performance is in line with our expectations. I think the key thing is, remember, we're kind of at the beginning of this journey. This is going to be a three-year journey. So we're going to have a mechanical rebuild of free cash flow as we get into next year, fiscal 2025 and also in fiscal 2026. So some of the comments that I made on the call are important, and that is helping you think about how to normalize our fiscal 2024 cash flow headed into fiscal 2025. So we're moving that $200 million at the beginning of fiscal 2024 as we head into fiscal 2025. And then broadly, the fact that we'll have bigger cohorts coming up for renewal in fiscal 2026, which drives faster growth in free cash flow in that period. So overall, things are going well, and we're at this interesting point where we expect to see mechanical rebuilding of free cash flow from here."
},
{
"speaker": "Adam Borg",
"content": "Got it. And maybe just a quick question. Interesting AI announcements with Autodesk AI, back at AU last week. Any commentary on how to think about any price uplift from those solutions? Thanks again."
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So I'll take that one, Adam. Look, some of these features are already and will be delivered through our existing products. However, there are new models will be exploring with some of these capabilities. Obviously, it's a little too early to talk about actual monetization. But I do think some of the things you're seeing with Microsoft right now are quite interesting where highly evolved large models, which we have not yet deployed out in the market are offered up to individual customers as a here's your model. Now you train it, you custom train it and extend it with your data. Those kind of models are going to be very interesting in the future and really look like possibilities that we'll probably explore and look at. As we move forward. But for now, a lot of this functionality is going to end up integrated with the existing products as it has been for the last several years."
},
{
"speaker": "Adam Borg",
"content": "Great. Thanks again."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Joe Vruwink of Baird."
},
{
"speaker": "Joe Vruwink",
"content": "Great. Hi, everyone. Maybe just a follow-up on that last question. Andrew, like you said, AI and automation is not new at Autodesk. But I did think the messaging was maybe a little more exact and pointed just as it pertains to the cloud data strategy and how that really is the gateway to future AI capabilities that Autodesk how customers need to be thinking about this. So my question is just curious to hear any feedback from customers on this approach. And maybe levels of resistance or buy in, you've started to hear just pertaining the customers kind of pooling their data and Autodesk ends up being the aggregator of industry information?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So look, we have a very strong point of view on ethical and high trust use of data, and we intend to continue to pursue that with our customers and take a broad and strong stance around look, it's your data. We're going to work with you to use it appropriately for things that make the whole ecosystem better. We're going to do it in a way that's trusted. And we're also going to work with you in a way that allows you to preserve the IP that you think is important to you that does not become part of the entire ecosystem. So this is a conversation I have with many, many customers most obviously recognize the trade-off between massive amounts of productivity in terms of automating model creation and some of the benefits there. So they want to participate in ways that actually make sense for them and that maintain the trust and integrity that we're looking to do. So look for us to handle this in exactly that matter as we move forward."
},
{
"speaker": "Joe Vruwink",
"content": "Okay. Great. And then I'm going to take my best shot at FY 2025 question as well. But I think maybe 2 points of clarification or additional information. So Debbie, just on kind of the known headwind to free cash flow next year because of the long-term deferreds that happened to hit in this year. Can you reconcile that with the normal seasonality comment. Should we be removing that and then thinking about modeling normal seasonality, part A? Part B, you've talked about currency a lot is having impacts on some of these numbers. And I would imagine just given what's on the balance sheet, you probably have a good sense of what currency will be next year. How does currency factor into that 9% plus revenue growth rate you provided?"
},
{
"speaker": "Debbie Clifford",
"content": "Sure. Thanks, Joe. So on the first question, I think you're thinking about it in a reasonable way. So take out the $200 million and then it should have a more reasonable that will give you more reasonable modeling expectations as you think about modeling fiscal 2025 and beyond. And then on currency, is it's really been all over the place. I think everybody has been seeing that. What we see right now is that it would be a headwind for us as we head into next year. But given the volatility, I think it really could go either way. But based on what we're seeing right now, it is a headwind to revenue growth next year."
},
{
"speaker": "Joe Vruwink",
"content": "Okay. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Tyler Radke of Citi. Please go ahead, Tyler."
},
{
"speaker": "Tyler Radke",
"content": "Okay. Great. Thanks for taking the question here. Andrew, you talked about some record contribution from the construction side of the business, I think, broadly, but also within the EBAs. Could you elaborate within Autodesk Construction Cloud. What are the strongest areas you're seeing customers about?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. No. What's interesting is. We're not seeing the softness in construction that others may have highlighted. In fact, we have incredibly strong performance at the top end of our business. We saw strong growth internationally. And we're seeing growth in the U.S. And a lot of things are going on in the construction business right now. And whereas you see some sectors slowing down retail warehouse office things like that. You're seeing other things offsetting it. Again, the dynamicism of Autodesk business, manufacturing, industrial, lots of factory construction going on data centers, health care, , infrastructure, all of these things are picking up. So we've got a lot of dynamics that are playing well with regards to our construction business right now. When we look at the business, we look at the indicators that we have, bid board activity was at record highs again. So we saw a good strong bid activity there. While construction backlog may have declined a bit, it's still high, all right? And the number one thing that I heard from general contractors at Autodesk University was still can't hire enough. So they're still going to be working through that backlog at a relatively slow pace. Also, what's really interesting is we're seeing ourselves in more deals down market now more competitive deals, and frankly, we're winning some of them. And I think that's interesting. I think that probably results in slowing down deals for some of our competitors in various markets. But we're actually seeing a lot more interesting deal activity."
},
{
"speaker": "Tyler Radke",
"content": "That's helpful. And a follow-up for Debbie. I appreciate you getting a lot of questions on FY 2025. And I'm not going to ask you to dissect it further. But if I think about just trying to bridge the 9%, which seems like it does have some tailwinds from the transactional changes relative to that 10% to 15% framework that you gave, it doesn't seem like macro has worsened relative to a few quarters ago or a year ago when you gave that out based on your commentary. Just help us understand that bridge. Is it mostly conservatism or maybe currency or some of the other headwinds are larger than we're thinking about? Thank you."
},
{
"speaker": "Debbie Clifford",
"content": "Yes. Sure. So remember, you got to be thinking about the non-recurrence of the EBA upfront and true-up revenue that we've been talking about all year. FX, as I just mentioned, could be a factor right now, we're assuming that it is a headwind to revenue growth. And then finally, we have been talking about the macro drag on new subscriber growth all year. And remember, given the ratable revenue recognition model that we have, what we're seeing with new subscriber growth this year has more of an implication for revenue growth next year than for revenue today. So those three factors are the biggest factors driving our estimate of 9% or more as we head into next year."
},
{
"speaker": "Tyler Radke",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Jason Celino of KeyBanc Capital Markets."
},
{
"speaker": "Jason Celino",
"content": "Great. Thanks for taking my question. Maybe one on the EBAs. So in Q3, did you see any of these renewals maybe happen earlier than expected? Overall, it sounds like you're still seeing some timing true-ups, but also some pretty big expansions. Is the overarching takeaway that the cohort is expanding maybe better than what you had anticipated?"
},
{
"speaker": "Debbie Clifford",
"content": "Thanks, Jason. So the EBA cohort has been performing really well all year, which has been great. Remember, this is a cohort that last renewed in late 2020. That was at the height of the pandemic. And back then, they made more conservative assumptions about usage because of the uncertain environment at that time. Fast forward to today, these customers are continuing to manage through a high demand for projects. That's led to higher overall usage on their contracts. And as we've mentioned before, we do monitor the usage. So we've had insight into the potential EBA upside as the year has progressed. We've continued to update our outlook, which is each quarter of the renewals and the true-ups. And as we look at Q4. We've got our eye on the remainder of this large EBA cohort and the signs continue to be strong. We factored all of this into our latest estimates, and that's what drove the top line upgrade that we communicated today."
},
{
"speaker": "Jason Celino",
"content": "Okay. Great. And then I asked this question last quarter, but it sounds like a few of your competitors might be starting to see some of the water infrastructure funding start to flow plan intended this time. Are you seeing this, too? And then is this the strength that you're already seeing? Or could this be an additional opportunity for maybe next year?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. Jason, one of the things that you may have heard is that some of that money from the infrastructure bill that was targeting modernization of departments of transportation was really, it's about $34 million that's significant in that not only it starts these DOTs on their process of modernization and evaluating the modernization, but it also was directed at several DOTs that we have relationships with and where we've actually displaced competitors and engaged with the infrastructure. So that's pretty exciting stuff. That shows money starting to flow to the projects. As I've always said, it takes time to release this money from the flood gates of Washington into the places floodgate of Washington, that's kind of an oxymoronic comment. But it takes time to get there. And that -- these -- this money is going to kind of again, build up momentum for the rest of the projects and help us move forward. So I would say it continues to be an emerging opportunity. Projects are getting started, but there's more hope in the future for even more projects."
},
{
"speaker": "Jason Celino",
"content": "Okay, Great. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Michael Funk of Bank of America."
},
{
"speaker": "Michael Funk",
"content": "Yes. Thanks for the questions. Two, if I could. So first for you, Andrew. A number of changes with partner relationships from last year, you mentioned the new transaction model I think earlier you also changed the commission structure to more back end versus front-end loaded. So curious what kind of reaction you're hearing from your partners and how you expect these changes to impact that relationship?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So obviously, we invest a lot in bringing our partners along on this. It doesn't mean all partners are going to be happy with these changes. Okay? It's just that is not an outcome that we're looking for or is likely. But many partners are going to be happy with these changes because we've been very clear about what the path is to growth for them. Beyond that, we've taken a really kind of incremental approach to these things with our partners. We kind of led them along, showed them the way. You might recall, we started the new transaction model with Flex, close to about 1.5 years ago in Australia, then we rolled it out to the broad-based partner network and everybody got experience with it. Now we're testing in Australia. Again, we take our partners along on these journeys in very deliberate ways. And frankly, the credibility we have with our partners in terms of making their businesses more consequential and significant and, frankly, larger over time has really created an environment where there's a lot of trust. And there's a lot of discussion about what's the best way to do this. What this means for them and where it's going to take their business. And this will make the partners ultimately more consequential in some of the business discussions with their partners with their customers by bringing them closer to the design and make infrastructure work that needs to happen in the services and support that."
},
{
"speaker": "Michael Funk",
"content": "Thank you for that, Andrew. And one for you, Debbie, will see a check on the accounting of the math. You mentioned EBA revenue, non-recurrence in fiscal 2025 a few times. So, two pieces. First, accounting. I thought that the true-ups with upsizing in EBA, I thought that was recognized ratably over the term of the contract. Just trying to think how that might carry over an impact 2025, I'm correcting that accounting? And then second, if you can just remind us on the actual benefit to fiscal year 2024 from those items so we can pull that out of the fiscal year 2025 number?"
},
{
"speaker": "Debbie Clifford",
"content": "Sure. So, from an accounting standpoint, the true-ups we recognize upfront. So, think of it as an enterprise customer signs up for X number of tokens. And when they exceed X number of tokens, we build them for the differential and we recognize that revenue upfront and it doesn't recur in future periods, unless over the next three-year contract term, they utilized more than the tokens allotted in their contract again. So, that's why it's something that is sort of a one-off -- a good one off, but a one-off nonetheless, that could only recur three years from now for these contracts if we found ourselves in the same situation. And then in terms of sizing the benefit to fiscal 2024, we haven't gotten into exact numbers, but you can think about the overall guidance upgrade that we talked about today is largely being driven by the strength that we're seeing from the enterprise business this year."
},
{
"speaker": "Michael Funk",
"content": "Great. Thank you both."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Matt Hedberg of RBC."
},
{
"speaker": "Matt Hedberg",
"content": "Great. Thanks for taking my questions. I guess for either of you, maybe thinking longer term, I'm curious if you could help us with maybe the -- this move from contra revenue. What is the impact to sort of like pro forma revenue growth once the business has migrated more so to the Flex model?"
},
{
"speaker": "Debbie Clifford",
"content": "Matt, it's going to be -- revenue growth will accelerate. And the pace at which it accelerates is going to be determined based on how we go about the rollout. But as we mentioned, we're working on that now. We launched Flex last year. We just launched Australia. We're learning from Australia -- as we -- right now. And then as we look ahead to next year, we intend to go global with this, but we need to make sure that we are set up for success, which is why we're watching Australia closely. But when we execute finally, on all aspects of this transition, it will be an accelerator to revenue growth."
},
{
"speaker": "Matt Hedberg",
"content": "Got it. Thank you. And then I know last quarter, you saw some pretty good non-compliant conversions I don't think you mentioned the other side - recall you're talking about that. Was there any this quarter that you called out?"
},
{
"speaker": "Debbie Clifford",
"content": "We continue to perform well with our non-compliant conversions. So, I think you've heard us talk about a couple of things. I think historically, we have talked about some of the larger deals that we've closed, and those types of deals are still happening. But as I recall, on last quarter's earnings call, Andrew was talking about some of the stuff that we've been doing in product that's driving more conversion. That's on a smaller scale in terms of deal sizes, but is driving significant volume for Autodesk. So, over time, you're going to see us continue to flex different means of driving more compliance from non-compliant users, and it continues to be a steady drumbeat contributor to our revenue growth over time."
},
{
"speaker": "Matt Hedberg",
"content": "Got it. Thanks."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Bhavin Shah of Deutsche Bank. Please go ahead, Bhavin"
},
{
"speaker": "Bhavin Shah",
"content": "Great. Thanks for taking my question. Just kind of following up on that last one on the new transaction model. Like what kind of learnings are you looking to see from Australia before kind of rolling the app more broadly and kind of any disruption kind of that we should think about from a pointer perspective?"
},
{
"speaker": "Andrew Anagnost",
"content": "Well, one of the things that we're trying to make sure that we see is how do the partners line up their deals so that they're able to enter them into the system and make sure they get their pipeline lined up with the new way of doing things because they're going after directly enter them into the system. Some of these services used to be taken over by distributors for some of our partners. We're going to make sure that -- we want to make sure that large volumes work well with the systems. We're pretty confident at this point because of the Flex experience, but we know we want to stress test these things. We want to make sure that it works for all the product offerings that there's no issues or hiccups with particular things that when people try to true up renewal dates or line them up, there's not issues with those things. It's all the things that go into the mechanics of a partner entering the deal, all right, and having those things actually function. We just want to make sure it all works. Again, we have a lot of confidence because of the Flex work, but those are the things we're going to be testing for in the Australia pilot."
},
{
"speaker": "Bhavin Shah",
"content": "That's helpful there. And just kind of following up on Fusion 360. I know you guys are making some pricing adjustments going into next year, kind of raising the list price on Fusion 360, but kind of rationalizing and lowering the price on the extensions. What's the kind of the rationale behind this? Is this to drive kind of further extension adoption down the road? And kind of how does this inform your views on as you think about rolling this out to the form and the like?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So Bob, what we're doing there is the price increase in Fusion is directly connected to the value we're delivering Fusion we're making sure some of the customers who have been with us for a long time are treated appropriately and fairly. So we're paying attention to all those things to customer dynamics. But what we saw is that the value in base Fusion has just increased to high level that we should be looking at the price more carefully. The value is going to continue to increase. And what we saw is that some of the extensions would probably see better adoption in some of the base -- the value was shifted to the base offering and the price of the extensions were contracted a little bit. So it's all this kind of balancing the overall cost of ownership for particular types of customers. And it's an appropriate time to do it."
},
{
"speaker": "Bhavin Shah",
"content": "Very helpful. Thanks for taking the question."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Steve Tusa of JPMorgan. Your question please, Steve,"
},
{
"speaker": "Steve Tusa",
"content": "Hi, guys. Thanks for taking my question. Just on the subscriber growth, are we talking like -- you mentioned the macro impact several times. What are we kind of talking about what kind of rate this year? Is that like in the low to mid-single-digit range? And then what would it take for that to go flat? What type of macro do you think it would take to go flat? And then secondarily, just on the free cash flow side, I think at the Investor Day, you had put a chart in there that insinuated that cash would still grow from 2023 through the number in 2026. Are we still on track for that kind of longer-term view just to level set us on the longer-term cash outlook?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So Steve, let me take the first question a little bit. I won't answer the specific question. What I want to say is our business is incredibly resilient. You have to really pay attention to that, we're built for resilience. And I want to highlight some of the differences in puts and takes here. For instance, you probably noticed that AEC grew 20% in the quarter. And that offset some of the headwinds from media and entertainment due to wider strikes and after strikes. Regionally, India and Canada offset the U.S. and the U.K. Market segment-wise, EBAs and small businesses offset the mid-market. You have to think of the business through this built for resilient framework. And so I want to shift your lens a little bit, and then I'll let Debbie comment on the second part of your question."
},
{
"speaker": "Debbie Clifford",
"content": "Yes, I would say, look, outside of the new transaction model, nothing has changed, and we're on track to achieving our goals. But this is a pretty big decision for us to transform our go-to-market. But I think is really beneficial to the company. It's going to drive greater free cash flow and greater revenue growth over the long term. I'm not going to parse comments about fiscal 2026 in addition to fiscal 2025 on this call. What we're really trying to do is set ourselves up for success over the long term and make smart decisions for the business and for our shareholders."
},
{
"speaker": "Steve Tusa",
"content": "Okay. Great. Thanks a lot."
},
{
"speaker": "Operator",
"content": "Thank you. That is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks."
},
{
"speaker": "Simon Mays-Smith",
"content": "Thanks, everyone, for joining us. Wishing those who celebrate a happy Thanksgiving and looking forward to catching up with you on the road over the coming weeks and at next quarter's earnings. Thanks so much, Latif. Handing back to you."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] |
adsk | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Thank you for standing by, and welcome to Autodesk's Second Quarter 2024 Earnings Call. [Operator Instruction] I would now like to hand the call over to Simon Mays-Smith, Vice President, Investor Relations. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"content": "Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the second quarter results of Autodesk's fiscal '24. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, products and product capabilities, business models and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today's press release for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numeric or growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release, or Excel financials and other supplemental materials available on our Investor Relations website. And now I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"content": "Thank you, Simon, and welcome, everyone, to the call. Resilience, discipline and opportunity again underpinned Autodesk's strong financial and competitive performance despite continued macroeconomic policy and geopolitical headwinds. Resilience provided by our subscription business model and our product and customer diversification discipline and focus in executing our strategy and deploying capital through the economic cycle and opportunity from developing next-generation technology and services which deliver end-to-end digital transformation of our Design and Make customers and enable a better world designed and built for all. Our leading indicators remained consistent with last quarter with growing usage and record bid activity on BuildingConnected and cautious optimism from channel partners. Customers remain committed to transformation and to Autodesk leveraging automation more where they are seeing headwinds from the economy, labor shortages and supply chains. That commitment was reflected in our Q2 performance, growing adoption and token consumption within Enterprise Business Agreement and strong renewal rates. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. We were delighted that Autodesk was recently highlighted as a Best Workplace for Innovators by Fast Company. I will now turn the call over to Debbie to take you through our quarterly financial performance and guidance for the year. I'll then come back to provide an update on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"content": "Thanks, Andrew. Overall market conditions and the underlying momentum of the business remained similar to the last few quarters. Despite a tough macroeconomic backdrop that continues to drag on the overall rate of new subscriber acquisition and the forward momentum of the business and may continue to do so. Our financial performance in the second quarter was strong. We said last quarter that we had a strong cohort of EBAs renewing in the second half of the year that last renewed three years ago at the start of the pandemic and that subsequent adoption and usage has been strong. Some of that strength came through in the second quarter, which was earlier than we were expecting and which boosted billings, free cash flow and subscription revenue. Total revenue grew 9% and 12% in constant currency. By products in constant currency, AutoCAD and AutoCAD LT revenue grew 9%, AEC revenue grew 14%, Manufacturing revenue grew 9% and in double digits, excluding a headwind from variances in upfront revenue, and M&E revenue grew 10%. By region in constant currency, revenue grew 15% in the Americas, 11% in EMEA and 6% in APAC. Direct revenue increased 18% and represented 37% of total revenue, up 3 percentage points from last year, benefiting from strong growth in both EBAs and the eStore. Net revenue retention rate remained within the 100% to 110% range at constant exchange rates. The transition from upfront to annual billings for multiyear contracts is proceeding broadly as expected. We had a full quarter impact in the second quarter, which resulted in billings declining 8%. Total deferred revenue increased 14% to $4.2 billion. Total RPO of $5.2 billion and current RPO of $3.5 billion grew 11% and 12%, respectively. Turning to the P&L. Non-GAAP gross margin remained broadly level at 92%. GAAP and non-GAAP operating margin remained broadly level with revenue growth and cost discipline, offsetting the impact of exchange rate movements. Free cash flow was $128 million in the second quarter, which was a bit better than we've been expecting, primarily due to the timing of EBAs, but also due to some favorable in-quarter linearity. Turning to capital allocation. We continue to actively manage capital within our framework. Our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. We are being vigilant during this period of macroeconomic uncertainty. During Q2, we purchased approximately 400,000 shares for $87 million at an average price of approximately $200 per share. We will continue to offset dilution from our stock-based compensation program and to opportunistically accelerate repurchases when it makes sense to do so. Now let me finish with guidance. The headline is that overall, the underlying momentum in the business remains consistent with the expectations embedded in our guidance range for the full year. Our sustained momentum in the second quarter and early expansion of some EBAs expected to renew later in the year, reduce the likelihood of our more cautious forecast scenarios given that, we're raising the lower end of our guidance ranges. Let me summarize some key factors we highlighted earlier in the year. First, we have a strong cohort of EBAs renewing in the second half of the year, although, as I mentioned earlier, some of that benefit was billed in the second quarter. Second, foreign exchange movements will be a headwind to revenue growth and margins in fiscal '24. The revenue headwind will moderate a bit in the second half of the year. Third, Switching from upfront to annual billings for most multiyear customers creates a significant headwind to free cash flow in fiscal '24 and a smaller headwind in fiscal '25. Our expectations for the billings transition are unchanged. Fourth, as we thought might happen, we saw some evidence of multiyear customers switching to annual contracts during the second quarter. It wasn't big enough to be called a trend, but we're keeping an eye on it. It's still early days, and we'll keep you updated as the year progresses. All else equal, if customers switch to annual contracts, it would proportionately reduce the unbilled portion of our total remaining performance obligations and negatively impact total RPO growth rates. Deferred revenue, billings, current remaining performance obligations, revenue, margins and free cash flow would remain broadly unchanged. Annual renewals create more opportunities for us to drive adoption and upsell and are without the price lock embedded in multiyear contracts. And fifth, we expect our cash tax rate will return to a more normalized level of approximately 31% of GAAP profit before tax in fiscal '24, up from 25% in fiscal '23. We the federal tax payment extension after the winter storms in California means cash tax payments shift from the first half of the year to the third quarter, reducing third quarter free cash flow. Second half free cash flow generation will, therefore, be significantly weighted to the fourth quarter. We still anticipate fiscal '24 will be the cash flow trough during our transition from upfront to annual billings for multiyear contracts. Putting that all together, we now expect fiscal '24 revenue to be between $5.41 billion and $5.46 billion. We expect non-GAAP operating margins to be similar to fiscal '23 levels with constant currency margin improvement, offset by FX headwinds. We expect free cash flow to be between $1.17 billion and $1.25 billion. We're increasing the guidance range for non-GAAP earnings per share to be between $7.30 and $7.49 to reflect higher interest income on our cash balances in addition to the reduced likelihood of our more cautious forecast scenarios. The slide deck on our website has more details on modeling assumptions for Q3 and full year fiscal '24. We continue to manage our business using a rule of 40 framework with a goal of reaching 45% or more over time. We think this balance between compounding growth and strong free cash flow margins captured in the rule of 40 framework is the hallmark of the most valuable companies in the world, and we intend to remain one of them. As we said back in February, the path to 45% will not be linear, given the macroeconomic drag on revenue growth from the rate of new subscriptions growth and the drag to free cash flow as we transition away from multiyear contracts paid upfront. But let me be clear, we're managing the business to this metric and feel it strikes the right balance between driving top line growth and delivering disciplined profit and cash flow growth. We intend to make meaningful steps over time toward achieving our 45% or more goal regardless of the macroeconomic backdrop. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"content": "Thank you, Debbie. Let me finish by updating you on our progress in the second quarter. Our strategy is to transform the industries we serve with end-to-end cloud-based solutions that drive efficiency and sustainability for our customers. We continue to see good growth in AEC, fueled by customers consolidating on our solutions to connect and optimize previously siloed workflows through the cloud. And as we talked about in February, digital momentum is also building among asset owners in infrastructure and other areas. This momentum is expected to accelerate with infrastructure investment programs like the U.S. Advanced Digital Construction Management System program, which launched during our second quarter. Cannon Design is a global design practice encompassing strategy, experience, architecture, engineering and social impact. It is driving forward its digital transformation and embracing the cloud to increase operational efficiency, enhance security, establish a single point of truth and enable more seamless end-to-end collaboration. During the quarter, it expanded its investment with Autodesk by leveraging Autodesk Docs as a common data environment adopting Forma and is exploring opportunities to integrate Autodesk's XR and asset management capabilities to its design portfolio. Outside the U.S. our construction platform is benefiting from our strong international presence and established channel partner network. During the quarter, a property developer and transit network operator based in Asia needed to simplify operations across its many infrastructure projects with a wide range of contractors and subcontractors. To manage this complexity, it needed a single source of truth for its project data and way to streamline workflows on a single platform. In Q2, it leveraged support from our local channel partner and standardize on one platform by adding Autodesk Construction Cloud to its existing portfolio of Autodesk AEC design tools to gain visibility into contractors and subcontractors workflow and the potential to unlock breakthrough productivity gains. Shook Construction, an ENR 400 general contractor based in Ohio made the decision to standardized on Autodesk Construction Cloud to better streamline their operational workflows. After evaluating many competitive options, Shook Construction chose Autodesk Construction Cloud as the best fit for driving consistent workflows, creating high-impact collaboration with their construction partners and eliminating cumbersome manual workflows. We continue to benefit from our complete end-to-end solutions, which encompass design, preconstruction and field execution through handover and into operations. Again, these stories have a common theme: managing people, process and data across the lifecycle to increase efficiency and sustainability while decreasing risk. Over time, we expect the majority of all projects to be managed this way, and we remain focused on enabling that transition through digital transformation. We talked last quarter about the short-term disruption from integrating our construction and worldwide sales teams. I'm pleased to report that things began to settle in the second quarter. We believe that combining the two teams will allow us to expand the scale and reach of our construction business, particularly in our design customer base and our ability to serve our customers across the complete project life cycle. Encouragingly, Autodesk Construction Cloud MAUs were up over 100% in the quarter. Moving on to manufacturing. We made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and consolidate on our Design and Make platform to grow their business and make it more resilient. For example, a multinational manufacturer which serves the construction industry on both a building product manufacturer and through tools and construction processes has been leveraging the Autodesk portfolio to connect workflows across the AEC and manufacturing industries. It's expanded its commitment to BIM using Revit, Navisworks and Construction Cloud, which has enabled the customer to adopt a collaborative and data-driven approach across design, construction and maintenance services. which minimizes clashes and rework and culminates in more efficient and successful building projects. In the second quarter, the customer grew its EBA with Autodesk ahead of its Q4 renewal date to accelerate the adoption of BIM and facilitate the design of its products and materials directly within MEP models. Fusion continues to provide an easy on rate into our cloud ecosystem for existing and new customers. In Europe, an appliance manufacturer who was already an existing user of our manufacturing collection and AutoCAD mechanical, purchased additional seats of Fusion for PCB design. It's heating systems division will leverage Fusion's electronic design automation capabilities to quickly and seamlessly connect more of its design to manufacturing workflow to drive greater efficiency. Fusion continues to grow strongly, ending the quarter with 236,000 subscribers as more customers connect more workflows in the cloud to drive efficiency, sustainability and resilience. At Investor Day, I talked about leveraging our key growth enablers, including business model evolution, customer experience evolution and convergence between industries to provide more and better choices for our customers. Our Flex consumption model is a good example of this. Flex's consumption pricing means existing and new customers can try new products with less friction and enables Autodesk to better serve infrequent users. Not surprisingly, the lion's share of the business has come from new or existing customers expanding their relationship with Autodesk. During the quarter, we signed 3 more million dollar Flex deals. As Steve said at our Investor Day, we've also introduced a new transaction model for Flex, which will give Autodesk a more direct relationship with our customers and more closely integrate with our channel partners over time. We will begin testing our new transaction model more broadly in Australia later this year. And finally, we continue to work with noncompliant users to ensure that they are using the latest and most secure versions of our software. For example, after identifying and alerting a Chinese-based automobile designer about noncompliant usage and despite working to ongoing challenges from the pandemic, the customer eventually committed to three year VRED and Alias subscriptions. As expected, our initiatives to tighten concurrent usage of named user subscription and expand the precision and reach of our in-product messaging drove incremental growth during the quarter. Now let me finish with the story. According to the National Oceanic Service, Coral reefs are some of the most diverse and valuable ecosystems on earth. While they take up less than 1% of the ocean floor, their extraordinary biodiversity supports about 25% of all marine life. Healthy coral reefs support fisheries as well as jobs and businesses through tourism and recreation. It also buffer shorelines against 97% of the energy from waves, storms and floods, helping to prevent loss of life, property damage and erosion. It can take 10,000 to tens of millions of years for our coral reefs to form, and just weeks for it to die. Rising ocean temperatures can cause coral to bleach and die. Half of living coral reefs have died since the 1950s. Without intervention, we're on track to lose 70% to 90% of the remainder by 2050. That is, unless we find a faster way to bring coral reefs back from the brink. With support from Autodesk and the Autodesk Foundation, a company called Coral Maker is using our digital tools, artificial intelligence, and robotics to deliver core restoration at scale with cloud collaboration to keep the global team connected across oceans and time zones. As Dr. Karen Foster, coral makers founder says, the partnership with Autodesk has empowered us to develop new technology to restore reef at a rate unimaginable a few years ago. Current restoration projects can deploy about hectare of portal per year. With coral makers technology, it's possible to deploy 100 sectors per year. From the oceans to the earth and Sky augmented design, powered by Autodesk will enable our customers to go further and faster to design and make a better world for all. We've been laying the foundation to build enterprise level AI for years with connected data, teams and workflows in industry cloud. real time and immersive experiences, shared extensible and trusted platform services, innovative business models and trusted partnerships. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. We are building the future with focus, purpose and optimism. Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Please go ahead, Saket."
},
{
"speaker": "Saket Kalia",
"content": "Okay. Great. Hi Andrew. Hi, Debbie. How are you guys doing? Thanks for taking my questions here."
},
{
"speaker": "Debbie Clifford",
"content": "We're doing great. How are you Saket?"
},
{
"speaker": "Saket Kalia",
"content": "Doing great, doing great. Debbie, maybe for you, just a quick housekeeping question here. Great to see the revised range on a lot of metrics, particularly revenue. And so, when I think about the midpoint of the revenue guide going up by about $25 million, first of all, great to see the impact of FX to start to lighten. But could you just maybe walk us through a broad brush how much of this year's raise on revenue is from FX versus maybe some underlying fundamentals in the business?"
},
{
"speaker": "Debbie Clifford",
"content": "Yes. So, we had a small increase in the midpoint of the guide. The dollar change was immaterial it's tough really to come up with a mix of assumptions that get us to the low end of our previous guidance range. So, the midpoint increase reflects a mix of both organic and FX assumptions. Overall, the business is tracking generally in line with our expectations."
},
{
"speaker": "Saket Kalia",
"content": "Okay. Got it. Got it. Andrew, maybe for you, of an open-ended question. But I guess now as you've completed the first quarter of this transition to a new billing model. Is there anything that's surprising you about maybe how customers or how partners are behaving, again, open ended?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. No real big surprises. Saket I mean - Debbie flagged last quarter that we might see some customers reverting back to annual contracts as a result of the change. We did see that. Nothing really out of bound zone, nothing really surprising. Debbie, do you want to add anything to the details or..."
},
{
"speaker": "Debbie Clifford",
"content": "Yes. I would say the initial rollout of the new billings model is going well. The systems are working, customer and partner behavior is pretty much as we expected. As Andrew mentioned, we are seeing a small proportion of our customers choose annual contracts versus multiyear contracts billed annually, but generally, we expected a bit of that, and the performance has been in line with our expectations. And remember, if customers choose annual contracts, it doesn't impact the P&L. It only impacts unbilled and total RPO. It's still early days. We're monitoring it closely. And I think it just continues to be a good example of how we're working to optimize the business. It's about reducing the volatility of our cash flow while simultaneously giving our customers, the purchasing pattern that they want. And then finally, I'd say that there's no change in how we expect the transition to impact our cash flow outlook."
},
{
"speaker": "Saket Kalia",
"content": "Got it. All very clear. Thanks guys."
},
{
"speaker": "Operator",
"content": "Thank you. Please stand by for our next question which comes from the line of Jay Vleeschhouwer of Griffin Securities."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Got it. Thank you. Good evening. Andrew, for you first, you made some constructive comments about what you're seeing in the AEC business. But more broadly, and as you're well aware, there's quite a bit of ferment going on in that market right now in terms of references to what's come to be called BIM 2.0 as you know, just a couple of months ago at an AUC conference, a customer group launched a new customer-developed design specification for software. You yourselves are working on a dual track of enhancing revenue, but focusing on format. So lots going on in terms of various currents in that industry or part of the industry. Help us understand how you're thinking about managing for all those different dynamics that are going on in the AEC industry. And then a follow-up."
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So Jay thanks. Jay, there's three threats to this, right? One is kind of the core platform threat around data and data flow. At the root of all of this, we need to make sure as much of the data that we have locked inside Revit files and lots of other types of files that our customers have gets turned into APIs wherever possible, right? This is a lubricant to the workflows that people are worried about. And I think a part of really what underpins the whole concept of BIM 2.0. That's one of the things. The second piece is you've got to make sure that their ability to do detailed in-depth complicated, sophisticated BIM models gets more performant, more productive and faster. That's core to kind of building up, and improving Revit in some significant ways, which we're absolutely looking at. But the third point, which I think is more important is you really need to reimagine how BIM is being done. The paradigm needs to shift, and it needs to shift to the world of not only being cloud-enabled but also being what we really like to call augmented design-enabled or outcome-based in whatever language we use, so that you can actually change the way people do BIM. And that's one of the big things that we're focusing on with Forma. And that's very different than - we have certain types of competitors. It's in line with what the spec is from the customers. But when you talk about data revenue improvements, and the move to what we call augmented design or outcome-based design. Those are the big thrust in terms of what we're trying to do to bring the industry to a better way of doing BIM?"
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Okay. Second question refers to the comments you made about a new transactional model and a pilot you're going to be undertaking in Australia. So maybe you could elaborate on that. When I hear that, it sounds to me like there's potentially going to be some further change to channel economics. You've just completed the move to back-end-only margins. Are you thinking about perhaps taking the flex commission model more broadly across the rest of the business? Or what exactly you're looking to accomplish with that?"
},
{
"speaker": "Andrew Anagnost",
"content": "So let's talk about the Flex experiment and the things you were doing with - I think with Flex last. First off, Flex because it's like a consumption-based model, and it involves usage of various different products - it really - it's really incredibly helpful for the customer for us to be able to have a much more direct relationship with the customer with regards to that offering. Because that way we're able to offer a lot more visibility to how they're using the offering, what they're using, when they're using it, how much they're consuming, and actually help them get the most out of the offer. So, what we've done over the last year is we've proved out a new transaction model working with our partners, and rolling out across various regions that is supporting Flex, and that is a much more direct transaction model. Through that process, we've learned a lot. We've gained a lot of knowledge. We've addressed a lot of issues both systems-wise and process-wise. And we are now in a position with Flex to start growing, and expanding that model at greater and greater volume. And that's exactly what's happening with Flex. The volume of Flex is increasing, increasing, and we're doing it reliably, repeatedly and in a pretty positive way. Where we go from here depends solely on how we watch these things evolve and what the benefits of this transaction model for us. And all options are open to us in the future, but that's where we are right now. We've perfected what we've done on the Flex."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Adam Borg of Stifel."
},
{
"speaker": "Adam Borg",
"content": "Awesome. And thanks so much for taking the questions. Maybe just for Andrew on the infrastructure opportunity. I know you've been calling out increasing traction with State Department of Transportation, and you even referenced some grants in the quarter in the script. So maybe just talk a little bit more about how you think about the infrastructure opportunity overall? And really what separates all of that from competitors in going after it?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So look, at a high level, one of the things I'm really excited about the thing with a really long name. The advanced digital construction management system program that the U.S. government rolled out, that is the program related to the money that's designed to help department of transportation look at their infrastructure, look at their processes, and start modernizing their digital processes around design and construction of infrastructure. That's an important step in getting a lot of these Department of Transportations to really start thinking about how they get ready to spend more money on infrastructure, and do it better and address the serious capacity challenges we have around materials, manpower, and dollars with regards to what we have to do. So pretty excited about, that because that's an open door to having new conversations with these departments about how they do things. Our focus has not changed. We are very much focused on water and road and rail, and we continue to innovate and drive improvements in those areas. I think our biggest differentiator is what we bring to market as a modern architecture. We bring to market more cloud-based solutions, more owner-based solutions for managing the infrastructure once you have it, and really just more technology that sits together in different ways. So, we're looking forward to having that discussion with the Department of Transportation over the next months and coming years. And I think you're going to start to see real change in some of those organizations."
},
{
"speaker": "Adam Borg",
"content": "That's really helpful. And maybe just as my follow-up, just on the earlier-than-expected EBA renewal pool in the quarter. So maybe just talk about - just given the softer macro obviously, that our checks have been suggesting, and you talked about no real change sequentially. But just what's leading to customers to choose to renew early and - maybe just as a quick follow-up to that, as we think about the guidance for the year, any way to quantify the type of expansion opportunity embedded from the EBA? Thanks so much."
},
{
"speaker": "Debbie Clifford",
"content": "I think, Adam, you were coming - in and out a little bit, but I think I got the bulk of what you were saying. So just stop me if I'm missing something. But in terms of the EBA behavior. Really, what we saw was driven by them. Our customers were managing their own budgets and cash flow. And so, their desire to get early billings for frankly, higher usage of their tokens was driven by their own - behavior, which we see as a real positive sign for us in engaging with those enterprise customers. They're seeing strong usage of our portfolio, and they're continuing to invest in their relationship with us. And those billings boosted our total billings, revenue, and free cash flow during the quarter. So overall, I think it's a win-win. There was a second part, I think, to your question."
},
{
"speaker": "Adam Borg",
"content": "Yes. Just curious. And so thanks. I was just curious, any way to quantify kind of the type of expansion opportunity from the EBA renewal pool in the back half of the year as you think about full year guidance?"
},
{
"speaker": "Debbie Clifford",
"content": "Not something we can quantify for you, Adam, but I would just reiterate the fact that we do see it as a real positive that for the first two quarters of the year-to-date that we're seeing strong usage, and that's already leading to early billings. So a positive from our standpoint overall."
},
{
"speaker": "Adam Borg",
"content": "Awesome. Thanks so much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Joe Vruwink of Baird."
},
{
"speaker": "Joe Vruwink",
"content": "Great. Hi, everyone. Maybe I wanted to revisit your AEC exposure. I know you've discussed this in the past and just as there's offsets, so commercial market see pressure, institutional or infrastructure far better. So you have diversification there. I guess when you think about the current business composition, and how the different subsectors are faring, do you think the nature of Autodesk and AEC is any better or worse than would have been the case in past cycles? And I'm asking less about Autodesk just as a subscription model now versus a license model in the past. And more about Autodesk and things like Revit adoption or reliance on the cloud which might create a different dynamic for the business this down cycle versus past down cycles."
},
{
"speaker": "Andrew Anagnost",
"content": "I think one of the things that you said, and I want to reinforce it, is that - we are diversified across all sectors of making things. Everything that gets made, we're involved in. It's not just AUC, it's buildings, it's bridges, it's car, it's electronics. And of course, it's film and game. So just remember, we're diversified across all of those segments. What's different now, and I think it's important to recognize this. Is that the AEC industry as a whole is chasing productivity and digitization gains, the entire industry, from construction, all the way through to any design in every part of the process in between, engineering and all the things associated with that. So that fundamental change is creating long-term pull for what we're doing. And what we're doing is we're connecting the design, and make processes across that industry together in the cloud in unique and highly integrated way. So that people can do things faster, more sustainably and with greater - with lower risk and better outcomes. That fundamental shift is very different than what we've seen before. And that's going to - we're going to be riding that fundamental shift for quite a few years."
},
{
"speaker": "Joe Vruwink",
"content": "Okay. Great. Andrew, that's helpful. And then second question, wondering if you can comment on how you see the writers and actors, strike potentially impacting business in media and entertainment, particularly if this goes on for a while and your customers are finishing what's in post-production with, I suppose, a lack of new things coming in, what that might mean towards the end of the year?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So you've hit one thing right there, right? People are still in post-production right now for the existing book that post production overhang will continue for a little while. If the strike continues for months on end, we will likely see an increased impact on our media and entertainment business. It's still growing now. It definitely slowed down in Q2, but it's still growing. So as we look forward, your guess is as good as mine about how long this strike will go on. But I do remind you our exposure to media entertainment is relatively small compared to the other parts of our business. But there's no doubt that an extended strike could have an impact on that business."
},
{
"speaker": "Joe Vruwink",
"content": "Okay. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Tyler Radke of Citi."
},
{
"speaker": "Tyler Radke",
"content": "Yes. Thanks for taking the question. So I wanted to just go back to the commentary on kind of the puts and takes in the quarter. So you talked about seeing some early expansions on some of the multiyear EBAs. And I just wanted to clarify, was that also stronger expansion? Or was it more of a timing factor? And then Debbie, this might be a bit of a nitpicky question. But just as I look at the constant currency revenue guidance, I think the high end of the guide says 12% plus versus 13% last quarter. I just wasn't sure if there was a change there. If you could just kind of comment on the puts and takes on that, too? Thank you."
},
{
"speaker": "Debbie Clifford",
"content": "Sure. Thanks, Tyler. So the EBA usage was strong, and we've been tracking it for the year-to-date. It wasn't necessarily stronger than our expectations, however. So to clarify, it's really more than anything it's a timing difference. We were expecting that the revenue would hit in Q4 and it hit in Q2. But the fact that our customers are using more than they had anticipated the onset of the contracts is a good thing. It's just that we've been tracking it. We've known about it for the year-to-date, and we just saw the invoices in Q2 versus Q4. In terms of the constant currency guide, the range, it was impacted really by rounding. The dollar change was immaterial. And overall, the business is tracking generally in line with our expectations."
},
{
"speaker": "Tyler Radke",
"content": "Okay. Great. And follow-up for Andrew. You talked about some encouraging signs on the Autodesk construction side, given the reorg, you talked about it kind of settling in. How - maybe just remind us kind of what were the big changes? What are you hoping to accomplish? And should we start to see the make revenue begin to accelerate throughout the rest of the year? Thank you."
},
{
"speaker": "Andrew Anagnost",
"content": "Yes, Tyler. Happy to clarify that. So look, what we did in Q1 is we merged the Autodesk Construction Solutions sales force with the mainline sales force. This was with the objective of long-term accelerating business growth in that area, particularly in our design-centric accounts. So we wanted to keep the contractor and subcontractor power of the ACS team and combine it with the teams that are focused on some of our design accounts as well. We expected some bumps in doing that because you have to realign account assignments, you have to realign players and who's in charge of what. We've seen a lot of those bumps get smoothed out into Q2. So we're seeing a return to expected patents. We've lost no business during the process. As I told you - as I told you earlier in the opening commentary, when we talked about - when I talked about things like Shook, the general contractor in Ohio. We're winning - we're continuing to win these contractors. Primarily, one of the things we hear a lot is the pricing predictability associated with our offering and the ability to show them a path not only to a stable pricing model, which customers really like and increasingly see a viable and strong alternative to project management and what ACS offers, but also in terms of the integration between design and banking. I expect the consolidation of the sales force is to continue to further accelerate the construction business moving forward as we continue to work this through. So progress in the right direction, and we can expect to see more progress."
},
{
"speaker": "Tyler Radke",
"content": "Great to hear. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Jason Celino of KeyBanc Capital Markets."
},
{
"speaker": "Jason Celino",
"content": "Great. Thanks for taking my question. This is a spin on Saket's very first question, but it relates to the quarter and not necessarily the guide. But when we look at the outperformance in the quarter, it's the biggest beat on a percentage and an absolute basis we've seen in many quarters. Can you just help us unpack maybe what the magnitude of the EBA strength was or the FX kind of benefits, if there were any?"
},
{
"speaker": "Debbie Clifford",
"content": "The biggest driver of the beat came from the EBAs."
},
{
"speaker": "Jason Celino",
"content": "Okay. Perfect. And then, Andrew, curious on updates on Innovyze. At the beginning of the year, I think there was this view that funding for sewer projects and water projects hadn't quite started to flow, no pun unintended yet, but that maybe we would see things start to open up in the second half or next year. Is that still the case? I guess what are you seeing?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. I mean, look, look at the news, right, all you get is increasing evidence that most regions and municipalities need to reevaluate their water management, both at a sewage level and a treatment level infrastructure. So that has fundamentally not changed. And we haven't yet seen the increase in project actually starting projects in that area. But what we are seeing is people buying ahead of demand. So we actually saw a lot of strength with Innovyze in our EBAs in our large accounts, which is an important precursor to some of the larger efforts that might go on moving forward. But no floodgates have opened up yet, no pun intended from my side. But we still see the exact same pattern we've talked about."
},
{
"speaker": "Jason Celino",
"content": "Okay. Great. Appreciate it. and I like the puns."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Michael Funk of Bank of America."
},
{
"speaker": "Michael Funk",
"content": "Yes. Thank you all for the questions tonight. A couple if I could. So on the EBA renewal comments that you made earlier, can you give us a sense of the like-for-like change there, whether or not customers on balance or upsizing, increasing the duration of the contract, what that looked like."
},
{
"speaker": "Debbie Clifford",
"content": "So to clarify, these contracts, they were not contracts that were renewed. We're expecting that these contracts will be renewed in Q4 per our normal cycles. What happened is that these customers have been using ahead of the usage that was built into their original contracts. And so what we saw in Q2 was billings for the overuse versus the original contracts. But we still expect the renewals will occur in Q4."
},
{
"speaker": "Michael Funk",
"content": "Understood. I must have miss heard you earlier. So for the overview then, do you expect that trend to continue for the remainder of the year? And what do you think is driving that over use?"
},
{
"speaker": "Debbie Clifford",
"content": "We're certainly hopeful that, that trend continues. We see it as a very positive sign that our customers are asking for early billings because they're using our products more than they anticipated, and they're using the broad breadth of the portfolio. The other thing I would say is that the usage that was built into these contracts when they were originally signed. Remember, this was three years ago, at the onset of the pandemic. And so the usage in those contracts might have been a bit lower just given the environment in which those contracts were renewed. And so as we start to come out of the pandemic, we're seeing more and more usage. We've talked about usage being broadly speaking for Autodesk, but also for our EBAs being a good leading indicator, and that usage continues to increase. I don't have a crystal ball, Michael. I wish I did. I could tell you for sure that the usage would continue to go up in the back half of the year, but we're certainly hopeful and all signs are leading in that direction."
},
{
"speaker": "Michael Funk",
"content": "Okay. So, in terms of trends so far this quarter to date are consistent with 2Q?"
},
{
"speaker": "Debbie Clifford",
"content": "Sorry, I didn't hear."
},
{
"speaker": "Michael Funk",
"content": "Your last comment about trends continuing is the interpretation there that the trend has continued in - from 2Q into this quarter of increased usage."
},
{
"speaker": "Debbie Clifford",
"content": "We're not commenting on Q3 at this point. Overall, the performance that we saw from our EBAs in Q2 is really strong, and we're hopeful that it will continue."
},
{
"speaker": "Michael Funk",
"content": "Great. Thank you, Debbie."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Matt Hedberg of RBC Capital Markets."
},
{
"speaker": "Matt Hedberg",
"content": "Great. Thanks for taking my questions. Congrats on the stability here. Really, really good to see. Maybe, Debbie, for you, maybe I missed it, but cash flow was - free cash flow was significantly better than we thought this quarter. I know you don't guide quarterly. So maybe just - again, maybe I missed it, but a little bit more on sort of why free cash flow is so strong this quarter? And as we think about Q3, Q4 kind of the linearity there, you took the low end of the full year up a little bit. How should we kind of think about that split sort of between 3Q and 4Q?"
},
{
"speaker": "Debbie Clifford",
"content": "Yes. So Q2 was strong, primarily because of the timing of the EBA billings that I've been talking about as well as some favorable in-quarter linearity. So the linearity that we saw was better than we had expected. And then when we look at the back half of the year, second half free cash flow will be significantly weighted to the fourth quarter. I've called out the federal tax payment extension that positively impacted the first half free cash flow, and it will negatively impact Q3. Overall, we still anticipate that fiscal '24 is going to be the free cash flow trough during this transition from upfront annual billings."
},
{
"speaker": "Matt Hedberg",
"content": "Great. Thanks. And then, Andrew, for you, following up on earlier questions kind of on the split of your business, obviously, an extremely diversified model. But I guess regarding commercial real estate exposure, I know it's difficult to give an exact percentage of your exposure there. But just broadly speaking, we get asked all the time, what's Autodesk's exposure to the category. How should we think about kind of Autodesk in the CRE market?"
},
{
"speaker": "Andrew Anagnost",
"content": "To be honest, you shouldn't, okay? This is some of the conversations we had during the housing crisis, like, how should we think about Autodesk relative to the housing. And the question is, you shouldn't, all right? The amount of things that need to be built and rebuilt in our customer base is ginormous, all right? They don't have current capacity, either people-wise, dollar-wise or capability-wise, to actually work through all the things that are going on. So the momentum of the industry pivots to other areas. Now even if you look at commercial real estate, people are still reconfiguring commercial real estate within the segment in order either to make it more attractive to a shrinking pool of renters or to repurpose that space to other uses. But in terms of exposure to Autodesk, you got to be careful about overblowing that because the money always goes somewhere else. There's always a lot of work to be done in other sectors. That just means that people that were traditionally bidding on commercial real estate projects are now bidding and engaging on other types of projects."
},
{
"speaker": "Matt Hedberg",
"content": "Super helpful. Thank you for that."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Bhavin Shah of Deutsche Bank."
},
{
"speaker": "Bhavin Shah",
"content": "Great. Thanks for taking my question. Andrew, we continue to hear good things from your customers and partners regarding your ability to innovate and enhance many of your acquired assets, whether it's Innovyze, PlanGrid, et cetera. Can you just remind us of your views on go-forward M&A and your M&A philosophy. And maybe kind of what are some of the lessons we learned from prior deals?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So we are an acquisitive company. We will continue to be an acquisitive company. We always like when the environment gets more attractive for acquisitions, but we are always looking to make sure that a potential acquisition is strategically aligned with our priorities. That means that it's either accelerating an effort that we're currently working on or bringing us into an adjacency that we weren't working on but that we see as an attractive place. Timing matters as well in terms of what timing is right for us to do these things that we keep the business reasonably focused on the things that are important and don't try to juggle 18 balls at once, right? But we will continue to be acquisitive, and we have the cash flow and balance sheet ability here to do whatever we need to do in terms of strategic fit and expansion that we're interested in moving forward. So don't expect any change. In terms of learning, look, you always learn, you can integrate some of the back office faster, all right? There's a [indiscernible] and all these things is integrate sales and back office infrastructure quicker and you go faster."
},
{
"speaker": "Bhavin Shah",
"content": "Super helpful there. Just on another topic, can you just talk about what you're seeing with A&E customers as it relates to hiring. I know many of these customers have got talent shortages over the past few years. Are you seeing any easing here or any kind of other general commentary in terms of hiring within A&E customers. Thanks so much for taking my question."
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. It depends on the sector. But honestly, in construction and manufacturing, you're seeing - they're still seeing challenges with hiring, right? It's one of the big things we hear from them is their ability to not only find but retain talent, especially qualified talent. So hiring continues to be an issue on the execution side of our customers, primarily towards the mix side."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Ken Wong of Oppenheimer & Company."
},
{
"speaker": "Ken Wong",
"content": "Great. Thank you for taking my question. Just a quick one for me. As we think about - I think Debbie, you mentioned new customer softness is kind of consistent with what you guys are seeing. But just wanted to make sure, relative to last quarter, I think you guys had called out a bit of an air pocket that normalized. How should we think about the way that played out this quarter in terms of adding new subs?"
},
{
"speaker": "Debbie Clifford",
"content": "The overall market conditions, new subs, momentum in the business was similar to last quarter. We talked about leading indicators being consistent with last quarter, growing usage, record bid activity on BuildingConnected ,cautious optimism from our channel partners. Beyond that, I would just add that our regional performance was broadly similar to what we've seen for several quarters. direct business, including enterprise and eStore as well as India actually were bright spots for us, but they were offset by some tougher patches like China as well as the softer performance that we talked about in M&A."
},
{
"speaker": "Ken Wong",
"content": "Got it. And then I realize maybe it's a very small nuance. But I think last quarter, you guys saw a little bit of a dip, and then it recovered in terms of new sub ads. I guess when you're saying it's consistent with last quarter, would it be more consistent with that exit or kind of full quarter dynamic where averaged out maybe a little lighter than anticipated."
},
{
"speaker": "Debbie Clifford",
"content": "So remember what we said last quarter was that we saw a slight dip after we stopped selling the multiyear contracts upfronts, but then it recovered as we exited the quarter and as we got into early Q2, and we saw that consistently throughout Q2."
},
{
"speaker": "Ken Wong",
"content": "Okay. Perfect. Thank you, Debbie."
},
{
"speaker": "Operator",
"content": "Thank you. Please standby. Our next question comes from the line of Nay Soe Naing, Berenberg."
},
{
"speaker": "Nay Soe Naing",
"content": "Hi. Thank you for squeezing me in. Just got a quick question from me. Coming back to the early was better than expected or earlier than expected EBA renewals I was wondering if we were to exclude that impact in the quarter, the performance in AEC, would we have seen an inflection in terms of the growth levels because what we've seen in the past couple of quarters is the gradual decline in growth rates. So I was wondering if we didn't have this early renewals and EPAs would be an easy segment would have seen a further deceleration in growth rates? Or would we see a bit of an uptick compared to Q1? Thank you."
},
{
"speaker": "Debbie Clifford",
"content": "So the early billings that we talked about for EBAs are what drove the revenue beat versus our guide. But when you think about that beat on a dollar basis in comparison to the totality of our AEC business, the AEC business is vastly larger. So it's not a big driver of the overall trend that we're seeing in AEC, but it was the driver of EBA."
},
{
"speaker": "Nay Soe Naing",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Patrick Baumann of JPMorgan. Please go ahead, Patrick."
},
{
"speaker": "Patrick Baumann",
"content": "Thank you. This is Pat on for Steve. So just a couple probably for Debbie. You touched on sales in terms of the moving parts of the guide raise there. I guess in terms of the free cash flow midpoint, what was - I know it was only - it was a small number, but what was the driver of the raise there? And then on the EPS, the adjusted EPS guidance rate - raise, there's like $25 million of other income. Is that simply the benefit from the interest on cash that you mentioned in the preamble?"
},
{
"speaker": "Debbie Clifford",
"content": "Yes. So starting with cash, it's due to the performance that we saw in Q2. So I talked a little bit earlier in this Q&A session about the EBA billings that we saw in Q2 as well as the favorable in core linearity. So those were drivers of the difference that you saw in our cash flow guidance. And then in terms of EPS, the other income is due to higher interest income from our cash balances."
},
{
"speaker": "Patrick Baumann",
"content": "Good. Does that flow through the cash flow?"
},
{
"speaker": "Debbie Clifford",
"content": "In part, well, yes, yes."
},
{
"speaker": "Patrick Baumann",
"content": "Okay. And then sorry, one more on cash flow for my second question. Is the - do you think is the third quarter going to be negative or positive on free cash flow. You said I think, significantly weighted to the fourth quarter in the second half, which I think is similar to your prior commentary from last quarter. But I think you also thought at that time that maybe second quarter and third quarter could be negative. Is your view that free cash flow will be negative in the third quarter given the impact of this cash item that was pushed from the first half to the third quarter?"
},
{
"speaker": "Debbie Clifford",
"content": "We're not going to guide on a quarterly basis for free cash flow, but I'll try to be helpful. I just want to reiterate some of the comments. So remember that second half free cash flow is going to be significantly weighted into the fourth quarter. And the biggest driver of that is the extension of our federal tax payments that had a positive impact on the first half but are going to negatively impact Q3. So think about that as you put your model together."
},
{
"speaker": "Patrick Baumann",
"content": "Okay. Thanks so much. Best of luck."
},
{
"speaker": "Operator",
"content": "Thank you. That is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks. Sir?"
},
{
"speaker": "Simon Mays-Smith",
"content": "Thanks, and thank you, everyone, for joining today. We look forward to updating you on our progress in November on our Q3 earnings call. I look forward to speaking to you then. Thank you so much."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] |
adsk | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Thank you for standing by, and welcome to Autodesk First Quarter Fiscal 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to Simon Mays-Smith, VP, Investor Relations. Please go ahead."
},
{
"speaker": "Simon Mays-Smith",
"content": "Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss the first quarter results of Autodesk's fiscal '24. On the line with me are Andrew Anagnost, our CEO; and Debbie Clifford, our CFO. Today's conference call is being broadcast live via webcast. In addition, a replay of the call will be available at autodesk.com/investor. You can find the earnings press release, slide presentation and transcript of today's opening commentary on our Investor Relations website following this call. During this call, we may make forward-looking statements about our outlook, future results and related assumptions, acquisitions, products and product capabilities and strategies. These statements reflect our best judgment based on currently known factors. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-K and the Form 8-K filed with today's press release, for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. During the call, we will quote several numeric or growth changes as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release or Excel financials and other supplemental materials available on our investor relations website. And now, I will turn the call over to Andrew."
},
{
"speaker": "Andrew Anagnost",
"content": "Thank you, Simon, and welcome everyone to the call. Autodesk's strong financial and competitive performance in the first quarter of fiscal 2024 is again a testament to three enduring strengths: resilience, discipline, and opportunity. In a more challenging macroeconomic, policy and geopolitical environment, our resilient business model, and geographic, product and customer diversification, enabled us to deliver 12% revenue growth in constant currency, healthy margins, and record first quarter free cash flow. Leading indicators remained consistent with last quarter with product usage growing modestly, bid activity on BuildingConnected again at record levels, and continued cautious optimism from channel partners. Consistent with year-over-year economic momentum, we saw new subscription growth decelerate in North America and accelerate in EMEA. But our customers remain committed to transformation and to Autodesk, leveraging automation more as they see headwinds from the economy and supply chains. That commitment is reflected in larger, broader and more strategic partnerships, improving renewal rates, consistent net revenue retention, and growing adoption and usage of our products within EBAs; all of which helped drive 12% growth in current RPO and 15% growth in total RPO. While macroeconomics are unpredictable in the short-term, we are executing our strategy through the economic cycle with disciplined and focused capital deployment, underpinned by one of the best growth, margin, and balance sheet profiles in the industry. This enables Autodesk to remain well invested to realize the significant benefits of its strategy, while mitigating the risk of having to make expensive catch-up investments later. Discipline and focus also mean making sure we are investing in the right places. This is a constant process of optimization and improvement with increased vigilance during periods of macroeconomic uncertainty to prioritize investment and recruitment. As you heard at our recent Investor Day, we are deploying next-generation technology and services and end-to-end digital transformation within and between the industries we serve and, in so doing, shifting Autodesk from products to capabilities. Our AEC industry cloud, Forma, launched on May 8, is a great example of our vision. During pre-release trials, customers like CUBE 3 clearly saw how Autodesk Forma's intuitive user interface enabled rapid adoption by existing and new users; how bi-directional data flows enhanced the value of other Autodesk products like Revit; and how a single, integrated environment in the cloud, enhanced by AI, accelerated modeling and response times while significantly enhancing the value delivered to its customers. While using Forma during its trial, CUBE 3 delivered more creative and valuable designs to its customers while reducing the concept design phase by 50% or more. At Investor Day, I also talked about leveraging our key growth enablers, including business model evolution, customer experience evolution, and convergence between industries, to provide more and better choices for our customers. Our Flex consumption model is a good example of this. Flex's consumption pricing means existing and new customers can try new products with less friction, and also enables Autodesk to better serve infrequent users. Not surprisingly, the lion's share of the business has come from new customers or existing customers expanding their relationship with Autodesk. As Steve said at our Investor Day, we've also introduced a new transaction model for Flex, which will give Autodesk a more direct relationship with our customers and more closely integrate with our channel partners over time. During the quarter, Flex moved up into the top 10 products on our e-store, and we signed our first million-dollar Flex deal. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. Our transformation from products to capabilities will enable us to forge broader, trusted and more durable partnerships with more customers; gives Autodesk a longer runway of growth and free cash flow generation; and enables a better world designed and built for all. I will now turn the call over to Debbie to take you through the details of our quarterly financial performance and guidance for the year. I'll then come back to update you on our strategic growth initiatives."
},
{
"speaker": "Debbie Clifford",
"content": "Thanks, Andrew. Amidst a more challenging macroeconomic environment and ongoing headwinds from currency and Russia, Q1 was strong. The overall momentum of the business was similar to last quarter with new subscriber growth decelerating a bit and renewal rates improving a bit quarter-over-quarter such that current remaining performance obligation growth was the same as last quarter. Strong renewal rates demonstrate existing customers are committed to, and investing in, their long-term strategic partnerships with Autodesk. Some customers are also elevating their relationships with Autodesk from subsidiaries to companywide. When this happens, it can sometimes cause quarterly timing differences for the renewal as multiple contracts are co-termed to a single renewal date. We saw an instance of that in Q1 and, as a result, some of the up-front revenue we expected to hit in Q1, we now expect later in the year. Q1 revenue would have been toward the top end of our guidance range if adjusted for this up-front revenue. Total revenue grew 8%, and 12% in constant currency. By product in constant currency: AutoCAD and AutoCAD LT revenue grew 10%, AEC revenue grew 11%, manufacturing revenue grew 13%, and M&E revenue grew 9%. By region in constant currency: revenue grew 14% in the Americas, 11% in EMEA, and 8% in APAC. Direct revenue increased 15% in constant currency and represented 35% of total revenue, up 1 percentage point from last year, due to strength in both enterprise and ecommerce. Net revenue retention rate remained the same as last quarter and within 100% to 110% at constant exchange rates. As we flagged in our annual guidance given last quarter, our transition from up-front to annual billings for multi-year contracts impacts our billings growth this year. That transition started on March 28, so we had about one month of headwind in the first quarter. Billings increased 4% to $1.2 billion, primarily reflecting growing renewal rates and early renewals, partly offset by about one month of annual billings for most multi-year contracts. Total deferred revenue increased 20% to $4.5 billion. Total RPO of $5.4 billion and current RPO of $3.5 billion grew 15% and 12%, respectively. Turning to the P&L, non-GAAP gross margin remained broadly level at 92%, while non-GAAP operating margin decreased by 2 percentage points to approximately 32%. This reflects ongoing cost discipline, including the expected Q1 cost of repurposing approximately 250 roles to invest in our strategic priorities, as well as the impact of exchange rate movements. GAAP operating margin decreased by 1 percentage point to approximately 17% for the same reasons. Free cash flow was $714 million in the first quarter, up 69% year-over-year. In addition to the underlying momentum of the business, there were three factors that provided a tailwind in the first quarter: first, cash collections from the last month of billings in fiscal '23 were strong; second, we saw favorable linearity and early renewals in the first quarter, driven by the end of our multi-year billed up-front program; and third, after the winter storms in California, we received a federal tax payment extension to the third quarter. Turning to capital allocation, we continue to actively manage capital within our framework. Our strategy is underpinned by disciplined and focused capital deployment through the economic cycle. As Andrew said, we are being vigilant during this period of macroeconomic uncertainty, paying close attention to attrition and recruitment rates, and the increased upward pressure on costs from a weakening dollar. We will continue to offset dilution from our stock-based compensation program and to opportunistically accelerate repurchases when it makes sense to do so. During Q1, we purchased 2.7 million shares for $534 million, at an average price of approximately $199 per share, reducing total shares outstanding by about 3 million shares. Now, let me finish with guidance. The overall headlines are: the expectations embedded in our guidance range for the full year remain consistent with the underlying momentum in the business; and, we expect a tailwind in the second half of the year from a strong cohort of Enterprise Business Agreements. These EBAs last renewed three years ago at the start of the pandemic, and subsequent adoption and usage has been strong. Let me summarize some key factors we highlighted last quarter. First, foreign exchange movements will be a headwind to revenue growth and margins in fiscal '24. Revenue headwinds from Russia and FX peak in the first half of the year. Margin headwinds from FX will persist throughout the year. Second, switching from up-front to annual billings for most multi-year customers creates a significant headwind for free cash flow in fiscal '24 and a smaller headwind in fiscal '25. Given this transition started on March 28, this will become more apparent from the second quarter onward. Our expectations for the billings transition are unchanged. And third, it's possible that during the transition to multi-year contracts billed annually, some customers may choose annual contracts instead. We haven't seen much evidence of this in the limited time since the annual billings program started on March 28, but it's early days and we'll keep you updated as the year progresses. All else equal, if this were to occur, it would proportionately reduce the unbilled portion of our total remaining performance obligations and would negatively impact total RPO growth rates. Deferred revenue, billings, current remaining performance obligations, revenue, margins, and free cash flow would remain broadly unchanged in this scenario. Annual renewals create more opportunities for us to drive adoption and upsell, but are without the price lock embedded in multi-year contracts. We still expect our cash tax rate will return to a more normalized level of approximately 31% of GAAP profit before tax in fiscal '24, up from 25% in fiscal '23 for the reasons we outlined last quarter. As I mentioned earlier, a federal tax payment extension after the winter storms in California means cash tax payments will shift from the first half of the year to the third quarter, reducing third quarter free cash flow. The tax payment extension will change the first half/second half free cash flow linearity a little bit. But we still think we'll generate roughly half of our free cash flow in the second half of the year, with second half free cash flow generation significantly weighted to the fourth quarter. We still anticipate fiscal '24 to be the free cash flow trough during our transition from up-front to annual billings for multi-year contracts. Putting that all together, we still expect fiscal '24 revenue to be between $5.36 billion and $5.46 billion, up about 8% at the mid-point, or about 13% at constant exchange rates and excluding the impact from Russia. Normal seasonality, peak second quarter currency and Russia headwinds and, as I mentioned earlier, a strong second half pipeline of enterprise agreements last renewed three years ago in the immediate aftermath of the onset of the pandemic, mean we expect reported revenue growth to accelerate in the second half of the year. We expect non-GAAP operating margins to be similar to fiscal '23 levels with constant currency margin improvement offset by FX headwinds. As I said earlier, in a more challenging macroeconomic environment, we are being vigilant and proactive to sustain our margins. We expect free cash flow to be between $1.15 billion and $1.25 billion. The mid-point of that range, $1.2 billion, implies a 41% reduction in free cash flow compared to fiscal '23, primarily due to the shift to annual billings, a smaller multi-year cohort, FX, and our cash tax rate. The slide deck on our website has more details on modeling assumptions for Q2 and full year fiscal '24. We continue to manage our business using a rule-of-40 framework with a goal of reaching 45% or more over time. We think this balance between compounding growth and strong free cash flow margins, captured in the rule-of-40 framework, is the hallmark of the most valuable companies in the world. And we intend to remain one of them. As we said last quarter, the rate of improvement will obviously be somewhat determined by the macroeconomic backdrop. But, let me be clear, we're managing the business to this metric and feel it strikes the right balance between driving top-line growth and delivering on disciplined profit and cash flow growth. We intend to make meaningful steps over time toward achieving our 45% or more goal, regardless of the macroeconomic backdrop. Andrew, back to you."
},
{
"speaker": "Andrew Anagnost",
"content": "Thank you, Debbie. Let me finish by updating you on our progress in the first quarter. Our strategy is to transform the industries we serve with end-to-end, cloud-based solutions that drive efficiency and sustainability for our customers. We continue to see good growth in AEC, fueled by customers consolidating on our solutions to connect previously siloed workflows in the cloud. HNTB, an employee-owned infrastructure solutions firm that serves public and private owners and contractors, expanded its EBA with Autodesk to help achieve its goals around design modernization, digital transformation and digital infrastructure solutions. The ability provided by our EBA means that HNTB can easily consolidate more workflows to Autodesk. For example, in addition to adopting and integrating Autodesk Build and Innovyze, HNTB has been prototyping Autodesk's immersive collaboration platform. By leveraging VR collaboration, it has been able to help transportation agencies like Florida's Turnpike Enterprise use digital twins to train facility management and first responder teams on real-life scenarios from the safety of their offices instead of on busy interstate highways. HNTB sees the potential of further applications in its work on complex bridges and tunnels, as well as its work with airports and state departments of transportation across the country. In construction, we continue to benefit from our complete end-to-end solutions which encompass design, preconstruction and field execution, through handover and into operations. DPR is among the top 10 largest general contractors and construction management firms in the U.S. and specializes in technically complex and sustainable projects. In the first quarter, DPR expanded and extended its partnership with Autodesk and unified on Autodesk Construction Cloud, our construction platform that connects stakeholders throughout the project lifecycle. In moving away from point solutions and onto Autodesk's common data environment and cloud, DPR aims to connect all workflows, centralize communications, and improve project management and operations across the office and job site. We continue to see significant opportunities to grow our construction platform outside the U.S., benefiting from our strong international presence and reputation. In Singapore, Autodesk Build was selected over three competitive offerings as the construction management platform for what will be Singapore's tallest skyscraper. When awarding the contract to our partner, China Harbour, the project owners chose Autodesk Build because it connected the design and make processes in the cloud, centralized project schedules, and generated automated clash reports to reduce risk during construction. Of course, these stories have a common theme: managing across the project lifecycle to increase efficiency and sustainability, while decreasing risk. And this means our customers are renewing and expanding their relationships with us. Over time, we expect the majority of all projects to be managed this way and we're getting ready today to scale to serve that demand. Jim talked at our Investor Day about how product innovation, go-to-market expansion, and customer success are helping us get ready. In the first quarter, we took another important step by integrating our construction sales force into our worldwide sales team. While integrations of this scale inevitably cause some short-term disruption, combining the two teams will allow us to expand the scale and reach of our construction business, particularly in our design customer base, and our ability to serve our customers across the project lifecycle. Moving on to manufacturing, we made excellent progress on our strategic initiatives. Customers continue to invest in their digital transformations and consolidate on our Design and Make Platform to grow their business and make it more resilient. For example, Rittal is a leading manufacturer of electrical enclosure systems. It uses Inventor, Vault and Moldflow to optimize and manage its product manufacturing to produce thousands of customized and configured switch cabinets daily. Rittal is focused on maximizing internal automation to accelerate its speed to market and respond more nimbly to changes in demand. In Q1, it increased its EBA with Autodesk to include Fusion to serve as its central data management system, build a more resilient supply chain, and drive competitive advantage through quicker turnaround times. Using Fusion, Rittal will be able to automatically route online customer orders through to its engineers and integrated production line and make deliveries in as little as one or two days. In the U.K., a precision engineering firm was looking to update its CAM workflow to increase engineering efficiency and optimize costs. After a competitive evaluation, the customer migrated from its existing provider to Fusion with the Machining Extension because of Fusion's intuitive UI, cloud capabilities, and simple integrations with its existing software and machines. Realizing the opportunities to drive breakthrough efficiency by consolidating all workflows on a single Design and Make Platform, the customer is now also evaluating the migration of its CAD workflows from a competitor to Fusion. Fusion continues to grow strongly, ending the quarter with 231,000 subscribers, as more customers connect more workflows in the cloud to drive efficiency, sustainability and resilience. In partnership with higher education providers across the globe, we continue to invest in the workforce of the future. We recently partnered with the Tamil Nadu Skill Development Corporation and Anna University in India to integrate Fusion into its 20 mandatory product engineering courses and launched the Fusion Design Challenge to showcase the skills of 20,000 students. Fusion's intuitive UI and cloud-based data management make it easy for students to learn and collaborate on class projects. Autodesk is also investing in a new Technology Engagement Center at California State University, Northridge, that will promote interdisciplinary collaboration in engineering and computer academic programs and house the Global Hispanic Serving Institution Equity Innovation Hub, which aims to build a more diverse and inclusive engineering workforce. And finally, we continue to work with non-compliant users to ensure they are using the latest and most secure versions of our software. In the first quarter, we made substantial progress on two initiatives we outlined at Investor Day: further hardening our systems by significantly tightening concurrent usage of named user subscriptions, and significantly expanding the precision and reach of our in-project -- product messaging. We expect both initiatives to drive further conversion and growth in the second half of the year and beyond. Let me finish where I started. Autodesk remains relentlessly curious with a propensity and desire to evolve and innovate. With our AI infused industry clouds, Fusion, Forma, and Flow, scaled on Autodesk Platform Services, our customers will be able to leverage their large, domain specific, inter- and intra-industry data sets to deliver further breakthrough productivity, operations, and sustainability gains. And with intuitive UIs and the application of multi-modal AI models that move beyond language models to capture sketches and reality directly into accurate 3D models, we will be able to accelerate the transition from products to capabilities that I talked about at our recent Investor Day. Our transformation from products to capabilities will enable us to forge broader, trusted and more durable partnerships with more customers; give Autodesk a longer runway of growth and free cash flow generation; and enable a better world designed and built for all. Operator, we would now like to open the call up for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Saket Kalia of Barclays. Your question please, Saket."
},
{
"speaker": "Saket Kalia",
"content": "Okay. Great. Hey, Andrew. Hey, Debbie. How you doing? Thanks for taking my questions here. Andrew, maybe just for you. Appreciate the macro commentary, very helpful. I think we all try to speak to at least a subset of your partners through the quarter. And frankly, through the quarter, some of those checks, albeit limited, were mixed or soft, right, of course, reflecting the macro. Maybe the question that I have for you is, I was wondering if you saw that as well. And if you did, whether some of those trends have maybe continued here through the second quarter?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes, Saket. Good to see you by the way. Good to talk to you. So, yes, let me tell you what we saw and consistent with what people heard from the partners. So, whenever we have a large event like ending multi-year, what happens is partners and teams tend to pack up deals into that event, they even pull pipeline forward to try to get it into the event, so that they can kind of close their deal, get things trued up around the event. This happens every time consistently when we have event like this. It's one of the reasons why we try to align these events with quarter-end, so we don't have conversations like this. So, if that was the case, what you would have expected is that business would rebound to kind of expected levels post the end of the quarter, which is exactly what happened. It's exactly what we're seeing at the beginning of the quarter [indiscernible] and we're back to what we would expect to be [indiscernible]. Debbie, you want to add anything about the macro environment that we haven't said already or anything -- any commentary that might help understand how the quarter progressed?"
},
{
"speaker": "Debbie Clifford",
"content": "Sure. So, overall, our leading indicators remain broadly the same as what we saw last quarter. We saw usage grow modestly. We saw record bid activity on BuildingConnected. We continue to see cautious optimism from our channel partners. New subscriber growth decelerated a bit quarter-over-quarter, but renewal rates improved. Also like last quarter, Europe was a bit better, the U.S. was a bit worse, Asia was about the same. So, net-net, the overall momentum of the business was somewhat similar to what we saw last quarter with some puts and takes. It's all in line with the guidance expectations for the year and it's consistent with macro trends. Current RPO growth is a good forward indicator for you. It was the same as last quarter at 12% growth. And as we've said before, the business is going to grow faster in better environments and slower in more uncertain environments, but our goal continues to be to set ourselves up for success in fiscal '24 and beyond."
},
{
"speaker": "Saket Kalia",
"content": "Got it. That's really helpful, Debbie. Debbie, maybe for my follow-up for you. Great to see the cash flow strength this quarter, well ahead of what we were expecting. I was just wondering if you could just zoom into what drove that. And maybe just looking forward, how you're sort of thinking about the shape of cash flow this year, particularly where we trough here in fiscal '24? Does that make sense?"
},
{
"speaker": "Debbie Clifford",
"content": "Yes. So, Q1 free cash flow was strong for a couple of reasons. First, cash collections from the last month of billings in fiscal '23 were strong. Second, we also saw favorable linearity and early renewals in Q1 that were driven by the end of multi-year build upfront. And then, third, as I mentioned on the call, after the winter storms in California, we received a federal tax payment extension for the third quarter. Our overall expectations for free cash flow on the year, including linearity, are unchanged. We still expect that we're going to generate about half of our free cash flow in the second half of the year, with heavier weighting to Q4. Some of the factors to think about across Q2, Q3 and Q4, we have the full quarter impact from the switch to annual billings. In Q2, remember that we had some early renewal billings that were pulled into Q1. And then with that tax payment extension to Q3, that has a positive impact to free cash flow in Q1 and Q2, but a negative offset in Q3. But overall, I just would reiterate that our expectations are unchanged and that we expect to generate about half of that free cash flow in the second half of the year."
},
{
"speaker": "Saket Kalia",
"content": "Got it. Very helpful, guys. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Your question please, Jay."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Thank you. Good evening. Andrew, you referenced the effect on channel behavior in the quarter as a result of the billing change. But more broadly, there are some other evolutions that your sales model is going through affecting not just the VARs but also the VADs. And I'm wondering how you're thinking about the operational or execution risks associated with that evolution which certainly goes beyond Q1 in terms of perhaps either demand generation, fulfillment of which you'll be doing more of on your own, perhaps the elements of channel comp as they change with the back end change. So maybe just let's talk about some of those ongoing executables that you need to get right vis-à-vis the sales model. Then, I'll ask my follow-up."
},
{
"speaker": "Andrew Anagnost",
"content": "Yes, Jay, that's a great question. So, one of the things that I'll say like first upfront is why are we exploring some of these things. And it's a great example of what we're doing with Flex in particular. We're doing these things because our customers get a much more instant on self-service like experience kind of more like an e-store experience from all their transactions. But they also get the added bonus of support that local and connected to them through their VARs. They get service and other types of supports from their VARs locally. It also allows us to really get a lot of visibility about what their usage patterns are, how they're using the product, and then also share that visibility with our partners and other people so that we can understand these customers better. So, there's lots of great things about it. But more importantly, rolling out kind of changes like that and exploring these kinds of new models and something like Flex, which is a lower volume offering right now, those doing quite well, gives us a lot of opportunity to learn a lot of things and work through a lot of things. Debbie, why don't you talk specifically about some of the things that we've been learning from Flex as we've been working through all of these new transaction models."
},
{
"speaker": "Debbie Clifford",
"content": "Sure. Yes. So, as Andrew mentioned, we launched this Flex agency model in Q1. We have learned a lot. Some of the things that we've been learning are things like the importance of driving a seamless vendor setup process. These are situations where customers will have to set up Autodesk as a vendor as opposed to a partner. We're getting insights and learnings around -- by having access to more data, and we're able to better forecast with having that access to better data. So, like Andrew mentioned, as with anything in this area, we're focused on testing and learning as we go. We want to make sure that we have scalable processes for all stakeholders and the ecosystem, and we'll continue to keep doing that."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Okay. As follow-up, Debbie, at the meeting two months ago in your slide with regard to double-digit growth or what you called sustainable double-digit growth, you had eight different line items referring to volume as component of your growth. When you look out over the balance of the year, what do you think might be of those perhaps the two or three most important volume drivers to the business?"
},
{
"speaker": "Debbie Clifford",
"content": "That's an excellent question, Jay. I mean, the view that I talked about from Investor Day hasn't changed much, granted our Investor Day wasn't very long ago, so that's a good thing. But we're going to be looking to continue to drive volume from all the different areas or growth vectors that we have. So, things like our investments in AEC, the proliferation of BIM, expansion and infrastructure, driving more growth from construction. I think what was interesting for us this quarter was really seeing continued strengthening of our renewal rate, because, ultimately, with higher renewal rates, that becomes a net volume driver for us. And that really goes down to the investments that we've been making in our customer success teams, who are really doing an excellent job of driving those renewal rates up, driving success with our customers, because that's a really important part of keeping the volume engine going at Autodesk. So, those are some initial thoughts, Jay."
},
{
"speaker": "Jay Vleeschhouwer",
"content": "Okay. Great. Thank you, both."
},
{
"speaker": "Andrew Anagnost",
"content": "Thank you, Jay."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Adam Borg of Stifel. Your line is open, Adam."
},
{
"speaker": "Adam Borg",
"content": "Great, and thanks so much for taking the questions. Maybe for you, Andrew, I know at Analyst Day, you talked a lot about the broadening opportunity around serving the owner market and not just in conceptual design, but during operations. So, I know it's still early in this journey. Maybe you could share with us how that message is resonating and as you look to expand into AEC and obviously [indiscernible]?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So the way -- the vector that we have into that space right now is through Tandem. And the best way to talk about that is the increase in people using more modeling assets in Tandem and the monthly active usage rates that are going associated with that, we're starting to see very nice pickup with that. We're engaging with a series of owner-level customers on direct collaborations in terms of how Tandem serves some of their needs, where it has development requirements to serve some additional needs. So, we've got a lot of really good customer engagement, which is definitely where you'd expect to be at this point in the process. So, we're really happy with the progress here and we're happy with the level of engaging with Tandem. Tandem is getting a lot of visibility, a lot of interest and a lot of focus with owners, but also with people that serve owners that want digital twins and things associated with digital twins from, say, other types of vendors."
},
{
"speaker": "Adam Borg",
"content": "That's really helpful. Thanks for that. And maybe, Debbie, as a quick follow-up. I think you've mentioned in the script about repurposing 250 roles in the quarter. Maybe you can provide a little bit more detail there? Thanks, again."
},
{
"speaker": "Debbie Clifford",
"content": "Sure. So, uncertainty really just is the new normal. I think we're all living this. Since we last reported earnings, we've seen a bunch of stuff happen. There was a major regional bank crisis. We're seeing deadlock discussions about the debt ceiling in Congress. The Fed, just a few weeks ago, acknowledged that those things could have an impact on the economy, but so they didn't know how. We're in the same boat. But it's very important to us to deliver on our margin goal. So, it's against that backdrop that we're taking a prudent approach to how we manage the business, that means tightening the belt a bit. So, in Q1, we did some repurposing of roles to allow us to reinvest. And in Q2 and onward, we proactively taken steps to slow the pace of our hiring to ensure that we don't get ahead of ourselves on spend in light of this continued macro uncertainty. And we think that slowing spending earlier in the year provides more investment flexibility versus trying to slow spending later in the year. Again, our goal continues to be to set ourselves up for success since fiscal '24 and the long term."
},
{
"speaker": "Adam Borg",
"content": "Excellent. Thanks again."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Joe Vruwink of Baird. Your question please, Joe."
},
{
"speaker": "Joe Vruwink",
"content": "Great. Hi, everyone. Maybe just a bit of clarification on near-term performance and reconciling, just the comment. I think, leading indicators around product usage, that's fairly consistent. But then, the new sub growth decelerating in the Americas. I guess, normally, I think the leading indicators kind of predict that. So was this something around new subs that just kind of popped up in the quarter?"
},
{
"speaker": "Andrew Anagnost",
"content": "No, it was consistent with what we were seeing in our monthly active user trends. That's how the monthly active user trends are so good at predictive behavior. We kind of expected a slight decrease in velocity in the Americas and more of an increase in Europe. So, it's consistent with the indicators we see and it's consistent with the indicators moving forward as well."
},
{
"speaker": "Joe Vruwink",
"content": "Okay. Great. Thanks for that. And then, just, I guess, I get the AI question. Just in terms of capabilities that already exist on the platform, thinking about things like Space Maker or the Generative Extension on Fusion, have you started to see kind of an uplift in interest just as more industries are studying adoption around AI? And is there anything you've seen to this point maybe specifically around video, media content where you start thinking about maybe changing product road maps, or all just based on kind of the pace of innovation that's coming out?"
},
{
"speaker": "Andrew Anagnost",
"content": "So, yes, first let's be very clear. We've been talking about AI for a long time, all right? And we've been building machine learning models into our application for a while now. So, there's already significant velocity inside of Autodesk conversations. What's changed is ChatGPT created a version of AI that everybody understood. So, we're all now having a common conversation about what AI can and cannot do and how it functions as a [indiscernible] or an assistant or a co-creator in these processes. So, make no bones about it, we've been working on these things for a while. This isn't a course and speed change for us. And I want to be super clear about that. Now, like I said, we've been in Construction IQ. Space Maker is no longer a product anymore, it's Forma now, which we rolled out, which even has more enhanced underpinnings or associated with machine learning. You probably -- if you follow what we do in our AI Lab, we published a lot of work on kind of fairly advanced things around large models and things that you can do with creating 3D models and representations using machine learning. So, we've been out there with this for a while. What it does allow us to do, it had a very meaningful customers about -- conversation with our customers about \"Look, we've been telling you that this was going to be a cocreation technology. Take a look at what you're seeing out there with the large language models and the things that you're getting from OpenAI and see how this kind of can be evolved to creating 3D building information models, more complex models, complex design, sustainability decisions, optionality, all the things associated in some of the things you're seeing inside of Forma.\" So, the customers now get it. They kind of get the connection between what we're doing and what we said it was going to do in the future, because there's an example here that everybody understands. And I think that's super powerful. So, it's current course and speed for us. We're going to be probably speeding up a little bit on some of our work with more larger and complex models, but this is something we've been doing for a while."
},
{
"speaker": "Joe Vruwink",
"content": "Okay. Thank you, Andrew."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Michael Funk of Bank of America. Your line is open, Michael."
},
{
"speaker": "Michael Funk",
"content": "Yes, thank you for the questions. So, Debbie, you mentioned you highlighted the slowing sub growth and usage has been strong. Can you help me understand the relationship if any between those two? And is the sub growth simply a factor of customers tightening their belts more due to the uncertain macro that you highlighted a few times, or is there some other -- something else behind that?"
},
{
"speaker": "Debbie Clifford",
"content": "Yes, thanks. So, the biggest factor driving the sub growth that we saw in Q1 was actually the end of sale of the multi-year upfront contracts. So, Andrew mentioned it at the top of this Q&A session, but remember that the demand pattern that we saw during the quarter was impacted by that end of sale. Before the launch, we saw higher volume. And then, post launch, demand was lighter. That's typical of what we see when we launch programs like this to the market. But what it meant was that, on a net basis, the new piece of our business decelerated as we headed out of the quarter. So, Andrew also mentioned that over the last several weeks in May, we've seen that demand bounce back a bit. And it's generally in line with our expectations at this point."
},
{
"speaker": "Michael Funk",
"content": "Okay. Great. And then one more. Debbie, you also mentioned tailwind in second half, one being the EBA renewal pattern, adoption and usage has been strong there, I think you noted. Can you give us some more detail just on the moving pieces around the EBA renewals? Is it contract changes, pricing changes, what will be driving that tailwind in the second half of the year around the renewals?"
},
{
"speaker": "Debbie Clifford",
"content": "Sure. So, maybe I'll just take a step back and talk about revenue linearity overall and then double click a bit into EBAs. So, to recap, we're expecting revenue growth deceleration in Q2, followed by growth acceleration in the back half of the year that's consistent with historical seasonal patterns for Autodesk. And it was built into our annual guidance from the start. When we look at things by quarter, in Q2, we have the peak of FX and Russia and their drag on revenue growth. In the second half, the negative impact from exiting Russia goes away, and that drag from FX reduces as the year progresses. And then, we have that big cohort of EBAs, particularly in Q4, those are deals that renewed three years ago, at the beginning of the pandemic, where subsequent adoption and usage have been strong. And it's that deal flow that drives that seasonal growth acceleration primarily in Q4. We thought -- you can go back and look at our opening commentary back in fiscal '21 for Q4 where we talked a bit about those deals they tended to be in the auto space. And so, we're anticipating that those deals will come through and we think the fact that they've had good adoption and usage is a good indicator that we're going to see that behavior happen in Q4 as expected. So, overall, I mean, our business, the momentum is pretty consistent with what we've seen for a while here now and the assumptions that we have embedded in our guidance reflect, but we've been seeing for a while and we remain on track to achieve our full year financial goals. And I can't reiterate enough that we continue to try and set ourselves up for success in fiscal '24 and beyond."
},
{
"speaker": "Michael Funk",
"content": "Great. Thank you for the questions."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Matt Hedberg of RBC. Your line is open, Matt."
},
{
"speaker": "Matt Hedberg",
"content": "Great. Thanks for taking my questions, guys. Andrew, in your prepared remarks, you talked a lot about AEC and obviously construction. This is an area obviously as we all know that's been sort of laggard to adopt SaaS and cloud. Can you talk about sort of where we're at in this evolution? The pandemic is behind us now, I think. But like, are you starting to see some of these field workers, some of the folks that are sort of like behind the scenes on construction starting to sort of embrace the technology more so? Is it a generational thing? Just any sort of like incremental sort of catalyst for further construction cloud adoption?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes, it's a good question the way you phrased that around incremental catalysts. I think actually the rising adoption is becoming its own catalysts in many respect. I mean, obviously, we're continuing to see good growth in construction. We're seeing solid adoption. We're seeing really significant adoption in our EBA account. And adoption tends to lead to more adoption, because the people who adopt these technologies and start using these technologies on a regular basis tend to have higher bid precision, higher bid accuracy, tend to be able to execute more effectively during the projects, manage cost better and all things associated with that. And that's a flywheel effect, because if you're better able to manage the cost of the project, you're better able to estimate the next project, bid on that project and win an envelope that preserves your margins. So that is kind of the biggest thing that's going on right now out there in the industry is the flywheel effect. There's no kind of generational catalyst that's yet coming in here. But I will tell you there's one other thing that's persistently out there that's driving people to look towards technology, and it's they can't hire people, all right? More and more, they are not able to fully staff their sites and their jobs to the level that they were in the past. So, they need these productivity gains from technology. And it's between that and the flywheel of competition, there's kind of a momentum here that I don't see slowing down."
},
{
"speaker": "Matt Hedberg",
"content": "Super insightful. No, that's great. Thanks again for the time tonight, guys."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Tyler Radke of Citi. Please go ahead, Tyler."
},
{
"speaker": "Tyler Radke",
"content": "Yes, thanks for taking the question. So, just a couple of questions on the indicators that you saw in the quarter. Andrew, you talked about bid activity at record levels in BuildingConnected. I guess, should we be thinking about that as a sign of health in the end markets or more of a function of buildings connected, strong competitive position and digitization tailwinds? And then, just curious if you could talk about the slowdown in new subscriptions or deceleration that you saw. Was that more on the AEC side or any end market or where -- the segment where you saw that?"
},
{
"speaker": "Andrew Anagnost",
"content": "Okay. So, let me address the next part of the question. Kind of the answer to your BuildingConnected question kind of both, all right? BuildingConnected certainly active. There's lots of activity going on there. But remember, it's the trend that matters. So, if the trends continue to indicate a large degree of bid activity, that means there's a large degree of bid activity out in the ecosystem. And what also is important to recognize is, our customers and especially in the AEC land, they're still working through backlogs. I mean, every customer I talk to has the same issue or same opportunity, however you want to look at it, that they still have to work through their backlog, they're still having trouble getting enough people to get the projects moving at the right kind of pace and so on and so forth. So there's still a backlog out there. But the trend on bid activity is real and it absolutely represents what's going on in the U.S. market in particular. Now with regards to deceleration and rebound in Q2 around volume, there was no hotspot, right? It was kind of uniformly the same across the board, right? So, it was more kind of dynamics of the business rather than any kind of particular hotspot."
},
{
"speaker": "Tyler Radke",
"content": "Great. And then, just on the EBA renewals for the second half, are you expecting those to renew at kind of the typical net expansion rate that you see for the broader company? Or are you expecting anything different just given the environment?"
},
{
"speaker": "Andrew Anagnost",
"content": "Well, I mean, I'll let Debbie follow-up on this. But one of the things that she highlighted was that a lot of these EBAs that are coming due were ones that were renewed during the pandemic at a time where there was downward pressure on their activity and their usage and [indiscernible], things have obviously changed significantly since then. So, Debbie, do you want to comment on kind of the average relative difference within -- with these cohort versus [direct to] (ph) company?"
},
{
"speaker": "Debbie Clifford",
"content": "Yes, I mean, I would say that in terms of what we're baking into our guidance, we're assuming that these customers renew at reasonable levels. I'm not going to get into more specifics beyond that. What's key is that they renew and we feel good about that happening given the fact that there has been high adoption and usage across these EBAs. It's a big cohort for us. We saw that performance back in fiscal '21. It was also an equally unusual economic time at that point. And so, I don't see this situation as any different. I think we've set the guidance at a reasonable point."
},
{
"speaker": "Tyler Radke",
"content": "All right. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Bhavin Shah of Deutsche Bank. Your question please, Bhavin."
},
{
"speaker": "Bhavin Shah",
"content": "Great. Thanks for taking my question. Andrew, just given what's going on with the debt ceiling, any sort of impact that we should think about regarding federal deals and the pace of that business? And then, kind of related point, can you give us an update on where we are into the FedRAMP Moderate for Docs and BIM 360, Collaborate Pro?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So let me talk a little bit about [FedRAMP] (ph) here. So we've submitted all our paperwork. Our systems are ready. Autodesk systems are already for FedRAMP. We're just waiting for the government to come back and give us the approval and move forward. So, that's all proceeding ahead for us. We're waiting for the government to respond now at this point. With regards to the debt ceiling, I'm not really going to speculate on the debt ceiling. I would say that I think the things that impact us are bipartisan priorities. These are things that both parties want. Infrastructure and the things associated with that, they all want this. So, I would suspect the things that matter a lot to Autodesk and to Autodesk business are probably not going to be impacted by all the activity going on in D.C. right now."
},
{
"speaker": "Bhavin Shah",
"content": "Helpful there. And then just maybe a quick pivot to Construction Cloud. I know you talked a little bit about combining sales [within organization] (ph). Can you just maybe elaborate on some of the assumptions in terms of what you're expecting in terms of disruption, for how long? And then maybe when should that [be merged] (ph) and drive better performance in productivity?"
},
{
"speaker": "Andrew Anagnost",
"content": "Yes. So, first, let me kind of clarify exactly what we did. So, we merged the independent construction team with the mainline sales team inside the company. And we had kind of a few goals in mind there. One, we wanted to get a little bit more emphasis on the territory business that covers all of our business. And we wanted to make sure that we were focused not only on pure construction accounts, but design and construction accounts where we actually have pretty significant competitive advantage and there's a lot of opportunity. So this just kind of sharpened the pencil on kind of pursuing those opportunities in kind of a concerted way and kind of getting all the energy behind one effort. And we're pretty confident that, that's exactly what we're going to get. But of course, when you do that, sales reps get new accounts, people get moved from accounts, so they'll get new responsibilities. So it creates a little bit of short-term disruption. We absolutely expect that to work its way out over the next quarter or two. And we expect it to kind of compound benefits from doing us moving forward."
},
{
"speaker": "Bhavin Shah",
"content": "Makes a great sense. Thanks for taking my questions."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Steve Tusa of JPMorgan. Your question please, Steve."
},
{
"speaker": "Steve Tusa",
"content": "Hey, guys. Good evening. The -- just if we were to see a continued decline in the things like the ABI or kind of an isolated decline in new office markets, if you will, can you just remind us of, is that even a big enough exposure to matter for you guys? Or just kind of remind us what part of your business is exposed to those trends just on the macro. And then secondly, if I just do the simple math on half-over-half free cash flow, that implies negative free cash flow for the second quarter to get it back to the half of the year. Is that kind of the right construct? Thanks."
},
{
"speaker": "Andrew Anagnost",
"content": "I'll let Debbie answer the second half of that, but let me talk more broadly about what's going on in the AEC sector. With everything in these sectors, there's always puts and takes, right? And what you see is one sector sees some kind of decline in activity, nobody is building new office buildings or whatever. And in other cases, some people are seeing increases in activity. And that's exactly what we're seeing. I'll give you a classic example of what goes on in this environment. So, people are pulling back from office space right now, pretty significantly downsizing their offices. And as a result, what's happening is that there's more competition for getting people to sign leases for new office space. So what that's leading to is a kind of modernization of office space to accommodate new ways of working or to attract the best renters. And people are spending money on that, which is offsetting money being spent in other places. And we've taken all of this into account as we look forward into our business throughout the year. So that kind of gives you a sense for how billings shift around and how money moves around and what our relative sensitivity as to some of these things. A lot of these indicators you talked about, they kind of tell you what's already happened, not what's going to happen necessarily. That's why we like to pay attention to kind of our leading indicators around monthly active usage of the products. Now, I'll turn it over to Debbie to discuss the other part of your question."
},
{
"speaker": "Debbie Clifford",
"content": "Yes, in terms of free cash flow, I'm not going to get into specific guidance by quarter, but I would say directionally, I think you're thinking about it in a reasonable way. And just to recap some of the things, remember, with the tax payment extension to Q3, we'll have a negative also in Q3. And some of the things that I outlined in terms of the linearity of free cash flow on the year are the things that you should be thinking about. So, I recommend going back and listening to some of those points because that will help you model free cash flow by quarter."
},
{
"speaker": "Steve Tusa",
"content": "Yes, great. Thanks for the details. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from the line of Sterling Auty of MoffettNathanson. Your question please, Sterling."
},
{
"speaker": "Sterling Auty",
"content": "Yes, thanks. Hi, guys. So, just wondering, given the comments about the second half acceleration, does that mean that you're expecting the peak of the macro impact to really hit next quarter? Or is some of that acceleration more just due to improvement in Autodesk execution based on some of the changes that you had mentioned during the prepared remarks?"
},
{
"speaker": "Debbie Clifford",
"content": "So, Sterling, what I would say is we're not assuming any peak or trough in macro. We have a range for our guidance in our 7% to 9% range for revenue. We have the ability to address whatever macroeconomic situation that we see. And what we saw in Q1 was consistent with our general expectations on the year, and we've continued those expectations as we think about our outlook for the rest of the year. And you can see that our outlook is in line. What's really driving the change in linearity in our revenue growth is some of the things that I talked about, so seasonality, the acceleration that we expect from EBAs in the back half of the year, the impact from FX, and not having the drag from the exit of Russia anymore. So it's more about those things than it is about any fundamental underlying changes in our assumptions related to macro."
},
{
"speaker": "Sterling Auty",
"content": "That makes sense. And then Andrew, one for you. When you think about the long-term opportunity for generative AI, LLMs, conversational interfaces, et cetera. Do you view this as something that's going to ultimately raise the ARPU and/or prices for Autodesk solutions, given the additional value add? Or is it going to be more differentiation at the current price levels just so you can drive more market share?"
},
{
"speaker": "Andrew Anagnost",
"content": "I think it's going to be a little bit of both, all right? In some cases, we're going to be delivering significantly more value to certain types of customers and we expect to charge for that value. In other cases, it's going to be a massive productivity enhancement for customers, and those customers are going to use that productivity to get more business, increase their book of business and it will be a competitive advantage for Autodesk. So it's a little bit of a mix of both, all right? But either way, we're going to be helping customers be a lot more efficient in one area and be much more creative in other areas in terms of designing what they need to do and how they need to design things."
},
{
"speaker": "Sterling Auty",
"content": "Got it. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And that is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks. Sir?"
},
{
"speaker": "Simon Mays-Smith",
"content": "Thank you, Latif, and thanks, everyone, for joining us on the call. We look forward to catching up with you next quarter. If you have any questions, please just e-mail us on [email protected]. Latif, back to you."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. Thank you for participating. You may now disconnect."
}
] |
aee | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Greetings and welcome to Ameren Corporation Fourth Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Senior Director, Investor Relations and Corporate Modeling for Ameren Corporation. Thank you, Mr. Kirk, you may begin."
},
{
"speaker": "Andrew Kirk",
"content": "Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now here's Marty."
},
{
"speaker": "Martin Lyons",
"content": "Thanks, Andrew. Good morning, everyone, and thank you for joining us. This morning, we will discuss 2024 financial results, recap events and accomplishments and look ahead to 2025 and beyond. What you'll hear is that the Ameren team's collective efforts produced strong results operationally and financially in 2024. And just as important, the team accomplished strategic goals that position our company to provide higher levels of satisfaction for our customers and strong returns for our shareholders in the years ahead. In 2025, we are again set up to deliver strong results, but also to take meaningful steps towards enabling our communities to benefit from significant economic development opportunities. Those opportunities offer direct investment in our states, bringing jobs and incremental tax revenue. And for Ameren, as we discuss our plans today, it means sales growth and the need to accelerate capital investments to meet the energy needs driven by that industrial demand. Starting on Page 4. We continue to be guided by our Three Pillar strategy. To invest in rate-regulated infrastructure, to enhance regulatory frameworks and advocate for responsible energy policy and optimize our operating performance. This strategy has served us well for the last decade and we will remain focused on solid execution year in and year out to maximize value for our customers, communities and shareholders. With that, let me summarize our 2024 performance on Page 5. I'm pleased to say that we accomplished all our key business objectives outlined at this time last year and on this page. Importantly, we strategically invested approximately $4.3 billion in energy infrastructure, secured timely regulatory approvals for future investment and prudently managed our operating costs while delivering reliable energy service. And yesterday, we announced 2024 adjusted earnings of $4.63 per share compared to earnings of $4.38 per share in 2023. This result was above our 2024 adjusted earnings guidance midpoint. Turning to Page 6, which highlights the benefits of the investments we are making for our customers. The successful execution of our strategy continues to drive improved reliability and strong customer service while keeping customer rates low in comparison to the national and Midwest averages. Further, our ongoing infrastructure investments improved grid resilience as demonstrated by the performance of our system during severe winter storms in early January of this year. Despite challenging conditions, our grid improvements prevented over 3.5 million minutes of potential outage time across our service territories in Missouri and Illinois. Importantly, we had no issues on the more than 250 miles of power lines that have already been updated through Ameren Missouri's Smart Energy Plan. On Page 7, we summarize our strong performance for shareholders over time. Our goal, like we said in the past, is to deliver at the midpoint or higher within our earnings guidance range. Our weather-normalized adjusted earnings per share have risen at an approximate 7.6% compound annual growth rate since 2013, while our annual dividends paid per share have increased approximately 68%. This has driven a strong total return of nearly 250% for our shareholders over the same period, which was significantly above utility index averages. Moving to Page 8. As we look to the opportunities ahead, in 2025, our focus will be on continuing to provide safe, reliable service to our customers at competitive rates while bringing additional growth opportunities to our states. We'll do this, first and foremost, by investing approximately $4.2 billion in electric, natural gas and transmission infrastructure to bolster the safety, security, reliability and responsiveness of the energy grid. Further, we're focused on enhancing our generation plans to meet customers' needs, achieving constructive regulatory outcomes and advocating for policies that enhance reliability and resource adequacy as well as attracting new businesses to our communities. As always, while we work to accomplish these objectives, we will remain focused on operating as efficiently and effectively as possible. Moving to Page 9 for an update on our long-term growth outlook. We continue to extract 2025 earnings to be in a range of $4.85 per share to $5.05 per share. The midpoint of this range represents approximately 7% earnings per share growth compared to our adjusted 2024 earnings results. Building on the execution of our strategy and track record of strong earnings growth, we expect to deliver 6% to 8% compound annual earnings per share growth from 2025 through 2029, using the midpoint of our 2025 guidance of $4.95 per share as the base. We're excited about the robust sales growth and energy infrastructure investment opportunities in front of us, which strengthen our confidence in our ability to deliver strong long-term earnings growth. I'll speak more about those things in a moment. In addition to growing earnings per share, last week, Ameren's Board of Directors approved a quarterly dividend increase of approximately 6%, resulting in an annualized dividend rate of $2.84 per share. This represents our 12th consecutive year of increasing our dividend, which reflects continued confidence by Ameren's Board of Directors in our business outlook and management's ability to execute our strategy. Looking ahead, we expect to grow our dividend in line with our long-term earnings per share growth expectations and for our dividend payout ratio to range from 55% to 65% of earnings per share. Combined, these elements support our strong total shareholder return proposition. Turning to Page 10 for more on the foundation of our earnings outlook. Our strong long-term earnings growth expectation is driven by robust rate base growth, reflecting investment in energy infrastructure, included in Ameren Missouri's Smart Energy Plan, which incorporates its Preferred Resource Plan, Ameren Illinois's Multi-Year Rate Plan and projects awarded to Ameren in MISO's long-range transmission planning. Today, we are rolling forward our five-year investment plan. And as you can see, we expect to grow our rate base at a 9.2% compound annual rate from 2024 through 2029. This robust rate base growth is driven by a 20% increase in our five-year capital plan compared to the previous capital plan laid out last February, primarily reflecting accelerated generation needed to serve our updated sales growth expectations. Now turning to Page 11 for more detail on the growth opportunities in Missouri driving the significant increase in our capital plan. We expect tremendous opportunities for economic growth over the next five to seven years. Our region's economy spans multiple sectors from aviation, biotechnology, chemicals, financial services, beverage and food manufacturing, life and plant sciences to health care and logistics and a variety of other manufacturing concerns. And increasingly, it is an attractive location for data centers. Based on our robust economic development pipeline, we are now expecting our weather-normalized retail sales to increase approximately 5.5% compounded annually from 2025 through 2029, compared to our prior plan expectations of flat to up 0.5%. This sales growth expectation is consistent with the notice we filed with the Missouri Public Service Commission of our intention to update our Preferred Resource Plan. That plan assumes approximately 500 megawatts of load growth by the end of 2027, a total of 1 gigawatt by the end of 2029 and 1.5 gigawatts by the end of 2032. Since our third quarter earnings call, we have signed additional construction agreements with data center developers for 1.5 gigawatts of new load to be interconnected to our transmission system, bringing our total to approximately 1.8 gigawatts. These construction agreements are subject to acceptance of a modified industrial tariff under which new customers would receive energy service. Earlier this week, we submitted the necessary transmission load request related to these agreements to MISO for expedited project review and expect approval in April. Further, we are actively working to propose a modified tariff for large industrial customers, including data center customers, and we expect to file for approval of the tariff with the Missouri Public Service Commission by the second quarter. While there's no deadline for commission approval, we are optimistic we'd receive a decision and that the tariff would be in effect before the end of the year. We remain aligned with key stakeholders across the state in our efforts to attract new businesses to the region. Our economic development pipeline beyond our current construction agreements remains robust and we will continue to pursue each opportunity vigorously to maximize value for our customers and communities. As the green shading on our slide indicates, a range of sales growth outcomes could ultimately occur. But based on our planned generation resource build out, we expect to have the capacity to serve 2 gigawatts of new demand by 2032 and even more thereafter. Moving then to Page 12 for an update on Missouri's generation plans. Considering the significant sales growth potential, the lead time needed to construct new generation and other key considerations, Ameren Missouri notified the Missouri PSC that we are changing the Preferred Resource Plan in our September 2023 IRP, which lays out generation, our generation plan for the next 20 years. As mentioned, our new preferred plan is designed to serve 1.5 gigawatts of additional demand by 2032. And as I mentioned, it provides for a range of outcomes. The key objectives of our resource planning remain the same. A balanced mix of resources to provide reliable, lowest cost and cleaner energy for our customers. Our preferred plan calls for acceleration and expansion of natural gas generation and battery storage, acceleration of solar generation investment, potential extension of the life of our Sioux Energy Center by up to three years and investment in additional nuclear generation by 2040. In total, the change in preferred plan represents the addition of 2.3 gigawatts of generation capacity by 2035 and when factoring in updated costs for all planned resources, represents approximately $7 billion of increased investment by 2035 compared to the 2023 IRP. Our execution of this investment plan will lay the foundation for reliable economic expansion in Missouri. For further details on the differences between the Preferred Resource Plan from the 2023 IRP and new 2025 Preferred Resource Plan, see Page 31 of this presentation. Turning to Page 13 for an update on the new generation recently placed in service or under development. This past year was just a start to the robust generation portfolio additions. Three new solar facilities totaling 500 megawatts and representing approximately $1 billion of investment were placed in service during the fourth quarter of 2024 as planned. Combined, the three facilities are expected to generate energy sufficient to power 92,000 homes annually and we continue to execute our IRP. We have another 1,200 megawatts of approved generation currently under construction. And we expect to file a request with the Missouri PSC for approval of additional generation and battery energy storage in the coming months. Moving now to Page 14 for a transmission update. In December, MISO approved a nearly $22 billion Tranche 2.1 portfolio, which is expected to provide significant reliability and capacity benefits for the region. MISO has already selected Ameren to lead $1.3 billion worth of these critical grid infrastructure projects in Missouri and Illinois. The portfolio also includes $6.5 billion of projects, which will be open for competitive bid, of which approximately $1.8 billion are in Illinois. We believe we are well positioned to compete for all these opportunities as we have a strong track record of developing and operating cost effective and high-quality transmission infrastructure. MISO and its transmission owners will continue to assess the current long-range transmission future scenarios to support our region's energy needs in the years ahead. This analysis is expected to be followed by development of the Tranche 2.2 project portfolio. Moving to Page 15 for a legislative update. In January, the Missouri legislative session began. Several bills are currently under consideration, including the Power Predictability and Reliability Act, the Missouri First Transmission Act, proposed modifications to integrated resource planning and the opportunity for future test year regulatory frameworks for natural gas and water utilities. While these bills are at various stages in the legislative process, they collectively demonstrate Missouri's commitment to enabling a reliable and efficient energy future and supporting economic growth and job creation within our communities. Ameren will remain actively engaged with policymakers and key stakeholders in the months ahead to advocate for constructive energy policy. Turning to Page 16 for an update on our 10-year investment pipeline. Looking ahead, we have a robust pipeline of investment opportunities of over $63 billion that will deliver significant value to all of our stakeholders by making our energy grid more reliable, stronger and smarter. In addition, these investments will support many thousands of jobs within our local economies. Of course, constructive energy policies that support robust investment in energy infrastructure will be critical to meeting our region's energy needs and delivering on our customers' expectations. Turning now to Page 17, to sum up our value proposition. We remain convinced that the execution of our strategy in 2025 and beyond will continue to deliver superior value to our customers and shareholders. Our earnings growth expectations are driven by strong compound annual rate base growth of 9.2% and strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. Investment in Ameren presents an attractive opportunity for those seeking a high-quality utility growth story. Combined, our strong long-term 6% to 8% earnings growth plan and an attractive and growing dividend result in a compelling total return story. Further, we have a strong track record of execution and an experienced management team. I'm confident in Ameren's team's ability to execute our investment plans and other elements of our strategy across all four of our business segments. Again, thank you all for joining us today and I'll now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"content": "Thanks, Marty, and good morning, everyone. I'll begin on Page 19 of our presentation with our 2024 earnings results. Yesterday, we reported 2024 adjusted earnings of $4.63 per share, compared to earnings of $4.38 per share in 2023. Our 2024 earnings exclude two charges totaling $0.21 per share. The first is related to the NSR settlement approved by the US District Court for the Eastern District of Missouri for the Rush Island Energy Center. The second is related to the Federal Energy Regulatory Commission's order on base return on equity. On Page 20, we summarize key drivers impacting adjusted earnings at each segment. Our strong 2024 adjusted earnings results were largely driven by our strategic infrastructure investments. In addition, weather-normalized retail sales grew approximately 2% across Ameren Missouri with 2%, 1.5% and 3% growth in our residential, commercial and industrial classes respectively. Notably, industrial sales continue to remain robust, driven largely by growth from customers in the manufacturing and technology sectors. This year's sales growth reflects the strong economy across our service territory, which will serve as a solid foundation for future potential growth. Our focus remains on balancing necessary investments with prudent cost management to support both system reliability and customer affordability. At the beginning of last year, we set an ambitious goal to hold O&M expenses flat given the importance of cost control and managing customer rate impacts. I'm proud to report that we've made significant strides in this area. Importantly, at Ameren Missouri, when excluding the onetime NSR charge, all-in O&M expenses were down $12 million year-over-year. As we navigate the current economic landscape, we expect our proactive cost management and strategic investments will continue to drive operational efficiencies and keep our customer rates below the national and the Midwest averages. Moving to Page 21 to cover regulatory progress made in the fourth quarter. In December, the Missouri PSC staff recommended a $398 million annual revenue increase in our 2024 Ameren Missouri electric rate review. The difference between our request of $446 million and staff's recommendation is primarily driven by staff's proposed return on equity of 9.74% versus our request of 10.25%, and treatment of High Prairie Energy Center, partially offset by estimated off-system sales and fuel costs, which will be subject to true-up in regulatory recovery mechanisms. The equity ratio will be updated to use the capital structure as of December 31st, 2024. Surrebuttal and True-up Direct Testimony will be available later today. As we have in the past, we will seek to work through these and other differences with interveners over the coming weeks. Evidentiary hearings are scheduled to begin in mid-March and the decision for the Missouri PSC is expected by May, with new rates effective by June 1st. Turning to Page 22 for an update on our regulatory proceedings in Illinois. In December, the Illinois Commerce Commission, or ICC, issued orders in two of our pending Illinois rate reviews. The ICC approved our revised grid plan and the corresponding Multi-Year Rate Plan or MYRP for 2024 through 2027 for a cumulative revenue increase of $309 million versus our request for an increase of $332 million. These annual revenues reflect our recoverable costs, average rate base of $4.8 billion by 2027, and as anticipated, no change in the 8.72% return on equity. Investments in the energy grid under this multiyear plan is expected to preserve safety, reliability and the day-to-day operations of our system while also making progress towards the clean energy transition. We're pleased to have an ICC-approved grid plan through 2027, which provides clarity on the work ahead. In addition, the ICC approved our request for $158 million reconciliation adjustment in the final electric distribution reconciliation of 2023's revenue requirement. The full amount will be collected from customers in 2025, replacing the prior reconciliation adjustment of $110 million that was collected during 2024. New rates from the 2023 reconciliation in 2024 through 2027 MYRP were affected at the end of last year. Moving now to Page 23 for an update on the Illinois gas regulatory matters. In January, Ameren Illinois Natural Gas Distribution requested $140 million annual base rate increase based on a 10.7% return on equity, a 52% equity ratio and a $3.3 billion average rate base during our future 2026 test year. An ICC decision is required by early December, with rates expected to be effective in December 2025. Turning to Page 24. We look ahead to our company-wide capital plan for the next five years. Here, we provide an overview of our $26.3 billion of planned capital expenditures for 2025 through 2029, by business segment, which support our consolidated 9.2% compound annual rate base growth expectations. As Marty highlighted, we have a robust capital investment opportunities ahead of us. The five-year infrastructure investment plan we are releasing today represents a 20% increase over our investment plan issued last year. This increase includes additional generation reflected in the Ameren Missouri Smart Energy Plan including the new Preferred Resource Plan and the Ameren Illinois MYRP order. As you can see on the right side of this page, we are continuing to allocate capital consistent with the allowed return on equity under each regulatory framework. Page 32 in the appendix of this presentation provides a summary of the Ameren Missouri Smart Energy Plan, now filed with the Missouri PSC, which outlines CapEx by year over the next five years. Turning to Page 25. Here, we outlined the expected funding sources for the investments noted on the prior page. We expect continued growth in cash from operations as investments are reflected in customer rates. From a tax perspective, we expect to generate significant tax deferrals, driven primarily by the timing differences between financial statement's depreciation reflected in customer rates and accelerated depreciation for tax purposes. We will continue to advocate, along with others in our industry, to retain clean energy tax credits for the benefit of our customers. From a financing perspective, we expect to continue to issue long-term debt to fund a portion of our cash requirements. To maintain a strong balance sheet while we fund our robust investment plan, we expect to issue approximately $600 million of equity each year from 2025 through 2029, a portion of which we expect to be issued through our dividend reinvestment and employee benefit plans. These actions are expected to maintain our strong balance sheet and credit ratings. Turning to Page 26 for further details on our 2025 financing plan. To fund a portion of the $4.2 billion of investment in 2025, we expect debt issuances totaling $500 million, $650 million and $750 million in Ameren Missouri, Ameren Illinois and Ameren Parent, respectively. In addition, as of today, we've entered into forward sales agreements for $265 million of common stock issuances under our at-the-market equity distribution program to address a portion of our 2025 equity needs. We expect to settle these by the end of the year. Moving to Page 27 of our presentation for our 2025 earnings guidance. Today, we are affirming our 2025 diluted earnings per share guidance range of $4.85 per share to $5.05 per share, the midpoint of which represents approximately 7% growth compared to our 2024 adjusted earnings results. These earnings drivers are summarized on this page and remain largely consistent with those discussed on our third quarter earnings call. We expect our disciplined cost management to hold operations and maintenance expenses to around a 1% compound annual growth rate over the five-year plan. Finally, turning to Page 28. We remain confident and excited in our long-term strategy, which we expect will continue to drive consistent superior value for all of our stakeholders. We have strong investment opportunities that benefit our customers and attract and support new business. We expect strong earnings per share growth driven by robust rate base growth, disciplined cost management and a strong customer growth pipeline. As we said before, we have the right strategy, the right team and the right culture to capitalize on opportunities, to create value for our customers and shareholders. We believe this growth will compare favorably with the growth of our peers. Further, Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"content": "At this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Shar Pourreza with Guggenheim Partners. Please proceed with your question."
},
{
"speaker": "Shahriar Pourreza",
"content": "Hey, guys. Good morning."
},
{
"speaker": "Martin Lyons",
"content": "Good morning, Shar."
},
{
"speaker": "Shahriar Pourreza",
"content": "Good morning, Marty. Maybe just, Marty, if you can dig into the growth profile a little more. So you're now just over 9% rate base CAGR. You've got this new sales number with 1 gig by '29, equity is largely the same. Can you speak to how close you are to the top end of 6% to 8% at this point? Are we another '29 hyperscaler deal away from piercing 8%? Thanks."
},
{
"speaker": "Martin Lyons",
"content": "Yes, Shar, thanks. You've got some of the building blocks that we laid out for you today. I'm pretty excited about the sales growth that we outlined on Slide 11. Very much excited about the capital plan that we laid out on Slide 24 and it's backed up by the new IRP changes that we've put forward that are on Slide 12. So lot of good building blocks. And like you said, we've provided the financing assumptions as well. So hopefully, I've given you and everybody else, some good building blocks to build out your models. I guess I'd say with respect to the EPS growth, we've said before that our goal is to deliver at or above the midpoint. And we really mean that year in and year out as we look ahead over the next five years. As we pointed out earlier, we certainly do have a history of doing that as well, really delivering within the upper end of that guidance range. As we look out over the next five years, and you kind of talked about this a little bit, we see that sales growth sort of occurring over time, really starting in late 2026 and into 2027. You see on that chart on Slide 11, 500 megawatts expected by the end of 2027. And as you point out, 1 gig of additional demand by the end of 2029. So it's sort of ramps up in the mid to late parts of this period. Similarly, with rate base growth, we certainly don't give that to you year-by-year. But as you look at that Slide 12, that I referenced with the updated IRP, you can see where some of the investments are going to come into service in order to serve that load. And again it's mid to back-end loaded over this five-year period. So look I think those are some of the building blocks and there's certainly a number of steps that need to take place to bring all these sales growth expectations to fruition and get this generation built. But based on the plans we've laid out today, we would expect to deliver near the upper end of the range in the mid to latter part of the plan."
},
{
"speaker": "Michael Moehn",
"content": "Hey, Shar. That was well said. The only thing I might add to that too is I think it's sort of implied what Marty's saying, if you look at that long-term capital plan too, we were at $55 plus billion out there over the next 10 years. Obviously, we updated that with this Preferred Resource Plan that was just filed this morning and updated that to $63 plus billion. So again, I think it just speaks to the longevity of the pipeline and the plan."
},
{
"speaker": "Shahriar Pourreza",
"content": "No, that's very well stated. And then on just the resource plan update, can you just help us sensitize a little more on the scenarios? The preferred plan is 1.5 gigs by 2032, so that's our baseline. But how much of capacity headroom is there in the resource mix if you wind up going beyond that? Are we looking at more generation capital? Would it be backfilled with retirement extensions, repowerings, et cetera? Thanks guys."
},
{
"speaker": "Martin Lyons",
"content": "Yes. As you look at the IRP update that we filed today, in a lot of ways, that reflects what in the short-term, in the next five years, we think, can realistically get done. And what you see there is mostly acceleration of things that we had in our prior plan. And we've talked about this before, the acceleration of renewable investments, battery storage, investment in gas-fired generation. And again, when we look at that opportunity that we have to build that generation out, we believe that we could serve that 2 gigawatts that we have outlined on Slide 11 by 2032 and even more thereafter. So we're really excited today to have the almost 1.8 gigawatts of construction agreements in place today. Last quarter, we provided sort of a sales funnel, if you will, that talked about tens of thousands of megawatts of potential new demand across Missouri and Illinois. That's all still true today. We're excited about that. As we outlined in our plans today that, again, in the IRP, we believe we can serve the load that's been signed up with the construction agreements. We're also continuing to engage with potential developers of data centers in Missouri and Illinois. And we're going to continue to court that interest. Like I said, having the opportunity to serve more even with these plans that we've laid out today. So I think it's all good. On Illinois, I just mentioned that while it's not stated in the slides here, we have several projects in the engineering review stage in Illinois. There are some attractive development sites there, just like there are in Missouri and some good state incentives. So we're doing all we can in each state to help businesses connect to the grid and grow, and grow the communities, the economies that we serve."
},
{
"speaker": "Shahriar Pourreza",
"content": "Perfect. Lots of tailwinds. Congrats, guys. Appreciate it. Fantastic."
},
{
"speaker": "Martin Lyons",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Our next question comes from Durgesh Chopra with Evercore. Please proceed with your question."
},
{
"speaker": "Durgesh Chopra",
"content": "Hey, team. Good morning. Happy Valentine's Day."
},
{
"speaker": "Martin Lyons",
"content": "All right. Same to you, Durgesh. Good to hear from you."
},
{
"speaker": "Durgesh Chopra",
"content": "Good. Thank you. Well, a quick shout out to your IR team. The IRP reconciliation is crisp as always and makes my job a lot easier. Listen, two questions. First, on the balance sheet, just like -- the capital line is about 20% higher. The equity is the same. Maybe just where are you tracking on FFO to debt? And are you positioned strongly enough with this capital plan to be at Baa1 or are we thinking about Baa2? Just thoughts there."
},
{
"speaker": "Michael Moehn",
"content": "Good morning. You're making Andrew smile over here, by the way, Durgesh. Nice shout out to him. So he's happy to hear that. Look, as we've talked in the past, we feel good about our balance sheet. We've been very proactive over time issuing equity. I think we've continued to protect and support the balance sheet in a really conservative way. As I sit here today and looking out over the five-year plan, we absolutely feel that this equity here will support the Baa1, BBB+. I mean we're at or above that 17% threshold that Moody's has us at. And that's really obviously the downgrade threshold that we have for us. Just to remind you, at S&P, we're at 13%. So we're probably closer to the upgrade threshold than we are the downgrade threshold given where we maintain the metrics. But again, as we sit here today and what we have from a funding perspective, we feel very, very good about it."
},
{
"speaker": "Durgesh Chopra",
"content": "Got it. Okay. Excellent. And then maybe just a lot of upside investment opportunities on the MISO side, on the IRP. Maybe can you just help reconcile what is in the five-year plan? And then what are the quantum of opportunities if there's a way to size the capital amount, which is truly upside and not yet in the capital plan, if you know where I'm going with this?"
},
{
"speaker": "Michael Moehn",
"content": "Yes. Let me start with the transmission piece and Marty can certainly chime in here as well. I mean I think probably the easiest way, Durgesh, to think about it is we had about $5 billion in the overall 10-year pipeline associated with LRTP. And so about $2 billion of that was in the first five years, which has been allocated to us as part of those that first Tranche 1 plus those competitive projects that we won. So that's that first piece. And then you got a remaining $3 billion that you're filling out and that has been $1.3 billion awarded to us here in Tranche 2. And so then we obviously have these competitive projects that we indicate about $6.5 billion worth of projects that we're going to bid on to fill out that piece. So I think the way to think about it, there is clearly upside with respect to some of those competitive projects today and how we think about that $5 billion that's in there. So Marty, anything to add on the transmission side?"
},
{
"speaker": "Martin Lyons",
"content": "On the transmission side, I would just say, overall, as we think about the capital plan, we feel like it's conservative and achievable. As you look at the other elements of the capital plan on Slide 24, in Missouri, what we've done is look to align the generation spending there with the updated IRP we filed today, the Illinois Electric Distribution is aligned with the outcome of the Multi-Year Grid and Rate Plans that we had last year. The Illinois gas spending is aligned with our 2023 gas rate review as well as the pending gas rate review and Michael just discussed transmission. So we've aligned all those things. I would note that Ameren Missouri non-generation spending is down a little bit from what we had in our last five-year plan. And I would say that overall, despite the increase in spending that you're seeing and investments you're seeing in Missouri, there's conservatism baked into those numbers as we think about the five-year plan. So I think it's conservative. It's achievable, but it is aligned with those things Michael and I talked about."
},
{
"speaker": "Durgesh Chopra",
"content": "Excellent. Appreciate the discussion there. Thank you."
},
{
"speaker": "Martin Lyons",
"content": "Take care."
},
{
"speaker": "Operator",
"content": "Our next question comes from Nicholas Campanella with Barclays. Please proceed with your question."
},
{
"speaker": "Nicholas Campanella",
"content": "Hey, good morning. Thanks for all the updates and taking my questions today."
},
{
"speaker": "Martin Lyons",
"content": "You bet."
},
{
"speaker": "Nicholas Campanella",
"content": "Hey so I just -- when I look across the portfolio, there's just a lot of tailwinds, whether it's Missouri rate review seems like it's going off to a solid start. And I know that there's legislation this year, you're kind of laying the framework for potentially more data centers to come into your territories. And if you were to have success here, let's just say you kind of move into the high scenario load growth range or you do have to kind of accelerate capital in the plan, is there a point in which you would kind of like reevaluate the growth rate or do these opportunities kind of extend that premium 6% to 8% offering at the?"
},
{
"speaker": "Martin Lyons",
"content": "Yes. Well, thanks for the question. And you're right, there are a number of tailwinds that we've got today. I mean we're very excited for our communities and for our customers as we think about some of the economic development opportunities that we're seeing in Missouri and Illinois. And as you mentioned for us, it certainly means opportunities to invest to support those businesses, to help grow those businesses and impact our sales. And we are pleased that in Missouri, in particular, there's good alignment, I believe, with stakeholders to really go after some of these economic development opportunities and provide some of the regulatory tools and mechanisms and outcomes to be able to support the continued investment and growth in our communities. So I think that's all good. As you think about our growth rate over time, certainly, our objective is going to be to maximize that growth rate as we think about the investments that are needed through time. We're not going to constrain it, is another way to put it. In answer, I think, to the first question we got, though, as we think about the next five years, still feel like this 6% to 8% growth guidance is the right guidance. Again, as I said earlier, in the short-term, we'll be at or above that midpoint. But as we see that load growth occurring later in the five-year period, as we see the rate base growing later in that five-year period, as I said before, we do expect to deliver near the upper end of the range in the mid to latter part of the plan. As we go through time, if some of these tailwinds continue and should the growth even accelerate further, we'll certainly reevaluate the overall earnings per share growth range. As I said, we certainly don't want to constrain it in any way."
},
{
"speaker": "Nicholas Campanella",
"content": "That's super helpful. I appreciate that. And I'm sorry to make you repeat yourself a little bit on what's in the plan versus not, but just you mentioned that you have capacity to serve 2 gigawatts of demand or you're working towards capacity to serve 2 gigawatts of demand by 2032. It does seem you have like 1.8 under construction. So I just is what you're doing freeing up additional capacity to attract an additional 2 gigs. So if you were to have an additional demand, you'd have to do more CapEx for that or does this kind of -- does this plan and this CapEx plan create that capacity for you? I just wanted to understand that."
},
{
"speaker": "Martin Lyons",
"content": "Yes. Thanks for the question. I'll try to clarify. As we look at some of this load, it ramps up over time. And so even when you think about that 1.8 gig, it's going to ramp up over some period of time based upon the customers' needs. And so the plan that we laid out today, the resource plan that we laid out, as I said, we think that would support the ability to serve a full 2 gigawatts by 2032 but even more after that. And so as that load grows, we can not only serve that 2 gigs by 2032, but even more so after that. And look, if there's more demand, we'll continue to explore ways to serve even beyond that. So again, we're not constraining ourselves. But as we look at this next five years, with the investments we've outlined are the things that, we do believe we can realistically achieve and support that load growth that I just talked about."
},
{
"speaker": "Nicholas Campanella",
"content": "All right. Thank you very much."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our next question comes from Carly Davenport with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Carly Davenport",
"content": "Hey, good morning. Thanks so much for taking the questions. Maybe just two quick ones for me. First, on the sales growth outlook. Can you just help us put that 5.5% CAGR into the context of sort of the total pipeline that you're seeing in Missouri or maybe said another way, can you just talk about how you sort of risked the pipeline to come out to this 5.5% level over the course of the new five-year plan?"
},
{
"speaker": "Martin Lyons",
"content": "Yes, I'll see what color I can provide on that. When you look back on the Q3 call, in that funnel, we talked about tens of thousands of megawatts of potential demand, 75% of that from data centers and about 65% of that Missouri. So significant demand. But what's happened through time is we worked with different developers in terms of transmission access. And as I said earlier, about 1.5 gigs of new construction agreements have been signed on top of the ones that we had when we talked last in Q4. So we've really been trying to take those in terms of in a fair and equitable way in terms of the orders that they came in and have asked for interconnection. And that's where we are today. Now to put it all in sort of scale terms. I mean 2 gigs, if we're serving 2 gigs by the end of 2032 that represents about a 45% increase in Missouri sales. So pretty significant. But as I said earlier, Carly, this is what we've got today, given the construction agreements that we've got signed, given the tariff discussions we have going on with end users and we look at the, again, the generation that we can accelerate and deliver within this time period. We think 1.5 gig is a good point estimate. But again it could be greater as we think about the sales by 2032."
},
{
"speaker": "Michael Moehn",
"content": "And Carly it's Michael. Just a little finer point. I mean I think the comments that we have made previously about this first 250 megawatts, I think, still stands. We talked about that being online by the end of 2026. And then as Marty said, it kind of ramps in over time, 500 by the end of '27 and then you get to 1 gig by the end of 2029. And the only thing I might add in addition to this, I mean, I think we're coming off of a good foundation as well, right? As I indicated in my talking points, we ended the year at just a little bit right at about 2% growth. And it was across all classes, 2% on the residential side, 1.5% on the commercial and then a really robust 3% on the industrial side. And we're forecasting additional growth in '25 relative to '24 as well. So I mean, I think, again, it gives us good backdrop just what we're talking about here in terms of the foundation."
},
{
"speaker": "Carly Davenport",
"content": "Great. I appreciate all that color. That's really helpful. And then maybe just on the updated IRP in Missouri. I know you mentioned this in your opening remarks, but you did have some new nuclear longer dated, of course, by 2040 reflected in that new filing. Obviously, it's a big focus of the market. So could you just talk a little bit about kind of how you envision that new capacity? Is that more focused on opportunities around SMRs or something more like an AP1000?"
},
{
"speaker": "Martin Lyons",
"content": "Yes. Thanks, Carly. And you're right, it's long-dated. When we look out to 2040 time frame, looking at adding new nuclear and we talked about that balanced energy portfolio we see in the future. And when you look out to, say, 2045, what we see is about 70% dispatchable resources with nearly 40% nuclear, a little over 30% gas and then about 30% of our energy coming from renewables. So that's what we're sort of looking towards when we look very long-term. And of course, we've got experience with nuclear. Our Callaway plant here in Missouri has served our customers well for the past 40 years and we expect it to continue for the next 40 years. That said, I'd say as we sit here today, we really haven't put a stake in the ground in terms of what technology would make the most sense for us in terms of a nuclear technology. Certainly, when you look at the megawatts that we have in there for new nuclear, about 1,500, you got a full range of options, as you mentioned, in terms of technology. But what we're really looking to do over the next three to five years is to devote resources internally to monitor and studying these technologies closely and exploring perhaps what activities might be prudent to take that would say be technology agnostic, which might include things like construction permitting and the like. I don't see in the next few years, any material financial commitment as it relates to new nuclear, as you say, it's sort of long-dated. But we do think that's part of our energy future as we look out to a balanced portfolio in Missouri."
},
{
"speaker": "Carly Davenport",
"content": "Great. Thanks so much for the answers. Appreciate the time."
},
{
"speaker": "Martin Lyons",
"content": "You bet."
},
{
"speaker": "Operator",
"content": "Our next question comes from Julien Dumoulin-Smith with Jefferies. Please proceed with your question."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Hey, good morning, team. How are you guys doing?"
},
{
"speaker": "Martin Lyons",
"content": "Great, Julian. How about you?"
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Hey, great. Happy Friday. With that said, you guys, I mean just a remarkable update here across the board, whether it's the minimal limited incremental equity, great roll forward of the rate base here. I mean really what's left to address on the call here is, as you think about regulatory lag in front of you in this investment cycle, can you speak to that a little bit here and what you're facing, if that, there's any kind of timing issues? Obviously, you're emphasizing being at the upper end of the plan in the back half of the year. Can you speak to maybe any kind of earned ROE expectations and maybe marry that up against expectations and how to frame and sensitize any potential legislative outcomes here? Obviously, you spoke to some of them in brief earlier, but maybe just kind of square that up, if you will, and set any expectations on the cadence of earnings through the five-year period, too?"
},
{
"speaker": "Michael Moehn",
"content": "Let me start on the regulatory lag and then Marty can come in and talk about the legislative process. I mean, Julien, as you know, I mean we've always managed these businesses prudently try to earn as close to our allowed as possible. I mean if you kind of look at where we are on a historical basis versus some place in excess of 10% kind of across the overall portfolio of different returns. And as you said, I mean, we got to continue to be thoughtful about this. Obviously, you have rate reviews and other things you got to be thoughtful about from a timing perspective. And so that goes into how we think about projects. And Mark Birk and his team do a really good job just thinking about when those are going to need to be in place from a cutoff date, et cetera, just again to make sure that we're maximizing the returns and minimizing any regulatory lag. And then the other thing that we've obviously done in addition to all of this, which I think is just a good practice in general is we've managed our overall O&M cost really, really well. We talked about this at the beginning of the year. I mean, we went through another process of kind of looking at spans and layers, doing a lot of benchmarking, looking up and down the P&L. We've made significant investments in technology over the past five, six years. We're continuing to start to see some of that benefit from a productivity standpoint today, both back office and in the field, which I think is helpful being very thoughtful about as we turn -- have turnover and the replacements we put back into the business et cetera. So I think all of that has served us well and it obviously manifests itself in having O&M be down $12 million, which I indicated in the talking points, year-over-year, which I think is good in this environment because we want to be doing everything we possibly can to try to minimize the impact of this transition. So that's what I would say about that from a regulatory lag perspective, Marty can certainly add in and talk about the legislative piece too."
},
{
"speaker": "Martin Lyons",
"content": "Yes, I thought that was good, Michael. I think, Julien, as you go through time, we'll have to adjust and think through the timing of our rate reviews, as Michael mentioned, for a variety of factors. And again, some of it is going to be really getting better visibility in terms of how some of the sales growth is going to occur through time and refined timing on some of the, I'll call it, chunkier in-service dates on some of the elements of our integrated resource plan. And those things will help to refine our regulatory timing as well as thoughts on regulatory lag. But you did mention legislation in Missouri. There are a number of legislative initiatives that are progressing. As you know, the legislative session just recently kicked off and goes through, I think, May 16th of this year. So quite a bit of time. But we outlined on Slide 15, a number of various pieces of legislation that are sort of percolating. And some of them are familiar to you, things we've talked about in the past like really extension of PISA. As you think about some of these generation investments we want to make, getting that sunset pushed out in time is really helpful to us, gives us greater visibility in terms of regulatory framework and certainty through time, extending that to include natural gas generation. Again, we've got that built into our plan. These things are important in terms of supporting this economic development, this investment in generation. You see other things like the Missouri First Transmission Act, really making sure that we can get transmission built quickly have good import-export capability in our region, again, supports the economic growth. And then you see some of the other things that are percolating, you have changes to the integrated resource planning, allowing QIP in rate base for new natural gas generation or other energy centers, you see forward test years for natural gas and water. So I think some good constructive things that would be, again, incrementally supportive of investment in the state and incrementally supportive of broader economic growth and development in the state. And so the active consideration on these, there's a long way to go, but as we have recently seen some Senate action on that, in particular, so a consolidation of a number of these bills into one bill with Senate Bill 4. So I'd encourage you to continue to monitor these. We'll certainly continue as well as others to actively engage. But I think it's just good constructive discussion that about things that would be supportive of investment and economic growth in our state. So thanks."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Excellent, guys. Best of luck. It's a real pleasure to see us come together. All right. You guys take care."
},
{
"speaker": "Martin Lyons",
"content": "You too, Julien. See you soon."
},
{
"speaker": "Operator",
"content": "Our next question comes from Anthony Crowdell with Mizuho. Please proceed with your question."
},
{
"speaker": "Anthony Crowdell",
"content": "Hey, good morning, guys. Thanks for the update. Hopefully, just two quick questions. One is, I think, on Slide 31, where you, kudos to Andrew again. You do a great job of breaking it out. Just wondering 2030 you have 1,600 megawatts of gas, 800 more than your original plan. We hear or seen in the papers, the challenges of procuring new gas fired generation. Just anything you could add on the ability to add that generation? I have one follow-up."
},
{
"speaker": "Michael Moehn",
"content": "Yes. No, Anthony, this is Michael. Look, we feel good about that addition. I mean, we've taken steps along the way in Missouri to make sure that we could procure what we needed to, to get this online, given the importance of it, given the significance of what we're seeing from a supply chain perspective. So I think we've mentioned this before, but I think those steps have served us well, and we should be in good shape to bring this online. Still a lot of work to do. But from a critical component standpoint we're set."
},
{
"speaker": "Anthony Crowdell",
"content": "Great. And then on the S&P rating just if you could just give me the numbers. I missed it to the earlier question. I think you said you're closer to the upgrade threshold. Would you mind just those numbers again?"
},
{
"speaker": "Michael Moehn",
"content": "Yes, our downgrade threshold at S&P is 13%, Anthony. And so we've been certainly north of 17% or above there on that calculation. And so I don't know exactly what the upgrade threshold is, but it's -- we're much closer to that than we are the downgrade threshold. That's the point I guess I was trying to make."
},
{
"speaker": "Anthony Crowdell",
"content": "Great. Thanks so much for taking the question and congrats on a great update."
},
{
"speaker": "Michael Moehn",
"content": "Thanks, Anthony."
},
{
"speaker": "Operator",
"content": "Our next question comes from Bill Appicelli with UBS. Please proceed with your question."
},
{
"speaker": "William Appicelli",
"content": "Hi. Good morning."
},
{
"speaker": "Martin Lyons",
"content": "Hey, Bill. Good morning."
},
{
"speaker": "William Appicelli",
"content": "A question on the large load tariff that you're going to be filing. Can you just share some details around that? Is that going to have minimum load commitments for a set period of time? Is there an expectation that this is new load that's going to be -- have a neutral impact or potentially a beneficial impact to existing customers? Any color you can share on that filing?"
},
{
"speaker": "Martin Lyons",
"content": "Yes, Bill, I'd say it's premature to say exactly how it's going to be structured. But you're hitting on the right points. We're actively working with some of the prospective customers to finalize the tariff. I'd say discussions are going well. But you're right. I mean typical contract items, things like revenues to cover cost, the cost to serve, tenor of contract, minimum takes, exit provisions, credit provisions. I mean these are the things that we're focused on."
},
{
"speaker": "William Appicelli",
"content": "Okay. But I mean but the point would be that existing customers would be held -- would be neutral to the large load coming on?"
},
{
"speaker": "Martin Lyons",
"content": "At a minimum, yes."
},
{
"speaker": "William Appicelli",
"content": "Yes. Okay. And then just on the Missouri rate case, I think, there's a settlement window coming up next week. I know you've got hearings set for middle of March. But any update on how you're feeling around maybe the possibility of settling the rate case in this upcoming window?"
},
{
"speaker": "Michael Moehn",
"content": "Bill, it's Michael. Again, I think as I indicated on the call itself, I mean, I think we sit in a good spot at this point in terms of the differences between us versus staff. I think we indicated, in the last update, we were at $446 million versus $398 million from staff and so most of that is being driven by ROE, they're at 9.74%, and we're at 10.25%. And then there's an issue associated with this High Prairie wind place. So I think, ultimately, we always look to try to find a constructive way to get these settled. You can never guarantee that. But I think we sit in a good spot to continue to have some constructive conversations here over the coming weeks and we'll see what time brings us."
},
{
"speaker": "William Appicelli",
"content": "Okay. All right. Great. Thanks very much."
},
{
"speaker": "Operator",
"content": "Our next question comes from Jeremy Tonet with JPMorgan Chase. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet",
"content": "Hi. Good morning and a very Happy Valentine's Day to all."
},
{
"speaker": "Martin Lyons",
"content": "Same to you. Michael's got his pink shirt on today. He's ready to go."
},
{
"speaker": "Jeremy Tonet",
"content": "Great to see. Great to see. I was just wondering if I go to the financing plan a little bit, the $4.4 billion of increase in CapEx, yet only $300 million of incremental equity, I haven't seen that from all your peers out there. Just wondering if you could talk a bit more about the specific drivers here that allow you to minimize additional equity issuance here? Is there any shaping of CapEx over the five-year plan and how that impacts financing considerations?"
},
{
"speaker": "Michael Moehn",
"content": "No, Jeremy, I mean, look, I think it's more of a product just how we've managed this over time, right? We came into this kind of super cycle of CapEx in a really strong position. We've always protected the balance sheet. Again we've liked our ratings where they have been historically. And so I think that's really probably the difference here as we just, as we worked into it, that we had some continued room. If you went back and looked over time, we were certainly in excess of even those downgrade thresholds where we are today. But as we look over the next five years, as I mentioned earlier, I feel good that we're going to be at or above that 17%, which is really the threshold metric for us on the Moody's side."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. Great to see what being conservative on the balance sheet can do to you, make sense. And maybe just one last one, if I could. Circling back to legislation, do these items represent upside to your plan? Any way to size the magnitude of earnings and cash flow benefits from possible legislation here?"
},
{
"speaker": "Martin Lyons",
"content": "I think these are really things that can create a win-win for customers and shareholders as we think about executing the capital plans that we've got. And I think in large respect, go a long way simply to helping us turn closer to our allowed return as we deploy the capital."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. Great. Thank you for that. See you next month in Denver."
},
{
"speaker": "Martin Lyons",
"content": "You bet."
},
{
"speaker": "Operator",
"content": "Our next question comes from David Paz with Wolfe Research. Please proceed with your question."
},
{
"speaker": "Martin Lyons",
"content": "Good morning, David."
},
{
"speaker": "David Paz",
"content": "Good morning. Sorry I think my question has mostly been answered, but maybe just a little more precise question here. I know you said that you expect to be within the 6% to 8% EPS growth target each year and then the upper end in the latter half of the planning period. But do you see any specific headwinds that puts you below the midpoint, say, next year in 2026 before that sales growth kicks in? And if so what are those?"
},
{
"speaker": "Martin Lyons",
"content": "No, David, I wouldn't say there are any specific headwinds with respect to being at the midpoint or higher as we look at next year. But again I think the point I was trying to make is, when you look at some of that sales growth again and Michael, I think, underscored this, we really see that ramping up late '26, into 2027 and then beyond. And you can look at also to some of the rate base growth, which occurs sort of again mid to latter part. But no I wasn't trying to suggest that next year we would be expecting to sort of miss that mark."
},
{
"speaker": "David Paz",
"content": "Got it. Okay. Thank you."
},
{
"speaker": "Martin Lyons",
"content": "All right, David. Hey, I think, we're going to have to wrap it up for today. We've got some other business we have to attend to this morning. I really appreciate all the interest we had on the call this morning. Lots of great questions and dialogue. I think you can tell that we're very energized by the opportunities ahead, the power growth for our communities and for our shareholders. And so with that, please be safe, and we look forward to seeing many of you at upcoming conferences."
},
{
"speaker": "Operator",
"content": "This concludes today's conference. You may disconnect your lines at this time and we thank you for your participation."
}
] |
aee | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Greetings and welcome to the Ameren Corporation Third Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Andrew Kirk, Director of Investor Relations, Corporate Modeling for Ameren Corporation. Mr. Kirk, please proceed."
},
{
"speaker": "Andrew Kirk",
"content": "Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President, and Chief Executive Officer, and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer, along with other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today's live broadcast, and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on page two of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance, and similar matters, which are commonly referred to as forward-looking statements. Please refer to our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now, here is Marty, who will start on page four."
},
{
"speaker": "Marty Lyons",
"content": "Thanks, Andrew. Good morning, everyone. Thank you for joining us today as we cover our third quarter 2024 earnings results. I will begin today on page four. We are focused on delivering strong long-term value for our customers, communities, shareholders, and the environment. By investing in rate-regulated infrastructure, enhancing regulatory frameworks, and advocating for responsible energy policies, we are positioning ourselves to take advantage of future opportunities to benefit all of our stakeholders. Through a disciplined approach to optimizing our operating performance, we have been able to keep our customer rates low in comparison to the national average as we transform the energy grid, enhance reliability, and provide cleaner energy to our communities. We remain excited for the future, and we see strong growth opportunities unfolding over the next decade. Turning to page five. Yesterday, we announced third quarter 2024 adjusted earnings of $1.87 per share, compared to earnings of $1.87 per share in the third quarter of 2023. These comparable adjusted earnings results were in line with our expectations. The third quarter and year-to-date 2024 adjusted results exclude two charges related to separate proceedings that have been ongoing for over a decade. The first related to an agreement in principle to settle the Rush Island Energy Center New Source Review and Clean Air Act proceeding, and the second, for customer refunds required by the Federal Energy Regulatory Commission's (FERC) October 2024 order, which established a new base return on equity within the Midcontinent Independent System Operator (MISO), that was applied retroactively to certain periods extending back to 2013. Key earnings drivers are highlighted on this page. Mike will discuss the factors driving the quarterly results in more detail in a moment. Our strong investment pipeline continues to drive earnings growth, and I am excited about the significant economic growth opportunities in the communities we serve. The Greater St. Louis region is experiencing some of the highest employment growth we have seen in the better part of three decades. In August, the region was ranked fourth among large metro areas in the country for employment growth, and we are seeing this strength in our region reflected in strong weather-normalized retail sales growth year-to-date across all customer classes in Missouri. Turning now to page six. Thanks to our team's execution of our strategy over the course of this year, we have a strong foundation as we head into the final months of 2024. We expect to deliver 2024 earnings within our adjusted guidance range of $4.55 per share to $4.69 per share. We expect our 2025 earnings per share to be in the range of $4.85 and $5.05, with the midpoint representing a 7.1% increase over the midpoint of our 2024 adjusted guidance range. While our historical practice has been to provide initial earnings guidance on our fourth quarter earnings call in February, we are issuing this 2025 guidance now to reinforce our confidence in our ability to deliver on our 6% to 8% earnings per share growth guidance expectations. We expect to provide our long-term earnings growth guidance and capital and financing plans on our year-end call in February. On page seven, we highlight the latest advancements across Ameren as we execute our strategic objectives for the year. Our infrastructure investment plan is designed to improve the reliability, resiliency, safety, and efficiency of our system. As we remain focused on a reliable clean energy transition, year-to-date, we have invested $3 billion to replace aging infrastructure and also build the new infrastructure needed to meet our customers' growing demand for a diverse mix of energy resources. Just last week, we announced that we have now closed on three solar energy centers this year, totaling 500 megawatts of new generation, which are undergoing final testing and are expected to be in service by the end of the year. On the regulatory front, MISO's long-range transmission planning process is progressing toward approval of the tranche 2.1 portfolio by the end of the year. In September, MISO released additional tranche 2.1 project details, which included approximately $3.6 billion of transmission investment needed in our Missouri and Illinois service territories to support reliability for the region. At Ameren Missouri, we are working to bring more dispatchable generation onto the grid. In October, the Missouri Public Service Commission (Missouri PSC) approved a certificate of convenience and necessity (CCN) and post-construction cost deferral for the 800-megawatt simple cycle natural gas energy center, Castle Bluff. This $900 million investment in dispatchable generation will support energy reliability in our region and will also create hundreds of construction jobs, several new permanent jobs, and additional tax revenue for the region. In addition, in November, we reached an agreement in principle with the US Department of Justice to settle the Rush Island Energy Center New Source Review and Clean Air Act proceeding. I will cover the details of the agreement in a moment. Finally, at Ameren Illinois, in October, the administrative law judge (ALJ) issued a proposed order regarding our revised 2024 through 2027 electric distribution multiyear rate plan. Importantly, the ALJ proposed order supports 99% of our requested rate base when excluding the impacts of other post-employment benefits (OPEB). Following our team's extensive engagement with key stakeholders, all interveners support the Illinois Commerce Commission's (ICC) approval of a revised grid plan with limited adjustments. We look forward to an ICC decision by the end of this year, which we expect to be consistent with the multiyear capital plans we issued in February. Last, operational performance across our company remains strong, with a focus on delivering safer, more reliable, and affordable energy through grid hardening, enhanced automation, optimization, and standardization. Turning to page eight for an update on Ameren Missouri's new generation project. We continue to execute our Ameren Missouri Integrated Resource Plan (IRP), which focuses on maintaining and building a diverse, cleaner generation portfolio to ensure our reliable and low-cost mix of energy resources to serve our customers' needs. As I mentioned, we have three solar projects in the later stages of commissioning and testing that are expected to be in service. We are also working toward the successful construction of another 400 megawatts of solar generation across three additional projects, which we expect will be ready to serve customers in late 2025 and 2026. Further, as I mentioned, in October, Missouri PSC approved the CCN for the dispatchable 800-megawatt simple cycle natural gas energy center Castle Bluff, following a constructive settlement with the commission staff and other interveners. The order also includes post-construction cost deferral to reduce unrecovered costs by allowing us to defer and recover the depreciation expense from the Castle Bluff Energy Center and an adjusted weighted average cost of capital return on the investment from the time it is placed in service to when it is incorporated into base rates. As solar energy predictably rises and then falls every day, it is vital to have Castle Bluff Energy Center to bolster grid reliability for our customers. Prep work has begun on Castle Bluff, which will be located on the site of our retired Meramec Energy Center, allowing us to cost-effectively expedite the construction by leveraging an existing site with infrastructure in place. The energy center is expected to be in service for our customers by the end of 2027. We look forward to continuing to work with key stakeholders to bring additional generation online as quickly as possible to meet the needs of all customers, including businesses looking to relocate or expand in Missouri. Moving now to page nine for an update on the MISO long-range transmission projects. In September, MISO provided additional detail and individual project cost estimates underlying the almost $22 billion tranche 2.1 portfolio, which is expected to drive significant reliability and capacity benefits for the region. The portfolio includes three projects in our Missouri and Illinois service territories that collectively represent an investment opportunity of approximately $3.6 billion. We await MISO's determination of which projects will be directly assigned and which will go through a competitive bidding process. MISO expects to approve the tranche 2.1 projects by the end of this year. Once approved, MISO plans to commence work in 2025 on the tranche 2.2 portfolio to address further transmission needs in the North and Midwest regions. As we continue to see substantial load growth across the country, MISO and its transmission owners will continue to assess whether the current long-range transmission future scenarios will be sufficient to support our region's energy needs in the years ahead. Moving now to page ten for an update on our expanding customer growth opportunities. Our service territories have a broad-based, diverse economy, which continues to expand across a variety of manufacturing sectors, including aerospace, agriculture, and food processing, to name a few. So far this year, we have received expansion commitments or executed new contracts for approximately 350 megawatts of new load from data centers, manufacturing, and other industries, 90% of which is located in Missouri. These projects are expected to create more than 2,200 jobs. We expect these new and expanding customers to be fully ramped up by 2028. We are excited about these opportunities and see tremendous additional opportunities for growth over the next five to seven years, which will bring jobs and additional tax base to benefit our state and local communities. Through ongoing collaboration with a variety of state and local stakeholders, we continue to attract new business and data center interest. Over the last few months, our economic development pipeline of potential additional demand has doubled in size, and we are making meaningful progress with several potential customers. These customers, representing several gigawatts of interest, have completed transmission engineering studies, and over the coming months, each will further evaluate the site locations and determine whether they will move forward with agreements. We are pleased to offer reliable service and competitive rates, as well as the people, resources, expertise, and partnerships needed to deliver for these customers. The ultimate net financial impact of any incremental load will be dependent upon a variety of factors, including customer ramp-up time, additional generation or grid investments needed, timing of rate reviews, and tariff structures. To that end, we are in the process of carefully evaluating potential load growth opportunities and our associated generation portfolio needs and would expect to update our IRP by February of 2025. This is an exciting time in our industry, and we look forward to finding solutions for these significant potential new customers. Turning then to page eleven. After almost fifty years of providing cost-effective energy to our customers, our Rush Island Energy Center was safely retired on October fifteenth. We are grateful to our coworkers who made this plant a reliable and low-cost energy source for our customers for many decades. Careful planning over several years enabled us to ensure that every employee impacted by the retirement of Rush Island had an opportunity with the company as we continue to thoughtfully transition our generation resources while retaining our talented workforce. The Missouri PSC has authorized recovery of approximately $470 million of cost related to the retirement of Rush Island through the issuance of securitized utility tariff. We are working through the next steps to execute that issuance. In addition, in November, Ameren Missouri and the US Department of Justice reached a settlement agreement in principle requiring Ameren Missouri to fund two mitigation relief programs in addition to retiring the energy center. The cost of these programs, which will provide for the electrification of school buses over a three-year period and air purifiers for eligible Ameren Missouri residential customers over twelve months, totaled $64 million. The charges recorded this year related to this agreement are excluded from our adjusted earnings results. The agreement between the DOJ and Ameren Missouri is subject to approval by the US District Court for the Eastern District of Missouri, which is expected by the end of the year. Moving to page twelve. Looking ahead over the coming decade, we have a robust pipeline of investment opportunities of more than $55 billion that will continue to deliver significant value to our stakeholders, create thousands of jobs, generate tax revenue for our local economies, and support economic growth in our region. Importantly, our ten-year investment pipeline does not reflect possible additional generation as we evaluate our needs to serve potential additional load growth. Any such changes to our ten-year investment pipeline will be reflected in our February earnings call update. Moving to page thirteen, our five-year growth plan released last February included our expectation of a 6% to 8% compound annual earnings growth rate from 2024 through 2028. This earnings growth is driven by strong compound annual rate base growth of 8.2% and strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. Investment in Ameren presents an attractive opportunity for those seeking a high-quality utility growth story. Combined, our strong long-term 6% to 8% earnings growth and an attractive and growing dividend, which today yields 3.1%, result in a compelling total return story. We have a strong track record of execution, a strong balance sheet, and an experienced management team. I am confident in our ability to execute our investment plans and other elements of our strategy across all four of our business segments. Again, thank you all for joining us today, and I will now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"content": "Thanks, Marty, and good morning, everyone. I will begin on page fifteen of our presentation with an earnings reconciliation for two earnings adjustments that Marty mentioned earlier. Yesterday, we reported third quarter 2024 GAAP earnings of $1.70 per share, which included a charge for additional mitigation relief related to the Rush Island Energy Center and a charge for the October 2024 FERC order on MISO's allowed base ROE. Both of these charges related to matters outstanding for the last decade. Excluding these two charges, Ameren reported third quarter adjusted earnings of $1.87 per share, compared to earnings of $1.87 per share for the year-ago quarter. The total after-tax charge of $0.17 per share in 2024 related to our Rush Island Energy Center reflects the estimated cost of the mitigation relief program agreed to with the US Department of Justice. This includes the $0.04 per share charge recorded in the first quarter of 2024. Subject to approval by the district court, we expect a settlement agreement to resolve the proceeding related to the new source review provisions of the Clean Air Act. Turning to the charge for the FERC order, recall, since November 2013, the allowed base ROE for FERC-regulated transmission rate base within the MISO has been subject to review. In FERC's October 2024 order, it established a new base ROE of 9.98% for the periods of November 2013 through February 2015, and September 2016 forward, which decreased the allowed base ROE from 10.02% and will require refunds with interest for these periods, totaling an after-tax impact of $0.04 per share. The return on equity from MISO projects is now 10.48%, including the 50 basis point adder, and we do not expect a four basis point decrease in ROE to have a material impact on earnings expectations going forward. Turning to page sixteen for detailed earnings results for the third quarter. Our adjusted earnings performance during the quarter was driven primarily by strategic investments and disciplined cost management, offset by changes in return equity for Ameren Illinois Electric Distribution and rate design at Ameren Illinois Natural Gas. Additional factors that contributed to the year-over-year earnings per share results are highlighted on this page. Year-to-date results are outlined on page twenty-six of today's presentation. Before moving on, I will touch on sales trends for Ameren Missouri and Ameren Illinois Electric Distribution. While miles were lower this quarter compared to the year-ago period, creating some earnings drag, our third quarter weather-normalized retail sales remained strong at an overall increase of approximately 1.5% compared to the year-ago period. Year-to-date, weather-normalized kilowatt-hour sales to Missouri residential, commercial, and industrial customers increased approximately 2%, 1%, and 3%, respectively, compared to last year. The year-to-date increase in industrial sales reflects production growth driven by new industrial plant additions and additional shift work in our service territory. Year-to-date, weather-normalized kilowatt-hour sales to Illinois customers were flat compared to last year. Recall that changes in electric sales, no matter the cost, do not affect the earnings since we have full revenue decoupling. On page seventeen, we summarize select earnings considerations for the balance of the year. We expect our 2024 adjusted earnings to be in the range of $4.55 to $4.69 per share. Notably, we expect a positive year-over-year earnings impact in the fourth quarter driven primarily by strategic infrastructure investments, strong cost management programs, and lower charitable trust contributions compared to the year-ago period. I encourage you to take the settlement-arranged drivers noted on this slide into consideration as you develop your earnings expectations for the remainder of the year. Turning to page eighteen, where we provide detail on our expectations for 2025. As we head into 2025, we feel confident that strong execution of our strategic plan this year will position us to deliver on our expected long-term earnings growth. With that in mind, we expect 2025 earnings per share to be in the range of $4.85 and $5.05. The midpoint of this range represents a little above 7% earnings per share growth compared to the midpoint of our 2024 adjusted earnings guidance range. Expected 2025 earnings detailed by segment as compared to our 2024 expectations are highlighted on this page. Beginning with Ameren Missouri, earnings are expected to benefit from new electric service rates effective by June 2025 and higher investment eligible for plant and service accounting. Earnings are also expected to benefit from higher weather-normalized retail sales, primarily to Missouri's commercial and industrial customers, which are expected to increase by 1% and 2%, respectively, driven primarily by the expansion and growth from our existing customers. We expect to update our long-term sales forecast in February. Further, we expect higher interest expense in Ameren Missouri and Ameren Parent, Transmission, and Ameren Illinois Electric Distribution, driven by higher infrastructure investment. Earnings in Ameren Illinois Natural Gas are expected to be lower due to cost recovery impacts between rate reviews. Ameren-wide, we expect increased weighted average common shares outstanding to unfavorably impact earnings per share. Robust infrastructure investment and economic growth opportunities, coupled with identified business process optimization opportunities and continued strong strategic focus, give us confidence in our ability to grow in 2025 and the years ahead. Turning to page nineteen for a brief update on Missouri regulatory matters. In August, the Missouri PSC set the procedural schedule for our ongoing Ameren Missouri electric rate review. Intervenor testimony is due in early December, and we expect a decision by the commission by May 2025, with new rates effective by June. Recall that approximately 90% of this request is driven by investments under Ameren Missouri's Smart Energy Plan, including major upgrades to the electric system and investments in generation. If approved as requested, new electric service rates would remain well below the national and Midwest averages. Turning to Ameren Illinois regulatory matters on page twenty. Under Illinois formula rate-making, which expired at the end of 2023, Ameren Illinois was required to file annual rate updates to systematically adjust cash flows over time for changes in the cost of service and to true up any prior period over or under recovery of such costs. For the final electric distribution reconciliation of 2023's revenue requirement, in August, the ICC staff recommended approval of our proposed $158 million reconciliation adjustment. The full amount would be collected from customers in 2025, replacing the prior reconciliation adjustment of $110 million that is being collected during 2024. This will result in a net increase in cash flow of $48 million, or approximately a 1.5% increase in the total average residential customer bill. An ICC decision is expected by December, with new rates effective in 2025. Turning to page twenty-one for an update on the multiyear rate plan covering 2024 through 2027. In October, the ALJ recommended a cumulative revenue increase of $315 million based on an average rate base of $4.9 billion by 2027. Excluding the OPEB issue, the ALJ's proposed order supports 99% of the rate base that we requested in a revised multiyear rate plan. This would allow us to invest in the energy grid to maintain safety, reliability, and the day-to-day operations of our system, while also making progress towards an affordable, equitable, clean energy transition. Following constructive engagement with the interveners to narrow the remaining issues, their latest proposals reflect a multiyear grid plan that is largely consistent with our guidance laid out in February. We expect an ICC decision by December, with new rates effective January 1, 2025. Under the multiyear rate plan, any annual revenues will be based on actual recoverable costs, year-end rate base, and a return on equity, provided they do not exceed 105% of the approved revenue requirements after certain exclusions. Moving to page twenty-two to provide a financing update. We continue to feel very good about our financial position. Ameren's parent long-term issuer credit ratings of Baa1 and BBB+ at Moody's and S&P, respectively, compare favorably to the peer average, providing us with financial flexibility. To maintain our credit ratings and strong balance sheet while we fund our robust infrastructure plan, we expect to issue approximately $300 million of common equity in total in 2024. By the end of 2023, we sold approximately $230 million of the expected $300 million through the at-the-market (ATM) program, consisting of approximately 2.9 million shares, which we expect to settle by the end of this year. Together with the issuance under our 401(k) and DRIP plus programs, our ATM equity program is expected to fulfill our 2024 equity needs. Additionally, as of September 30th, we have entered into forward sales agreements under our ATM program for approximately $155 million to support our 2025 equity needs, with an average initial forward sales price of approximately $82 per share. As always, we are thoughtful about strategically financing our robust capital plan. Turning to page twenty-three. We remain confident in our long-term strategy, which we expect to continue to drive consistent superior value for all of our stakeholders. As highlighted today, we have made significant progress towards our goals. We have strong infrastructure investment opportunities to benefit our customers and attract new businesses, and we continue to see signs of an attractive regional economy, including solid retail sales growth, strong employment growth in the St. Louis region, moderating interest rates and inflation, and a robust economic development pipeline that will deliver strong earnings growth in 2025. Looking beyond, we expect consistent strong earnings per share growth driven by robust rate base growth, disciplined cost management, and a robust customer growth pipeline. As we said before, we have the right strategy, team, and culture to capitalize on opportunities to create value for our customers and shareholders. We believe this growth will compare favorably with the growth of our peers, and shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Jeremy Tonet with JPMorgan. Please proceed."
},
{
"speaker": "Robin (for Jeremy Tonet)",
"content": "Hey, this is Robin on for Jeremy. How are you? Oh, great. Good morning. So maybe just to follow-up, you mentioned providing 2025 guidance at 3Q to underscore your confidence in your earnings trajectory. Could you elaborate on that strategy given several ongoing regulatory proceedings? And specifically, how should we think about the 2025 range relative to potential regulatory outcomes?"
},
{
"speaker": "Marty Lyons",
"content": "Yeah, sure. Well, you know, first of all, as you look back on some of the comments we made at the second quarter, we have a long history of growing at 7% or above. Our goal as we go into each year, of course, is to deliver at the midpoint or even higher within our range. Some of the things that we pointed to last quarter that are just giving us more long-term conviction have to do with inflation cooling, strong local economy, demand improving, some of the things we have talked about even on this call with respect to customer growth opportunities and great investments that we have got across all of our segments, whether it is distribution, transmission, and generation, and, of course, a strong balance sheet. So we have strong conviction in our ability to grow long-term. As we looked at 2025, we certainly have confidence in our ability to deliver within the range that we pointed out today. As we look ahead over the next few months, typically, we have delivered this guidance in February. We are delivering it now because we do have strong confidence, and we believe that whatever unfolds in the months ahead, we will be able to adjust our plan and hit the mark in terms of the guidance that we delivered."
},
{
"speaker": "Robin",
"content": "Great. Thanks. And then maybe just a follow-up on the mentioned economic development opportunities. You mentioned you have gotten some interest from an impressive several gigawatts of potential opportunities. Just any high-level thoughts on how you factor in potential double counting, like, say, if those customers are also submitting those inbounds to other utilities or service territories?"
},
{
"speaker": "Marty Lyons",
"content": "Yeah, sure. And look, I think you are absolutely right. We pointed out on our slide that we have tens of thousands of megawatts of potential new demand, so a significant amount. We certainly expect that, if we call it double counting, but a lot of these folks are looking at the same properties. You have got developers as well as hyperscalers. And so, yeah, there is certainly duplication in there. What we are doing is really working through with each of those counterparties in a methodical way. We mentioned that we have had progress with potential counterparties representing several gigawatts of demand. We are working through with them on evaluating the sites, the transmission access, the generation that might be needed to serve them. Eventually, we expect that to be narrowed down. It is one of the reasons why we have been cautious about not really announcing any of this load until we get a construction agreement because these conversations have to progress to the point where we have a construction agreement. The other thing to keep in mind is we have mentioned in our prepared remarks that we expect that over the coming months, we will get even greater visibility. We will have a better sense of what the demand might be over the coming years and be able to incorporate that into our plans for incremental generation. So expect to put a greater stake in the ground, if you will, in February, which is when we believe we will be in a position to update some of those sales forecasts and update our IRP."
},
{
"speaker": "Robin",
"content": "Great. Thank you. Appreciate the color."
},
{
"speaker": "Operator",
"content": "The next question comes from the line of Paul Patterson with Glenrock Associates. Please proceed."
},
{
"speaker": "Paul Patterson",
"content": "Hey. Good morning."
},
{
"speaker": "Marty Lyons",
"content": "Hey, Paul. Good morning."
},
{
"speaker": "Paul Patterson",
"content": "Just a few quick questions. On the refilled group plan, it looks like, I guess, they are going to have oral arguments, I guess, based on what the AG wanted. Any thoughts about that? I mean, at this late date that they are looking at doing that?"
},
{
"speaker": "Marty Lyons",
"content": "Yeah. Paul, I do not think I would read anything into that. Obviously, there are some differences, which I think because of the hard work of our teams along with the various stakeholders in these cases, we have really narrowed down the potential adjustments that folks have argued for. If you look on slide twenty-one in our materials, we laid out where the proposed rate base would be taking into consideration potential adjustments that have been advocated by various parties. You see where the staff is and where the ALJ came out. But I think it is normal that you would have oral arguments over the remaining differences. But again, I would point to the ALJ's proposed order, which certainly gives us confidence in terms of where this may land with the commission when they ultimately decide in December."
},
{
"speaker": "Michael Moehn",
"content": "Hey, Paul. This is Michael. I was just going to add that these oral arguments have been scheduled for a long time, so that is fairly typical, and they are actually being held on November twentieth. So as Marty said, I think what we have today is a constructive data point from the ALJ. I think all the interveners are recommending approval of the grid plan at this point. We will just see where the arguments take us."
},
{
"speaker": "Paul Patterson",
"content": "Okay. Great. And then on slide nine, you mentioned the transmission projects and the reliability and also the growing customer calls. I was wondering if you could elaborate a little bit more on the customer call side, like what this might mean to customers. Because we do not see them. Go ahead. I am sorry."
},
{
"speaker": "Marty Lyons",
"content": "Yeah. No. It is okay, Paul. I mean, we are really referring to, and we added a bullet which we have not had in the past, about the customer benefits in a range of 1.3 to 5.6 times in terms of the portfolio cost. So that relates to the overall approximately $22 billion of projects. When MISO goes through these and they propose these various projects, one of the things they do is obviously estimate the cost of these projects, which we have listed, at least for the projects in our service territory down below. But they also do an assessment of what the benefits to the customers are going to be in relation to those costs. Each of these projects has the positive math behind it, if you will, that suggests that customers' costs over time will be lower as a result of these investments. So that is what we are really trying to convey."
},
{
"speaker": "Paul Patterson",
"content": "Okay. But there is not going to be some dramatic cost, I guess, when these new lines show up and cheaper stuff comes in? Or is it sort of all mixed up together and it is going to take some time for it all to show up kind of thing?"
},
{
"speaker": "Marty Lyons",
"content": "Yeah. I think it will show up over time. I do not have any exact rate impact to point to."
},
{
"speaker": "Paul Patterson",
"content": "I got it. Thanks. Okay. Then finally, on the new customers, you mentioned with one tranche of the new customers that there was 90% Missouri versus Illinois. I guess I was wondering when people are looking to, with all these robust discussions that you are having, is there more interest in one state versus another, or is there any flavor as to if there is, what might be driving that?"
},
{
"speaker": "Marty Lyons",
"content": "Yeah. Look. We have data center interest really in each of the states. So if you look over to the right, on that slide ten, we talked about tens of thousands of megawatts of potential new demand. You see various elements of that. I would say today in our pipeline, about 75% is data centers, 15% is manufacturing, and 10% is other, which is probably how that breaks down. Within that data center interest that we have got, about 65% of it is Missouri, and 35% of it is Illinois today in terms of what is in our pipeline. So there is clearly data center interest in each of the states. Each of the states is attractive for various reasons and in some cases, different reasons. But what we have announced today with respect to these construction agreements, which is more over on the left where we have 250 megawatts of data center demand, 100 megawatts of additional load from a variety of sources, it just so happens that 90% of that is actually in Missouri. About 10% of that is Illinois today in terms of those agreements that we have in place. Now, as we look ahead, certainly, the impact to us from an earnings perspective is going to be differentiated in the two states. In Illinois, obviously, if we have transmission or distribution investment that supports that load growth, we get the earnings impact of that. In Missouri, which is vertically integrated, we also have the impact of the opportunity to earn on any incremental generation."
},
{
"speaker": "Paul Patterson",
"content": "Okay. But there is no specific reason for that? It just that is the way it fell out, I guess. Okay. I appreciate it. Thanks so much. Have a great one."
},
{
"speaker": "Operator",
"content": "You bet. The next question comes from the line of Carly Davenport with Goldman Sachs. Please proceed."
},
{
"speaker": "Carly Davenport",
"content": "Hey. Good morning. Thanks so much for taking my questions. Maybe just to follow-up on an earlier question on the earnings guidance range. As you think about 2025 growth at just over 7% relative to the midpoint of 2024, can you just give us your thoughts on looking forward where you see yourself in the range, just taking into consideration some of the incremental opportunities that you have highlighted and if there is any potential upside to that range going forward?"
},
{
"speaker": "Marty Lyons",
"content": "Yeah. Carly, look. In terms of our range, we have said 6% to 8% is our EPS CAGR that we are targeting for the period 2024 to 2028. As I mentioned earlier, when we look back, we have got a strong track record of delivering above the midpoint, above 7%, and our goals as we look ahead are to deliver at or above. As you said, we have some positive data points we are seeing today. Again, one of the things is the slow growth, which we just talked about. Some potential load growth. We are working hard to bring that to fruition for the benefit of our customers, our communities, and we are going to work hard to do that. At this point, I would say that is where we are at now. We will come out in February. We will provide our perspectives on load growth going forward, update our investment plans, and we will note any potential implications on guidance. But we feel good about the 6% to 8% and, again, our target of hitting at or above that midpoint. Michael, anything to add?"
},
{
"speaker": "Michael Moehn",
"content": "Hey, Carly. It is Michael. I think it is well said. The only other thing I might add is just again, the overall backlog of investment opportunities. Marty spoke about this earlier. We have got the $55 billion that we continue to point to. I think that pipeline remains robust. We talked about this opportunity just with the data centers. That could potentially drive some additional capital. So, I mean, your question specifically was what could take you to the upside of that? I think it is those additional investment opportunities over time. I think there is also opportunity, as Marty said, not only just from the data center, but the underlying economic data within, certainly in the Missouri territory, is very strong today. Just looking at the overall employment, the GDP rate, we are seeing customer growth, which we just alluded to. We are seeing customer account growth, population growth, and all of those things, I think, are a great backdrop. Then, yeah, we continue to think about just how do we optimize the financing in this going forward. So that is where I would probably leave it at this point."
},
{
"speaker": "Carly Davenport",
"content": "Got it. Great. That is super helpful. And then maybe just another quick one. You have previously talked about some O&M reductions coming in the second half of the year. Looks like 3Q was still up year over year, but then you called out some efficiency in the earnings driver slides for 4Q. Are you able to give some color on what programs you are sort of pursuing there? And if what you have called out on the slides is all-inclusive of what you are looking at on O&M."
},
{
"speaker": "Michael Moehn",
"content": "Yeah. You bet. And you are right. We have been pointing to this towards the beginning of the year. I said it was going to be in the back half. And I think you are certainly seeing that show up in Missouri. Specifically, you know, $0.05. You look at what we are pointing to in the fourth quarter, year over year expecting $0.03 and $0.01 in Missouri and Illinois Natural Gas, respectively. And, again, just consistent with some of the things I have talked about in the past. This is not something that is new to us. We have been after these programs for a long time. Beginning in the year, we talked specifically about some things that we were doing around just being thoughtful with respect to headcount, discretionary spend coming out of some of the Illinois decisions. I think we continued to lean into them. We continue to find more opportunities. Looking at spans and layers, looking at simplification. We just have an opportunity for us to be more consistent across our platform, which drives efficiencies, back-end reduction, overhead cost, etc. We do a lot of benchmarking in this. You see some of that public benchmarking, and we benchmark well, but in areas we have opportunities. So wherever we are benchmarking, constantly looking at how do we move up a quartile. I think the team is absolutely committed to this, and we have not exhausted all the opportunities at this point."
},
{
"speaker": "Carly Davenport",
"content": "Got it. Great. Thanks so much."
},
{
"speaker": "Operator",
"content": "The next question comes from the line of Julien Dumoulin Smith with Jefferies. Please proceed."
},
{
"speaker": "Brian (for Julien Dumoulin Smith)",
"content": "Yeah. Hi. Good morning. It is actually Brian. I am still on for Julien."
},
{
"speaker": "Marty Lyons",
"content": "Brian?"
},
{
"speaker": "Brian",
"content": "Alright. Hey. Just to follow-up on Ameren Transmission. It looks like just the assumption in this 2025 versus 2024 looks like growth in rate base is pushing 9%, and it seems that the growth there is accelerating as we move through the five-year plan, approaching, I guess, the double-digit overall rate base growth CAGR. Is the near term in 2025 and 2026 really just the prior MISO tranche projects that have been approved and that you are developing? And then is there any possibility of these tranche two projects being pulled forward versus the early to mid-2030s target dates?"
},
{
"speaker": "Marty Lyons",
"content": "As it relates to the MISO projects, the tranche one projects, I tell you, the construction there is really going to take place between 2026 and 2030 is our projection today. Some of these MISO tranche 2.1 projects, those will probably go in service in the 2032 to 2034 time frame. We think most of the expenditures for those are outside of the current five-year period. Although, we will be certainly looking to accelerate those if possible. There is no reason that tranche two project work and tranche one project work cannot overlap. So we will be looking to bring this to fruition for the benefit of our customers and communities as soon as we can once they are approved and once they are assigned to us. Otherwise, we always have ongoing projects in the transmission space that are outside of those that are part of the tranche one or tranche two that are approved through annual MISO processes. Those continue to be foundational in our overall spending and growth in the transmission space."
},
{
"speaker": "Michael Moehn",
"content": "The only thing I might add to that is, you think about those $55 billion pipeline. We have talked about this, about $5 billion is in there with respect to the LRTP projects. Brian, so you think about tranche one, we had the $1.8 billion assigned, the $700 million on the competitive projects. There will be some variation of those ultimately where they ended up settling out, but then you have tranche 2.1, which will again we will see what ultimately gets assigned or competitive, but there is $3.6 billion of eligible projects. Then you are going to obviously roll into this 2.2 tranche. I am just giving you the math if you kind of want to think about that $5 billion, and it is, yeah, you can see the pipeline associated with getting there pretty easily."
},
{
"speaker": "Brian",
"content": "Okay. Great. And just as we look towards the 2025 Missouri legislative session, how active will Ameren be or involved in any proposed bills that I think might need to be proposed as early as this December, whether it is PISA for fossil fuel or gas-fired generation, any road for or, I guess, expanding expediting the generation review, which would tie into maybe your February 2025 IRP update."
},
{
"speaker": "Marty Lyons",
"content": "Yeah. Look, those are all potential considerations. They are very logical. Last session, we were advocating for things along those lines, which was the expansion of PISA to be able to cover generation assets, extending the sunset date on the PISA, the generation assets that are included in our IRP. We did, and we will continue to advocate for the right of first refusal on transmission because, again, we think it is critical to get these transmission projects done sooner rather than later. Just talked about the great benefit-to-cost ratios they have got. Of course, I think their key as well is building incremental generation to making sure that we have got reliable power, low-cost power here in our region. Those are going to be key things that we focus on, and then my sense is that there will be a variety of other things that might be considered as we focus on, as a state, on economic development, job creation, and making sure that we have got a strong, reliable, affordable, balanced portfolio of energy resources to be able to meet the needs of prospective customers. Certainly, we will be considering all those things as we move towards that next legislative session."
},
{
"speaker": "Brian",
"content": "Great. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. The next question comes from the line of David Paz with Wolfe Research. Please proceed."
},
{
"speaker": "David Paz",
"content": "Hi there. Good morning."
},
{
"speaker": "Marty Lyons",
"content": "Morning."
},
{
"speaker": "David Paz",
"content": "You may have just hit on this, but let me ask it a little differently. Could you maybe elaborate on how these potential agreements with large load customers may transpire? Could they entail potential new generation that the customer helps cover directly, and then just how are regulators and policymakers facilitating those types of discussions if they are?"
},
{
"speaker": "Marty Lyons",
"content": "Yeah. No. Good question. As we look at some of the potential load growth specifically in Missouri where we are vertically integrated, we own generation. We have got to be thoughtful about what incremental resources might be needed to serve some of the incremental load. We mentioned on our last call with respect to the 350 megawatts of additional load that has been announced with the construction agreements. We have the available resources to be able to serve them. But as these load forecasts grow, we are going to need to consider additional resources. That is under consideration now. That is going to be what we will be trying to work through as we think about updating our integrated resource plan early next year. I think that plan when we file it will deliver more clarity in terms of our thoughts there. With respect to the incremental cost, it is something we need to think through as we think about the incremental investments that we made to serve all of our customers, including these additional customers, just need to think through the appropriate portion of the costs so that all parties are treated fairly. That is ongoing consideration, ongoing dialogue with some of the entities that are looking to expand here. I think those conversations will continue over the coming months."
},
{
"speaker": "Michael Moehn",
"content": "Hey, David. It is Michael. I am just pointing out the obvious. Historically, we were a bit long. Right? We began this transition, and we have some of these plants closing. Obviously, we have less length today. Adding Castle Bluff that Marty spoke about earlier, that is definitely in the right direction. That is exactly what the team is evaluating as part of this IRP evaluation and whether we are going to need to file again, trying to take some various scenarios under these load growth opportunities and match that really up against our generation to see if we need to add additional generation on top of that."
},
{
"speaker": "Marty Lyons",
"content": "Great. I would just say this. When you look at our IRP, you can see the elements that we might bring forward. We had renewable resources in there. We will be evaluating. Can we pull those forward? Can we pull forward battery storage technology? As Michael said, we have got some simple cycle, combined cycle that we need to add some additional gas-fired generation. These are the elements we are looking at as we think about updating that IRP."
},
{
"speaker": "David Paz",
"content": "Okay. That makes sense. Then just on 2025 quickly, do you anticipate your consistent EPS growth guidance from February to be based off of 2025?"
},
{
"speaker": "Marty Lyons",
"content": "Got it. I mean, that has sort of been our historical practice, David. We will update based on whatever that midpoint is for that 2025 we have got. In this case, it is that $4.95. So that would be the expectation."
},
{
"speaker": "David Paz",
"content": "Okay. Great. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. The next question comes from the line of Nick Campanella with Barclays. Please proceed."
},
{
"speaker": "Nick Campanella",
"content": "Hey. Good morning. Thanks for taking my question. I got up a little late. I will try not to repeat. But clearly, you gave 2025 guidance earlier here, which is a sign of confidence going into next year. Capital is going up. How much capital is going up in the near term versus kind of the long term of your financial plan? Does that impact your equity needs? Do you still just kind of programmatically lean on the ATM, or would you contemplate other mechanisms around that? Thank you."
},
{
"speaker": "Michael Moehn",
"content": "Hey, Nick. Michael here. From a capital perspective, I mean, I just continue to think in terms of the $21.9 billion that is out there. We have talked about a number of factors that we are updating for and just spent some time talking about this IRP. That is the process that we are going through, going through our typical capital planning process as we speak and putting the final touches on that. That is what we will come out with here in February. From a financing perspective, the plan that we put out there last February still stands today, focused on that $300 million. Got that largely done for 2024. Starting to lean into the 2025 piece. Got about $155 million of that done. In terms of ongoing financing assumptions, we have talked about this. We like our ratings where they are, the Baa1, BBB+. Downgrade threshold of 17 at S&P is, we have got quite a bit of margin there. The threshold metric for us is on S&P. It is 17. That is the one we will continue to watch. From a financing assumption standpoint, I would assume what we have sort of put out there at this point. So maintaining those and that consolidated equity ratio, around 40%, which is where it is today."
},
{
"speaker": "Nick Campanella",
"content": "Thanks a lot. I appreciate that. Then maybe some considerations with the election that just happened. I believe that there are some EPA-driven investments in your plan today. Do you think any of that could change? How would you quantify your positioning around the new candidate? Can you also clarify if you have transferability cash flow in the plan? Thank you."
},
{
"speaker": "Marty Lyons",
"content": "Yeah. There is a lot there. Obviously, the election just happened. When we think about the election, overall, one of the things to keep in mind is our strategy and our priorities of the company certainly do not change. Our focus is on making great infrastructure investments for the benefit of our customers and communities, advocating for energy policies to maximize that value, and, of course, as I mentioned before, seeking great economic development opportunities. We are going to be working with policymakers to make sure we maximize the benefit of those for our communities. While you did not ask about this, I think the most significant area of focus coming out of the federal elections probably could be around tax policy. As you know, as a fully regulated company, all the increases and decreases in taxes flow directly through to our customers' rates. Things like the corporate income tax rate, value of tax credits, those are things that have pretty meaningful effects on our customer rates. My sense is with Republican leadership, it is going to certainly be less likely that we see an increase in corporate taxes. I think that is positive for our customers from a bill perspective. I do expect there is going to be a conversation around some of these clean energy tax provisions in the IRA. I think we in our industry will all engage with policymakers on the considerations. My expectation is that Republicans will probably take a surgical approach to adjustments to the IRA given some of the direct customer benefits. For us, specifically, I would say the most meaningful benefits of the tax credits are around solar, battery storage, nuclear, and wind. Those are some of the things we will be thinking about. You mentioned transferability. Transferability of tax credits is important to us. We will make sure that policymakers are certainly aware of the importance of those too. Frankly, based on our IRP that we have on record, we filed, all of those things have a value of about a billion and a half positive value. Those tax credits do to our customers in Missouri alone. It is a significant benefit, and that is over about a ten-year period, the next ten-year period in our IRP. We will just make sure that as we engage with policymakers, whatever they decide, that at least they have those facts and they are aware of those benefits that we expect to have for our customers. At the end of the day, you should know that the investments in our system that we are going to make are whatever we think are appropriate from a reliability and affordability perspective and as we continue to adopt some of the new technologies that are out there. I think those are the biggest points with the election. You had mentioned EPA rules. I think that with respect to the EPA rules and the CapEx that we have in our plans today, I do not see those as changing. The EPA's greenhouse gas rules, on the other hand, that are working their way through the courts, I do expect that, ultimately, those rules would be stayed given some of the provisions that are in them with respect to carbon capture and storage and co-firing with natural gas. We will see what happens with respect to those proposed rules as we go through sort of a change in administration and change in legislature. But I think those rules, personally, in my mind, are flawed as they stand today. Those would be my comments. Any other questions from you?"
},
{
"speaker": "Nick Campanella",
"content": "I would say that you answered the four-part question very well. I appreciate it. Thanks."
},
{
"speaker": "Marty Lyons",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this concludes our question and answer session. I will turn the call back to Marty Lyons for closing remarks."
},
{
"speaker": "Marty Lyons",
"content": "Terrific. Hey, thank you all for joining us today. As you can tell, we remain absolutely focused on closing out the year very strong, and we look forward to seeing many of you at the conference next week. Again, thank you very much, and everybody have a great day."
},
{
"speaker": "Operator",
"content": "This concludes today's conference. You may disconnect your lines at this time. Enjoy the rest of your day."
}
] |
aee | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Greetings, and welcome to Ameren Corporation's Second Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations and Corporate Modeling for Ameren Corporation. Thank you, Mr. Kirk. You may begin."
},
{
"speaker": "Andrew Kirk",
"content": "Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer as well as other members of the Ameren management team. This call contains time sensitive data that is accurate only as of the date of today's live broadcast and redistribution of this broadcast is prohibited. We have posted a presentation on the amerenvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday, as well as our SEC filings for more information about the various factors that cause actual results to differ materially from those anticipated. Now here's Marty, who will start on Page 4."
},
{
"speaker": "Marty Lyons",
"content": "Thanks, Andrew. Good morning, everyone. We're pleased to have you joining us today as we cover our second quarter 2024 earnings results and recent developments across our business segments. Overall, it was a very productive and positive quarter. As always, our dedicated and experienced management team remained laser focused on executing our strategic plan, positioning us well to take advantage of future opportunities to drive significant value for our customers and shareholders. Speaking of opportunities, I'm tremendously excited about the investment opportunities ahead for us in this dynamic period for the utility industry. In my 20 plus years with the company, our economic development and sales growth pipeline is the most robust I have seen, which I'll touch on more in a moment. First, let me cover our earnings and operations results for the second quarter. Yesterday, we announced second quarter 2024 earnings of $0.97 per share compared to earnings of $0.90 per share in the second quarter of 2023. Key drivers of these strong results are highlighted on this page. And for the six months of the year, our results have been solid, driven by infrastructure investments made for the benefit of our customers, encouraging weather normalized retail sales and disciplined cost control. We remain on track to deliver earnings within our guidance range of $4.52 per share $4.72 per share. Turning to Page 5, our strategic plan is designed to deliver on our steadfast commitment to providing safe and reliable energy in a sustainable manner. We do this by investing in rate regulated infrastructure, enhancing regulatory frameworks, and advocating for responsible energy policies, while optimizing operating performance through ongoing continuous improvement in order to keep rates affordable. I'd like to express appreciation for my Ameren coworkers unwavering commitment to our strategy. On Page 6, we highlight our key accomplishments in the second quarter as we execute our strategy to deliver on our 2024 objectives. The strategic infrastructure investments we have made in the first six months of the year are designed to maintain the safety and reliability of the energy grid, to modernize the grid, and to harden against more frequent severe weather events. Over Memorial Day weekend, severe thunderstorms swept through Missouri and Illinois, bringing strong winds, flooding, and golf ball sized hail. As always, our teams quickly and safely assessed the damage, cleared trees, and worked long hours to make repairs to restore power as quickly as possible, allowing critical infrastructure to continue operations, businesses to remain open, and homes to stay cool and safe. But even better, during the first half of 2024, over 22,000 Missouri and 11,000 Illinois customer outages were prevented during storms due to rapid detection, rerouting and restoration of power by automated switches across our system and over 6.4 million minutes of customer outages across both states were avoided due to investments to modernize the grid. As we look ahead to future investment for the benefit of our customers, it's important to operate under constructive regulatory jurisdiction and legislative policies. This quarter, we've made significant regulatory advancements, which Michael and I will cover in more depth on the coming slides. At Ameren Missouri, our largest business segment, we continue to make regulatory progress with the Missouri Public Service Commission for new solar and natural gas generation, which supports our integrated resource plan. Our Cass County solar project was approved in June and is expected to be one of three solar projects placed in service this year, which collectively, along with Huck Finn and Boomtown, represent an investment of approximately $1 billion. The Commission also approved a constructive order for the securitization of costs associated with our Rush Island Energy Center in connection with its retirement in October of this year. And finally regarding generation updates, in June, we filed the CCN with the Missouri PSC for our dispatchable Castle Bluff Energy Center. Overall, we continue to make significant progress on our smart energy plan in Missouri, a combination of distribution, transmission and generation projects to bolster reliability and empower our customers. In late-June, Ameren Missouri filed its electric rate review request with the commission, which is substantially driven by infrastructure improvements made under this plan. If approved, Ameren Missouri customer rates would still remain well below national and Midwest averages. Turning to transmission, the Midcontinent Independent System Operator or MISO's long range transmission plan continues to evolve. In April, MISO concluded the bid evaluation process for the Tranche 1 competitive projects in our service territory, ultimately awarding all three competitive projects to Ameren. And they continue to develop the $23 billion to $27 billion Tranche 2.1 project portfolio, which promises meaningful brownfield and greenfield investment opportunities within our service territory. Finally, in Illinois, the Illinois Commerce Commission issued an order on the rehearing of Ameren Illinois' multi-year rate plan for 2024 through 2027. Importantly, the order supports our planned base level of grid reliability investment that is reflected in our 2024 earnings guidance. Further, the ICC order reflects 94% of the rate base in our ongoing multiyear rate plan proceeding. We look forward to an ICC decision on the multiyear grid investment and rate plans by the end of this year. In addition to these significant regulatory advancements, we have seen strong operational performance across the business with a focus on delivering safe, reliable, affordable energy service through enhanced automation, optimization, and standardization, which Michael will cover in more detail. Moving now to Page 7 for an update on our expanding customer growth opportunities. On the first quarter call, we touched on economic development opportunities in our service territory. Since then, collectively across Ameren Missouri and Illinois, we have seen a significant increase in the number of data center inquiries and formal engineering reviews underway, which combined would represent thousands of megawatts of additional demand. Our teams along with a variety of state and local stakeholders are working aggressively to attract these and manufacturing and other economic development opportunities to our service territories. Of course, Ameren has a strong track record of reliable infrastructure development and we have the people, resources, expertise and partnerships needed to go after these opportunities. Further, our Missouri and Illinois territories offer an attractive value proposition for commercial and industrial customers. This includes sites with transmission, fiber and water access coupled with competitive rates and tax incentives. In Missouri, we also have reliable generation with a growing portfolio of clean and dispatchable assets and the ability to expand in order to serve these economic development opportunities. So far this year, a construction agreement has been executed for a 250 megawatt data center, which would represent an approximate 40% and 5% annualized increase to Ameren Missouri's industrial megawatt hour sales and total megawatt hour sales respectively upon completion and full ramp up. Our construction to extend transmission and distribution services to support this data center is expected to be completed in December of 2025 with the customer ramping up operations from 2026 through 2028. In addition, we've received expansion commitments or executed new contracts for over 85 megawatts of additional load for manufacturing, smaller data centers and other industries across both states. We would expect these new and expanding customers to be fully ramped up by 2028 with sufficient generation to serve them, creating value for all customers over time. We're excited about these opportunities, which will bring jobs and additional tax base to benefit our state and local communities. Importantly, the new data center and other customer commitments were not reflected in the weather normalized sales expectations included in our five year earnings per share growth guidance issued in February. Of course, the ultimate net impact of any incremental load will be dependent upon a variety of factors, including customer ramp up time, additional generation investment needs, timing of rate reviews and tariff structures. To that end, we currently expect to update our Ameren Missouri Integrated Resource Plan or IRP by February 2025 following a careful evaluation of potential load growth and our planned generation portfolio. And we will work with all stakeholders to bring the economic benefits of these customer expansion opportunities to all customers, our communities, and shareholders. Turning to Page 8. We continue to execute our Missouri IRP, which focuses on maintaining and building a diverse generation portfolio to ensure a reliable, low cost and cleaner mix of energy resources to serve our customer needs. We had two key developments this quarter. First, in June, the Missouri PSC approved the CCN for the 150 megawatt Cass County solar facility, which is expected to begin serving customers in the fourth quarter of this year. This facility will serve business customers who subscribe through our Renewable Energy Solutions program to receive all or part of their energy needs from renewables. The Missouri PSC approval followed a successful auction held in May, where customers across Missouri signed up to take part in the Renewable Energy Solutions program expansion. Demand remains strong for programs that bring businesses readymade solutions to help them reach their sustainability goals. Second, in June, we also filed a CCN with the Missouri PSC for our Castle Bluff Energy Center, an on demand 800 megawatt natural gas simple cycle facility to serve as a reliable backup source of energy ready to operate on the most extreme winter nights and summer days. Castle Bluff, subject to commission approval, represents an approximately $900 million investment and is expected to be in service by the end of 2027. Moving now to Page 9 for an update on the MISO long range transmission projects. MISO and its transmission owners continue to engage in economic analysis of the Tranche 2 proposed set of projects. In June, an initial set of Tranche 2 projects now referred to as Tranche 2.1 were proposed with a cost estimate of $23 billion to $27 billion. The portfolio identifies a need for a mix of brownfield and greenfield transmission lines of varying voltage levels and new or improved substations in both our Missouri and Illinois service territories. Ultimately, we won 100% of the Tranche 1 projects in our service territories, reflecting our ability to deliver timely, cost effective, high value projects to our communities. We expect we'll be able to compete for Tranche 2 greenfield projects in a similarly competitive manner to better serve our customers. MISO expects to approve the Tranche 2.1 projects by the end of the year. Once approved, MISO plans to propose a second set of Tranche 2 projects or Tranche 2.2 in 2025 to address further transmission needs in the North and Midwest regions. Turning to Page 10, looking ahead over the next decade, we have a robust pipeline of investment opportunities of well over $55 billion that will deliver significant value to our stakeholders and create thousands of jobs for our local economies. In addition, we see several tailwinds forming across our business segments. Specifically, we are seeing significant sales growth potential, which I discussed a few moments ago, and this may require us to reassess our Ameren Missouri IRP and further expand our generation investment pipeline. We're seeing a growing focus amongst Missouri stakeholders on generation planning and reliability, and we see a strong need to embrace enhanced reliability focused policies in legislative sessions to come. Further, MISO's analysis of transmission needs in the Midwest region will likely identify additional opportunities to improve the ability to move electricity across the region. Maintaining constructive energy policies that support robust investment in energy infrastructure and to maintain reliability while transitioning to a cleaner energy future in a responsible fashion will be critical to meeting our country's growing energy needs and delivering on our customers' expectations. Moving to Page 11, in February, we updated our 5-year growth plan, which included our expectation of a 6% to 8% compound annual earnings growth rate from 2024 through 2028. This earnings growth is primarily driven by strong compound annual rate base growth of 8.2%, supported by strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. Investment in Ameren presents an attractive opportunity for those seeking a high quality utility growth story. Combined, our strong long term 6% to 8% earnings growth plan and an attractive and growing dividend, which today yields 3.4% result in a compelling total return story. We have a strong track record of execution, a strong balance sheet, and an experienced management team. I'm confident in our ability execute our investment plans and strategies across all four of our business segments. Again, thank you all for joining us today and I'll now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"content": "Thanks, Marty, and good morning, everyone. I'll begin on Page 13 of our presentation. Yesterday, we reported second quarter 2024 earnings of $0.97 per share compared to $0.90 per share for the year ago quarter. We delivered strong earnings performance during the quarter, driven primarily by strategic infrastructure investments and disciplined cost management. While earnings saw a strong benefit from favorable weather, we also continue to see encouraging levels of customer growth and energy usage. Further, through disciplined cost controls, operations and maintenance expenses companywide were flat for the quarter when excluding the impacts from non-reoccurring items as part of the 2023 Ameren Missouri rate order. Additional factors that contribute to the overall $0.07 per share increase are highlighted on this page. Year-to-date results are outlined on Page 24 of today's presentation. Notably, year-to-date 2024, we've experienced strong weather normalized industrial sales growth of 3% as compared to the prior year period. This has been driven primarily by significant growth from our existing large primary service customers in the digital and data analytics industry. We expect to see continued growth as we bring on new customers and support existing customers' expansions in the coming years. Further, we continue to see strong weather normalized kilowatt hour sales growth across all rate classes in Missouri. Moving to Page 14, as we think about the remainder of the year, we remain confident in our 2024 earnings guidance range and continue to expect earnings to be in the range of $4.52 to $4.72 per share. The warmer spring and early summer temperatures experienced this quarter offset the mild first quarter as we are flat year-to-date for weather. In addition, as we outlined in our first quarter call, we expect to see meaningful year-over-year O&M reductions in the second half of the year, reflecting several cost savings initiatives implemented in 2024, the benefits of which continue to build throughout the year. I encourage you to take these and other supplemental earnings drivers noted on the slide into consideration as you develop your expectations for quarterly earnings results for the remainder of the year. Moving to Page 15, Ameren Missouri Regulatory Matters. In June, the Missouri PSC approved the securitization of approximately $470 million of costs associated with the scheduled retirement of our Rush Island Energy Center on October 15. We expect the difference between our original ask of $519 million and the final order to be reflected in future rate proceedings. Turning to Page 16. In late June, Ameren Missouri filed for a $446 million electric revenue increase with the Missouri PSC. 90% of this request is driven by increased capital investment under Ameren Missouri Smart Energy Plan to recover investments in major upgrades to the electrical system and investments in generation. The request includes a 10.25% return on equity, a 52% equity ratio and a December 31, 2024 estimated rate base of $14 billion. We expect a decision from the Missouri PSC by May 2025 with new rates affected by June of next year. Turning to Ameren Illinois on Page 17. Under Illinois formula rate making, which expired at the end of 2023, Ameren Illinois was required to file annual rate updates to systematically adjust cash flows over time for changes in cost of service and to true up any prior period over or under recovery of such cost. For the final electric distribution reconciliation of 2023's revenue requirement, in July, the ICC staff recommended a $157 million base rate increase compared to our updated request of $158 million. The full amount would be collected from customers in 2025, replacing the prior reconciliation adjustment of $110 million that is being collected during 2024. This will result in a net customer impact of $48 million or an approximately 1.5% increase in the total average residential customer bill. The ICC will review this matter in the months ahead with a decision expected by December of this year and new rates effective early next year. Turning to Page 18 for an update on the multiyear rate plan covering 2024 through 2027. We are pleased to receive a constructive decision from the ICC in the rehearing of our multiyear rate plan. Recall in January, the ICC upon approving our rehearing request had ordered that we identify a base level investment needed to adequately operate the grid safely. In June, after extensive stakeholder engagement and additional analysis provided by our team, the ICC approved a $285 million cumulative revenue increase from 2023, representing approximately 94% of our rehearing request and a 1% average residential bill increase for 2024. Excluding OPEB, the order represents approximately 99% of our rehearing rate base request and also 96% of the rate base included in the revised multiyear rate plan, which will be reviewed by the commission later this year. Interim rates for this order were effective in late June and will remain in effect until superseded by a revised MYRP order. The [real] was a positive first step in getting a base level grid investment approved. However, there is still much work to be done in the State of Illinois to achieve the objectives laid out in The Climate and Equitable Jobs Act passed in 2021. Approval of our revised multiyear grid plan and rate plan will allow us to appropriately invest more in the energy grid to preserve safety, reliability and day-to-day operations of our system. And make progress towards an affordable, equitable clean energy transition. In July, the ICC staff recommended a cumulative revenue increase of $302 million versus our July 2024 updated request of $334 million with the variance driven primarily by the renewal of OPEB and certain capital projects from rate base. Annual revenues will be based on actual recoverable costs year-end rate base and a return on equity adjusted for any performance incentives or penalties provided they do not exceed 105% of the approved revenue requirement. Lastly, with the narrowing of remaining issues, cross examination was weighed for hearings earlier this week, and we expect an ICC decision by December with rates effective January 1, 2025. Moving to Page 19. We provide a financing update. We continue to feel very good about our financial position. Our Ameren parent credit ratings of Baa1 and BBB+ at Moody's and S&P, respectively, compare favorably to the peer average, providing us with financial flexibility. To maintain our credit ratings and a strong balance sheet while we fund a robust infrastructure plan we expect to issue approximately $300 million of common equity in 2024. By the end of 2023, we had sold forward approximately $230 million of this $300 million through the at-the-market or ATM program consisting of approximately 2.9 million shares, which we expect to issue by the end of this year. Together with the issuance under our 401(k) and DRIP plus programs, our ATM equity program is expected to support our equity needs in 2024. Turning to Page 20. Ameren continuously strives to find ways to work more efficiently to reduce costs for our customers. At the start of the year, we instituted several cost savings initiatives, including a detailed review of all hiring with a focus on spans and layers, reducing some of our contractor and consultant workforce. And deferring or eliminating discretionary spending while we identified further opportunities for sustainable cost reductions. Since then, we have enhanced our continuous improvement in disciplined cost management efforts through numerous customer affordability initiatives that will provide greater collaboration and coordination across our business. Through company-wide automation, standardization and optimization, we are streamlining processes, leveraging shared capabilities and eliminating redundant work to provide sustainable cost savings. Our leadership team is committed to prudently managing costs on behalf of our customers, while providing quality service and reliability. Turning to Page 21. We're off to a solid start in the first half of the year and expect to deliver strong earnings growth in 2024 as we continue to successfully execute our comprehensive business strategy. We continue to expect strong earnings per share growth driven by robust rate base growth and disciplined cost management. As Marty mentioned, we see several tailwinds forming in the months and years ahead. We have the right strategy, team and opportunities to create value for our customers and our shareholders. We believe this growth will compare favorably with the growth of our peers. Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"content": "We'll now conduct a question-and-answer session. [Operator Instructions]. Our first question is from Shar Pourreza with Guggenheim Partners."
},
{
"speaker": "Shar Pourreza",
"content": "So just real quick on Rush Island kind of the bid-ask saw you guys got a third-party media a few days ago. Any sort of read through from that to timing or where the process could land within that $100 million range?"
},
{
"speaker": "Marty Lyons",
"content": "Yes. Thanks, Shar. We posted a slide in the appendix, Slide 27. The just provides to be listening a little bit of background in the case. But we were pleased that the judge ordered mediation, which hopefully will lead to some constructive settlement negotiations between the parties. We expect the mediation to take place this summer in the event that mediation isn't successful in reaching a settlement between the party. We would expect that the judge would likely have evidence year hearings in September, and we'd still get a resolution of the case this year. So I don't think any read through on exactly where we'll end up between -- in that bid-ask spread, but nonetheless, we think, a positive step forward."
},
{
"speaker": "Shar Pourreza",
"content": "Okay. Perfect. And then just on the transmission side, and obviously, it was a little topical as part of the on Tranche 2.0, 2.1. Any color at this point on how to think about the competitive allocation within that? Is it line by line, greenfield versus brownfield? And just remind us on potential timing of spend associated with these, what are in-service dates."
},
{
"speaker": "Marty Lyons",
"content": "Yes, Shar. All good questions. So when you look at Tranche 2.1 and you look at the map that we provided on Page 9, you see a breakdown between the 765 kV lines and the 345 kV lines, and you see some of those in Missouri and Illinois. We're pretty excited about the way this is shaping up overall. With respect to the red lines, we see those as being more likely brownfield the green dotted lines more likely greenfield. And so you see a mix of those things there. At this point, no specific cost estimates for those lines that run in our service territory. The $23 billion to $27 billion numbers we give overall or MISOs estimates for the total portfolio, but I can't give you a breakdown right now on those that are in our footprint. And of course, if the brownfield, we would expect them to be allocated to us. If the greenfield, we would expect to compete for those. And we were very pleased with our ability to compete for the Tranche 1 projects. As we noted on our -- in our prepared remarks, really winning all three that were in our service territory. And Shar, at the end of the day, we think it speaks to our ability to deliver these projects in a timely way in a cost-effective way. Again, we feel like we are good at constructing these and great at operating them. And we've done a great job partnering with munis, co-ops, contractors and others to make sure we can deliver. Now with respect to the time line on the Tranche 1 projects, we really expect the construction of those to extend from 2026 to 2030. I think we have about $1.6 billion or so in our 5-year plan for those Tranche 1 projects. And then with respect to the Tranche 2.1 projects, I think largely that spend is probably outside of our 5-year plan. However, there's really no reason that these have to happen sequentially to the extent that any of these Tranche 2.1 projects can be started and overlap with some of the work on Tranche 1. No problem there. And again, excited about this Tranche 2.1, but also expect in Tranche 2.2 that we'll see even more projects in our Missouri and Illinois footprint. And so overall, again, just very pleased with the work MISO is doing here and the responsiveness to stakeholders in the process."
},
{
"speaker": "Operator",
"content": "Our next question is from Nick Campanella with Barclays."
},
{
"speaker": "Nick Campanella",
"content": "So I just wanted to ask on the data center construction slide. It just seems that you're really only kind of focusing on things where third is turning but you have -- looks like gigawatts of opportunity. The Missouri system seems to have capacity to supplement this 85-plus megawatts, if I'm right. But what do you think the tipping point is to really accelerate procurements in this next IRP? And I guess how many more megawatts do you think you'll have realistically kind of have clarity on by the time you get to that fine line?"
},
{
"speaker": "Marty Lyons",
"content": "Yes. Nick, those are all good observations and takeaways from the information we provided on Slide 7. When you look at that graph on the right, there, we talk about the economic development pipeline we have thousands of megawatts or gigawatts of opportunity. And in fact, that is true. So we've got just a number of parties that are doing engineering reviews and interconnection studies, and all of that's great. Those are initial processes. What we called out on the left, however, is -- you mentioned it turning. I would say when we have construction agreements, it means we have an executed agreement between ourselves and a data center, which confirms transmission capacity, cost to extend service and time lines, et cetera. And importantly, obligates the customer to pay for that extension of service with down payments for equipment. So you're right, things have begun to take shape. And so that's when we felt like we can move it into the category of really kind of talking about what we see in terms of the time line, how that would ramp up its overall size. And so pretty excited there to have a 250-megawatt data center that we see starting to use service in 2026 and ramping up through 2028. And of course, that's a nice tailwind as we think about that usage over that period of time. And then mentioned this other 85 megawatts. We're not just going after data centers from an economic development standpoint, really going after manufacturing and others. And that 85 megawatts that you mentioned is really a mix of manufacturing, smaller data centers, et cetera. So look, we're pretty excited. There's a -- certainly, I think you mentioned there's a concentration of interest in Missouri. And to the extent that this load grows, that very well may require that we would provide an update to our IRP. So again, we expect that over the coming 6 months or so that we'll see a firming of some of these other economic development opportunities. And as we further assess that load and what it means to our sales, and we give thought to what that means to our generation portfolio. That's where we expect that we would need to update our IRP with in mind right now, we're thinking February of next year."
},
{
"speaker": "Michael Moehn",
"content": "Nick, this is Michael here. I might just add. That's a great update from Marty and just from an overall macro perspective, I mean, I think the backdrop in the St. Louis region is positive though, even putting aside this data center opportunity. I think we noted this in the slide, year-to-date sales residential up 2.5%, commercial 1.6%, industrial 3.1%. So a little bit over 2% year-to-date, which is a mark change where we've been in the past. And so there are some really positive things happening about 25,000 jobs created in the past year in the St. Louis region. One of the kind of hotter job markets here, unemployment rates running below the national average. So all of those things, I think, bode well with respect to all the things that Marty talked about as well."
},
{
"speaker": "Nick Campanella",
"content": "And I guess just to count a few things that have changed in the fourth quarter when you kind of set this guidance of the 6% to 8%. The IRP is coming. You have this Tranche 2 visibility to MISO. I understand that, that's a little bit more longer dated. Obviously, we have more kind of clarity on Illinois with the rehearing process. But your stock is also up year-to-date, and that should also help your kind of financing accretion, if you're still doing that $600 million a year through the plan? And in the fourth quarter, you kind of talked about tracking towards the 6.2%. You said 6.2% when kind of discussing the 6% to 8%. Just how do you feel about your position within the 6% to 8% now? Has that improved a bit, with some of these tailwinds? How should we think about that?"
},
{
"speaker": "Marty Lyons",
"content": "Yes. Yes, Nick. I'd tell you that was a great question/statement. I think you got it right. If you look back at our track record over the past 10-plus years, we've been growing EPS at north of 7%. And that's our goal, which is to deliver at or above the midpoint of our earnings per share growth range. And as I sit here today versus where we were 6 months ago, I agree with you that there are a number of tailwinds that have been forming. Inflation has been interest rates have been moderating. Stock price has been improving. You're all right on all those things. Our demand outlook has been improving with data centers and other. Michael just talked about some of the job growth that we're seeing in the Greater St. Louis region. We're really excited about these transmission investment prospects we have with Tranche 1, Tranche 2.1, Tranche 2.2, all very exciting. We still have a tremendous amount of investment needed for grid modernization and the clean energy transition and we've got a really strong balance sheet to be able to get it done. So very excited about those prospects and again, when we look back just in terms of what our team was able to accomplish in the second quarter, I'm very proud of that overall. We continue to make great investments for the benefit of our customers. And on Page 6, we'll set out a half dozen things that we completed during the second quarter that really position us for success in the years ahead. And I have to say this was all accomplished by a team that is also, at the same time, really focused on customer affordability. We put a lot of cost savings initiatives in place this year and the team overcame that and delivered a really strong quarter from an operations and earnings standpoint. And again, I think you're right, we're set up very well for the future given some of the tailwinds we have."
},
{
"speaker": "Operator",
"content": "Our next question is from Jeremy Tonet with JPMorgan."
},
{
"speaker": "Jeremy Tonet",
"content": "Just wanted to pick up -- I guess, start with the Chevron doctrine here. In recent changes, does that impact your thought process going forward? Or any thoughts you could share there?"
},
{
"speaker": "Marty Lyons",
"content": "Yes. Nick, I don't know that it really changes our thought process going forward. Obviously, Chevron is going to probably have far-reaching implications for federal agencies and core proceedings going forward. Of course, it doesn't affect any prior cases. I mean I think when the Supreme Court ruled on Chevron, they basically said, \"Hey, this doesn't call into question any prior cases”. But my sense is it will impact ongoing rule makings and court reviews as it relates to things coming out of FERC or things coming out of EPA, et cetera. So again, I think there'll be far-reaching impacts, but I'll leave it to the lawyers that are working through all those matters to assess how it may impact things."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. This is Jeremy. But Nick a friend, so we're all good here. But maybe to follow up on the -- just as far as that -- it just seems like a vast opportunity set with the multiple gigs you're talking about and how you think about, I guess, conversion rate there. It still seems like a sizable opportunity. But just wondering, there talks about double counting out there. So just wondering how you, I guess, think about that whole process."
},
{
"speaker": "Marty Lyons",
"content": "Yes, Jeremy. I don't think I called you Nick, but if I did, I apologize. But in any event, Jeremy, it's a good question. I think, again, when I did respond to Nick earlier, I think that, again, we're going to be conservative, I would say, in how we bring these things into our guidance. Obviously, when we gave our guidance at the beginning of the year, none of this was in our load growth projections. And so we're going to be thoughtful about it. As I said earlier, we thought it'd be good to share with you all the economic development pipeline that we have, and it's robust. But again, a large amount of this is still in the process of engineering reviews and interconnection studies, and so we're really excited about that. And as I said in the prepared remarks, our team as well as state local, stakeholders are working hard to bring these fruition. We think that our -- both of our states, Missouri and Illinois should be very competitive with respect to these opportunities. Again, access to transmission, fiber, workforce, water, all those things, both of our states have very good sales and use tax incentives. I think we're two of just 26 states that have these and our incentives are very competitive with those that do. So we feel like we're positioned very well to convert these and bring these to fruition. But to your point, Jeremy, it's hard to know with some of these folks. They're looking at our sites, they're looking potentially at sites in other states. And so we're going to be conservative about how we bring those into our guidance. Again, just repeating, we felt comfortable talking about this 250-megawatt data center because we have a construction agreement. We think that's a firmer position to be in. And then as we update our sales guidance again in February, we'll incorporate those opportunities that we believe are firmer like this one that has a construction agreement."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. That's helpful there. Maybe just picking up real quick with stakeholders in the state, our conversations with stakeholders in Missouri seem to indicate a view of constructive commentary, I guess, coming out of the commission there, and we've seen some kind of changes over time with the composition. I'm just wondering, any updated thoughts you could share on Missouri. Any changes you see there?"
},
{
"speaker": "Marty Lyons",
"content": "Well, I would just say that I'd refer you back just to even this past quarter, Jeremy, and some of the things that we accomplished from a regulatory standpoint, which is back on Page 6. The approval of the Cast County project. We filed the CCN for the 800-megawatt Castle Bluff natural gas energy center, some of the commentary coming out of the commission suggests a desire for more dispatchable resources and understanding that we need that for reliability. So we're excited to make that filing. We got the approval of the securitization. So I think that what we're seeing is a continuation of constructive regulatory results in Missouri, the commission is going to have a forum to talk about reliability for the state looking forward, and we think that's a constructive thing. We're seeing these exciting economic development opportunities, and we need to make sure that Missouri has the resources to serve our existing customers and those additional economic development opportunities. So we think, again, that's a good constructive forum setting up for the future."
},
{
"speaker": "Operator",
"content": "Our next question is from Carly Davenport with Goldman Sachs."
},
{
"speaker": "Carly Davenport",
"content": "Maybe just to start to go quickly back to the IRP update that you guys expect to file early next year. Recognize you've got the low growth element that could have an impact there. But could you also talk a little bit about the expectations around resource mix as you sort of have some more time to work through the EPA regulations?"
},
{
"speaker": "Marty Lyons",
"content": "Yes. Carly, it's a good question. And look, it's -- something we file in February, a lot of work to be done, as I mentioned, really trying to assess the load growth, get our arms around, what of this will come to fruition, how do we want to serve it. I think when you look at the IRP that we filed back in September 2023, it was a good mix of resources, maintaining our existing dispatchable assets thinking about bringing in a mix of renewables, dispatchable resources like simple cycle gas combined cycle gas as well as battery storage technologies. And my sense is that if we see load growth that we're going to build into our plans going forward, it probably means in the short-term, an acceleration of some of the renewables, the batteries and very possibly additional simple cycle natural gas. When you look longer term, we will have to give some thought as we file that, and to your point about how we think about the EPA's proposed greenhouse gas rules. And that may be impacted by whether the Supreme Court issues the stay of those later this year. But again, I would just say the things we have to think about, as I mentioned on one of our prior calls is the implications of those rules for carbon capture at our planned combined cycle facility as well as co-firing with gas at our Labadie Energy Center. And so those are some of the things we'll be thinking about. And given the uncertainty of whether that greenhouse gas rule will ultimately come into effect, we'll have to think about how we do or don't reflect that in our plans going forward. So a lot to think about. So I appreciate you teeing it up. I don't have any firm answer for you today, but those are some of the considerations."
},
{
"speaker": "Michael Moehn",
"content": "Yes. Carly, it's Michael. The only thing I might add to that is with respect to some of these environmental rules, there probably are some regrets moves that we'll continue to look at. Marty mentioned this co-firing issue, trying to make sure we have access to gas some of these facilities that we don't have today. So taking some steps there that we think probably are prudent just to give us some additional flexibility, not knowing exactly where these rules will ultimately end up."
},
{
"speaker": "Carly Davenport",
"content": "Got it. Okay. That context is super helpful, and we'll stay tuned there. The follow-up is just on MISO Tranche 2. I know you guys addressed kind of Tranche 2.1 a bit earlier. But could you talk a little bit about 2.2 kind of how that split of the tranches came about. And ultimately, if you have any views on what that could look like from a sizing perspective relative to Tranche 2.1 and also Tranche 1."
},
{
"speaker": "Marty Lyons",
"content": "Yes, I'll -- this is Marty again, Carly. I'll start. I think is MISO looked at these projects and heard from stakeholders, there was some logical order in terms of how you might want to build out some of the infrastructure that we believe is ultimately going to be required in the Midwest region, given all of the region's goals with respect to clean energy transition and what MISO sees in terms of potential relocation of generation facilities and load, et cetera. So I think it was more or less what's a logical order to build some of these things out and then to step back and use the expectation of these investments in the consideration and planning for the next set of projects. Now with that said, I'd mentioned, for example, we have this 345 line that they're planning in Missouri. It may or may not preclude the need for a 765 line, which was in the last presentation presented. We also don't see a whole lot of investment on the current map in the Southern part of Illinois and extending Indiana, so we may see some more investment there. But again, it's premature. Again, we'll get these finalized by MISO expecting this year. Talking to MISO, while they've been at it working on potential for 2.2, there's still a lot of more work to be done, which is why they really don't expect to get those approved until sometime into 2025. So look, I just think it's really premature to talk about what those might be and what the size of it's going to be. I don't think it will be insignificant in terms of the additional investment there probably premature to specifically speculate."
},
{
"speaker": "Operator",
"content": "Our next question is from Paul Patterson with Glenrock Associates."
},
{
"speaker": "Paul Patterson",
"content": "Just to follow-up on the weather and the sales growth and what have you. [Indiscernible] correct that absent you would be up 2%. And with EMEA, it's flat. Is that pretty much right? Or if you could just elaborate a little bit on that. I apologize for not being completely clear."
},
{
"speaker": "Michael Moehn",
"content": "Paul, this is Michael. From a year-to-date standpoint, again, residential is up 2.5%, 1.6% on the commercial side and 3.1% on the industrial side. So about 2.2% overall. With EMEA impact, I mean, it is a little bit less than that. I don't have it right here in front of me. But overall, I mean, look, it's just -- it's been much stronger than it has historically been."
},
{
"speaker": "Paul Patterson",
"content": "I apologize. I was just looking at Slide 24, and if I looked at it, it seems to say like versus normal, it was zero. So in terms of -- at least on the EPS impact. So I'm just sort of -- if I -- so if I'm looking at it, I just wanted to -- it sounds like you guys have -- it is really working in terms of its impact on keeping for efficiency. Am I right about that? Or --"
},
{
"speaker": "Michael Moehn",
"content": "Well, I mean, there certainly is some impact from an energy efficiency standpoint. Although I think it's less than that. I mean the one thing that you're not seeing in here a little bit is a bit of price variance. So as you're switching kind of from between summer and when at rates, you get some different price variances in the block sales. And so when you strip that out, that's masking a little bit of the growth there and that will -- should like it typically does will flip around as you kind of move through time. So -- but I mean, EE does have an impact."
},
{
"speaker": "Marty Lyons",
"content": "Yes. I think, Paul, if you're looking at that zero versus normal, what that's really just meant to say is that the weather to date has been normal. In the first quarter -- Yes. In the first quarter, weather was weak, second quarter weather was strong. What we're saying here is year-to-date there's been no weather impact versus normal conditions."
},
{
"speaker": "Paul Patterson",
"content": "Okay. Sorry about that. Okay. And then with respect to your low forecast and the IRP that's going to be refreshed. I was wondering can you give us maybe just a little bit of a sense as to it sounds obviously like you've got a lot of positive things happening here. What kind of maybe range we might be looking at in terms of when the IRP -- when it's refreshed like how much it might go up?"
},
{
"speaker": "Michael Moehn",
"content": "Yes Paul, Michael here again, a bit premature, I think, to get into that conversation. Again, I mean as we came out in February, and I probably recall this, I mean we've been seeing historically kind of flat to up maybe 0.5% in terms of growth. And then I think there's been some positive updates as we've kind of moved through the year here and I just went through the year-to-date statistic. I mean we will absolutely do that. I think we're just wanting to make sure we feel good about the confidence level around, as Marty mentioned, around a number of these data centers, et cetera. And as we, I think, kind of March through time, we're going through our typical update and planning processes we always do right now. And so we'll do that here into the fall and then I think be in a much better position as we refresh that IRP and refresh that sales forecast, to give you a sense. Again, just -- I think we've used a little bit of the statistic in the past. I mean, just from an industrial perspective, that 250-megawatt project that Marty referenced, I mean that would represent about a 40% increase in our industrial sales and about an overall 5% increase in Missouri's retail sales. Just to give you a sense of it."
},
{
"speaker": "Marty Lyons",
"content": "Yes. And I think, Paul, following up on Michael's comment there, I mean, we have the ability to serve that data center today with our existing mix of resources and the planned additions that we've got. So as we set up that IRP update, it's really about thinking about those thousands of megawatts that are in the queue today, looking -- doing its engineering studies, interconnection studies and really working with them and giving more thought to what if that's going to come to fruition? And what changes to the IRP might need to be made in light of those?"
},
{
"speaker": "Paul Patterson",
"content": "Okay. And then just should we think of this as sort of a consumer that the existing resources can serve all this? Is this basically going to be something that would help customers or even near-term at least in terms of just more cost being spread over more megawatt hours or is there an economic development issue that's happening here that -- I guess what I'm trying to say is, with your -- how should we think about this impacting rates vis-a-vis earnings if you follow what I'm saying, at least in the near-term?"
},
{
"speaker": "Marty Lyons",
"content": "Yes. Well, the customers that are signing on today, the 250 megawatts as well as the 85-plus megawatts are really utilizing existing tariffs that we have in place today that obviously have been vetted by the commission and put in place. And the goal of any of these tariffs is to make sure that costs are allocated appropriately and spread appropriately amongst customer classes. I think sit here today, I think we're fine. As we move through time, if we have thousands of megawatts that come to fruition, and we start to think about the different resources we may need to put in place to serve them. We're going to have to be thoughtful about what the appropriate tariffs are for those customers to make sure that they pay a fair price and that value again, accrues to all of our customers and communities."
},
{
"speaker": "Operator",
"content": "Our next question is from Anthony Crowdell with Mizuho."
},
{
"speaker": "Anthony Crowdell",
"content": "Just one quick one, kind of like a follow-up and maybe challenging to answer. I mean if I think back to -- and I know you guys don't have the exposure to the PJM capacity auction, but if I think back 10, 15 years ago, where we started to see some real bullish prices on capacity, I think the utilities kind of in that part of the country really responded with higher CapEx and the regulators really supported it. If we fast forward maybe last December, Illinois really, I think, tend to message or maybe slow down the CapEx spend in the state. I know you're not exposed to PJM capacity prices, but do you think the Illinois regulators maybe change their view and maybe realize the value of the added infrastructure maybe to help our customer build as more way to get power to them?"
},
{
"speaker": "Marty Lyons",
"content": "Yes. Look, I think in both states, I mentioned this earlier and the commission having a forum on reliability and resource adequacy and the same concerns I know exists in Illinois. And so, we'll see how policies shift and change over time. But look, I think at the end of the day, all stakeholders in both states. And certainly us as a utility and other service providers were all concerned and mindful of resource adequacy, reliability, affordability and a clean energy transition. And so I think your intuition is right that as you see cost pressures grow because of things like capacity prices or you see the need to support economic development and growth logically, you're going to have to start to think about the policies that support those things and resource adequacy. So I think your intuition is correct."
},
{
"speaker": "Operator",
"content": "Our next question is from David Paz with Wolfe Research."
},
{
"speaker": "David Paz",
"content": "So I just -- one thing just popped up a listen your responses. Just have you provided what of just a simple rule of thumb from sensitivity on EPS for every 1% increase in industrial sales?"
},
{
"speaker": "Michael Moehn",
"content": "Yes. We have historically, David. For every 1% on the industrial side, it's about $0.05 here's a good way to think about it. Now that change will change over time as you kind of move through and you got to change the generation mix, et cetera. But I mean, I think it's probably a decent rule of thumb today."
},
{
"speaker": "David Paz",
"content": "And just on the discussions, and I know there's been plenty of questions here on attracting large load and the efforts you're making. But just what have you to rate stakeholders and leaders that what you need from a ratemaking standpoint. And could we see efforts to add trackers or riders expect the amortization of the large load or maybe an expansion of piece? I guess what are you telling them that [indiscernible] -- sorry, in Missouri."
},
{
"speaker": "Marty Lyons",
"content": "Yes. I think David, all things for consideration. As I mentioned a few moments ago, with respect to the data center that we show on Page 7, this 250-megawatt data center and the other 85 megawatts of load, again, they're able to use our current industrial tariffs, and we're able to serve them with our current generation and plan generation. So no need for any special tariff there. Over time, as I said, to the extent that these other opportunities come to fruition, we may need to think about special tariffs. One thing to point to is we just had that Cass County Solar project approved. And there, we did put a special sort of tariff arrangement into place to ensure that there was a -- an appropriate apportionment of cost between our customer base as well as those industrial customers that are going to take power from Cass County. So we do have some experience working with the commission to put special tariffs in place. And we'll be giving thought to that as we move forward with additional data centers that we may be able to serve. And then to your point on -- I think it was on PSA, Certainly, one of the things we pursued legislatively last spring that had very good support was the extension of PSA to dispatchable generation. Such as the simple cycle assets that we're planning and combined cycle asset that we're planning. And so again, we had very good support for that. Again, the legislative session ended with that not getting across the finish line, but certainly expect that strong support as we go into next year."
},
{
"speaker": "Operator",
"content": "Our next question is from Julien Dumoulin-Smith with Jefferies."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Just following up on this, right? So just on the process behind the -- shall we say, shorter-term procurement potential here, right? You alluded to it earlier, obviously, you have enough resources to deal with the 250 here initially. Perhaps that's not it, as you alluded to -- how do you think about the process itself, right? You do typically these IRPs at relatively consistent periods interims as well as there's a construction cycle behind that. There's a PSC process behind that you mentioned kind of the shorter-term potential in the medium-term potential need. How do you think about expediting that? We've seen that potentially in some of your adjacent jurisdictions? How do you think about that, A; and then, B, going back to the point raised, would you expect some of these tariff dynamics just play out in the, like, should we say, a subsequent rate case process beyond the current instance?"
},
{
"speaker": "Marty Lyons",
"content": "Yes. All good questions, Julien. So first of all, as I mentioned, with respect to these opportunities, we're certainly not waiting. We and other stakeholders around the states are aggressively interacting with these folks that are doing these engineering reviews, interconnection studies and doing everything we can to be able to support them and locating these facilities either in Missouri or Illinois as is appropriate. And so we're aggressively doing that. When you look at some of opportunity. Think about this 250-megawatt one that we talked about specifically. They’re going to be in service in 2026, ramping up usage through 2028. And that's what we're hearing from any of these is really a desire to ramp up over time. And so the idea is that, that would sort of dovetail with an update to the IRP, where we would potentially accelerate some of the planned additions, perhaps add some additional resources that we would get in place in time to be able to serve this load as it grows. When you think about that, certainly, there are some limitations. But when you think about that 800-megawatt simple cycle that we're putting in our plans today, the Castle Bluff about 4 years to get that in service between turbines, transformers, construction time line, et cetera. So we feel like we'll be able to work with some of these data center opportunities, get the IRP updated and filed. And hopefully be able to sort of have all these things dovetail and brought together at the right pace and speed. And yes, in terms of the any kind of changes in tariffs. We think those can happen both inside the context of a rate review or outside of a rate review. So we think we have flexibility there."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Okay. Even outside of the rare review, nice. It sounds like you got something in mind already. All right. And then separately quickly, just coal ash new rigs here in the last few months. I'm just curious on AROs accumulating and just the thoughts about some of the twist here."
},
{
"speaker": "Michael Moehn",
"content": "Hey, Julien, Michael here. It's really not a significant issue for us. I mean we did go through and a couple of AROs, but a really immaterial amount. If you think about our exposure from a coal ash standpoint, I mean, we really got in front of this issue, probably 7 or 8 years ago. All of our ponds are closed or in the process of being finalized here. And so just not a lot of additional exposure, just a little bit of stuff around the edges."
},
{
"speaker": "Operator",
"content": "There are no further questions at this time. I'd like to hand the floor back over to Marty Lyons for any closing comments."
},
{
"speaker": "Marty Lyons",
"content": "Yes. Thanks, everybody, for joining us today. Some great questions. Appreciate the dialogue. Look, overall, we are really pleased to share our updates with you today, and we remain absolutely focused on strong execution for the remainder of this year. And we look forward to seeing many of you in the coming months. So with that, thanks. Have a great day. Have a great weekend."
},
{
"speaker": "Operator",
"content": "This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation."
}
] |
aee | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Greetings, and welcome to Ameren Corporation’s First Quarter 2024 Earnings Call. At this time, all participants are on a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andrew Kirk, Director of Investor Relations and Corporate Modeling for Ameren Corporation. Thank you, Mr. Kirk, you may begin."
},
{
"speaker": "Andrew Kirk",
"content": "Thank you, and good morning. On the call with me today are Marty Lyons, our Chairman, President and Chief Executive Officer; and Michael Moehn, our Senior Executive Vice President and Chief Financial Officer; as well as other members of the Ameren management team. This call contains time-sensitive data that is accurate only as of the date of today’s live broadcast, and redistribution of this broadcast is prohibited. We have posted a presentation on the amereninvestors.com homepage that will be referenced by our speakers. As noted on Page 2 of the presentation, comments made during this conference call may contain statements about future expectations, plans, projections, financial performance and similar matters, which are commonly referred to as forward-looking statements. Please refer to the forward-looking statements section in the news release we issued yesterday as well as our SEC filings for more information about the various factors that could cause actual results to differ materially from those anticipated. Now, here’s Marty, who will start on Page 4."
},
{
"speaker": "Marty Lyons",
"content": "Thank you, Andrew. Good morning, everyone, and thank you for joining us today as we discuss our first quarter 2024 earnings results. Our team continues to successfully execute on our strategic plan across all of our business segments, allowing us to deliver for our customers, shareholders and the environment, while laying a strong foundation for the future. Turning now to Page 5. Yesterday, we announced first quarter 2024 earnings of $0.98 per share compared to earnings of $1 per share in the first quarter of 2023. The key drivers of our first quarter results are outlined on this slide. Overall, our operating performance was strong during the quarter. We had periods of extreme cold weather in January and our natural gas and electric systems and our operating teams performed well. On balance, however, weather was mild during the quarter, marked by unseasonably warm temperatures in February and March. Despite the mild temperatures, our retail sales grew driven by encouraging signs of customer growth and usage. While we experienced higher operations and maintenance expenses, that was driven largely by a charge for proposed additional mitigation relief related to the Rush Island Energy Center New Source Review litigation. Despite the year-to-date weather headwinds and the Rush Island charge, our team is taking steps to contain spend, and we remain on track to deliver within our 2024 earnings guidance range of $4.52 per share to $4.72 per share. I’ll provide an update on our Rush Island Energy Center proceedings, and Michael will cover the first quarter and balance of the year earnings results in a bit more detail later. Moving to Page 6. On our call in February, I highlighted some of our top priorities for 2024 as we invest strategically, enhance our operating jurisdictions and optimize our business processes. Our team’s unwavering commitment to these objectives has already begun to produce results, as you can see on Page 7. Our investments continue to improve the reliability, resiliency, safety and efficiency of our service to our customers. In the first three months of this year, we have invested significant capital for the benefit of our customers. During the quarter, Ameren Missouri installed over 55,000 smart meters, 60 smart switches, 15 miles of energized underground cable, 8 miles of hardened overhead lines and upgraded 5 substations. In Illinois, our first quarter investments included replacing 550 poles due to standard inspections and storm damage, replacing switchgear at a key substation and installing 30 miles of underground cable for relocations, new customers and aged cable replacement. Further, our transmission business is on track to complete over 15 new or upgraded transmission substations and 45 miles of new or upgraded transmission lines in the first half of the year. These critical investments support our commitment to delivering safe and reliable energy for the benefit of our customers and we are seeing the benefit in 2024 in terms of reduced outages and shorter outage durations as a result of spring storms. For example, during the recent April storm, over 7,500 Missouri customer outages were prevented due to rapid detection, rerouting and restoration of power by automated switches across our system in over 2.3 million minutes of customer outages were avoided due to these investments. Moving on to first quarter regulatory and legislative outcomes. In March, Ameren Missouri received Missouri PSC approval of our largest-ever solar investment, three projects representing a total of 400 megawatts capable of powering approximately 73,000 homes. The approval of certificates of convenience and necessity, or CCN, for these projects is another constructive step along the pathway to executing our Ameren Missouri Integrated Resource Plan, or IRP. On the legislative front, the Missouri General Assembly is addressing power quality and reliability by considering bills to enhance and extend the current plant-in-service accounting, or PISA, legislation that would support investment in dispatchable resources and reliability. PISA has supported much needed reliability investments in the state’s energy grid over the past five years. While these bills, House Bill 1746 and Senate Bills 740 and 1422, have strong bipartisan support, time is short in the current general assembly session ends Friday, May 17. While the legislature has many priorities, we will continue to work with key stakeholders towards passage. At Ameren Transmission, progress continues to be made on the long-range transmission regional and beneficial projects, which I will cover in more detail in a moment. Turning to Illinois Electric delivery. We continue to diligently work for approval from the Illinois Commerce Commission, or the ICC of an electric grid investment plan, revised revenue requirements incorporating ongoing and prospective investments and an overall improved regulatory environment. In January, the commission granted a partial rehearing of our multi-year rate plan to address the base level of investment needed to operate the grid reliably. Subsequently, in February, we filed an updated plan as part of the rehearing proceeding. Then in March, we filed our revised multi-year grid and rate plans to address the commission’s findings stated in their December order. The rehearing and revised multi-year grid and rate plan proceedings are operating in parallel and with update rates for 2024 through 2027. We expect a decision from the ICC on the rehearing in June, which would provide a 2024 interim rate adjustment by July. We expect an ICC decision on the revised multi-year grid and rate plans by the end of the year, which would revise rates beginning January 2025. We continue to work with all impacted stakeholders to advocate for constructive regulatory frameworks and outcomes that support the state’s energy transition goals. Our ability to invest and deliver reliable and affordable energy is essential for our customers and the communities we serve and will support continued growth in our region. Moving on to operational matters. We remain committed to maintaining disciplined cost management to hold operations and maintenance expenses flat in 2024 to 2023 levels. I’d like to express my sincere appreciation to our Ameren team members who are working efficiently, collaboratively and safely to serve our customers. Now moving to Page 8 for details on the Rush Island securitization case at Ameren Missouri. Our request with the Missouri PSC to securitize the remaining balance of the Rush Island Energy Center and other related costs continues to make progress. In March, the Missouri PSC staff recommended securitization of $497 million as compared to our request of $519 million. Refinancing these investments through the issuance of securitized bonds, versus financing and recovery through traditional ratemaking will save our customers millions of dollars. Hearings were completed in April, and we expect the PSC’s decision by June 21. Now turning to Page 9 for an update on the new source review proceeding for Rush Island. As previously reported in 2017, the U.S. District Court of Eastern Missouri issued an order requiring the installation of a flue gas desulfurization system or scrubbers on our Rush Island Energy Center for violating new source review provisions of the Clean Air Act and install a dry sorbent injection system at our Labadie Energy Center, as mitigation for excess emissions at Rush Island. Upon appeal, the A circuit upheld the district court’s ruling with respect to the installation of scrubbers at Rush Island, but overturn the decision with respect to Labadie. Subsequently, we made the decision to accelerate the planned retirement of our Rush Island Energy Center, which was more economic for our customers than installing scrubbers. The District Court approved Ameren’s retirement proposal and established a retirement date of no later than October 15, 2024 to allow for the completion of various transmission reliability projects. The U.S. Department of Justice is seeking additional mitigation relief beyond the retirement of the energy center. In March of this year, the District Court ordered both parties to file proposals outlining additional mitigation relief for the court to consider. On Wednesday, Ameren Missouri and the DOJ filed their respective mitigation proposals. Ameren’s mitigation proposal consists of four essential elements: retirement of Rush Island, which eliminates all emissions through its previously planned 2039 retirement date, a school bus electrification program, including buses and charging stations, an air filter program geared towards underserved residential customers and surrender of sulfur dioxide allowances. Collectively, these programs are estimated to cost approximately $20 million, which resulted in a first quarter charge to earnings. The Department of Justice mitigation proposal includes a significantly greater number of buses, charging stations and advanced filters. The DOJ estimates their aggregate program cost to be approximately $120 million. We expect an evidentiary hearing will be scheduled sometime this summer, and we expect the District Court will issue a final ruling during the second half of 2024 that could be subject to further appeals. Before moving on, I’d like to provide an update on the series of new rules issued by the Environmental Protection Agency last week. As you know, Ameren Missouri remain committed to investing in a clean energy transition in a responsible manner, balancing reliability and affordability. The new rules expect generators to rely heavily on carbon capture and storage technologies, which are not ready for full-scale economy-wide deployment. These new rules apply not only to existing coal-fired units, but new gas-fired units with greater than 40% capacity factors as well, which would include the gas combined cycle facility called for in our current IRP in the early 2030s to maintain system reliability. In addition, for coal units retiring between 2032 and 2039, the rules will require natural gas co-firing by 2030. And as we noted in our comments to the proposed rules, co-firing with natural gas presents challenges from a permitting and construction standpoint. These requirements would most directly impact our Labadie Energy Center, which has units scheduled to retire in 2036 and 2042. While we are still assessing the impact of the rules on our Integrated Resource Plan, these new rules are making it more challenging and costly to maintain existing dispatchable generation or build new dispatchable generation. These challenges come at a time when supply and demand is tight, and the industry has seen significant potential load growth, particularly from data centers, the manufacturing industry and through the electrification of transportation. We will continue to closely review the final regulations and as with many environmental regulations, litigation by various stakeholders is likely. These rules, if not modified, would require significant investments beyond what’s in our current 10-year pipeline to meet compliance obligations and maintain a reliable system. Moving to Page 10. We look ahead to our future renewable generation developments. As I mentioned in March, the Missouri PSC approved CCNs for three Ameren Missouri solar projects totaling 400 megawatts. Split Rail, Vandalia and Bowling Green, all located in Missouri. The Missouri PSC in its March order also set terms upon which a fourth solar facility, the 150-megawatt Cass County, Illinois project could be approved if it is fully subscribed under Ameren Missouri’s renewable solutions program. The renewable solutions program is a subscription-based program that allows eligible businesses and organizations to manage their carbon footprint by replacing up to 100% of their total energy use with renewable sources. The online auction for customers to subscribe to the Cass County Solar Project is expected to take place in mid-May with Missouri PSC approval of the Cass County CCN expected following full subscription. Initial non-binding notices of intent for the subscription auction will receive from interested businesses in early April and reflected strong interest. Investing in solar energy is part of Ameren Missouri’s plans to affordably meet the long-term energy and reliability needs of our customers. The IRP calls for new dispatchable energy resources, including an on-demand 800-megawatt gas simple-cycle energy center by 2027 which could be turned on as needed in a matter of minutes to ensure reliability of the energy grid during periods of peak energy demand. Later this month, we expect to file a request for a CCN for this simple cycle plant, Castle Bluff Energy Center, to be located on the site of our retired Meramec Energy Center. Moving to Page 11. The Midcontinent Independent System Operator, or MISO, continues to advance its long-range transmission planning and project approval processes. For Tranche 1, we were pleased to be selected in April to develop the third and final competitive project in our service territory, which again emphasizes our track record of being able to deliver cost-effective, high-value projects to our communities. Ultimately, Ameren was assigned or awarded approximately 25% of total Tranche 1 portfolio projects addressing the MISO Midwest region in 100% of the projects in our service territory. We expect Tranche 1 construction to substantially begin in 2026 with completion dates through 2030. Looking ahead to Tranche 2, in March, MISO announced a long-range transmission Tranche 2 proposed project portfolio estimated to cost $17 billion to $23 billion, which included significant investments within our Ameren Missouri and Ameren Illinois service territories. Since then, we, and other key stakeholders, have been working with MISO to evaluate and comment on the portfolio of projects to assist MISO in ultimately approving the most appropriate path forward. MISO expects to vote on Tranche 2 in the third quarter of 2024. Moving to Slide 12. Looking ahead over the next decade, we have a robust pipeline of investment opportunities of more than $55 billion that will deliver significant value to all of our stakeholders by making our energy grid stronger, smarter and cleaner. Of course, our investments also create thousands of jobs for our local economies. Maintaining constructive energy policies that support robust investment in energy infrastructure and a transition to a cleaner future in a responsible fashion will be critical to meeting our country’s growing energy needs and delivering on our customers’ expectations. Turning to Page 13. In February, we updated our five-year growth plan, which included our expectation of 6% to 8% compound annual earnings growth rate from 2024 through 2028. The earnings growth is primarily driven by strong compound annual rate base growth of 8.2%, supported by strategic allocation of infrastructure investment to each of our business segments based on their regulatory frameworks. Combined, we expect to deliver strong long-term earnings and dividend growth, resulting in an attractive total return. I’m confident in our ability to execute our investment plans and strategies across all four of our business segments as we have an experienced and dedicated team to get it done. Again, thank you all for joining us today. I’ll now turn the call over to Michael."
},
{
"speaker": "Michael Moehn",
"content": "Thanks, Marty, and good morning, everyone. Turning now to Page 15 of our presentation. Yesterday, we reported first quarter 2024 earnings of $0.98 per share compared to $1 per share for the year ago quarter. The key factors that drove the overall $0.02 per share decrease are highlighted by segment on this page. We delivered solid earnings performance during the quarter as we continue to execute our strategy, including making infrastructure investments for the benefit of our customers. The first quarter included new service rates in Ameren Illinois Natural Gas and Ameren Missouri. In addition, strong customer growth and usage contributed to 3% higher electric weather-normalized retail sales at Ameren Missouri across all customer classes which were partially offset by milder weather impact. In fact, the third one was first quarter in the past 50 years. Earnings were also reduced by an increase in O&M and Ameren Missouri, largely driven by a $0.04 charge for proposed additional mitigation relief related to the Rush Island Energy Center. Moving to Page 16. As we think about the remainder of the year, we remain confident in our 2024 guidance range, and we continue to expect earnings to be in the range of $4.52 to $4.72 per share. As we think about the first quarter results versus our expectations, we lost $0.07 compared to normal for weather and $0.04 for the charge related to Rush Island. But experienced $0.02 of favorable weather-normalized sales beyond our expectations. As we look ahead, we expect to see meaningful year-over-year O&M reductions in the second half of the year reflecting several cost savings initiatives instituted in 2024, which are expected to build throughout the year. This includes hiring restrictions, reducing our contractor and consultant workforce, and deferring or eliminating discretionary spend. As we’ve discussed before, we have been actively managing costs for years and continue to create opportunities for further cost reductions through process redesign and digital technology investment leading to increased productivity and better experiences for our customers. In addition, we expect to benefit from higher earnings in Ameren Transmission over the balance of the year due to timing of financing and project expenditures. I encourage you to take these supplemental earnings drivers into consideration as you develop your expectation for quarterly earnings results for the remainder of the year. Finally, late last week, MISO concluded its planning resource auction for the 2024 to 2025 planning year, which assesses seasonal resource adequacy in each zone. As a result of higher load requirements, changes to the accreted capacity of generation available and reduced import capability, Zone 5, Ameren Missouri’s territory showed a model capacity shortfall and prices went through the cost of new entry or CONE for the non-peak load fall and spring seasons. Clearing prices in all other zones within MISO remained relatively flat. Unlike what Ameren Illinois experienced a couple of years ago, we do not expect to see material customer bill impact at Ameren Missouri resulting from this auction because our generation resources available to serve customers, nor do we see any issues with providing reliable electric service throughout the year for our customers. The MISO auction results do reinforce a couple of things. First, there is a strong need for us to continue to execute the generation plans called for an IRP. And second, the integration of new large electric loads and carbon-free renewable generation to the grid will require significant transmission expansion with some projects needed locally to ensure reliable service. We stand ready to work with stakeholders in our region to address the capacity needs. Before moving on, I’d like to provide an update on economic development. Through mid-April, we have successfully supported 21 new projects that have selected locations in our service territories which are expected to increase electric demand by almost 45 megawatts and natural gas issues by 1.6 million tons within the next few years. These projects will add an estimated 950 jobs across our service territories. The majority of these projects are existing customer expansions in the manufacturing, aerospace, data center, food processing and mining industries. Ameren Missouri and Ameren Illinois are actively working with state, regional and local partners on more than 150 economic development projects that are considering on location in our service territories including large low data centers and manufacturers in the automotive, aerospace and agricultural industries, among others. We will continue to work on development opportunities to build thriving communities in our service territory. Moving to Page 17 on Ameren Illinois regulatory matters. We have several Ameren Illinois electric distribution regulatory updates to cover with you, including the 2023 annual reconciliation, the 2024 through 2027 multiyear rate plan rehearing as well as a revised grid and rate plan filings. Starting with the 2023 annual reconciliation. Under Illinois formula ratemaking, which expired at the end of 2023, Ameren Illinois is required to file annual rate updates to systematically adjust cash flows over time for changes in cost of service and to true up any prior period over or under recovery of such costs. In April, we filed our electric distribution annual rate reconciliation requests for $160 million adjustment for the 2023 revenue requirement to reflect actual costs. The full amount would be collected from customers in 2025, replacing the prior period reconciliation adjustment of $110 million that is being collected during 2024. For a net customer impact of $50 million or an approximately 1.5% increase in the total average residential customer bill. The ICC will review the matter once ahead with a decision expected in December of this year and new rates effective in early next year. Turning to the multiyear rate plan for 2024 through 2027 on Page 18. In January, Ameren Illinois has granted a partial rehearing by the ICC to address a base level of grid reliability investment and 2023 rate base additions. We filed our revised request enable for a cumulative annual revenue increase from 2023 rates of $305 million by 2027. Our request, which includes investments and costs related to preventive and corrective maintenance inventory, metering, new business and customer relocations would allow us to appropriately maintain the energy grid to preserve safety, reliability and day-to-day operations of our system. The ICC staff recommends a cumulative increase of $283 million, with the variance driven primarily by the renewal of other post-employment benefits and certain 2023 projects from rate base, the latter of which the staff deemed to be outside the scope of this rehearing. We expect an ICC decision on the rehearing proceeding by June 20, which will allow new 2024 interim rates to be effective by July. Moving to Page 19. In March, Ameren Illinois filed its revised electric multiyear grid plan and revised multiyear rate plan. Our request for a $321 million cumulative annual revenue increase from 2023 rates with supersede revenues granted through rehearing. Request is based on a return on equity of 8.72% and an equity ratio of 50%. Annual revenues will based on actual recoverable costs, year-end rate base and a return on equity adjusted for any performance incentives or penalties, provided the actual revenue requirement does not exceed the reconciliation cap. Our plans as proposed support an affordable, equitable energy transition, which we’ll advocate for over the remainder of the year. We expect the ICC staff and intervenor testimony in May and we expect an ICC decision by December with rates effective January 1, 2025. In other regulatory matters, last week, Ameren Missouri filed a 60-day notice with the Missouri PSC for our next electric service rate review. Moving to Page 20 to provide a financing update. We continue to feel very good about our financial position. On January 9, Ameren Missouri issued $350 million of 5.25% first mortgage bonds due 2054. And on April 4, Ameren Missouri issued $500 million or 5.2% first mortgage bonds due 2034. Net proceeds from both issuances were used to fund capital expenditures and/or refinance shorten debt. Further, in order for us to maintain our credit ratings and strong balance sheet, while we fund our robust infrastructure plan, we expect to issue approximately $300 million of common equity in 2024. We sold for approximately $230 million under our at-the-market or ATM program, consisting of approximately 2.9 million shares, which we expect to issue by the end of this year. Together with the issuance under our 401(k) and DRPlus programs, our ATM equity program is expected to support our equity needs in 2024 and beyond. Finally, turning to Page 21. We’re off to a solid start in 2024 and well positioned to continue executing our plan. We expect to deliver strong earnings growth in 2024 as we continue to successfully execute our comprehensive business strategy. Looking to the longer term, we continue to expect strong earnings per share growth driven by robust rate base growth and disciplined cost management. We also believe this growth will compare favorably with the growth of our peers. Ameren shares continue to offer investors an attractive dividend. In total, we have an attractive total shareholder return story. That concludes our prepared remarks. We now invite your questions."
},
{
"speaker": "Operator",
"content": "Thank you. At this time, we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Shar Pourreza with Guggenheim Partners. Please proceed with your question."
},
{
"speaker": "Shar Pourreza",
"content": "Hey, guys. Good morning."
},
{
"speaker": "Marty Lyons",
"content": "Good morning, Shar."
},
{
"speaker": "Shar Pourreza",
"content": "Good morning, Marty. Marty, can you just maybe elaborate a bit more on the recent EPA regs. I mean you touched a bit on the fleet impact like Labadie, but maybe expand on potential shifts to timing and scale the spending opportunities versus last year’s IRP if it makes it through the courts. I mean, could we see some pull forward of generation spend? What do you see as kind of an updated pathway here should we be thinking of an IRP update like you did with the Rush Island – rush decision. Thanks."
},
{
"speaker": "Marty Lyons",
"content": "Well, Shar, you’ve outlined a number of the considerations. I mean, first of all, we’re all just still absorbing the rules. And so our teams are studying the new rules thoroughly and will be over the coming weeks, really trying to assess what the potential impacts are on our IRP. And certainly, that could mean, as you know, a revision to the IRP. But of course, too, we’ll expect these rules to likely be litigated, and so we’ll have to take into account that litigation and the uncertainties that it creates. In my prepared remarks, I noted a couple of the more notable concerns that we have. The first being that the rules do really rely on carbon capture and sequestration, which I think we all recognize is it really ready for prime time today. And the things that would impact we have, as you know, in our IRP planned combined cycle facility, 1,200 megawatts plan for the 2032, 2033 time frame, which is really important from a reliability perspective as we expect to retire our Sioux power plant, our coal-fired power plant in that 2032 time frame. And certainly, new combined cycle that would operate with greater than a 40% capacity factor, which we would expect this one to – would be impacted by that carbon capture and sequestration. So that certainly has significant implications as it relates to that planned combined cycle facility. And we’ll have to reassess and thinking through that. The other one I mentioned is our Labadie Energy Center, that plant is scheduled to retire really in phases with about half of it in 2036 and the other half of it 2042. So the rule would have implications for the ultimate retirement date, pulling that forward a little bit. But in order to be able to maintain the life of that facility out through 2039. The rules require co-firing with natural gas in the 2030 time frame. And of course, trying to get things permitted and constructed in that amount of time, certainly proposes challenges as well. And so I highlighted those in my prepared remarks today. So at the end of the day, Shar, I think as we look at these rules, we do have concerns about the feasibility and ultimately the reliability of our system. Those were our primary concerns. But you’re absolutely right. As we think about these rules, it certainly could cause revisions to the IRP and on balance, suggest a greater level of investment that would be required to maintain reliability of our system over the next 10 years."
},
{
"speaker": "Shar Pourreza",
"content": "Got it. And then just a bit nuanced, but what exactly was going on with PI auction in Zone 5. I mean, obviously, it’s quite a large breakout for you, net neutral from a customer impact perspective, which you just highlighted. But maybe just some color on the backdrop. Is this kind of structural should we should expect it again or really kind of an administrative or design error? Thanks."
},
{
"speaker": "Michael Moehn",
"content": "Hey. Shar, it’s Michael. Good morning. A couple of things. I mean, as you noted, I mean, obviously, Zone 5, we’ve moved to this new seasonal construct, we did see quite a bit of variability. You had $30 in the summer and $0.75 in the winter and then CONE in the fall and the spring, at 719. So as you note, I mean, this is a capacity issue. It’s not an energy issue. And so I think it’s always important to start with that. We expect to have obviously enough energy available for customers we don’t foresee any issues with respect to providing reliable service, which I think is important. Also from a customer impact standpoint, we really don’t see any material, if any impact to customers as well. And it gets a little complicated. I mean the MISO model is a revenue neutral model and so it will be some shifting that goes on. We have Missouri owns generation in Zone 4, we’re able to point to those as hedges, and so it helps offset all that. But I think when you step back, I mean, it is right trying to send a price signal with respect to meeting additional dispatchable generation that you just spoke about. I mean, there were a couple of things I noted in my prepared remarks. I mean it was due to increased load. There were some accreditation issues with respect to some generation. They got dinged for some past performance. That should go away over the next couple of years. And then there was a reduction in import capabilities. And also, I think there’s probably some transmission opportunities there that would relieve that. So I think, again, it does speak to what we’re trying to do from a dispatchable perspective. And I think, Shar, there’s a way to work around this and see some relief over the next couple of years."
},
{
"speaker": "Shar Pourreza",
"content": "Okay, perfect. I appreciate it, guys. Thank you so much."
},
{
"speaker": "Marty Lyons",
"content": "Thanks for the question, Shar."
},
{
"speaker": "Operator",
"content": "Our next question is from Jeremy Tonet with JP Morgan Chase. Please proceed with your question."
},
{
"speaker": "Jeremy Tonet",
"content": "Hi, good morning."
},
{
"speaker": "Marty Lyons",
"content": "Hey, Jeremy. How are you today?"
},
{
"speaker": "Jeremy Tonet",
"content": "Good. How are you?"
},
{
"speaker": "Marty Lyons",
"content": "Good."
},
{
"speaker": "Jeremy Tonet",
"content": "Just wanted to go to Missouri and as far as legislative initiatives there, if you could provide us, I guess, thoughts on the environment there, what you’re looking for and specifically PISA legislation and I think the session is ending soon. And so any thoughts there would be helpful."
},
{
"speaker": "Marty Lyons",
"content": "Yes, Jeremy, you got it. I think that as we sit here today, the legislation that is most likely to get across the finish line, is that a piece of legislation. And so as you know, and I’m sure you’ve been following House Bill 1746 and Senate Bills 740 and 1422. I would say, at this point in session, they’re probably as well positioned as you could be for Passage Senate Bill 1422 and Senate Bill 740. They’re on the Senate informal calendar that could be brought up at any time and House Bill 1746, which passed out of the house with a very strong supportive vote of 119-17 is also now passed through the Senate Commerce Committee. It’s listed as #1 on House Bills for third reading. So things are well positioned. The challenge that I highlighted in the prepared remarks, however, is the time is short. The legislative session ends in two weeks on 17, and the legislature does have some significant things to get done, including the budget. So that’s really the concern is just whether time will run short. But in the meantime, we’ll continue to work with key stakeholders towards passage if we have a window to get it done."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. That’s helpful. And then maybe just pivoting towards Illinois. As far as the regulatory processes are concerned with the electronic hearing the grid plan refiling, any incremental thoughts you can share with progression versus expectations there? And really, I guess the question is more on the other side with the legislature. Do you see any potential there to maybe secure more constructive development?"
},
{
"speaker": "Michael Moehn",
"content": "Hey, Jeremy, it’s Michael. Good morning. Maybe I’ll handle the regulatory if Marty wants to come on the legislative one, you can certainly do that. I think – but things are continuing to move along there. I think we mentioned this in our prepared remarks, I mean, from a rehearing process, feel good about where we stand today. Again, just really proud of the work the team has done. [Indiscernible] has been working really hard going through a number of public hearings, a number of workshops, et cetera, just getting this prepared. And I think you’re seeing that producing results here as we kind of work through this rehearing process. And so we should have a decision here in early – sometime in June with a great effective in July, and this will be an interim adjustment. And then obviously, we’ll have the more comprehensive multiyear rate plan, grid plan piece in the back half of the year. It’s great to have a procedural schedule around that, have some finality around this in the December time frame with rates in January. With respect to the rehearing piece, the differences between us and staff are fairly minimal at this point. As we indicated, we were at 305, and it sits at 283 today. It really comes down to 2 issues there. The OpEx issue that we’ve spoken about in the past. We still are continuing to advocate for that. We think it’s the right thing. I think our range accommodates that if it goes in a different direction. And then there were some projects that were really deferred into the grid plan itself. And so we’ll have another opportunity to advocate for those. So again, we feel as good as you can feel at this point in time. And team is focused on it and getting some stability put back in that process."
},
{
"speaker": "Marty Lyons",
"content": "Yes, really, Jeremy, to add at this point. I mean, in terms of legislative initiatives, nothing to point to, of course, this year, both in Missouri and Illinois. We have supported a right of first refusal legislation in both states. In either states do we see those as moving forward at this time but continue to advocate for the benefit of those for our customers and for the reliability of the grid broadly but nothing to tack on right now."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. That’s helpful. I’ll leave there. Thanks."
},
{
"speaker": "Operator",
"content": "Our next question comes from Carly Davenport with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Carly Davenport",
"content": "Hey, good morning. Thanks so much for taking the questions today. Maybe just to follow up really quickly on the Illinois rehearing process. First, can you just remind us, what of that 305 revenue increase requested there is embedded in the 2024 guidance and kind of flexibility there to the extent there’s some gap. And then is there any potential for that decision to come earlier than the late June time frame that you laid out?"
},
{
"speaker": "Michael Moehn",
"content": "Hey, good morning, Carly. This is Michael. With the second part first, no, I think at this point, the expectation is kind of a little on that time frame and should have a decision here in July. In terms of sort of what’s embedded, that 305 is obviously over that four-year period. And so there’s a component, you can see that we have broken out for 2024. Again, feel good about what we have embedded in there and just sort of where the positions are. To the extent that something ended up changing that would have to just step back and look at it from a rate base perspective to the extent that it’s capital again, I mean, you’re earning 8.72%. So I mean that obviously minimizes the impact and we just have to see what our options are. I mean we do have flexibility with some additional capital there. But really just looking to see the process move along and feel better about the framework first."
},
{
"speaker": "Carly Davenport",
"content": "Got it. Thank you. That’s super helpful. And then maybe just on Rush Island, you talked a bit about the delta between Ameren’s proposal and the DOJ proposal there. Is that just a matter of sizing the program that you expect to be the piece of debate? Or is there anything else that sort of sticks out as a point of debate as you think about into hearing there this summer."
},
{
"speaker": "Marty Lyons",
"content": "Yes, you’re talking about which one were you asking about? Were you asking about NSR case, Carly? Yes. I think, you were. Listen, as it relates to the NSR, as we outlined in our slide prepared remarks, we’ve proposed a program set up a value of about $20 million and the Department of Justice is outlined a series of programs that they’ve estimated at $120 million. And when you look at the components of the two programs that are very similar in terms of electric school buses, air filtration programs, charging infrastructure, so very similar. So it really is seemingly not a matter of the program mix. But sort of the extent of them and the cost of them. So we can’t predict what mitigation the court would ultimately order. We would generally expect though, that the positions I just talked about that the parties have and the proposed orders that sort of just book ends for the degree of mitigation relief that was either ultimately reached through a settlement between ourselves and the Department of Justice for a court order. But really can’t speculate further at this point."
},
{
"speaker": "Carly Davenport",
"content": "Got it. Okay. Thank you so much for the color."
},
{
"speaker": "Operator",
"content": "Our next question is from Paul Patterson with Glenrock Associates. Please proceed with your question."
},
{
"speaker": "Paul Patterson",
"content": "Hey, good morning."
},
{
"speaker": "Marty Lyons",
"content": "Hey, Paul."
},
{
"speaker": "Paul Patterson",
"content": "So I just wanted to follow-up on the EPA rule. It seems so challenging, I guess. I’m just wondering, assuming that it’s largely in place or something, when you mentioned different reliability things you might have to do for reliability and stuff. Could you just sort of give us a general sense of what would happen? I mean, because as you mentioned, I think that carbon capture and sequestration is – got so many challenges associated with it. Would you just start running the plants lower? Would there be more batteries? Would it be – what would be sort of the remedy that might be thought about? And also, would there be any change in depreciation schedules? Or I’m just sort of wondering, I mean, it just sounds like a very difficult thing to sort of talk about potentially changing the IRP with a plan that seems so radical kind of, if you know what I’m saying."
},
{
"speaker": "Marty Lyons",
"content": "Well, Paul, it’s Marty. I think you hit on a number of the considerations. And I’ll go back to what I said before. It’s early days. We just got in the rules. We’re going to go through a thorough assessment of the rules and reassessment of the IRP. And again, you’ve got the likelihood of litigation, which will have to be factored in as well to our considerations. But I think when you look at the steps we’re taking between now and 2030 as we currently have outlined, I think the EPA rules underscore the importance of these. We’ve got 2,800 megawatts of renewables planned by 2030. We got 400 megawatts of battery storage planned between now and 2030. We’ve got 800 megawatts of simple-cycle generation plan between now and 2030. And I think given these rules, certainly, it underscores the importance of all of those things. I think the broader implications that are down the line. I think with respect to the retirement of the Sioux Energy Center that we have plan for 2032 generally in line with the rules. The Labadie Energy Center, I mentioned earlier, half of it retired in 2036, half of it 2042, again, if that need to be retired by 2039, maybe a little bit of a change in depreciation there recovery. But I think the bigger thing for Labadie then would be getting gas into Labadie and the ability to be able to co-fire with natural gas so that we’ve got that. And then I think when you think about that combined cycle facility and again, first of all, the feasibility of doing carbon capture much less of the cost of doing carbon capture, you really have to reassess that, that plan in light of these rules. But you’re right, what it might mean otherwise is more simple cycle gas fired generation, more battery, storage technology, more renewables. Because, again, anything if you’re going to operate a combined cycle over 40% capacity factor, it calls for carbon capture. So that – but those are – I think you’ve got your sort of finger on the things that you have to consider, which is what would be an alternative mix of renewables and dispatchable resources that can maintain reliability for the system."
},
{
"speaker": "Paul Patterson",
"content": "Okay. So we’ll just, I guess, monitor this. Okay. That’s very helpful. And then with respect to transition, there’s been a lot of focus on the part of officials in Washington and other places on great enhancing technologies. And I was just wondering how you thought about those and the potential deployment at Ameren and just any thoughts you might have on that."
},
{
"speaker": "Marty Lyons",
"content": "Maybe we’ll let Shawn Schukar who runs our transmission operations comment on that."
},
{
"speaker": "Shawn Schukar",
"content": "Yes. Thanks for the question. So the grid-enhancing technology, generally allow us to flow more across the system. They don’t take care of some of the capacity needs. And we see those as complementary as we transition through the grid investments, which means that we’ll be making some enhancements like you see from the MISO, but we also look at those grid-enhancing technologies to support the system, and we’ll be utilizing a combination of both."
},
{
"speaker": "Paul Patterson",
"content": "Okay. Thank you. Good talk to you guys."
},
{
"speaker": "Marty Lyons",
"content": "Thanks, Paul."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our next question comes from Nick Campanella with Barclays. Please proceed with your question."
},
{
"speaker": "Nick Campanella",
"content": "Hey, good morning. Happy Friday."
},
{
"speaker": "Marty Lyons",
"content": "Hello, Nick, same to you."
},
{
"speaker": "Nick Campanella",
"content": "Hey, so I just wanted to ask quickly on the mitigation proposal on Rush Island because I know that you booked this $20 million figure, which was an ongoing hit in your O&M line, but then you kind of mentioned the risk the DOJ is asking for $120 million. And obviously, we’ll see where this goes at the end of the year. But like if it does go against you, is that still an ongoing item in your view? Or is that kind of more one-time in nature?"
},
{
"speaker": "Marty Lyons",
"content": "Nick, it’s a great question. And I think, ultimately, wherever this settles, it really is a one-time item, it is non-recurring. Given the size of it today, we didn’t think it appropriate to sort of carve it out. And as we talked about on our call, we’d look to overcome the cost of that with respect to ongoing operations savings. However, again, as I outlined, the $20 million we proposed and the $120 million of the DOJ propose probably bookends as we think about settlement and an ultimate potential court order here. But like I would agree with you that ultimately, whatever this cost is non-recurring in one-time and won’t be something that affects ongoing operations or earnings."
},
{
"speaker": "Nick Campanella",
"content": "Hey, I really appreciate that. And as it just relates to 2024, I know you’re highlighting that you kind of have this line of sight to O&M in the back half of the plan. So just any comments on how you feel like you’re trending versus your full 2024 number at this point? Are you at the mid-point? Or I guess any comments there?"
},
{
"speaker": "Michael Moehn",
"content": "Yes. Hey Nick, it’s Michael here. Good Friday to you. Yes, look, I mean, we obviously reiterated our range of $450 million to $472 million really focused on the mid-point of that range. The team is completely aligned on flexing what we need to flex here from an O&M perspective. We talked about a number of programs. I think the first part of the year that we put in place with respect to some hiring freezes looking at discretionary spending and looking at contractors, travel, all those kinds of things. And again, those programs are fully ramped up at this point and feeling good about it. We have a long history of this. You’ve heard us talk about this. I mean we’ve been doing a number of things really from an automation and technology investment perspective. We’ve now fully deployed AMI [ph] and we feel we have distribution automation. We’ve done a great deal of stuff from the back office perspective in terms of accounting systems, HR systems, all of those are driving productivity improvements and we’re taking full advantage of. And I was sort of reflecting on the situation and thinking about 2020, that terrible COVID year, we only lost 15% of sales within about a week, and the team came together and really looked for tens of millions of dollars worth of opportunities that will really flex and continue to end up hitting our guidance for that year. I don’t see this as any different. We’ll continue to look for these opportunities. And ultimately, we’re going to make the decisions right for the long-term at the end of the day, but we do have the ability to flex out as we not as needed."
},
{
"speaker": "Nick Campanella",
"content": "That’s really helpful and definitely acknowledge the ability to flex here, especially based on past. One more thing. Just you’re very clear, your 2024 equity needs are basically done outside of internal programs and maybe some DRIP, but just for 2025 and beyond, is $600 million a year still the kind of right number to be thinking about? I think that’s what you guys talked about in the fourth quarter?"
},
{
"speaker": "Michael Moehn",
"content": "Yes, yes, that’s correct. That still stands we delivered back there in February."
},
{
"speaker": "Nick Campanella",
"content": "All right. Have a great day. Thanks."
},
{
"speaker": "Michael Moehn",
"content": "Okay. Thanks for the questions."
},
{
"speaker": "Operator",
"content": "Our final question is from David Paz with Wolfe Research. Please proceed with your question."
},
{
"speaker": "David Paz",
"content": "Good morning."
},
{
"speaker": "Marty Lyons",
"content": "Good morning, David."
},
{
"speaker": "David Paz",
"content": "Could you maybe expand on the data center opportunities? I know you mentioned them, mentioning centers along with some other large customers. But just what opportunity are you seeing there, particularly on the investment side, and maybe any sense of the size of the projects that potentially could come down the pipe and just how much would an incremental investment from Ameren for a typical size project? Thank you."
},
{
"speaker": "Michael Moehn",
"content": "Yes. Hey, good morning, David. I’ll start here. And certainly, Marty, I’ll probably chime in as well. But I mean, I think we have a strong value proposition, right, when it comes to serving both data centers and manufacturers. I mean, we’ve talked about this. We start from a really strong position just in terms of where our rates are, both on the Midwest and national average went well below. We presented a number of sites in both states that can ramp up quickly, sewer water transmission capabilities, et cetera. I’ve never seen state local regional leaders work together as they are right now, really trying to come together on a combined effort, offer various incentives to again, this is beyond just data centers, but manufacturers in general in terms of things around state and local we use taxes, development grants for workforce development, et cetera. We have a number of incentives in place here that are available to customers based on location and size. As we sit here today, Dave, we’ve executed a construction agreement for one data center and it’s got an estimated 250-megawatt lows. That’s sizable for us. We haven’t seen this kind of load growth in a really, really long time. We should be serving that customer by 2026. And I would say, we’re actively working 1,000-plus megawatts beyond that. And so these are all in different stages at this point, they’ll come online differently. But again, I think as we think about the IRP and just adding the renewables and the dispatchable generation that we’ve been adding in the last few years, I mean, this is exactly what we need. And again, all of these projects probably won’t come to fruition, but some of them are really, really moving along nicely. And beyond data centers, there’s just a tremendous amount happening in the manufacturing side as well. I mean, Boeing is the largest manufacturer here in the state of Missouri, started a $1.8 billion expansion here in Jefferson City is also doing a very large expansion, Illinois Wieland rolled products of $500 million expansion. I mean there are a number of projects here that continue – should continue to add to some significant growth. In terms of what that means from a capital perspective, obviously, it’s a net positive. I think we’re going to continue to step back and assess that. But it’s certainly great to see from an investment standpoint and certainly a customer affordability perspective, right? Because it’s going to make it obviously more affordable for all customers at the end of the day."
},
{
"speaker": "David Paz",
"content": "Great. Thank you for that color. Maybe just sneak a quick one. I think you sounded like your tranche, the Tranche 2 initial concept map suggests that there will be some opportunities in your service areas. Any sense how to compare that to what the initial concept at Tranche 1 looks for you guys? Is it roughly the same in terms of potential dollar either size or dollars?"
},
{
"speaker": "Marty Lyons",
"content": "Yes. David, this is Marty. I’ll tell you, well, first of all, the map is encouraging as we shared. And I think if you look at our Slide 11 that we provided, you’ll see substantial proposed additional lines, both in our service territory and in Central Illinois as well as in the Eastern half of Missouri. And so that’s certainly exciting to see. We’re excited that the overall project portfolio was about twice the size of Tranche 1. You – everybody else, I’m sure recalls Tranche show 1 was about a $10 billion portfolio. We ended up having about 25% of that, as we talked about on the call and we were happy to be awarded some directly. We’re very proud to have won all three of the competitive projects that were in our service territory. So we certainly feel good about the way Tranche 1 turned out. It’s too soon to really say what level of investments would be in our service territory from Tranche 2 for really a couple of reasons. One, I would say that the – while we’re excited about these projects that were in our service territory, as you well know, right now, the MISO is going through a process of getting input from stakeholders regarding these proposed projects. And we do expect that as MISO considers the input from various stakeholders that these project plans will be modified. So it’s premature there, number one. Number two, when MISO put out these Tranche 2, they really didn’t assign while they came up with an overall portfolio investment of $17 billion to $23 billion, it really didn’t put any particular quantification of investment value on any particular substations or lines, et cetera. So really premature to even say how much these investment opportunities would be that are shown on this map. So for a couple of reasons, I think it’s premature to say how much of this would be in our service territory. And ultimately, how much would be brownfield or greenfield. So – but I think we will start to see iterations of this through time, and we’re excited that MISO seems to be very much targeting an approval of the Tranche 2 portfolio by mid-September. And so – and it should be pretty exciting over the next few months as we see how this unfolds."
},
{
"speaker": "David Paz",
"content": "Great. Thank you."
},
{
"speaker": "Marty Lyons",
"content": "Thanks, David."
},
{
"speaker": "Operator",
"content": "We’ve reached the end of the question-and-answer session. I’d now like to turn the call back over to Marty Lyons for closing comments."
},
{
"speaker": "Marty Lyons",
"content": "Great. Well, hey, I want to thank everybody for joining us today. We invite you to attend our Annual Shareholder Meeting, which is next week on May 9. And then Michael and Andrew, look forward to seeing many of you at the AGA Financial Forum in a couple of weeks. With that, thanks, and have a great day and a great weekend."
}
] |
aep | 2,024 | 4 | [
{
"speaker": "Rodger",
"content": "My name is Rodger, and I will be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power Company's conference. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press. At this time, I would like to turn the conference over to Darcy Reese, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Darcy Reese",
"content": "Good morning, and welcome to American Electric Power Company's fourth quarter 2024 earnings call. A live webcast of this teleconference and slide presentation are available on our website under the Events and Presentations section. We have a few members of our management team with us today, including William Fehrman, President and Chief Executive Officer, Trevor Michalek, Executive Vice President and Chief Financial Officer, and Kate Sturgis, Senior Vice President Controller and Chief Accounting Officer. We will be making forward-looking statements during the call. Actual results may differ materially from those projected in any forward-looking statement we make today. Factors that could cause our actual results to differ materially are discussed in the company's most recent SEC filings. Please refer to the presentation slides that accompany this call for a reconciliation to GAAP measures. We will take your questions following opening remarks. With that, please turn to slide four and let me hand the call over to William Fehrman."
},
{
"speaker": "William Fehrman",
"content": "Thank you, Darcy, and good morning, everyone. Welcome to our fourth quarter 2024 earnings call. Let me start by saying that after six months on the job, I continue to get more excited about the very strong and comprehensive AEP value proposition. Our future is extremely bright, and we are committed to delivering on our promises to customers, regulators, and investors by putting our robust capital plan to work. We are building a platform of success by focusing on execution and accountability. These are exciting times at AEP, and I see incredible value in this, which I am confident can further unlock by advancing our long-term strategy and providing safe, affordable, and reliable service across our large footprint. Before we jump into our results, I'd like to start by introducing our new CFO, Trevor Michalek, who joined AEP last month and is on the call with me today. Trevor is a proven leader and an industry veteran. He's hit the ground running and is already considered a very strong, disciplined, and focused member of our senior leadership team. Structure by eliminating management layers, reorganizing and reducing the size and scope of the service corporation, and improving procurement processes to drive much higher value from suppliers. The leadership team is coming together to make AEP a premium traded utility that is highly respected and trusted by our many stakeholders. Lastly, I'd like to take a moment to thank Charles Zebula for his more than twenty-five years of dedicated service to AEP. We're grateful for his steady hand during the transition and will continue to benefit from his expertise until his well-earned retirement in March. In my remarks this morning, I will discuss our strategic focus and our results at a high level before passing it over to Trevor to walk through our financials in more detail. Today, we announced fourth quarter 2024 operating earnings of $1.24 per share, $660 million, bringing our full-year 2024 operating earnings to $5.62 per share. Recall as part of our commitment to continuing to deliver value to our shareholders, last October, we increased the quarterly dividend from $0.88 to $0.93 per share. In addition, today, we are reaffirming AEP's 2025 operating earnings guidance range of $5.75 to $5.95 per share and affirming our long-term operating earnings growth rate of 6% to 8%. All reinforced by our robust $54 billion capital plan from 2025 through 2029. As we have talked about previously, I'm committed to a strong balance sheet, and I believe it is critical to funding our robust capital plan. We will responsibly finance the great opportunities ahead of us from a position of strength. Trevor will address this further in his remarks. We will also be disciplined around portfolio management. In fact, last month, we announced the Ohio and INM minority interest transaction on the transmission business with KKR and PSP investments for $2.82 billion. The transaction is highly accretive at 2.3 times rate base and valued at 30.3 times price to earnings. Put this into another perspective, this is equivalent to issuing AEP common stock at $170 per share. Moreover, in the last couple of weeks, we filed for approval with FERC, and we expect to close in the second half of 2025, at which time we'll still retain 95% of AEP's total transmission assets. The proceeds from this transaction allow us to rotate capital into investments that benefit our customers as we enhance reliability and deliver on growing energy demand. In addition to the minority interest transaction, we also recycled almost half a billion dollars in net cash proceeds in 2024 through the sale of the New Mexico Renewable Development solar portfolio and distributed resources business. We continue to work with federal policymakers, state legislators, and regulators across our large service footprint to determine what their goals are so we can relentlessly deliver on them. I would also like to spend some time this morning walking through AEP's future growth, which is underpinned by four major drivers: large load in our service territories, including data center load that we appreciate having the chance to serve and are aggressively pursuing, economic development efforts in our states, investment across the system in our transmission and distribution infrastructure, and new generation. Our capital plan includes customer commitments for 20 gigawatts of incremental load by 2030, driven by data center demand, reshoring and manufacturing, and continued economic development. In fact, large load impacts are already being felt in many of AEP's service territories, especially in Ohio, Texas, and Indiana. As demonstrated in our fourth quarter results, we experienced commercial load growth of 12.3% over the fourth quarter and 10.6% growth on the full year compared to 2023. One of the reasons we are seeing such growth now is that we have an advanced transmission system that can help support current large loads, which is a significant advantage for us versus our peers. As we execute on our $54 billion capital plan to support customer needs, affordability remains top of mind, and we are committed to fair cost allocations associated with large loads. We proactively filed the data center tariff in Ohio and large load tariff modifications in Indiana, Kentucky, and West Virginia, and we look forward to commission decisions in Indiana and West Virginia, both states, unanimous settlements in the near future. The data center tariff hearing in Ohio concluded last month, and we should have a commission decision by the third quarter of this year. In addition to our efforts to support load growth, our current capital plan contemplates sustained and substantial investments across our distribution infrastructure to better meet our customers' energy needs and improve customer service. Since AEP's distribution system is one of the nation's largest, at approximately 225,000 distribution miles, these efforts include work to harden or replace poles, conductors, transformers, and other assets, as well as deploy automated technologies like AMI meters and GridSmart for enhanced operational performance. In total, we are investing more than $13 billion over the next five years in these areas to improve reliability and reduce both frequency and duration of outages. By advancing these initiatives, as well as an aggressive vegetation management program, we will increase customer satisfaction, strengthen our system's resilience to weather events, and reduce costs for operations and maintenance. Demand for power is growing at a pace not seen over my 44 years in this business. As we discussed last quarter, meeting this demand could require incremental investment of up to $10 billion, driven by additional transmission, distribution, and generation infrastructure not included in our current $54 billion capital plan. For example, in our three primary RTOs, we see an opportunity of approximately $4 billion to $5 billion of incremental transmission awards recently approved or expected to be approved in the near term, with additional upside on other initiatives. The remainder of the $10 billion of incremental capital upside is in transmission, distribution, and generation infrastructure across the business. In addition, as you'll recall, in November, we announced a partnership with Bloom Energy related to fuel cells. Our current capital plan does not include any investment in this custom solution, which will enable our large customers to quickly power their operations while the grid is built out to accommodate further demand. Once the necessary infrastructure is connected to these large customers, they can use the fuel cells as backup generation, further adding resiliency to their operations. This demonstrates our commitment to finding innovative customer solutions that let them power up much quicker, allowing their business to deliver service to their customers, which will generate profits much sooner than waiting for a grid connection. As a matter of fact, just this week, AEP Ohio filed with the Ohio Commission for approval of the first two customer projects using this fuel cell technology, totaling 100 megawatts. Not only is AEP working to bring solutions tailored to the current power needs of our customers, but we are leading efforts in the industry on the potential that small modular reactors, or SMRs, have to meet the growing needs of the future. We're looking to partner with the US Department of Energy to support the early site permit process for two potential SMR locations, one in Indiana and the other in Virginia. We are laying the groundwork to find solutions to support large loads and are fortunate for the opportunity to build these SMRs, but only with appropriate risk sharing. The tech companies are fast movers, and AEP will be there to support them with whatever tech solution they want to deploy. We need to ensure that we are protected and compensated. Moving on to regulatory, over the last six months, I have visited ten of our eleven states and have been actively engaged with various stakeholders, listening to their preferences as we invest more in resources at the local level. I firmly believe that by delivering for our states and the customers who live there, we can, over time, improve our earned ROEs and increase equity layers as states are more receptive to the need to attract capital. It is an absolute imperative that AEP listens closely to our states and then aggressively delivers on the agreed-upon commitments. That's my promise to them. When I look at 2024 in review, our operating company has achieved a number of positive regulatory developments, including receiving constructive base rate case outcomes in Indiana, Michigan, Oklahoma, Texas, and Virginia. Obtained commission approval of the Ohio Electric Security Plan, updated formula rates in Arkansas and Louisiana, and filed system resiliency plans in both of our operating companies in Texas. As we discussed on our last call, APCO files its base case in West Virginia while offering securitization as a concept to help mitigate the proposed base rate increase. Interviewer testimony in this case is set for April, with rebuttal testimony following in May and a hearing set to start in mid-June of this year. We look forward to working with everyone involved in this case to achieve a positive outcome for both our customers and shareholders. Shifting now to our generation fleet, we previously filed approval of PSO's Green Country 795 megawatt gas facility, SWEPCO's new Haulsville 450 megawatt natural gas plant, as well as SWEPCO's Welch 1,053 megawatt natural gas conversion project. These facilities and RFPs, which are currently in progress at APCO, INM, and DSO, in addition to future integrated resource plan filings over the next four years in Arkansas, Kentucky, Indiana, Michigan, Virginia, and West Virginia, support our capacity obligations and will go a long way in meeting our customers' energy needs. In summary, we are engaged with key stakeholders on the regulatory front as we keep affordability, system reliability, resiliency, and security top of mind. I'm excited to start the new year having made meaningful progress and will continue these important efforts as we advance on our commitment to excellence and deliver on what our states want. I'll close by thanking everyone at AEP for their hard work and dedication in 2024. I'm energized as we enter 2025 with a strong team and a more streamlined structure that is significantly driving efficiencies, reducing bureaucracy, and creating a much more nimble company that can quickly execute on opportunities. Also, having our employees who have been working from home return to the office full-time by June 1st. Put all hands on deck with a renewed focus on execution and accountability, that will serve us well as we advance our strategic priorities to enhance value for our stakeholders. With that, I'll now turn it over to Trevor."
},
{
"speaker": "Trevor Michalek",
"content": "Thank you, Bill. Good morning to everyone on the call. I want to start today by thanking Bill and the board for placing their trust in me to help lead this organization into a bright and exciting future. I am honored and grateful for the opportunity to join a dynamic team that is focused on positioning the company for future success. And I'm committed to building on our momentum to create value for all of our stakeholders. As part of my transition, I have reviewed AEP's financial and capital plans, and I have confidence in executing on them with this team. Today, I will walk us through the fourth quarter and full-year results for 2024, expand on Bill's comments related to load growth, and discuss what we expect to see in the years ahead. I will finish with commentary on credit metrics, liquidity, and portfolio management, as well as my focus on disciplined capital allocation. Please turn to slide seven. This slide shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the fourth quarter were $1.25 per share, compared to $0.64 per share in 2023. GAAP earnings for the year were $5.60 per share, compared to $4.26 per share in 2023. Detailed reconciliations of GAAP to operating earnings are shown in the appendix on slides 25 and 26. Next, I will briefly cover fourth quarter operating results before moving on to a more detailed walkthrough of our year-to-date results by segment. Fourth quarter operating earnings came in at $1.24 per share, which was a one-cent improvement versus the prior year. We saw $0.22 of incremental rate changes across multiple jurisdictions along with higher normalized retail sales at both the vertically integrated and transmission and distribution segments. Partially offsetting these favorable drivers were higher O&M and lower margins at the generation and marketing segment. For reference, the full details of our fourth quarter results are shown on slide eight. Let's have a look at our year-to-date results. Operating earnings for 2024 totaled $5.62 per share, compared to $5.25 per share in 2023. This was an increase of $0.37 per share or about 7% year over year. Adding to AEP's long track record of delivering on its financial commitments for investors. Looking at the drivers by segment, operating earnings for vertically integrated utilities were $2.63 per share, up $0.16 from a year earlier. Positive drivers included rate changes across multiple jurisdictions, notable outcomes in Virginia and Indiana, and a return to relatively normal weather in 2024 compared to the mild weather experienced in 2023. These items were partially offset by higher depreciation and higher O&M as we made investments to serve our customers. The transmission and distribution utility segment earned $1.51 per share, up $0.21 from last year. Favorable drivers in this segment included increased rates in Texas and Ohio, increased transmission revenue, a favorable year-over-year change in weather, and higher normalized retail sales. Partially offsetting these items were increased property taxes, depreciation, interest expense, and O&M. The AEP Transmission Holdco segment contributed $1.51 per share, up $0.08 from last year. Our continued investment in transmission assets, as the new loads are added to our system, was the main driver in the segment. Generation and marketing produced $0.48 per share, down $0.11 from last year. The reduced contribution from this segment was primarily driven by the sale of our universe of 2023, higher income taxes, and lower retail energy margins. These items were partially offset by lower interest expense and higher wholesale margins. Finally, corporate and others saw a benefit of $0.03 per share driven by lower income taxes and O&M, which are partially offset by higher net interest expense. As Bill mentioned earlier, we are reaffirming our operating earnings guidance range for 2025, of $5.75 to $5.95 per share. For convenience, we've included an updated waterfall bridging our actual 2024 results to the midpoint of our guidance for 2025 on slide 20. While some variances change due to the 2024 actual results, there is no change to our 2025 segment or overall guidance. Turning to slide nine. You can see more evidence of just how important load growth is to our financial story. Weather-normalized sales grew 3% in 2024, and we expect that to nearly triple in the years ahead. These are exciting times in the utility industry, as we incorporate this tremendous growth. As Bill mentioned, the load growth that I'm going to talk about is providing the opportunity to potentially add up to $10 billion of incremental capital over the next five years to our already sizable $54 billion plan. We are continuing to evaluate the magnitude and timing of this spend to meet the growth opportunities across our footprint. The gains we are seeing from the data centers and industrial customers represent a once-in-a-generational opportunity to shape and grow the system. So before I jump into the details, I want to emphasize a few key points about our confidence in the projections you see here. First, this isn't just a future story. This is a now story. We're already seeing these loads come online across our system. In December of 2024, we added almost 450 megawatts of hyperscale data center load in Ohio alone. Second, the load additions built into the forecast you see here are all backed by signed customer financial obligations demonstrating their commitment to bring these projects online. In fact, nearly all of these loads are backed by take-or-pay contracts and have already been accepted by certain RTOs, including PJM. This means that our customers are committed to paying for a minimum amount of power over a period of time. What's more, we've achieved tariff settlements in Indiana, Ohio, and West Virginia to strengthen and lengthen those commitments even further. Beyond those contracts, we have substantial interconnection queues waiting to sign additional commitments as well. Diving a little further into the details, you can see where the bulk of our growth is concentrated. New data centers drove double-digit growth in our commercial sales in 2024, with system-wide data processing load hitting a new high in December of 1.3 million megawatt hours. The gains are expanding beyond this transmission and distribution utilities into our higher-margin vertically integrated segment. Recently, we also connected the first of several hyperscale data center customers in Indiana, including AWS and Google. Across the entire system, we're contracted to see nearly 5 gigawatts of data processing load come online in 2025, representing almost a 25% increase from 2024. Beyond commercial load, our industrial sales are also set to accelerate after a resilient 2024. AEP's industrial load grew by more than 402,000 megawatt hours last year. This was punctuated by growth of almost 5% in Texas, highlighting the diversity of our service territory and giving us a lot of confidence going into the new year. We expect industrial sales growth to more than double in 2025 as several new large customers are contracted to come onto the system, like Cheniere in Texas. We also have several other large and well-publicized industrial projects set to come online in 2026 and 2027. More detailed load projections by class can be found on slide 13. As a reminder, we have more than 20 gigawatts of commercial and industrial load additions contracted to come onto our system through the end of the decade. Roughly half of those are in ERCOT, and the other half are spread across our PJM companies. As a result, we expect these quarterly sales numbers to continue their rapid growth for several years to come. Let's move on to slide ten to discuss the company's capitalization and liquidity. Our financial performance and strong balance sheet provided good credit metrics for the last twelve months. Our debt to capitalization remained largely consistent with our historical range. Our FFO to debt metrics stood at 14% for the twelve months ended December 31st, which was within our target range and well above our downgrade threshold of 13%. Available liquidity remained very strong at $4.6 billion and is supported by $6 billion in credit facilities. Our strong balance sheet and credit metric results, coupled with ample liquidity and the outcome of the minority interest transaction, expected to close in the second half of this year, have enhanced our financial flexibility. We can efficiently access the capital market to support the capital needs in front of us. We are committed to maintaining a strong balance sheet and credit metrics as we evaluate the upcoming capital spend opportunities and match them with optimal financing instruments. On a similar note, last week, I spoke directly with all three rating agencies and conveyed this leadership team's commitment to a strong balance sheet. Focused on executing the regulatory and financing plans, as well as disciplined allocation of O&M and capital to our companies. Finally, let's move on to slide eleven. Before we take your questions, I wanted to summarize what you heard from us today. First, you heard we had a strong year-over-year performance in 2024, growing our earnings roughly 7% with operating earnings coming in at $5.62 per share. We reinforced our commitments to stakeholders and built solid momentum heading into 2025. Second, you heard that we are absolutely focused on execution in 2025 to support one of the great load growth stories in our industry. We're executing on strategic investments and delivering our regulatory strategy, giving us confidence in our financing plans. Third, you heard we have $10 billion of incremental growth capital that we are currently evaluating. And fourth, you heard that the $2.82 billion pending minority interest transaction on the transmission assets is an exceptional value proposition to our shareholders. The transaction further boosts our earnings and credit profiles and helps to reduce near-term equity needs. Recall that the value we transacted on this is comparable to issuing equity at $170 per share. And we're still retained 95% of AEP's total transmission asset post-close. These components are key to our future success and reinforce our confidence in reaffirming our commitments, including our 2025 guidance range of $5.75 to $5.95 per share. Our long-term growth rate is 6% to 8% while targeting FFO to debt of 14% to 15%. We really appreciate your time and attention today. I'm gonna ask the operator to open the call so we can answer any of your questions that you may have. Thank you."
},
{
"speaker": "Rodger",
"content": "Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star one on your telephone keypad to raise your hand and join the queue. If you would like to withdraw your questions, simply press star one again. We'll take our first question from Shar Pourreza at Guggenheim Partners."
},
{
"speaker": "Shar Pourreza",
"content": "Hey, guys. Good morning."
},
{
"speaker": "Trevor Michalek",
"content": "Good morning, Shar."
},
{
"speaker": "Shar Pourreza",
"content": "Morning. Just on the balance sheet, the forty-six to sixty basis points of FFO improvement, you highlight that kind of on the slides as a near-term target. Can you sustain that over the plan? And then on equity, any sense on the means of issuing the remaining $2.5 billion? Is it junior or is it asset optimization, a block? I mean, I know, Bill, in your comments, you did highlight portfolio management in your prepared remarks. So just wanna get a sense on that remaining equity as well."
},
{
"speaker": "Trevor Michalek",
"content": "Sure. So here's Trevor. Sure. Appreciate the question. You know, we are targeting FFO to debt in that 14% to 15% range. And again, from our perspective, that is a target that we're looking at. I will note that, you know, we are going to have a revision to the way that Moody's calculates the deferred fuel. So, we will drop down probably forty, fifty bps, sixty bps depending on, you know, where things go with that, which I think it's gonna happen. But again, that's gonna be above the 13% threshold. And again, from our perspective, both Bill and I are very focused on issuing, you know, the or executing on the $54 billion capital plan with a strong balance sheet. So I think what you'll see is this will dip down a little bit in the current year, and then really the deferred fuel issue kind of rolls off by 2026. And so from that perspective, you know, we're really focused on getting that, you know, in that 14% to 15% range in the near term. Then getting to your financing question, you know, again, like you said, we put out that $5.35 billion of equity needs last year and kind of talked about that at EEI. The good news is with this transaction, the $2.8 billion goes a long way to solving that. So that really leaves then, like you said, the $2.5 billion of which there's, you know, call it $500 million over the five-year period, $100 million a year on the drip. So then it's a very manageable $2 billion. And then looking at various things that we have here to solve for that, you know, there's potential securitization that we're continuing to work on in some of our locations. But we'll also utilize, you know, hybrids or other equity-like instruments. And then if we need to issue equity, you know, we could do that. And I'm not opposed to issuing equity for growth, and we have a growth plan that is incredible here. Especially, you know, articulating around that incremental $10 billion, but we want to be very judicious with issuing equity, but we think there's a lot of different levers that we can pull, securitization, hybrids, and then potentially, you know, over the longer term, if we had to issue incremental equity, we would consider it. But again, very focused on FFO to debt, and also executing on, you know, this kind of historic $54 billion growth plan."
},
{
"speaker": "Shar Pourreza",
"content": "Perfect. And then just lastly, obviously, a lot of load growth and you guys have that new CapEx upside disclosures. Specifically on the 20 gigs of load you're leaning on, just wanna get a sense on how much of that is in Ohio and on the dual tariff settlements that are out there. Can the differences be bridged? And what if the commission's order swings against your settlement? I know, Bill, you've been very active on the stakeholder engagement side. Just wanna get a sense there. Thanks."
},
{
"speaker": "William Fehrman",
"content": "So we're very, obviously, focused on the rate case and on the tariff filing for data centers. A lot of discussion going on. We're clearly looking to try and find a solution for bringing these folks into our system and bringing the economic development opportunities with us. And so we're continuing to look. If you think about the data center story that we have, in December alone, AEP Ohio added nearly 450 megawatts of data center load from AWS and Meta. So very strong. Looking ahead, we anticipate adding similar amounts of load almost every month through 2025. We've got over 4.7 gigawatts of data processing load contracted to begin service this year. And then while most of this load, to your point, is concentrated in Ohio and actually Texas, we also have nearly a gigawatt contracted to come online in Indiana. So that's extending our growth into the vertically integrated utility segment as well. So I would note that both Google and AWS have recently begun service in Indiana. So that's very positive for us, and they're gonna continue to ramp up progressively over the next several years. So this growth certainly underscores our commitment to economic development and highlights significant opportunities ahead, but, clearly, we're going to make sure that this doesn't fall on the shoulders of our existing customers and make sure that the appropriate parties who are driving the incremental cost will pay for the incremental cost."
},
{
"speaker": "Shar Pourreza",
"content": "Perfect. Trevor, big congrats to you and the AEP team. I know you're gonna do really fantastic there. Big congrats on phase two."
},
{
"speaker": "Trevor Michalek",
"content": "Sure. I really appreciate it. Excited to be here. This is an incredible story, and quite the team here. So thank you."
},
{
"speaker": "Shar Pourreza",
"content": "Great. Thanks, guys."
},
{
"speaker": "Rodger",
"content": "We'll move next to Ross Fowler at Bank of America."
},
{
"speaker": "Ross Fowler",
"content": "Morning."
},
{
"speaker": "Trevor Michalek",
"content": "Thanks, Ross."
},
{
"speaker": "Ross Fowler",
"content": "So just wanna dig into maybe the data center tariffs you talked about sort of protecting yourself around sort of stranded cost risk or minimum take risk. So in that tariff, you know, have you disclosed what that rate is versus maybe other industrial commercial rates? Is it, like, a minimum power take requirement that's in there? And what kind of terms are you looking at in those tariffs that you filed?"
},
{
"speaker": "William Fehrman",
"content": "So the tariffs are really driven by the cost of the incremental project. And so there's not a specific, say, price in the tariff until we understand what the cost of the incremental load is going to be or the incremental transmission is going to be to serve that load. And so it really is a case for us to protect the existing customer base and that the driver behind the data center cost will be covered essentially by the company that's requiring it. So we feel very good about where we sit. I would say there are a couple of differences in the tariffs if you look across the states. For instance, in Ohio, that tariff is very much focused on data centers, whereas if you look at the similar proposal in Indiana, that is a broader tariff that would apply to any and all large loads that are similar to a data center. So some minor differences across the states, but generally, the same purpose holds, which is make the customer who's driving the incremental cost pay for the incremental cost and put it in place for a longer period of time so that we know as we're building out this incredible investment that, oh, if the customer goes away in year six or seven, we still have coverage for some of those costs, and it's not stranded and placed on the shoulders of our existing customers. So very, very positive outcome for us. I think it sets us up, and I don't think that it's been a detriment to the economic growth we have if you look at the overall increases that are already signed up. We have significant growth in accordance with these tariffs. So very, very strong interest still even though these tariffs are going into place."
},
{
"speaker": "Ross Fowler",
"content": "That's great, Bill. Thank you. And then Trevor, maybe one for you. You mentioned securitization as an avenue for maybe some of that equity need. Did you have a scaling of that versus the $2 billion you need in the current plan, or have you sort of not walked through all of that yet?"
},
{
"speaker": "Trevor Michalek",
"content": "Yeah. We're still working through that with the various states, Ross, but, you know, honestly, I think you could look at it and securitization could, if successful, could potentially, you know, be a big chunk of that remaining $2 billion. So, you know, right now, if you the way I think of it is we kind of laid out the $5.35 billion over a five-year period. The $2.8 billion from the sale transaction really takes care of a big chunk of that in the immediate term here, and then we have a lot of other levers to pull over the remaining, you know, four years of the plan to solve for that $2 billion. But securitization could be, if successful, you know, a real win because it could help the customers with regards to rates, but it can also help us with regards to the need for the cash that would fill that gap on the $54 billion plan that we laid out."
},
{
"speaker": "Ross Fowler",
"content": "Perfect. Thank you. And then if we can squeeze one more in back to techy Bill. You mentioned SMRs and kind of how you're trying to very early stages looking at that, but, you know, under the right risk structure. In other states, we've sort of seen, like, this idea where, you know, the off-taker would put in a significant portion of the capital and take more of the risk into that project? Are you thinking about similar structures there or how far have you kind of walked down the thought process of what that structure would look like or might look like?"
},
{
"speaker": "William Fehrman",
"content": "Yeah. Thanks for that question. Obviously, very interested in SMRs as a technology, and that's really driven by the fact that our major customers are also interested in that as a solution. And as we noted, we've started with the early site permit work in Indiana and Virginia and have signed MOUs with various parties to support that type of work. We did put in our tier one application with the DOE for one of the sites and the tier two application for the other site to try and get some support for those. At a broader look, with regards to how we would think about this, clearly, I'm not going to put the company at risk in any type of a move as a first-of-a-kind type of technology. And so as we've been talking with potential customers, we haven't got to any specific arrangements or how this might look at this stage. But certainly, there's discussions ongoing to see if there's a way to do this. Clearly, the SMR technology providers, somebody needs to be first, and somebody needs to step up and figure out how they're going to deliver their product and back it. I mean, this is one of those situations where, to me, I'm buying a technology from somebody, and it should work. And it should be at a price that is very understandable and protected. And so I'm very excited about where we sit with regards to discussions, but I would say we're quite a ways away from having anything firmed up or really any firm structure at this point. But whatever we ultimately end up with, we'll be very principled and disciplined on our side of this to make sure that our shareholders and our customers are protected from any significant types of negative outcomes."
},
{
"speaker": "Ross Fowler",
"content": "That's great. Thank you. And, Trevor, congratulations again on the new role. Wish you nothing but success."
},
{
"speaker": "Trevor Michalek",
"content": "I really appreciate it, Ross. Thank you."
},
{
"speaker": "Rodger",
"content": "We'll go next to Steven Fleishman at Wolfe Research."
},
{
"speaker": "Steven Fleishman",
"content": "Hi. Good morning."
},
{
"speaker": "Trevor Michalek",
"content": "Hey, Steve. Congrats, Trevor, as well. Let me echo that."
},
{
"speaker": "Steven Fleishman",
"content": "So just on the, I guess, on the upside to the capital plan and particularly the transmission, so, for example, there's these PJM transmission that the joint venture that you have and the like that's being decided the next month or so. Is that that would be upside to the plan that's not in the plan? To things like that."
},
{
"speaker": "Trevor Michalek",
"content": "Yeah, Steve. That's right. That would be upside to the plan. So, you know, here again, what we've got is, you know, the $54 billion plan that has very definitive things in it, and we really aren't putting things into the plan that aren't for sure. And so then when you look at this $10 billion, a lot of this is coming to fruition over the next, you know, kind of months here. And so we're gonna be pretty excited about rolling out kind of in a normal cadence on the third quarter call a revision to the $54 billion plan, but, yeah, that would be upside."
},
{
"speaker": "William Fehrman",
"content": "And, Steve, just to add to that, yeah, just to add that a little bit specifically to PJM, you probably know we've announced the joint planning agreements with Dominion and FirstEnergy to propose those projects through the regional transmission expansion plan. We expect PJM approval in the first quarter on those projects. And so, again, as Trevor noted, all of those, if they would come to fruition, would be upside."
},
{
"speaker": "Steven Fleishman",
"content": "Okay. And then I, you might have answered this, Trevor, and I missed it. But just in the event that you see that capital plan come up, how should we think about funding for incremental capital?"
},
{
"speaker": "Trevor Michalek",
"content": "Yeah. So again, yeah. You know, Steve, I think on the incremental capital side, we really do have a lot of positives here. Again, with the $2.8 billion coming in this year, that's gonna set us up really well for, you know, call it roughly half of the equity needs that we laid out before. And then with securitization and other things, that's really gonna kind of take us a long way to filling that gap. At the end of the day, I'm not opposed to, you know, issuing equity for growth, and this kind of growth I think that really makes sense. At the end of the day, you know, there's a lot of other things that we're working on internally as we rightsize this organization to get, you know, costs in line with where this is going. As well as other opportunities we're looking at that I want to be somewhat, you know, careful here in how we say it. But there is, you know, capital allocation internally looking to support this growth plan. And, you know, equity, we take equity very seriously here. We know it's very precious, but we're not opposed to issuing equity for growth purposes."
},
{
"speaker": "Steven Fleishman",
"content": "Yep. Okay. And then, I guess, two questions on data centers. First, just a high level curious after the Eatsy kind of freak out. Just what kind of color are you getting from your customers on their plans? Is anything changed, good or bad? In terms of the commentary influenced by the customers?"
},
{
"speaker": "William Fehrman",
"content": "Really, no change in plan for us at all. It's been full speed ahead, and when the Eatsy came out, we had conversations with a number of our customers, and none of those individuals spoke in any way that we would be seeing a change. And so I think at least for us, I can't speak for others, obviously, but it continues to be full speed ahead."
},
{
"speaker": "Steven Fleishman",
"content": "Okay. And then lastly, on the Bloom partnership, and the like, just you know, I think you had made a firm order for the 100 megawatts since it sounds like you have customers for that. Just how are you feeling about the likelihood to get, you know, into that full gigawatt, or is it too early to kind of say?"
},
{
"speaker": "William Fehrman",
"content": "Well, first, I'm really excited about customers that we have that have taken up the first 100 megawatts that we announced when we talked about the supply agreement with Bloom last November. I feel very good about where we're at with those customers. It's obviously proven that it's a viable opportunity for others to use in order to speed their ability to build their data centers and get online significantly sooner than waiting for perhaps five to seven years for a grid interconnect. And so I like where we're at with this technology. We're obviously on the leading edge from an innovation perspective. AEP is solving problems for these data centers that while others are maybe just issuing press releases, we're actually getting to solutions for these folks. And so I'll keep, we'll keep you updated, obviously, as our Greenwood Bloom allows for further expansions up to the one gigawatt mark and keep in mind, I would note also that this potential capital outlay is also not included in the current $54 billion capital plan. As we've talked about, but it is part of the $10 billion incremental investment opportunity that we're currently evaluating. And so, obviously, if more of that comes on, we'll have more updates for you. But overall, again, the feedback on this innovation and solution for customers has been extremely positive."
},
{
"speaker": "Steven Fleishman",
"content": "Yep. Great. Thank you. Appreciate it."
},
{
"speaker": "William Fehrman",
"content": "Thanks, Steve."
},
{
"speaker": "Rodger",
"content": "We'll go next to Jeremy Tonet at JPMorgan."
},
{
"speaker": "Jeremy Tonet",
"content": "Hi. Good morning."
},
{
"speaker": "Trevor Michalek",
"content": "Good morning."
},
{
"speaker": "Jeremy Tonet",
"content": "And, Trevor, congratulations as well."
},
{
"speaker": "Trevor Michalek",
"content": "Jeremy, I appreciate it."
},
{
"speaker": "Jeremy Tonet",
"content": "Just want to start off, I guess, picking up with the custom solutions as you outlined there, you know, being kind of bridge solutions. Is when if you could provide a bit more detail what it means from the AEP side potentially. Just if we could frame what that could look like from CapEx or any other way to kind of think about that, you know, potential in specifically just wires or other elements as well as it relates to AEPs."
},
{
"speaker": "William Fehrman",
"content": "Sure. Well, first and foremost, again, in the spirit of protecting our existing customers for these deals, all costs for the fuel cell projects will be covered by the large customers that are under stand-alone contracts with AEP. And these are very customer-specific, and they'll need state commission approval. And so we're very excited about how this is rolling out and the fact that each of these individual customers, again, will cover the costs that are associated with the project. As far as the capital side now, Trevor, maybe you add a little bit on that or how we're thinking about it."
},
{
"speaker": "Trevor Michalek",
"content": "Yeah. And then what I'd like to do on that, Jeremy, is roll that out, you know, if and when that comes to fruition, but that's all kind of part of that $10 billion upside. So we haven't really disclosed, you know, specifics around that, but expect more of that to come in the normal cadence. The only thing I would also add, Bill, is that, you know, I think AEP has had a rich history of, you know, being an innovator in this industry. You know, whether it's being the first to kind of have 765 kV lines, you know, all the way to this, you know, solution to help our commercial industrial load come on with this Bloom solution. But as Bill said, you know, we're gonna do it in a very disciplined way and, you know, it kind of talks to what AEP has done over the years to be a leader."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. Thank you for that. And just pivoting here to West Virginia if you could. Just wondering if you could provide any incremental color on stakeholder conversations in just the state of, I guess, stakeholder relationships in the state at this point and how that has evolved over time."
},
{
"speaker": "William Fehrman",
"content": "Yeah. I really appreciate that question. I've been very focused on West Virginia since I joined AEP last August. I spent a considerable amount of time in the state and talking with key stakeholders, including the prior administration as well as members of the current administration. I would say that right now, we were very innovative again in the filing that we put in. We corrected the deficiencies that we had and put in a very robust filing. But inside of that filing, we also offered the commission a separate solution for them to consider. As I noted in my remarks, the hearing is in June, and we expect a commission decision in the third quarter. We'll obviously see progress as the intervener testimony is due in April. Rebuttal testimony is due in May. And the proposed securitization option that we have on the table is not in our current financial plans. So, again, if it does come to pass, that would be a good adjustment. But we did include it in the filing as an option and really, purposely, to support customer affordability. This option is a very strong option that helps reduce the cost to customers. And so we really look forward to collaborating with all of the stakeholders there and achieving a favorable outcome for really all parties. And I think that so far, as the process has gone through, we've gotten positive feedback on how we approach this."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. Thank you for that."
},
{
"speaker": "Rodger",
"content": "We'll go next to Durgesh Chopra at Evercore ISI."
},
{
"speaker": "Durgesh Chopra",
"content": "Hey. Good morning, Trevor. Welcome. I look forward to working with you. Listen, I just had two clarification questions, a lot of discussions on the topics I'm gonna ask you on. But just to clarify, Bill, I think you know, you discussed the large load tariff in Ohio and decision in Q3 by the commission. Is I understand it, the data center customers are not part of that settlement technology customers are not part of that settlement. Is that completely off the table, or could you still work in agreement with them? I guess, what I'm trying to get at with this is, is there an active dialogue conversations happening with them, or is it just now in the hands of the commission?"
},
{
"speaker": "William Fehrman",
"content": "So you're correct. There's actually two settlements that were being discussed. There was a settlement amongst the data centers themselves that they filed. And then there was a second settlement that was ourselves plus the commission staff plus some other large load entities that was filed. Both of those went through the hearing process. And then, as I said, there's basically now in the rebuttal and hearing, excuse me, intervener testimony and rebuttal process. I would say that there's continuing discussions going on as always as you go through these processes. But at this point, I would say we're really into waiting for the commission to issue their ruling, and we'll see what happens. Again, we're very open. These are our customers. We want to work with our customers. We want to find solutions for them just like we did with the Bloom Energy deal. And so we'll always try to find a way forward. But we do have certain principles that we want to make sure stay in place, which is good protection for our existing customer base."
},
{
"speaker": "Durgesh Chopra",
"content": "Well, that's very helpful, Bill. Thank you. And then, Trevor, back to you, just a little bit more color on the 2025 financing plans. Obviously, congrats on the asset sale. That's a big bite at the apple from the overall equity in the plan. And then your commentary about, you know, the deferred fuel balance while taking your effort to get down, but still keeping you comfortably above the downgrade threshold. Should we take all that to mean that from an equity standpoint, you're done for 2025, or could you still kind of punch in, you know, more equity as you think about just I'm focused on 2025. Not sure if you can answer that or not, but just thinking about whether you're done for 2025 or not."
},
{
"speaker": "Trevor Michalek",
"content": "Yeah. So I think, you know, Durgesh, the thing that I look at is, you know, the $2.8 billion of cash coming in the door when we close that transaction will really go a long way to, you know, getting what our needs are right now because really, you know, when we laid out that $5.35 billion, that was over a five-year period. So over half of that is coming in in year one. That being said, you know, again, we are really focused on this growth of the $10 billion and seeing how we can get that into our plan as quickly as possible. So, you know, and then there's other things we're dealing with as well, you know, with as Bill just mentioned, the potential securitizations. So a lot moving around right now, but, you know, I think we're in that great position with this transaction that, you know, I kind of got the benefit of stepping into after Chuck and Bill had kind of solved that issue that it really takes a lot of the pressure off of 2025 right now. But again, you know, my commitment is to, you know, be in a situation certainly where we would be above our downgrade thresholds. And this plan, fortunately, as we've got it right now with the $2.8 billion even with the deferred fuel adjustment mechanism keeps us above the 13%. And, you know, it puts us in a good position going forward. But again, a lot of moving parts around the growth, and that's what we're excited about right now is this incremental growth opportunity."
},
{
"speaker": "Durgesh Chopra",
"content": "Got it. Appreciate that discussion there. Thanks, Trevor."
},
{
"speaker": "Trevor Michalek",
"content": "Thanks, Durgesh."
},
{
"speaker": "Rodger",
"content": "We'll move next to Nicholas Campanella at Barclays."
},
{
"speaker": "Nicholas Campanella",
"content": "Hey. Good morning, and congrats to Trevor. Welcome to Columbus. And, you know, Chuck, if you're in the room, congrats on your retirement too. So hey. I just wanted to just a couple follow-ups. When you announced the transmission sale, you kind of said it's 1.7% accretive, like, on average to the plan. And can you just talk about the flexibility that that offers you as you work to kind of add this capital to the plan and strengthen the balance sheet and, you know, I guess where I'm heading is, when we get to the end of this year, like, is this transaction lengthening to six to eight, or do you expect kind of a step higher, you know, and at the 1.7% level? Thanks."
},
{
"speaker": "Trevor Michalek",
"content": "Yeah. So, Nick, you know, to kind of convert that into an EPS, you know, that's roughly eleven or twelve cents of, on a full-year basis, that this transaction is accretive. But again, it depends on the timing of when we close it during the year, and so that will kind of, you have to take that into consideration as it gets towards the end of the year on what that really does. My view is I think we put out the range of $5.75 to $5.95, and, you know, we'll be at this point, in that range, you know, with the transaction and, you know, in good shape with regards to credit. So again, it probably the later it goes into the year, the less impact it has on 2025. With regards to the accretion, but it more really does help with where we're gonna be on the credit metrics."
},
{
"speaker": "Nicholas Campanella",
"content": "Right. Okay. And then just how are you kind of thinking about further portfolio management at this point? I mean, the transmission sale is a great data point, and I definitely note, like, kind of the clear focus here on Indiana, Ohio, and Texas, and just do you guys still see opportunity to kind of prune things in the portfolio if it's accretive to your plan?"
},
{
"speaker": "Trevor Michalek",
"content": "Yeah. You know, again, I think on any type of M&A, we wouldn't really speak to it. But I tell you, the thing that we're most excited about is investing $54 billion at one time's rate base. And if you think about that, you know, that's basically the size of our market cap right now. With a potential upside of an additional $10 billion. So our view is we want to get scale and scope, and we believe we're growing this business and, you know, we think we are, we've got great footprints over a large area that helps us to mitigate risk. And so from the, at the end of the day, you know, I look across the portfolio and believe we've got a really good fit footprint relative to our competitors. And so I'm very, very positive about what I've stepped into here and feel that this is really good. But, Bill, I'm not sure if you want to add anything on this."
},
{
"speaker": "William Fehrman",
"content": "I think, again, as Trevor noted, we've got a tremendous opportunity in front of us. And as a company, we're going to drive ourselves to be the biggest and the best energy infrastructure company in this country. I mean, again, it's in our name. We're American Electric Power. We're gonna power America. And as Trevor noted, the opportunity is almost unlimited for us going forward, and I have very strong confidence that we're gonna be able to deliver and execute."
},
{
"speaker": "Nicholas Campanella",
"content": "Alright. That's great. Excited to see it, and have a great day. Thank you."
},
{
"speaker": "Rodger",
"content": "We'll move next to Carly Davenport at Goldman Sachs."
},
{
"speaker": "Carly Davenport",
"content": "Hey. Good morning. Thanks for squeezing me in. Maybe just one quick one for me. Just as you think about the generation needs across the portfolio to accommodate this load growth, I know you referenced some of the gas filings at PSO and SWEPCO in the opening comments. Can you just talk about the status of procurement of key equipment like turbines to execute on those plans?"
},
{
"speaker": "William Fehrman",
"content": "Sure. I appreciate the question. We have a very strong generation plan that has been developed within AEP and a bit of it also predated me with regards to looking at strategies around procuring turbines, procuring transformers, and other key equipment. I'm very confident in the plan that the team has. Our procurement strategy is strong. And we have a lot of activity out in the market right now. We're doing RFPs for a number of our states. We have significant IRP activity going on. And obviously, there's a growing energy demand out there, which is really why we're leading the efforts in the industry to try to find solutions for them, like in the near term bloom and in the longer term SMRs. And so we'll be all over this. I'm confident in our team, and I'm confident in the fact that we're going to deliver what our states want from a generation plan. And, clearly, as the year goes on, we'll be providing more updates in that area."
},
{
"speaker": "Carly Davenport",
"content": "Great. Thanks so much for the call. I'll leave it there."
},
{
"speaker": "Rodger",
"content": "And we have time for one more question, and that question comes from Julien Dumoulin-Smith at Jefferies."
},
{
"speaker": "Jamieson Ward",
"content": "Hi, team. It's Jamieson Ward on for Julien. How are you?"
},
{
"speaker": "Trevor Michalek",
"content": "Yeah. Good. Good morning."
},
{
"speaker": "Jamieson Ward",
"content": "Morning. Yeah. Thanks for fitting us in here at the end. Very thorough Q&A covered pretty much all the questions that we had. Did have one that was remaining, which is just on the ATM that you filed. It mentioned that $400 million had been already issued. In combination with the $2.8 billion of net cash proceeds that we'd expect to receive, you know, to see you receive it in the second half of the year. Do those two meet your 2025 equity needs? Or should we assume any further usage of the ATM in 2025? Is it just the 2026 and beyond tool? Thank you."
},
{
"speaker": "Trevor Michalek",
"content": "Yeah. Look. As I said, you know, Jamieson, we're continuing to evaluate all of that. The good news is we do have access to the $1.3 billion that's remaining under the ATM. We can always hit that if we need to. But again, right now, I think we've got a very positive situation that we will be, you know, getting the $2.8 billion coming in later this year. And then as we look to the $10 billion growth opportunities here, you know, we will continue to evaluate that. But I think, you know, largely you've got it right with the ATM in place, and what we're doing with the drip program. And the cash coming in and the securitizations that potentially could come to fruition by the end of this year, we're in good shape."
},
{
"speaker": "Jamieson Ward",
"content": "Gotcha. Gotcha. Really quick follow-up there. I guess the $2.55 billion that you had left, $500 million or so for the drip, $100 per year, the $1.7 for the ATM, that $350, it would seem kind of perfect for a JSN or some sort of equity content or equity-linked security. So I guess that kind of fits with what you've described. Is that a reasonable way to think about it? And then I just had one more on the $10 billion."
},
{
"speaker": "Trevor Michalek",
"content": "Yeah. No. I think absolutely you're thinking about it correctly. There's a lot of levers for us to use here as we continue to look at things. And so, again, it's very positive with the $2.8 billion and then securitizations and other equity-like instruments are all very positive. And then if need be, we do have that $1.3 billion ATM. But again, we're in good shape here."
},
{
"speaker": "Jamieson Ward",
"content": "Terrific. And the last one I'll leave you with, I know that you've answered one or two questions already on the $10 billion. Just wondered if there was a rule of thumb, you know, a couple of years ago at EEI that talk was all about 30% or 50% or whatever percent of incremental CapEx. And I get there's certain thresholds. If you get a billion of the $10 billion, it's a different scenario than if you get all $10 billion of the $10 billion. But any rule of thumb you can give us on high-level thinking about the amount of equity or equity-like portion that be looking to finance of that incremental CapEx versus debt financing?"
},
{
"speaker": "Trevor Michalek",
"content": "Yeah. The biggest thing that I would say is we're excited to roll that out, you know, in a normal cadence on our third-quarter call. And again, there's a lot of moving parts that we're managing here. And we are going to finance it in the most efficient way possible to ensure we can continue to meet the needs of our customers. But also to deliver on value to our shareholders, and that's what we're very focused on."
},
{
"speaker": "Jamieson Ward",
"content": "Thank you so much. Appreciate it."
},
{
"speaker": "Rodger",
"content": "And that concludes our Q&A session. I will now turn the conference back over to William Fehrman for closing remarks."
},
{
"speaker": "William Fehrman",
"content": "Yeah. Thank you. We appreciate everyone joining us on the call today. I'd like to close with just a few summary remarks. First, very exciting times are ahead for AEP as we put our robust capital plan to work, as you've heard, and continue to grow the business while delivering shareholder value. Second, I'm very confident we can unlock the incredible value in this company by advancing our long-term strategy and providing safe, affordable, and reliable service across our large footprint. And then third, Trevor and Darcy will be hitting the road actually in March, meeting with many of you and discussing AEP's very strong and comprehensive value proposition. And finally, if there are any follow-up items, please reach out to our IR team with requests. So thank you again for joining us today. This concludes our call."
},
{
"speaker": "Rodger",
"content": "And again, this concludes today's conference call. You may access the replay for today's conference by dialing 1-800-770-2030 and entering the conference ID of 1336080 followed by pound. The replay will be available until Thursday, February 20, 2025, at 11:59 PM Eastern Time. Thank you for your participation. You may now disconnect."
}
] |
aep | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Thank you for standing by. My name is Danica and I will be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power's Third Quarter 2024 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] I would like to turn the conference over to Darcy Reese, Vice-President of Investor Relations. Please go ahead."
},
{
"speaker": "Darcy Reese",
"content": "Thank you, Danica. Good morning, everyone, and welcome to the third quarter 2024 earnings call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides, and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for discussion of these factors. Joining me this morning for opening remarks are Bill Fehrman, our President and Chief Executive Officer and Chuck Zebula, our Executive Vice President and Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Bill."
},
{
"speaker": "William Fehrman",
"content": "Thank you, Darcy and good morning everyone. I'm happy to be with you for my first earnings call as AEP's President and CEO. In my remarks this morning, I'll discuss our results and outlook before turning to the key pillars of our strategy to enhance value for customers and investors. I'll then cover regulatory updates before handing it over to Chuck to walk through our financials in more detail. You can find a summary of third quarter 2024 business highlights on Slide 4 of our presentation. We have a lot of exciting ground to cover today, but first I'd like to briefly introduce myself to those I haven't had the opportunity to meet yet. I spent my entire career in the utility and energy business. Most recently I was at Berkshire Hathaway Energy, which has an asset base 1.4 times the size of AEP, operates in 11 states but also in Canada and Great Britain and has a diverse group of regulatory interests. While I'm familiar with most of the industry players, bankers, regulators, companies and debt investors, I am new to many of the AEP shareholders and I look forward to delivering for you. With that, I'm honored to join a leader like AEP at a pivotal time for both the organization and our industry. Since assuming the role of CEO, I've met our many stakeholders and the AEP team across our 11 state footprint, including four governors and over 30 regulators and legislators. We've had robust discussions about critical initiatives and I've appreciated the opportunity to engage, listen and learn over the past three months to help shape our vision for the future. AEP has built a strong foundation for growth, including our robust transmission system, which represents 55% of AEP's total earnings stream. However, we can improve reliability, streamline cost, use technology better, and put power in the hands of local leaders to build financially strong utilities in our communities. I look forward to the future and working with the many talented people across the company to drive operational excellence, best-in-class service earnings growth and overall success. I'll begin with our financial results. Today we report third quarter 2024 operating earnings of $1.85 per share, or $985 million. Building on our strong momentum this year we are confident in narrowing our 2024 full year operating earnings guidance range to $5.58 to $5.68, maintaining the original $5.63 midpoint. As referenced on Slide 5, today we also formally introduce our 2025 operating earnings guidance range of $5.75 to $5.95. We have thought a lot about this range, especially since I've been in the CEO role for just three months. The foundation of our 2025 earnings guidance range is based on robust growth in our regulated utilities. This range also reflects lower contributions from our generation and marketing segment due to reduced scope of activities going forward and lower retail and wholesale margins likely to be realized. While AEP's earnings range rose 4% in 2025, you have my commitment that we will do significantly better in 2026 and beyond after we go through an optimization exercise and we retool our personnel and processes over the coming months. As the new CEO at AEP, I need to establish a record of delivering on promises to you while demonstrating goodwill to our regulators and customers as we focus on service, reliability and enhanced vegetation management to reduce customer outages. My objective is to improve our customer experience and stakeholder relationships which over time will result in more positive regulatory outcomes and enable a stable platform for growth. AEP's future growth opportunities are very significant as we embrace the large load opportunity in our service territory as well as substantial upgrades to the distribution system. We are focusing on economic development efforts in our states to help address affordability and investing in our energy delivery infrastructure to improve reliability in addition to new generation to support resource adequacy. Because of this tremendous growth, today we are unveiling AEP's new long-term earnings growth rate of 6% to 8% off a 2025 base year and a $5.85 midpoint, all reinforced by a balanced and flexible $54 billion capital plan from 2025 through 2029. When I look at this newly raised $54 billion capital plan, which is up more than 25% over the prior $43 billion plan, there is even more upside to go. In fact, we see significant opportunity to capture $10 billion in incremental transmission and generation infrastructure investment to satisfy all of the load growth. We will provide more details at EEI regarding these investment opportunities that drive our updated 8% rate base CAGR. Note that during the 2025 through 2029 timeframe, we also expect our customer rates will go up by less than 3% annually on a system wide basis due to built headroom created from economic development activities and new generation. Understand that this customer rate impact could change due to effects of potential future generation needs. Please refer to slides 5 and 6. As you know, maintaining a strong balance sheet is critical to funding the increased capital spend associated with these growth rates and we remain committed to responsibly financing our capital needs. In addition to equity and equity like tools, we will explore asset monetization opportunities to the extent they can be executed upon while achieving the right price. If we do explore asset sales, we won't tell you about them until they happen. Our newly rolled forward five year capital and financing plans can be seen in the appendix on slides 13 and 14. Turning to slide 7, our robust financial outlook will be underpinned by a culture of accountability and execution. This business is transforming rapidly and we recognize the need for change to better serve our customers. Since joining the company in August, we have made several changes to align and simplify the organizational structure to ensure we have the right talent and the right roles to execute our strategy and achieve our objectives. For example, our operating company Presidents and Chief Nuclear Officer now report directly to me, while power plants and site managers will report directly to our operating Company Presidents. We have streamlined the leadership structure by eliminating management layers and reorganizing the service corporation. These actions move decision making closer to customers, all to ensure our money making businesses have the authority they need to accelerate improved performance. I'm confident our new structure will help us drive value as we advance three core areas of strategic focus, growth and financial strength, customer service and regulatory integrity. I'd like to spend a few minutes walking through each of these areas. First, AEP's future growth potential and financial strength is significant with customer commitments for 20 gigawatts of load additions through 2029 driven by data center demand and we have updated our load growth forecast accordingly through 2027. In fact, large load impacts are already being felt in our service territories, predominantly in Ohio, Texas and Indiana. This is demonstrated in our third quarter results in which we realized commercial load growth of 7.9% compared to the third quarter of last year and 10.1% growth year-to-date in 2024 compared to 2023. We are committed to supporting this new load growth in our service territory, but we also remain focused on ensuring affordability by fairly allocating costs resulting from associated incremental investments. This is why we proactively filed the data center tariff in Ohio, the large load tariff modifications in Indiana, Kentucky and West Virginia, and a complaint with FERC related to a co-located load arrangement. Load growth from data center demand has the potential to benefit all stakeholders including investors, customers and local communities, but only with fair and proper cost allocation. While some may think that our FERC complaint is anti-data center, it is actually the opposite. We are trying to welcome all data centers to our service territory by making sure that those data centers help all customers. The second area of focus for us is best-in-class customer service. We will leverage technology to enhance service and better meet our customers’ energy needs through reliability and outage reductions while transforming our processes with a focus on efficiency and accountability. Business transformation and technology innovation will also drive O&M discipline to help keep customer rates affordable amid rising costs and a growing rate base. The last pillar of our strategy is regulatory integrity. We will listen to and respect the preferences of our regulators, policymakers and communities to achieve positive regulatory outcomes. If our states want renewables, we will work with them to deliver. If they want continued operation of coal or investment in gas or nuclear, we will work with them to deliver. As long as our states pay for what they want and we are treated fairly, we will deliver. At the same time, we will work closely with key stakeholders to advance affordability, system reliability, resiliency and security. To that end, we have aligned our organizational structure to strengthen our focus at the state level, and we continue to prioritize improving our earned ROEs as we listen to each of our states and their preferences. While it will take time for this work to bear fruit, this is headed in the right direction. Continuing on our operating companies achieved a number of other positive regulatory developments in the third quarter as well. Starting with AEP Texas, last month, the Commission issued an order approving a unanimous and unopposed comprehensive settlement which included a 9.76% ROE. The order was effective October 1st. In Oklahoma, major parties reached a settlement agreement with a 9.5% ROE in early October, and the ALJ recommended approval of the settlement without any modifications. While PSO awaits a commission decision, interim rates were implemented on October 23rd. In Virginia, a hearing was held in September related to the biennial filing, focusing primarily on incremental investment. A Commission order is required in November, with rates going into effect in early January 2025. Last week, APCO refiled its base case in West Virginia, requesting a 10.8% ROE while also offering securitization as the rate mitigation concept to the proposed $250.5 million base rate increase. This securitization option includes $2.4 billion of undepreciated plant balances, CCR and ELG investments, fuel deferrals and storm expenses. While reduced rate base of $1.9 billion would result from securitizing the plant balances and environmental investments, any earnings impact would be dependent on how quickly we redeploy capital throughout the business. That said, we should have an early indication from the Commission if securitization is preferred and we would plan capital redeployment accordingly. But let me be very clear, securitization is not included in our new five year capital and financing plans introduced today and is not needed to hit our credit metrics. Rather, securitization is driven by the desire to consider alternative rate case options to mitigate customer bill impacts. I was highly disappointed by the initial rate case filing that was rejected by West Virginia. Be assured that going forward, additional internal quality control checks and leadership changes have been implemented to ensure that each of our operating companies filings meet all requirements. A rate case rejection should not happen like it did in West Virginia, and I won't accept this kind of performance from our team. Moving on to SWEPCO, updated formula rates went into effect in early August for Louisiana, in mid-October for Arkansas. And finally, I&M issued new requests for proposals or RFPs for both owned resources and PPAs seeking to secure up to 4,000 megawatts of diverse generation resources for target completion by year end 2028 or 2029 to support new load growth in the region. As such, we expect to make the applicable regulatory filings in 2025. So in short, while the team is making progress towards achieving positive regulatory outcomes, we do have more work to do. We look forward to continuing to engage constructively with our regulators and strengthen new relationships, including by investing more resources at the local level and focusing on delivering what our individual states want as outcomes. The bottom line here is we have made progress transforming the business over the past three months, but we have significantly more wood to chop. Before wrapping up, I'd like to briefly update you on a legal item. AEP and the Security Exchange Commission are engaged in discussions about possible resolution of the SEC's ongoing investigation and we recorded a loss contingency of $19 million in the third quarter. Given this is an active matter, we don't plan on making any further comments on this matter. I'd now like to close by reiterating my strong confidence in the tremendous potential for AEP's growth and success well into the future. With the support, dedication and hard work of the entire AEP team, we are well positioned to continue providing safe, reliable and affordable service while advancing our long-term strategy to deliver value to our stakeholders. Related to our new vision statement of improving customer’s lives with reliable, affordable power, we will accomplish this together through commitment and execution. I look forward to seeing many of you in a few days at EEI where we'll be happy to discuss our newly released financial plans in even more detail. I'll now give the floor to Chuck."
},
{
"speaker": "Charles Zebula",
"content": "Thank you, Bill. It's been a pleasure working with you over the past three months. Your leadership and passion for operational excellence and customer service is infectious, and everyone at AEP looks forward to working with you to capture the incredible opportunities that we have before us. Good morning everyone. Let me move on with the discussion of the third quarter results. Slide 8 shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings for the third quarter were $1.80 per share compared to $1.83 per share in 2023. Year-to-date, GAAP earnings are $4.35 per share versus $3.62 per share last year. There's a detailed reconciliation of GAAP to operating earnings for the third quarter and year-to-date results on pages 20 and 21, respectively. Let's walk through our operating earnings performance by segment for the third quarter on Slide 9. Operating earnings for the third quarter totaled $1.85 per share, or $985 million, compared to $1.77 per share, or $924 million in 2023. Operating earnings for vertically integrated utilities were $1.08 per share, up $0.08. Positive drivers included rate changes across multiple jurisdictions driven by outcomes in Virginia and Indiana, higher normalized retail sales and lower income taxes. These items were partially offset by higher depreciation and O&M. The transmission and distribution utility segment earned $0.46 per share, up $0.07 compared to last year. Positive drivers in this segment include rate changes driven by the distribution cost recovery factor in Texas and the distribution investment rider in Ohio along with higher transmission revenue. These items were partially offset by lower normalized retail sales and higher depreciation. The AEP transmission Holdco segment contributed $0.40 per share, up a penny compared to last year, primarily driven by investment growth. Generation and marketing produced $0.19 per share, up a penny from last year. Favorable drivers included higher retail margins and lower interest expense. These items were partially offset by lower wholesale margins and higher income taxes compared to last year. Finally, Corporate and Other was down $0.09 compared to the prior year, primarily driven by higher interest expense, timing of other operating revenue, higher income taxes and O&M. The year-to-date operating earnings segment detail is shown on page 16 of the presentation. Note that year-to-date, operating earnings are up $0.36 per share this year, increasing from $4.02 per share in 2023 to $4.38 per share this year or about a 9% increase year-to-date. The data on Slide 10 shows continued strong growth in load. Weather normalized retail sales grew 2.1% in the third quarter. This marks the 14th consecutive quarter of load growth across our system, and year-to-date overall weatherized normalized retail sales grew 2.9%. Declining residential sales have been offset by double-digit growth of 10.1% in commercial sales. Thanks to the game changing developments around data centers and AI. Also, our industrial sales have consistently grown despite challenging economic conditions for many of our customers. Our companies have attracted a steady pipeline of economic development projects over the past several years and those projects are beginning to come to fruition. Besides the data centers, we also see companies investing in energy, manufacturing and primary metals driving consistent growth in our industrial sales. Industrial sales grew 1/2 of 1% in the quarter, propelled by nearly 5% growth in Texas. Looking ahead to 2025 and beyond, you'll notice that we have updated our sales projections out to 2027 in this presentation. Looking first at 2025, we are projecting overall sales to increase by an additional 8.3% over our estimate for this year. Flat residential sales will continue to be offset by double-digit growth in the commercial segment. This growth is propelled by a mix of new and existing customers spread across our Ohio, Indiana and Texas service territories. In the T&D segment, we estimate about 30% year-over-year growth in commercial sales each in AEP Ohio and AEP Texas. And in the vertically integrated segment, our projections have commercial sales at I&M up nearly 60% year-over-year. Note this is happening now, and in the next several years, not later this decade. New customer growth will also support a projected increase in industrial sales of 1.6% next year, with most of that growth expected to be powered by ongoing economic development in Texas. We have several large energy and manufacturing loads slated to come online within the next year. While these numbers are substantial, we take a lot of comfort in the fact that the large load additions reflected in these forecasts are all backed by signed customer financial commitments. In AEP Ohio and I&M, nearly all of these loads are backed by take or pay contracts. This means that customers are locked in to pay for a minimum amount of power over the next several years depending on their local tariff. Also, the impact of higher loads will enable our fixed costs to be spread over a higher base, benefiting all customers. As Bill mentioned, based on contract activity across the system, we expect about 20 gigawatts of additional load to come online through the end of the decade. For context, our summer peak load at the end of last year was 35 gigawatt. This represents about a 60% increase in peak load in the next six years. That magnitude of increase in peak load is driving the sales projections that you see in Slide 10. We expect consistent retail growth above 8% over the next three years, driven by not only double digit commercial load increases, but accelerating gains in the industrial space. Roughly half of the additions are located in our PJM footprint, mostly hyper scale data centers in Ohio and Indiana. The other half are located almost entirely in AEP Texas. However, the growth in Texas is more diverse and spread across both data processors and large industrial customers. The last time we have seen sustained years of load growth in the 8% range. The Beatles in the late 1960s were still making music. Truly, this is a pivotal and transformational time for our company as we work to capture this opportunity. Let's move on to slide 11. In the top left table you can see the FFO to Debt Metric stands at 14.7% for the 12 months ended September 30, which is a 10 basis point increase from the prior quarter. Our debt-to-cap decreased slightly from last quarter and was 62.1% at quarter end. We understand that in its next credit opinion in March, Moody's intend to change how it treats deferred fuel impacts to align the consolidated view of AEP without how our subsidiary company metrics are calculated. Importantly, based on discussions with Moody's in our annual management meeting last week, their view of AEP's credit is not changing and we will continue to exceed our downgrade threshold of 13% in all forecasted periods. We are committed to a goal of being in the 14% to 15% FFO-to-debt range and regardless the impact of deferred fuel on our metrics will dissipate to a normal state over the next two years. Again, importantly, this does not change our cash inflows or Moody's view of our credit profile. In the lower left part of this slide you can see our liquidity summary which remains strong at 5.5 billion and is supported by 6 billion in credit facilities. Lastly, on the qualified pension front, our funding status remains stable at 99%. In summary, our third quarter and year-to-date financial results put us in a strong position to meet our goals this year and we are tightening our 2024 guidance range to $558 to $568 per share and also in the quarter, I'll note that we completed the sale of AEP on site partners with approximately $320 million of net proceeds received at the end of September. For 2025, we have set our operating earnings guidance range at $575 to $595 per share with a guidance midpoint of $585 roughly 4% growth from our 2024 midpoint guidance estimate. Our 2025 earnings guidance is based on a strong foundation of growth in our regulated businesses and lower contributions in the generation and marketing segment due to the reduced scope of activities as well as lower expected retail and wholesale margins in the segment. Going forward, we expect improved performance in our vertically integrated utility segment as we work to narrow the gap between our earned and authorized ROEs and invest where we have alignment with our regulators. We have also introduced a robust long-term growth rate of 6% to 8% from the 2025 guidance midpoint. This is supported by a $54 billion capital plan which is more than a 25% increase from our previous five year plan. These investments with 63% related to wires and 26% related to new generation result in a five year rate base CAGR of nearly 8%. Future updates to capital are more likely to go up as we continue to see economic development activities in our territories due to our high voltage 765 transmission backbone, our attractive industrial footprint in Texas, as well as the incremental transmission and generation infrastructure that Bill described earlier. Our 5-year cash flow and financing plan forecast is shown in the Appendix on Slide 14. We have consolidated the forecast over the five year period as impacts in individual years due to large loads, generation investments and tax credits will have inter-period movement over time. Note however, the plan is supported with equity, equity like instruments, opportunities to explore, portfolio optimization as well as efficiently monetizing tax credits related to our investments in renewable generation and from our existing nuclear facility. In addition, we will decouple our dividend growth rate from our earnings growth rate resulting in a lower dividend payout ratio over time in the range of 55% to 65%. This will allow us to retain additional cash flow to fund our increased capital plan and new growth objectives while maintaining a market competitive shareholder return. Access to the capital markets is critical and we will finance sensibly to protect and maintain our balance sheet solidly in the investment grade category. We appreciate everyone's time today and your interest in AEP. We look forward to seeing many of you at the EEI conference next week. Operator, can you open the call so that we can address your questions? Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Your first question comes from Shar Pourezza with Guggenheim Partners. Please go ahead."
},
{
"speaker": "Shar Pourezza",
"content": "Hey, guys. Good morning."
},
{
"speaker": "William Fehrman",
"content": "Morning."
},
{
"speaker": "Shar Pourezza",
"content": "Morning, Bill. So, obviously, big update this morning. Cleared the decks and rebased as we're thinking about your new 6% to 8% growth rate. Asset sales haven't helped, but anything you can point to that can be maybe incremental to your 2025 guide. Any tailwinds that aren't in plan, like maybe on the cost side and as we're thinking about maybe the longer range, you have material load growth driven by the data centers. Has the 20 gigawatts of customer commitments hit any of your numbers? Or could some of those opportunities become further accretive as we saw with some of your peers during this earnings season? Thanks."
},
{
"speaker": "William Fehrman",
"content": "Yes, thanks, Shar. With regards to additional opportunities, clearly this year we've done a number of things across the company. We had a voluntary separation plan that was put in place to help offset inflation. And as we're looking at transforming the company, I did bring on an expert in transformation who's worked with me for many years, who will help us continue to look for opportunities to take costs out of the business, look for more opportunities to reduce layers of management and expand span of control of the management team. All in the effort to remove bureaucracy out of the company and reduce bloat. And so clearly there's opportunities for that. I've just been here three months, so we've got a lot yet to do. As I noted in my comments, a lot of wood to chop yet around the company. And so we've looked at what we were able to do and made sure that we were confident in what we put into those numbers at this time. But clearly more to do with regards to the 20 gigawatts that is essentially in the plan. 12 gigawatts of that is in the first three years of the plan, with the remainder towards the end of the plan. But we've got more opportunities out there. As I noted, $10 billion of transmission potential generation development. Again, as I was sorting through the numbers here with the $54 billion capital plan that we have, making sure that that was fully understood and that we could deliver it. But there's much more load growth to come for this company and I would say we're only really limited by our ability to execute on the opportunities that are in front of us. Chuck, anything to add?"
},
{
"speaker": "Shar Pourezza",
"content": "Okay, got it. And then just lastly on the funding source. So 5.35 billion in equity needs. You obviously kind of mentioned asset sales. Can you just give us a sense on the asset? Is it transmission as media has been reporting, or the off goes an opportunity and just maybe a sense of timing? When do you need the equity? Thanks."
},
{
"speaker": "William Fehrman",
"content": "Yes, with regards to potential asset sales and stuff, we won't comment on those until something might happen, but we're clearly going to consider sort of all of the above to get us to where we need. Chuck, you want to."
},
{
"speaker": "Charles Zebula",
"content": "Yes, sure. I would just add to that, in our plan we also will pursue equity like products out there, instruments that give us equity credit. You'll note in my comments, we are looking to decouple our dividend growth rate from our earnings growth rate as well, which would drift the payout ratio lower as well. We do have PTC and ITC monetization and as far as any asset monetization opportunities, as Bill said, we are looking holistically at all alternatives. As you look at the needs that we have and the timing of such, we will need equity support in 2025 and how and how that comes it could come in any of the forms that I just talked."
},
{
"speaker": "Shar Pourezza",
"content": "Okay, that's perfect. Thanks, guys. We'll see you in a couple days. Appreciate it."
},
{
"speaker": "William Fehrman",
"content": "Yes. Thanks, Shar."
},
{
"speaker": "Operator",
"content": "All right, our next question comes from Steve Fleischman with Wolfe Research. Please go ahead."
},
{
"speaker": "Steven Fleischman",
"content": "Yes, hi. Good morning. Thanks for the time. So first, the new kind of outlook. What are you seeing in terms of earned returns across the utilities over the period? Are you you've had the issue with the earning below? Do you have that improving over the period by how much? Any sense on that?"
},
{
"speaker": "William Fehrman",
"content": "So as we look at our regulatory opportunities right now for the regulated utilities, we're looking at a 9.1% ROE tend to plan. As I've gone around and met with the states, as I noted in my comments, our focus is changing to where we will be working with them to understand what they want to be able to achieve, and we will work to deliver that with them. And through that, then we would hope to continue to improve the relationship that we have with the regulator. And hopefully that then also then turns into more positive outcomes with regards to ROE and the general relationship that we have. As part of that, we also have to significantly improve our customer service. I've noted that we have to put more investment into the distribution side of the business, vegetation management, reduce outage time, and all of that will then go to helping us with regards to our regulatory relations and customer service. So we're very, very focused on that. I've made it around now to seven of our states in the three months I've been here to meet with the regulators, and we're continuing to build those relationships. And as I noted in West Virginia, we made the new filing very disappointed in the quality of our prior filing. We've made changes internally to correct that. And so we'll be very much focused on these returns. And I know how much it adds to our business as we're able to get those closer to our allowance."
},
{
"speaker": "Steven Fleischman",
"content": "Thank you. One other question just on the balance sheet. I appreciate the clear commentary on the Moody's and the deferred fuel. I just want to maybe restate or to clarify what you said. So they are going to make the adjustment. It sounds like you might be temporarily below the 14 to 15 target, but above the 13% downgrade threshold. And that overall the general view of the credit is that it's stable. Is that fair?"
},
{
"speaker": "William Fehrman",
"content": "I think that's an accurate representation of what I said."
},
{
"speaker": "Steven Fleischman",
"content": "Okay. Okay, thank you."
},
{
"speaker": "Operator",
"content": "All right, our next question comes from Jeremy Tonet with JPMorgan. Please go ahead."
},
{
"speaker": "Jeremy Tonet",
"content": "Hi, good morning."
},
{
"speaker": "William Fehrman",
"content": "Good morning."
},
{
"speaker": "Jeremy Tonet",
"content": "Just wanted to speak to the data centers in Ohio, I guess, a little bit more. And given the challenge there, could you speak to settlement dynamics in your data center tariff proposal, given, all the stakeholder, I guess, views on this?"
},
{
"speaker": "William Fehrman",
"content": "Sure. As we've looked at the data center opportunities in Ohio, one of our fundamental principles around all of this is to ensure that our existing customer base is not negatively impacted by the significant increase in data center load that is being proposed for the state. And as such, we filed a tariff in Ohio that would essentially put more pressure on the data centers to stand up for the costs that they're creating on the system. And that filing has been going through the process. There's been settlements filed by the data center coalition, as well as ourselves with a number of other parties, including the staff from the commission. And right now that's moving the hearing on December 3rd, and we would expect to get an outcome from the commission shortly after that. But conversations are still going. We want that load in Ohio. We definitely want it to be on our system and we want to see that growth, but we also want to make sure that our existing customer base is not negatively impacted by this. And so we'll do what we need to ensure that we protect that customer base. And I think, honestly I've worked with data centers for a long time. In my prior role at Berkshire and Iowa in particular, we had a significant customer base of data centers there. And I've seen how the load comes on and what the commitments are, and so got a pretty good feeling for how this is going to potentially play out. And we want to make sure that we have everything in place to serve that load, but bottom line is only if we can protect the rest of the customer base."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. Understood. That's helpful there. Thanks. And was just wondering if you could talk a little bit as well on the AEP on your JV proposal with FirstEnergy and Dominion as it relates to the transmission project and I guess what you see as unique or beneficial to this offering versus others."
},
{
"speaker": "William Fehrman",
"content": "So that was a great partnership led by our transmission team, Antonio Smith and the rest of the team there to pull that coalition together and go in and bid on these projects. Obviously, PJM is putting forth a significant amount of potential transmission investment and it was our view that we're stronger together as entities and that we would have a very, very good chance of winning these projects. And so that JV came together really well and we're working well together and we're excited about hearing where we might end up later next year. But I have confidence in our team and the team from FirstEnergy and Dominion that we're going to come out of this with some really strong opportunities to grow our transmission business."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. Thank you. One quick last one, if I could just on G&M, seems like 2024 is going to notably outperform initial guidance there and AEP is on the midpoint. So just wondering if there's other segments of the business that are kind of underperforming expectations there. Do you expect them to kind of bounce back next year and also the G&M step down next year given the lower scope of the business, as you said, is that to indicate that there could be sales more likely in this segment than others, knowing that you're not going to identify specific asset sales in advance of them happening?"
},
{
"speaker": "William Fehrman",
"content": "So the G&M segment we're reflecting about $0.24 and lower contributions over 2024 and 2025, which is obviously a significant change for us. But we are seeing good improvement across the rest of our lines of business. We're obviously also going to be going after the transmission projects that I noted in my opening comments. And then as far as other potential asset sales as again I said I will consider all things and if they make sense we'll take a look at them, but we'll talk about those at the time."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. Thank you for that."
},
{
"speaker": "Operator",
"content": "Our next question comes from David Arcaro with Morgan Stanley. Please go ahead."
},
{
"speaker": "David Arcaro",
"content": "Good morning. Thanks so much for taking my question."
},
{
"speaker": "William Fehrman",
"content": "Yes, good morning."
},
{
"speaker": "David Arcaro",
"content": "Morning. Just a bit of a follow up on that. Could you just help me understand the 26 EPS outlook? Is there no G&M earnings contribution there just so I could make sure I understood that and maybe specifically what's driving it to zero there? Is that an implied sale or exit of those businesses or something else?"
},
{
"speaker": "William Fehrman",
"content": "Yes, thanks for the question. And perhaps the slide you're looking at may not make that clear. We're just showing the change in G&M from 2024 to 2025. There would still be a contribution from that segment in 2026 and beyond."
},
{
"speaker": "David Arcaro",
"content": "Got it, got it. Okay, thanks for that. Yes, that's more clear. And then could you touch on how you're thinking about the incremental new generation in terms of the CapEx that has come into the plan? I would assume a lot of that is going to be gas. I'm wondering kind of where, where and when you'd be investing in that kind of what the process is to firm that capital up."
},
{
"speaker": "William Fehrman",
"content": "So we do have a lot of gas coming into the system. We've got a number of RFPs out on the street as I mentioned, particularly at I&M, and we’ll see what kind of prices come in for those projects. The CapEx will be spread obviously as those projects come into play. But I'll also say that as we continue to work with some of our other states, particularly say West Virginia, there's a lot of opportunity yet to be sorted through in those states with regards to the economic development that they are pushing forward. And so be happy to talk more about these things in detail at the EEI meeting coming up. But really excited about the potential opportunities we have across a number of our states."
},
{
"speaker": "David Arcaro",
"content": "Got it. Okay, great. Well, thank you so much."
},
{
"speaker": "Operator",
"content": "All right, our next question comes from Julien Dumoulin-Smith with Jefferies. Please go ahead."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Hey, good morning team guys. Thank you very much. Appreciate it."
},
{
"speaker": "William Fehrman",
"content": "Hey, good morning."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Good morning. Doing quite well, thank you. A couple things real quickly. First off on the G&M piece, I know you elaborated a little bit what's reflected through the course of the plan. Is that more of a static expectation off the 2025 baseline or further moderation there? Again, I know you clarified the 9:1 on the utility component, but just on the other piece there if you can."
},
{
"speaker": "William Fehrman",
"content": "Yes, Julien, I think that the business supports the level that we would see in 2025."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Okay, all right. Through the plan. Excellent. Thank you for that. Appreciate all the details. And then related here, you know, 765 has really caught a lot of attention across all the RTOs. I just want to make sure I understand what's reflected in this new CapEx baseline as far as 765 adoption goes across the various footprints. And again, I know you provided particularly detail on this coalition here in PGM. But to what extent can we see sort of comparable efforts emerge, say in ERCOT or what have you, as some of the 765 details become a little bit more formalized here, if you will."
},
{
"speaker": "William Fehrman",
"content": "So obviously we have a big opportunity in ERCOT around the 765 down there in the event that they decide to go that way. We've put in our proposals for that significant opportunity in the Permian area, significant opportunity on the various backbone growth areas for, for Texas. That just alone is a good $4 billion or $5 billion of opportunity potential there for us on the 765 front. We've also got good 765 opportunities in PJM and SVP as well. And so the fact that AEP is essentially the only U.S. Company that knows how to build and operate 765 gives us a strong competitive advantage in these situations and certainly something that I'm very excited about to pursue. That's one of the really strong strategic things that frankly AEP has done over the years is build out this 765kV backbone because it's paying huge dividends right now as all of this load growth is starting to combine. And I think that's being seen by some of the other decision makers around who are looking for ways to significantly increase their ability to move energy. And so with the 765kV experience that we have, I'm very excited about the opportunity to engage with ERCOT, SVP and PJM and maybe a little bit in MISO."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Yes, it's pretty exciting, actually. Quick clarification on the utility ROE. You're moderating it to 9:1 seemingly from your earlier plan despite the accelerating load. Is there something else disintermediating that relationship? I mean, I could imagine a few things, but I'm curious if there was anything purposeful there."
},
{
"speaker": "William Fehrman",
"content": "Nothing really purposeful. We're trying to continue to increase the ROE and work diligently with the regulators. If you blend in, the transmission component of this, we're at 9:3. Obviously we want to continue to get up closer to our allowance, but frankly, we have to earn our way up. As I said, we've had some mishaps in West Virginia that we've now corrected with the most recent filing, and we've got some significant work to do on the customer service side to put us in a better position with our regulator so they're not getting complaints from customers. And so as this continues to move forward, we've got a tremendous amount of wood to chop in this area, but we're very focused on it. We've taken our board through the details of reliability and where we sit, and we've essentially created a new foundation and we're going to blast off from there to really accelerate our improvements in customer service."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Excellent, guys. Talk soon."
},
{
"speaker": "William Fehrman",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from Nick Campanella with Barclays. Please go ahead."
},
{
"speaker": "Nicholas Campanella",
"content": "Hey, good morning. Thanks for taking my questions today."
},
{
"speaker": "William Fehrman",
"content": "You bet. Good morning."
},
{
"speaker": "Nicholas Campanella",
"content": "I wasn't around for the Beatles, but I'm excited to be here for the load growth and I wanted to come back to the generation comments? I think you talked about working with regulators and policymakers on whatever solutions can facilitate this higher load outlook. You talked a lot about gas, but in your prepared remarks you also talked about nuclear. And Bill, I know you talked about your love for nuclear in the past, and maybe you can kind of just expand on your thoughts of how nuclear kind of fits into the AEP strategy, if at all. Thanks."
},
{
"speaker": "William Fehrman",
"content": "Sure. Well, first and foremost, a number of our customers are pursuing projects based on nuclear power plants, and those are many, many years out, as far as I can tell. But we need to continue to work with our customers and if they want to pursue a small modular reactor type of co-location approach, then we'll work with them and we'll continue to work with developers of the various technologies that are out there. But this is going to require a very significant approach to risk mitigation. It will take a combination of the federal government, state government, input from the customer and ourself to build some risk mitigation such that our existing customer base isn't carrying the full exposure of something like this. And we'll, with our nuclear team that we have here, we'll continue to follow the various technologies that are being built in Canada with regards to the BWRX and the new scale plant that's being built in Romania. We'll follow those as well as the GE Hitachi project at TVA and watch how these are progressing. But ultimately if our customers want this and our states want this, then we'll have to figure out a way to deliver it. That's what we do. And so I'm fairly favorable that there'll be one or two designs that make it through the NRC process and will start to be built. But we have to figure out the first of a kind risk and make sure that we are not carrying that, that load and that there's a very broad base of people engaged in this that can help push this along."
},
{
"speaker": "Nicholas Campanella",
"content": "Hey, I really appreciate your thoughts there. And just to tie things off on the 6% to 8% growth rate, so you have 8% rate base growth net of some financing drag. You could also be raising CapEx here too, I hear you on the 10 billion. Where do you kind of think you're trending in this new 6% to 8% range? Over the long-term, do you kind of grow linearly off this midpoint? Could you be kind of higher or lower in certain years? Just trying to understand that. Thank you."
},
{
"speaker": "Charles Zebula",
"content": "Yes, thanks Nick. The 6% to 8% right is based off the 2025 new midpoint. And as you can imagine, as Bill described, the kind of components of our capital plan and the addition of load over time, I don't expect it to be completely linear like it may have been in the past. So I do expect all years to be in that range. But I certainly don't expect a --if our guidance was linear, we would have just said 7%. Our guidance is 6% to 8%. I think that does mean over the long-term we would average somewhere in between there, but I don't expect it necessarily to be linear."
},
{
"speaker": "Nicholas Campanella",
"content": "Very helpful though, still within the ranges. I appreciate the time today. Thanks so much."
},
{
"speaker": "Operator",
"content": "Our next question comes from Carly Davenport with Goldman Sachs. Please go ahead."
},
{
"speaker": "Carly Davenport",
"content": "Hey, good morning. Thanks so much for taking the questions. Maybe just to start a quick follow up on transmission as we look at the new capital plan, obviously significant increases on that side relative to the prior plan. Just as you think about some of the opportunities in PJM that you ran through in I think Jeremy's question, are those all upside to the plan or is there any spend built in in the back end of this plan related to those opportunities?"
},
{
"speaker": "Charles Zebula",
"content": "Yes, this is all basically upside to the plan. And as I mentioned in my remarks, the potential for $10 billion of additional transmission and new generation build out is what we would be chasing with regards to not only just PJM, but ERCOT, MISO and SPP as well."
},
{
"speaker": "Carly Davenport",
"content": "Got it. Great, that's helpful. And then just lastly, with the increase in the long-term earnings growth rate to that 6% to 8% range, could you just talk a little bit about how you're thinking about dividend growth relative to that range going forward?"
},
{
"speaker": "Charles Zebula",
"content": "Yes. So Carly, we have followed a pattern of pretty much matching dividend growth, right. With our earnings growth, with the increased capital needs, the cash right from decoupling. Right. The dividend growth from the earnings growth will help fund that. And we would be targeting, a payout ratio in the 55% to 65% range. Our old policy was 60% to 70%. I think right now our payout ratio is in that 63%, 64% range. So we will provide a market competitive total shareholder return opportunity for our shareholders. But that will be decoupled going forward."
},
{
"speaker": "Carly Davenport",
"content": "Got it. Great. Thank you so much for the color."
},
{
"speaker": "Operator",
"content": "Our next question comes from Andrew Wiesel with Scotiabank. Please go ahead."
},
{
"speaker": "Andrew Wiesel",
"content": "Hi. Thank you. Good morning everyone. If I could first follow up on that dividend question. Are you able to indicate how quickly you expect to go from the roughly 64% to roughly 60%? Or said differently, if earnings are growing at 6% to 8%, what would be a good expectation for dividend growth? Would it be 6% like we've seen, or potentially something slower?"
},
{
"speaker": "Charles Zebula",
"content": "Well, that's a discussion, Andrew. That is, as you know that the board, approves the dividend and we will drift down in that range. It won't be anything significantly abrupt to expect there, but you could imagine, right. That we would just drift down in that range as we go through time."
},
{
"speaker": "Andrew Wiesel",
"content": "Okay, so sounds like something fairly gradual then. If that's maybe a fair way to put it. Okay. Then on the -- great, thank you. Then on equity, I just want to better understand, I see this slide shows 100 million per year of drip and I fully understand your commentary that asset sales or something like a hybrid might mitigate the need. But for modeling purposes, should we take that 5.35 billion and straight line it over five years? Maybe you could give a little more guidance in terms of timing per year and if this would be an ATM or a block in the absence of one of those alternatives. Thank you."
},
{
"speaker": "Charles Zebula",
"content": "Yes, so it's a good question. Obviously, consolidating the five year cash flow, just indicates that there's a lot of options on the table. What I would tell you that as I said earlier, we do need equity support in some form in 2025 and 2026 to continue to hit our credit metrics. So I think, as you maybe looked at last year's kind of shape and think of it in a similar way, is a good way to perhaps look at it because we do need support in 2025 in some form or fashion. And we are holistically looking at all of the options, including the equity like securities which wouldn't show up in the true equity line on the cash flow."
},
{
"speaker": "Andrew Wiesel",
"content": "Okay, can that be a little more direct? What's embedded in the assumption for share count for 2025?"
},
{
"speaker": "Charles Zebula",
"content": "I don't have that specifically. We could talk about that at EEI."
},
{
"speaker": "Andrew Wiesel",
"content": "Okay, sounds good."
},
{
"speaker": "Charles Zebula",
"content": "You could follow up with Darcy later."
},
{
"speaker": "Andrew Wiesel",
"content": "Very good."
},
{
"speaker": "Operator",
"content": "Our next question comes from Bill Appicelli with UBS. Please go ahead."
},
{
"speaker": "William Appicelli",
"content": "Hi, good morning. Just a question about the. You talked about some of the funding over the years and with the efficient monetization tax credits, can you speak to the magnitude of the tax credits or these going to be contributing to earnings or is this utilization of transferability to provide funding?"
},
{
"speaker": "Charles Zebula",
"content": "Yes, it's just transferability to provide funding. It's neutral to earnings largely. And over the 2025 to 2027 period, it's roughly $300 million a year. In the latter two years there's some ITC opportunities with some solar projects. So you'd be some big, bigger numbers, but in the next three years, about an average of 300 per year."
},
{
"speaker": "William Appicelli",
"content": "Okay, thank you. And then on the sales outlook on residential, so that had been, trailing a little bit behind expectations, but you are assuming some improvement, back to relatively flatter or slightly positive next year maybe. Can you speak to what's driving that?"
},
{
"speaker": "Charles Zebula",
"content": "Yes, I mean, it's a trend I think that we and others are seeing in the industry as well as people have returned to work as inflation has crept in and the share of the wallet becomes more critical. I think you're just seeing reduced usage. We are seeing increased customer counts, in places like Texas and Oklahoma and Ohio and other areas. But it's not offsetting, right. The existing customer decline in usage. We do think that that levels off at some point in time. I think there's also probably some energy, continued energy efficiency things creeping in there. But nonetheless, we're as we, as you see in our forecast, after some years of decline, we're now assuming it flat going forward pretty much."
},
{
"speaker": "William Appicelli",
"content": "Okay. All right. And then just lastly, maybe just you can speak to the colocation issues, that FERC has recently addressed. You guys did intervene in the case. Maybe can you just highlight what you think next steps are, coming out of FERC or some of the policy issues more broadly?"
},
{
"speaker": "William Fehrman",
"content": "Yes sure. So this is a very simple issue in our mind. If you use the transmission system, you should pay for it. It's really that simple. And our view of colocation is that we don't have an issue with colocation. We don't have an issue with data centers looking to use nuclear power plants as an energy source. But what we do have an issue with is when they use the transmission system and try not to pay for it. That's a problem for us because that cost gets shifted to other customers. And so as this process continues to go through the FERC decision making process, we'll continue to reiterate our concerns around cost allocation. And at the end of the day for us it's, it's just a simple principle. If you use the transmission system, pay for it. And that's really where we're at."
},
{
"speaker": "William Appicelli",
"content": "Okay, great. See you next week. Thank you."
},
{
"speaker": "William Fehrman",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from Anthony Crowdell with Mizuho. Please go ahead."
},
{
"speaker": "Anthony Crowdell",
"content": "Hey, good morning. Hey, Nick. Did. I'm sorry, Chuck, did Nick have you write that Beatles reference?"
},
{
"speaker": "Charles Zebula",
"content": "I think he may have. I think he may have."
},
{
"speaker": "Anthony Crowdell",
"content": "Well, that's great. Just two cleanups. I think one of them to Julien's question on the ROE improvement that you're seeing, 9.1%. What's a fair assumption where we should start baking in that improvement? Is it gradual over time or is that something you think we could bake in a certain year?"
},
{
"speaker": "Charles Zebula",
"content": "Yes. So trailing 12 months, as you could see in the deck, we're at 9.0% for the entire regulated complex. So I think as you think about going into next year, you should think about that. The regulated utilities in the range of 9.1% and the Transco right in that 10.5% range, which then averages things to 9.3%."
},
{
"speaker": "Anthony Crowdell",
"content": "Great. And then you talk about the load growth, the data centers, great tailwinds. I'm just curious. It was maybe something investors were asking about maybe six months ago, but even with all this demand, is it taking longer to connect these large customers to the system or. It's at a very manageable pace for the company. I'm just thinking that with all this load coming on, whether it's supply chain or just labor connecting all these large customers, but it doesn't appear to be an issue."
},
{
"speaker": "William Fehrman",
"content": "Well, it's certainly a challenge for us to get everyone connected at the speed that they would like to be connected, which is tomorrow for the most part. And we're working with data centers to try to find creative ways to allow them to continue to build out and get the power that they need. But this is going to be a long-term build out for us and we'll try to connect as many data centers as we can onto the system. We'll try to come up with other creative options for those data centers while we get transmission built. But it's going to be an evolution of working with the customer, working with particularly PJM and then our ability to get the construction done. I don't foresee significant supply chain issues at this time. The construction is fairly well spread out and I think we can manage the supply chain side of this. But we certainly have a very high demand coming on from the data center crowd and will work hard to try to accomplish what they want as quickly as we can."
},
{
"speaker": "Anthony Crowdell",
"content": "Thanks for taking my questions. See you in EEI."
},
{
"speaker": "William Fehrman",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "All right, and our final question from today with Ryan Levine with Citi. Please go ahead."
},
{
"speaker": "Ryan Levine",
"content": "Thanks for taking my questions. I guess a couple one, in terms of your confidence level and these load forecasts, how confident are you and when do you think you that could evolve?"
},
{
"speaker": "William Fehrman",
"content": "Well, as we stated earlier, we've got essentially signed contracts for all of this load, so we feel very confident about the load coming on. Certainly we're in discussions with a number of other economic development opportunities across a number of our states. Those clearly are not in our plan, nor do we know if they'll come to fruition. But for what we're showing you, we have signed agreements and our confidence level is quite high."
},
{
"speaker": "Ryan Levine",
"content": "And then in terms of the recent election, with federal tax rates potentially to change in coming years, how exposed is your free cash flow and credit outlook to changes in federal policy And I guess on a similar vein, you have generation build out and ownership expected in your plan. Is there any exposure to tariffs that you're thinking through?"
},
{
"speaker": "William Fehrman",
"content": "Yes, I mean, it's a question we're going to have to evaluate here as we go through time and see what the platform for the new administration is going to be. So give us some time to absorb that."
},
{
"speaker": "Ryan Levine",
"content": "Okay. Thanks for taking my questions."
},
{
"speaker": "William Fehrman",
"content": "Yes. Thank you."
},
{
"speaker": "Darcy Reese",
"content": "Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Danica, would you please give the replay information?"
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's conference call. A replay of the call will be available for one week. The North American toll free phone number is 1-800-770-2030 and you must enter the playback ID as 133-6080 for today's recording. Thank you. You may now disconnect."
}
] |
aep | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Thank you for standing by. My name is JL and I'll be your conference operator today. At this time, I would like to welcome everyone to the American Electric Power's Second Quarter 2024 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] I would like to turn the conference over to Darcy Reese, President of Investor Relations. You may begin."
},
{
"speaker": "Darcy Reese",
"content": "Thank you, JL. Good morning, everyone, and welcome to the second quarter 2024 earnings call for American Electric Power. We appreciate you taking time to join us today. Our earnings release, presentation slides, and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for discussion of these factors. Joining me this morning for opening remarks are Ben Fowke, our President and Interim Chief Executive Officer; Chuck Zebula, our Executive Vice President and Chief Financial Officer; and Peggy Simmons, our Executive Vice President of Utilities. We will take your questions following their remarks. I will now turn the call over to Ben."
},
{
"speaker": "Ben Fowke",
"content": "Good morning, and welcome to American Electric Power's second quarter 2024 earnings call. Shortly, Peggy will provide a regulatory update, followed by Chuck, who will review our financial results in more detail. A summary of our second quarter 2024 business highlights can be found on slide 6 of today's presentation. Before I dive into our results, I would like to start by welcoming Bill Furman to AEP as our new President and CEO, effective August 1st. Bill brings decades of utility operational leadership experience and in-depth knowledge of the energy industry, most recently serving as President and CEO of Century Holdings, and prior to that, President and CEO of Berkshire Hathaway Energy. With Bill's expertise and diverse background, you can anticipate a smooth transition and continuity of strategic direction. Expect more focus on execution, and Bill has the background to do just that, including capturing growth, listening and responding to our regulators and investors, and using innovation to mitigate inflationary pressures. While I will be serving as Senior Advisor for several months to ensure a smooth transition, it's been an honor to lead AEP as Interim President and CEO, and I'm proud of what the team has accomplished so far this year. Now, turning to AEP's financial results. Today, we announced second quarter 2024 operating earnings of $1.25 per share, a $0.12 increase over one year ago. Our operational execution through the first half of the year, combined with our efforts to efficiently manage the business, have put us well on track to achieve our targets. Today, we reaffirm our 2024 full-year operating earnings guidance range from $5.53 to $5.73, and our long-term earnings growth rate of 6% to 7%. Regarding data center load, we have commitments from customers for more than 15 gigawatts of incremental load by the end of this decade, mostly driven by large load opportunities. To put this in perspective, AEP's system-wide peak load at the end of last year was 35 gigawatts. We continue to work with data center customers to meet their increased demand, while ensuring contracts and new initiatives are fair and beneficial for all of our customers. In the fall, we will provide an update on what this large load opportunity means for our capital spend, including generation and transmission investment, and on our plan to responsibly finance this growth initiative. While we certainly encourage innovation when it comes to meeting the energy needs of our customers, data centers included, I want to emphasize that it is critically important that costs associated with these large loads are allocated fairly, and the right investments are made for the long-term success of our grid. For this reason, we filed new data center tariffs in Ohio and large load tariff modifications in Indiana and West Virginia, and it's the reason why we filed a complaint with FERC related to a co-located load agreement. We will know soon what FERC decides, but this is the rationale we used. Given the co-located load agreement is an active case before FERC, I don't plan on making any further comments. I'd also like to note that large load impacts are already being felt here in AEP's service territories, primarily Ohio and Texas, as our commercial load grew an impressive 12.4% over the second quarter of last year. Looking ahead, we expect the incremental load I just mentioned to move forward in these states and others, including Indiana. Moving to another example of capital opportunities, PSO announced an agreement at the end of June to purchase a 795-megawatt natural gas generation facility conditioned on regulatory approval. The facility, known as Green Country, is located in Jenks [ph] Oklahoma, and will ensure PSO customers continue to benefit from reliable and affordable resources. For this resource adequacy-driven capital, PSO plans to seek regulatory approval this fall, at which time the economics of this acquisition will be made public. As you know, maintaining a strong balance is critical to fund increased capital spend to support our growth initiatives. We will sensibly finance our capital needs, and we're open to incremental growth equity and equity-like tools, in addition to portfolio optimization. On a similar portfolio note, the sale of AEP on-site partners remains on track to close in the third quarter following FERC approval. Now let's move on to the Federal EPA's Coal Combustion Residual Rule, or CCR, which was finalized in the second quarter and expanded the scope of the rule to include inactive impoundments at existing and inactive facilities. We continue to evaluate the applicability of the rule to current and former plant sites, and have developed preliminary estimates of compliance costs. While we are working with others and looking at potential legal challenges to the revised rules, as appropriate, we do plan to seek cost recovery through new and or existing regulatory mechanisms. Chuck will have more information on this shortly. Before I turn it over to Peggy for additional updates, I'd like to thank all of you for your support during my time as AEP's interim CEO. I've been privileged to serve AEP over the past five months, and the board and I are confident that Bill is the right person to build on the momentum underway and to lead AEP into its next chapter. On a related note, we are planning an informal meet and greet in New York City soon, so analyst investors can say hello to Bill in person. We are targeting something in August, so stay tuned for more information coming your way in the next couple of days. Finally, I'm excited about what the future holds for AEP as we execute on our strategic priorities and enhance value for all of our stakeholders. Peggy?"
},
{
"speaker": "Peggy Simmons",
"content": "Thanks, Ben, and good morning, everyone. Now let's turn to an update on several of AEP's ongoing regulatory initiatives. We are engaged in our regulatory and legislative areas, continuing to strengthen relationships, including implementation of our investment in more people and resources at the local level. And as the utility industry is changing, now more than ever, AEP's operating company leaders are staying increasingly engaged with regulators amidst this dynamic environment. Customer bills and affordability remain top of mind for AEP, in addition to system reliability and resiliency. We are focused on advancing interest in each of the states we operate, which includes economic development, work across service or service territory to bring jobs and create Bill headroom from a larger load perspective, and to ultimately achieve the regulatory outcomes that are good for AEP's customers, communities, investors, and employees. We continue to work through regulatory items with the focus on our authorized versus earned ROE gap, which remained flat at 8.9% for the past 12 months as of second quarter 2024. Turning to some positive rate case development, let's start with INM. I'm pleased to report that in May, we received an order in Indiana approving all key items in our settlement, including an improved 9.85% ROE. In June, we received a constructive order in Michigan maintaining our existing 9.86% ROE, with new rates taking effect in mid-July. Just last week for AEP Texas, parties filed a unanimous and unopposed comprehensive settlement with the ALJ increasing our authorized ROE to 9.76%, with rates effective in early October pending commission approval. As you know, earlier this year, we filed an APCo biennial rate review in Virginia and a base rate case for PSO in Oklahoma, where we received intervener testimony in the PSO case last evening. We're at the beginning of the procedural schedules in both cases and expect commission orders in the fourth quarter. We look forward to sharing updates on our progress in the coming months. Relative to future cases, APCo plans to file a base rate case in West Virginia in the next week. While we have many trackers in place to help mitigate regulatory lag, we have not had a rate case here in a few years and look forward to working with the parties to achieve a balanced and fair result. Looking ahead, I am proud of the progress we continue to make on the regulatory front and I remain excited about advancing our regulatory strategies in 2024 and beyond. Let's discuss AEP's recent fleet transformation activities and the progress we made on that important initiative. In May, APCo issued requests for proposals for 800 megawatts of wind or solar owned resources with regulatory filing anticipated in 2025. Finally, as Ben mentioned, PSO signed an agreement in June to purchase Green Country's 795 megawatt natural gas generation facility to help ensure resource adequacy. The agreement is conditioned on regulatory approval and we plan to make the related filings with the Oklahoma Commission in the fall. This is an example of a proactive approach by the team in meeting ever increasing resource needs and we're enthusiastic about the opportunity as we advance our fleet transformation. To wrap up, I'd like to thank Ben for his leadership and welcome Bill to the AEP team. This is an exciting time here at AEP and when I think about the future, I'm motivated by the opportunities we have ahead of us, embracing large loads, advancing our regulatory strategy, and driving overall long-term success. I'll now turn things over to Chuck who is going to walk through second quarter 2024 performance drivers and details supporting our financial results. Chuck?"
},
{
"speaker": "Charles Zebula",
"content": "Thank you, Peggy, and good morning, everyone. Let's jump right into our second quarter results. Slide seven shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. GAAP earnings for the second quarter were $0.64 per share compared to $1.01 per share in 2023. Year-to-date GAAP earnings are $2.55 per share for this year versus $1.78 per share last year. There's a detailed reconciliation of GAAP to operating earnings for the second quarter and year-to-date results on pages 13 and 14 respectively. Let's briefly highlight a few of the non-operating items for the quarter that mostly make up the difference between GAAP and operating earnings. First, as disclosed in an 8-K in May, an after-tax provision of $126 million for customer refunds was recorded based on recent developments in the remand proceeding related to the cost cap associated with the Turk plant that has been debated over the last decade. Secondly, we incurred a $94 million expense associated with a voluntary severance program that we completed in the second quarter. And finally, as Ben mentioned, the final revised EPA CCR rule became effective in May. We recorded a $111 million accrual for compliance costs largely related to our Ohio properties where generation is deregulated. We also updated our asset retirement obligations for sites in our regulated entities where we intend to seek cost recovery. Let's walk through our quarterly operating earnings performance by segment on slide eight. Operating earnings for the second quarter totaled $125 per share or $662 million compared to $113 per share or $582 million in 2023. This results in an increase of $80 million or $0.12 per share, which is a 10.6% increase over last year. Operating earnings for vertically integrated utilities were $0.46 per share, down $0.05. Positive drivers included favorable year-over-year weather and rate changes across multiple jurisdictions, with the 2022 PSO base case and the 2023 Virginia proceeding being the most significant. These items were offset by higher income taxes, which are largely a reversal of favorable income taxes in the first quarter, lower normalized retail sales, and higher depreciation. Note the year-to-date results in this segment consolidate the income tax loss that is shown in this quarter, resulting in an immaterial year-to-date income tax variance versus last year. The transmission and distribution utility segment earned $0.41 per share, up $0.11 compared to last year. Positive drivers in this segment included favorable weather, increased transmission revenue, rate changes primarily from the distribution cost recovery factor in Texas, and higher normalized retail sales. These items were partially offset by increased property taxes and depreciation. The AEP transmission Holdco segment contributed $0.39 per share, up a penny compared to last year, primarily driven by investment growth. Generation and marketing produced $0.12 per share, down a penny from last year. Recall that AEP renewables was sold in the third quarter last year, which has two impacts, a negative earnings variance due to the business being sold and removal of the interest costs for financing these assets. Additional drivers were lower retail margins offset by higher generation margins and lower taxes. Finally, corporate and other was up $0.06 compared to the prior year, primarily driven by lower income taxes and increased other operating income related to timing in the prior year. These items were partially offset by higher interest expense and lower interest income from the GNM segment. Let's turn to slide nine, which shows weather normalized retail sales of 4% in the quarter from a year ago, headlined by a double-digit 12.4% increase in commercial sales, which is where our data processing customers are classified. I'll note that in our T&D segment, the increase in commercial load was over 20% for the quarter. This is a trend that will continue over the coming years based on already signed customer commitments. Our operating footprint and robust transmission system position us perfectly to grow along AI and other technologies and industries in need of access to affordable and reliable power. Through the remainder of this year, data processing gains will remain mostly concentrated in Ohio and Texas. But beyond this year, we are seeing strong commitments from new customers looking to connect at some of our vertically integrated companies as well. Outside of data processors, our industrial sales have remained resilient in the face of a slowing economy. Industrial sales were strongest in Texas, driven by an influx of new customers, mainly in the energy industry. Thanks to our success over the past few years on the economic development front, we expect to see our industrial sales continue to be resilient in the next few years as several new large customers in steel, energy, renewable energy, and semiconductors come online across our footprint. In the residential segment, we continue to see growth in customer count and load in Texas, but residential load remains weak in most of our territories, likely due to the cumulative effects of inflation. Bottom line, the amount of demand from new large loads we're seeing across our system is unprecedented. We are excited, challenged, and poised to embrace this opportunity. Let's move on to slide 10. In the top left table, you can see the FFO to debt metric stands at 14.6% for the 12 months ended June 30th, which is a 40 basis point increase from the prior quarter. Our debt-to-cap decreased slightly from last quarter and was 62.6% at quarter end. We took credit-supportive financing actions in the second quarter by issuing $400 million of equity under our at-the-market program and by issuing $1 billion in junior subordinated notes at the parent, which qualified for 50% equity credit at all three rating agencies. In the lower left part of this slide, you can see our liquidity summary, which remains strong at $5.4 billion and is supported by $6 billion in credit facilities. Lastly, on the qualified pension front, our funding status is near 99%. In summary, our second quarter results provide additional momentum this year, bringing year-to-date earnings up to $2.52 per share, an increase of $0.28, or 12.5% compared to the same period last year. We reaffirm our operating earnings guidance range of $553 to $573 and remain committed to our long-term growth rate of 6% to 7%. And as we move through the balance of the year, our focus is on providing reliable and affordable service to our customers, executing our plan, and embracing the growth opportunities that we have ahead of us. Also, a quick update on the sale of AEP on-site partners. We expect the transaction to close in the third quarter and result in approximately $315 million in net proceeds to the company. I'd be remiss if I didn't acknowledge the skilled leadership of Ben Folk during this time of transition at AEP. Ben told you that this company would not be in neutral during the transition, and I can say that that is absolutely true. Ben, while I know you'll still be engaged as an advisor and board role going forward, I want you to know that the AEP team appreciates your engagement and contributions over the past five months. Finally, the AEP team looks forward to the arrival of our new CEO and President, Bill Furman. We all look forward to Bill bringing his accomplished leadership to AEP and working with him as we take on the exciting opportunities that we have before us. Thank you for your interest in American Electric Power. Operator, can you open the call so we can address your questions? Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Your first question comes from the line of Shar Pourezza of Guggenheim Partners. Your line is open."
},
{
"speaker": "Shar Pourezza",
"content": "Hey, guys. Good morning."
},
{
"speaker": "Ben Fowke",
"content": "Morning. Morning."
},
{
"speaker": "Shar Pourezza",
"content": "Just firstly, obviously, you guys highlighted in the deck, “the direction and strategy” kind of remain on track. I guess how much latitude will Bill have to make kind of strategic changes if need be to accrue value? Or is the plan kind of the plan and any kind of changes you expect will likely be more on the fringe, given your and the board's comfort level with the trajectory, with obviously the latter kind of being a similar situation to one of your other Ohio peers in the state when they had an incoming CEO? Thanks."
},
{
"speaker": "Ben Fowke",
"content": "Yes. I think that was a lot different circumstance, Shar, but Bill's very familiar with our strategy. We clearly had conversations with Bill about our strategy. So I think it's, I think we're on the right strategic direction. I do think Bill's going to come in and focus very much on execution. He's got a ton of experience, as we mentioned. And so I mean he'll take some time, assess where we are and I'm sure he's going to make some changes, but I don't see significant changes in the strategic direction. It's not like we gave him a plan, a to-do list, and you do all these things. He's going to be a dynamic leader. But the path we're on is, I think we're all in agreement, it's the right path and we need to execute on it."
},
{
"speaker": "Shar Pourezza",
"content": "Okay, perfect. And then last time, obviously we've talked about higher CapEx coming, driven by customer growth, data centers, etcetera. As we're kind of thinking about that incremental CapEx, potentially with a 3Q update and a funding source, the balance sheet doesn't have a material amount of capacity. You touched on this a little bit on your preparedness, but maybe you can elaborate on how you're kind of thinking about incremental equity versus asset sales, and with asset sales, how you're thinking about distribution versus transmission. Thanks, guys."
},
{
"speaker": "Ben Fowke",
"content": "Yes, I mean, clearly we're going to have an update in the fall, either at or right before EEI, that incorporates what it means to CapEx to fund this low growth, both in generation and transmission, and of course, what it means to make sure the balance sheet is strong in terms of equity and equity-like products, including portfolio optimization. Regarding portfolio optimization, you've heard me say it before, we're always open to it, but price has to be there, and the ability to execute has to be there. And the regulated utility spaces, those are two hard things to put together at the same time, but we're open to it. Chuck, I don't know if you want to add anything to it."
},
{
"speaker": "Charles Zebula",
"content": "Ben, the only thing I would add is, right, it's so important as we are a regulated utility and have significant capital needs not only today, but going forward right, to maintain investment credit ratings, and we will defend that right in our plan."
},
{
"speaker": "Shar Pourezza",
"content": "Got it. Perfect. Thank you. And by the way, just a real big congrats on Bill. He's one of the best hires. Thanks, guys."
},
{
"speaker": "Charles Zebula",
"content": "Thanks. You did mention, Shar asked the mix between distribution and transmission. So, it's going to, there's obviously going to be a lot of transmission that needs to be built, as well as distribution."
},
{
"speaker": "Operator",
"content": "Thank you. Your next question comes from the line of Jeremy Tonet of JPMorgan. Your line is open."
},
{
"speaker": "Jeremy Tonet",
"content": "Hi, good morning."
},
{
"speaker": "Ben Fowke",
"content": "Hey, Jeremy."
},
{
"speaker": "Jeremy Tonet",
"content": "Hey, I know you're not going to give us the full details here, but I was just wondering if there's any way you could help us think through size and shaping of this incremental CapEx, as you talked about, with the incremental wires needs here. It just seems like everything is materializing quicker than expected. And so, just wondering if you could comment, I guess, any shaping there that would be helpful."
},
{
"speaker": "Ben Fowke",
"content": "Yes. Well, as I mentioned, with Shar's comment, I mean, you're definitely going to see a lot of increase in transmission spent. There's got to be something to plug into, so we're going to have generation, as well, and we recognize the need to make sure we have reliable distribution grid. So, I think if I had to rate it, it would be transmission increases, followed by generation, followed by distribution."
},
{
"speaker": "Charles Zebula",
"content": "Jeremy, I would say you'll note, in our materials that we raised our CapEx this year already by $500 million. That largely is in T&D, right? It's for reliability spend, also customer hookups, and then storm-related capital. So the shape of it right, is going to be as these customer additions, come online. And again, as Ben mentioned, we'll be laying all that out in the fall."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. So, it sounds like there's an opportunity for more near-term, as opposed to just later data at this point, if I understand correctly."
},
{
"speaker": "Charles Zebula",
"content": "I think that that's true."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. I was just wondering if you could talk a bit more on PSO's natural gas generation purchase there. To what extent do you see the need for incremental gas generation, across Oklahoma, other service territories? Just wondering if you expect to see more of this."
},
{
"speaker": "Peggy Simmons",
"content": "So, I would say, this is Peggy, and I would say with the increased reserve margins that we're seeing from the RTOs and the additional load that we're starting to see across our system, we are going to need some additional generation. And this was a very proactive approach that the team took as I mentioned in my comments earlier, to go out and find some affordable assets that we could bring onto the system. And we plan to make that filing at the Commission later this fall."
},
{
"speaker": "Ben Fowke",
"content": "Yes. Peggy mentioned proactive. It really, I think, was creative. It was outside of the RFP process, but we have an RFP process to compare the pricing to, and it's clearly very favorable. So, we're really excited about it. I think it'll be great for our customers."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. Thank you for that."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Steve Fleischman of Wolfe Research. Your line is open."
},
{
"speaker": "Ben Fowke",
"content": "Hey, Steve."
},
{
"speaker": "Steven Fleishman",
"content": "Hey, good morning. Sorry, I've got several questions on data center, or data processing, as you called it. So first of all, just in the quarter, you had the very strong commercial sales growth, but then your normalized sales growth between the two subs, I think was actually down $0.04. When you kind of look at both vertical and T&D, could you just talk to how we should think about that?"
},
{
"speaker": "Ben Fowke",
"content": "Yes, in T&D, Steve, normalized sales were up $0.02."
},
{
"speaker": "Steven Fleishman",
"content": "Right. But then the vertical was down $0.06, I think. So I guess just thinking, when I look at the whole picture, it's not kind of, at least in that line item, doesn't seem to be showing up as a benefit."
},
{
"speaker": "Ben Fowke",
"content": "Yes. So, let me comment on the negative $0.06 in vertically integrated. That's largely due to in vertically integrated, we had in the quarter, but a 4.9% decrease over last Q2 in residential sales. And that's largely what drove that number. In our SWEPCO territory, we had in kind of mid to late May into early June, we had a number of repeated storm activity, tornadic activity that took, large swaths of customers out for significant amounts of times that drove that number down. We've seen that start to normalize back in June and July. So I expect that to return to a more normal state."
},
{
"speaker": "Steven Fleishman",
"content": "Okay. Thanks. And then on the 15 gigawatts of committed data center sales to 2030, could you just maybe better define what committed means when you give that data point?"
},
{
"speaker": "Ben Fowke",
"content": "Yes. I mean, it basically means that we have a letter of agreement, and those letter of agreements, Steve, start the clock running, if you will, for us to do work that pretty quickly can go into the millions, which that customer who signed the letter of agreement is required to pay. So that's how we define it. As we look forward, we look at a number of filtering criteria, ownership of sites, etcetera, that we use. So these are far from just inquiries. These are, serious customers that want to get on the grid and are willing to financially commit to do what it takes to get on the grid."
},
{
"speaker": "Steven Fleishman",
"content": "Okay. And are those customers kind of committing to these new tariffs you filed, or are we not at the point where they've made the agreement that those tariffs work for them when they've kind of done this?"
},
{
"speaker": "Ben Fowke",
"content": "Yes. Those tariffs, as you know they haven't been approved yet, but they will need depends where they are in the signing process as to whether or not they will be held to those tariffs or not. But going forward, customers, if approved, will all be required to step up to the tariffs."
},
{
"speaker": "Steven Fleishman",
"content": "Okay. And then….yes."
},
{
"speaker": "Ben Fowke",
"content": "Which, as you know, I mean, well, as Steve was just going to say, it's just, it's really important. We're going to see more growth than we've seen in maybe generations. And it's going to be really important that that growth is beneficial for all customers and at the worst case, at least neutral. And that's exactly why we're trying to, that's exactly why we're so keenly focused on making sure that we have these tariffs and the modifications I mentioned in Indiana and West Virginia. And it's just, we got to get it right."
},
{
"speaker": "Steven Fleishman",
"content": "Okay. And then maybe just in terms of helping to frame the capital needs, just, can you give us some rough sense of that 15 gigawatts, how much might be related to vertically integrated parts of AEP versus the transmission only parts?"
},
{
"speaker": "Ben Fowke",
"content": "Yes, Steve. So the way to think about it is, think of it as a 50-50 split between Texas and PJM. 50%, or of course, Texas, right, is our wires company and PJM, take that 50% and basically split it 50-50 between INM, which is vertically integrated and AEP Ohio, right, which is wires only."
},
{
"speaker": "Steven Fleishman",
"content": "Okay. So that would be kind of 75-25, I guess, roughly, I think. Yes."
},
{
"speaker": "Ben Fowke",
"content": "Okay. I think I've, yes. But we are seeing additional interest amongst other vertically integrated utilities, but that interest is not as firm yet."
},
{
"speaker": "Steven Fleishman",
"content": "Amongst some of your other vertically integrated."
},
{
"speaker": "Ben Fowke",
"content": "Yes, that's correct."
},
{
"speaker": "Steven Fleishman",
"content": "Yes. Okay. Great. I'll leave it there. Thank you very much."
},
{
"speaker": "Ben Fowke",
"content": "Thanks, Steve."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Nick Campanella of AEP [ph]. Your line is open."
},
{
"speaker": "Unidentified Analyst",
"content": "Nick Campanella at Barclays here. Thanks for the time."
},
{
"speaker": "Ben Fowke",
"content": "Did we just hire Nick?"
},
{
"speaker": "Unidentified Analyst",
"content": "I never got the call. I never got the call, but thanks for the time. A lot of my questions have been answered, but I just, curious as we kind of try to think about the magnitude of capital that the plan can handle here. I know that there's financing considerations, but there's also kind of bill growth considerations. Just how high do you think your rate-based growth can get before you have to start thinking about customer bill impact, especially as some of this load should be able to supplement that, but just trying to see, where this rate-based CAGR could go at the end of the day. Thank you."
},
{
"speaker": "Ben Fowke",
"content": "Yes, I think the incremental CapEx will be driven to support new load growth. And that's why we're just so keenly focused on making sure we get the rules right. And our modeling suggests that it will be good for all customers. And that's, I mean, that's what makes me so excited about this is that everybody can benefit, load's good for all, and it's going to, there are certainly pressures, on the grid and the resiliency and things like that, but I think the load's going to be beneficial to mitigate cost increases."
},
{
"speaker": "Unidentified Analyst",
"content": "Okay. Thanks. And then I guess, since you've kind of taken over, you have kind of pulled some strings on this involuntary, this voluntary severance program, just where are there other opportunities in the plan to cut costs today, or just things that maybe we're not thinking about that could be incremental to the positive?"
},
{
"speaker": "Ben Fowke",
"content": "Again, as I mentioned, I think, you've got Bill Furman coming in, he's got a track record of innovation. The companies in the Berkshire Hathaway portfolio were extremely well run. Bill is extremely well respected. So I think he's going to bring a lot of great ideas. It's a lot of blocking and tackling, and also taking advantage of innovation, smart technologies, etcetera, that'll get us there. But, the team has done a really good job, if you look back, in keeping O&M in check. So, again, I think the biggest way we keep costs down on our customers is to bring this new load on and bring it on in ways and rules and tariffs that are fair to all."
},
{
"speaker": "Unidentified Analyst",
"content": "Thank you."
},
{
"speaker": "Ben Fowke",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Carly Davenport of Goldman Sachs. Your line is open."
},
{
"speaker": "Carly Davenport",
"content": "Hey, good morning. Thanks for your time. Just a couple of clarification questions, if I could. First, just on the 15 gigawatts of incremental load by the end of the decade, could you just clarify, is all of that related to data centers, or is there anything else in there? And then, is there anything you can provide on how to think about the cadence of that load materializing from a timing perspective?"
},
{
"speaker": "Ben Fowke",
"content": "Yes, the 15 gigawatts refers to all data centers, and we're not announcing the cadence of that at this time. But it's already, as you can see, it's already showing up in our numbers. So we are hooking up, folks, and you'll see continued increases, over the next several years."
},
{
"speaker": "Carly Davenport",
"content": "Great. Thank you for that. And then, just a follow-up is just on the earned versus authorized ROE gap. I know you mentioned the earned ROE sort of flatted at 8.9% on a trailing 12-month basis. Do you have that comparable weather normalized number similar to what you've provided in previous quarters?"
},
{
"speaker": "Peggy Simmons",
"content": "Oh, we're looking forward to be at 9.1% for this year. As I mentioned, over the past 12 months, I mean, on a rolling average right now, we’re at 8.9% [ph] which is flat to where we were last quarter, but continuing to make progress on that front."
},
{
"speaker": "Carly Davenport",
"content": "Got it. Great. Thanks so much for the time."
},
{
"speaker": "Ben Fowke",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from Andrew Wiesel of Scotiabank. Your line is open."
},
{
"speaker": "Ben Fowke",
"content": "Good morning."
},
{
"speaker": "Andrew Weisel",
"content": "Hi, good morning. First, a quick governance question. Can you please talk about the outlook for the board, and specifically what roles will Ben and Bill each have? Who will be chair of the board, and will it be executive or non-executive? And how large will the board ultimately be?"
},
{
"speaker": "Ben Fowke",
"content": "Okay. Well, I will go back after my time as advisor, I'll go back to being a board member, and I will keep my independence. Bill obviously will be on the board. He'll be a non-independent director. Sara Martinez Tucker, or Sara Martinez Tucker will be the chair, and she will remain chair, and she's independent. Size of the board, we are basically at full size, and so there won't be any change to the size of the board. I don't know. Did I get all those questions?"
},
{
"speaker": "Andrew Weisel",
"content": "Yes. That's great. Thank you very much. And then just a quick question on the cash flow slide, page 22. Some moving parts in 24 has led to slightly higher equity needs this year by about $100 million. Can you elaborate a little bit on that? And then looking to 2025 and beyond, I see no changes. Would I be right to assume that sort of just waiting for the update in three months? And just to clarify your comment on the equity-like tools, are you referring to the junior subordinates, or could there be something else in there, like equity units perhaps?"
},
{
"speaker": "Ben Fowke",
"content": "So, Andrew, first question. You also note in 2024, we had a $500 million increase in CapEx, and versus our plan for the year, we had additional asset sales that were part of the original plan that ended up changing through the year. So, in our financing, in our cash, we received less proceeds because of that change in plan. So, those two things basically drove the opportunity for the increase in equity, and just being opportunistic in the market as well. You're right, going forward, we have not updated those cash flows yet for our annual update, which we'll do at EEI."
},
{
"speaker": "Andrew Weisel",
"content": "Okay. The equity-like, was that just referring to the junior subordinates, or was there more to it?"
},
{
"speaker": "Ben Fowke",
"content": "Yes, that refers to the notes that we issued in June. But we would look at various forms of equity alternatives and be holistic in our approach."
},
{
"speaker": "Andrew Weisel",
"content": "Very good. Appreciate the details. Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Durgesh Chopra of Evercore ISI. Your line is open."
},
{
"speaker": "Durgesh Chopra",
"content": "Hey, team. Good morning. Good morning, Ben. Andrew actually asked my question on the financing slide. Chuck, maybe a little sort of more color, there were kind of more negatives to positives in that cash flow slide. I mean, the asset sale proceeds were lower, right, and the CapEx is higher. Just assuming normal weather for the rest of the year, are you going to be below 14.6 where you said, or should we kind of think about 14.6 as strong as going into the end of the year?"
},
{
"speaker": "Charles Zebula",
"content": "Yes, our plan is to be in the 14% to 15% range. I'll just note, right, that we're well above the 13% downgrade threshold. So, yes, we plan to be in that range."
},
{
"speaker": "Durgesh Chopra",
"content": "Okay. Thank you. Appreciate the time."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Sophie Karp of KeyBanc Capital Markets. Your line is open."
},
{
"speaker": "Sophie Karp",
"content": "Hi. Good morning. Thank you for squeezing me in. If I could quickly go back to the 15 gigawatts of data center load, I guess, could you provide some color on how much of that can be connected without any incremental investment in your system versus how much would they require incremental investments to facilitate that?"
},
{
"speaker": "Peggy Simmons",
"content": "Right now, none of that can be connected at this point in time, but as we look at our LOA process, that's why we are looking at any initial upgrades that are needed as we prepare to plan the system to connect this load over that period of time."
},
{
"speaker": "Sophie Karp",
"content": "Got it. Got it. Thank you. And then maybe a little bit more of an open-ended question. Your current outstanding RFPs don't have any gas in them. It's mostly renewables. And I'm just curious of how you think about the cadence of needing to add dispatchable generation there. And when it comes to gas, will you continue to have a bias towards acquiring existing assets or will we see some new builds potentially?"
},
{
"speaker": "Peggy Simmons",
"content": "So, our RFPs are all-source RFPs, so we're evaluating all technologies that come in. And we do believe the dispatchable resources are needed to be added to the grid as well, and they will be part of the plan."
},
{
"speaker": "Sophie Karp",
"content": "Okay. Thank you."
},
{
"speaker": "Peggy Simmons",
"content": "You're welcome."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Bill Appicelli of UBS. Your line is open."
},
{
"speaker": "William Appicelli",
"content": "Hi. Good morning. Thanks for taking my questions. Just want to dig into a little bit more on the sales growth trends. So, on the residential side, you commented that Texas looks strong, but that more broadly, the cumulative effects of inflation have been weighing on it. So, any more color there? Are you expecting an improvement in the second half of the year?"
},
{
"speaker": "Ben Fowke",
"content": "Yes. So, Bill, in Texas, right, there is customer growth as well as, increase in use or as a result, increase in usage. In vertically integrated year-to-date, residential is down 1.3%, and T&D is actually up 0.3%, largely due to Texas. So, we are seeing, I think, in Appalachian Power, in Kentucky Power, in SWEPCO in particular, and I mentioned, some of the weather occurrences that we had in the SWEPCO area, weaker residential sales in those areas in particular."
},
{
"speaker": "William Appicelli",
"content": "Okay. I mean, I guess we think about the EPA activities here, right, because you've got the, tremendous growth in the commercial side, right, tracking well above plan, but that's going to be lower margin volumes. And then maybe on the residential side, going back sort of four of the last five quarters, sort of as a negative, and that's obviously a bit of a higher margin, but, smaller overall change. What, we sort of reconcile that a little bit as we think about the EPA's impact."
},
{
"speaker": "Ben Fowke",
"content": "Yes. I mean, clearly the residential sales are higher margin, but, again, I think it's, in particular, the effects of inflation. So, if inflation comes in tame, tamer as we begin to, as we've begun to see if wage growth, continues to close that gap. And as Ben mentioned, right, the opportunity to bring on large loads to spread fixed costs, right, over a much larger denominator, right, should mitigate, right, some of those customer rate impacts as well. So the combination of those things, right, should begin to, slow that decline. But, clearly, the effects of inflation have hit home for a lot of customers."
},
{
"speaker": "William Appicelli",
"content": "Right. Okay. And then I guess the other question is, it's come up a little bit, but on the episode of debt, under, I guess, the Moody's methodology, do you know what that number would be?"
},
{
"speaker": "Ben Fowke",
"content": "Yes, it's 14.6 under Moody's."
},
{
"speaker": "William Appicelli",
"content": "Oh, it's under Moody's. Okay. All right. Thank you very much."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Julian Smith of Jefferies. Your line is open."
},
{
"speaker": "Julian Smith",
"content": "Hey, good morning, team. Thank you guys very much for the time. I appreciate it. Going back. Thank you very much. Appreciate it. Maybe going back to some of the conversation on the layoffs and severance bit. I just want to understand the extent to which this process is finalized, right? You've given very specific jurisdictional level details. And given that, how are you thinking about rebuilding and devolving some decision-making power and some of the roles to the local OpCo’s? Can you speak to perhaps what seems like perhaps a strategic shift in looking at local level decision-making and really what level or what quantity of the roles in terms of overall layoffs will actually be ultimately recreated, if you will, at the local level here? So both the financial question in terms of what's the sort of ongoing net savings and B, how do you think about this fitting within the strategic question of devolvement?"
},
{
"speaker": "Ben Fowke",
"content": "Yes, I'm going to turn it over to Peggy in a second. But just as a recap, we did hit our targets that we laid out under that voluntary severance program. And we plan to hold as much of those gains as possible. Probably have to do some hiring back, but try to keep that minimized. Remember, there was two-pronged approach for this. One, we wanted to mitigate some of the inflationary pressures that we were seeing, higher interest rates, just overall increase in supply chain, etcetera, and take a portion of that, albeit a smaller portion, and start putting those, some of those resource, some of that money back into our local communities with more boots on the ground, if you will, more community leadership positions and that sort of thing. So Peggy, do you want to?"
},
{
"speaker": "Peggy Simmons",
"content": "Yes, Ben. So yes, that's exactly, Julian, what we're looking to do. We are, some of those positions were leadership positions that report to some of our Presidents. We are making sure that we are getting those filled and we're adding additional resources in the regulatory and legislative space, because we know that as dynamic as our industry is and as much change as is occurring, we want to make sure that we have that enhanced engagement at those levels. So you'll see more of that."
},
{
"speaker": "Julian Smith",
"content": "Excellent. All right. Looking forward to that. And then related, you talk about these staggering levels of the 15 gigawatts of firm commitments at this point. How do you think about that marrying up, especially in your wires businesses against an effort to address generation needs? I know this has been an ongoing tension, but given what seems like yet an accelerating backdrop of generation needs, how do you think about your utilities, especially in the buyers only businesses, potentially re-engaging in that narrative? And in what ways?"
},
{
"speaker": "Ben Fowke",
"content": "Well, I mean, I think that would take legislation clearly in Ohio. I guess it would take it in Texas, too, but I don't see that happening. I think it's probably a long shot in Ohio as well. So, we are going to have to rely on the market, but our vertically integrated utilities are all going to need generation and in different timeframes. But I think Peggy mentioned, we've got, we do have more with the changes in the reserve margin requirements, for example, in SPP. It creates a resource need, and we're developing our plans to fill that, which will require increased CapEx, which I think is a good thing. And we're really, again, excited about Green Country. The load is tremendous, and it's primarily data centers, but of course we'd be remiss if we didn't mention we've seen industrial load in Texas as well. And I think when we think about economic development, we're going to continue to look for opportunities to bring industry back on shore. And I'm right here in Columbus today, and the Intel has just been an enormous success, and we're going to keep looking for opportunities for our communities, and, again, all customers benefit from that."
},
{
"speaker": "Julian Smith",
"content": "All right, guys. Thank you very much. I appreciate it."
},
{
"speaker": "Ben Fowke",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Your last question comes from the line of Paul Patterson of Glenrock. Your line is open."
},
{
"speaker": "Paul Patterson",
"content": "Good morning. How are you doing?"
},
{
"speaker": "Ben Fowke",
"content": "I'm doing good."
},
{
"speaker": "Paul Patterson",
"content": "Great. So I asked this question some time ago about Chevron, and we now have a Supreme Court decision. And I'm just wondering how you guys see it potentially impacting either EPA or FERC regulation or anything else you might, if you think it has any potential impact on AEP, I guess."
},
{
"speaker": "Ben Fowke",
"content": "I think it's early, but, yes I think it could potentially be helpful as courts have more discretion not to have to rely on the agencies, which that was the whole point of that. And I just think it doesn't bind the courts as much as it probably did in the past. Now, whether that, how the courts interpret it, what, the rulings are, we'll have to wait and see. But Paul, I think in general it's going to be helpful. And we are going to challenge a lot of these EPA rules, as you know, the CCR rule, the ELG rule, the 111 rules. I guess all of the rules that have come out we're going to challenge and for good reason."
},
{
"speaker": "Paul Patterson",
"content": "Okay, great. And then just on FERC, do you see anything happening there maybe?"
},
{
"speaker": "Ben Fowke",
"content": "I don't know. I think, I know there's some, there's some thought that it would, but I think that really, I'm not convinced it will. So, I think that remains to be seen."
},
{
"speaker": "Paul Patterson",
"content": "Okay. The rest of my questions have been answered. Thanks so much. Have a great one."
},
{
"speaker": "Ben Fowke",
"content": "All right, Paul. Thank you."
},
{
"speaker": "Darcy Reese",
"content": "That concludes it. Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. JL, would you please give the replay information?"
},
{
"speaker": "Operator",
"content": "Certainly. Echo replay will be available in two hours until August 6th at 1-800-770-2030. That's 1-800-770-2030 using playback ID 6645529. That's replay playback ID 6645529 followed by the pound key. This concludes today's conference call. You may now disconnect."
}
] |
aep | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning, ladies and gentlemen, and thank you for standing by. My name is Abby, and I will be your conference operator today. At this time I like to welcome everyone to the American Electric Power First Quarter 2024 Earnings Conference Call. [Operator Instructions]"
},
{
"speaker": "",
"content": "Thank you. And I would now like to turn the conference over to Darcy Reese, Vice President of Investor Relations. You may begin."
},
{
"speaker": "Darcy Reese",
"content": "Thank you, Abby. Good morning, everyone, and welcome to the First Quarter 2024 Earnings Call for American Electric Power. We appreciate you taking time today to join us. Our earnings release, presentation slides and related financial information are available on our website at aep.com."
},
{
"speaker": "",
"content": "Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Ben Fowke, our President and Interim Chief Executive Officer; Chuck Zebula, our Executive Vice President and Chief Financial Officer; and Peggy Simmons, our Executive Vice President of Utilities. We will take your questions following their remarks."
},
{
"speaker": "",
"content": "I will now turn the call over to Ben."
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "Well, good morning, and welcome to American Electric Power's First Quarter 2024 Earnings Call. Shortly, Peggy will give a regulatory update, followed by Chuck, who will provide more detailed financial review."
},
{
"speaker": "",
"content": "The summary of our first quarter 2024 business highlights can be found on Slide 6 of today's presentation. Beginning with AEP's financial results, today, we announced first quarter 2024 operating earnings of $1.27 per share, a $0.16 increase over 1 year ago. We are also reaffirming AEP's 2024 full year operating earnings guidance of $5.53 to $5.73. And the long-term earnings growth rate of 6% to 7%."
},
{
"speaker": "",
"content": "I'm pleased to note, we achieved a 14.2% FFO to debt ratio this quarter, which is within our stated range. Let me assure you that AEP's direction and strategy remain on track as this team is fully engaged, energized and working well together to enhance the customer experience and investor value. I've reviewed AEP's financial targets, and I have total confidence in the plan's achievability."
},
{
"speaker": "",
"content": "It's hard to believe it's been just 2 months, since I stepped into the role of interim CEO, and it has been a busy and productive 60 days. I've had the opportunity to meet with many different stakeholders, including elected officials, regulators, community leaders, customers, investors and, of course, the team right here at AEP. All of these meetings have been very useful in helping shape the initiatives I will discuss shortly."
},
{
"speaker": "",
"content": "Before I dive into other business, I want to give you a brief update on the search for a permanent CEO. The process is well underway, and I am certain, based on the talent pool that we're looking at that we will find the right person to lead AEP. As I mentioned, when we first talked at the end of February, the search will probably take between 6 to 12 months. We will take the time necessary to find the best candidate, and we're committed to keeping you informed."
},
{
"speaker": "",
"content": "So across the AEP system, I see the need to increase capital spend in the future, including incremental investment related to commercial load growth from data centers and resiliency spend. Specific to load growth, the amount of service request is truly staggering and ranges between 10 to 15 gigawatts of incremental load by the end of the decade, in addition to many, many more gigawatts from hundreds of inquiries."
},
{
"speaker": "",
"content": "The key to capturing this commercial and industrial growth is to work with parties to make sure that commitments are real and secure, the tariffs and contracts are fair to all customers and growth is self-funded. And of course, that the load can be met. A couple of great examples of new commercial commitments can be evidenced by last week's announcements from both Amazon Web Services and Google to build large data centers in I&M's Northern Indiana service territory."
},
{
"speaker": "",
"content": "At AEP, we have the largest transmission system in the United States with a high-voltage backbone in the Midwest. We expect more transmission investment possibilities driven by this data center growth, specifically in substations and customer connections. As a side note, I'd like to call attention to AEP's commercial load in the first quarter of 2024 which grew at 10.5% over the first quarter of last year."
},
{
"speaker": "",
"content": "In addition, we will file our system resiliency plan in Texas, no later than the third quarter of this year, related to legislation passed in 2023, including investment related to hardening and modernizing the grid, expanding vegetation management and, of course, wildfire mitigation."
},
{
"speaker": "",
"content": "Clearly, a strong balance sheet is critical as we look to fund potential increased capital spend. And I believe incremental growth equity needed to fund smart capital is a positive thing."
},
{
"speaker": "",
"content": "That said, we are open to equity alternatives through portfolio optimization, looking at opportunities where price meets execution, while at the same time, staying focused on our efforts to achieve constructive regulatory outcomes. On a similar note, I'd now like to provide a brief update on the sales of our AEP Energy Retail and AEP OnSite Distributed Resources businesses, both of which are included in the Generation & Marketing segment."
},
{
"speaker": "",
"content": "We are working through final phases of the process and expect to conclude that process by our second quarter earnings call. Now let's move on to last week's newly published federal EPA rules on greenhouse gas standards, coal combustion residuals or CCR, Effluent Limitation Guidelines or ELG."
},
{
"speaker": "",
"content": "Although our team is still reviewing the rules, we will likely pursue legal challenges, while working with others, including our states who are aligned with AEP's commitment to provide customers with reliable and affordable energy. These new regulations in some cases, require the use of unproven technologies, are extremely expensive and establish unreasonable compliance schedules."
},
{
"speaker": "",
"content": "We are at a time when our nation needs to add dispatchable generation to support grid reliability and growth, and these rules have the potential to not only prematurely accelerate plant closures, but also discourage new dispatchable generation from being built."
},
{
"speaker": "",
"content": "Now turning to labor management. We announced a voluntary severance program earlier this month, taking effect July 1. We expect this initiative will save labor cost of approximately $100 million and will assist us in managing our cost to better serve our customers, allow us to redeploy resources locally in our regulated footprint and finally, mitigate impacts from inflationary pressures and interest rates."
},
{
"speaker": "",
"content": "Of course, we will do it so in a way that is fair and equitable to all of our valued employees. So as I mentioned, it's been a busy and productive couple of months. Have confidence in our strategy and team. I'm excited about the opportunities ahead to drive growth and create value for our investors. We look forward to providing you even more positive updates as we move forward in the year, further solidifying stakeholder confidence in our financial targets."
},
{
"speaker": "",
"content": "Before we turn to Peggy for additional updates, know that I am aware of AEP's regulatory successes and some of our challenges. We continue to review plans to strengthen our regulatory compacts as we work through the past and are ready for the future. Peggy?"
},
{
"speaker": "Peggy Simmons",
"content": "Thanks, Ben, and good morning, everyone. Now let's go to an update on several of AEP's ongoing regulatory initiatives. We are currently focused on investing more in people resources at the local level, particularly in regulatory and legislative areas."
},
{
"speaker": "",
"content": "The utility industry is changing and more now than ever, it's critical that we enhance our engagement in this dynamic environment. More details of our related regulatory activity can be found in the appendix beginning on Slide 23. AEP's operating company leaders are running the business and engaged with our state regulators. Higher costs for materials and frequency of cases shines a spotlight on affordability and customer builds are top of mind for us."
},
{
"speaker": "",
"content": "We are focused on advancing interest in each of the states we operate to achieve outcomes that are good for our customers, our communities and our investors. This includes economic development work across our service territory, which brings jobs and creates headroom from larger load perspectives."
},
{
"speaker": "",
"content": "We continue to reduce our authorized versus actual ROE gap. We're doing the work and our ROE improved slightly this quarter to 8.9%. Even considering this measure is depressed by approximately 30 basis points from mild weather conditions. Staying with the recent positive developments, I'm pleased to report AEP Ohio's Electric Security Plan V settlement obtained last summer -- excuse me, last September was approved by the commission earlier this month."
},
{
"speaker": "",
"content": "This ESP covers a 4-year term of June 2024 through May 2028. As we shared previously, we filed new base cases in Indiana and Michigan in the latter half of 2023. In Indiana, we reached settlement, which was filed in December, and we expect the commission decision by June of this year."
},
{
"speaker": "",
"content": "In Michigan, we completed the procedural schedule and expect a relief in that case in July. The team has been busy in 2024 so far, filing an Oklahoma base case for PSO in January and an AEP Texas case in February. Last month, we filed the APCo Virginia biennial rate review, required by statute from legislative changes attained in 2023."
},
{
"speaker": "",
"content": "Earlier this month, in SWEPCO, Arkansas and Louisiana jurisdictions we filed the annual formula rate plan. Now on to the regulated resource additions. We continue to advance our 5-year, $9.4 billion regulated renewable capital plan and have a total of $6.6 billion approved by state commissions at APCo, I&M, PSO and SWEPCO. As you can see, we're making great progress. We are also considering the renewables market local input, as well as evolving reserve margins and resource adequacy as we meet the needs of our customers."
},
{
"speaker": "",
"content": "We are advancing toward our fleet transformation targets, which are aligned with and supported by our integrated resource plan. We have pending requests for proposals for a diverse set of additional generation resources at I&M, Kentucky Power, PSO and SWEPCO with more to come from other operating companies, including APCo."
},
{
"speaker": "",
"content": "These generation investments are an integral part of our broader capital program, which is 100% focused on regulated assets. Looking ahead, we know there is more work to be done as we advance our regulatory strategies in 2024 to achieve a forecasted regulated ROE of 9.1%. We look forward to continuing to engage constructively with our regulators and strengthening relationships."
},
{
"speaker": "",
"content": "With that, I'll pass it over to Chuck to walk through the performance drivers and details supporting our financials."
},
{
"speaker": "Charles Zebula",
"content": "Thanks, Peggy, and good morning, everyone. Today, I'll review our financial results for the first quarter, build on Ben's comments about our service territory load and finish with commentary on our financial metrics and portfolio management activities."
},
{
"speaker": "",
"content": "Let's go to Slide 7, which shows the comparison of GAAP to operating earnings for the quarter. GAAP earnings for the first quarter, were $1.91 per share compared to $0.77 per share last year. There is a detailed reconciliation of GAAP to operating earnings on Page 13 of the presentation today."
},
{
"speaker": "",
"content": "One significant item I want to highlight in our GAAP to operating earnings walk is the onetime positive adjustment of $260 million, primarily for the remeasurement of a regulatory liability for excess deferred taxes, due to guidance recently received from the IRS, related to the stand-alone treatment of taxes for ratemaking purposes."
},
{
"speaker": "",
"content": "Let's walk through our quarterly operating earnings performance by segment on Slide 8. Operating earnings for the first quarter totaled $1.27 per share or $670 million, compared to $1.11 per share or $572 million in 2023. This results in a quarter-over-quarter increase of $98 million or $0.16 per share."
},
{
"speaker": "",
"content": "Operating earnings for Vertically Integrated Utilities were $0.57 per share, up $0.05. Positive drivers included rate changes across multiple jurisdictions with the PSO base case and the Virginia proceeding being the most significant favorable year-over-year changes in weather and income taxes. These items were partially offset by higher interest, higher depreciation and other taxes."
},
{
"speaker": "",
"content": "The Transmission & Distribution Utilities segment earned $0.29 per share, up $0.05 compared to last year. Positive drivers in this segment included rate changes, primarily from the Distribution cost recovery factor in Texas, and the distribution investment rider in Ohio, increased transmission revenue, higher normalized retail load and favorable year-over-year changes in weather. These items were partially offset by higher depreciation, other taxes and interest."
},
{
"speaker": "",
"content": "Please note that although weather was a positive variance quarter-over-quarter, in both the Vertically Integrated and T&D segments, weather for the first quarter 2024 was very mild. Compared to normal weather, our estimate of the variance is roughly $80 million unfavorable, which is about $0.12 per share."
},
{
"speaker": "",
"content": "The AEP Transmission Holdco segment contributed $0.40 per share, up $0.05 compared to last year, primarily driven by investment growth and favorable income taxes. Generation & Marketing produced $0.12 per share, up $0.03 from last year. Positive drivers included higher generation and retail margins, along with favorable interest expense. These items were partially offset by lower wholesale margins, higher income taxes and lower distributed and renewable generation results compared to the prior year, largely due to the sale of the universal scale assets in the third quarter of 2023."
},
{
"speaker": "",
"content": "Finally, Corporate and Other was down $0.02 compared to the prior year, primarily driven by higher interest costs. Moving to Slide 9. Overall retail load continues to accelerate ahead of expectations. This is due to our ongoing success in economic development, as well as the rapidly increasing demand from the many data centers finding a home within our footprint."
},
{
"speaker": "",
"content": "Weather normalized retail load grew 2.9% in the first quarter, highlighted by a remarkable 10.5% increase in our commercial load, which is where the data center load is classified. This is a trend we expect to continue over the next several years as the growth of AI and other technologies boost the need for additional data storage and processing. Driving the demand our existing and new projects that have ramped up more quickly than first anticipated, especially with some of our largest customers in Ohio and Texas."
},
{
"speaker": "",
"content": "As we refine our forecast for the remainder of this year and next, expect that those projections to move higher to reflect the rapidly evolving situation, as Ben had outlined in his comments. Outside of data centers, our economic development efforts are also helping us maintain growth in industrial load despite softness in manufacturing activity nationally. Industrial load grew 0.4% in the first quarter, roughly in line with expectations for the full year. This was driven primarily by increased activity amongst our plastics, tire and paper manufacturing customers."
},
{
"speaker": "",
"content": "We are keeping a close eye on our industrial customers, given the higher interest rates for longer environment. However, the number of large new loads anticipated to come online in the next 2 years, provides us with confidence that demand will remain steady in the face of any economic challenges for our existing customers."
},
{
"speaker": "",
"content": "The main takeaway on load, however, is the significant growth in large customers that we continue to bring online across our footprint. As I mentioned earlier, beyond the lookout for higher load projections, as we provide additional guidance later this year."
},
{
"speaker": "",
"content": "Let's move on to Slide 10 to discuss the company's capitalization and liquidity position. In the top left table, you can see the FFO to debt metric, stands at 14.2% for the 12 months ended March 31, which is a 100 basis point increase from year-end and in alignment with what I discussed on the last 2 earnings calls."
},
{
"speaker": "",
"content": "Our debt to cap decreased slightly from year-end and was at 62.8% at quarter end. In the lower left part of this slide, you can see our liquidity summary. Which remains strong at $3.4 billion and is supported by $6 billion in credit facilities that were recently renewed and upsized by $1 billion to support our liquidity."
},
{
"speaker": "",
"content": "Lastly, on the qualified pension front, our funding status has remained relatively flat, since the end of the year and ended the first quarter at 100.6%. Let's go to Slide 11 for a wrap up of today's message. The first quarter has provided a solid foundation for the rest of the year with a $0.16 increase in earnings per share, compared to the first quarter of last year despite the mild weather conditions that we experienced this winter."
},
{
"speaker": "",
"content": "We remain focused on achieving our objective, which include improving the financial performance of our utilities, offsetting cost increases due to inflation to keep electricity affordable and embracing the opportunity to bring economic development to our communities by serving large loads."
},
{
"speaker": "",
"content": "As an update, we successfully closed on the sale of our New Mexico solar assets for $107 million in cash proceeds in February, and we continue to work through the final phases of the AEP Energy and AEP OnSite Partners process. We expect to announce the results of the process by our second quarter earnings call."
},
{
"speaker": "",
"content": "Our first quarter results give us the confidence to reaffirm our operating earnings guidance range of $5.53 to $5.73 per share. We remain committed to our long-term growth rate of 6% to 7% and FFO to debt solidly in the 14% to 15% range. We appreciate your investment and interest in American Electric Power."
},
{
"speaker": "",
"content": "Operator, can you open the call so we can address your questions?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] And your first question comes from Jeremy Tonet with JPMorgan."
},
{
"speaker": "Jeremy Tonet",
"content": "Just wanted to peel in maybe a little bit more on the data center points that you laid out there. And just wondering, we see a lot of forecasts out there on the time line of how quick some want to come to market, and we're trying to figure out how that matches against the system's ability to provide the power there in the connects. And just wondering how you see those 2 aligning? What does that mean for AEP over time versus plan?"
},
{
"speaker": "",
"content": "And just how do you think about, I guess, structuring rates in the right way so that other rate payers don't bear more of a burden?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "Yes, those are all really good questions, Jeremy. And our team has done a tremendous amount of work thinking this through. I mean, first of all, I like to say, here at AEP that really wired for growth. And as you know, we've been making significant transmission investments over the years, and that's going to allow us, I think, to accommodate this first wave of growth we're seeing from data centers."
},
{
"speaker": "",
"content": "And -- so in our next 5 years, you will see that load coming on, and you'll see some of the capital spend -- the incremental capital spend to support it. As we get out further in the decade, I think, it's going to be a function of an additional transmission and perhaps even generation that will need to get built to meet it all."
},
{
"speaker": "",
"content": "But this team is working really hard. We have a great economic development team, very supportive business community in States and we've done a lot of groundwork to put ourselves in this position. And you're also seeing, Jeremy, data center load ramp up at the same time. So that's a natural trend, too."
},
{
"speaker": "",
"content": "Now to your latter question, this is one I've been keenly focused on. And the good news is we believe that the load growth that will be coming on, will be fair to all customers and in fact, will help us keep our rates affordable across all of our jurisdictions. We are developing new tariffs. Tariffs that require longer-term commitments. Tariffs that require the data centers to deliver on the load expectations that we're building for obviously, credit quality, et cetera."
},
{
"speaker": "",
"content": "And when you do the math, that load growth then benefits all customers. And that's what I'm really excited about because that was really important to myself and the team that we do keep rates affordable and this growth will do just that."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. That's helpful. And maybe just to dive in a little bit more as we think about data center load sensitivity. Should we be thinking that more along the lines of commercial sensitivity or industrial sensitivity, as provided in your guidance if you think about demand outstripping the forecast?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "Go ahead, Chuck."
},
{
"speaker": "Charles Zebula",
"content": "Yes. So I would think of it, Jeremy, more like an industrial customer and that sensitivity there."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. That's helpful. And then just the last one, if I could. As it relates to the external CEO search. Just wondering, has anything changed with regards to, I guess, the characteristics that are in focus for a candidate? How is the pool building at this point? Just wondering if there's any other color that you might be able to share on how the process is going?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "Well, I can just tell you that the attributes and the qualities we're looking for remain unchanged from what I described on the fourth quarter call. We are well underway now. We've got some really good candidates, impressive candidates. It takes time to sort it all out. And there's other obviously, things that we need to look at."
},
{
"speaker": "",
"content": "But the timetable that I outlined for you just a couple of months ago was 6 to 12. So truncate 2 months off of that, and it's 4 to 10. And -- but that said, we'll take as much time as we need to get the right person in place, and I'm very confident that we'll do just that."
},
{
"speaker": "Jeremy Tonet",
"content": "Got it. And actually, if I could just sneak 1 last in. Just wondering on overall corporate strategy, could you talk more about where things stand for AEP decentralization efforts. And looking to kind of more closely align P&L to the end decision maker at the local levels. Just wondering how that's progressing?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "Well, I think it's -- this is a focus of ours. And one of the -- and I'm going to turn it over to Peggy, she's developing -- has developed a detailed plan. But one of the things we want to do is put those local resources in our communities. And I know that's the right thing to do, just talking to stakeholders."
},
{
"speaker": "",
"content": "It costs money to do that which is one of the reasons why we did the voluntary severance, so we can free up some of those resources going forward to make those critical investments in our communities. Peggy, I don't know if you want to add anything."
},
{
"speaker": "Peggy Simmons",
"content": "Yes, Ben, I think you pretty much covered. We have worked with the team and looking at how we can get some more of those -- enhance the resources from a regulatory and legislative perspective, having more boots on the ground."
},
{
"speaker": "",
"content": "As I mentioned in the opening statement, there's a lot of change in our industry and having folks out there having these ongoing conversations is really important. So we're working through that process and more to come on that topic."
},
{
"speaker": "Operator",
"content": "And we will take our next question from Steve Fleishman with Wolfe Research."
},
{
"speaker": "Steven Fleishman",
"content": "So just in Ohio and Texas, your wires company, but in Indiana, where these last 2 announcements, I think you've got generation too. And are you -- so in some of these recent deals that announced -- the past week, are you supplying the generation as well? And is there going to be a generation need in Indiana related to those?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "Well, we do have RFPs outstanding. Peggy, do you want to take that?"
},
{
"speaker": "Peggy Simmons",
"content": "Yes. We do have RFPs outstanding in I&M. But to answer your question, yes, and are vertically integrated like Indiana, we will have to serve the generation component, and we are working with those large loads that are coming to us on what that would look like. And we are also focused on, as Ben mentioned earlier, redefining and looking at our tariffs as well. So that will be part of our strategy."
},
{
"speaker": "Steven Fleishman",
"content": "Okay. And just to kind of clarify back to the initial question. So the transmission grid is built up and has capacity to take on these customers near term. But is there still, even near term, is there more capital needed? Or is it more of this after this 5 years?"
},
{
"speaker": "Charles Zebula",
"content": "No, Steve, there'll be more capital needed, but I don't think it will be those massive 765 lines, it can take a long time to get built. We believe the team has done a lot of work on how we could accommodate that load within our footprint, working with PJM and others. And so yes, there'll be more spend, but it will be manageable and doable to the point."
},
{
"speaker": "Steven Fleishman",
"content": "Okay. And then on the FFO to debt, you're in the target range now. Is there anything about that that's kind of -- are you in there for good, do you think now? Is there any -- was there any timing reason? Or is it you're in that and expect to be in it throughout the year?"
},
{
"speaker": "Charles Zebula",
"content": "We were in the range. We expect to be in that range now. Our forecast that we review internally and with the agencies show us being in that range. So that's the plan, and we plan to defend that."
},
{
"speaker": "Operator",
"content": "We will take our next question from Shar Pourezza with Guggenheim Partners."
},
{
"speaker": "Jamieson Ward",
"content": "It's actually Jamieson Ward on for Shar. He's on the road and regrets that he's not able to join you today, but we have a couple of questions for you here. The first was just on the annual customer bill increase, the pace there, you reduced it to 3% increases per year through 2028, which is great to see. Does that already take into account the anticipated infrastructure investment needed to support any future data center growth? Or could we see that number be revised as well?"
},
{
"speaker": "Charles Zebula",
"content": "Well, I mean -- the answer is the incremental stuff we're talking about and the incremental transmission investment, it's not included in that, but it's not going to be -- it's not going to drive that from 3 to 4. If anything, it should keep it level and perhaps even drop it a bit."
},
{
"speaker": "",
"content": "Obviously, there's other things that go into that other inflationary factors, supply chain pressures, et cetera. But as I mentioned, this -- we've done a lot of work, making sure that the incremental investment that we would need to make over the forecast 5-year time frame is actually at a level that is accretive, if you will, to keeping customer rates affordable. And that's why I'm very confident of moving forward with it."
},
{
"speaker": "Jamieson Ward",
"content": "Got it. Terrific. And then expanding on Jeremy's earlier question, how are you approaching some of the more unique issues presented by data centers, for example, those who want to be behind the meter but still want to have an emergency tariff with the utility or data centers, which, as you mentioned, want to socialize the cost of interconnection through all rate classes but which may not have a major economic impact. If we can just get a bit more detail there."
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "I'm going to turn it over to Peggy in a second. But listen, it's got to be fair to all customers now, okay? I mean this is a big deal. It's an exciting big deal. But growth needs to be as close to self-funded as possible. And that's what I think we'll get with these tariffs and some of the other analysis that we're looking at."
},
{
"speaker": "Peggy Simmons",
"content": "Yes. So what I would add to Ben's comment there is that on our tariffs, we are looking at what minimum demands are. Most of the large loads are wanting to be connected to the system. But if they want some form of self-generation, we are asking so that we understand that, and we can include that, as part of our planning."
},
{
"speaker": "",
"content": "So we're trying to get all of that information on the front end. So that we can appropriately serve customers and make sure that it's fair and balanced for all customers and everyone is paying their fair share, as Ben has mentioned."
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "Yes. I mean the worst case scenario, and this is what -- to Peggy's point, what we're preventing is the load doesn't show up consistent with how we built the infrastructure. And when it does show up, it doesn't use, especially on a peak basis, the energy that we built for."
},
{
"speaker": "",
"content": "So -- and -- but if you control that, which, by the way, I think, we also have to be very careful, too, that these large, large loads are -- don't jeopardize good reliability. And so these tariffs address that, too. If you do all those things, then growth is good for all. And that's what we're pushing for."
},
{
"speaker": "Jamieson Ward",
"content": "That's very clear. And then on the updated load growth forecast coming later this year, should we assume that at a high level, that means the EEI or are there particular IRPs or other proceedings that we should maybe watch out for? Which could come say, before EEI that would be driving that?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "I mean I think the big update will come -- well, I understand EEI in the third quarter's earnings call right on the same, but it would either come on the third quarter or EEI unless there might be drips and drabs that get released before that, but that's what we're planning to do right now."
},
{
"speaker": "Jamieson Ward",
"content": "Understood. Got you. Last question from us is just on asset sales. In the deck, you mentioned remaining committed to simplifying the business in the immediate term with a focus on continued execution of the sale processes. So how should we think about the potential for any additional sales announcements, following the conclusion in the second quarter of the current process for the Retail and Distributed Resources businesses?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "It would be on an opportunistic basis. We're going to look at -- we're always open to ideas. Chuck and I and the team have been around a while. We know that sometimes good ideas sound good on paper, but you can't execute on them. So we do filter that through the regulatory screening process, as you can imagine."
},
{
"speaker": "",
"content": "And then we like our assets. So obviously, the price has to be right. But -- what you're not going to see from us is like strategic review, too, and preannounced kind of things that we're looking at. If the opportunity arises and we can execute on it, then you'll hear about it."
},
{
"speaker": "",
"content": "But -- in the meantime, our status quo plan, I think, is a pretty darn good plan. And to the extent that we issue equity to fund additional incremental CapEx, this is going to be smart CapEx, good growth for all and we'll keep our balance sheet strong, which I think is so important as you enter, I think, an extended era of higher CapEx growth."
},
{
"speaker": "Operator",
"content": "And we will take our next question from Carly Davenport with Goldman Sachs."
},
{
"speaker": "Carly Davenport",
"content": "Maybe just going back to the balance sheet. As you think about your financing needs for the remainder of the year, can you just give us an update there? And if you expect to see any impacts relative to your initial plan with the move that we've seen in rates year-to-date?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "Yes. Carly, the plan that we laid out at EEI is still intact. Other than I think at EEI, we had the West Virginia securitization in the plan, and that has been replaced by a Kentucky securitization, nearly of equal amounts."
},
{
"speaker": "",
"content": "So the plan is still intact. There's been no significant changes, and we're proceeding on that plan."
},
{
"speaker": "Carly Davenport",
"content": "Great. And then just going back to the commercial load and data centers. As you think about that and the expectation to raise later this year. Could you just talk a little bit about sort of what surprised the plan to the upside so materially thus far? Is it just sort of more success on the economic development front or more consumption from existing customers? Just any color on that would be helpful."
},
{
"speaker": "Charles Zebula",
"content": "Yes. Carly, it's just mainly the ramp rates of the customers that have hooked up, have come on more rapidly than we anticipated. And so that's why you're seeing those big bumps in commercial load, as we go through the quarters here."
},
{
"speaker": "Operator",
"content": "And we will take our next question from Nicholas Campanella with Barclays."
},
{
"speaker": "Nicholas Campanella",
"content": "I'll try to keep it to 2. So I guess you talked about this need for growth equity. Can you just elaborate when you anticipate needing that? And what part of this 5-year plan would that be? And then I guess, just -- you do have $700 million to $800 million, I think, a year in your financing walk here of equity needs. Just why not do something sooner than later to kind of knock that out if the opportunity presents itself? I know you don't want to preannounce and go into a strategic review around 2, like you said, but maybe you can kind of give us some additional thoughts on how you're thinking about that."
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "I'll turn it over to my esteemed colleague here, Chuck."
},
{
"speaker": "Charles Zebula",
"content": "No, Nick, it's a good question. I mean, look, as we said earlier, right? We're formulating, right, the changes to our plan and how ultimately, right, how financing is going to affect that."
},
{
"speaker": "",
"content": "You are right. We have $400 million in equity this year, followed by $800 million in equal amounts in the following 2 years. So I think the point that I tried to make earlier on FFO to debt, look, we're going to defend our BBB credit."
},
{
"speaker": "",
"content": "Right? We're going to maintain a strong balance sheet. So as we put out additional capital forecast, I think, you could assume, right, that strong balance sheet is going to remain intact. So just kind of wait for that update on CapEx, and you should be able to figure that out pretty clearly."
},
{
"speaker": "Nicholas Campanella",
"content": "Okay. I appreciate that. And then Chuck, I know that weather at VIU is kind of a $0.10 drag versus normal, but you also have some of these tax items in there as well. Just on the tax item benefits, is that normalizing from last year? Or is that one time in nature, as we kind of think about year-over-year into '25?"
},
{
"speaker": "Charles Zebula",
"content": "Yes. So Jeremy, about half of that will normalize throughout the year and the other half is onetime. Things that happened in '23 that won't happen again in '24. So it's a true increase."
},
{
"speaker": "Operator",
"content": "We will take our next question from Durgesh Chopra with Evercore ISI."
},
{
"speaker": "Durgesh Chopra",
"content": "I wanted to go back on your commentary, Ben, on portfolio optimization, new financing plan. Just to be clear, the financing plan, the CapEx update, the load board updates. Is that sort of -- should we think of that as a separate process and the CEO search? I'm just thinking about the 2 and are those 2 independent processes that we should think about? Or are they somehow tied? I'm thinking about the cadence of your updates, your new plan and then the parallel CEO search?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "I mean, if I understand your question right, are we holding things back until the new CEO gets in place? Is that what you mean?"
},
{
"speaker": "Durgesh Chopra",
"content": "That's right, Ben. Yes."
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "No, no. I mean, no. I mean, we typically -- as you know, we typically update all our CapEx and financing plans and all those sorts of things at the time of EEI. And if there's something major in between, obviously, we give you updates. But we're not -- no, I mean I -- this company is not in neutral. I mean we really -- we're moving forward."
},
{
"speaker": "",
"content": "This team is -- they share my belief that this growth is here. We need to accommodate it. We need to talk about it, and we need to make sure it's fair to all. So we're really, really focused on that. Focused on, I think, the strategy of putting more control at the local level, more resources at the local level."
},
{
"speaker": "",
"content": "So -- and we just announced a voluntary severance. So we're not kind of just putting it in neutral and coast until a permanent CEO gets in there. I honestly think these are all no regret type decisions that the new CEO will ultimately benefit from. But did I answer your question?"
},
{
"speaker": "Durgesh Chopra",
"content": "You did. That's exactly what I wanted to ask you, a very clear response. And then second question then, again, like you mentioned challenging the EPA proposed ruling. Maybe can you share a little bit more color there? Is it the carbon capture technology that you are referring to? And then you mentioned the accelerated plant retirements? Was that directed towards coal? Just any color you can share there."
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "Yes. Well, it's a great question. And again, I just -- I harken back to Steve Fleishman's report that came out a couple of months ago, where he talked about our industry, which if you aggregate market cap of somewhere around $0.5 trillion, being responsible for this -- we want our onshore data centers, artificial intelligence, reshoring of manufacturing. And it's our industry that has to do it. And we're going to build all the transmission we possibly can. That's not easy to get built either, but we are going to have to plug in to something."
},
{
"speaker": "",
"content": "And as you know, in my former role, I'm a big advocate for renewable energy. I think it's great, particularly when it's economic. Now some of that changes over time and regionally. But to think that we don't need dispatchable generation, I mean, it's -- we need it. And I'd love to see things like SMRs and other things develop, but they're not going to happen overnight. And in the meanwhile, we can't -- we have to be willing to move forward realistically."
},
{
"speaker": "",
"content": "And yes, it's not just the carbon capture rules. I mean there's -- we're looking at all the other rules, the CCR rules, the ELG rules, which by the way, we just spent a lot of money coming into compliance on that, and that was only a couple of years ago. And now it's a completely different role, which would require different technologies."
},
{
"speaker": "",
"content": "So it's -- our industry has come so far in carbon reduction. And I think we're willing to do so much more, but it has to be with affordability, reliability and resiliency in mind. And I'm just -- I'm really passionate about that. And you never like to have to sue, but we're going to do what we have to do to defend our grid and our customers that use that grid every single day."
},
{
"speaker": "Operator",
"content": "And we will take our next question from Andrew Weisel with Scotiabank."
},
{
"speaker": "Andrew Weisel",
"content": "Two quick ones here, please. First, to elaborate on the commentary on load growth. Ben, I think, you mentioned that the incremental 10 to 15 gigawatts by the end of the decade. I assume that's across the entire portfolio. Can you talk a bit about the Vertically Integrated Utilities? You have about 20 gigawatts identified through the current IRPs. My question is, how soon might we see more filings to include the new expected load, which there is no doubt coming quickly."
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "Yes. So when I look at those incremental loads, I mean, Ohio, within the PJM footprint, Ohio is the biggest driver of it, although Indiana is definitely getting its share. And I suspect we will have to do incremental RFPs to capture that load. I can't give you the exact timing of when that would be."
},
{
"speaker": "Peggy Simmons",
"content": "We have -- so Indiana, we have an IRP that's coming up that's going to be later in November. But -- so that will be part of the process as we start to look at how we accommodate some of this load as we start to see it to come on as well. We'll be using those same types of process."
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "And just maybe outside of data centers, if you look down at SPP, that's a very constrained region as it is right now. They haven't seen a tremendous amount of data center growth today. It doesn't mean they won't. But in the meantime, we've got to make sure we've got adequate load to serve the load that we do know we have."
},
{
"speaker": "",
"content": "In Ohio, again, we don't have generation in Ohio, so the incremental investment will be Transmission. There's lot of talk here in Ohio in the business community, at the state level do Regulated Utilities need to be back in the generation game? I don't know. I think -- honestly, I think that would take legislation, at least from my perspective. So that we'd be assured of good recovery and potentially any kind of stranded cost risk because we've seen that play out before. Doesn't mean we're not -- we wouldn't be open to it, but it would probably require legislation."
},
{
"speaker": "",
"content": "ERCOT. ERCOT, we don't own generation, but we would obviously, need to be building a lot of transmission and ultimately needing something to plug into."
},
{
"speaker": "Andrew Weisel",
"content": "Okay. Great. That's very helpful. And one quick one on the voluntary separation program. Would there be any kind of meaningful onetime cash outflow associated with that? And if so, how would you finance it?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "Yes. I think the -- so it would go into effect midyear, July 1, and so the annual savings that we would see this year would just about offset the severance cost. And then, of course, then on an annualized basis, '25 and beyond would benefit from that. And again, this is about -- yes, okay, I'll just stop there."
},
{
"speaker": "Operator",
"content": "And we will take our next question from Ryan Levine with Citi."
},
{
"speaker": "Ryan Levine",
"content": "On rate design for data center load what duration commitments and load ramp, are you assuming or looking for to help protect residential customers? Any differences on rate design between jurisdictions to call out? Any color is appreciated."
},
{
"speaker": "Peggy Simmons",
"content": "Yes. So I'll take that. Thank you for the question. I mean, generally, we need -- we'd have to be building long-term assets. So we need some commitments that are longer in nature. So I mean, we would think somewhere around the 10-plus, 15-plus year range, but we're working through that process now."
},
{
"speaker": "Ryan Levine",
"content": "And then in the prepared remarks, you're seeing higher load and potential new investments. In terms of funding that potential new investments in the back half or outside of plan. Any -- how are you thinking about what tools are most advantageous to execute on that potential opportunity?"
},
{
"speaker": "Charles Zebula",
"content": "Well, as Ben mentioned, we would consider everything. Everything is on the table. But I think the underlying tenet is that we will defend our BBB credit."
},
{
"speaker": "Operator",
"content": "And we will take our final question from Paul Patterson with Glenrock Associates."
},
{
"speaker": "Paul Patterson",
"content": "I wanted to circle back on the onetime gain associated with the PLR ruling that you got -- or the letters that you got. What's the ongoing impact of that? And could you just elaborate a little bit more on -- I did read the 10-Q and that section of it, but I just wanted to make sure I fully understood it."
},
{
"speaker": "Charles Zebula",
"content": "Yes. So thanks for the question, Paul. So that stand-alone ratemaking for tax purposes has really been on our radar for some time now. Really kind of results from some of our affiliates today generate taxable income and others generate tax losses, which has really kind of created the issue for us."
},
{
"speaker": "",
"content": "And really, kind of compounding that is our significant capital program over the last 5 years, as well as bonus depreciation has extended that dynamic. So we were concerned that if we did not address that, we may have a normalization issue. So we asked the IRS for a private letter ruling. Interestingly, some of our jurisdictions support the stand-alone approach, either in legislation or in their own rate making. And other utilities also endorsed and use the stand-alone approach as well."
},
{
"speaker": "",
"content": "So we received the PLRs in the first quarter. And the PLR really kind of boil down to 4 key facts. One is the stand-alone NOL must be included in rate base. The second, which addressed the gain in our adjustment from GAAP to operating is that the NOL must be included in the calculation of excess ADIT."
},
{
"speaker": "",
"content": "So that reduced the overall regulatory liability for excess ADIT, which, of course, was created due to tax reform. And then any adjustment to offset the NOL would constitute a normalization violation. So we took corrective action. We're glad that we did to avoid a normalization violation. And our plan now is to work with regulators to make the appropriate adjustments to rates so that we can include that going forward."
},
{
"speaker": "Paul Patterson",
"content": "Okay. So that should be a positive going forward, assuming the regulators agree?"
},
{
"speaker": "Charles Zebula",
"content": "Once we're able to go through our jurisdictions and get it into rates. Yes."
},
{
"speaker": "Paul Patterson",
"content": "And when I read the 10-Q, it said West Virginia was -- they've agreed to the stand-alone approach, correct? In the past, they've been a little bit -- is that right?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "Yes, that's correct."
},
{
"speaker": "Paul Patterson",
"content": "Okay. And then just with respect to transmission, FERC has some stuff coming out in a few weeks. And I was wondering if you had any idea about -- if you know what I'm talking about, it's the planning and what have you, sort of long-awaited reforms."
},
{
"speaker": "",
"content": "Do you guys have any sense as to what you might -- we might see there? And then sort of a related question on grid-enhancement technologies. Do you -- how do you see those playing with your large transmission system? Just any thoughts you have with respect to that?"
},
{
"speaker": "Benjamin Gwynn Fowke",
"content": "Yes. As far as the planning, I am told from our experts -- in-house experts that we don't anticipate having much of an impact on us. The grid-enhancing technologies, I'm not quite sure about that one."
},
{
"speaker": "Peggy Simmons",
"content": "So we do use grid-enhancing technologies. And as it relates to the planning information at FERC. I mean, our team has been very involved in it. I mean, I think they're looking at longer planning horizons and things of that nature. So our team has been at the table the whole time working with FERC on those."
},
{
"speaker": "Darcy Reese",
"content": "Thank you for joining us on today's call. As always, the IR team will be available to answer any additional questions you may have. Abby, would you please give the replay information?"
},
{
"speaker": "Operator",
"content": "Thank you. This call will be available for replay today approximately 2 hours after the conclusion of the call and will run through Tuesday, May 7, 2024 at 11:59 p.m. Eastern Time. The number to access the replay is 1 -800-770-2030 or 1 -609-800-9909. The conference ID to access the replay is 79-39-795#. Thank you, ladies and gentlemen. This concludes today's call. We appreciate your participation, and you may now disconnect."
}
] |
aes | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning. Thank you for attending today's AES Corporation Third Quarter 2024 Financial Review Call. My name is Megan, and I'll be your moderator for today. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. [Operator Instructions]. I would now like to turn the call over to Susan Harcourt, Vice President of Investor Relations at AES Corporation. Susan, you may begin."
},
{
"speaker": "Susan Harcourt",
"content": "Thank you, operator. Good morning, and welcome to our third quarter 2024 financial review call. Our press release, presentation and related financial information are available on our website at aes.com. Today, we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements, which are disclosed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer; and other senior members of our management team. With that, I will turn the call over to Andres."
},
{
"speaker": "Andres Gluski",
"content": "Good morning, everyone, and thank you for joining our third quarter 2024 financial review call. We are pleased with our performance this year. And today, I will discuss our third quarter results, a robust growth we are seeing at our renewables and U.S. utility businesses and our progress towards our asset sales target. Beginning on Slide 3 with our third quarter results, which were generally in line with our expectations. Adjusted EBITDA with tax attributes was about 1.2 billion, adjusted EBITDA was 692 million and adjusted EPS was $0.71. We're on track to meet our 2024 financial objectives, including our expectation to be in the top half of our ranges for adjusted EBITDA with tax attributes and adjusted EPS. At the same time, we now expect adjusted EBITDA to be towards the low end of the guidance range for the year, primarily due to the one-time impact of extreme weather in Colombia and the lower margins in the Energy Infrastructure SBU. We are reaffirming our expected growth rate through 2027. Steve Coughlin, our CFO, will provide more detail on our financial performance and outlook. I'm also very pleased to report that since our last call in August, we have signed or been awarded 2.2 gigawatts of new contracts. This includes both long-term renewable PPAs and new data center load growth at our U.S. utilities. Moving to our Renewables business on Slide 4. Since our Q2 financial review call, we have added 1.3 gigawatts of new PPAs to our backlog, bringing our year-to-date total to 3.5 gigawatts, more than 70% of which is with corporate customers. As a reminder, last year, we set a target of signing 14 to 17 gigawatts of new PPAs from 2023 to 2025. And with 9.1 gigawatts signed or awarded since the beginning of last year, we're currently well on track to meet this objective. Since setting that goal, we also materially increased our project return targets and we are focused on prioritizing the most profitable PPAs. Moving to Slide 5 and our construction progress. Since our second quarter call in August, we have completed construction of an additional 1.2 gigawatts of new projects, bringing our year-to-date total to 2.8 gigawatts, which represents nearly 80% of the 3.6 gigawatts we expect to complete this year. On-time execution is one of our competitive advantages, and we believe we have the best supply chain management in the industry. In the U.S., we have 100% of our solar panels on site for those projects coming online this year and 84% in country for next year. For 2026, we have 100% of our solar panels either in country or contracted to be domestically manufactured, providing protection against potential changes in tariff policy. We have also been a first mover in securing domestically manufactured battery modules and cells. We expect our first battery energy storage project with domestic content to come online in the first half of 2026. Additionally, we have established a robust supply chain for wind through our strategic suppliers with domestic manufacturing. Regarding long lead time equipment, such as transformers, and high-voltage breakers, we have secured all of the supply for our backlog through 2027. Turning to Slide 6. We are very well positioned as a leading provider of renewable energy to data center companies, particularly in the U.S. and to large mining companies outside the U.S. These customers want to work with AES due to our track record of providing customized solutions that best serve their specific needs and delivering our projects on time and on budget. With the U.S. elections only a few days away, I have great confidence in the resilience of our business plan, regardless of the outcomes of the presidential and congressional elections. While we do not believe the elimination of the investment tax credit or production tax credit is likely, even in an extreme scenario, we're uniquely well positioned due to the following. First, regardless of federal policies, our corporate customers had a massive need for new power that can only be met by renewables over the next decade. McKinsey estimates that in the U.S. data centers alone could require an additional 450 terawatt hours through the end of the decade, which is equivalent to more than the annual electricity consumption of France. With these market dynamics, we will continue to sign high-return renewables PPAs with our core customers. Second, should there be any changes to U.S. tariff policy, we have a resilient supply chain, with a large majority of our project components manufactured domestically by 2026. Finally, our strategy of procuring our equipment at the time of the PPA signing provides clear Safe Harboring protection from potential changes in policy. Now turning to Slide 7. Over the last 12 months, we have embarked on the most ambitious investment program in the history of our U.S. utilities, which will improve reliability and quality of service for our customers, while maintaining some of the lowest rates in both states. AES Indiana and AES Ohio are now 2 of the fastest-growing U.S. utilities, with projected double-digit rate base growth through 2027 based on necessary investments for our customers. As you may recall, in the third quarter of last year, we received commission approval for a new regulatory structure for AES Ohio, providing for timely recovery of the majority of these investments. Similarly, earlier last year, we received commission approval for new rates at AES Indiana, our first rate case in seven years. We are starting to see the benefits from the $1.2 billion we have invested in both utilities so far this year, representing a year-over-year increase of investment of 60%. Excluding the onetime settlement benefit recognized in 2023, year-to-date EBITDA is up 25%. Turning to Slide 8. We're also seeing additional investment opportunities from data center growth in our service areas above and beyond our existing rate base projections. Our utilities have many natural advantages that are attractive to large technology companies, such as proximity to fiber networks and the presence of ample land and water. We have worked to proactively identify sites that are well positioned to support new data centers, capitalizing on our deep relationships with technology companies. At AES Indiana, we expect to have specific data center deals to announce in the coming months, as we've been in active negotiations with several parties. We recently launched an RFP for 3 gigawatts of new generation to support accelerating demand growth. From a regulatory perspective, we will use the results of this RFP to help inform our IRP submission next year. At AES Ohio, we have now signed agreements for new data center load growth of 2.1 gigawatts, including an incremental 900 megawatts, on top of the 1.2 gigawatts we already announced on our last call. On our fourth quarter call in February, we will provide a comprehensive update on how these agreements impact our long-term investment plan and rate based growth. Today, we can indicate that just what we've signed to date provides a nearly 30% increase in investment through the end of the decade over our current plan. Turning to Slide 9. In September, we announced the plan to sell down 30% of AES Ohio to CDPQ, our longtime partner in AES Indiana. This transaction builds upon our strong relationship with CDPQ and allow us for common ownership across our U.S. utilities. This partnership will support growth at AES Ohio, with CDPQ as a funding partner for increasing investments to support reliability and economic development. Finally, as you may have seen in our release, we are pleased to report that we have now closed the sale of our equity interest in AES Brazil. We are proud of the work our people have done in Brazil to expand beyond the 2.7 gigawatt hydro portfolio by adding 2.5 gigawatts of operating wind and solar, creating one of the largest renewable businesses in the country. With these two transactions, we have now signed or closed agreements for more than three quarter of our 3.5 billion asset sale proceeds target through 2027. We have also further simplified our portfolio and eliminated Brazilian weather, interest rate and currency risks. With that, I would now like to turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"content": "Thank you, Andres, and good morning, everyone. Today, I will discuss our third quarter results and our 2024 guidance and parent capital allocation. Turning to Slide 11. Adjusted EBITDA with tax attributes was approximately 1.2 billion in the third quarter versus 1 billion a year ago. Although we realized 458 million of additional tax value year-over-year, renewables EBITDA was down 68 million, driven mostly by breaking drought conditions in South America. In addition, our energy infrastructure SBU was down 221 million largely due to expected items, which I'll cover in more detail on a later slide. Turning to Slide 12. Adjusted EPS for the quarter was $0.71 versus $0.60 last year. Drivers were similar to those of adjusted EBITDA with tax attributes, but partially offset by higher parent interest due to growth investments as well as a higher adjusted tax rate. I'll cover the performance of our SBUs, or strategic business units, on the next four slides. Beginning with our Renewables SBU on Slide 13. Higher EBITDA with tax attributes was driven primarily by significant growth from new projects in the U.S., where we've added 3.3 gigawatts since Q3 2023, but was partially offset by significant declines at our Colombia and Brazil businesses. This year, we've experienced unprecedented weather volatility and a record-breaking drought in South America, driven by El Nino conditions. In June, a historic flooding event took out our 1 gigawatt Chivor facility in Colombia for nearly 2 months, followed by an extreme drought across the entire country. Also, you may recall that the third quarter of 2023 was extremely positive as we had better hydrology at our Chivor facility than the rest of the country, while spot prices were very high, yielding significant margins. As a result, Colombia is down 92 million versus the third quarter of last year and over 130 million year-to-date versus last year. In Brazil, the record drought and extremely low wind resource this year have also negatively impacted renewables in Q3 and year-to- date. While 2024 has been a difficult year due to the events in South America, we expect our renewables segment will grow significantly in 2025. Emerging La Nina conditions in the Pacific are expected to return the region to much better hydrology. While in the U.S., by the end of this year, we will have brought online a total of nearly 2 gigawatts of new capacity, which will drive a large increase in our Renewable segment EBITDA in 2025. Now turning to Slide 14. Lower adjusted PTC at our Utilities SBU was mostly driven by the prior year recovery of 39 million of purchase power costs at AES Ohio, included as part of the ESP IV settlement, as well as higher interest expense from new borrowings. This was offset by returns on new rate base investment in the U.S. as well as new rates implemented in Indiana in May. Adjusting for the onetime settlement last year, utilities adjusted PTC grew by 18% in the third quarter over prior year. Lower year-over-year Q3 EBITDA at our energy infrastructure SBU was primarily driven by nearly 200 million of expected declines at our Warrior Run Southland legacy businesses and the impact of several sell-downs, all of which were baked into our guidance. At Warrior Run, we recognized revenues from the accelerated monetization of the PPA beginning last year and ending in the second quarter of this year. Our legacy Southland assets benefited from energy margins earned in the prior year, which are no longer an opportunity in 2024 under the new extension monetization structure. In addition to these known drivers, we experienced lower margins at our new Southland combined-cycle asset U.S. due to much milder weather as well as extended outages at our TEG and TEP thermal plants in Mexico. Finally, higher EBITDA at our New Energy Technologies SBU reflects continued high growth and margin increases at Fluence. Now turning to our expectations on Slide 17. We are reaffirming our 2024 adjusted EBITDA with tax attributes guidance of 3.6 billion to 4 billion and adjusted EPS guidance of 1.87 to 1.97 and continue to expect to be in the top half of both ranges, driven in part by the success we've had securing higher tax value on our new projects. Our renewables team expects to capture over 200 million in tax value upside this year, which reduces our growth capital needs. EBITDA from renewables will be favorable in the fourth quarter from revenues earned on our PPAs, although we expect lower tax attributes in the fourth quarter as a result of the more balanced timing of renewable commissionings throughout the year. We also expect further growth in our U.S. utilities in Q4 as we continue to realize returns from our investment program. This will be offset by the negative impact from the prior year monetization of the Warrior Run PPA as well as incremental impact from asset sales, including AES Brazil. Drivers of adjusted EPS will be similar along with higher interest expense from growth capital, but benefiting from a lower adjusted tax rate. As a result of our efforts to spread renewables construction more evenly throughout the year, we've achieved more than 80% of our adjusted EPS guidance year-to-date, providing greater certainty around our 2024 financial objectives. Turning to Slide 18. We are also reaffirming our adjusted EBITDA guidance range of 2.6 billion to 2.9 billion. While I'm pleased with our execution this year on our growth objectives, several large drivers have impacted results, primarily at our legacy businesses, and we now expect to end the year towards the lower end of our guidance range. Milder weather compressed spark spreads in California resulting in lower margins at our South and combined cycle gas plants. The PPA for these assets contains an option that allows us to choose to sell the energy to the market in a given year. We previously chose to execute this option for 2024 and were therefore impacted by declining spark spreads that occurred later in the year. In Mexico, the unplanned outages, which have now been resolved, further impacted our results in the second and third quarter. In Colombia, the combination of the Q2 flood-related outage at Chivor and year-long record drought have negatively impacted us versus our guidance. Finally, inverter failures at several of our solar sites impacted availability versus our plan. These inverters were under warranty and are being remediated by the manufacturers. Despite the confluence of these onetime negative impacts, growth in U.S. renewables remains very strong, and our U.S. utilities have outperformed. We expect to continue this momentum and substantially increase EBITDA at both our renewables and utilities businesses in 2025. Now to our 2024 parent capital allocation plan on Slide 19. Sources reflect approximately $2.7 billion of total discretionary cash, including $1.1 billion of parent free cash flow, $950 million of hybrid debt that we issued in May and $650 million of proceeds from asset sales. Sale proceeds will be slightly lower than expected in 2024 due to timing, but we are well ahead of our $3.5 billion long- term target through 2027. On the right-hand side, you can see our planned use of capital. We will return approximately $500 million to shareholders this year, reflecting the previously announced 4% dividend increase. We also plan to invest $2.2 billion to $2.3 billion in new growth. In summary, we've continued to execute in the year-to-date and are well positioned for a strong finish to 2024. Our substantial renewables commissioning thus far give us greater line of sight toward achieving our earnings and cash targets, and our funding plan is largely complete. With $1.60 of adjusted EPS year-to-date, we have overachieved on our EPS growth with a clear path to landing at least in the upper half of our guidance range. As we look ahead to 2025, we see strong growth in our Renewables and Utility segments and continued execution of our decarbonization strategy in energy infrastructure. I look forward to providing additional detail around 2025 and beyond on our fourth quarter call. With that, I'll turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"content": "Thank you, Steve. Before opening up the call for Q&A, I would like to summarize the highlights from today's call. We continue to execute well on our strategic priorities, including robust growth at our renewables and U.S. utility businesses. With 9.1 gigawatts of new PPAs signed or awarded in 2023 and year-to-date 2024, we are well on our way towards achieving our goal of 14 gigawatts to 17 gigawatts in 2023 through 2025. Regarding our construction program, we have added 2.8 gigawatts of new projects to our operating portfolio so far this year, and we're seeing the direct financial benefits in our adjusted EPS and adjusted EBITDA with tax attributes results. At our U.S. utilities, we have embarked on the most ambition investment program in their history, while signing agreements for 2.1 gigawatts of data center load growth, and we expect more in the coming months. We're also executing well on our asset sale and transformation program and we feel good about the remainder of 2024 and our long-term outlook, despite specific onetime weather-related events this year. Finally, I can confidently say that I believe no one is better positioned with large technology customers than AES. Energy market fundamentals and the strong demand we're seeing from our corporate customers give us great confidence in the resilience of our business plan, regardless of the outcomes of the upcoming U.S. elections. Operator, please open up the line for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions]. Our first question will go to the line of Nick Campanella with Barclays."
},
{
"speaker": "Nicholas Campanella",
"content": "Good morning, thank you for taking my question. So, I wanted to just ask the comments about supply chain, you seem well positioned through 2026 with panels, etcetera. But you continue to construct 3.5 gigs for this year. You kind of outlined this previous target at the Analyst Day of 14 gig into 2025. So, we're getting closer up to '25 now. I just kind of check in and see how you feel progressing towards that target because it seems like it will be a pretty good step up into '25 here? And is that still attainable?"
},
{
"speaker": "Andres Gluski",
"content": "Yes. Thanks for the question, Nick. I mean we feel very strong about our supply chain management and construction program. We are the only large renewables developer, which really hasn't had to abandon any large PPAs over the last 3, 4 years. So, what we've said, we have all the equipment we need this year. We have 84% of what we need for next year already in country. In the next month or so, we should have 100%. So, we feel very good about supply chain. We intend to concentrate on the big items like wind turbines, batteries, solar panels. But you also have inverters and you have transformers, which are long lead time and we feel very solid there. In addition, we've really had no problems with the workforce either because we have strategic relationships with EPC contractors so that they can move the crews from one project to the next. So, in answering your question, we feel very good about our construction program. And as you know, in 2023, we geared up 100%. So now we've been able to really smooth out our commissioning throughout the year, and we expect that in 2025 and 2026."
},
{
"speaker": "Nicholas Campanella",
"content": "All right. When I think about '25 again, obviously, you had, on a tax attribute basis, some one-timers that's kind of putting you a little lower here. And I sense the notable confidence on the growth into 2025. Can you just kind of quantify for us how much has really just returned to normal versus new EBITDA from renewables contributions? And then when you consider things like Brazil rolling off, do you still expect that renewable segment to grow year-over-year?"
},
{
"speaker": "Andres Gluski",
"content": "Yes. Look, that's a very good question. We aren't giving guidance for 2025 at this time. But you're right, what you really have is mean reversion. You were really coming back to sort of more normal year. 2024 is a year that we've never had before, the sort of combination of extreme floods and extreme droughts in some of our service territories, largely driven by El Nino, coming into La Nina, we expect a return to normal. But you also correctly point out that we're maintaining all of our guidance and our long-term growth rates without Brazil. And so that means that the other sectors are picking up. So, to the extent that I can say we expect next year to be a more normal year and we've absorbed the sale of Brazil by increasing the growth rates, especially in U.S. renewables and U.S. utilities."
},
{
"speaker": "Stephen Coughlin",
"content": "Hi, Nick. It's Steve. I would just add. We've added and will add a total of 3 gigawatts of new renewables this year across the portfolio. So in addition to some more normalization, like La Nina coming in South America, the installed base is going to be significantly higher. So that's part of it. Renewables segment will grow significantly. And we also have outside the renewables, we have the utilities growth. So, with a full year of new rates in Indiana and continued rate base growth in Ohio."
},
{
"speaker": "Nicholas Campanella",
"content": "That makes sense. Thanks for answering my question and see you soon."
},
{
"speaker": "Operator",
"content": "Thank you, Nick. Our next question comes from the line of David Arcaro with Morgan Stanley. David your line is now open."
},
{
"speaker": "David Arcaro",
"content": "Hi. Thanks so much. Good morning. I was wondering if you could elaborate on the outperformance you had in tax credits that you received. You referenced the $200 million higher-than-expected tax credits. Wondering what that stemmed from? And is there an opportunity for any more outperformance from here?"
},
{
"speaker": "Steve Coughlin",
"content": "Dave, it's Steve. Definitely been a very good year. Look this is I would say, a very core competency for us and a key differentiator. We have I think the strongest tax team and renewables finance team there is. We're always looking to ensure that we maximize the tax value opportunity because what does that do? It reduces our capital requirements and also increases returns. So we've had a good year. We've done a number of things to ensure we qualify for bonuses, including places where there's a brownfield at or -- that allows us to qualify for the energy community. These are sites that were formerly, say, agricultural sites that had, had different materials, chemicals applied that allowed them to qualify. So we've done a lot of research and digging to justify adders where we can. So the other thing we're doing is all tax credits are not created equal. So because of our track record, people tend to come to us, expect -- and we get less of a discount and we get people very focused on working with us. So I would say monetizing through transfers, we've had a lot of success and transfers do tend to get recognized a little earlier than through the tax equity partnerships the credit value. So that's part of it as well. So I do see this as potential upside in the future. But of course, there's other things going on in the portfolio. We have to take a holistic look. And when we give guidance in '25, we'll update you guys on the entire portfolio."
},
{
"speaker": "David Arcaro",
"content": "Okay. Got it. That's helpful. Good to see just chipping away at the financing need with that. And then wondering if you could just touch on what renewable returns have been on the incremental projects that you've been signing, I guess, since raising your return expectations earlier in the year, how those return levels have been trending? Has there been continued momentum upwards?"
},
{
"speaker": "Andres Gluski",
"content": "Well, we're seeing good returns from our projects, and we continue to see a market that values what we bring to our customers. So the answer to that is yes, that we continue to see -- our newer projects have been within that range towards the upper end of that range. So we feel very confident in the numbers that we've provided."
},
{
"speaker": "David Arcaro",
"content": "Okay got it. Appreciate it. Thanks so much."
},
{
"speaker": "Andres Gluski",
"content": "Thanks, David."
},
{
"speaker": "Operator",
"content": "Thank you, David. Our next question comes from the line of Durgesh Chopra with Evercore ISI. Durgesh your line is open."
},
{
"speaker": "Durgesh Chopra",
"content": "Hi. Thank you. Good morning team thanks for taking my question. Just wanted to start off with the actual portfolio that is going to come online, not from the guidance. But in terms of the 2.8 gigawatts that's coming online this year, should we expect an uptick in that number as we go into 2025, the actual construction and getting projects online?"
},
{
"speaker": "Steve Coughlin",
"content": "Yes. So this is Steve. So we'll give that guidance in February. So there's a number of moving pieces here. I would say the largest inflection will be beyond 2025, Durgesh. And so I expect renewables will be up somewhat. But I think based on what our COD schedules look like, the largest increases will come in '26 and '27."
},
{
"speaker": "Durgesh Chopra",
"content": "Got it. Okay. That's very helpful. That's just project timing. Okay. I have two other questions. First, on the hydrogen project with APD, there may have been some changes there, with the activist involvement with the company. Just can you update us what your plan is there? How much capital might you have invested to date? And what do we do with those gigawatts coming online? Just anything you can share there, that would be helpful."
},
{
"speaker": "Andres Gluski",
"content": "Sure. No, I appreciate the question. Look we have developed a very attractive 1.5 gigawatts of renewables which, as you know, there is a market that there's a shortage of large advanced renewable projects. So we have to see when 45 V comes out and other things, how much of this goes to hydrogen. But in any case, we have a very attractive asset there. Regarding outside of the states, I do see those projects likely going forward with Asian buyers stepping up and as partners in the early part of it. So we don't have a lot of money invested other than development money that we've done. However, I think that this is probably some of the best pipeline development that we've done because it's a particularly attractive asset."
},
{
"speaker": "Durgesh Chopra",
"content": "Got it, Andres. That's very helpful. And this is part of the backlog that you show, right? The -- I believe that number is 12 now. Is that the 1.5 gig that's included in the 12?"
},
{
"speaker": "Andres Gluski",
"content": "No, no. We only include in our backlog, that's which is signed or awarded at the very final stage. We've never taken any project out of our backlog really. Nothing but -- so we wouldn't include it until we have a signed PPA."
},
{
"speaker": "Durgesh Chopra",
"content": "Understood. Okay. Very clear. And then one final question, sorry for dragging for this long. Steve, just on Moody's basis, earlier in the year, we've had conversations on the methodology -- potentially a methodology change at Moody's. Maybe just update us on where you stand on Moody's basis and the latest conversations you've had with the credit rating agency?"
},
{
"speaker": "Steve Coughlin",
"content": "Sure, Durgesh. So the dialogue continues. I do expect that they will publish an update before year-end. I characterize the conversation continuing to be very constructive. I hate to see that our credit quality has indeed improved since they gave us the initial upgrade a few years back. What's the reality here is that we've been really transforming the portfolio, exiting markets, exiting carbon-intensive assets and rotating capital into long duration, U.S. dollar, high creditworthy counter-parties with no fuel exposure. So we have a very, very attractive profile. I think what they're working through since Moody's looks at AES on a consolidated basis, as opposed to S&P and Fitch, which is at the parent recourse level only, they're looking at the project finance structures and how they take account of those. Project finance is amortizing when we put debt on our projects, it amortizes over the life of the contract, so there's not an exposed levered tail there. So it's a low-risk structure. It's actually investment-grade-rated debt at the project level. So it's an attractive structure, it just hasn't fit within the well within the way they define their thresholds. So they're looking at that. They're also looking at how -- given our high growth, we carry a fairly material amount of construction debt, and that's not yet yielding. And so they're looking at that in ways to recognize that there is cash flow pending that's certain. And of course, this is nonrecourse debt as well that they're looking for adjustments along those lines as well. So I feel good about where we are. I feel really good about the conversations. And I do expect there'll be sharing their view here before the end of the year."
},
{
"speaker": "Andres Gluski",
"content": "I would add that if you think of the sort of the big picture overall, we continue to improve our credit profile. So we exited Brazil which was a substantial amount of our FX, certainly a big part of our foreign interest rate exposure and weather-related exposures we learned this year. So as we shut down coal plants or sell coal plants, you're changing 2-year PPAs with fuel risk for really long-term 20-year PPAs with no fuel risk with investment-grade off-takers in the U.S. So I feel very confident that any credit rating agency looking at overall company, where we are today versus where they gave us the ratings a year or 2 ago is a substantially better company."
},
{
"speaker": "Durgesh Chopra",
"content": "Got it. Really appreciate that color guys. Thank you."
},
{
"speaker": "Andres Gluski",
"content": "Thank you, Durgesh."
},
{
"speaker": "Operator",
"content": "Thank you, Durgesh. Our next question comes from the line of Julien Dumoulin-Smith with Jefferies. Julien, your line is open."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Hi, good morning team. Thank you guys very much for the time. I appreciate it. Can you guys hear me?"
},
{
"speaker": "Andres Gluski",
"content": "Yes, Julien very well."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Thanks you, Andres. Excellent. Well, actually since we're talking on the credit here, just to kick off on the nuance, just where do you see your metrics getting here and then more specifically, do you anticipate needing to upsize the asset sales or accelerate the asset sale target to kind of true up the balance sheet for any reason here? I get the Moody's methodology is in flux, but as you think about the asset sale piece of this, any observations to make on that front since we were focused on in the second year?"
},
{
"speaker": "Steve Coughlin",
"content": "No, certainly. So I mean the credit metrics remain strong at the parent level. And actually, things that we've been doing are quite credit accretive. So some of the largest things we've done here now just closing on Brazil. Brazil, while it was generating a significant amount of EBITDA in the Renewable segment was actually producing very, very little cash. The business is highly levered and so the sale is actually very credit accretive. Similarly, with the Ohio sell-down when that closes next year, we're going to be paying down a tranche debt that's due at the holdco over 400 million. So we see that as also credit accretive and that we do, in fact, expect as a result of the transaction Ohio will be able to start paying dividends at least a year sooner than it otherwise would have. So we really feel good about the trajectory. I would expect at the end of this year, the parent level metrics will be between 22% and 23% which are well above the threshold of 20% that we have. And so yes, no, Julien, I think the asset sale program, we've had a lot of success, targeted 3.5. The universe is, in fact, bigger. So we'll see what makes sense going into the future. But I see us having a lot of runway here and that the credit metric has actually, in fact, been supported by the asset sale program."
},
{
"speaker": "Andres Gluski",
"content": "I'd like to sort of also say that we've always exceeded our asset sale program targets. And I would also say, quite frankly, I think we have a very good record of selling assets at good value. And what we've always been doing is maximizing the value for our shareholders and not just doing asset sales to hit a certain, let's say, megawatt or generation composition target."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "No. Fair enough, guys and thank you for that. Let me pivot real quickly to Palco here. We saw your peers to the north with NIPSCO. NiSource gave a very robust update. You guys are talking about 3 gigawatts of procurement activity. I know you guys already had a team's trajectory articulated at the Analyst Day last year, but I suspect that number is potentially meaningfully higher or potentially extend it out for meaningfully greater duration given A the 3 gigawatts and B the baseline of the rate base at Palco here. If you can speak a little bit to what your expectations on what total portion that you can own and how it impacts your financials here?"
},
{
"speaker": "Steve Coughlin",
"content": "Okay. So look, I mean the rate case this year was resolved early settled early and approved early. So we had a significant increase over $70 million annual increase. And so that is driving a significant year-over-year. We'll have a full year of the new rates next year. And then as Andres described in his comments, we're once RFP for a lot of new generation in the utility. It will go into the integrated resource plan to be filed next year. And we're talking -- I think we said in the last call, 3 gigawatts total and that's increasing of data center load across the utilities, in addition to what we've already signed. So there's a -- I would say what we guided to is double-digit rate base growth across the utilities. It's going to be much higher than that. So we'll give more guidance in '25, Julien, but -- given what we're seeing the utility investment is going to increase, the returns are going to increase, the rate base will increase. And that's also part of why we also sold down Ohio because although we're selling down 30%, in fact, our net investment in the utilities is increasing. So this sell-down is allowing us to improve credit, get to earlier distributions from the utility, it will improve the credit quality in Ohio and it helps fund a much bigger investment program than even we anticipated a year ago. And our net investment, even though we're at 70% ownership in both utilities it’s going to be even higher. So that's how I would look at it. And of course, in Indiana, it's an integrated utility. So not only do we have the load on the network, but we also have the generation piece to supply as well. So we see a lot of generation growth."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Right. So even the medium-term rate base growth CAGR, it could potentially be heading higher is what I'm hearing. But actually, you made allusion to one thing here, if I can just clarify. You'll be providing an updated outlook here on the fourth quarter. And I know that there's a lot of different things that are moving around in the plan. So as you guys have done historically, expect that kind of integrated update here on 4Q roll forward from the Analyst Day?"
},
{
"speaker": "Steve Coughlin",
"content": "Yes, absolutely. Yes, we will update you on our long term for -- in February."
},
{
"speaker": "Julien Dumoulin-Smith",
"content": "Wonderful. Excellent, guys. Thank you for the time. Appreciate it."
},
{
"speaker": "Steve Coughlin",
"content": "Thanks Julien."
},
{
"speaker": "Operator",
"content": "Thank you, Julien. Our next question comes from the line of Angie Storozynski with Seaport. Angie your line is open."
},
{
"speaker": "Angie Storozynski",
"content": "Thank you for taking my question. So I just wanted to focus on the renewable power EBITDA. So the one without credits for cash EBITDA, I would call it. So I'm looking at these results. I mean you will be basically flat since 2022. And now it looks like 2025 is going to be also like 620, 630 range. So I mean I understand that there are one-off items that weighed on this year's EBITDA which is going to be even lower than the number I just mentioned. So I mean there has to be some growth in that number. And I hear you, Steve, that there will be some in '26, '27, but you're making very substantial investments and we're not seeing growth in that cash renewable EBITDA. Now the reason I'm actually asking about it is because if you look at the parent free cash flow, parent distributions, I mean the vast majority of them come from energy infrastructure, but that's a segment that is shrinking. So I will have to rely on cash distributions from renewables very soon in order to hit the free cash flow expectations. So I'm just hoping that we can reconcile this. Thanks."
},
{
"speaker": "Andres Gluski",
"content": "Yes. First, we're not saying that the renewable EBITDA will grow substantially in 2025. And what you have is the fact that we're selling Brazil. That's 5 gigawatts, so -- which are having a little bit of apples and oranges here. So we're seeing the operating results from our renewable build, absolutely in where we think it should be. So it is -- there's a number of things going on here, Angie, that we can -- time will clarify. But I don't think that it's -- you can say that we're not getting the results from the investments that we're making. It's just moving. And then second, on the energy infrastructure, yes, I mean, we have a balanced portfolio. So we tend to have that event in one spot, offset by good events in the other. And this was a particular quarter where really a lot of things came together that normally don't come together. So normally, if you have conditions, you have more win. This time we had both. But what we also had was sort of all the years rain came in a very short period of time and damage of 1 gigawatt hydro, so I think we really did have sort of onetime events, and I think you're drawing sort of longer-term conclusions from that. I'll pass it to Steve."
},
{
"speaker": "Steve Coughlin",
"content": "Yes. I would just say, Angie, the only reason we're down year-over-year is because of the record drought. The only material reason is because of the record drought, primarily Colombia and to a degree, Brazil as well. So those conditions are known to be changing, moving to La Nina. Obviously, Brazil is out of the portfolio. So Colombia, we do expect returning to much more normal conditions next year. And don't forget, we also had an extremely high third quarter last year in Colombia, unusually high. So it makes the year-over-year comparison look more extreme. But what's the reality is the U.S. growth is significant. And so this year and even higher into next year, more than overcoming the loss of Brazil from the renewables segment. So the renewables growth will be very material this year. So we get that we're not on track at this point with the guidance for -- if you were to straight line the guidance, but we're picking up substantially into next year and are reaffirming through 2027 that 19% to 21% growth rate, and that's largely driven by all of this U.S. growth, which is taking off. As I said, we have added a total of 3 gigawatts of renewables across the across the year since Q3 of last year. We also will ultimately move Chile into the renewable segment where it belongs as we execute on our coal exit. So the cash from this renewable segment will grow accordingly as well, and the EBITDA will be on track with that growth rate."
},
{
"speaker": "Angie Storozynski",
"content": "Okay. So let me just push back the latter, meaning that Chile was supposed to be additive to the growth trajectory that you were showing at the Analyst Day. And now that we see the results, like year-over-year changes versus '23 results, you clearly point out that the second half of '23 had some big onetime benefits, which you could not have counted on during your '23 Analyst Day, and yet you came below your expectations, even the low end on renewables EBITDA for '23.So again, I mean I hear you that there is growth in the U.S. portfolio, which will benefit the EBITDA, but again, I mean, you had some big positives in the second half of '23, which you could not have expected when you were giving guidance on '23 on renewables and you came below expectations on renewables in '23 now. So why should I have conviction that the same is not going to true in future years?"
},
{
"speaker": "Andres Gluski",
"content": "Well, we feel confident we're going to hit the long-range growth that we talked about. I mean it has to do with reaching critical mass on some of these things. And certainly, we can have onetime weather events. But I think the important thing is what returns are you actually seeing from the projects you're bringing online? What is the value of the PPAs you are signing? And as we move forward, it will be easier to make apples-and-apples comparisons as we have the same portfolio new year."
},
{
"speaker": "Steve Coughlin",
"content": "Yes. The other thing I would say, Angie, is referring to last year, we did end up having more of our commissionings very late in the year, in fact, most in December. So a little later than expected this year. We have substantially changed that trend. And so the renewable commissionings were much more really spread throughout the year. That's why we've already recognized $900 million of tax attributes already. So I think that's another reason that, that program has become more mature and spread throughout the year that we're seeing a better result, and that ‘23 was lower."
},
{
"speaker": "Angie Storozynski",
"content": "And just one other question. So I'm looking at your guidance here on the free cash flow for the parent for the year. It seems like you are expecting about $1.5 billion to $1.6 billion in distributions from subsidiary and you are at about 800, 880, I forget. So is this apples-to-apples, meaning that I am basically 50% of distributions, meaning that the fourth quarter will be the big catch-up on distributions?"
},
{
"speaker": "Steve Coughlin",
"content": "Yes, but that's a normal trend. So that's -- we've been having that type of seasonality for a long time. And I would say, in most cases, the cash is already sitting there. It's based on the windows in time relative to our debt service that we're also allowed to pay dividends. So we have clear visibility into the remaining dividend. It's just a matter of timing at this point as to when they get released on the periodic twice a year, once a year in some cases. So I'm very, very confident in the distribution level."
},
{
"speaker": "Angie Storozynski",
"content": "Okay. Thank you."
},
{
"speaker": "Steve Coughlin",
"content": "Thank you, Angie."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Michael Sullivan with Wolfe Research. Michael your line is now open."
},
{
"speaker": "Michael Sullivan",
"content": "Hi. Good morning."
},
{
"speaker": "Steve Coughlin",
"content": "Good morning, Michael."
},
{
"speaker": "Michael Sullivan",
"content": "Yes, just -- I know that kind of got passed through a bunch there on the last line of questions or commentary, I guess. Just to make it simple, like you keep talking about significant growth in '25. We obviously don't know what that means exactly. But you have this 5% to 7% EBITDA CAGR off of '23. When do you get inside of that within your plan?"
},
{
"speaker": "Steve Coughlin",
"content": "Yes. So again, we'll give an update in February. The early years as we have been executing on the transformation and things like the Brazil exit, we'll have the Vietnam exit next year. We had the Warrior Run shutdown, and so that goes away. So that weighs on the early years, but the trajectory, as I said, there's more of an inflection point beyond next year, overall, getting through the 2027. Period. So what's happening is that the renewables will grow significantly next year. The utilities will grow significantly, catching back up to closer to that level of return of growth that we've been expecting, but the energy infrastructure shrinking has been a little more front-end loaded. And then the Brazil sale, obviously, is a headwind in renewables in the near term, but we're more -- significantly more than offsetting it next year. So that's how I would characterize it. We feel good about the growth rate overall, but it's influenced by how we execute on the transformation as well as the growth, and the transformation shows up in the shrinking of the energy infrastructure. So that's how I would characterize it. And so we'll give more in February. But again, I feel really good about the renewables and the utilities. And then the energy infrastructure we’ll look at choices we have around how fast to continue the transformation and discuss that in February."
},
{
"speaker": "Michael Sullivan",
"content": "Okay. That's very helpful, Steve. And then I had 2 ones just on your resource additions. The first, just in terms of looking at new gas at the utility, do you see that in the RFP? Or is that not until the IRP? And do you have a good handle on how much you could look to be doing in gas? And then on the nonutility side, you all have traditionally been pretty solar heavy though I think you mentioned wind a few times just in terms of supply chain. But when I look at you and your peers, it doesn't seem like anyone's adding too much wind these days. So just curious what you're seeing on that front?"
},
{
"speaker": "Andres Gluski",
"content": "Yes. On your first question, that would be really waiting for the IRP. So we certainly are looking at all options. So it will be likely a mix of renewables and some thermal, of course, batteries as well. Now regarding the second question in wind. Well, we were -- we had been building quite a lot of wind in Brazil. But a lot of the projects that we have in the pipeline have a considerable amount of wind. So if you think of the -- what's been known as sort of the green hydrogen project in Texas, 1.5 giga, that's primarily wind. So we'll have a more of a balance in the U.S. between wind and solar in future years."
},
{
"speaker": "Michael Sullivan",
"content": "Okay. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you, Michael. Our next question comes from the line of Ryan Levine with Citi. Ryan your lines are open."
},
{
"speaker": "Ryan Levine",
"content": "Good morning, and thanks for taking my question. What is the time line for the $92 million Colombia impact to return to historic norms? And what is the risk to achieving this ramp at this stage in the year?"
},
{
"speaker": "Steve Coughlin",
"content": "Yes. So conditions are already improving. The fourth quarter, in fact, I expect will be higher in Colombia than last year, Ryan. And all forecasts point to La Nina being highly probable over the next couple of months and lasting well into next year. So it's pretty much turning around now. Again, I expect the fourth quarter to be higher. And then throughout next year, I expect Colombia to be higher in this year overall. So Colombia has been -- and it was $92 million in the quarter alone. It's $130 million down year-to-date over prior year. So that is the single largest driver here, and it shows up in the Renewables segment. But the U.S. growth is doing hard work to offset that and significantly overcome overcomes it in the fourth quarter here and into next year."
},
{
"speaker": "Andres Gluski",
"content": "Yes. I would add we had a two-month outage. Yes. So the truth is that outage was at the worst possible time because if we hadn't had the outage because we had a rain, which was 25% higher than anything prior previously recorded, we could have used that water to very good results subsequently in the drought. So being out for two months is -- that's part of the recovery."
},
{
"speaker": "Ryan Levine",
"content": "Okay. So then by 2026, you should be back to a more normal performance?"
},
{
"speaker": "Steve Coughlin",
"content": "No, '25, Ryan. So the conditions are already improving. We expect this quarter, fourth quarter to be higher than last year. And next year, in 2025, we expect normal to better hydrology from the La Nina."
},
{
"speaker": "Ryan Levine",
"content": "Okay. And then maybe switching gears, as you referenced in your prepared comments, impact to California spark spreads, are you looking to change your hedging strategy there? Or any color you could share around the outlook going forward for the Southland?"
},
{
"speaker": "Steve Coughlin",
"content": "Yes. So just -- as a reminder, the Southland structure has a 20-year contract for capacity and energy. So we have a very known monetization stream. It is at our election annually a year in advance to decide whether we want to market the energy ourselves and hedge it or put it to the uptake or under the PPA. So for '24 we did previously decide, at the end of '22, to call the energy to us and to market it. Unfortunately, spark spreads changed significantly during the time that we made that decision, and we're executing on the hedge program. And so we had downtime this year. But still relative to the put value, still a good decision. And so we have made that decision also for 2025 that we will market the energy. We are over 95% hedged already at values well in excess of the put value. So it -- the market has changed. The market has compressed a lot due to better hydro conditions. What we've had is milder weather. There's been a lot more battery penetration in California. So the market value is not as high over the long term as it had been back in '22 when we first made that decision. But nonetheless, we see, overall, the strategy is -- has been increasing or has added over the put is just not as much as we expected when we gave the guidance, unfortunately."
},
{
"speaker": "Ryan Levine",
"content": "So, then as a follow-up, given that framework and your decisions for next year, is there any color around -- any direction of travel for that asset's performance for '25 given what your parties decided?"
},
{
"speaker": "Steve Coughlin",
"content": "Yes. I would say, at this point, since we've already decided on '25, it is in excess of the put value. And we're already nearly 100% hedged, 95% hedged, as I said. So it the value is lower than it was in the original guidance, but still above had we taken a no-risk strategy. And then for 2026, we have not yet made that decision. And we'll have to here later in the fourth quarter, and we'll update you all on that later. And that will be based just upon what we see in the hedge market at the time relative to the put value."
},
{
"speaker": "Ryan Levine",
"content": "Thanks for taking my question."
},
{
"speaker": "Operator",
"content": "Thank you. Ryan. Our next question is from the line of Richard Sunderland with JPMorgan. Richard, your line is open."
},
{
"speaker": "Richard Sunderland",
"content": "Thanks for the time. I know you've covered a lot of ground. Just one quick cleanup. You've talked at various points about asset sale program and how you've thought about timing that and affecting that it sounds like more to come on year-end around that. But just curious how you're thinking about monetizing the new energy technologies investments? And if that's something that should fall within the planned period? Any thoughts there."
},
{
"speaker": "Andres Gluski",
"content": "When you think about the new energy technologies, look, what we've talked about is through 2027. And we approached these strategically. So what we've always said is that we will monetize these assets when we feel it's appropriate. And when we are out of long-term venture capitalist investors. So we'll monetize them at the right time when we don't think we're adding a lot of value. And we've already done some monetization and taking some money off the table. So it's been a very successful program. And I think there's a lot more value there than is being recognized by most of the parts. But what I would say is that so long as we add a lot of value, we'll stay in. However, we'll continue to opportunistically monetize. And certainly, we're well ahead of our plan for 2027. But as Steve mentioned, the universe is greater. So it would include some things from new energy technologies."
},
{
"speaker": "Richard Sunderland",
"content": "Great, thank you."
},
{
"speaker": "Operator",
"content": "Thank you, Richard. There are no additional questions waiting at this time. So I'll turn the call back over to Susan Harcourt for closing remarks."
},
{
"speaker": "Susan Harcourt",
"content": "We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. We look forward to seeing many of you at the EEI Financial Conference later this month. Thank you, and have a nice day."
},
{
"speaker": "Operator",
"content": "That concludes today's conference call. Thank you for your participation. I hope you have a wonderful rest of your day."
}
] |
aes | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Hello, everyone, and a warm welcome to the AES Corporation Q2 2024 Financial Review Call. My name is Emily, and I'll be coordinating your call today. [Operator Instructions] I will now hand over to our host, Vice President of Investor Relations, Susan Harcourt, to begin. Susan, please go ahead."
},
{
"speaker": "Susan Harcourt",
"content": "Thank you, Operator. Good morning and welcome to our second quarter 2024 financial review call. Our press release, presentation, and related financial information are available on our website at aes.com. Today we will be making forward-looking statements. There are many factors that may cause future results to differ materially from these statements which are disclosed in our most recent 10-K and 10-Q filed with the SEC. Reconciliations between GAAP and non-GAAP financial measures can be found on our website along with the presentation. Joining me this morning are Andres Gluski, our President and Chief Executive Officer; Steve Coughlin, our Chief Financial Officer, and other senior members of our management team. With that, I will turn the call over to Andres."
},
{
"speaker": "Andres Gluski",
"content": "Good morning, everyone, and thank you for joining our second quarter 2024 financial review call. We are very pleased with financial performance so far this year. Today, I will discuss our results, the significant advancements we've made with large technology customers, and the work we are doing to incorporate generative AI in our portfolio to develop new competitive advantages. Beginning on slide three, with our second quarter results, we had a strong second quarter that was in line with our expectations, with adjusted EBITDA with tax attributes of $843 million, adjusted EBITDA of $652 million, and adjusted EPS of $0.38. We are on track to meet our 2024 financial objective, and we now expect to be in the top-half of our ranges for adjusted EBITDA with tax attributes and adjusted EPS. We are also reaffirming our remaining 2024 guidance metrics and growth rate to 2027. Steve Coughlin, our CFO, will give more detail on our financial performance and outlook. I'm also pleased to report that, since our last call in May, we have signed 2.5 gigawatts of new agreements in total, including 2.2 gigawatts with hyperscalers across our Utilities and Renewal businesses. This includes 1.2 gigawatts of new datacenter load growth across AES Ohio and AES Indiana. A PPA to provide 727 megawatts of new renewables in Texas, and a 310 megawatt retail supply agreement in Ohio. With these arrangements, we are expanding our work with the major datacenter providers to new areas of business. Turning now to datacenter growth at our U.S. utilities, on slide four, since our last call, we have signed agreements to support 1.2 gigawatt of new load across AES Ohio and AES Indiana, expected to come online in phases, beginning in 2026. Additionally, we're in advanced negotiations across several sites to support another 3 gigawatts of new load. These agreements are transformative for both utilities, with the potential to increase the peak load at both AES Ohio and AES Indiana by more than 50%. As a result, AES Ohio's rate base will consist predominantly of FERC-regulated transmission assets, receiving timely recovery through a formula rate. For AES Indiana, this growth creates the potential for significant investment in transmission, as well as additional build-out of new-generation assets. These opportunities will even further increase our industry-leading U.S. utility rate base growth plans. Our service territories are particularly well-positioned to serve datacenters and other large loads with available interconnection, lower rates, and land prices, access to water resources and local incentives. Turning to slide five, and the generation build-out at AES Indiana, we continue to make progress in upgrading and transforming our generation fleet as we shutdown or convert our coal units to gas, and build our renewable fleet. I am pleased to announce that we have signed a deal to acquire 170 megawatt solar plus storage development project that AES Indiana will construct and own. The project will require approximately $350 million of CapEx, with an expected completion date in late 2027. Once approved by the Indiana Utility Regulatory Commission, this will be the sixth project supporting AES Indiana's recent generation growth. Now turning to our Renewables business on slide six, since our last all in may, we have further expanded our partnership with Google, signing a 15-year PPA for 727 megawatts in Texas to power its datacenter growth. The agreement includes a combination of wind and solar to further Google's 24-7 carbon-free energy goals. These projects are expected to come online in 2026 and 2027. We also recently signed a retail supply agreement with Google for 310 megawatts to support their Ohio datacenters. This agreement demonstrates the strong trust and collaboration between our companies, which began with our original 2021 partnership to provide 24-7 renewable power in Virginia. We see further opportunities to add renewables to support Google's datacenter growth in Ohio. Turning to slide seven, with these major announcements today on our collaborations with hyperscalers, we have now signed a total of 8.1 gigawatts directly with technology companies, which is clearly a leading market position. As you can see on slide eight, our backlog of projects under signed long-term contracts now stands at 12.6 gigawatts. Our focus remains on maximizing the quality of megawatts over the quantity, which means delivering high-quality projects with higher returns and long-duration PPAs. We have never felt better about our key customer relationships, the long-term market dynamics that are supporting growth and value creation in our portfolio. Turning to slide nine, the demand for power that is coming from the rise in generative AI in datacenters, represents a significant structural change in the Power segment, and no one is better positioned than AES for sustained growth from this opportunity. Regardless of election or policy outcomes, we are confident in our ability to continue signing renewable PPAs with mid-teen IRRs. Our corporate customers value our unique record of bringing projects online on time over the past five years. Furthermore, looking at the interconnection queues, time to power and price certainty, we see renewables as the only source of new power that can meet most of the demand over the next decade. AES has a longstanding and deep relationship with hyperscaler customers. This includes our ability to co-create new offerings and structure innovative clean energy solutions, such as hybrid PPAs, shaped products, and 24/7 renewables. As you can see on slide 10, of the 3.6 gigawatts that we expect to bring online this year, we have already completed the construction of 1.6 gigawatts and expect the remainder to be weighted towards the third quarter. I should note that for the projects coming online this year, we have all of the major equipment already on site in almost all for 2025. Additionally, we expect a significant portion of our solar panels to be domestically produced beginning in 2026. All of the above combined with having panels on site for 2025 projects, greatly mitigates our exposure to any potential new tariffs. Our diversified and resilient supply chain has been and will continue to be best-in-class. Finally, turning to slide 11, not only is generative AI shaping the customer landscape, but it is also transforming how we work internally, providing new opportunities for efficiencies, customer service and innovation that will give us new competitive advantages. As you may have seen, in June, we announced a partnership with AI Fund to accelerate AI-driven energy solutions. Founded by AI leader, Andrew Ng, AI Fund is a venture studio that works with entrepreneurs to rapidly build companies. We are collaborating with AI Fund on co-building companies that leverage AI to address bottlenecks and improve efficiencies in the energy transition in areas such as developing and operating renewables and asset management. At the same time, we continue to leverage AI across our portfolio with our culture of innovation and continuous improvement. We are increasingly using proprietary tools across a wide range of our business operations, enabling our people to work faster and smarter. For example, our renewables team has built sophisticated tools that utilize generative AI to accurately predict the speed at which projects will move through interconnection queues, helping us more efficiently coordinate the various simultaneous development processes. As you can see on slide 12, earlier this week, we launched the world's first AI-powered solar installation robot, Maximo, which uses state-of-the-art AI and robotics to complement our construction crews in the installation of solar modules. Maximo enables faster construction times and reduces overall project costs. It can work three shifts, even in the worst weather conditions, with a more inclusive workforce. Not only does it reduce time to power, which is highly valued by our customers, but it will boost overall project returns. We plan to ramp up our use of Maximo in 2025 and are already utilizing it to construct a portion of our two gigawatt Bellefield project in California, which is the largest solar plus storage project in the U.S. and is contracted to serve Amazon. With that, I would now like to turn the call over to our CFO, Steve Coughlin."
},
{
"speaker": "Steve Coughlin",
"content": "Thank you, Andres, and good morning, everyone. Today, I will discuss our second quarter results and our 2024 guidance and parent capital allocation. Turning to slide 14, adjusted EBITDA with tax attributes was $843 million in the second quarter versus $607 million a year ago. This was driven by growth in our renewables SBU, new rates and growth investments in our U.S. utilities, and higher margins in our energy infrastructure SBU. Turning to slide 15, adjusted EPS for the quarter was $0.38 versus $0.21 cents last year. Drivers were similar to those of adjusted with tax attributes, but partially offset by higher depreciation and higher interest expense as a result of our growth. I'll cover the performance of our SBUs or Strategic Business Units on the next four slides. Beginning with our renewables SBU on slide 16, higher EBITDA with tax attributes was driven primarily by contributions from new projects, but was partially offset by lower availability from a forced outage event at our 1 gigawatt Chivor hydroplant in Columbia. The outage was caused by record water inflows in early June, which brought significant sediment into the plant and damaged the units. Repairs of the plant were completed quickly and all units resumed operations by mid July. Higher adjusted PTC at our utilities SBU was mostly driven by higher revenues from the $1.6 billion we invested in our rate base in the past year, new rates implemented in Indiana in May, year-over-year low growth of 3.1% as well as favorable weather. Higher EBITDA at our energy infrastructure SBU primarily reflects higher revenues recognized from the accelerated monetization of the PPA at our Warrior Run plant and higher margins in Chile. Partially offset by lower margins in the Dominican Republic and the sell-down of our gas and LNG businesses in Panama and the Dominican Republic. Finally, relatively flat EBITDA at our new energy technologies SBU reflects our continued development of early stage technology businesses. Partially offset by continued margin increases at Fluence. Now turning to our expectations on slide 20, as a result of our strong first-half performance and high confidence in a strong second-half, I am very happy to share that we now expect adjusted EBITDA with tax attribute to be in the top half of our 2024 expected range of $3.6 billion to $4 billion. Drivers of adjusted EBITDA with tax attributes in the year ago include higher contribution from new renewable commissioning, contributions from growth investment, and expected higher load at our U.S. utilities. Partially offset by expected closings in our asset sale program. Turning to slide 21, I am also very glad to share that we now expect our 2024 adjusted EPS to be in the upper half of our guidance range of $1.87 to $1.97. We increased our share of earnings in the first-half of the year from 25% in 2023 to nearly half in 2024. Growth in the year to go will have similar drivers as adjusted EBITDA with tax attributes. Partially offset by higher interest expense from growth capital. Now to our 2024 parent capital allocation on slide 22, sources reflect approximately $3 billion of total discretionary cash including $1.1 billion of parent free cash flow, $900 million to $1.1 billion of proceeds from asset sales, and $950 million of hybrid debt that we issued since our last earnings call in May. On the right-hand side, you can see our planned use of capital. We will return approximately $500 million to shareholders this year, reflecting the previously announced 4% dividend increase. We also plan to invest $2.4 billion to $2.7 billion towards new growth. Of which, 85% will go to renewable and utility. Turning to slide 23, we are well on our way to towards achieving our long-term asset sale target of $3.5 billion from 2023 through 2027. We signed or closed more than $2.2 billion of asset sales since the beginning of last year. And we are now nearly two-thirds of the way to reaching our target even though we are only 1.5 years into our five-year guidance period. We do not announce specific asset sales in advance. But the remaining proceeds could come from sell-downs of renewables projects, our intended coal exist, monetization of our new energy technologies businesses, and sales or sell-down of other noncore assets. In summary, we made excellent progress this quarter toward all of our strategic and financial targets. We have clear line of sight towards achieving the key drivers of our year-to-go earnings growth. And we are well-positioned to continue delivering on our financial goals beyond this year. We also made significant headway on our long-term funding plan which allows us continue simplifying and focusing our portfolio while we scale our leading renewables and utilities business. Our strategy to serve high value corporate customers including a rapidly growing base of datacenter providers across our Renewables and Utilities businesses is highly resilient, and will continue to yield financial success for AES and our shareholders. With that, I'll turn the call back over to Andres."
},
{
"speaker": "Andres Gluski",
"content": "Thank you, Steve. Before opening up the call for Q&A, I would like to summarize the highlights from today's call. With more than 8 gigawatts of agreements already signed directly with large technology customers, including 2.2 gigawatts signed since our last call. We continue to be the industry leader in this segment. At the same time, we continue to deliver our projects on time and on budget, with 1.6 gigawatts completed so far this year. We are fully on track to add a total of 3.6 gigawatts by the end of 2024. We see demand for power from datacenters in the U.S. growing around 22% a year. And we could not be better positioned to serve these customers, from our Renewable business to our Utilities. I would like to reiterate that with strong demand for the projects in our 66 gigawatt development pipeline and our existing 12.6 gigawatt backlog of signed long-term PPAs. We are very confident in our ability to continue to meet or exceed our long-term objectives. Operator, please open up the line for question."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Our first question today comes from Durgesh Chopra with Evercore ISI. Durgesh, please go ahead."
},
{
"speaker": "Durgesh Chopra",
"content": "Hey, team, good morning. First off, congrats on a solid quarter and first-half. Too bad the market is [viscose] (ph) today. Maybe just I had one question on the numbers, and then I have just one high-level macro question. First, to Steve, could you update us on credit metrics, where did you end up as of Q2, and then were do you expect to be at the end of 2024 on FFO to debt?"
},
{
"speaker": "Steve Coughlin",
"content": "Yes, sure. Hi, Durgesh, it's good to hear your voice. So, the credit is looking very, very strong. So, we continue to be on a path of improving credit. At the parent level, I expect will be even higher than last year's year-end. And so, it looks very good. There's obviously intra movement in quarters as we have some cash flow lumpiness coming up, but it continues very strong. I think we'll see the year end be even better than last year."
},
{
"speaker": "Durgesh Chopra",
"content": "So, just to be clear there, Steve, I think the target last year was 22%, if I have those numbers right on FFO to debt basis is the S&P methodology. Is that still kind of a good goalpost?"
},
{
"speaker": "Steve Coughlin",
"content": "Yes. So, we have a threshold of 20%. So, you're referring more to, I think, where we ended, which had plenty of cushion above that. And I think we will likely see ourselves even higher than that at the end of this year."
},
{
"speaker": "Durgesh Chopra",
"content": "Okay, perfect. [A lot of] (ph) question on the balance sheet. Okay, then maybe just one election question. Andres, appreciate the commentary in your prepared remarks. But I'm just wondering, obviously a great quarter here. You added to the Utilities, you added on the Renewable side. But I'm just wondering if all the noise around repeal of tax credits and other policy chatter, does that hurt your ability to sign new contracts? Does that come up in your contract negotiation, is that a risk? Maybe just help us sort through that. Thank you."
},
{
"speaker": "Andres Gluski",
"content": "Sure, Durgesh. No, it's not slowing down our signing of contracts. What we really had is a situation that we had, to some extent; foreseen a couple years ago where it's really there's a shortage of renewable power for datacenters in many markets. So, what's the biggest concern of our clients is actually time to power, can you get me the power on time to power datacenters. And that's their main constraint. So, no, there has been anything holding us down or, quite frankly, a major issue of conversation with them. I do think we have to step back and say, \"Look, ITC investment tax credits, production tax credits, they've been around for 32 years.\" Second, there's been a tremendous amount of investment related to the Inflation Reduction Act. And 85% of that investment has gone into republican districts. Today, there are eight million people working directly or indirectly in renewables in the U.S. So, a total dismantling is highly unlikely in any scenario, whether there are some changes around the margin; sure. But thinking about the sector, quite frankly we operate in markets where there are no subsidies. We actually make more money in those subsidies. And it would change somewhat the structure of the contracts. But we see a wholesale revision of this very, very unlikely. Something more likely what happened to NAFTA, where it became the USMCA, and actually was, quite frankly, updated and improved in some areas. So, that's where we se the market right now."
},
{
"speaker": "Durgesh Chopra",
"content": "Got it. [Indiscernible]. Thanks so much for the time, I appreciate it."
},
{
"speaker": "Andres Gluski",
"content": "You're welcome. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Richard Sunderland with J.P. Morgan. Please go ahead."
},
{
"speaker": "Richard Sunderland",
"content": "Hi, good morning, and thank you for the time today."
},
{
"speaker": "Andres Gluski",
"content": "Hi, good morning, Rich."
},
{
"speaker": "Steve Coughlin",
"content": "Hi, Rich."
},
{
"speaker": "Richard Sunderland",
"content": "Starting on the Utility announcements, can you outline the utility load opportunity in terms of the breakdown of that 3 gigawatt in advanced negotiations between Indiana and Ohio, plus how much of that capital could fall into the transmission and generation buckets relative to what's in the plant today?"
},
{
"speaker": "Andres Gluski",
"content": "Okay, look, that's a great question. But we will give you more color on that as time passes, because these are multiple agreements with multiple clients. And we'd really like to see how it shakes out. We're certain that there's going to be a lot of load added, a lot of transmission assets added. But this is between two utilities, between multiple clients. So, right now it's a little bit too early for us to give too much in term of exact load growth by business."
},
{
"speaker": "Steve Coughlin",
"content": "Yes, and just to add to that, Rich, we had previously guided to around 10% up for the utilities combined, this is definitely upside. There's significant acceleration of discussions. So, definitely upside to the plans that we've given in the past. Timing matters here though, so we'll see some within our long-term guidance period, and some beyond that. But we do see a lot more growth than we saw even at the start of this year."
},
{
"speaker": "Richard Sunderland",
"content": "Understood. Thanks for the color there. And then, your language in the slides on maximizing megawatt quality over quantity; that message has certainly been clear. But I'm curious if this is consistent with your raise per turn assumptions, I think that was back in 4Q. Or do you see further upside potential to returns given the supply and demand dynamics currently?"
},
{
"speaker": "Andres Gluski",
"content": "Okay. Basically, I think there's several things. One, when we talk about pipeline, that means we have something in the interconnection queue. And we have some degree of land control. So, I would say not all pipeline were created equal. And when we talk about backlog, that's actually contracts that are signed and that we have to deliver, and people have to buy that energy. So, we've never taken anything material out of our backlog, even during COVID. So, what we're saying here with -- the basic message is, one, yes we increased our average rate of returns on these projects. We're not talking about mid-teens. The other thing is that rather than sign like one umbrella agreement with one particular client, we're optimizing the value of this resource among various clients and among opportunities. So, we see this as something where we invest in, we create this real pipeline. And then, we want to optimize the value from it. Will the average returns go up further? Well, I think it would depend market by market, and the opportunity. But right now, we feel very good about the mid-teen returns that we talked about. And we also feel very good about that we're making the best use of that pipeline to create value for our shareholders."
},
{
"speaker": "Richard Sunderland",
"content": "Great, thank you for the color there. I'll leave it there."
},
{
"speaker": "Andres Gluski",
"content": "Okay. Thanks, Rich."
},
{
"speaker": "Operator",
"content": "The next question comes from Antoine Aurimond with Jefferies. Please go ahead."
},
{
"speaker": "Antoine Aurimond",
"content": "Hey, guys. Hope you're well. Thank you for taking my question."
},
{
"speaker": "Andres Gluski",
"content": "Good morning."
},
{
"speaker": "Antoine Aurimond",
"content": "Good morning. I guess to follow-up on Durgesh on the credit side, how do you frame the prospects of going towards a mid-BBB rating and what would be the timeline, we'll be contemplating?"
},
{
"speaker": "Steve Coughlin",
"content": "Yes. So, as I said, credit metrics are definitely continuing to improve and so I see that as a possibility in a matter of years, not this year, that will be have those metrics. So, we don't have a specific target to share with you at this point, but I expect to be higher than last year and I expect it to continue to improve. As the installed base of our growth continues to grow and add cash. Today, we do carry construction debt that's not yet yielding. But relative to the base, the base is increasing every year significantly in this moment that we are in. So, yes, I think that's very possible, but I don't have a specific date to share with you at this point."
},
{
"speaker": "Andres Gluski",
"content": "One thing I'd like to add, as we exit countries and as we're investing primarily in long-term contracted with investment grade off takers in renewables, or our U.S. utilities, which also with this transformation are moving more towards a transmission rate base. The quality of our cash flow continues to improve. So, it's not only a question of the metrics, which as Steve said are improving, but the quality of that cash flow or how it's seen by credit rating agencies is improving as well. So, on both sides, we feel very good about it."
},
{
"speaker": "Steve Coughlin",
"content": "Yes, and actually, I guess we'll keep going here because I have just that reminds me of another topic really here. Keep in mind that 80% of our debt is nonrecourse to the parent, and nearly all of that is amortizing investment grade rated subsidiary debt. So, it's a very high quality structure, and the agencies are seeing that. So, I think this, both the quantified metrics as I've mentioned as well as Andres said in the quality and looking at the debt structures, amortizing investment grade, it's a very, very robust, healthy structure."
},
{
"speaker": "Antoine Aurimond",
"content": "Got it. Yes, that makes sense guys. I guess on that note, with 85% of the CapEx going towards U.S. based businesses, where do you see the geographical mix trending towards the end of the time period?"
},
{
"speaker": "Steve Coughlin",
"content": "End of the time period, like 2027 you're speaking?"
},
{
"speaker": "Antoine Aurimond",
"content": "Yes, yes."
},
{
"speaker": "Steve Coughlin",
"content": "Okay. Look, I'd say we can I think there's a transformation in terms of, we're moving more towards U.S. dollar based investment grade off takers? So, yes, there's going to be heavier weighting towards the U.S. We do have opportunities to serve the same type of clients outside the U.S., with your investment grade dollar contracts, many times with the same, with the same client. So, if we serve hyperscalers in the U.S. and they want the same services, say, in Chile or in Mexico, then we can service. And that is a competitive advantage we have."
},
{
"speaker": "Antoine Aurimond",
"content": "Got it. Okay. That makes sense. And then, I guess, so you mentioned more sort of quality of megawatt versus this is just volume. We're going to do, what 3.6 gigs this year. How should we think about that number evolving? Assuming it's still going to increase, but I guess you mentioned more quality, right? So what's sort of like that number fast forward a couple years?"
},
{
"speaker": "Andres Gluski",
"content": "Look, when I put it this way, we have a backlog of more than 12 gigawatts of signed PPAs we have to deliver. The majority of that will be within the period of by 2027. So, that gives you -- that that's a guaranteed build out that we have to do over the next three years. So, over time, assuming we're signing somewhere about 4.5, 5.5 gigawatts of new PPAs, those numbers have to converge. Unless, we grow the number of megawatt, PPAs that we're signing, and then it'll take a little bit more time to converge. But given -- that gives you sort of the run rate. Yes. We'll be 4 plus in coming years just from the backlog we have today, and expect that to grow over time past that period of time of 2027."
},
{
"speaker": "Antoine Aurimond",
"content": "Yes, that makes sense. Okay, great. Well, Andres, thank you so much."
},
{
"speaker": "Andres Gluski",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from David Arcaro with Morgan Stanley. Please go ahead."
},
{
"speaker": "David Arcaro",
"content": "Hey, good morning. Thank you. Maybe back on the utility side of things, it's great to see all that load growth opportunity coming. When do you think you'd have an opportunity to relook at the CapEx outlook? And then at a high level, how do you think about financing, upsides in the utility CapEx trajectory?"
},
{
"speaker": "Andres Gluski",
"content": "Yes, hey, David. Good morning. So, as we are looking through the details of the timing of what we've recently signed, we'll flesh that out in our planning process, in the second-half of this year and bake that into our update of guidance for the beginning of next year. So, definitely, I would see in the long-term horizon that we have out there through '27, this will start to come into play in the capital plan, but our funding plan, I don't expect to change at all. We have really done well on our asset sale plan. We are two-thirds of the way through, after only 18 months on a five year plan. We've got a lot of flexibility there. We have partnership capital. So, there is no shortage of capital to invest in the utility growth here. It's a very attractive profile. And so, I see it becoming material, but I see it within the funding plan that we've already released through '27."
},
{
"speaker": "David Arcaro",
"content": "Got it. That's really helpful. Thanks for that. And then, just appreciate the comments on the supply chain outlook on the renewable side. I was just curious if I could get your sense, like how much line of sight do you have right now for that domestic supply in 2026, just as we think about navigating some of the tariffs on solar panels and battery storage? How are you feeling right now in terms of the line of sight for both of those supply chains?"
},
{
"speaker": "Andres Gluski",
"content": "Well, we're feeling very good. And what I would say is, as we've mentioned, we have everything we need for this year, for 2024, and most of you know, vast majority of what we want for 2025. And then, we have signed agreement with domestic suppliers for starting in 2026. So, we feel very good about our ability to execute, deliver on our backlog in the U.S. And I would say that again, to date, we have not had to postpone or abandon any material project in our pipeline over the last five years. So, compared to what happened to supply chains with COVID, this is much more predictable. So, we feel very good about it. And basically, we're again going to make that switch to domestic supply starting in 2026."
},
{
"speaker": "David Arcaro",
"content": "Okay, great, understood. Thanks so much."
},
{
"speaker": "Andres Gluski",
"content": "Thank you."
},
{
"speaker": "Steve Coughlin",
"content": "Thanks, Dave."
},
{
"speaker": "Operator",
"content": "The next question comes from [Feeney Shea] (ph) with Barclays. Please go ahead."
},
{
"speaker": "Unidentified Analyst",
"content": "Hi, good morning. Thanks very much for taking my question. So, I guess just first quickly on renewable execution, really great to see the guidance update in terms of EBITDA with tax attributes. I guess, could you maybe just talk about, given the backlog, the PPA signing cadence, the ability to bring projects online, how does your EBITDA excluding tax attribute would trend, I guess given where it is now year-to-date? Seems a little light, but just wanted to see how should we think about it going deeper into the year? Thanks."
},
{
"speaker": "Steve Coughlin",
"content": "Yes, good morning. Thanks. So, we do have a significant upside in our tax credits as I mentioned in my remarks, primarily that's driven by -- we're qualifying for more energy communities than originally anticipated. And we also have seen the valuation of our tax attributes, particularly through transfers, be valued at a higher level. What's important, as I've always emphasized is that these are cash. It's a very attractive profile. This is not just earnings, but it's cash coming in, which is a very early return of a significant amount of capital 30% up to 50%. So, we're really, really pleased with this upside. There are a few other upsides in EBITDA as well. So, we have had higher margins and higher dispatch in our gas business in the Dominican Republic. We've also continued to drive efficiency and productivity in our renewables and utilities businesses where we're very focused on growth. And in fact, growing those businesses is actually costing less than we anticipated. So, we see favorability in costs going through EBITDA this year. So, as you caught on, there has been an offset to that, and it's what I mentioned in my remarks, which is primarily the Columbia outage. It was a record amount of flooding and inflow that took the units out for all of the month of June and the first part of July. So, that unfortunately did offset and is a negative driver to EBITDA this year. And then, the other, and I think we mentioned this, we did have a very low wind resource in Brazil, more so in the first quarter, but that also had impacted our EBITDA this year. So, we have some offsets, but overall really pleased with the growth, the cash-driven growth, and that we continue to be even more efficient in our renewables and utilities growth machines."
},
{
"speaker": "Unidentified Analyst",
"content": "Got it. No, that's very helpful. I guess second, we noticed a comment on being able to bring the majority of the backlog online by 2027. I guess with this year, 2024, a targeted 3.6 gigawatts of new projects online, could you talk about the cadence on bringing new projects online -- just on this front, from this year through 2027, and what kind of lumpiness should we expect coming out of it?"
},
{
"speaker": "Andres Gluski",
"content": "Yes, well, I think we've very much smoothed out the cadence of bringing projects online. At the beginning where we were ramping up very fast, in fact, last year we grew 100% the number of projects we're bringing online. So, this year we're able to manage it much better in the sense that it's almost about half is being done in the first-half, and the third quarter is going to be quite heavy as well. So, the cadence is going to be much more even throughout the year, as again, the growth rate is not 100% in one year, and obviously it will increase because again, we have to deliver 12.6% over the next three years. And so, most of that is it gets your numbers closer to four. So, we feel very good about the cadence. The biggest challenge was to ramp up 100%, and we did that, and we actually did all of our projects that we needed to get done last year on time."
},
{
"speaker": "Unidentified Analyst",
"content": "That's great. Really appreciate the colors from both. Thanks."
},
{
"speaker": "Andres Gluski",
"content": "Thank you."
},
{
"speaker": "Steve Coughlin",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Michael Sullivan with Wolfe Research. Please go ahead."
},
{
"speaker": "Michael Sullivan",
"content": "Hey, good morning."
},
{
"speaker": "Andres Gluski",
"content": "Good morning, Michael."
},
{
"speaker": "Michael Sullivan",
"content": "Yes. Hey, Andres. A couple of questions, I know there's been some on the utility growth, but 50% plus load growth seems pretty eye-popping, and I'm just curious, like, how you're feeling about the supply side and ability to serve that. Like, for example, if I just look at, you have an AES Indiana, I don't know, I mean, there's like a planned conversion, and then a handful of renewables, and a lot of load growth coming. And then, obviously, in Ohio, you have less control over the supply, and we got a data point on that earlier this week. I guess, yes, just how explosive load growth, how are you feeling about the ability for generation to serve that in those two states?"
},
{
"speaker": "Andres Gluski",
"content": "Yes. Look, that's a great question. This is going to be timed over the years, so it's not like all at once we have to deliver this in the next two years. So, it represents opportunities, definitely, for additional generation. And as I've been saying in my remarks a good part of that's going to come from renewables. Some of that increased demand may come from gas in some locations. So, definitely all of this is we feel it will get done, and the solution will be different in MISO or PJM, there will be differences, and it'll be different between the two utilities, in terms of one of them will involve more direct securing the generation itself. So, this will pan out, but it's a very good question, because yes, there is quite a high number of growth. It represents a great opportunity, but we wouldn't have said it if we didn't know how this could be served."
},
{
"speaker": "Steve Coughlin",
"content": "Yes. And I would just add to Andres' point in Indiana, where generation will be part of the solution keep in mind, we have multiple existing gas sites. So, we have the conversion at Petersburg, but we also have space for additional gas at Eagle Valley, at Harding Street, and at the Georgetown site. So, we are seeing the whole package being able to support datacenter growth there. In Ohio, of course, you mentioned that that's a distribution transmission. We have a very attractive area for datacenters, our service territory is quite large, a lot of available cheap land, very centrally located to fiber networks and data load, accessible water. So, it is a very appealing area. You can see from the -- I think you're referring to the PJM capacity auction, was quite high, demonstrating how significant demand has increased. But within PJM, I think our territory in Western Ohio is one of the most attractive areas, if not the most."
},
{
"speaker": "Michael Sullivan",
"content": "Yes, appreciate all that Color. Just to follow up on that last point this came up on some of your peers' calls, but any appetite from your standpoint to own regulated generation in Ohio, and what could that look like if it turns out that this can't be done through competitive markets?"
},
{
"speaker": "Andres Gluski",
"content": "Yes, look, right now we have no appetite for generation in Ohio directly, but again, this represents opportunities for our renewables team. So, I would say stay tuned, but certainly we feel that these targets can be met, but again realize this is going to happen over time, as Steve had said in his comments."
},
{
"speaker": "Michael Sullivan",
"content": "Okay, great. And then, just one more, over to like the renewable side, I think since the last call we had the Brazil asset sale announcement, should we just think about that as fully embedded in your longer-term guidance, or is there like more additions than expected that are going to kind of backfill that in terms of the longer-term growth?"
},
{
"speaker": "Andres Gluski",
"content": "No, that's already embedded in our guidance."
},
{
"speaker": "Steve Coughlin",
"content": "Yes, both this year and obviously the long-term Brazil exit is included in our numbers."
},
{
"speaker": "Michael Sullivan",
"content": "Great. Thank you."
},
{
"speaker": "Andres Gluski",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Willard Grainger with Mizuho. Please go ahead."
},
{
"speaker": "Willard Grainger",
"content": "Hi. Good morning, everybody. Can you hear me?"
},
{
"speaker": "Andres Gluski",
"content": "Yes. Good morning."
},
{
"speaker": "Willard Grainger",
"content": "Thanks for taking my question. Just maybe one, with the results of the PJM capacity auction coming out this week and just directionally higher power prices and projects coming out of the queue for next year, just how are you thinking about the cadence of your development pipeline? And any color on that would be super helpful. Thank you."
},
{
"speaker": "Andres Gluski",
"content": "Look, we have been saying, again, for several years that we were seeing shortages developing, just looking at the corporate demand, especially for renewables, and the ability of suppliers to ramp up to meet that demand. So, to some extent, what is happening in the market is what we expected. This is not going to make any difference to our plans. Again, we have contracts, we have sites, we've already locked in financing, et cetera. So, equipment prices, so it doesn't make any change to our plans. What it does, I think, signal is the value of our existing assets are going to go up as this shortages materialize. So, no effect in the, generally, in the shorter term, but in the longer term, it means that our assets are more valuable, and to some extent, it's what we've been planning for. So, it's not, of course, a specific option, we don't intend to be clairvoyant, but the general direction of the market that's unfolding is what we expected."
},
{
"speaker": "Willard Grainger",
"content": "I appreciate the color there. Most of my questions have been answered. Thank you. I'll get back in queue."
},
{
"speaker": "Andres Gluski",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Angie Storozynski with Seaport. Please go ahead."
},
{
"speaker": "Angie Storozynski",
"content": "Thank you. So, I have lots of questions. So, first, maybe in this low interest rate environment, I'm just, I'm actually wondering. So, first, again, so does that actually help further boost the profitability of the projects that are yet to be built? Meaning, I mean, you have embedded certain assumptions about interest rates for like construction financing, for cost of debt, et cetera. So, do I get actually an incremental benefit now that we're seeing seemingly in a lower interest rate environment?"
},
{
"speaker": "Steve Coughlin",
"content": "So, Angie, this is Steve. Good morning. So, look, we can't have it both ways. So, we have, as I've often talked about, a very low risk way of executing, which means we lock in almost all of our costs when we sign our PPAs, including hedging the long-term financing. So, for anything that we've signed, we're pretty much, we've baked in the price of that financing. But on a go-forward basis, look, lower interest rates are a good thing. They reduce the cost of new infrastructure, and so reduce the cost to the customer. So, overall, I think it's a further catalyst to demand and will help the whole sector. But we maintain a low risk structure in the way we execute."
},
{
"speaker": "Andres Gluski",
"content": "Obviously, we are highly contracted for future cash flows. So, lower interest rates means a lower discount rate. It means those cash flows are worth more. But the benefits on a sort of new contract basis will be for new contracts being signed, but not for the backlog."
},
{
"speaker": "Angie Storozynski",
"content": "Okay. So, then, changing topics, so those emission reduction targets or renewable power targets for hyperscalers, so obviously, here are those points that they're making, but I also see a number of these datacenters being developed on very coal-heavy grids, like Kentucky and Mississippi. I mean, and then the utilities that are on the other side of those transactions are basically saying that hyperscalers have eventual targets for emission reductions or carbon goals. But they're happy with just absorbing carbon-heavy power early on and then dealing with that carbon footprint later. So, how does that tie into this pitch that, in a sense, they have to just procure renewable power when, again, when we have these instances where they're just going for large quantities of available power, largely regardless of the carbon footprint?"
},
{
"speaker": "Andres Gluski",
"content": "That's a great question. The way I would put it is their preference is renewable power. Right? So basically, you're talking about situations where they have no other alternative. So, they're not happy to suck up coal power from the grid. They basically will either have offsets with a VPP or by RECs, and quite frankly, in most cases, will require that renewables come online in the future. So, you have to put it like this is the last alternative. And so, obviously, if you have a datacenter, the most important thing is to have power. So, if you have no other alternative, you will not go for renewables. But they do have the renewables goals, and they do want that power to be as low carbon as possible. So, that's in terms of the demand. Now, let's look at the supply. If you look at what's in the interconnection queue, almost all of it is renewables, if you include batteries. So, the fact is what can get built, let's say, over the next five years, for sure, is going to be very heavily weighted towards renewables. As Steve mentioned, you have to combine these in the lowest carbon way possible. And if that means adding some gas plants, that will be done. But I think that the direction is clear, because I remember you on one call said that it's all going to be nuclear. And I kind of laughed, we both laughed and said, tell me what the price of an SMR is? How can we sign a PPA with embedding nuclear? Second of all, the regulatory hurdles to bringing on nuclear are still very significant. And we really don't have price certainty on it. So, renewables are going to be the bulk of that add-on. That's what they want. Again, yes, they will make deals for the short run if that's the only alternative. But it's not their preferred route."
},
{
"speaker": "Angie Storozynski",
"content": "No, I understand. But again, I obviously hear your point, yes. It's just that I'm wondering if renewable power is more like a source of basically carbon-free credit, or is it the source of energy? Because again, one could argue that the datacenters are basically using traditional thermal power for the supply of energy. And then, renewables, again, just offset the carbon footprint. And I'm not sure if that's actually bad or good. I'm debating it myself; it depends on my question. But I'm just again."
},
{
"speaker": "Andres Gluski",
"content": "Yes, I think it depends on the client, quite frankly. Some clients are much more stringent. Some clients actually want hourly-matched renewables. Some clients require additionality. Most of them require additionality. So, it's not just one-size-fits-all. I think the renewable standards will differ among them. But the direction is very clear. So, I don't see anybody sort of walking away from it at this point. And quite to the contrary, they're under pressure a lot because as they ramp up very significantly their datacenters and they're taking some power which is not renewable, their total carbon footprint goes up, and that's something that they've had to address. So, I would say that, yes, they're being pragmatic. But in terms of their goals and desires, those remain unchanged. And it's not uniform across all of them. It's not one-size-fits-all."
},
{
"speaker": "Angie Storozynski",
"content": "And then lastly, you have this page where you mention all of these additional transactions you've entered into with hyperscalers. So, is this co-location? Is it that this is sort of a set of assets located at least in the same sort of zone, like say in PJM or again, I'm just -- I'm not trying to be facetious here? But I'm just wondering, so is this power really directly feeding into these hyperscalers? Or is it just like being commingled with other power and it's, again, this sort of a carbon attribute as opposed to the energy?"
},
{
"speaker": "Steve Coughlin",
"content": "Yes. So, I'll just add on to what Andre said. So, in almost all these cases, even you're talking about, Angie, not to say, yes, these are resulting in renewable PPAs, some cases in the same location or nearby locations, and others where they're focused on time to power going to the grid, but then also contracting for renewables perhaps further away. Most of what we are doing is I would say you would call more of a co-location regionally where we're supplying energy, including most of what we signed recently in the same grid and relatively close to the datacenter. So, that is by and large what we've seen most looking for. But when time to power is, of course, a priority, they're looking for alternatives. But the great thing is that in all cases, the additionality of renewables, whether it's direct or through RECs, is a top demand from these customers."
},
{
"speaker": "Angie Storozynski",
"content": "Okay. And then, lastly, so what happens, for example, with AES Ohio now that we have this pickup in capacity prices, most of the energy prices will follow. I mean, this is a wires only business. Are you concerned about the impact on electric bills and affordability and how that might suppress any sort of a T&D investment?"
},
{
"speaker": "Andres Gluski",
"content": "I would say, look, first, we have the lowest rates in the state. So, we're starting off from the best position of anybody. Second, realize that our new additional growth, these are people who, again, the most important thing is to find a good location and to have the power and the other services that they need. So, that does not concern me in terms of, let's say, saying, well, this growth will not happen because the capacity prices went up. And as I've said before, to some extent, not this particular auction, not the extent of this one-time jump. But we had been expecting this. So, this is not something that's like out of left field and we have to scramble. We have been talking about, and you can hear from all our earnings calls, and we've been saying, look, there's going to be a shortage. And returns are going to improve over time. And so, directionally, this is very much what we expected."
},
{
"speaker": "Angie Storozynski",
"content": "Okay. Thank you. Thanks."
},
{
"speaker": "Andres Gluski",
"content": "All right. Thanks, Angie."
},
{
"speaker": "Operator",
"content": "The next question comes from Biju Perincheril with SIG. Please go ahead."
},
{
"speaker": "Biju Perincheril",
"content": "Yes, thanks for taking my question. A question on domestic content bonus, can you talk about when your projects might -- when you're targeting your projects to be eligible for that and maybe the implications for your returns? And if you could talk to separately the solar and storage projects, that would be great. And then, I have a follow-up."
},
{
"speaker": "Andres Gluski",
"content": "Okay. So, first, I'd say in terms of domestic content, in terms of our wind project, those already meet the criteria. Remember, it's a criteria based on the total cost of the project, the different components. In terms of solar panels, again, we expect to be meeting that by 2026. In terms of batteries, our main supplier is Fluence, and they should be meeting that, quite frankly, starting in 2025. So, all together we feel very good about meeting domestic content requirements. And then, there are other things like trackers, inverters, et cetera, that we've been working on as well. So, I think the team's done a very good job to combine the various assets such that they do meet the domestic content criteria. So, it's not one-size-fits-all. It's like what's available and if you have wind, it may be greater. If you have, say, solar panels, it may be lesser, but you put it together and the total meets it. So, we feel very good about that meeting the domestic content criteria."
},
{
"speaker": "Steve Coughlin",
"content": "And I would just add, keep in mind that the adder is across the entire capital cost of the project once you meet the threshold for the certain components that have to be domestically sourced. So, it's a 10% across not just those components, but the whole thing, which is really attractive."
},
{
"speaker": "Andres Gluski",
"content": "Yes. And we have no trouble meeting things like prevailing wage, et cetera."
},
{
"speaker": "Steve Coughlin",
"content": "Right."
},
{
"speaker": "Andres Gluski",
"content": "So again, the team's been working very hard on this, and we feel that we're very well positioned."
},
{
"speaker": "Biju Perincheril",
"content": "And is your expectation that you would be able to retain most of that or you would have to pass along that in terms of PPA pricing, just trying to understand the impact to your returns?"
},
{
"speaker": "Andres Gluski",
"content": "Again, I think it's on a case-by-case basis. It depends on the demand supply in the particular market. So, --"
},
{
"speaker": "Biju Perincheril",
"content": "Okay."
},
{
"speaker": "Andres Gluski",
"content": "I think the best answer would be shared. And then, the vision of spoils will depend on the particular circumstances."
},
{
"speaker": "Biju Perincheril",
"content": "Got it. My follow-up was -- and we talked about a lot about sort of time to power. So, for renewables projects, can you talk about sort of the advantages or what you bring to the table specifically from a technology perspective? I think last quarter you sort of talked about DLR and batteries and that almost that or there are other solutions that you could bring to the table in terms of addressing that concern for your end customers."
},
{
"speaker": "Andres Gluski",
"content": "Yes, we really look at this sort of holistically and we tend to co-create with the client. Say, look, what do you want? And then we'll bring the technologies to bear. We don't come and say, look, we have this really neat widget. This is what you should buy. Now, given the new technologies I really do feel that we've been a leader in this. So, in everything from we did invent lithium ion -- the use of lithium-ion batteries for grid stability. We started that 14 years ago. We do have the biggest dynamic line rating project in the country. Fluence is doing a number of very innovative things to use batteries to be able to get more use out of existing transmission lines. We also were the first to do hourly matched 24/7 long-term contracts for hyperscaler clients. So, we continue to do that. And with Uplight, there's a number of VPP facilities that's well-managed -- energy management. And finally, I think Maximo is a great example of we are thinking about the future. One of the constraints, and I am sure you've heard it, was like labor force for building solar projects. And the fact is you have lift 65 pound today solar panels. In heavy heat the restrictions, crews can only work six hours for example. And it takes a very strong individual to be able to do this task at all. So, with Maximo this really allows us, first, to do it much more quickly. You can work three shifts even in terrible weather or hot weather conditions. In addition to that, we don't have to be particularly physically strong to do it. You have to be able to supervise the robot. So, Maximo is an example of how we would bring projects online faster and also with cost at damages as well. So, this is the first step. We are starting to use it. Next year, we will be ramping up. But after that, we can see a fleet Maximo out there, which would give us a competitive advantage. In other words, that we could bring -- we wouldn't say it's labor shortages, because we can hire a much broader universe of individuals. We can work in three shifts in all weather conditions. And we can quite frankly do it faster and better. So, that's another example. So, again, I think our AES Next and our views on technology have been really industry leading."
},
{
"speaker": "Biju Perincheril",
"content": "Okay. Thank you."
},
{
"speaker": "Andres Gluski",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Those were the questions we have time for today. And so, I'll turn the call back to Susan for any closing remarks."
},
{
"speaker": "Susan Harcourt",
"content": "We thank everybody for joining us on today's call. As always, the IR team will be available to answer any follow-up questions you may have. Thank you. And have a nice day."
},
{
"speaker": "Operator",
"content": "Thank you everyone for joining us today. This concludes our call. And you may now disconnect your lines."
}
] |
afl | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good day. And welcome to the Aflac Incorporated Fourth Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. If you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press Please note this event is being recorded. I would now like to hand the call over to David Young, Vice President of Capital Markets. Please go ahead."
},
{
"speaker": "David Young",
"content": "Good morning and welcome. Thank you for joining us for Aflac Incorporated's fourth quarter earnings call. This morning, Dan Amos, Chairman and CEO of Aflac Incorporated, will provide an overview of our 2024 results and operations in Japan and the United States. Then Max Broden, Senior Executive Vice President and CFO of Aflac Incorporated, will provide an update on our fourth quarter and 2024 financial results, current capital and liquidity, as well as some color on our outlook for 2025. These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com. In addition, Max provided his quarterly video update, which also includes information about the outlook for 2025. We also posted under financials on the same site updated slides of investment details related to our commercial real estate and middle market loans. For Q&A today, we are also joined by Virgil Miller, President of Aflac Incorporated and Aflac US, Charles Lake, Chairman and Representative Director, President of Aflac International, President and Representative Director, Aflac Life Insurance Japan, and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discussed today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-US GAAP measures. I'll now hand the call over to Dan."
},
{
"speaker": "Dan Amos",
"content": "Thank you, David, and good morning, everyone. We are glad you joined us. Before Max provides a more detailed view of our financial results, I would like to reflect on what was another very good year. Aflac Incorporated delivered very strong earnings for the year with net earnings per diluted share up 23.8% to $9.63 and adjusted earnings per diluted share up 15.7% to $7.21. Aflac Japan represented more than 70% of pretax adjusted earnings and three-quarters of the company's consolidated balance sheet in 2024. Aflac Japan also generated a 15.5% increase in pretax adjusted earnings and a record 36% pretax profit margin in 2024. I am pleased with Aflac Japan's 93.4% premium persistency and 5.6% year-over-year sales increase, which included a 9% sales increase in the fourth quarter. By maintaining strong persistency and adding new premium through sales, we are partially offsetting the impact of reinsurance and policies reaching paid-up status. This will be integral to the future growth of Aflac Japan. Taking into account Japan's demographics, our product strategy is to fit the needs of customers throughout all stages of life. Acquiring younger customers is critical to our success. We believe Sumitos appeals to younger customers in Japan. Our strong sales in Japan reflect the success our agencies have had selling Sumitos. As the pioneer of cancer insurance and leading third-sector insurer, we also aim to sell the Sumitos policyholders a medical policy or cancer policy. Our last cancer insurance, Wings, was launched in stages in 2022. Therefore, we are planning a staged launch through our distribution channels of our new cancer insurance product between March and April. This new product includes our unique Uriso cancer consultation support service along with insurance coverage that offers enhanced protection before, during, and after cancer treatment. This product also features flexible coverage and introduces a new plan for children, thus providing comprehensive protection for customers. We will also maintain our focus on being where the customers want to buy insurance through our broad network of distribution channels, including agencies, alliance partners, and banks. This reach continually optimizes opportunities to help provide financial security to Japanese consumers. Turning to Aflac US, we have focused on updating our products to ensure that our policyholders understand the value our products provide. When people experience the value of our products, we believe it enhances product persistency, which both benefits our policyholders and lowers our expenses. In the US, I continue to be pleased with our 70 basis point improvement in premium persistency to 79.3%. We also generated a 2.7% increase in net earned premiums, a measure we continue to focus on improving. Additionally, our pretax profit margin for the year was strong at 21.1%. Sales were lower than expected in the fourth quarter, leading to a 1% decline for the year. We continue to focus on more profitable growth through our stronger underwriting discipline. At the same time, we are engaging agents and brokers following the stabilization of our network dental operation. As always, we continue our prudent approach to expense management and maintaining a strong pretax margin. I believe that the need for our product and the solutions we offer is as strong or stronger than they have ever been before in both Japan and the United States. We are leveraging every opportunity and avenue to share this message with consumers. Knowing our products help lift people up when they need it most is something that makes all of us at Aflac very proud and inspires us to reach more people. We continue to reinforce our leading position and build on that momentum. We continue to generate strong capital and cash flows while maintaining our commitment to prudent liquidity and capital management. We have been very pleased with our investments, which have continued to produce strong net investment income. As an insurance company, our primary responsibility is to fulfill the promises that we make to our policyholders while being responsive to the needs of our shareholders. Our solid portfolio supports our promise to our policyholders, as does our commitment to maintain strong capital ratios. We balance this financial strength with tactical capital deployment. I am very happy with how management has handled capital deployment and liquidity and specifically how well we have adapted to this environment. Year to date, Aflac Incorporated's deployment of $2.8 billion in capital to repurchase more than 30 million shares of Aflac stock. Additionally, we treasure our track record of what is now 42 consecutive years of dividend growth. At the same time, we have maintained our position among companies with the highest return on capital and the lowest cost of capital in the industry. Combined with dividends, this means that we delivered $3.9 billion back to the shareholders in 2024. We believe in the underlying strengths of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. I'll now turn the program over to Max to cover more details of the financial results."
},
{
"speaker": "Max Broden",
"content": "Thank you for joining me as I provide a financial update on Aflac Incorporated's results for the fourth quarter of 2024. For the quarter, adjusted earnings per diluted share increased 24.8% year over year to $1.56, with a one-cent negative impact from FX in the quarter. In this quarter, remeasurement gains on reserves totaled $43 million, reducing benefits. Variable investment income ran $17 million above our long-term return expectation. Adjusted book value per share excluding foreign currency remeasurement increased 3.2%. The adjusted ROE was 12% and 14.5% excluding FX remeasurement, an acceptable spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment, net earned premiums for the quarter declined 5.4%. This decline reflects a 7.2 billion yen negative impact from an internal cancer reinsurance transaction executed in the fourth quarter of 2024 and a 4.4 billion yen negative impact from paid-up policies. In addition, there's a 300 million yen positive impact from deferred profit liability. At the same time, policies in force declined 2.3%. Japan's total benefit ratio came in at 66.5% for the quarter, up 40 basis points year over year, and 62.5% for the year. The third sector benefits ratio was 56.9% for the quarter, up approximately 70 basis points year over year. We estimate the impact from remeasurement gains to be approximately 100 basis points favorable to the benefit ratio in Q4 2024. Long-term experience trends as they relate to treatments of cancer and hospitalization continue to be in place, leading to continued favorable underwriting experience. Persistency remains solid at 93.4%, which was unchanged year over year and in line with our expectations. Our expense ratio in Japan was 20.8% for the quarter, down 30 basis points year over year, driven primarily by a decline in expenses. For the year, the expense ratio in Japan was 19.1%. For the quarter, adjusted net investment income in yen terms was up 3.7%, as the transfer of assets to Aflac Bermuda associated with reinsurance and lower floating rate income was more than offset by higher returns from structured private credit infrastructure and our alternatives portfolio. Adjusted net investment income was up 12.1% for the year. The pretax margin for Japan in the quarter was 31.6%, up 120 basis points year over year, a very good result. For the full year, the pretax margin was even stronger at 36%, which is also the highest in 30 years. Turning to US results, net income premium was up 2.7%. Persistency increased 70 basis points year over year to 79.3%. Our US total benefit ratio came in at 46.3%, 170 basis points higher than Q4 2023, driven by lower remeasurement gains than a year ago. We estimate that the remeasurement gains impacted the benefit ratio by approximately 170 basis points in the quarter. Claims utilization has rebounded from depressed levels during the pandemic and is now more in line with our long-term expectations. For the full year, the US total benefit ratio was 46.8%. Our expense ratio in the US was 40.3%, down 310 basis points year over year, primarily driven by platforms improving scale and strong expense management. For the year, the US expense ratio was 38.5%. Our growth initiatives in group life and disability, network dental and vision, and direct-to-consumer increased our total expense ratio by 170 basis points for the quarter. This is in line with our expectations, and we would expect this impact to decrease going forward as this business grows to scale and improves its profitability. Adjusted net investment income in the US was up 0.9% for the quarter, mainly driven by high returns from alternatives, and 3.3% for the year. Profitability in the US segment was solid with a pretax margin of 19.7%, also a good result, as was the 21.1% for the full year. We continue managing through the worst commercial real estate downturn in decades. During the quarter, we increased our CECL reserve associated with our commercial real estate portfolio by $40 million net of charge-offs as property values remain at distressed valuations. We also foreclosed on two loans, adding them to our real estate-owned portfolio. We continue to believe that the current distressed market does not reflect the true intrinsic value of our portfolio, which is why we are confident in our ability to take ownership of these assets, manage them through the cycle, and maximize our recoveries. Our portfolio of first lien senior secured middle market loans continues to perform well, with losses below our expectations for this point in the cycle. In our corporate segment, we recorded a pretax loss of $4 million. Adjusted net investment income was $153 million higher than last year, due to a combination of continued lower volume of tax credit investments, higher rates, and asset balances, which included the impact of the reinsurance transaction in Q4 2024, which was similar in structure and economics in yen terms to our October 2023 transaction. These tax credit investments impacted the corporate net investment income line for US GAAP purposes negatively by $46 million in the quarter, with an associated credit to the tax line. The net impact to our bottom line was a positive $4 million for the quarter. To date, these investments are performing well and in line with our expectations. Our capital position remains strong, and we ended the quarter with an SMR above 1150%, an estimated ESR above 270%, and combined RBC, while not finalized, we estimate to be greater than 650%. These are strong capital ratios, which we actively monitor, stress, and manage to withstand credit cycles as well as external shocks. US statutory impairments were $3 million, and there were 700 million yen of Japan FSA impairments in Q4. This is well within our expectations and with limited impact to both earnings and capital. Our leverage was 19.7% for the quarter, which is just below our target range of 20 to 25%. As we hold approximately 60% of our debt in yen, this leverage ratio is impacted by moves in the yen-dollar exchange rate. This is intentional and part of our enterprise hedging program, protecting the economic value of Aflac Japan in US dollar terms. Unencumbered holding company liquidity stood at $4.1 billion, $2.3 billion above our minimum balance. We repurchased $750 million of our own stock and paid dividends of $277 million in Q4, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. On December 3rd, we shared estimated ranges for annual key metrics for both segments for 2025 through 2027 at our financial analyst briefing, and we continue to stand by these ranges. However, for 2025, we expect the benefit ratio in Japan to be toward the higher end of the 64 to 66% range, and we continue to expect the expense ratio to be at the lower end of the 20 to 23% range as we pursue various growth and strategic initiatives. As a result, we expect Aflac Japan's pretax profit margin to be at the lower end of the 30 to 33% range. In the US, we expect the benefit ratio for 2025 to be at the lower end of the 48 to 52% range, and the expense ratio to be at the upper end of the 36 to 39% range as we continue to scale new business lines. At the same time, we expect the pretax profit margin for 2025 in the US to be at the upper end of the 17 to 20% range. Thank you. I'll now hand it back to David to begin the Q&A."
},
{
"speaker": "David Young",
"content": "Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. You may then rejoin the queue. We will now take the first question."
},
{
"speaker": "Operator",
"content": "To ask a question, if you are using a speakerphone, please pick up your handset before entering the key. To withdraw your question, please press star then two. And our first question will come from Joel Hurwitz of Dooling and Partners. Please go ahead."
},
{
"speaker": "Joel Hurwitz",
"content": "Hey. Good morning. One to start. On US sales, Virgil, can you just provide some more color on what you are seeing in the competitive environment that's impacting your sales? Is it specific products or specific areas of the market?"
},
{
"speaker": "Virgil Miller",
"content": "Hey. Thank you, Joel. Good morning. Yeah. Look, first, let me set the stage for going into the fourth quarter. We knew going through the fourth quarter, Joel, that we were up against one of the tougher comparisons with Q4. In Q4 of 2023, that was one of the largest sales quarters we have had in the history of Aflac. So we knew we had to have strong solid performance. The second thing I would say is that we also knew that we would stick to the underwriting discipline we have put forth in our group BB products. What that really means is that we are not going to be bringing business on board that does not fit our profit profile. Therefore, businesses that have high turnover, businesses that have low claims filing, we are not going to accept those because they are not good for the company longer term. The stronger underwriting just wants to help set us up for profitable business and profitable growth in the long-term vision that we have at Aflac. Then the third thing I would say is we knew that the market needs to respond to the improvements we have made with our dental and vision platform. I had disclosed in prior conversations that we had a failed system implementation that we were recovering from. I am very pleased with the recovery that we have seen, though. A partnership that we formed with one of the industry-leading third-party administrators out there has helped substantially move the needle on improvements. And we are open for business. We needed to get the brokers and our veteran agents to come back on board and really put that product back in the market as a very competitive product. And quite frankly, we did not get the response we needed. We saw a 33% decline in our dental sales for Q4. Along with the dental sales themselves, though, there's the impact that we call halo, which means that on a general census, we get additional voluntary benefit sales when we sell the dental product. Those are really the things that we add them up that impacted how we performed in that Q4. I would say, Joel, that I am disappointed with the softer sales, but I am very pleased with our overall performance. We did demonstrate solid financial management. If you heard from Max, you heard from Dan, they mentioned that pretax earnings were up 9.3%. Our margins were up 1.3%. Earned premiums up 2.7%. Persistency up 0.7% overall. Very pleased with that. That tells you though this management discipline of making sure that we are looking at proper business is generating the response that we need, reduced expenses by 3.1%. And then overall, we were able to give other additional value to all policyholders with an increased benefit ratio. Now we are watching that very closely. But very solid performance based on that discipline we put out there in the market."
},
{
"speaker": "Joel Hurwitz",
"content": "Alright. Very helpful. Thank you. And then for my second one, just wanted to move to the 2025 outlook area that Max provided. So for Japan, you guided to the pretax margin to be at the low end of the range, which is below where I was, and I think most were. I think it's largely on net investment income and there's some misunderstanding on how the accounting works on the floating rate security hedges. Could you just provide more color on how the benefits from those hedges flow through earnings?"
},
{
"speaker": "Max Broden",
"content": "Yes. Thank you, Joel. So we obviously have a floating rate book in the Japan segment that is a little bit less than $9 billion of notional balance. Also at the corporate segment, we have a little bit over $4 billion of cash that is invested at the short end of the curve. That means that all these asset balances are very sensitive to SOFR. And that is both the one-month and the three-month SOFR that they reprice at. As we go into 2025, obviously, we had a rate cut in December, and there is an expectation about further rate cuts in 2025 when you look at the forward curves. When we just inject the forward curves onto our projected yields for 2025, that means that they are likely to be lower than what they were in 2024. So that is why our floating rate income is expected to be lower. As it relates to our interest rate swap, this is really a tail hedge swap that made sure that we protected our floating rate income from any significant declines in interest rates at the short end of the curve. That means that, obviously, we are at higher rates now than when this swap was entered into. That means that it is out of the money and somewhat ineffective at this point. And that's why you see the full brunt of any relatively even relatively small declines of interest rates at the short end immediately flows through and impacts our net investment income in 2025. Also, the mark-to-market component of the interest rate swap that falls below the line in the realized gains losses, i.e., outside of adjusted earnings but obviously included in our US GAAP earnings. I hope that's helpful."
},
{
"speaker": "Joel Hurwitz",
"content": "It is. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Jimmy Bhullar of JPMorgan. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"content": "Hey. Good morning. So first, just had a question either for Dan or for Charles on Japan sales. You obviously grew at a strong pace this quarter. But if you look at where sales are versus where they used to be pre-pandemic, they're still fairly depressed. So just wondering what's changed in the market, and what's your optimism of being able to get to, in an absolute sense, the sales levels that you had before that'll allow you to potentially grow your in-force as opposed to report declining premium growth."
},
{
"speaker": "Koichiro Yoshizumi",
"content": "This is Yoshizumi from Aflac Japan. Pandemic public has recovered. So we do not see we see that it has recovered, and that is her. So we have been focusing on making a recovery in a solicitor's activity because during the two, three years of the COVID, the sales activities had been stagnant. So that has been a focus point, which is to make a recurring revenue. Let me answer. This is Yoshizumi. First of all, we have gone through this marketing and sales transformation starting January. This is to conduct integrated or end-to-end marketing activities based on the different brand group pipelines starting with medical, cancer, asset formation, and nursing care. And we will be continuously injecting our competitive product centered around our main products, cancer and medical insurance. And we plan to launch a new cancer insurance product in stages from March to April in order to respond to change in customer needs. And now with the launch of the new product Sumitasso, which was launched last June 2024, we have managed to expand our product lineup and now been able to approach a greater customer audience. And we will be executing measures in order to develop and enhance the potential of the solicitor or agent. With these efforts, we would like to recover our performance on the pre-COVID level. That's all."
},
{
"speaker": "Jimmy Bhullar",
"content": "And then maybe for Virgil, in the US business, I think there have been a couple of reasons that you've cited for sales being weak in 2024. One is just the dental DPA issues, and then secondly, competition in and margins in supplemental products or in the voluntary market. I'm assuming that the competition and market issue is something that's not going to change, but and if that is the case, assuming that that'll be an ongoing headwind to your sales, but then on the dental rollout, should is that starting to get to normal, or is that more of a 2026 event?"
},
{
"speaker": "Virgil Miller",
"content": "No. I thank you for the question. We absolutely want everyone listening to know we're open for business. We've invested time, resources, and dollars to make sure we got a strong platform. We went through a very diligent process to get the right partner who is an industry-leading partner to make sure that we're prepared to deliver on the customer experience that we need. So we are confident in our dental platform the way we have it now. The concern though is making sure that the brokers and the agents are back in market with it and that they're on board to sell it. I expected to see a stronger return for them in the fourth quarter, but I'm looking forward to see how we deliver on that this year. We're out meeting with them. We'll let them know about how the process works. We're energetic to say come back and sell the product. I would also say, though, what's going well for us is you look at the investments we made in our life and assets disability platform, we term as PLAT. We exceeded our sales expectations there. We are strong in that large case market now. Very competitive against some very known brands that have been in that space for a long time. Our disability products are competitive. Have a world-class absence management discipline. Where we're doing it for, you know, one state in particular, and we're delivering well on that. And then we are also selling our what we would call our paid-up life or employee life product. We also invested in a direct-to-consumer flat as consumer markets. We draw a better than expected sales year there. So those are the things that are going well. We get our dental platform back in line this year, and I expect it to demonstrate an increase."
},
{
"speaker": "Dan Amos",
"content": "And this is Dan. I am encouraged about what I'm seeing. Virgil talked to me early on in the first quarter and said, you know, there's some ways we can make this sales number. And do you know, I but I've got to push some areas. And I said, don't push lower profits for the sake of making the sale now. That's the wrong way. I want to look at earned premium. I want to look at what's going on. And I think our model for the future is much stronger to date than it was a year ago, especially on the dental and vision side. And we are expecting that to come through for the full year."
},
{
"speaker": "Jimmy Bhullar",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Mike Ward of UBS. Please go ahead."
},
{
"speaker": "Mike Ward",
"content": "Thank you. Good morning. I was just wondering just on the contribution to the Japan sales growth from Sumikasu seems like a primary driver of the growth. I guess, is it how fair is it to assume that we might be relying on first sector sales maybe more heavily than we previously thought in order to reach the Japan sales targets?"
},
{
"speaker": "Koichiro Yoshizumi",
"content": "To begin with, we do not announce or disclose the sales percentage or contribution. However, Aflac is a company centered around the third sector insurance product. And the main way to conduct our sales activity today is to also offer medical or cancer insurance whenever the product Sumitasso is being offered. Although we didn't show that Sumitasso will make a certain contribution to our first sector performance, our goal is to grow our third sector performance. And last year, right after the launch of this, we have enjoyed significant growth in sales. And we expect sales to settle compared to 2024. However, we believe the product will continue to generate solid results. And Sumitasso is unlike the traditional product features in the first sector product. It is developed to respond to the needs of the younger generation who are looking to accumulate their assets. Another nature of this product is that in addition to the asset formation nature, it also carries a nursing care feature. And another characteristic is that after the policy premiums are paid up, they can convert it to medical insurance or other types of insurance. And it also carries a strategic objective, which is to expand our customer base by capturing the younger generation and through concurrently offering this product together with a third sector product. So this is a very unique product. That's all."
},
{
"speaker": "Max Broden",
"content": "Thank you. I just wanted to add a few comments as well, Mike. We do not have a sales cap on our Sumitomo sales. And the reason why is that number one, we do believe that we get very good profitability out of this product. This is both on a GAAP basis but also on an IRR basis post-reinsurance. And what it means is that we also now have a very good hook product that ultimately will drive higher third sector sales as well. So we definitely see ourselves as a third sector company but this is an additional product that will help grow both our first sector business and the third sector business while also giving another tool to our distribution to sell more and make more commissions. Now I do want to say that the reason why now is because interest rates are higher in yen terms. But more importantly, we have built reinsurance expertise in and around the company which means that we can now conduct these operations and get the better capital efficiency associated with these products so we can really make them work."
},
{
"speaker": "Dan Amos",
"content": "And I will add that I have been so impressed with the job that Koichiro and his team have done in monitoring this through the guidance of Max, and what and Steve Bieber and what we've done to watch this. And every Sunday night, I get a report when we have our call on what is taking place and how interest rates are going, and where the lines are and our actuarial department is on it. And it's just I think you'd be proud if you saw the inner workings of what has taken place over the last couple of years with reinsurance. It shows that we're a company that's evolving over time. And just getting stronger in what we're doing and having better financial controls over the things that are taking place."
},
{
"speaker": "Operator",
"content": "The next question comes from Wes Carmichael of Autonomous Research. Please go ahead."
},
{
"speaker": "Wes Carmichael",
"content": "Hey. Good morning. My first question, just on remeasurement gains losses. It appears that the gains benefit has been flowing, which is, you know, perhaps not surprisingly given a pretty sizable unlocking in the third quarter. But when you look at trends going forward, would you expect that to continue, Max, or should that be relatively muted?"
},
{
"speaker": "Max Broden",
"content": "We obviously have experienced very significant remeasurement gains and also favorable gains from the unlock of our actuarial assumptions in the US in 2023 and in Japan in 2024. As it relates to our assumptions going forward, we do feel that we obviously have realistic and very good assumptions that by definition, otherwise, we would have to change it. This is something that we look at every quarter. But we and if something material were to change, we will unlock assumptions but our deep dive study occurs in the third quarter of every year. Each quarter, though, there are remeasurement gains, losses, that are coming through our results as we true up for the experience in that quarter. And that has continued to be favorable as we have come out of the pandemic. That being said, I do want to be a little bit cautious as we are seeing higher claims come through, especially on products, for example, in the US on our accident and our hospital product and to some extent also cancer. And that means that our remeasurement gains may not be as strong going forward as they have been in the past. But generally speaking, we are a company that takes a cautious approach to our underwriting to make sure that we get good results. And I think that the remeasurement gains that you have seen is a testament to the underwriting decisions that a company has taken in the past."
},
{
"speaker": "Wes Carmichael",
"content": "Thank you. And my follow-up, I guess, in the press release, Dan, you mentioned efforts on reengaging agents in the US. Can you just talk about the recruiting environment in the US? Are you seeing progress there, or is that kind of slowed?"
},
{
"speaker": "Virgil Miller",
"content": "Hey. Good morning. This is Virgil. Let me give you a color on that. I mentioned last year, so we're in a new regime out here. So definitely, there's a lot of competition. There are things like, you know, the economy that would impact recruitings from time to time. But all in all, I'm sticking to the point that we're going to always be around the ten thousand mark with our recruiting. We've demonstrated that now back to back. Although it's a little bit down from the year over year, we're still right around that ten thousand mark. Here's what I would say is that the core strength of our Aflac has always been our distribution. When you think about that, we will continue to go out, recruit agents, convert them, make the field force strong and dominant in that small market. I've added some new levels of leadership where we continue that focus. Our compensation plans are built around recruitment, and conversion to average week of producer and opening new small accounts. We continue to be strong doing our partnership with brokers in the mid-market and as I mentioned earlier, very strong in the upper case market now with the relationships we formed in our life and as the disability discipline. So we've got the market covered when it comes to distribution. I expect to recruit another ten thousand, around ten thousand this year. And continue to invest in what we're doing in that field force."
},
{
"speaker": "Wes Carmichael",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Elyse Greenspan of Wells Fargo. Please go ahead."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi. Thanks. Good morning. I guess my first one's on capital. You know, buyback picked up $750 million the quarter. You know, you guys obviously have pretty healthy capital positions in both the US and Japan. Does that $750 million, you know, feel like a good run rate level, or, you know, how should we think about share repurchase in 2025?"
},
{
"speaker": "Max Broden",
"content": "Thank you, Elyse. Your observation is correct that we obviously have a very healthy capital position around the company. And together with that, we also have a very good free cash flow generation overall as well, and that is what gives us the opportunity to reinvest into our operations and to redeploy capital back to our shareholders as well. We are very IRR driven, and as of right now, I would say that we get by far the best IRR on selling another policy. So as it relates to capital, that is the number one area. There are capital is going to. So we're looking for areas to grow our business organically. On top of that, we obviously have increased our dividends quite significantly over the last five years where we almost doubled our dividend per share. And on top of that, we want to be opportunistic and tactical in the way we redeploy capital back to shareholders through share repurchase. We stepped that up a little bit in the fourth quarter by $750 million, which I believe is the most that we've done in a single quarter. So that's a meaningful return back to shareholders. But going forward, we will continue to obviously evaluate all the opportunities that we have and make sure that we get good IRRs on all the deployments that we do."
},
{
"speaker": "Elyse Greenspan",
"content": "Thanks. And then my second question, you know, I believe there was, you know, a data sharing issue with Japan Post. Not related to Aflac, I believe. Right? But in general, you could just comment on that. And then did that have any impact on your sales in the fourth quarter? Would you expect there to be an impact in 2025?"
},
{
"speaker": "Koichiro Yoshizumi",
"content": "This is speaking from Aflac Japan. First of all, let me be clear, there were no issues with the sales of Aflac Japan's cancer insurance upon this incident. And given its past experience, Japan Post is taking a conservative approach to addressing this matter. The Japan Post Group is committed to selling your products and for our standard practice, Aflac Japan is in close communication with Japan Post Group at all levels of the organization. We'll continue to work closely with Japan Post Group in support of its sales of Aflac Cancer Insurance."
},
{
"speaker": "Elyse Greenspan",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from John Barnidge of Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"content": "Good morning. Thank you for the opportunity. Virgil, in your comments, you talked about a failed implementation that was corrected. And how much of the market was dental and vision not present?"
},
{
"speaker": "Virgil Miller",
"content": "Hey, John. Great to hear from you. Ask me that question one more time. I didn't catch the last part, please."
},
{
"speaker": "John Barnidge",
"content": "So, yeah, you talked about a failed implementation that was corrected. And how much of the market was dental and vision not present as a result of the failed implementation?"
},
{
"speaker": "Virgil Miller",
"content": "Oh, no. I have it. Thanks, John. Yeah. We were available, John. So I would tell you this, though, that we had some service degradation earlier in the year. That definitely impacts the perception of trust. And making sure that the brokers and the agents will come back and sell it. So during the fourth quarter, we were open for business and ready to go. We have tested all of our processes. We work with a partner who has a strong reputation and who's doing a good job with Aflac. Our network of dentists is one of the largest out in the industry. We do a rented network, and we also have a proprietary network, both to offer. What I would say to you though is that in this business where agents and brokers have a choice of business, we have to earn trust. That's what we're focused on, getting back that trust and demonstrating that the processes work. So if you look again, just to mention, in Q4, sales from the prior year were down 33%. Now although they don't make up a large part of our overall sales right now, I would say to you though that we get additional voluntary benefits alongside. So it's not just impacting dental, it also has this halo effect where you're not bringing other business that you normally would have. Seeing progress here, as we look into January. We're regaining some confidence. We are going around to all of our broker partners, and we put all types of messages out, demonstrating confidence to our agents. And I'm looking forward to seeing them come back and sell the product. It is a competitive product. We spend a lot of time developing it, I think it's good for all consumers out there to give it a try."
},
{
"speaker": "John Barnidge",
"content": "Thank you for that. And my follow-up question is remains on distribution. Ahead of the anticipated new cancer product launch. Should we expect more modest sales in the near term for that?"
},
{
"speaker": "Koichiro Yoshizumi",
"content": "Hi. Yoshizumi speaking. This new cancer insurance will be launched in March 2025. And we're expecting this to be a big driver. And we have been introducing innovative cancer insurance to the market this past year. But this time, in addition to the insurance coverage, we'll be integrating our Aflac Yodizel Cancer Consultation Support, which is our unique concierge service into the coverage. And I would like to mention three characteristics. It carries a very rich and simple coverage structure. And not only during the treatment, but there will be a coverage will be enhanced before and after the treatment. And we have changed the payment conditions for the benefit to be more easy to understand. The next major is the fact that it has a very flexible coverage design that allows combining the existing policies and other products. And we have also newly established a child plan with lower premiums to support pediatric cancer patient families whose economic burden tends to be high with longer treatment periods. And we expect to see a big increase in performance by introducing this product to various channels in stages."
},
{
"speaker": "Dan Amos",
"content": "Let me add one thing that I think is part of your question is that anytime we introduce a new product or revised product, we'll call it, there's a little dip in sales waiting for the new product and then the product should take off with the excitement of it being introduced throughout the country. So I just want to be clear on that. You can see a little dip and then strong growth."
},
{
"speaker": "John Barnidge",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Wilma Burdis of Raymond James. Please go ahead."
},
{
"speaker": "Wilma Burdis",
"content": "Hey. Good morning. First question, could you talk a little bit about any change in your thinking regarding the 10% reinsurance of the Japan block to Bermuda? And also just maybe touch on how you would reevaluate that, if at all. Thanks."
},
{
"speaker": "Max Broden",
"content": "Thank you, Wilma. So we currently have no change in our thinking. To date, we have seeded roughly 6% of our asset base of Aflac Japan to Bermuda. And so we have significant capacity as it relates to our internal cap of 10%. I want to stress that this is not an external cap, but it's an internal cap. And I think it's good risk management practice to have these kinds of caps in place because it means that we now have an opportunity to evaluate what we have done. And once we get closer to that 10%, then, obviously, all legal entities involved will make their own evaluation of if it makes sense to then move forward and increase that level for reasons where it may make sense for that legal entity. That applies to Aflac Bermuda, that applies to Aflac Japan, and obviously to Aflac Inc, as well. To date, we are very pleased with the outcomes of our reinsurance operations both in how they are being conducted, but also the overall outcome of it as it relates to improved balance sheet efficiency. And as you can see, improved return on equity overall for the group. And in fact, it has also reduced the risk of our Aflac Japan operations as well. So overall, we're quite pleased with where we are. And as we get closer to that 10% level, we will reassess."
},
{
"speaker": "Wilma Burdis",
"content": "Thank you. And then, are there any dynamics of the weaker yen that could impact Aflac's operations or results aside from, I guess, the repatriation impacts? Thank you."
},
{
"speaker": "Max Broden",
"content": "So, Wilma, the yen-dollar exchange rate does have an impact on our GAAP financials. As you know, we do not hedge our GAAP financials. So as you translate our yen-denominated earnings into US dollars, it does have an impact. And you obviously have seen that, especially over the last three years when you have experienced a significant depreciation of the yen versus the dollar. That being said, we do believe and we have the philosophy that we protect the economic value of Aflac Japan through an enterprise hedging program, and this is, as you know, three components to it. Where we hold US dollar assets on the Aflac Japan balance sheet, it is us at Aflac Inc. We are borrowing in yen and we also have an overlay of FX forwards at the holding company as well. And you add that up, and we believe that gives us very good protection on an economic basis to any moves, both small and significant, to the yen-dollar rate."
},
{
"speaker": "Wilma Burdis",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Tom Gallagher of Evercore ISI. Please go ahead."
},
{
"speaker": "Tom Gallagher",
"content": "Morning. Max, how much of the Japan margin coming in at the low end of the guide is floating rate impact on NII and how much of it is more limited benefit ratio improvement? If you can unpack that."
},
{
"speaker": "Max Broden",
"content": "I would say that the vast majority of it is obviously driven by net investment income. And I'll let Brad comment a little bit on that because, obviously, we're coming off a very good base here in 2024. That being said, when you think about the components of the benefit ratio, I would expect that over the forecast period at 2025 to 2027, that as we travel through that forecast period, the benefit ratio, all things being equal, we would expect to decline. Yeah. So it will start at the high end of the range and end at the lower end of the range. And the reason for that is that as our in-force mix is changing and it's each year tilting a little bit more towards third sector and a little bit less towards first sector, that means that the third sector lower benefit ratio business makes up a bigger component. So the mix impact of that is going to push us from the higher end of the benefit ratio range towards the lower end of the benefit ratio range. But it also means that from a pretax margin standpoint, it means that we expect to travel throughout the forecast period starting at the lower end of the range and then travel higher towards the higher end of the range throughout the forecast period. But I'll let Brad give some more color on net investment income as we go into 2025."
},
{
"speaker": "Brad Dyslin",
"content": "Yeah, Tom. You're right that we are definitely facing some headwinds with the floating rate portfolio. As discussed, this is driven by the decrease in short rates, the 100 basis points decline we saw last year in SOFR. It does hit our $9 billion floating rate portfolio, but it also impacts our cash holdings and other short-term opportunities that we can see throughout the year, which we were able to take advantage of in 2024. But we also had a couple of one-off items that had a strong contribution last year. That we're facing this year. One was a rather large make-whole. And then we were also able to accelerate deployment in certain asset classes that had very attractive spreads earlier in the year. So there's a variety of things that contributed to a very strong 2024 that puts us up against some very difficult comps for 2025 that is the source of that headwind."
},
{
"speaker": "Tom Gallagher",
"content": "Gotcha. And then just for a follow-up around looking at your capital position in Japan, it looks like you have about $4 billion of excess under the new ESR framework anyway. Would you anticipate getting an extraordinary dividend out of that entity? And any updated thoughts on what you might do with that much level of excess? I guess it's a high-class problem, but still, you know, without robust growth opportunities, I can't imagine it makes a lot of economic sense to leave that much excess in Japan."
},
{
"speaker": "Max Broden",
"content": "So, Tom, I would characterize it. Our capital position in Japan is very strong. We are still going through the transition of the capital regime framework from SMR to ESR. And while ESR has not formally been implemented yet, I think it would not be very smart to go and try to right-size your capital base on a future capital regime basis. So step one is we would expect to certainly wait and fully evaluate this until after the ESR has been implemented. And as you know, that is at the end of the first quarter of 2026. So that means that over time, we would expect to be in the target operating range of 170% to 230%. But for the time being, I would not expect any special dividend in the near term."
},
{
"speaker": "Tom Gallagher",
"content": "Okay. Thanks."
},
{
"speaker": "Operator",
"content": "The next question comes from Josh Shanker of Bank of America. Please go ahead."
},
{
"speaker": "Josh Shanker",
"content": "Yeah. Thanks for fitting in. I guess this is for Virgil. I was wondering with the elevated expense ratio in Aflac US, how long do you expect the investments in the work you're doing to accelerate growth to weigh on the expense ratio?"
},
{
"speaker": "Virgil Miller",
"content": "Yeah. Hi. Thanks, Josh. I would say, you know, we started to bend that curve. You know, we had one time been up to around 41% with the expense ratio. This year, we came in around 38.5%, I think, to be exact. So very, very pleased with that performance that we are bending it. And that is why we're still, as you pointed out, investing in the buy the bills. The key is to get these buy the bills to scale. And we are experiencing solid better than expected growth on the PLAS platform, better than expected growth on the consumer markets platform. And like I said, it sounds like I'm a broken record, but we've got to turn the curve with the dental vision platform. We're doing all the right things to get that done. If we do that right, that will help not only contribute to the expense ratio by bringing in additional new sales revenue that we need to offset that expense ratio, but we will continue to do strong, though, disciplined expense management. I expect the curve to come down even further this year in 2025."
},
{
"speaker": "Josh Shanker",
"content": "Are you know, if we think out more long term, you know, 2026, 2027, are we thinking it's on the margin or this is several hundred basis points?"
},
{
"speaker": "Virgil Miller",
"content": "Yeah. So I would tell you that we would at FAL, we put forth a range on the margin between 17 and 20%. We're going to stay within our range because we're going to make sure that our disciplined expense management hits those marks. If you look at 2025, 2026, and 2027, I am showing a decrease though in expense margin in expense ratio incrementally year over year over year."
},
{
"speaker": "Josh Shanker",
"content": "Okay. Thank you very much."
},
{
"speaker": "Dan Amos",
"content": "I think the important factor to get from this sales part of dental and vision is we got it right in the we want that distance. We just didn't execute to the level we needed to. And made a mistake, and I've got that now on target. And we've just got an outcome through with it. So we can achieve and will achieve."
},
{
"speaker": "Josh Shanker",
"content": "Appreciate it. Appreciate it. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Alex Scott of Barclays. Please go ahead."
},
{
"speaker": "Alex Scott",
"content": "Hey. Good morning. First question I had is just on the competitive environment a bit. And going back to some of the comments you all made around sales and, you know, you remain disciplined, like, you know, you could've shown better sales, but you're remaining disciplined. And I just want to dig into that a bit. I mean, when I think about, like, the signpost that I look at, I mean, it seems like well, reinsurance to Bermuda. The new money yields were in excess of 9% in the US and 8% in Japan. So I'm just trying to understand, you know, you're pulling are you getting those targeted IRRs because of some of the leverage or, you know, do you still feel like there's the same opportunity here that you've had in the past?"
},
{
"speaker": "Max Broden",
"content": "Let me address our life insurance business in Japan in particular because I think that's what you're really driving at. Obviously, higher yields matter, especially in yen terms as we sell yen-denominated products. But it's really the new business strain associated with these products and high reserving levels still puts the IRRs under significant pressure. But if you look at it on a post-reinsurance basis, we get very, very good IRRs, and that's why we feel very confident selling both our waste and our consummator product into the marketplace."
},
{
"speaker": "Alex Scott",
"content": "Okay. And maybe as a follow-up, I mean, one of the themes we've seen in group benefits this quarter from some of the peers is there seems to be sort of a have versus have-nots in terms of, like, capabilities on the platform and, you know, having that translate to sales growth being favorable or less favorable. And I guess I just pose the question to you. I mean, how do you feel about the capabilities in your group benefits platform, the scale? Do you have what you need? Is there more that you could go out and acquire whether inorganically or things that you may need to invest in?"
},
{
"speaker": "Virgil Miller",
"content": "I would say this is, Virgil. I would say this that when we acquired the life and disability business, we had invested to make sure we've got the right platform for that business line. I'm very technical on this, meaning that we have the right technology. We have the right resources, the talent to scale. On our group BB, we've made significant investments over the years to get the same with talent, with technology. And then we're doing that. We just did the same with our dental platform. Where I'm going with this is we have put forth what I would call a market segmentation strategy. We've got the right products for each segment. We've got the right distribution for each segment. What we're investing in right now is the ability to bring those things together so we're able to be more competitive with the ability to bundle and to present one unique experience to the market. Each platform stands strong independently. The talent stands strong independently. The product stands strong independently. Our core strategy will be bringing those things together. So there will be little additional investment to do that over the next couple of years. We're currently doing it right now. We respond to RFPs in the market as one Aflac, and we're going to really demonstrate the ability to be best in class with the technology and the discipline to have those things fit together going forward."
},
{
"speaker": "Alex Scott",
"content": "Got it. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Jack Matting of BMO Capital Markets. Please go ahead."
},
{
"speaker": "Jack Matting",
"content": "Hi. Good morning. Most might have answered, but maybe just one on commercial real estate. Could you just talk a little bit more about trends in that market and how you expect things to develop on Aflac's portfolio in 2025?"
},
{
"speaker": "Brad Dyslin",
"content": "Sure. Thank you, Jack, for the question. As you're undoubtedly aware, the market remains pretty difficult. It does seem that we may have hit the bottom, but we're very slow to recover. We'll continue working through our portfolio. Our preference is to work with borrowers to find a solution, but if the best way to protect our interest is to foreclose, we've demonstrated we're willing to do that to maximize our recoveries. We do expect this to be a long recovery. We have seen some early signs that things are moving the right way, but it's very early and values remain still quite depressed. At this point, we expect 2025 to largely play out much like 2024. We'll continue working through our watch list. We will manage our REO portfolio to maximize our long-term returns. We expect it is going to take quite some time for this recovery to happen. But that's our general outlook at this point. We do think it's going to be one that's going to take time to work through."
},
{
"speaker": "Jack Matting",
"content": "Thank you. And then, just a quick follow-up on the Japan sales outlook. I guess other than the major kind of cancer product launch you have coming in a couple of months, are there any kind of other launches or refreshes that you have planned this year that could impact the cadence of sales in 2025?"
},
{
"speaker": "Koichiro Yoshizumi",
"content": "Yes. As for the new product, we'll be launching the new cancer insurance in stages from March to April. And for the medical insurance, we have rebranded and improved the service last August. And we have also been strengthening our sales with a new plan targeting the middle-aged and older customers that was launched in September 2024. And we'll be able to provide one more strengthened promotion through our end-to-end structure, and that has been developed recently. And this structure is developed by each brand. In terms of the parameters, in comparison to the sales volume of 2024, this year will settle down. However, we believe that this will continue to generate solid results. With regards to the channel, we started an effort two years ago to enhance and increase other agents. And in 2023, we have hired approximately 600 agents. And they have made a great deal of contribution to our activities last year in 2024. But we have succeeded in hiring much more than 600 people in 2024. And we expect these new agents to be more active in 2025. As I said earlier, we will be utilizing the first sector product as a hook to expand the third sector business, actually. And such training is being implemented and strengthened. That's all."
},
{
"speaker": "Jack Matting",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "This concludes our question and answer session. I'd like to turn the call back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"content": "Thank you, Andrea, and thank you all for joining us on today's call. We appreciate your interest in Aflac Incorporated and look forward to hearing from you and seeing you soon. Have a good day."
},
{
"speaker": "Operator",
"content": "The conference is now concluded. Thank you for attending today's presentation, and you may now disconnect."
}
] |
afl | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Aflac Incorporated Third Quarter 2024 Earnings Call. All participants will be in listen only mode. [Operator Instructions]. After today's remarks, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Capital Markets. Please go ahead."
},
{
"speaker": "David Young",
"content": "Good morning and welcome. Thank you for joining us for Aflac Incorporated third quarter earnings call. I hope you will also join us for our Financial Analyst Briefing on December 3rd at the New York Stock Exchange. Registration reminders for this event will go out over the next few weeks. This morning, Dan Amos, Chairman, CEO of Aflac Incorporated will provide an overview of our results and operations in Japan and the United States. Then, Max Broden, Executive Vice President and CFO of Aflac Incorporated will provide an update on our financial results and current capital and liquidity. These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com. In addition, Max provided his quarterly video update, which also includes information about the outlook for 2024. We also posted under Financials, on the same site, updated slides of investment details related to our commercial real-estate and middle-market loans. For Q&A today, we are joined by Virgil Miller, President of Aflac U.S.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our Annual Report on Form 10-K for some of the various Risk Factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures. I'll now hand the call over to Dan. Dan?"
},
{
"speaker": "Dan Amos",
"content": "Thank you, David, and good morning. We're glad you joined us. As you saw, Aflac Incorporated reported a loss of $0.17 per diluted share on a U.S. GAAP basis for the quarter, primarily due to increased foreign exchange related losses from the yen and the strengthening of 12.9% during the quarter. However, adjusted earnings per diluted share for the quarter increased 17.4% to $2.16. Year-to-date, earnings per diluted share were $6.23 and adjusted earnings per share on a diluted basis rose 13.5% to $5.64. Beginning with Japan, we drove a 12.3% year-over-year increase in sales in the third quarter, maintaining the initial momentum from the June launch of Tsumitasu. As you'll recall, Tsumitasu combines asset formation with a nursing care option. It is part of our strategy to attract new and younger customers while also introducing them to our third sector policies. Tsumitasu also played an important role in the sales growth at the agencies. I'm also very pleased with the continued improvement in cancer insurance sales through Japan Post Channel, especially considering that WINGS has been in the market for over two years. On November 15, we'll be celebrating 50 years in Japan. Our marketing efforts will focus on creating additional touch points with customers around their needs and our products. Overall, Koide San and his team have done a great job of driving sales in Japan and even more so of delivering record profit margins for the quarter. Turning to the U.S., we achieved 5.5% sales growth for the quarter. These sales results reflects strong growth in Group Life, absent management and disability, which is encouraging as we continue to scale up that platform. In addition, it's good to see a continued increase in cancer insurance sales given our efforts to enhance the value proposition to our cancer policyholders. As we enter the fourth quarter and what tends to be our heaviest enrollment period, we will continue to focus on profitable growth, disciplined expense management, and optimizing our Dental and Vision platform. Overall, Virgil and his team are doing a good job balancing profitable growth, enhancing the value proposition of our policyholders, and curving the expense ratios. Their efforts contributed to the strong 20.8% pre-tax profit margin for the quarter. Max has done a great job leading the team to proactively defend our cash flows and deployable capital against a weakening yen, as well as establish our reinsurance platform in Bermuda. Over the course of this year, Virgil and Max as well as Audrey Tillman have taken on additional responsibilities. The Board and I are thrilled to recognize the tremendous contributions these executive leaders have made with their promotion announcements yesterday. You've probably heard me say many times that in conjunction with the Board, one of my key responsibilities is succession planning for key roles and I look forward to continuing to work with them and prepare them for the future. Turning to investments. We have been very pleased with our investment portfolio's performance as it continues to produce strong net investment income with minimal losses and impairments. As an insurance company, our primary responsibility is to fulfill the promises we make to our policyholders, while being responsive to the needs of our shareholders. Our solid portfolio supports our promise to our policyholders as does our commitment to maintaining strong capital ratios. We balance this financial strength with tactical capital deployment. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows. This supports both our dividend track record and tactical share repurchase. We treasure our track record of what is now 42 consecutive years of dividend growth with the Board of Directors declaration of the fourth quarter dividend of $0.50. We repurchased $500 million in shares during the quarter and intend to continue our balanced tactical approach of investing in growth and driving long-term operating efficiencies. Our management team, employees, and sales distribution continue to be dedicated stewards of our business, being there for the policyholders when they need us most just as we promised. This exemplifies our goal of providing customers with the best value in the supplemental insurance products in the United States and Japan. We believe in the underlying strengths of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. Aflac is well-positioned as we work toward achieving long-term growth while also ensuring we deliver on our promise to our policyholders. I'll now turn the program over to Max to cover more details of the financial results. Max?"
},
{
"speaker": "Max Broden",
"content": "Thank you, Dan. Thank you for joining me as I provide a financial update on Aflac Incorporated's results for the third quarter of 2024. For the quarter, adjusted earnings per diluted share increased 17.4% year-over-year to $2.16 with a $0.03 negative impact from FX in the quarter. In the quarter, remeasurement gains on reserves totaled $408 million, reducing benefits while an offsetting unlock of the deferred profit liability in Japan reduced earned premium by $75 million. Variable investment income ran $27 million below our long-term return expectations. Adjusted book value per share, including foreign currency translation gains and losses increased 7.3% and the adjusted ROE was 16.7%, an acceptable spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment, net earned premiums for the quarter declined 10.5%. This decline reflects a ¥7.3 billion negative impact from an internal cancer reinsurance transaction executed in the fourth quarter of 2023 and a ¥4.6 billion negative impact from paid-up policies. In addition, there is a ¥13.3 billion negative impact from deferred profit liability, the majority of which is a one-time impact from unlocking of LDTI assumptions. At the same time, policies in force declined 2.3%. Japan's total benefit ratio came in at 49.2% for the quarter down 15.9 percentage points year-over-year and the third sector benefit ratio was 41.8% down approximately 13 percentage points year-over-year. We estimate the impact from remeasurement gains to be approximately 18 percentage points favorable to the benefit ratio in Q3 2024. Long-term experience trends as it relates to treatments of cancer and hospitalization continue to be in place, leading to continued favorable underwriting experience. Given the impact from unlocking, we now expect the full year benefit ratio to end up in the range of 62% to 63%. Persistency remained solid with a rate of 93.3%, which was down 20 basis points year-over-year. This change in persistency is in line with our expectations. Our expense ratio in Japan was 20% up 100 basis points year-over-year driven primarily by decline in revenues. Adjusted net investment income in yen terms was up 0.1% as the benefits from lower hedge costs and favorable impact from foreign currency on U.S. dollar investments in yen terms were largely offset by lower floating rate income and lower volume as we have continued to shift assets from Aflac Japan to Aflac Re Bermuda. The pre-tax margin for Japan in the quarter was 44.7%, up 11.9 percentage points year-over-year, a very good result. For the full year, we now expect the pre-tax margin to be in the range of 35% to 36%. Turning to U.S. results, net earned premium was up 2.8%, persistency increased 20 basis points year-over-year to 78.9%. Considering our year-to-date results, we now expect full year net earned premium to be towards the lower end of our guidance range of 3% to 5%. Our total benefit ratio came in at 47.6%, 11.7 percentage points higher than Q3 2023 driven by lower remeasurement gains than a year ago. We estimate that the remeasurement gains impacted the benefit ratio by approximately 120 basis points in the quarter. Claims utilization has rebounded from depressed levels during the pandemic and are now more in line with our long-term expectations. For the full year, we would expect the benefit ratio to be towards the higher end of our guidance range of 45% to 47%. Our expense ratio in the U.S. was 38% down 260 basis points year-over-year, primarily driven by platforms improving scale and strong expense management. Given business seasonality, we would expect an uptick in expense ratio for Q4, but to remain with our guidance range of 38% to 40% for the full year. Our growth initiatives Group Life and Disability, Network Dental Vision and direct-to-consumer increased our total expense ratio by 100 basis points. This is in line with our expectations and we would expect this impact to decrease going forward as these businesses grow to scale and improve their profitability. Adjusted net investment income in the U.S. was up 0.5% mainly driven by higher fixed rate income. Profitability in the U.S. segment was solid with a pre-tax margin of 20.8% also a good result. Our total commercial real estate loan watchlist remains approximately $1 billion with less than $250 million in process of foreclosure currently. As a result of these current low valuation marks, we increased our CECL reserves associated with these loans by $3 million in this quarter, net of charge-offs. We've had one foreclosure moved into real estate-owned. We continue to believe that the current distressed market does not reflect the true intrinsic value of our portfolio, which is why we are confident in our ability to take ownership of these assets, manage them through this cycle, and maximize our recoveries. Our portfolio of first lien senior secured middle market loans continued to perform well with losses below our expectations for this point in the cycle. In our Corporate segment, we recorded a pre-tax gain of $15 million. Adjusted net investment income was $37 million higher than last year due to a combination of higher rates and asset balances, which included the impact of reinsurance transactions in Q4 of 2023, as well as continued lower volume of tax credit investments. These tax credit investments impacted the corporate net investment income line for U.S. GAAP purposes negatively by $57 million in the quarter with an associated credit to the tax line. The net impact to our bottom line was a positive $5 million in the quarter. To-date, these investments are performing well and in line with our expectations. We are continuing to build out our internal reinsurance platform, and I'm pleased with the outcome and performance. In the fourth quarter, we intend to execute another tranche with similar structure and economics in yen terms to our October 2023 transaction. Our capital position remained strong, and we ended the quarter with an SMR about 1,100% and our combined RBC, while not finalized, we estimate to be greater than 650%. These are strong capital ratios, which we actively monitor, stress and manage to withstand credit cycles as well as external shocks. U.S. statutory impairments were $58 million, and there were no additional Japan FSA impairments in Q3. This is well within our expectations and with limited impact to both earnings and capital. As we hold approximately 60% of our debt in yen, our leverage increased to 21% as a result of the move in the yen-dollar exchange rate, well within our target range of 20% to 25%. Our leverage will fluctuate with movements in the yen-dollar rate. This is intentional and part of our enterprise hedging program protecting the economic value of Aflac Japan in the U.S. dollar terms. Unencumbered holding company liquidity stood at $3.9 billion, $2.1 billion above our minimum balance. We repurchased $500 million of our own stock and paid dividends of $280 million in Q3, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Thank you. And I will now hand over to David to begin Q&A."
},
{
"speaker": "David Young",
"content": "Thank you, Max. Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. You may then rejoin the queue. We'll now take the first question."
},
{
"speaker": "Operator",
"content": "We'll now begin the question-and-answer session. [Operator Instructions]. And our first question comes from Joel Hurwitz from Dowling & Partners. Please go ahead."
},
{
"speaker": "Joel Hurwitz",
"content": "Hi, good morning. I wanted to start on Japan sales. So third sector sales continues to be a bit challenged. Can you just talk about plans for both cancer and medical? And what are you expecting from sales promotions related to the 50th anniversary?"
},
{
"speaker": "Koichiro Yoshizumi",
"content": "[Foreign Language] This is Yoshizumi, in charge of Sales and Marketing in Japan. [Foreign Language] So let me first start off with how we are successful. And the reason for that is because of this new product that we've launched, which is an asset formation product plus the nursing care coverage. And this product also has a feature that once it becomes paid up, this can be converted into medical, nursing care or death benefit. [Foreign Language] First of all, again, this Tsumitasu was developed to meet the young and middle-aged customers' needs for asset formation and contribute to the expansion of third sector sales. [Foreign Language] And considerable preparations for sales from June through third quarter led to 12.3% growth. [Foreign Language] And the purpose was to approach young and middle aged new customers and new customers. [Foreign Language] As well as proposing additional sales of third sector products. [Foreign Language] And also to cross-sell products. [Foreign Language] And this has led to revitalizing the sales activities of the associates. [Foreign Language] So as a result, what we are expecting is that our third sector sales would grow increase by selling Tsumitasu. [Foreign Language] Now let me turn to cancer insurance. [Foreign Language] And as you mentioned, by using 50th anniversary as our trader or a hook, we are trying to sell our cancer insurance and cross-sell cancer insurance. [Foreign Language] And as you may know, our cancer insurance was launched two years ago, meaning that it has gone two years already. [Foreign Language] We have a service called concierge service that no other company is able to offer. [Foreign Language] In other words, this is called the Yoriso cancer consultation support service. [Foreign Language] And what we are trying to do is by using to appeal this product and service; we are using TV commercials and web advertisement to really appeal the value of this product and service. [Foreign Language] And we are also considering to launch a new product around spring next year. [Foreign Language] So as a result, we are expecting that our cancer sales will increase. [Foreign Language] Now turning to medical insurance. [Foreign Language] We've changed the product name and rerounded. [Foreign Language] And this is also one of its kind that only Aflac has in terms of the coverage, and it's really attracting attention of the market. In other words, we have this mostly coverage feature that no other company has. [Foreign Language] And we would like to grow the sale of this product together with Tsumitasu. [Foreign Language] And we've also launched a new plan for middle and older aged customers over 50 years old. [Foreign Language] So as a result, we are seeing a gradual recovery in medical sales, and we are expecting good sales from it. [Foreign Language] And overall, we are expecting that our third sector product sales will recover and increase because of the reasons that I've mentioned. At the same time, we have been quite successful in recruiting sales agents for the third sector, and we are strengthening our sales force, too. [Foreign Language] That's all for me."
},
{
"speaker": "Operator",
"content": "The next question comes from Tom Gallagher from Evercore ISI. Please go ahead."
},
{
"speaker": "Tom Gallagher",
"content": "Good morning. First question just on capital allocation, and I'll just have a quick follow-up on sales. So can you talk a bit about broader capital allocation, how you're thinking about it? I know the buyback was a bit lower this quarter, but you have the strong level of excess capital accumulating. Any thoughts on a special dividend, M&A, as you think about -- let's just say if the stock does continue to trade at strong levels, what would your plans be? Would you still do good levels of buybacks heading into next year? Or would you consider these other options? Thanks."
},
{
"speaker": "Max Broden",
"content": "Thank you, Tom. You're right in acknowledging that our capital ratios, they are strong. We are also generating significant capital both organically throughout our operations, plus what we are doing around reinsurance as well, freeing up additional levels of capital. So we are very strong on that front. And then we look at all of those opportunities that you mentioned, and I would not put anything off the table. We evaluate what -- where we can get the best returns currently, but more importantly, long-term. When we evaluate our business, we think about it over the next 1, 2, 3, 5, 10, 15, 20 years and think about what is going to generate the highest return on that capital for us over that time period. And especially when you think strategically around things like M&A, you have to take that into consideration. So these are the things that go into our capital allocation consideration, both in terms of, obviously, how much we have, how we see capital generation coming to us and then ultimately, the returns that we can get. And we really mean it when we say that we are thinking about what those returns are, and it is a dynamic world where these things are changing but I will not take anything off the table. That includes, obviously, everything that you mentioned."
},
{
"speaker": "Tom Gallagher",
"content": "Okay. Thanks for that, Max. And just a follow-up on sales. Can you give a sense for the split between -- of the first sector product you're selling? What's the split between new customers versus existing customers that are buying that product? Thanks."
},
{
"speaker": "Koichiro Yoshizumi",
"content": "[Foreign Language] If you're asking about the new customer ratio of the sale of first sector product. [Foreign Language] Well, right now, sales to existing customers is larger than to those of new customers. And this is always the case when we launch a new product. [Foreign Language] And when we do this kind of first sector sale, there's always a cross-sell, and we do -- we are meeting the expected level of cross-sell rate at the moment. And as we move forward on a monthly basis, more and more new customers are increasing. [Foreign Language] And what it also means is that when we explore -- try to acquire young and middle-aged customers using Tsumitasu that just purely means that we are trying to acquire new customers. [Foreign Language] So our strategy to increase new customers after we go around the cycle of approaching to our existing customers, and that's what we are doing and that's our strategy. Thank you. That's all."
},
{
"speaker": "Dan Amos",
"content": "Yes. I'd like to make a comment about that. I would say that the numbers are falling in line with our expectations. We thought it would be over 20%. We hope it would be closer to 25%. Sure not been started at about 20%, and it's moved up to 25%. And so that's in the range of what we had anticipated or maybe even a little better. So we're very pleased with Tsumitasu and what is taking place and how it's bringing on new customers for us, young and middle age. So that should answer your question."
},
{
"speaker": "Operator",
"content": "Next question comes from Wes Carmichael from Autonomous Research. Please go ahead."
},
{
"speaker": "Wes Carmichael",
"content": "Hey, thanks. Good morning. From Yoshizumi-san's remarks, it sounds like the sales force is really leaning into Tsumitasu. I guess my question is, does this really kind of like contemplate a fee change where we should see a greater contribution from first sector sales going forward. And I know, Max, you said the returns after reinsurance are kind of similar to third sector products. So really just want to understand strategically if we should expect that mix to be more balanced going forward, between first sector and third."
},
{
"speaker": "Max Broden",
"content": "Given -- given what Japan is going through and I would -- and I would expect that --"
},
{
"speaker": "Koichiro Yoshizumi",
"content": "[Foreign Language] So our strategy can be divided into two parts. One is, of course, to ensure profitability by using reinsurance. And the other is as I've mentioned earlier, by Tsumitasu, we are also bringing in new third sector. And that way, we are trying to secure profits and revenue from that perspective."
},
{
"speaker": "Max Broden",
"content": "Let me add a comment to that answer. Tsumitasu has important aspects to many parts of our business. And it is the fact that Japan, as a society, obviously, is aging. And with that, there is a significant increase in retirement needs and retirement funding. And Japan is pushing harder to become more of an asset management country as well with policies. That means that we would expect that a retirement products are going to going to be and more important tool for both the financial industry and for us going forward. And you have seen how Yoshizumi-san outlined how we are using Tsumitasu to then also cross-sell our third sector business. So I would expect it to be a more meaningful part of our portfolio going forward than what it has been in a more recent past. I still definitely think that we will predominantly be a third sector company, but where the first sector savings business will be a meaningful component of our total sales."
},
{
"speaker": "Operator",
"content": "The next question comes from Ryan Krueger from KBW. Please go ahead."
},
{
"speaker": "Ryan Krueger",
"content": "Hey, thanks. Good morning. I had a question on the Japan benefit ratio. I think coming into the year, your guidance was 66% to 68%. I guess when we think about the assumptions unlocking, and year-to-date experience, would you expect that to be improved from the original expectation going forward? I guess, it looks like your guidance for the full year implied maybe something closer to 65% to 67% in the fourth quarter."
},
{
"speaker": "Max Broden",
"content": "Yes. The impact from this unlock is that we have lowered the future net premium ratio by roughly 100 basis points. So all things being equal, that means that we would expect our benefit ratio going forward for our in-force business to be roughly 100 basis points lower than what we previously expected before the unlock. So it does have an impact for future benefit ratios as well and that would apply going into 2025 as well."
},
{
"speaker": "Ryan Krueger",
"content": "Thanks. And then just a quick one. Can you give us your run rate earnings expectations for the Corporate segment at this point? I guess, let's say, assuming 0 tax credit impact."
},
{
"speaker": "Max Broden",
"content": "So, in this quarter, we had a $15 million pre-tax profit and the tax credit investments lowered that number by roughly $57 million on a pre-tax basis. So that will get you closer to the run rate as of this quarter. I would acknowledge that this is an area where we are sensitive to short-term yields. So if you have a short-term yields coming down, that would put pressure a little bit on that number. But I would expect that in the near-term, our run rate profitability should be that we will continue to be profitable in that segment, all things being equal for -- that's the current run rate."
},
{
"speaker": "Operator",
"content": "The next question comes from John Barnidge from Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"content": "Good morning. Thanks for the opportunity. My question sticks there. On the 100 basis points of future benefit ratio benefit that are or do you take into account long-term experience? Would short-term experience that continues to be favorable, be incremental to that 100 basis points. Thank you."
},
{
"speaker": "Max Broden",
"content": "Let me start off, and I'll ask Alycia, our Global Chief Actuary, to fill in with any comments she may have. Obviously, when we do a deep dive study as we just concluded, we try to incorporate all the experience that we've had to-date, but then also obviously unlocking future assumptions. In those future assumptions, there is a future trend incorporated in that. And if future experience tends to -- if it would were to deviate to that trend that could lead to either further releases or increases related to that. But I do want to acknowledge that there is an element of a future trend incorporated in these unlocks as well."
},
{
"speaker": "Alycia Slyck",
"content": "Thank you, Max. Yes, we incorporated our future trend into our unlock this year. So we believe we have reflected all of our current experience and expectations. We do review our assumptions annually to investigate new trends, but all of that has currently been reflected in this unlock."
},
{
"speaker": "John Barnidge",
"content": "Thank you for that. And my follow-up question that's related following an 18-point benefit from the unlock, do you view that, that increases the total addressable market for liabilities that over the long-term could potentially go to Bermuda? Thank you."
},
{
"speaker": "Max Broden",
"content": "Yes. I would view them as somewhat unrelated. This unlock is a U.S. GAAP unlock only with no impact to our U.S. statutory results in the U.S. and reserves and no impact to our FSA results or FSA reserves. So I would not draw that link."
},
{
"speaker": "Operator",
"content": "Our next question comes from Jimmy Bhullar from J.P. Morgan. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"content": "First, I had a question on just your expected -- your expectations for how Tsumitasu sales are going to trend? Should we assume that they're going to keep growing from here? Or was there sort of a pent-up demand phenomena to where sales will begin to fade over the next few quarters?"
},
{
"speaker": "Koichiro Yoshizumi",
"content": "[Foreign Language] Thank you for the questions. Let me answer this question. This is Yoshizumi once again. [Foreign Language] Well, Tsumitasu was launched in June as a new product. And in that month, in June, we had a very big sales. And the reason why we were able to do so is because we had fully prepared for it in advance of the launch. [Foreign Language] And from July and on, Tsumitasu sales have been successful, and it is meeting -- it is meeting the level that we have been expecting. [Foreign Language] And as I have mentioned several times that Tsumitasu is very well known and we're very well taken by customers, and it's a very popular product in the market. [Foreign Language] So as a result, what we are thinking is that until the end of the year, perhaps next quarter, we should be able to generate a very stable number from Tsumitasu. [Foreign Language] And as I have mentioned earlier that this product is very popular among young people because this product does meet the needs of these young people. And what that means is that during their payment period, they would have asset formation function as well as nursing care. And then, after that period, the customer can choose from medical, nursing care or a death benefit. And that's the reason why this product is so popular among young people. [Foreign Language] So my conclusion is that we are expecting to have a certain level of sales from Tsumitasu going forward as well. [Foreign Language] That's all for me."
},
{
"speaker": "Jimmy Bhullar",
"content": "Okay. Thanks. And then on the U.S. business, it seems like incurred claims are running a lot higher so far this year than they have in the last several years. Is that a mix issue? Or are you just seeing usage in some of the products pick up? Or are there other factors driving that?"
},
{
"speaker": "Virgil Miller",
"content": "Hi, good morning. This is Virgil from the U.S. It is -- I would say that some of it is definitely delivered an extension on our part. We want to make sure that we put the value of the benefits in the hands of the policyholders but we don't want to over toggle. So what we've done this year is we've increased benefits on certain lines of business at no additional cost. We've gone out and pushed campaigns for consumers to file one of those benefits to make sure that we try to catch any type of problem before it turns into a long-term condition. And then the last thing I would say to you, though, is that mix does matter. We've been pushing on the cancer business while an individual line of business, and we've had good success year-to-date with sales up about 9%. And then the last thing I would say is we introduced and I mentioned this before, about our stronger underwriting discipline on our VB benefits. And we're really looking now to bring on business with high turnover and thus yielding better persistency for us over the long-term. All of these things are factoring in to help drive a move that benefit ratio. We are constantly monitoring though, to make sure that we're within our tolerance."
},
{
"speaker": "Max Broden",
"content": "And then just to add to that, there is one more mix impact that is running through the U.S. results. And that is as we grow our Group Life and Disability business and that becomes a greater proportion of our in-force that will, over time, drive up the benefit ratio for the U.S. segment. The Group Life and Disability business, we would expect to run at sort of a low 80s benefit ratio. So all things being equal, that will continue to push that benefit ratio higher."
},
{
"speaker": "Operator",
"content": "The next question comes from Wilma Burdis from Raymond James. Please go ahead."
},
{
"speaker": "Wilma Burdis",
"content": "Hey, good morning. I guess, what is the Dan's recent promotions? Could you talk a little bit about what you're most focused on from a development and succession perspective over the next couple of years? Thanks."
},
{
"speaker": "Max Broden",
"content": "Wilma, there was something that moved when you asked the question at the very start. What were you asking?"
},
{
"speaker": "Wilma Burdis",
"content": "Sorry, I said for Dan, given the recent promotions, could you talk a little bit more about what you're focused on from a development and succession perspective for the next couple of years? Thanks."
},
{
"speaker": "Dan Amos",
"content": "Well, I think the first question is how does it relate to me specifically and what are my plans? And my plans really haven't changed. I serve at the pleasure of the Board and frankly, enjoy doing that. They ultimately make the final decisions on what they want to happen, but I'm enjoying it. But at the same time, I owe it to the shareholders and the Board to make sure there's a succession plan and there's a depth in management that is there to show our ability to continue on without disruption. And I believe that we've got the people in place with the opportunity. And first, I have suggested to the Board and that they begin to place someone internally several people that they think have potential to take over one day. And certainly, Virgil is at the top of that list. He -- I have to say I'm very pleased with the U.S. because it's become a much different company than it was five years ago. As we've gotten into the plans business that I think it was Max was talking about, and we've seen look at group business and how Virgil mentioned that we're not right in certain types of business. And then we've got our distribution channel, which is very unusual. There really aren't many people out there that have the distribution channel that we have from an independent agent's perspective. And then building on the broker business and what's going on there in the U.S. And so, yes, I think he certainly deserves the opportunity to have his name in the pot for what will take place when I do retire at some point in time. I think Max is showing his strength on the call today and what he's doing. And he's gone in as if it was uninterrupted with the job that Fred was doing before he left at this year. And so I've been very pleased with that. And then Audrey has always been an outstanding person for us from counsel, from independent review of not just that, but any issue that might be out there that concerns understanding the employees, understanding the law, understanding all of those aspects of it. So I feel very good about these promotions. And then we had several others our Head of IT, being Executive Vice President, and she is doing a great job. She's rated one of the 100 in best women in America in the IT area. So we're lucky to have her. You heard Alycia has been with us a little over a year, and she has jumped right in. So I'm very pleased with the bench. We've got Robin, who's now Chief Accounting Officer of the company and you, we've got Fred Simard. Certainly, what Brad has done has been uninterrupted in terms of taking over Eric's position. So all in all, I have to tell you that our bench is strong. There -- most of them are relatively new in the positions. They've had more responsibility added to them in certain cases, as is in the case of Brad, he's picked up more. You've seen it with Max and what's taking place. So all in all, that's where I am. And I'll just tell you that I'm happy and we'll continue on. But I want someone that if something happened tomorrow, there would be a smooth transition and the Board has plenty of options to do what they deem as necessary."
},
{
"speaker": "Wilma Burdis",
"content": "Thank you, and congrats to Virgil, Max and Audrey as well. One maybe for Virgil, could you discuss any macro or employment environment impacts that you're seeing in the U.S. that are impacting sales and/or recruiting. Thanks."
},
{
"speaker": "Virgil Miller",
"content": "Yes. Thank you for the question. And thank you for the congratulations. I'm excited about the opportunity and look forward to partnering with my colleagues here in pushing the Aflac forward for the future. I would say that you saw that earlier in the year, we started out of the gate slow with our sales, put it up a negative quarter that we were able to rebound in the second quarter, coming up with about a 2.2% increase. And then for this quarter, really exceeded what I expect at a 5.5% increase. And it's really accumulating from a couple of things. Max and Dan both mentioned the plans business. What that means from my perspective, till is we have an opportunity right now in a strong product base to compete in the jumbo case market. Generally, we're talking about employer groups with more than 5,000 employees. And then we're also talking about the relationships that we forged with the brokers in that space. At the same time, though, we continue to focus on building our career field force channel bank. And what you're seeing, though, is in that first quarter, slow movement on recruitment. We were able to come back with a 10% increase in recruiting. And I'm pleased, again, this quarter; we were able to come up with a positive increase in recruiting. So therefore, I will tell you that there are some economics of things happening around us, but it's all about getting and building up our field and making sure we've got talented recruits that become veterans. Our pipeline is stronger this year and will have strong. Our goal is to convert them into average week of producer. So in that environment, we're going to continue to play in the small case market, make sure we for its broker relationship and then continue to build reputation up in that larger case space. And I would think that we continue to see consistency in the U.S. like you're saying."
},
{
"speaker": "Operator",
"content": "The next question comes from Nick Annitto from Wells Fargo. Please go ahead."
},
{
"speaker": "Nick Annitto",
"content": "Hey, good morning. Thanks. Just on the U.S., can you touch a little bit on persistency and what's driving the strength there, assuming it's just some sort of mix?"
},
{
"speaker": "Virgil Miller",
"content": "Hi, yes. Let me start again. This is Virgil, and let me start with the dimension of Max mentioned that earlier. Mix does matched. So as we continue to scale up our life and absence and disability business that we brought on Board, it does start now to influence overall. But I would say if you kind of go back and just look at our original individual business; we are also seeing some improvement there. That is driven by some intentional efforts. So some of the things we're doing, I mentioned earlier, is making sure we focus on those products that have a higher persistency. We started in this business known with the reputation of a cancer insurance company. Cancer insurance is still extremely important to us. We continue to push on that product have success. And as Dan would say, cancer is a disease of age. Therefore, people are more likely to keep it once they have it, and we absolutely see that in our numbers. I would also tell you though that we're also doing intentional efforts, and this is why you're seeing some of the movement in the benefit ratio. We continue to drive our wellness benefits. We've actually made some increases on what we pay out on some of our policies. We've also increased the benefit though, on things like our hospital, our policy groups demonstrating though adding additional benefit and value for those consumers. As long as we can demonstrate consumer value, we have a likelihood of building that loyalty we're going to keep the products, we want to continue those things and we do think that it's having to influence our persistency along with the mix that you mentioned."
},
{
"speaker": "Operator",
"content": "The next question comes from Alex Scott from Barclays. Please go ahead."
},
{
"speaker": "Unidentified Analyst",
"content": "Good morning. This is Jack Ellison [ph] on for Alex. So I appreciate all the color around sales initiatives in Japan. But do you mind talking more about the competitive environment you're seeing over there and specifically in third sector products. Thank you."
},
{
"speaker": "Koichiro Yoshizumi",
"content": "[Foreign Language] Okay. This is Yoshizumi once again. I will be answering your questions. [Foreign Language] And when you talk about third sector, it's basically about medical insurance. And as you may know, the competition continues to be very to severe. [Foreign Language] So the situation where one company launched their product and then another company will launch a product, and that situation has not changed. [Foreign Language] So in order for us to survive in this competitive environment, what we need to do is, first of all, to have some uniqueness. [Foreign Language] And also the flexibility that would serve customers' needs. [Foreign Language] An easy-to-understand feature. [Foreign Language] These would be the features that would be needed in a product. [Foreign Language] And then on top of that, we would need a distribution channel to sell this kind of product. [Foreign Language] And Aflac now currently has this new medical feature called monthly coverage, which is very reasonable and which is very well received by the market. [Foreign Language] And this product also has a very flexible features, too. [Foreign Language] So because of these products, uniqueness as well as the flexibility, this product is attracting a lot of attention in the market. [Foreign Language] And talking about our distribution channel, which is really a strength of ours is that there are agencies that only sell Aflac products and they're very loyal to our products. [Foreign Language] And at the same time, we also register our products with large non-exclusive agencies that have large volume of young and middle aged customers. [Foreign Language] And we firmly believe that we can win in the competition by increasing our sales through these channels. [Foreign Language] And now let me talk about cancer. [Foreign Language] We have 50 years of history with cancer insurance. [Foreign Language] So that intelligence that we've gathered. [Foreign Language] And the expertise that we have is something that no other company has and we also have a relationship with the government, politics, and also other areas of businesses. And this network is not something that any other company has. [Foreign Language] And as a very big channel, we also have Japan Post. [Foreign Language] Well, Japan Post sells Aflac Cancer Insurance. [Foreign Language] And Japan Post does not sell any other companies cancer insurance. [Foreign Language] And I do firmly believe that we can have a very good future and have had expectation for the future in both cancer and medical by fully leveraging this third sector power, and we truly become number one or we are the number one third sector company. [Foreign Language] We will constantly be looking at the market. [Foreign Language] And we'll be launching products to meet the needs and respond to the customers' needs. [Foreign Language] And of course, develop and grow our distribution channel. [Foreign Language] And win against our competitors. [Foreign Language] And that is my way of thinking."
},
{
"speaker": "Operator",
"content": "This concludes our question-and-answer session. I would like to turn the conference back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"content": "Thank you all for joining us today. We hope you'll join us on December 3rd at our Financial Analyst Briefing. If you have any questions, please follow-up with Investor and Rating Agency Relations, and we appreciate it. Have a good day."
},
{
"speaker": "Operator",
"content": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
afl | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Aflac Incorporated Second Quarter 2024 Earnings Conference Call. All participants will be in a listen only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President of Investor and Rating Agency Relations. Please go ahead."
},
{
"speaker": "David Young",
"content": "Good morning, and welcome. Thank you for joining us for Aflac Incorporated Second quarter earnings call. While I have your attention I also want you to mark your calendars to join us for our Financial Analyst Briefing at the New York Stock Exchange on December 3rd. Now this morning, Dan Amos, Chairman, CEO and President of Aflac Incorporated will provide an overview of our results and operations in Japan and the United States. Then, Max Broden, Executive Vice-President and CFO of Aflac Incorporated will provide an update on our financial results and current capital and liquidity. These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com, including Max's quarterly video updates which also includes information about the outlook for 2024. We also posted under Financials, on the same site, updated slides of investment details related to our commercial real-estate and middle-market loans. For Q&A today, we are also joined by Virgil Miller, President of Aflac US.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments. Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-US GAAP measures. I'll now hand the call over to Dan."
},
{
"speaker": "Dan Amos",
"content": "Thank you, David, and good morning, and we're glad you joined us. Aflac Incorporated delivered another quarter and six months of very solid earnings results. Net earnings per diluted share were $3.10 for the quarter and $4.64 for the first six months. On an adjusted basis, earnings per diluted share for the quarter were we're up 15.8% to $1.83 and for the first six months, we were up 11.5% to $3.49. From a broad operational perspective, we've generated profitable growth in the United States and Japan with new products and distribution strategies. We believe our strategy will continue to create long-term value for the shareholders, at the same time, we believe that the need for our products we offer is a strong or stronger than it has ever been before in both the United States and Japan. Beginning with Japan, we have continued to focus on third sector products like our cancer insurance product called the WINGS as the new fiscal year began in Japan, we saw continued improvement in cancer insurance through the Japan Post Channel. We have continued our strategy of introducing life insurance products including Tsumitasu, which we launched on June 2nd. This product offers policyholders an hazard formation component with nursing care option. It was designed to attract new and younger customers, while also introducing opportunities to sell them our core third sector products. While still very early, we are pleased with how our agencies have sold this product, which drove a 4.5% sales increase for the second quarter being where consumers want to buy insurance remains in an important element of the growth strategy in Japan. Our broad network of distribution channels including agencies, alliance partners and banks continually optimize our opportunities to help provide financial protection to the Japanese consumers. We will continue to work hard to support each channel. Overall, Koide San and his team have done a great job of turning around sales in Japan and delivering record profit margins for the quarter. I am very pleased with their efforts. Turning to the US, we achieved a 2% sales growth for the quarter benefiting from good growth in Group Life Absent Management and Disability and individual voluntary benefits This is a welcome results as we enter the second half of the year that tends to be the heaviest enrollment period. At the same time, we continue to focus on more profitable growth by exercising a stronger underwriting discipline. Additionally, we've increased benefits in certain policies to improve the value for the policyholder. We believe persistency will remain strong as customers realize the value of their policies and the related benefits. We have also continued our disciplined approach to expense management, which Max will address. As we enter the second half of the year, we are continuing to focus on optimizing our Dental and Vision platform. Overall, I'm pleased with what Virgil and his team are doing to balance profitable growth enhance the value proposition for the policyholders and curb the expense ratios. Their efforts contributed to the very strong pre-tax profit margin of 22.7% for the second quarter. Now turn to our ongoing commitment to prudent liquidity and capital management. Max has done a great job leading his team to take proactive steps in recent years to defend our cash flow and deployable capital against a weakening yen, as well as establishing a reinsurance platform in Bermuda. We have been very pleased with our investment portfolios’ performance as it continues to produce strong net investment income with minimal losses and impairments responsibility is to fulfill the promises we make to our policyholders, while being responsive to the needs of our shareholders. We remain committed to maintaining strong capital ratios on behalf of the policyholders. We balance this financial strength with tactical capital deployment. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows. This supports both our dividend track record and tactical share repurchase. We treasure our track record of 41 consecutive years of dividend growth and remain committed to extending it. I am pleased that the Board set us on a path to continue this record when it increased the first quarter 2024 dividend 19% to $0.50 and declared the second and third quarter dividends of $0.50. We repurchased a record $800 million in shares during the quarter, and intend to continue our balanced, tactical approach of investing in growth and driving long-term operating efficiencies. Our management team, employees and sales distribution continue to be dedicated stewards of our business, being there for the policyholders when they need us most just as we promised. This underpins our goal of providing customers with the best value in the supplemental insurance products in the United States and Japan. In November, we celebrate our 50th year of doing business in Japan. Additionally, in June, we celebrated our 50th year as a publicly traded company on the New York Stock Exchange. We are reminded that one thing has not changed since the founding in 1955, families and individuals still seek to protect themselves from financial hardships that not even the best health insurance covers. Today’s complex healthcare environment has produced incredible medical advances that come with incredible costs. It’s more important than ever to have that partner. We believe our approach to offering relevant products makes us that partner. We believe in the underlying strengths of our business and our potential for continued growth in Japan and the United States, two of the largest life insurance markets in the world. Aflac is well-positioned as we work toward achieving our long-term growth while also ensuring we deliver on our promise to our policyholders. I'll now turn the program over to Max to cover in more details the financial results. Max?"
},
{
"speaker": "Max Broden",
"content": "Thank you, Dan and thank you for joining me as I’ll provide a financial update on Aflac Incorporated’s results for the second quarter of 2024. For the quarter, adjusted earnings per diluted share increased 15.8% year-over-year to the $1.83 with a $0.07 negative impact from FX in the quarter. In this quarter, reinvestment gains on reserves totaled $51 million and variable investment income ran $1 million above our long-term return expectations. We also received a make whole payment adding approximately $20 million or $0.03 per share to our adjusted earnings. Adjusted book value per share, including foreign currency translation and the gains and losses increased 9.4% and the adjusted ROE was 14.3%, an acceptable spread to our cost of capital. Overall, we view these results in the quarter as solid. Starting with our Japan segment, net earned premiums for the quarter declined 5.7%. This decline reflects a 7.4 billion yen negative impact from internal reinsurance transaction executed in the fourth quarter of 2023 and 4.8 billion yen negative impact from paid up policies. In addition, there is a 1.2 billion yen positive impact from deferred profit liability. Lapses were somewhat elevated but within our expectations. At the same time, policies in force declined 2.4%. Japan's total benefit ratio came in at 66.9% for the quarter up 120 basis points year-over-year and the third sector benefit ratio was 57.8%, up the approximately 160 basis points year-over-year. We estimate the impact from reinvestment gains to be 140 basis points favorable to the benefit ratio in Q2 2024. Long-term experience trends as it relates to treatment of cancer and hospitalization continue to be in place leading to the continued favorable underwriting experience. Persistency remains solid with a rate of 93.3%, which was down 50 basis points year-over-year. This change in persistency is in line with our expectations. Our expense ratio in Japan was 17.8%, down 170 basis points year-over-year, driven primarily by the expense allowance from reinsurance transactions and continued discipline expense management. Adjusted net investment income in Yen terms was up 28.4%, mainly by favorably impact from FX on US dollar investments in yen terms, lower hedge costs, higher return on our alternatives portfolio compared to second quarter of 2023 and call income. The pre-tax more than for Japan in the quarter was 35.3%, up $490 basis points year-over-year, a very good result. Turning to US results, net earned premium was up 2.1%, persistency increased 50 basis points year-over-year to 78.7%. We are encouraged by early signs from our persistency efforts and we will remain focused on driving profitable growth. Our total benefit ratio came in at 46.7%, 140 basis points higher than Q2 2023 driven by product mix and lower reinvestment gains than a year ago. We estimate that reinvestment gains impacted the benefit ratio by 170 basis points in the quarter. Claims utilization has rebounded from depressed levels during the pandemic and are now more in line with our long-term expectations. Our expense ratio in the US was 36.9%, down to 210 basis points year-over-year, primarily driven by platforms improving scale and strong expense management. We tend to benefit from seasonality in the first half and would expect higher expenses in the second half. Our growth initiatives, Group Life and Disability, network, dental and vision and the direct-to-consumer increased our total expense ratio by 230 basis points. This is in line with our expectation and we would expect this impact to decrease going forward as these businesses grow to scale and improve their profitability. In just that net investment income, in the US was up 7.4%, mainly driven by higher yields on both our alternatives and fixed rate portfolios. Profitability in the US segment was solid with a pre-tax margin of 22.7%, also a very good result. Our total commercial real estate loan watch list stands at approximately $1 billion, with less than $300 million in process of foreclosures currently. As a result of these current low valuation marks, we increased our seasonal reserves associated with these loans by $14 million in this quarter net of charge-offs. We had six loan foreclosures and moved nine properties into real estate owned. We continue to believe that they currently distressed market does not reflect the true intrinsic economic value of our portfolio, which is why we are confident in our ability to take ownership of these assets, manage them through this cycle and maximize our recoveries. Our portfolio of first lean senior, secured middle market loans continue to perform well with losses below our expectations for this point in the cycle. In our Corporate segment, we recorded a pre-tax gain of $23 million. Adjusted net investment income was $39 million higher than last year due to lower volume of tax credit Investments at Aflac Inc. and higher volume of investable assets at Aflac REIT. These tax credit investments impacted the corporate net investment income line for US GAAP purposes negatively by $30 million with an associated credit to the tax line. The net impact to our bottom-line was a positive $4 million in the quarter. To-date, these Investments are performing well and in line with expectations. We're continuing to build up our reinsurance platform and I'm pleased with the outcome and performance. Our capital position remains strong and we ended the quarter with an SMR above 1100 % in Japan, now combined RBC, while not finalized we estimate to be greater than 650%. Unencumbered holding company liquidity stood at $4.1 billion, $2.3 billion above our minimum balance. These are strong capital ratios, which we actively monitor stress and managed to withstand credit cycles, as well as external shocks. US statutory impairments were released of $7 million and Japan FSA impairments were 10.4 billion yen or roughly $67 million in the quarter. This is well within our expectations and with limited impact to both earnings and capital. Adjusted leverage is 19.5% and below our leverage corridor of 20% to 25%. As we hold approximately 60% of our debt denominated in the yen, our leverage will fluctuate with movements in the yen dollar rate. This is intentional and part of our enterprise hedging program protecting the economic value of Aflac Japan in US dollar terms. We repurchased $800 million of our own stock and paid dividends of $283 million in Q2, offering good relative IRR on these capital deployments. We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital. Thank you. I will now turn the call over to David."
},
{
"speaker": "David Young",
"content": "Thank you Max. Before we begin our Q&A, we ask that you please limit yourself to one initial question and a related follow-up. Then you're welcome to rejoin the queue. We will now take the first question."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] The first question today comes from Joel Hurwitz with Dowling & Partners. Please go ahead."
},
{
"speaker": "Joel Hurwitz",
"content": "Hey, good morning. So the new product launch in Japan that happened in June had very strong sales. I guess, can you just talk about the target return on that that first sector product and how it compares to the third sector product? And then what do you see as the cross-sell opportunity there?"
},
{
"speaker": "Dan Amos",
"content": "Max might just take that for chat."
},
{
"speaker": "Max Broden",
"content": "Yeah, let me start on the product profitability. So, when we look at this product through a GAAP lens, it has at or higher GAAP margins than our core third sector business. And on an IR basis, this is obviously lower than our third sector business because of the very significant new business strain associated with the high reserves, but we have lined up reinsurance that we then expect on a post-reinsurance basis it brings us very, very attractive returns, as well. And not too different from our core first sector business."
},
{
"speaker": "Joel Hurwitz",
"content": "Okay and the cross-sell opportunity there with the third sector products?"
},
{
"speaker": "Max Broden",
"content": "I think we'll evolve over time where obviously this product targets a younger clientele that gives us the opportunity to build that relationship and as we travel with that customer through their lifetime, we have an opportunity to then cross-sell both medical and cancer, as well. So over time, I think, there's a good opportunity for us to both get the – Tsumitasi product to the younger clients but also over the lifetime cross-cell cancer and medical to those new clients."
},
{
"speaker": "Dan Amos",
"content": "Yeah, I think Aflac team nicely explains that. It's important that I say it, is remember it with the Tsumitasu product we are hiding a younger group less disposable income than does an older set of potential policyholders. And so whereas, with the older, we might offer the Tsumitasu product or another product and our supplemental for third sector product. With this group, we'd start by putting in one product, which would be the Tsumitasu product and then in a year or so later follow-up and add more. So it's different as we're building that policyholder base, which of course is one of the things we promised you we would work toward doing and Aflac Japan we believe is doing the right thing here for us."
},
{
"speaker": "Operator",
"content": "The next question comes from Jimmy Bhullar with JPMorgan. Please go ahead."
},
{
"speaker": "Jimmy Bhullar",
"content": "Okay. First question just on the expense ratio in both the Japan and the US businesses, I think is the best it’s been in the past several years. So wondering how much of that is sustainable and driven by expense savings or other actions versus maybe just being timing - driven by the timing of discretionary and that spending in advertising?"
},
{
"speaker": "Dan Amos",
"content": "Thank you, Jimmy. Let me start with Japan. Obviously, 17.8% in a quarter is a very low number. We have a guidance range of 19% to 21% and long-term I think that is the range that we will operate within for the Japan segment. We tend to have some seasonality in Japan with the second half having a little bit higher overall spend and I would specifically call out that Aflac Japan turns 50 this year. So we will have some promotional spend associated with that including advertising and a lot of sales activities around that. So therefore I would for the full year that we would end up in the lower end of that 19% to 21% range. For the US, we also have had very good expense control especially in the first half. There are timing differences where I would expect our spend would increase in the second half and I would also caution you to please keep in mind that the fourth quarter, every year has the highest level of sales activity with that comes expenses spend, as well as our expense ratio in the fourth quarter tends to be the highest. Over time, the US still have a number of businesses that are not at scale. And therefore we have we are running those businesses with expenses overruns right now. This includes our Group Life and Disability business, it includes our dental and vision business and it includes our direct-to-consumer business and to some extent also our group our group BB platform. As those businesses really reach that scale then they come down in expense ratio and we will no longer have that expense overrun. So that means there are - there is downward pressure over time to our US expense ratio. But we're very pleased with the expense management and expense control for the first half and in particular into second quarter. But I would caution you when you think about the full year, I still would expect us to be inside of the range of 38% to 40% for the expense ratio in the US."
},
{
"speaker": "Jimmy Bhullar",
"content": "Okay. And then, just maybe for Dan or the Japanese team, you talked a lot about competition in Japan on the last call. And it seems like as rates gone up in Japan some of the companies have cut prices to adjust for that. But what are you seeing in the competitive environment? And is it any different than what you've seen in the last few months or over the past few years?"
},
{
"speaker": "Dan Amos",
"content": "Yoshizumi, would you like to take that?"
},
{
"speaker": "Koichiro Yoshizumi",
"content": "[Foreign Language] Thank you for the question. Good morning everyone. I'm Yoshizumi. I am in charge of sales in Japan. So as you have mentioned our competitors have entered third sector market. And so the environment is totally different compared with maybe five years ago or 10 years ago. [Foreign language] And there are competitors that are launching a very reasonable or low price products. [Foreign language] However, in Aflac, our concept is to launch and sell products that have values to our customers and not just lower product buy for the sake of lowering product - lowering prices, excuse me. [Foreign language] And as we enter into our 50th anniversary this year in Aflac Japan. And this is based on the history and trust that we have from our customers in providing the appropriate insurance policies at all points by thoroughly thinking about what is needed in each environment or at times because the illnesses change and treatment methods change. [Foreign language] Now according to the data that’s been publicized between April 2022 and March 2023, [Foreign language] And Aflac is record the number one most sold policy company in Japan in third sector products. [Foreign language] What we will aim for is to continue to provide customers that most appropriate product for our customers, so that we can maintain our number one position. That’s all for me."
},
{
"speaker": "Operator",
"content": "The next question comes from John Barnidge with Piper Sandler. Please go ahead."
},
{
"speaker": "John Barnidge",
"content": "Good morning. Thank you for the opportunity. My first question is on distribution of the new first sector product in Japan. The closest customers and existing customer and one that doesn’t have that products, I know the product was introduced in early June. Have you identified how much of the existing customer base is the target for this new product? Thank you."
},
{
"speaker": "Dan Amos",
"content": "They're translating give us one second. And Koide, or Yoshizumi please?"
},
{
"speaker": "Koichiro Yoshizumi",
"content": "Hey, this is Yoshizumi once again. Let me continue to answer your question. [Foreign language] We have a large number of existing customers as you know. [Foreign language] And our target customers are young and middle-aged customers. [Foreign language] And the reason why I say our target is young and middle-aged customers is as follows: [Foreign language] Well first of all, the Japanese government is really pushing and encouraging the Japanese citizens to go after asset accumulation products and the Japanese government is offering various systems so that the Japanese citizens can do that. [Foreign language] And as a result of that asset formation needs is heightening very strongly in Japan. [Foreign language] And we’ve launched our new product in order to respond to the kind of asset accumulation needs in Japan. [Foreign language] And this product is very well taken by the market and selling well and it is increasing our sales. [Foreign language] And the reason why this product is attracted attention is because there are various options that would allow our customers to choose after they paid up their premiums for example after they paying off the premiums, this policy can be converted to death benefit or nursing care benefits or the customer can receive cash value and use that cash as asset accumulation. [Foreign language] And as we go through these kind of discussions with our customers there will be more touch points with our customers and there will be more opportunities for our sales people to talk to our customers about third sector products. We’ve already have this established sales pattern and we have trained our sales agents to do so. [Foreign language] So our purpose is to increase our third sector sales by using this new product Tsumitasu as a hook. [Foreign language] Because we are the company that would increase sales by centering on third sector product sales. [Foreign language] And the way we are doing sales is to really ultimately sell third sector products by launching first sector product. And that is based on the needs of younger middle-aged customers at each times and a period of time. [Foreign language] That's all for me."
},
{
"speaker": "John Barnidge",
"content": "Thank you for that. Very helpful my follow up on distribution is the 50th anniversary plans mainly related to this product or is it broader? Could you to about that? Thank you."
},
{
"speaker": "Koichiro Yoshizumi",
"content": "Hey, this is again Yoshizumi. [Foreign language] And as I just mentioned, it’s not just about Tsumitasu, but since we are a company that mainly sell third sector product. [Foreign language] Then for example as for the 50th anniversary, we will be selling pushing for cancer insurance sales and in order to increase our touch points with our customers, we will be having campaigns to offer gifts to our customers. [Foreign language] We also have a conservative service that no other competitor has. [Foreign language] And so so what we were trying to do is to appeal this conservative service in line with our 50th anniversary through the website, TV commercials, and video services. [Foreign language] We have a large number of sales agents and agencies that only sell Aflac and have walked together with Aflac for the past 50 years. [Foreign language] And these agents and agencies are extremely pleased and happy about celebrating 50th anniversary. [Foreign language] And there's a very big momentum for these sales agents and agencies to sell a large proportion of third sector products. [Foreign language] We, as a sales team would like to support these sales agencies at our maximum. [Foreign language] That’s all for me."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] The next question comes from Tom Gallagher with Evercore ISI. Please go ahead."
},
{
"speaker": "Tom Gallagher",
"content": "Good morning. A couple of follow-up questions on the Tsumitasu product in Japan. In response to John's question, I just want to be clear I'm assuming you're not selling this product. The Tsumitasu product to existing customers that already have third sector Aflac products. This would be all brand new Aflac customers. Is that is that correct?"
},
{
"speaker": "Dan Amos",
"content": "Correct. Our thrust is to write new customers, but if someone wants to buy, we certainly will sell it to them because as was mentioned by Max, the profit margin is very acceptable on this product. And so, yes, we'll take anyone that wants to buy. But it is not our push. We want the younger customers is what we're working toward."
},
{
"speaker": "Tom Gallagher",
"content": "And Dan, do you have a - are you keeping track of that to make sure this doesn't become a situation where the sales force kind of monetizes the in-force customer base and does a lot of selling there because then obviously that would limit the cross-sell opportunity?"
},
{
"speaker": "Dan Amos",
"content": "Absolutely, we are. Now they can call more about it. I just was cutting through the translation and Max can cover that a little bit more too."
},
{
"speaker": "Max Broden",
"content": "Tom, we track that closely. So we know what those numbers are. We will not necessarily publish those publicly, but it's an important factor that we keep track of."
},
{
"speaker": "Operator",
"content": "The next question comes from Nick Annitto with Wells Fargo. Please go ahead."
},
{
"speaker": "Nick Annitto",
"content": "Hey, thanks. Good morning. Just wanted to touch on the US a bit. I know, sales came in a little late in the quarter relative to the full year guidance. I just wanted to get your overall thoughts there on the confidence of hitting something in the guidance for the year?"
},
{
"speaker": "Virgil Miller",
"content": "Yeah, good morning. This is Virgil from the US. Let me say that, I think the big thing - the big takeaway is very strong quarter for the US, because of the balanced approach. You heard yourself from Herc and Max earlier, Herc or Dan earlier, what we saw was an increase in not just in sales of 2% but we had an increase of 50 basis points in our premium persistency. We drove a higher benefit ratio that was intentional some intentional actions to put more value into the hands of our customers. We lowered our expense ratio and then that led to one of the highest pre-tax margins we've had in US in some years of 50 basis points and 22.7%. My point on that is that, we knew going to the quarter we’ve came up negative and Q1. Second quarter, I mentioned a previous earlier that we have made a lot of changes to go to a more profitable business. That was really focused in our group with VB business, formerly it’s Continent American business that we bought. We wanted to make sure that we are only bringing business that has higher benefits where people actually filing claims and less churn. So we knew that would have an impact. So this the 2% is actually right on target of what I expected. But I am expecting a stronger push in the second half of the year. A lot of that is seasonality. But it is also what Max mentioned earlier some scale will see from buy to bills. We're going to see a stronger performance with the new files we bought with Life and Disability that we call PLATS. We're going to see better performance in the second half from our Dental and Vision property. I mentioned before that we're making huge Investments to stabilize that platform. We also announced a partnership with SKYGEN that’s bringing some operational excellence to the table with us to help manage that property. And so, all in the state being higher sales on the dental property. Stronger push with PLATS and then continue to what we have driven year-over-year with our veteran agents and with our broker partnerships, good performance from them and we'll see how our yield in the second half of the year."
},
{
"speaker": "Dan Amos",
"content": "And I just want to make a comment. I think that we've seen one of the best years and certainly one of the best quarters in the U.S. in terms of we've got a lot of balls in the air. And to realize that they brought up the loss ratio. They brought down the expense ratio. They had switched business and our business is more complicated as we go into other products. They're training their people better. I just have a kudos to Virgil and the team for the hard work they're doing. And I think long term, our US operation is going to be a much stronger company because we're doing all the right things I think we need to do to prepare us for the future. So, I'm extremely - the sales yet I want more than 2%. But I promise you that the 2% that we had is much bigger than a normal 2%, because it's cleaner business is more profitable and it should compound as we move forward."
},
{
"speaker": "Nick Annitto",
"content": "That's helpful. Thanks. I guess, sticking with the US can you just touch on recruiting trends there. I know you said you still have a bit of a way to go to get back to pre-pandemic levels. So it would be just good to get your thoughts on the recovery there."
},
{
"speaker": "Virgil Miller",
"content": "Yeah, in the first quarter you know we came up with negative on recruiting came in with the second quarter though very strong with - I think we were over a 10% increase. I see us continue on that trend going forward to the second half. But when I mentioned if you kind of go back and look pre-pandemic and you look at where we are today we're going for quality recruiting. We're going for a better conversion rate. And then, that’s leading to the higher productivity. You continue to see better productivity from what we're seeing with our agents. And that is really the bigger factor for us. Last year, we were recruited over 10,000. I would expect the same this year. We've got some national recruiting efforts going on right now across the country. What we really do is we leverage support from headquarters to drive our message and then we leverage - when we call a nomination process is to local agents, local brokers going out telling people about the Aflac career path and bringing people and listen to that story. And then we actually turn them into and to recruit in the ultimately trying to get them to be average weaker producers. I am very pleased with what we did in the second quarter. Some of those efforts will definitely continue in third or fourth quarters also."
},
{
"speaker": "Operator",
"content": "The question comes from Tom Gallagher with Evercore ISI. Please go ahead."
},
{
"speaker": "Tom Gallagher",
"content": "Hey, thanks for taking my follow-up. Just a Tsumitasu product follow-up question. Can you talk a little bit about how you think this rollout is going to go? Clearly, the June rollout seems to have been a big success. Would you expect this to become a much larger percentage of sales as you think about the rollout over the next couple of quarters here? How do you think third sector sales are going to hang in there? Because I think it's being sold through the same distribution as your third sector. So I'm just wondering while this gets rolled out, are we going to see a slowdown in third sector? How do you see that all playing out I guess over the near term next couple of quarters? Thanks."
},
{
"speaker": "Dan Amos",
"content": "Let me kick it off and then I'll hand it over to Yoshizumi for some more details. We do not have an explicit caps around this product. And the reason why it’s because it producing very good returns for us, both from a profit margins standpoint and also from a total - from an IRR standpoint i.e. with a significant spread to our cost of capital. So we actually do want to sell quite a bit of all this product. That being said, this product is very much about how it can lift our third sector franchise. We still believe that we are a third sector company. And we want to make sure that we keep our exceptionally strong position in that marketplace as the number one as third sector player in Japan. So, that is the context and of this product. And Yoshizumi can help give you some more details in terms of the timing of the full rollout of the product."
},
{
"speaker": "Koichiro Yoshizumi",
"content": "[Foreign Language] Thank you. This is your Yoshizumi. I would like to answer your question. [Foreign Language] First of all this product was launched on June 2nd. We have able to record a very successful big sales. [Foreign Language] And the reason why we have been able to record such big sales at the beginning of its launch is because, we, we meaning our distribution channel has been fully prepared to really wear to sell this product where they should be selling. How we should be selling and that's what we'd be working on since the beginning of the second quarter. [Foreign Language] And the reason why this kind of preparation was needed was because. [Foreign Language] And our agents. [Foreign Language] Talk to about Tsumitasu new customers, our agents really need to practice how to sell this product. [Foreign Language] As a result, our agents did visit those customers that are easy for them to be talking to and as a result it made a big hit in the sales. [Foreign Language] And as a result of this through preparation for the June launch we are not expecting the same level of sales from July and on. [Foreign Language] But at the product to earn certain level of volume. [Foreign Language] And we are quite sure that this product will serve that kind of a role. [Foreign Language] And the big role that this product will play is to cross-sell third sector products. [Foreign Language] And it would be easier for our sales agents to talk about third sector products through their customers once they start talking about Tsumitasu. [Foreign Language] And that is the difference between other first sector products because Tsumitasu has its own feature that can make that sales agents easily talk about third sector products. [Foreign Language] So what we are expecting is to have Tsumitasu sell to certain volume on its own, but on top of that sell third sector products is to certain level, as well. [Foreign Language] That's all for me."
},
{
"speaker": "Dan Amos",
"content": "This is Dan, I want to make a couple of comments. Number one is, we normally don't show the first month. We show a quarter of whatever new product is. It is not unusual to have a spike. What I've always said is we introduce new product no matter of what it is. You have a spike and then it levels off. We're in the spike period. And we've seen that with others. But it it will it will come down as he said and we expect that. So, just keep that in mind the other thing is that the numbers were small numbers in the past. And so that also as a percentage makes it look bigger than it normally is. But there's nothing here that makes me think that is any different from other new products other than it's doing very well as a few of our products have. And we're excited about that and pleased that we were able to find the way to get the profit margins to acceptable levels, so we could do this. We've been wanting to do it, but we haven't been able to do it and given Max his credit. He was been able to find a way to help do this and we appreciate that very much on his part."
},
{
"speaker": "Max Broden",
"content": "Tom, I want to address a question that you did not ask, but I think you wanted to ask and that is, how is this different from the waste sales that we had in the years 2012 through 2014? And I would characterize is there are three main differences. The first one is that we will do much more frequent repricing of new business for this product. And that's very important because this is a more interest rate sensitive product than our core third sector business. The other one is that we will have a much more diligent management of the distribution channels and the third piece is that we are not utilizing reinsurance to make sure that we can relieve some of that new business train and get the IRRS higher. And if you take all of that to get or that is what makes this different from the waste sales that we had of that were very very significant back in that timeframe of 2012 through 2014. Thanks Max. You stole my follow-up. That was great. Appreciate it."
},
{
"speaker": "Dan Amos",
"content": "Well, apparently it’s teamwork."
},
{
"speaker": "Operator",
"content": "The next question comes from Joel Hurwitz with the Dowling & Partners. Please go ahead."
},
{
"speaker": "Joel Hurwitz",
"content": "Hey, thanks for taking the follow-up. I just wanted to touch on net investment income in Japan and particularly, the US dollar portfolio unified just for the make whole and the slightly favorable VIII it seem to have a pretty sizeable step up in yield from the first quarter. Is there any color on what drove that and do you think that the - I guess the normalized NII level implied in Q2 is sustainable?"
},
{
"speaker": "Brad Dyslin",
"content": "Yeah, hi, Joel, this is Brad Dyslin. Thank you. Thank you for the question. We did have a very solid second quarter as you pointed out and there were several things that drove that that we do think are sustainable into the back half of the year. Besides the adjustments that you that you’ve highlighted short rates remain very attractive even with the Fed likely to cut sometime this fall, short rates remain very, very attractive compared to historical levels. And that benefits us in a few ways including our significant floating rate portfolio. We also took some actions early in the year, some tactical things we did with the portfolio. We moved a few bonds around in our public portfolio to capture some yield opportunities. It was a pretty sizable switch trade. We also took advantage of some attractive spreads and accelerated deployment in our structured private credit portfolio. So we think the things that have carried us in the second quarter these tailwinds are going to continue through the second half of the year. Now there are risks of course, but we think we're pretty well positioned and should have a good second half."
},
{
"speaker": "Joel Hurwitz",
"content": "Great. Helpful. And then just, I had won on us persistency. So Max, you mentioned in your prepared remarks that you're encouraged by the early signs from some of the initiatives that you guys put in place. I guess, just what are you seeing and how much improvement do you guys think you can drive in persistency in the US?"
},
{
"speaker": "Max Broden",
"content": "I'm not going to put an exact number on that, but I would say that anything if you get even something like a hundred basis points is meaningful when the overtime translates that into the economic impact that would have from additional net earned premium. So, it's something that we will continue to drive over time. The other thing I want you to be aware of is that that persistency will jump around somewhat driven by mix of business. So our in-force in the US, it is gradually changing. So you are going to see more Group Life and Disability business as a proportion of our in-force, which clearly has a much, much higher persistence rate than our average. And then also the same thing applies to over time our Dental and Vision businesses as well should have an improved persistency. So we're driving all the underlying businesses and the way they improve persistency then the mix impact will be an important component as well. So, over time, what we are driving is both that business-by-business improved persistency and then obviously the mix impact, as well. So we will over time sort o. call that out and give you some more colors on that, as well."
},
{
"speaker": "Joel Hurwitz",
"content": "I got it. Thank you."
},
{
"speaker": "Operator",
"content": "This concludes our question and answer session. I would like to turn the conference back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"content": "Thank you, Betsy, and thank you, all for joining us this morning. I hope you'll be able to join us on the morning of December 3rd at the New York Stock Exchange or on our webcast for our Financial Analysts Briefing. If you have any additional follow-ups, please reach out to the Investor and Rating Agency Relations team. We look forward to hearing from you. Thank you."
},
{
"speaker": "Operator",
"content": "The conference is now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
afl | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Aflac Incorporated First Quarter 2024 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to David Young, Vice President, Investor and Rating Agency Relations. Please go ahead."
},
{
"speaker": "David Young",
"content": "Good morning, and welcome. Thank you for being here a bit earlier than our usual start time. This morning, Dan Amos, Chairman, CEO and President of Aflac Incorporated, will provide an overview of our results and operations in Japan and the United States. Then Max Broden, Executive Vice President and CFO of Aflac Incorporated, will provide an update on our financial results and current capital and liquidity."
},
{
"speaker": "",
"content": "These topics are also addressed in the materials we posted with our earnings release and financial supplement on investors.aflac.com, including Max's quarterly video update. We also posted under Financials on the same site, updated slides of investment details related to our commercial real estate and middle market loans. For Q&A today, we are also joined by Virgil Miller, President of Aflac U.S.; Charles Lake, Chairman and Representative Director, President of Aflac International; Masatoshi Koide, President and Representative Director, Aflac Life Insurance Japan; and Brad Dyslin, Global Chief Investment Officer, President of Aflac Global Investments."
},
{
"speaker": "",
"content": "Before we begin, some statements in this teleconference are forward-looking within the meaning of federal securities laws. Although we believe these statements are reasonable, we can give no assurance that they will prove to be accurate because they are prospective in nature. Actual results could differ materially from those we discuss today. We encourage you to look at our annual report on Form 10-K for some of the various risk factors that could materially impact our results. As I mentioned earlier, the earnings release is available on investors.aflac.com and includes reconciliations of certain non-U.S. GAAP measures."
},
{
"speaker": "",
"content": "I'll now hand the call over to Dan."
},
{
"speaker": "Daniel Amos",
"content": "Thank you, David, and good morning, and we're glad you joined us at this earlier hour. The first quarter marked a good start for the year in terms of earnings, but proved to be challenging for sales. Aflac Incorporated delivered another solid earnings result. Net earnings per diluted share for the quarter were $3.25. On an adjusted basis, earnings per diluted share were up 7.1% to $1.66."
},
{
"speaker": "",
"content": "Beginning with Japan, our latest medical insurance launch in September of 2023, we are encouraged by the success that independent corporate and individual agencies have had in marketing this product, especially to the younger individuals. However, we clearly need to make better progress and plan on doing so. Cancer insurance sales, however, were modestly better year-over-year. We entered the final stage of our new cancer insurance launch in April of 2023 through the Japan Post channel, while we saw a significant and understandable year-over-year increase in cancer insurance sales through Japan Post channel."
},
{
"speaker": "",
"content": "We expect to see improvement with the start of the new fiscal year as they cross-sell Aflac cancer insurance along with the new Japan Post life insurance product. Being where customers want to buy insurance remains an important element of our growth strategy in Japan. Our broad network of distribution channels, including agencies, alliance partners and banks, continually optimize opportunities to help provide financial protection to Japanese consumers. We will continue to work hard to support each channel."
},
{
"speaker": "",
"content": "In addition, we are initiating sales campaigns around our 50th anniversary in Japan starting this quarter. Let me be clear, we have not lowered our sales outlook for 2024 and still expect to achieve it. With the launch of the new policy this quarter, Koide-san and his team are working hard achieving that objective. In addition, we have maintained disciplined underwriting and expense management to continue driving strong pretax profit margins of 32.8%."
},
{
"speaker": "",
"content": "Turning to the U.S. As you've seen in prior years, the first quarter tends to generate the lowest sales of the year. We have focused on driving more profitable growth by exercising a stronger underwriting discipline. We are deliberately avoiding sales opportunities to certain less profitable accounts. While this appears to have a temporary impact on sales in the first quarter, we are seeing positive results in net earned premium growth, which grew 3.3%."
},
{
"speaker": "",
"content": "At the same time, we have increased benefits in certain cases to improve value for the policyholders. We believe persistency will continue to improve as customers realize the value of their policies and the related benefits. We are pleased with the 80 basis points improvement in persistency this quarter. I believe that the need for the products we offer is as strong or stronger than it has ever been before in both Japan and the United States. We continue to work to restore our momentum and reinforce our leading position as we aim to exceed $1.8 billion of sales by the end of 2025."
},
{
"speaker": "",
"content": "We have also continued our disciplined approach to expense management. We are beginning to see progress on our expense ratio in group life and disability and consumer markets continue to grow in scale. We are continuing to focus on optimizing our dental and vision platform and expect to see stronger second half sales this year. At the same time, we have maintained a strong pretax margin of 21%. Overall, I'm very pleased with what Virgil and his team are doing to balance profitable growth, enhance the value of the proposition of our policyholders and curb the expense ratio."
},
{
"speaker": "",
"content": "I'd like to end on addressing our ongoing commitment to prudent liquidity and capital management. I'm very pleased with how Max has led the team to take proactive steps in recent years to defend our cash flows and deployable capital against a weakening Yen as well as the establishment of our reinsurance platform in Bermuda. As an insurance company, our primary responsibility is to fulfill the promises we make to our policyholders while being responsive to the needs of the shareholders."
},
{
"speaker": "",
"content": "We remain committed to maintaining strong capital ratios on behalf of the policyholders. We balance this financial strength with tactical capital deployment. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows. This supports both our dividend track record and our tactical share repurchase."
},
{
"speaker": "",
"content": "We treasure our track record of 41 consecutive years of dividend growth and remain committed to extending it. I am pleased that the Board set us on a path to continue this record, when it increased the first quarter 2024 dividend 19% to $0.50 and declared the second quarter dividend of $0.50. We repurchased a record $750 million in shares in the first quarter and intend to continue our balanced and tactical approach of investing in growth and driving long-term operating efficiencies. Our management team, employees and sales distribution continue to be dedicated stewards of our business, being there for our policyholders when they need us most, just as we promised."
},
{
"speaker": "",
"content": "This underpins our goal of providing customers with the best value in the supplemental products in the United States and in Japan. In 2024, we celebrated our 50th year of doing business in Japan and 50th year as a publicly traded company on the New York Stock Exchange. We are reminded that one thing has not changed since our founding in 1955. Families and individuals still seek to protect themselves from financial hardships that not even the best health insurance company covers."
},
{
"speaker": "",
"content": "Today's complex healthcare environment has produced incredible medical advances that come with incredible cost. It's more important than ever to have a partner. We believe our approach to offering relevant products makes us that partner. We believe that in the underlying strengths of our business and our potential for continued growth in Japan and the U.S., two of the largest life insurance markets in the world, Aflac is well positioned as we work toward achieving long-term growth while also ensuring we deliver on our promise to our policyholders."
},
{
"speaker": "",
"content": "I'd now like to turn the program over to Max to cover more details of the financial results. Max?"
},
{
"speaker": "Max Broden",
"content": "Thank you for joining me, as I provide a financial update on Aflac Incorporated's results for the first quarter of 2024."
},
{
"speaker": "",
"content": "For the quarter, adjusted earnings per diluted share increased 7.1% year-over-year to $1.66 with an $0.08 negative impact from FX in the quarter. In this quarter, remeasurement gains totaled $56 million and variable investment income ran $11 million or $0.01 per share below our long-term return expectations. Adjusted book value per share, including foreign currency translation gains and losses, increased 8.7%, and the adjusted ROE was 13.7%, an acceptable spread to our cost of capital."
},
{
"speaker": "",
"content": "Overall, we view these results in the quarter as solid. Starting with our Japan segment. Net earned premiums for the quarter declined 6%. This decline reflects a JPY 6.2 billion negative impact from paid-up policies. In addition, there is a JPY 7 billion negative impact from internal reinsurance transactions and a JPY 1.4 billion positive impact from deferred profit liability. Lapses were somewhat elevated, but within our expectations. At the same time, policies in force declined 2.3%."
},
{
"speaker": "",
"content": "Japan's total benefit ratio came in at 67% for the quarter, flat year-over-year. And the third sector benefit ratio was 57.5%, down approximately 20 basis points year-over-year. We continue to experience favorable actual to expected on our well-priced, large and mature in-force block. We estimate the impact from remeasurement gains to be 144 basis points favorable to the benefit ratio in Q1 2024. Long-term experience trends, as it relates to treatment of cancer and hospitalization, continue to be in place, leading to continued favorable underwriting experience. Persistency remained solid with a rate of 93.4%, which was down 50 basis points year-over-year, but flat quarter-over-quarter."
},
{
"speaker": "",
"content": "We tend to experience some elevations in lapses as customers update and refresh their coverage. This change in persistency is not out of line with expectations. Our expense ratio in Japan was 18%, down 170 basis points year-over-year, driven primarily by good expense control and to some extent, by expense allowance from reinsurance transactions. Adjusted net investment income in yen terms was up 19.3%, mainly by lower hedge costs and favorable impact from FX on our U.S. dollar investments in yen terms as well as higher return on our alternatives portfolio compared to the first quarter of 2023."
},
{
"speaker": "",
"content": "This was offset by the transfer of assets due to reinsurance in the previous year, leading to a lower asset base and lower floating rate income. The pretax margin for Japan in the quarter was 32.8%, up 460 basis points year-over-year, a very good result."
},
{
"speaker": "",
"content": "Turning to U.S. results. Net earned premium was up 3.3%. Persistency increased 80 basis points year-over-year to 78.7%. This is a function of a poor persistency quarter falling out of the metric and stabilization across numerous product categories. Our total benefit ratio came in at 46.5%, 90 basis points higher than Q1 2023, driven by product mix and lower remeasurement gains than a year ago. We estimate that the remeasurement gains impacted the benefit ratio by 200 basis points in the quarter."
},
{
"speaker": "",
"content": "Claims utilization has stabilized, but as we incorporate more recent experience into our reserve models, we have released some reserves. Our expense ratio in the U.S. was 38.7%, down 90 basis points year-over-year, primarily driven by platforms improving scale and lower acquisition expenses. Our growth initiatives, group life and disability, network dental and vision and direct-to-consumer increased our total expense ratio by 230 basis points. We would expect this impact to decrease going forward as these businesses grow to scale and improve their profitability."
},
{
"speaker": "",
"content": "Adjusted net investment income in the U.S. was up 4.6%, mainly driven by higher yields on both our alternatives and fixed rate portfolios. Profitability in the U.S. segment was solid with a pretax margin of 21%, driven primarily by net earned premiums growth and improved net investment income year-over-year. Our total commercial real estate watchlist remains approximately $1.2 billion, with around $600 million of these in active foreclosure proceedings. As a result of these current low valuation marks, we increased our CECL reserves associated with these loans by $10 million in this quarter."
},
{
"speaker": "",
"content": "We also moved 1 property into real estate owned, which resulted in a $3.7 million gain. We continue to believe that the current distressed market does not reflect the true intrinsic economic value of our portfolio, which is why we are confident in our ability to take ownership of these quality assets, manage them through the cycle and maximize our recoveries."
},
{
"speaker": "",
"content": "Our portfolio of first lien, senior secured middle market loans continue to perform well with losses well below our expectations for this point in the cycle. In our Corporate segment, we recorded a pretax loss of $3 million. Adjusted net investment income was $43 million higher than last year due to higher volume on the investable assets at Aflac REIT and a lower volume of tax credit investments at Aflac Inc. These tax credit investments impacted a corporate net investment income line for U.S. GAAP purposes negatively by $32 million, with an associated credit to the tax line."
},
{
"speaker": "",
"content": "The net impact to our bottom line was a positive $4 million in the quarter. To date, these investments are performing well and in line with our expectations."
},
{
"speaker": "",
"content": "We are continuing to build out our reinsurance platform, and I am pleased with the outcome and performance. Our capital position remains strong and we ended the quarter with an SMR above 1,100% in Japan, and our combined RBC, while not finalized, we estimate it to be greater than 650%. Unencumbered holding company liquidity stood at $3.7 billion, $2 billion above our minimum balance. These are strong capital ratios, which we actively monitor, stress and manage to withstand credit cycles as well as external shocks."
},
{
"speaker": "",
"content": "U.S. statutory impairments were a release of $3 million. And Japan FSA impairments were JPY 3.6 billion or roughly $24 million in Q1. This is well within our expectations and with limited impact to both earnings and capital. Adjusted leverage remains at a comfortable 20.4%, at the low end of our leverage corridor of 20% to 25%."
},
{
"speaker": "",
"content": "In the quarter, we issued JPY 123.6 billion in multiple tranches with an average coupon of 1.72%. As we hold approximately 60% of our debt denominated in yen, our leverage will fluctuate with movements in the yen/dollar rate. This is intentional and part of our enterprise hedging program, protecting the economic value of Aflac Japan in U.S. dollar terms. We repurchased $750 million of our own stock and paid dividends of $288 million in Q1, offering good relative IRR on these capital deployments."
},
{
"speaker": "",
"content": "We will continue to be flexible and tactical in how we manage the balance sheet and deploy capital in order to drive strong risk-adjusted ROE with a meaningful spread to our cost of capital."
},
{
"speaker": "",
"content": "I'll now turn the call over to David so that we can begin our Q&A."
},
{
"speaker": "David Young",
"content": "Thank you, Max. Before we begin, I just want to remind everyone, please mark your calendars for our financial analyst briefing on December 3 at the New York Stock Exchange. We'll have more information coming out. [Operator Instructions]."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] The first question today comes from Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"content": "My first question, starting with U.S. sales, which you guys said were weaker than expected in the quarter, but you did reaffirm the longer-term guidance for sales in that business. So can you just give us a sense of how you expect sales in the U.S. to trend from here?"
},
{
"speaker": "Virgil Miller",
"content": "This is Virgil from the U.S. First, let me start with a little bit more color on how sales performed in Q1. As you mentioned, they were a little bit softer for Q1. A couple of drivers for that. First, let me start with our plans, our life, absence and disability business. Normally, that is a business that takes place the latter part of the year. Well, last year, in 2023, we did have some business process in Q1, so therefore, we were down with that comparison. That is an anomaly. That normally doesn't happen. So again, I expect continued strong performance from that line of business for the remainder of the year. So that was a timing element."
},
{
"speaker": "",
"content": "The other timing element involved on the dental and vision business. As Dan mentioned in his opening, we continue to work on optimizing that platform. So we had softer sales. We have a dental product. We're expecting to continue to build out that platform, make those improvements and have a stronger year in the second half of the year."
},
{
"speaker": "",
"content": "Last, I will close with -- to emphasize, though, I will continue to focus on our strong underwriting discipline. To give more color on that, we're really looking to bring on business that has long-term profitability, which we believe has strengthened the company over a long-term range. This allows us to pay claims and return shareholder value and also helps us with building on persistency. So we do have an improvement in persistency of 80 basis points. We had higher earned premium of 3.3% and we had strong profitability of 21% -- profit margin of 21% in the quarter. So we believe this is the rightly way to manage the company going forward."
},
{
"speaker": "Elyse Greenspan",
"content": "And then my follow-up, shifting to sales in Japan. The third sector sales went negative this quarter. You guys did highlight some initiatives you have to improve sales in Japan. But just hoping you could provide more color specifically on how you expect the third sector sales to trend over the course of 2024."
},
{
"speaker": "Daniel Amos",
"content": "Let me let Aflac Japan answer that, but I think the most important thing is we still expect to attain our objective for the full year. So Koide, would you mind taking that or Yoshizumi."
},
{
"speaker": "Koichiro Yoshizumi",
"content": "[interpreted] Thank you for the question. This is Yoshizumi, I will be answering your question. Starting from 2024, what we are expecting is that we expect to exceed 2023 results. Due to the following reasons, we are expecting our sales will recover. Number one, we are planning to enhance our associates' channel sales agents, I mean increase the number of sales associates. And in 2023, we approximately hired 600 new sales agents -- recruited and have enhanced their training. We are expecting that these 600 will become more productive in the second quarter and be successful."
},
{
"speaker": "",
"content": "And we are also continuing agent recruitment in 2024 and taking steps to ensure their effectiveness. And the second point is that we are going to be promoting the sales of Japan Post new product as well as our cancer product through the Japan Post channel. And we do expect that cancer insurance sales will increase in the second quarter. And then my third point is related to Yorisou Cancer Consultation Support, which has been highly rated by our customers. This is our consultation service for our customers that could further differentiate ourselves from our competitors."
},
{
"speaker": "",
"content": "And we will be using TV commercials, web video ads, et cetera, and leverage them to differentiate further against our competitors. And my fourth point is that we have plans to implement measures to attract more young and middle-aged customers as medical insurance has been well received among those segments and with significant growth at large nonexclusive agencies."
},
{
"speaker": "",
"content": "And furthermore, we are planning to launch a new asset formation type of product in June. The product will include future nursing care coverage feature that will bring value to young customers. We also expect to sell additional third sector product to these new customers through concurrent and follow-on sales. And by implementing these measures, we expect an increase in second quarter sales and exceed 2023 results, and as we aim to steadily increase sales. We are aiming for a steadily increase in sales toward our 2026 targets. That's all from me."
},
{
"speaker": "Operator",
"content": "The next question comes from Tom Gallagher with Evercore."
},
{
"speaker": "Thomas Gallagher",
"content": "Just wanted to circle back on Japan sales. Do you think the issue, as you try and assess it today, is more of an industry issue? Is it Aflac-specific? The reason I ask is I think you mentioned you're deliberately not underwriting certain products in Japan. When I hear that, I think that implies there's some irrational pricing or product features that you don't like. So just a little bit of color on what's going on? Is it medical, where that's happening? And overall, how do you see that playing out?"
},
{
"speaker": "Daniel Amos",
"content": "Let's let our Japanese cover that, and I don't -- I'll pick up on it a little bit more, too."
},
{
"speaker": "Koichiro Yoshizumi",
"content": "[interpreted] This is Yoshizumi once again. Let me answer your questions. Regarding the medical insurance sales, we have been increasing our sales on year-on-year basis, especially to those customers under age 50 or 40 and below. And also, this -- our sales in large nonexclusive agency sales on a year-on-year basis, increasing significantly this year. And this large nonexclusive agency sales is a benchmark to see how well the medical insurance is doing."
},
{
"speaker": "",
"content": "We are planning to roll out promotional measures to further enhance our sales to young and middle aged customers, who we have been selling already successfully. That's all for me."
},
{
"speaker": "Masatoshi Koide",
"content": "[interpreted] This is Aflac Japan, Koide. I would like to be adding a few comments. In Japan right now, third sector sales is becoming more and more competitive year-on-year. And our strategy is to have solid sale by meeting these customers under the very competitive situation by launching new products in both medical and cancer insurance. And we'd like to do this in a timely manner by really taking in the needs of customers."
},
{
"speaker": "",
"content": "And as Yoshizumi-san mentioned earlier, regarding the associates channel sales agents increase, particularly as we increase the number of sales agents, we are not only increasing the headcount, but we are also trying to increase the productivity per head per year through training. In that way, we should be able to increase our sales and strengthen our sales in third sector. Another strength of Aflac in Japan is that we have very strong alliance across the entire Japan, namely the Japan Post network because Japan Post has a nationwide network that can sell our products."
},
{
"speaker": "",
"content": "And as Yoshizumi-san mentioned, the Japan Post network sales recovery is taking a bit more time. However, just as Yoshizumi-san mentioned, Japan Post Insurance sales is increasing, especially in its activity volume. So not will they only be only increasing their sales activities and association activities, they will also -- they should also be increasing the actual sales on cancer, and that's what we are hoping to have done. That's all from us."
},
{
"speaker": "Thomas Gallagher",
"content": "Dan, anything you would add? Or should I ask a follow-up?"
},
{
"speaker": "Daniel Amos",
"content": "Yes. Okay. Let me make a couple of comments, and then anything else you want to ask, we'll be glad. First of all, our cancer insurance is doing very well, both through our existing distribution channel and Japan Post. The other thing I would say is that the medical products are more competitive, and we have to continue to watch that. That's really nothing new, but it hasn't slacked up. And then we don't sell the foreign currency products that some of our competitors sell. We just don't think we want to take on that exposure and pass it on to our customers. And so we haven't done that. So I think those are the real differences that are created. Any other question you had, Tom?"
},
{
"speaker": "Thomas Gallagher",
"content": "Yes. And just for a follow-up, the weaker persistency in Japan. Can you talk a little bit about what you're seeing there from a product standpoint? Is that cancer and medical that you're seeing it on? And do -- is it just lapsing of coverage? Or is it switching to other companies, do you suspect?"
},
{
"speaker": "Max Broden",
"content": "So Tom, let me take that. One of the main reasons is that we obviously have an aging block of in-force. So our new sales is lower than our lapsation. That means you have a natural aging of the overall block, yes. When you have that, then you're going to see some higher surrenders, lapses and also mortality associated with the overall block. So it's very natural when you have an aging block that you have higher lapses. That in combination with -- we've also now -- in the last 5, 6 years, we moved into a little bit of a shorter product cycles. When you have that and you refresh products, you tend to have a little bit higher structural lapse and reissue come through your block. So I would point those are the 2 main reasons why we are probably in an environment now where you have a slightly lower persistency now structurally than what we did see 5, 6 years ago."
},
{
"speaker": "Operator",
"content": "The next question comes from Jimmy Bhullar with JPMorgan."
},
{
"speaker": "Jamminder Bhullar",
"content": "So the first question is just along the lines of what's been discussed already. And I think Virgil mentioned this as well. This is in your press release also, Dan. Just disciplined underwriting is not something that people generally associate with Aflac because your products have pretty high margins, just given the nature of your business. So I'm wondering what's changed? Because it seems like the environment for pricing in your business -- with higher interest rates, you could potentially even price them better than before. So wondering if it's outside factors that have gotten worse? And maybe you could talk about the U.S. as well, where you're seeing your competitors trying to be more aggressive? Or what's really different now than before? Because it's not like before you weren't trying to be disciplined, right? So just anything that you could sort of highlight on that, especially in the U.S. market, you talked a little bit about Japan."
},
{
"speaker": "Virgil Miller",
"content": "Yes. Let me add to that. Again, this is Virgil. I just want to say that what you're seeing is the evolution of our block of business. Our group voluntary benefit business has continued to grow over the past several years. And really, when we talk about that underwriting discipline, that is where you're most are going to see that. If there's strong competition out there, fierce competition in the group business, and what we're doing is making sure though that we are able not only to compete, but we want to look at the business that yields profits."
},
{
"speaker": "",
"content": "So any time you bring in new business on the books, of course, there is acquisition expenses and everything that go into that, we want to make sure that we're getting the right business on the books that has the tendency to persist. So we're able to end up absolutely making profit on that business over a couple of years' period."
},
{
"speaker": "Daniel Amos",
"content": "And if you think about it a minute, it will make plenty of sense is that -- you take an account that has high lapsation, then you have a low benefit ratio and you have a high expense ratio and basically no profit. So you actually improve every aspect of the business -- the overall business when you just don't write it. And that's what we've been looking at and seeing and then that allows us by doing that for our -- as we've increased benefits and other policies to move it up and give a better value. So it's a good balance that we think ultimately creates value not only for the policyholder, but ultimately for the shareholders as well."
},
{
"speaker": "Jamminder Bhullar",
"content": "Okay. And then, Max, do you have an update on the Japan ESR and its potential impact on your Bermuda reinsurance or just overall capital management strategy?"
},
{
"speaker": "Max Broden",
"content": "So our ESR in Japan continues to track well. We are running a little bit north of 250% on our ESR based on our internal model. We would expect relatively soon in the second quarter for the FSA to come up with a final calibration. I would not anticipate that, that would have a material impact on our -- i.e., the difference between the FSA calibration and our current internal model. So I wouldn't expect to have that number move materially."
},
{
"speaker": "",
"content": "But then obviously, we will assess the ESR based on that, and we will talk about it in more detail in December. But currently, we're tracking on our internal model a bit north of 250%."
},
{
"speaker": "Operator",
"content": "The next question comes from Joel Hurwitz with Dowling and Partners."
},
{
"speaker": "Joel Hurwitz",
"content": "So Japan continues to see pretty strong remeasurement gains. Can you just talk about the underlying claim trends that you're seeing there? And I guess if this level of favorability of the remeasurement gains persists, should we likely see a bigger unlocking this year or would more experience be needed?"
},
{
"speaker": "Max Broden",
"content": "So Joe, the main driver continues to be the hospitalization trends that have been favorable for a long, long period of time, and they quite frankly have continued to improve. The way we do -- when we do our reserving, we are looking to true up to current experience, but we don't necessarily anticipate that it will be a continued future improvement in that experience. And that's why you see these -- if the hospitalization trends continue to improve from current levels, then you could see in the future but that will lead to future remeasurement gains as well. But if they stabilize at current levels, then you wouldn't necessarily see that."
},
{
"speaker": "Joel Hurwitz",
"content": "Okay. Makes sense. And then just in Japan expenses, they came in very favorable this quarter. How much of that was cost controls that could be sustainable longer term versus just seasonality or timing?"
},
{
"speaker": "Max Broden",
"content": "Yes. There's a significant element of both seasonality and timing in this number. And for the full year, we are tracking towards our expense ratio outlook of 19% to 21%."
},
{
"speaker": "Operator",
"content": "The next question comes from Josh Shanker with Bank of America."
},
{
"speaker": "Joshua Shanker",
"content": "There's a lot of news out there right now about the Japanese government doing some major intervention to support the yen. What does that mean for the cost of your hedging program?"
},
{
"speaker": "Max Broden",
"content": "So Josh, volatility can obviously impact the pricing of options. That will be -- that together with all the other sort of normal inputs into the pricing of an option would be the main impact from that. The level itself has less impact to the ultimate cost of those put options. So at this point, we see relatively limited impact to the pricing of options. Quite frankly, I think that the volatility in the yen -- even though it's been trending, the short-term volatility has been quite low recently."
},
{
"speaker": "",
"content": "So given that, we don't see any significant impact. I would tell you, though, that obviously -- that there's been a significant move overall in the yen because it's been trending and it has been weakening. And that obviously has an impact to all of our financial statements and capital ratios. The way we approach this is that we take an economic view and we try to protect the economic value of Aflac Japan with a holding company lens. And we feel that we are very well protected with the 3 levers that we are using to do that. That being the U.S. dollar assets we hold in a Japanese general account. That being the yen-denominated debt that we issue out of the holding company and then also the FX forwards that we have at the holding company. So we have designed this program with these kind of moves in mind. And at this point, the program overall is performing very well."
},
{
"speaker": "Joshua Shanker",
"content": "And look, I don't want to lessen the significance of a very large dividend increase as well as a lot of shares bought back in the quarter, but it seems to me that the capital ratios are even higher now at the end of the first quarter than they were at the end of this past year. I've been harassing David a little bit on better color, but can you walk through all the gating factors in your internal model that guide your willingness to return capital to shareholders?"
},
{
"speaker": "Max Broden",
"content": "So the overall return on capital to shareholders is really, quite frankly, driven by, number one, satisfy the capital ratios in the subsidiaries, and that means all of the subsidiaries. Then we look at the pool of capital that we have at the holding company, which currently sits at $3.7 billion on an unencumbered basis, which is roughly $2 billion north of our minimum liquidity level. We then think about what is the capital generation going forward. And that helps us then think about how we can deploy capital, both short term, i.e. in the next couple of quarters, but also long term, i.e., thinking about what it's going to look like over the next 2, 3, 5 years as well."
},
{
"speaker": "",
"content": "That helps us sort of guide then also what kind of returns we can expect on dividend, buybacks, et cetera, when we take these into account what other alternatives we have for that capital. And obviously, we try to deploy the capital in the areas where we think we can get the best IRR."
},
{
"speaker": "Operator",
"content": "The next question comes from Wes Carmichael with Autonomous Research."
},
{
"speaker": "Wesley Carmichael",
"content": "In the transitional real estate portfolio, Max, I think you mentioned foreclosing on a loan and taking it on balance sheet as real estate owned. Can you just talk about are there other loans that you're monitoring right now? And maybe just give us an update on the size of the overall watchlist there?"
},
{
"speaker": "Bradley Dyslin",
"content": "Sure. Wes, this is Brad Dyslin. In the quarter, we saw our overall commercial real estate, which is predominantly the transitional real estate, as you've called out, the watchlist has been relatively stable. Our overall foreclosure watchlist is about $1.2 billion. Of that, about half is in active workout proceedings where we are fully prepared to foreclose on the property. We did have one, as you mentioned, that we foreclosed in the quarter. We were actually able to book a small gain on that. The accounting rules are such that if the appraised value exceeds our loan value, we're able to book it at the higher value. It's a pretty small number, but it does highlight the value of disciplined underwriting and maintaining a good, solid loan-to-value on the underlying assets."
},
{
"speaker": "",
"content": "Generally, things were stable in the quarter. We are seeing some very early signs of life in the market. We're seeing headlines about a lot of capital being raised in different outlets, focused on commercial real estate. That will certainly help with liquidity. It's a little bit early, but we're optimistic that we could be turning a corner here in the next couple of quarters. Of course, all eyes are on the Fed right now to see the impact that will have. But all in all, nothing really significant to happen to our watchlist in the quarter."
},
{
"speaker": "Wesley Carmichael",
"content": "Thanks, Brad. And just turning to the U.S., could you maybe just talk about agent recruiting. What's the environment like given the strong employment in the U.S.? And are you kind of expecting that to change any in your outlook there?"
},
{
"speaker": "Virgil Miller",
"content": "Yes. So I would say it's definitely a tough environment we're recruiting for commission roles out there. Still, I would tell you, if you look back at Q1 of 2023, it was a strong Q1 quarter for us. So this year, we knew we had a tough comparison. And so therefore, I would tell you we expect it to be slightly down. So I'm not throwing off about the performance of Q1. I'm expecting us to rebound and continue to recruit, develop, convert, train and actually build up on average we can produce as going forward. Again, knowing the environment is tough, we just have to recruit differently. We're deploying different means to make sure we hit our expected numbers this year."
},
{
"speaker": "Operator",
"content": "The next question comes from Suneet Kamath with Jefferies."
},
{
"speaker": "Suneet Kamath",
"content": "I wanted to start with Japan sales. It seems like one of the issues, I think, that you're having is the mix of sales between exclusive and nonexclusive channels. So my question is, what percentage of your sales come from these nonexclusive channels? And relatedly, are you behind the industry in terms of the mix from that channel?"
},
{
"speaker": "Daniel Amos",
"content": "Hold on there. Let me -- guys, can you hear. Did you all hear the question, Koide?"
},
{
"speaker": "Masatoshi Koide",
"content": "Yes. We will answer to that question."
},
{
"speaker": "Daniel Amos",
"content": "Hold on, just 1 second, they'll translate."
},
{
"speaker": "Koichiro Yoshizumi",
"content": "[interpreted] This is Yoshizumi. I will be answering your questions. I'm sorry, this is translator speaking. I just needed to clarify what Yoshizumi said about the numbers that he mentioned. Here I go."
},
{
"speaker": "",
"content": "In terms of the number of exclusive and nonexclusive agencies, 60% are exclusive agencies and 40% are nonexclusive agencies. That is in terms of the number of sales agencies, but then when it comes to sales, it's 70-30, exclusive agencies, 70% and nonexclusive agencies 40% (sic) [ 30% ]. It's not that which is larger, which is smaller that really matters, but it is what it is."
},
{
"speaker": "",
"content": "In addition to explaining about our nonexclusive agencies channel, there are particular agencies that are called large nonexclusive agencies among the nonexclusive agency channel. And the sales from that large nonexclusive agency channel accounts for about 5% of our sales."
},
{
"speaker": "Suneet Kamath",
"content": "The bigger question is, are you behind the curve here, right? It seems like the industry is moving towards these nonexclusive agencies. That's my sense. And if it's only 5% in terms of these large nonexclusive agencies, is that just going to be an ongoing headwind in terms of your sales growth? Or do you have strategies to gain share in that channel?"
},
{
"speaker": "Masatoshi Koide",
"content": "[interpreted] Let me start out. This is Koide from Aflac Japan speaking. So first of all, let me just clarify our agency structure, our agency purpose. Ever since our foundation in Aflac Japan, we have always had exclusive agency channel as our main channel plus the so-called nonexclusive agencies that sells mainly our product in cancer and medical insurance area. And these are the main agencies that we have been dealing with."
},
{
"speaker": "",
"content": "And this, in fact, is the strength of Aflac Japan. And because this just means that there are many agencies that are very loyal to Aflac. And as you know, other companies are entering into agency channel in recent years. Because they are new entries, they are not able to build their own exclusive channel anymore. So as a result, what they've been doing is to go into the nonexclusive channel, especially trying to deal with the large nonexclusive agencies to increase their sales."
},
{
"speaker": "",
"content": "So in other words, as we mentioned, the sales from large nonexclusive agencies is small in Aflac's overall sales. However, this does not mean that we are any behind other insurance companies because we have our strength. This is in fact, our strength because we have our own exclusive channels. But then at the same time, it is also a fact that the market of large nonexclusive agency customers is increasing because the main customers of large nonexclusive agencies is young and middle aged customers."
},
{
"speaker": "",
"content": "So however, as a result, what we need to do to grow Aflac Japan going forward is not just focus on exclusive agencies, but we also need to start focusing more on large nonexclusive agencies. And that has been the strategy for the past few years. And as a result of that, what we have done last year is to launch a new medical insurance product, which we have been able to sell a lot through our large nonexclusive agencies. Because we have targeted mainly young and middle aged customers who are using this medical insurance. So as a result of this, we have had a very large growth in our medical insurance sales in the first quarter this year."
},
{
"speaker": "Daniel Amos",
"content": "Suneet, let me try to summarize, because I think it's important here. Number one is, in the nonexclusive area, this isn't something new. If you go back and you look, and you've been around a long time, you'll remember that there was this major agency that was independent and other competitors were selling for them, we ended up selling for them. They had been in the cell phone business and transferred over to the insurance business."
},
{
"speaker": "",
"content": "We found a way to get into that market. We ended up selling a lot with them. They ended up going a different direction. But the point being is, wherever the business is, we'll be there as the leader in the third sector product. And yes, we do have a strategy. And yes, we do plan on winning. But the point that I think Aflac Japan is making is the bread and butter of everything we do are the agencies that we've had since the inception. That along now with Japan Post has made a big difference. Again, Japan Post being only cancer. But all in all, it's what's dominated our business, and we will be ready to handle that. And it's really nothing new. It was going on 15 years ago."
},
{
"speaker": "Masatoshi Koide",
"content": "[interpreted] Dan, thank you. And I would like to add a little bit more color to that. We are really truly working on the large nonexclusive agency channel right now. However, as Dan mentioned, we have Japan Post, we have exclusive agencies, we have nonexclusive agencies and as I mentioned, we have Japan Post channel as well as other business partners and bank channel. So we have this variety of channels that sell our third sector products. And so that is how we are going to be increasing and growing our sales."
},
{
"speaker": "Koichiro Yoshizumi",
"content": "[interpreted] So this is Yoshizumi once again. Let me just add a little bit more information to your question. The large nonexclusive agencies, the main product that they sell to a customer is the first sector product. And Aflac, our main products are cancer and medical insurance products and the total number of policies of cancer and medical added altogether combined, we are #1 in overall Japan. So we truly believe that we will be able to increase the number of sales through other channels as well. And I do think that our driver will be our exclusive agencies."
},
{
"speaker": "Daniel Amos",
"content": "Right, I think we've answered that question. If you need a follow-up, we'll be glad to do that. But David?"
},
{
"speaker": "David Young",
"content": "Betsy, I think that's our last call, correct?"
},
{
"speaker": "Operator",
"content": "Correct. I'd like to hand it back over to David Young for any closing remarks."
},
{
"speaker": "David Young",
"content": "Yes. Thank you all very much for joining us this morning. And in the coming months, you'll get more information about our financial analyst briefing at the New York Stock Exchange on December 3. And if you have any questions that you want to follow up, please reach out to Investor and Rating Agency Relations. We will talk to you again. Have a great day."
},
{
"speaker": "Operator",
"content": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
},
{
"speaker": "",
"content": "[Portions of this transcript that are marked [interpreted] were spoken by an interpreter present on the live call.]"
}
] |
aig | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good day and welcome to AIG's Fourth Quarter and Full Year 2024 Financial Results Conference Call. This conference is being recorded. Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead."
},
{
"speaker": "Quentin McMillan",
"content": "Thanks very much, Michelle, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements, circumstances or management's estimates or opinions should change. Today's remarks may also refer to non-GAAP financial measures. A reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com. Following the deconsolidation of Corebridge Financial on June 9th, 2024, the historical results of Corebridge for all periods presented are reflected in AIG's consolidated financial statements as discontinued operations in accordance with US GAAP. Additionally, in the fourth quarter, AIG realigned its organizational structure and the composition of its reportable segments to reflect changes in how AIG manages its operations, which our Chief Financial Officer, Keith Walsh, will discuss in detail during his remarks. Finally, today's remarks related to AIG's adjusted after tax income per diluted share as well as General Insurance results, including key metrics such as underwriting income, margin, and net investment income are presented on a comparable basis, which reflects year-over-year comparison adjusted for the sale of Crop Risk Services and the sale of Validus Re as applicable. Net premiums written and net premiums earned are also presented on a comparable basis, which reflects year-over-year comparison on a constant dollar basis and adjusted for the sale of Crop Risk Services, Validus Re, and the global personal travel and assistance business as applicable. We believe this presentation provides the most useful view of our results and the go forward business in light of the substantial changes to the portfolio since 2023. Please refer to pages 37 through 39 of the earnings presentation for reconciliation of such metrics reportable on a comparable basis. With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino."
},
{
"speaker": "Peter Zaffino",
"content": "Good morning, and thank you for joining us today to review our fourth quarter and full year 2024 financial results. Following my remarks, Keith will provide additional perspectives on our financial results, and then we'll take your questions. Don Bailey and Jon Hancock will join us for the Q&A portion of the call. Before I begin, on behalf of all of us at AIG, I want to acknowledge the devastating impact of the recent wildfires in California on families, communities and the businesses affected. Our local teams remain on the ground in California, providing critical expertise and support to our customers and partners. This tragic event serves as a stark reminder of the escalating risks, elevated catastrophe landscape and the complicated evolving environment that we operate in. It also underscores AIG's purpose to help our customers and clients navigate these challenges with resilience in rebuilding communities and restoring businesses. Let me take a moment to cover what I will walk you through during my remarks this morning. First, I will briefly share highlights from our strong fourth quarter performance. Second, I will discuss our 2024 strategic and operational accomplishments. Third, I will provide an overview of the full year financial results for AIG and our General Insurance business. Fourth, I will comment on the reinsurance market, including the January 1 renewals and provide some observations on the impact of the recent California wildfires. And lastly, I'll provide an update on the progress we have made on our capital management strategy, our path to achieving a 10% plus core ROE and how we are positioning the company for 2025. Let's begin with the fourth quarter results. We recently announced a realignment of our General Insurance business into three segments. North America Commercial, International Commercial and Global Personal. All of our comments will be aligned to these segments. During the quarter, we continued to deliver exceptional underwriting results and we maintained rigorous expense discipline. General Insurance reported strong net premiums written of $6.1 billion, an increase of 7% year-over-year led by 8% growth in Global Commercial lines. Global Commercial generated new business of $1.1 billion a 16% increase year-over-year along with continued strong retention of 86% across the portfolio. Net premiums earned of $6 billion grew 6% year-over-year. Adjusted after tax income per share grew 5% year-over-year to $1.30 per share. The calendar year combined ratio was 92.5%. And the accident year combined ratio, excluding catastrophes, was 88.6% which was an outstanding result. 2024 was a terrific year of accomplishments for AIG, during which we not only delivered strong financial performance, but also successfully executed significant strategic and operational initiatives. We delivered disciplined growth in our businesses with a primary focus on risk adjusted returns supported by our underwriting expertise. We reshaped the portfolio, including divesting a number of non-core businesses. Following the sale of Validus Re in November of 2023, we closed on the sale of the global individual personal travel insurance business in December of 2024 to further position us for the future. While these divestitures help to further simplify AIG, the biggest accomplishment of the year was the deconsolidation of Corebridge Financial. The separation was a four year journey during which we strategically positioned Corebridge for its future while creating a new capital structure for AIG. Some of the major milestones of the Corebridge journey included establishing a very important partnership with Blackstone through an initial 9.9% sale in 2021, executing the largest US IPO in 2022, setting up a strategic asset management partnership with BlackRock, divesting non-core foreign businesses, completing five successful secondary offerings, two of which were in 2024 and culminating in the fourth quarter with AIG sale of a 22% stake in Corebridge for $3.8 billion to Nippon Life, securing another strategic partner for the company. With the accounting deconsolidation of Corebridge, AIG is now a less complex and more streamlined global business. AIG Next was another operational accomplishment in the year, which further supported our journey to make the company leaner, weave the organization together and reduce expenses. We exited 2024 achieving $450 million in run rate savings as part of the program and we expect the remaining benefits to be realized in the first half of 2025. We also continue to successfully execute on our capital management strategy in a very disciplined manner with nearly $10 billion of actions in 2024. AIG reduced shares outstanding by 12% and increased the quarterly dividend per share by 11%, resulting in the return of $8.1 billion of capital to shareholders. We received over $4 billion in dividends from our subsidiaries due to the improved profitability of our operations. We further reduced our debt to total capital ratio to 17% and we ended the year with $7.7 billion of parent liquidity. Our capital management actions to-date have provided us with tremendous financial flexibility. Another strategic accomplishment in 2024 was the delivery of AIG's first generative artificial intelligence large language model powered solution to support business growth. Specifically, we implemented AIG Underwriter Assist, which automates qualitative unstructured data extraction from underlying submissions, internal AIG data sources, and external research in minutes to support underwriter review of submissions. To support and advance our GenAI aspirations, we've cultivated an ecosystem of top tier technology partners, including Palantir, Anthropic and AWS in support of an agentic architecture operating model that allows for maximum flexibility. We also launched the Reinsurance Syndicate 2478 at Lloyd's through a multiyear strategic relationship with Blackstone as part of AIG's Outwards Reinsurance Program. The syndicate began underwriting on January 1, 2025 and now serves as a key component of AIG's reinsurance strategy, which I will go over in more detail later. Turning to the financial results for the full year 2024. Adjusted after tax income was $3.3 billion or $4.95 per diluted share, an increase of 28% year-over-year. The improvement was primarily driven by stronger underlying underwriting results, expense reduction benefits from AIG Next, an increase in net investment income and the execution of our balanced capital management strategy. General Insurance delivered terrific financial performance for 2024. For the full year, net premiums written were $23.9 billion, a 6% increase year-over-year. Net premiums earned were $23.5 billion, a 7% increase year-over-year. The accident year combined ratio as adjusted was 88.2%, which marked the sixth consecutive year of improvement, largely driven by the GOE ratio. The full year General Insurance combined ratio was 91.8%. This was the third consecutive year of a sub-92% combined ratio. Prior year reserve development, net of reinsurance and prior year premium was $289 million a benefit of 1.4 points to the loss ratio. General Insurance full year underwriting income was $1.9 billion roughly in line with the prior year despite higher catastrophe losses. In Global Commercial, net premiums written of $16.8 billion increased 7% year-over-year. North America Commercial grew net premiums written by 9% year-over-year. Lexington grew net premiums written by 14% fueled by robust new business of $1.1 billion and a 42% increase in submissions year-over-year, and that was balanced across all lines. Retail casualty grew net premiums written by 11%, excluding the closeout transaction we mentioned in the third quarter. Our portfolio continues to benefit from a strong rate environment, high retention of our existing portfolio at 93%, and we have select opportunities in new business. International Commercial grew net premiums written by 4% year-over-year, driven by energy at 13%, retail property at 11% and Talbot at 7%. Global Personal grew net premiums written by 3% year-over-year, driven by International Personal Auto at 8% and our high net worth business at 6%. I would now like to turn to reinsurance and provide some observations on the market and an update on AIG's reinsurance renewals at January 1 of this year. Overall, AIG had a very strong 01/01 renewal season. Since the reinsurance market's major reset on January 1 of 2023 our consistency in strategy, placement and execution has positioned us very favorably. Benefiting from an environment of higher retentions and commensurate pricing increases, property reinsurers sought to deploy more capital, but were predominantly focused on upper layers with more remote return periods. Depending on loss activity, limited additional demand led to risk adjusted rate reductions that were consistent with expectations, with the bottom catastrophe layers renewing flat to down 5% and upper catastrophe layers receiving reductions of 10% to 15%. I want to provide some context and observations on the changes in the market as a result of the increase in reinsurance retentions, which I've mentioned on previous calls is creating an interesting dynamic for the market in 2025. One insightful statistic from an Aon study of over 150 companies over the past ten years is that retentions have risen significantly around the world with the US attachment points on average increasing by 280%. As a reminder, in 2024, insured loss from natural catastrophes was approximately 145 billion. The sixth costliest on record and this compares to the average for the last five years of 140 billion. With the increased retentions and increased catastrophe activity, much more of the risk is now being retained by insurance companies. In 2023 and 2024, primary insurance carriers are estimated to retain approximately 90% of the insured loss from natural catastrophes with the reinsurance industry absorbing 10%. Contrast this with the period prior to 2023, reinsurers would often share a significantly higher proportion of the insured loss with the distribution of losses between insurers and reinsurers at approximately 50-50 on average. Meanwhile, AIG is focused on maintaining lower excess of loss attachment points, including meaningful aggregate coverage to manage frequency of loss tailored to our geographic exposure and to the type of perils that we are exposed. Taking a closer look at wildfires and how the market has changed, the average annual insured loss from 2000 to 2024 was approximately 4 billion globally of which the US is the majority at 3.5 billion Narrow that period to the last ten years and average annual losses from wildfires have roughly doubled to around 8 billion of which 7.4 billion has occurred in the United States. Insured loss estimates for the California wildfires are currently coalescing around 40 billion with some estimates from credible catastrophe experts reaching as high as 50 billion. The economic loss is estimated to be in excess of 250 billion producing a protection gap of as much as 80%. Contrast that to the top 10 largest insured cat events on record, where insurance has typically covered 40% to 50% of the economic loss. As a point of reference, insurance covered approximately 50% of the economic loss from Hurricane Katrina, the largest natural catastrophe event this century. The California wildfires demonstrate the increased loss from secondary perils and the magnitude of tail events that are not captured well in modeling. In a month with one of the lowest model probabilities of loss, the California wildfires alone would make the first quarter of 2025 the second most costly first quarter for natural catastrophes on record. Fifteen years ago, adjusting for inflation, 100 billion was considered the benchmark for an outsized cat year. With the last eight years averaging more than 140 billion this thinking is clearly outdated. If you assume the upper end of the range for the California wildfires taking a $50 billion loss pick, adding the average annual insured loss for the past eight years, and assuming we have an active, but not abnormal wind season, which is realistic given the 2024 hurricane season experience and ocean temperatures are the warmest on record, 2025 could be a year of more than 200 billion of insured catastrophe losses. This could recalibrate the entire industry. AIG reduced our overall California exposure beginning in 2022. This decision, coupled with our 2025 reinsurance structure has effectively reduced our exposure such that the expected loss to AIG from the recent wildfires is approximately 500 million before reinstatement premiums and barring any unforeseen additional developments. Turning specifically to AIG's reinsurance outcomes at 01/01, we successfully maintained our prior objectives, our reinsurance purchasing strategy to preserve and optimize capital and enhance the quality of earnings through active management of the volatility of our underwriting results. Starting with our property catastrophe placements, our core commercial North America retention of 500 million remains unchanged in nominal terms for the third consecutive year despite growth in the underlying portfolio. We also expanded coverage and maintained our core international occurrence attachments and renewed our dedicated occurrence tower for our high net worth business, which attaches at 200 million. We improved our 500 million of aggregate protection by reducing the annual aggregate deductible for North America, creating a specific non-peak section and expanding the coverage for the high net worth portfolio. Overall, for North America, depending on loss distribution, AIG's modeled net first loss exposure, including the impact of reinstatement premiums is comparable to 2024 and our second and third event exposure is materially lower following its renewal cycle. For all of our major proportional treaties, we were able to improve or maintain our ceding commission levels, a strong recognition of our underwriting expertise and our position as a market leader across multiple classes. We were also able to establish two new proportional treaties to support the high net worth portfolio. Our strategy to establish Private Client Select as a standalone MGU and introduce capacity to support growth in the platform beyond AIG's balance sheet has been validated with the addition of five of the leading underwriting companies in the world to the platform, taking 30% of our homeowners and auto portfolios through quota share reinsurance. Casualty remains an area of caution for many reinsurers with appetite generally diminished. They are highly selective of the insurance companies they support. And overall, the casualty renewals were more orderly for the companies that have strong underwriting portfolios. We were pleased with the successful renewal of our core casualty treaties at favorable terms. This renewal cycle again signals the strong external industry recognition that AIG continues to be a leader in the casualty market. We remain optimistic on the outlook for our casualty portfolio and see considerable opportunities ahead, while being cautious and very focused on maintaining our high underwriting standards. Also of significance for AIG at 01/01 was our launch of a new dedicated reinsurance syndicate at Lloyd's supported by funds managed by Blackstone. This pioneering structure announced in December 2024 is an example of how insurance risk can be directly connected to sophisticated investors to generate attractive returns for both parties. The syndicate provides AIG with a long-term meaningful reinsurance partner and an additional source of fee income. Blackstone has access to a high quality, well diversified underwriting portfolio with the ability to generate attractive returns by taking a sizable participation in the majority of AIG's outward reinsurance treaties at market terms. We're pleased to partner with a leading global asset manager on its innovative structure. Our reinsurance strategy has played a pivotal role in our journey to establish AIG as an industry leading global P&C underwriter. We're grateful for the long-term support and partnership of the industry's leading reinsurers, which has helped position us where we are today. Turning to capital management, we continue to execute very well on our balance and disciplined strategy. We made major progress in 2024 and in many ways exceeded expectations. As we outlined last year, our guidance was to repurchase $10 billion of shares in 2024 and in 2025. The current guidance is expected to bring us within our target share count range of 550 million to 600 million shares. We have $3.4 billion of the $10 billion guidance that I provided remaining for 2025. We will likely exceed this guidance and we have over $5.6 billion remaining on our current share repurchased authorization. We expect to return to more normalized levels of share repurchases as we enter 2026, assuming we have no further sell downs of Corebridge or other additional sources of liquidity. We ended the year with a very strong parent liquidity of $7.7 billion. Additionally, we do not anticipate taking any actions that would significantly affect leverage in 2025. We are committed to reviewing our dividend annually and anticipate that we will increase our dividend in 2025 in line with the decrease in our share count over the past year, subject to AIG board approval. Going forward, our key focus is on profitable growth and allocating capital to the best opportunities for the most attractive risk adjusted returns. Our very early forecast indicates we're off to a strong start for 2025 and barring any unforeseen developments, we expect to achieve meaningful organic growth driven by our Global Commercial business and the benefits of our restructured reinsurance program. As a result of our disciplined capital management, combined with our sustained underwriting excellence and continued focus on expense management, we're well on track to deliver a 10% plus core operating ROE for the full year 2025. We have several ways in which we can deliver on this commitment. These are maintaining our strong underwriting results with a focus on improving Global Personal, improving our investment income yields, executing on a simpler, leaner business model across AIG and continued balanced capital management. In summary, I'm very pleased with our outstanding fourth quarter and full year 2024 performance. 2025 is a new chapter for AIG and we're moving forward with strong momentum. We continue to differentiate ourselves with deep industry expertise and disciplined focus on underwriting excellence and outstanding operations and claims capabilities, which drive exceptional value for our clients, partners and stakeholders. With that, I will turn the call over to Keith."
},
{
"speaker": "Keith Walsh",
"content": "Thank you, Peter. This morning, I will provide details on fourth quarter results for General Insurance, net investment income and other operations as well as key balance sheet items. I would like to begin by addressing a few changes in our financial reporting. As Peter mentioned, we have realigned our General Insurance business into three reporting segments. North America Commercial, International Commercial and Global Personal. Global Personal lines have been consolidated into a single reporting segment. This brings together our Global Accident and Health, Personal Home and Auto, Global Warranty and Services and High Net Worth businesses. Along with our new reporting segments, we have updated the product line net premiums written disclosure on Page 8 of our financial supplement to give more transparency into the underlying trends in our businesses. The three segments and updated product line disclosure are reflected retrospectively in AIG's 2024 fourth quarter and full year financial results. Additionally, we have streamlined other operations to include activities only related to having a global regulated parent company and now exclude the results of runoff businesses from adjusted pre-tax income. We believe these changes enhance the clarity of our financial disclosures and provide a better representation and alignment of our core business. Historical results have been recast to reflect these changes with de minimis impact to operating EPS. Other operations now largely consists of net investment income from our parent liquidity portfolio, Corebridge dividend income, corporate general operating expenses and interest expense. Turning to our fourth quarter General Insurance results. Adjusted pre-tax income or APTI was $1.2 billion. In North America commercial, net premiums written increased 9% year-over-year, driven by strong new business, which grew 17% with retention of 85%. International Commercial net premiums written increased 7% year-over-year with new business growth of 15% and excellent retention of 88%. In Global Personal, net premiums written increased 1% on a constant currency basis. The sale of the Global Personal Travel and Assistance business, which closed in early December, was about a four point headwind to the year-over-year comparison. Adjusting for that, growth was 5% in the quarter on a comparable basis, driven by 16% growth in our Global High Net Worth business. The sale of the Global Personal Travel business will have an impact on the Global Personal segment in 2025. For full year 2024, this segment had $7.1 billion of net premiums written. When modeling 2025, the sale of the Global Travel business will remove approximately $720 million of net premiums written. This is a roughly 10 percentage point growth impact for the segment. General Insurance underwriting income for the quarter was $454 million, a $156 million decrease from the prior year quarter, driven entirely by higher catastrophe losses. General Insurance calendar year combined ratio was 92.5%. The accident year combined ratio as adjusted was 88.6%, a 30 basis point increase from the prior year quarter. This was driven by a slight increase in the accident year loss ratio, while the expense ratio remained flat despite absorbing more AIG parent expenses. Catastrophe losses were $325 million or 5.5 points on the loss ratio. This includes $224 million of losses from Hurricane Milton and an adjustment for prior quarters events largely from Hurricane Helene, which occurred on the final day of the third quarter. Turning to reserves and our detailed valuation reviews or DVRs. This quarter, General Insurance had $102 million of favorable prior year development, including $34 million from the ADC amortization, $16 million from our fourth quarter DVRs and $52 million from non-DVR adjustments, predominantly recognition of AVE on US short-tail lines. The fourth quarter's DVRs covered the remaining 10% or approximately $4 billion of our total loss reserves focusing on the remaining portion of US financial lines, global personal lines Canada and Glatfelter. The favorable prior year development was primarily driven by Canada Casualty and US E&O. We conduct a comprehensive DVR annually for each product line across our $40 billion of reserves. While DVRs are spread across quarters, we have a robust year-round process on our entire book in addition to our quarterly DVRs. Going forward, our comments will focus less on reporting the DVR outcomes and more on our overall reserve analysis, which reflects AVE claims diagnostics and rate monitoring across all lines and geographies. One additional item I would like to discuss is a provisional reserve we created in 2022 in response to the potential uncertainty with inflation and other variables in the post-pandemic macro environment. This provision, which is included in IBNR, has been carried in the lines that we viewed as most susceptible to rising inflation with a large portion booked in our workers' compensation reserves. This year, we undertook a thorough review of the uncertainty provision which was set above the loss picks from our actuarial reviews and refined our analysis, including its allocation among our lines of business. The uncertainty provision did not reflect any emergence and we have maintained the overall estimate. However, we have decided to reduce the provision in excess workers' comp and reapportion approximately $150 million of the provision within excess casualty. We elected to move this portion of the reserve to excess casualty as the development factors and the length of the tail can drive a wider range of outcomes on our reserves. To be clear, our traditional reserve methods are not indicating any emergence in excess casualty, but we felt, given the nature of the provision, it was more appropriate to be situated within this line. As a reminder, our reserving philosophy is to react to bad news quickly and wait to recognize good news over time as we monitor developments. Moving on to rates and pricing. Fourth quarter Global Commercial Lines pricing, which includes rate and exposure increased 5% year-over-year, excluding workers' compensation and financial lines. In North America Commercial, renewal rate increased 3% year-over-year or 7% if you exclude workers' compensation and financial lines. Exposures increased 2% year-over-year with an all-in pricing change above loss cost trend. Property market conditions were under pressure in the fourth quarter due to increased competition across both the admitted and E&S markets, while the underwriting margin remained healthy. Supported by the cumulative rate increases over the past several years and our disciplined approach. In North America Casualty lines, rate continued to outpace loss cost trend with increases in the mid-teens in wholesale and excess casualty. In North America financial lines, we continue to experience headwinds, but see indications that rate reductions are moderating. In International Commercial, overall pricing was flat or up 2% excluding financial lines. While rate is below trend, we feel good about our book given we've had over 60% cumulative risk-adjusted rate since 2018. Our well-diversified portfolio allows us to navigate different market conditions effectively prioritizing lines of business that offer the most compelling risk adjusted returns while upholding our underwriting standards. For the full year 2024, excluding workers' compensation and financial lines, Global Commercial lines pricing, which includes rate and exposure increased 6%, with 8% in North America and 4% in International. Turning to other operations. Fourth quarter adjusted pretax loss was $150 million, which improved 34% year-over-year. This was primarily driven by lower GOE reflecting AIG Next benefits as well as incremental movement of GOE into General Insurance. We continue to realize the benefits of AIG Next and push nonpublic company-related expenses into the business. We expect corporate GOE expenses to migrate towards approximately a $90 million per quarter run rate over the course of 2025. Interest expense improved $10 million year-over-year, as a result of our liability management, which reduced total debt by $1.6 billion in 2024. One other item I want to discuss is a runoff business, Blackboard. In the fourth quarter, we increased the prior accident year reserves for Blackboard by $112 million to reflect loss activity that has been well above what was expected. Turning now to investment income. For the full year 2024, net investment income on an APTI basis was $3.5 billion, up 13% from 2023, primarily driven by Corebridge dividends, an increase in short-term investment income and higher reinvestment rates on fixed maturities. Fourth quarter net investment income on an APTI basis was $872 million largely unchanged year-over-year. General Insurance net investment income was $779 million, including income on fixed maturities, loans and short-term investments of $720 million and alternative investment income of $72 million. Other operations net investment income was $93 million, consisting of income from our parent liquidity portfolio of $64 million and Corebridge dividend income of $29 million. During the fourth quarter, we continued to benefit from higher reinvestment rates on the fixed maturity and loan portfolio. The average new money yield of 5.38% was roughly 175 basis points higher than the sales and maturities in the quarter. The annualized yield on the fixed maturity and loan portfolio, excluding calls and prepayments was 3.92%, up four basis points year-over-year or three basis points sequentially. The fourth quarter alternative investment income was $67 million, an increase of $26 million year-over-year, driven by improved private equity performance, partially offset by lower hedge fund income owing to our strategy to reduce exposure. Private equity yielded 6.42% for the quarter, below our long-term expected return of 7.5%. The makeup of our private equity portfolio is a little over 25% real estate and with the current macro environment, we expect pressure from this portion of the portfolio to continue through 2025. Turning to tax. The adjusted effective tax rate for the fourth quarter and full year was 24.6%. For 2025, we expect the adjusted tax rate to be in line with 2024, but may vary based on the geographic mix of income. We finished 2024 with a very strong balance sheet. Book value per share was $70.16 at year-end, up 8% from December 31st, 2023, mainly due to the favorable impact of lower interest rates on AOCI and reduced shares outstanding. Adjusted book value per share was $73.79 down 6% from year-end 2023, primarily due to the impact of Corebridge deconsolidation. Core operating ROE was 9.1% in the quarter and for the full year. As Peter laid out, we are committed to achieving our target of a 10% plus core operating ROE for the full year 2025. As Peter mentioned, we had a substantial $6.6 billion returned to shareholders in 2024 through share repurchases and are well on our way to completing our guidance of $10 billion of repurchases in 2024 and 2025. Through February 7, we have repurchased $952 million of shares year-to-date in 2025. We are proud of the significant progress we've made in 2024 and the ability to deliver outstanding core operating results while successfully executing significant transformation initiatives. With that, I will turn the call back over to Peter."
},
{
"speaker": "Peter Zaffino",
"content": "Thank you, Keith and Michelle, we're ready for questions.."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Our first question comes from Alex Scott with Barclays. Your line is open."
},
{
"speaker": "Alex Scott",
"content": "Hey, good morning. First one I have for you, excuse me, is on the core ROE that you gave. I just wanted to confirm that that's including the wildfire impact. And it looks like it's running a bit better than I would have expected based on the combined ratios that you've talked about in the past and corporate expenses and so forth. So I was just interested if you define it all on maybe some of the things that you're running ahead on or that are improving relative to some of those comments you've made in the past? Thanks."
},
{
"speaker": "Peter Zaffino",
"content": "Yes. Certainly, Alex. And, yes, we are confirming the 10% plus ROE including the $500 million wildfire that we had in January. If I could spend a second, I think we've done an exceptional job over the past few years of structuring our sort of global portfolio structuring the reinsurance to supplement that and having net retentions well within our expectations and what we budget. If I look at what we do budget for AAL over the last couple of years relative to our overall experience, it's been exactly where we anticipated even with elevated activity. So this is no different. I mentioned on the call that we're going to take first event losses around the same with reinsurance that we did in 2024, but second and third events will be less. And so that's how we structured it. And we are confirming guidance on the 10% including what happened in January. I think Keith noted that we have a lot of different ways in which we can sort of drive improvement in terms of earnings. I did as well in my prepared remarks. We're really pleased with the commercial portfolio and how it's performed on a combined ratio basis. We just continue to, I think, elevate our overall performance. I have singled out personal because I think that combined ratio is not where any of us want to be. We consolidated that under one leader. Jon Hancock, he's shown exceptional leadership in what he's done with the commercial portfolio in international. And I think it's going to give us a much better line of sight on the overall portfolio in terms of how we can improve it, which we fully expect to do. I think there's opportunities in NII further capital management. And I think we reconfirmed what we're doing on return of capital to shareholders. So I think we have a lot of very positive momentum and want to confirm guidance. Do you have a follow-up, Alex?"
},
{
"speaker": "Alex Scott",
"content": "Yes. So as a follow-up, I'd just be interested in some of the areas you're targeting towards organic growth. And maybe in particular, your updated view on price adequacy just given some of the declines in property pricing in E&S and then maybe also on casualty?"
},
{
"speaker": "Peter Zaffino",
"content": "Okay. I'm going to have Jon Hancock and Don Bailey talk a little bit about the growth because they've done an exceptional job in terms of outlining where our portfolio can grow, focusing on risk-adjusted returns. What I would say and this is complementing their efforts is that we've just done a tremendous job in terms of client retention focusing on an underwriting culture of maintaining and improving profitability. And so like we deploy capital where we think we have the best opportunities for improved risk adjusted returns. And they've done an exceptional job on new business in targeting parts of our business where we think we can have those outsized returns over time. And I think that's how you've seen the portfolio shape. So Jon why don't I start with you in terms of international and maybe give us a little bit of insight in terms of the growth."
},
{
"speaker": "Jon Hancock",
"content": "Yes. Okay. Thanks, Peter, and Alex. Growth through retention and new business was strong in the quarter. Peter and Keith called out a lot of that in their opening remarks, so I won't repeat it now. But what I will say is, we're working from such a strong base in this commercial portfolio in international. And when we look at where we've been growing, if you look at the quarter, there's a lot of seasonality across international. For example, in Q4, 50%, more than 50% of our net premiums come from just two lines. We like the global specialty and financial lines, but that's not the full year mix. So I think looking at growth, looking at new business, quarter-on-quarter isn't always the most insightful way. And Q4 is obviously the end of the year as well. So I think it's a good time to reflect on what we've been doing the whole of 2024 and talk about that momentum that we have been building. If I look at the full year, Keith called it out, 4% growth in the year across International Commercial. Renewal retention in the full year, 89%. I'm really, really pleased with that on such a good book of business. And new business for the year, more than $2 billion of new business during the year in International Commercial. Again, a great outcome, really reflective of the fact that we're still seeing great new business opportunities all around the world actually. And I also do want to make clear that new business is a big driver of our growth. We manage the quality, the price advocacy of our new business just as closely as we do our renewal book. And we trade on a value we offer. Our recognition as market leader, first class claims, risk management, strong balance sheet, not just price and that matters to a lot of customers. And if I could, I know you asked about property specifically. If I can just call out two places where we've been working really hard with our distribution partners on being clear on risk appetite, building propositions that customers want, building strong opportunity pipeline. That's where we've been getting the growth momentum from, and that's what we will see all through this year. There's too many areas to call out across international, but Global Specialty. A number of new business submissions up 24% year-on-year. Marine absolutely outstanding at 46% increase. Our straight rate on the business, we quote more than 25%. And again, Marine Energy, which Peter talked about earlier, 40% strike rates. So that's more than $700 million of new business in Global Specialty. Just a final one to show that momentum. Our commercial property book another standout. We spent a lot of time fixing and repositioning that portfolio. And we've now seen over the last couple of years, really strong growth and profit. Growth of 11% in the year. We're still seeing strong mid-digit rate rises as well as growth and some real high quality new business. The rating environment today, as Peter said earlier, is different to what it was in Q4. So we see lots of great opportunity all over and we'll build on that momentum."
},
{
"speaker": "Peter Zaffino",
"content": "That's great, Jon. Thank you. Don, maybe I just want to have a little bit of a highlight of achievements in North America in terms of growth."
},
{
"speaker": "Don Bailey",
"content": "Great. Thank you, Peter. I'll break down the North American Commercial numbers. For 2024, and you mentioned this, we grew net premiums by 9% driven by retention and our new business. We had strong retention of 91% in retail and 76% in wholesale. We also delivered impressive new business growth like Jon in North America, 15% up on a year-over-year basis and that's on top of 14% new business growth in 2023. This growth is intentional, it's strategic, it's diversified. With the great work over the past few years in our portfolio, we came into 2024 with distribution engagement as a top priority for us in all the channels in which we operate and it's paid off. Our new business was strong through all three channels. Retail, wholesale and alternative. With Lexington, we had another strong year. They represented 48% of our new business. Lex property, casualty, western world, all delivered. And as Peter referenced, Lex another big increase in submissions, 42% increase on a year-over-year basis. And there's a clear opportunity to harness the strong submission activity there to drive growth as we go forward. The rest of the new business was balanced across the portfolio. And finally, Peter, I'll just say this at the end that our growth given our unique assets at AIG, we really are able to underwrite with great discipline within our risk appetites and target opportunities with attractive risk-adjusted returns. Thanks, Peter."
},
{
"speaker": "Peter Zaffino",
"content": "That's great, Don. Jon, thank you. I know that answer was they were very thorough, but they're doing the work. And so I thought it would be really helpful to hear from them. Next question."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Meyer Shields with KBW. Your line is open."
},
{
"speaker": "Meyer Shields",
"content": "Great. Thanks. Peter, I was hoping you could walk us through how we should think about the impact of the artificial intelligence deployed in underwriting? I know it's simplistic to say how many loss ratio points would have moved, but how should we think about it more broadly?"
},
{
"speaker": "Peter Zaffino",
"content": "Thanks, Meyer, and good morning. For us, I could spend a meaningful amount of time talking about GenAI and we fully intend to do that at Investor Day. Our focus has always been on driving growth certainly there's opportunities in contact centers and call centers and operational capabilities that through large language models, robotics that we will gain efficiencies. But for us, it's all about ingestion of data, getting more qualified data to the underwriters in a fraction of the time. And in order to do that, you need to be very disciplined sort of end-to-end. So how we ingest data from brokers and agents, how we define what data we want in the underwriting criteria when it gets to the underwriter, how do we load that into models and how do we get more data from credible sources that may supplement the underwriters' decision making in order to continue to improve the portfolio. If I use Lexington as an example, in 2017 and 2018, we received 40,000 submissions. This year, it's over 400,000. So it's more complex today than just building out algorithms to get to different industry groups or different classes of business. We want to get more to the underwriters real time. And so we've been doing this for the better part of 18 months. I said we built out a really strong agentic ecosystem with, again, data ingestion with Palantir, building out large language models with Anthropic and using other reliable third parties to help us accelerate the modeling. And so I think it's going to help us propel top line growth by getting more data, getting richer data sets, giving the underwriters more capabilities to underwrite and having it done in the fraction amount of time and doing it at scale."
},
{
"speaker": "Meyer Shields",
"content": "Okay. Thank you. That's very helpful. The second question is on the timeline for getting the high net worth personal lines business to growth underwriting profitability. I don't know if there's anything you can share on that."
},
{
"speaker": "Peter Zaffino",
"content": "Yes, absolutely, Meyer. And, look, I think we've been on that journey for a couple of years, and everybody has been patient with the story. We continue to improve the combined ratio. We continue to improve the loss ratio. And if you look at Global Personal, the biggest contributor in terms of that improvement, it was primarily all the private client service or a high net worth business. There was a significant improvement in the loss ratio and we expect that to continue. We have a balanced growth strategy with non-admitted as well as admitted and believe that as we see more submission activity, which we are, not admitted that we're able to deploy our capital with more flexibility to be responsive to client needs. So I'm thinking about structure pricing, the amount of limit that we can put out and it's not only in peak zones, it's in non-peak zones. And so we expect to see that continue to accelerate. We got to scale this year. And so we've renegotiated ceding commissions with PCS and so you'll see a meaningful improvement there, which should translate into overall expense ratio improvement and combined ratio improvement. And last I mentioned is that we have tremendous partners that have joined us based on how we've repositioned the portfolio and our encouraging growth. And so we have a 30% quota share with six participants all have very strong expertise in the high net worth space that are backing us for more growth. So I think we have it all moving in the right direction, attritional loss ratios, cat support from great partners and improvement in expense ratio and you'll see that contribute in 2025 to helping overall Global Personal improve."
},
{
"speaker": "Meyer Shields",
"content": "Okay, fantastic. Thank you so much."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Jon Newsome with Piper Sandler. Your line is open."
},
{
"speaker": "Jon Newsome",
"content": "Good morning. Congrats on the quarter."
},
{
"speaker": "Peter Zaffino",
"content": "Thank you, Jon."
},
{
"speaker": "Jon Newsome",
"content": "Two sort of big picture question. One is are we at a point where there are aspirational areas of business that AIG is not in that you would be looking for either on organic or inorganic basis? And I guess sort of relatedly on the other side of that question is where are we from a divesting of noncore businesses perspective? Are we pretty much done at this point?"
},
{
"speaker": "Peter Zaffino",
"content": "Sure. Thanks for the question. I'll start with the second one first. I think we are largely done. I mean, I don't ever say never or always. But I think we now have the portfolio in a place where we'd like it, certainly on the commercial side, and now having one segment for Global Personal. We know we have work to do, but really like the mix of the portfolio, its global balance and think that we can grow it. In terms of M&A, we're going to remain very disciplined. I always use the word when I get the question on the calls or I'm in front of you. It's around being, it has to be compelling, which just means that it's either going to be a geography that's complementary that actually adds value to AIG and our clients' products that we may not be in that we like and think that it's going to be accretive to ROE and how we grow our business. There are businesses that we have that have scale, but additional scale could be quite compelling. And so we are looking at that businesses that may do that and accelerate. And of course then there's complementary businesses that we may not be in that we think could be very additive to the platform. So we have a very disciplined approach. We always are looking around the world to see if there's things that are additive. But I do want to say I think we're at the size and scale where we don't need to add anything. We are showing, and I think Jon and Don provided tremendous insight as to why we think we can grow the business organically. We have a really strong capital base, which we can grow into, and believe that there's a path there. So I don't think it's an either or. I think we have now set the company up with enormous strategic and financial flexibility. We'll remain very disciplined as we look at inorganic, but we're very excited about the organic opportunities that are in front of us."
},
{
"speaker": "Jon Newsome",
"content": "Great. Maybe as a second question. Do you have any thoughts on the regulatory environment? Clearly lots of, as my grandmother would say, interesting things happening in California from a regulatory perspective. But broader, do you think there's some changes here that are coming or do you think it's pretty status quo?"
},
{
"speaker": "Peter Zaffino",
"content": "Insurance is complicated because we're regulated state by state. And that makes every state a little bit different, right? And I think the ones that get the attention are going to be ones that have peak zone exposure like we're seeing within California. And California is particularly complicated because I relate it almost to Japan. It's a geography that has two major perils that drive catastrophe results. And so I was in Japan's typhoon quake, California's quake and now wildfire. And but there's regulators. We work very closely with them to try and be helpful and constructive on the changes that have happened in the catastrophe climate, which is looking at modeling, looking at loss cost, looking at cost of goods sold and looking at ways in which we can be more responsive to client needs. And I think that in California, we just saw that the modeling is flawed. It doesn't necessarily always take into account tail events. There's not a lot of model losses north of $40 billion. And so therefore, it becomes very complicated. And I don't mean this in California, but we're now seeing it, which is some of these state set up sort of vehicles that become a market of last resort be sometimes become a market of only resort and then they end up taking on a lot of aggregate. So I think we just need a reset in certain spots. And I think like insurance companies that have technical capabilities working very closely with regulators. I hope that we're going to position the businesses where we will have more flexibility in the future."
},
{
"speaker": "Jon Newsome",
"content": "Thank you very much."
},
{
"speaker": "Peter Zaffino",
"content": "Yes. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Michael Zaremski with BMO. Your line is open."
},
{
"speaker": "Michael Zaremski",
"content": "Great. Follow-up, morning, on the expense ratio. I heard the comments about ceding commissions improving, so that should be a positive going forward. The expense ratio has been running a bit higher than expected for a while now. I mean, obviously, the loss ratio has been excellent. So that's the main focus. But just curious if you're willing to give any specific more specific guidance on kind of what type of expense ratio level or acquisition expense ratio level we should be thinking about on a go-forward basis?"
},
{
"speaker": "Peter Zaffino",
"content": "Michael, are we talking about PCS and high net worth or just general insurance?"
},
{
"speaker": "Michael Zaremski",
"content": "Sorry, I was talking about the whole company, General Insurance."
},
{
"speaker": "Peter Zaffino",
"content": "Yes. So let me unpack, I mean, again, I know with AIG, it's like with the divestitures and a lot of the moving pieces from other operations into General Insurance, it's complicated. But I'm actually really pleased with what we've done on the expenses. I think we've remained incredibly disciplined. We focused on a lean parent, which just meant that there's simplicity. There's not a lot of expenses sitting in other operations and they're going to be more in the business. So if I actually take you through what happened, and if you look at our financial supplement, you'll see $2.9 billion or thereabout $2.952 billion as sort of the expenses. But if you get underneath that, look, AIG Next, the business was very proactive in getting expenses out. And so we would have gotten around $125 million to $140 million out through AIG Next. But we've added in from other operations and other technology that would have sat in other operations, almost $200 million. And so the business has absorbed a lot of expenses as we reposition the company to have this lean parent very transparent, not with a lot of expenses and the business is absorbing it as we go. And so not only am I proud that they've been able to do that and we haven't had a blip, we also believe that there's opportunities to get more expenses out and the ratios to improve as we get through the rest of 2025. Do you have a follow-up?"
},
{
"speaker": "Michael Zaremski",
"content": "Yes. Quick follow-up. Just I know you made some comments on the casualty marketplace. I'm not fast enough to update all the pricing data you gave us, which is always helpful. But I'm curious, are you experiencing any acceleration in casualty pricing, either excess or retail? And do you still feel that I feel like a couple of quarters ago, you mentioned this might be an area you're willing to play a bit of offense in."
},
{
"speaker": "Peter Zaffino",
"content": "Yes. So it's a great question. And again when we look at rate across North America, International, it's an index. And so you don't always get a line of sight. But we do see real opportunities in casualty. We're very cautious, but the rate environment is actually quite strong. I mean in Lexington Casualty, you'll start there. We had 14% rate in 2024. In retail excess casualty, we had 15%, that's the fifth year in a row of double-digit rate increases in retail excess casualty, it's above loss cost trend. So we feel like we're building margin, really strong retention. We've been able to reposition the portfolio as we've liked. We have an exceptional particularly in the US leadership with Barbara Luck. I mean we have the best underwriting team in the industry and that's being demonstrated because clients are asking us to be on their business, help structure it, help the terms and conditions. So others will be active participants in the market. And so we're leading. We're underwriting really well. We've repositioned the portfolio. We've got great reinsurance support for severity. And we're getting rate above loss cost. So I want to be very cautious and careful, but I also don't want to miss the opportunity to be an industry leader."
},
{
"speaker": "Michael Zaremski",
"content": "Thank you"
},
{
"speaker": "Peter Zaffino",
"content": "Okay. I want to thank everybody for questions and your active participation today. In closing, I want to thank our AIG colleagues around the world for their continued commitment, teamwork and the significant contributions. I mean, we accomplish a lot every year, and we try to capture it for you today and we really appreciate joining us today. And we look forward to sharing a lot more detail on March 31st during AIG's Investor Day. Have a great day."
},
{
"speaker": "Operator",
"content": "Thank you for your participation. This does conclude the program and you may now disconnect. Everyone have a great day."
}
] |
aig | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to AIG's Third Quarter 2024 Financial Results Conference Call. This conference is being recorded. Now at this time, I'd like to turn the conference over to Quentin McMillan. Please go ahead."
},
{
"speaker": "Quentin McMillan",
"content": "Thanks very much, Michelle, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements, circumstances or management's estimates or opinions should change. Today's remarks may also refer to non-GAAP financial measures. A reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com. Additionally, note that following the deconsolidation of Corebridge Financial on June 9, 2024, the historical results of Corebridge for all periods presented are reflected in AIG's condensed consolidated financial statements as discontinued operations in accordance with U.S. GAAP. Finally, today's remarks related to General Insurance results, including key metrics such as net premiums written, underwriting income, margin and net investment income are presented on a comparable basis, which reflects year-over-year comparisons on a constant dollar basis as applicable and adjusted to the sale of Crop Risk Services and the sale of Validus Re. We believe this presentation provides the most useful view of General Insurance results and the go-forward business in light of the substantial changes to the portfolio since 2023. Please refer to Pages 26 through 28 of the earnings presentation for reconciliations of such metrics reported on a comparable basis. With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino."
},
{
"speaker": "Peter Zaffino",
"content": "Good morning and thank you for joining us today to review our third quarter 2024 financial results. Following my remarks, Sabra will provide more detail on the quarter. Then our North America and international leaders, Don Bailey and Jon Hancock will join us for the Q&A portion of the call. Before we begin, I want to acknowledge the devastating impact the recent weather events had on our communities, which underscores the difficult reality of changing weather patterns and the frequency and severity of these events. At AIG, our claims teams have been working hard to ensure that we respond quickly. I'm grateful to our colleagues for their commitment to our clients and distribution partners. This is our purpose and it's when our company is needed most. Now let me move to the highlights of our outstanding third quarter performance. We continue to deliver exceptional underwriting results, maintain rigorous expense discipline, execute on our capital management plan and make excellent progress on our strategic priorities. Adjusted after-tax income was $798 million or $1.23 per diluted share, representing a 31% increase in earnings per share year-over-year, driven by strong core earnings growth and disciplined execution of our capital management strategy. Underwriting income for the quarter was $437 million, which included total catastrophe related charges of $417 million. The calendar year combined ratio was 92.6%. Consolidated net investment income on an adjusted pre-tax income basis was $897 million, a 19% increase year-over-year. Other operations, adjusted pre-tax loss was $143 million, an improvement of $135 million or nearly 50% year-over-year. Core operating ROE was 9.2% with core operating equity of $34.5 billion as of September 30, 2024. In the third quarter, we returned approximately $1.8 billion to shareholders through $1.5 billion of stock repurchases and $254 million of dividends. In addition, we repurchased $520 million of common stock in October. We ended the third quarter with a debt-to-total-capital ratio of 17.9%, including AOCI and parent liquidity of $4.2 billion. During my remarks this morning, I will provide information on the following five topics. First, I will review the financial results for our General Insurance business. Second, I will provide observations on the catastrophe market and specifically AIG year-to-date. Third, I will update you on our progress with AIG Next and its impact on other operations. Fourth, I will provide an update on our significant progress in AI and related objectives moving forward. And finally, I'll give more detail on our capital management plan and the path to achieving 10% core ROE. Turning to General Insurance. We had another excellent quarter with strong profitability and growth across our businesses. Gross premiums written for the quarter were $8.6 billion, an increase of 3% from the prior year. Net premiums written for the quarter were $6.4 billion, a 6% increase. Net premiums earned for the quarter were $5.9 billion, a 7% increase with $4.2 billion coming from Global Commercial. The accident year combined ratio as adjusted was 88.3%. We had favorable prior year reserve development of $153 million, a benefit of 2.6 points to the loss ratio. Sabra will provide more detail in her prepared remarks. In Global Commercial, we had 7% net premiums written growth over the prior year quarter, driven by over $1.1 billion of new business, which grew 9% year-over-year. Retention remained at 88%, which is an outstanding outcome. The accident year combined ratio as adjusted was 84.2% and the calendar year combined ratio was 89.9%. The GOE ratio was flat year-over-year, while absorbing over $50 million of expenses that shifted from other operations. In Global Personal, we had 3% net premiums written growth over the prior year quarter, led by 9% new business growth across our Global portfolio. The accident year combined ratio as adjusted was 97.8% and the calendar year combined ratio was 98.8%, both were improvements year-over-year, and we expect this segment to continue to improve its financial performance in 2025. North America Commercial grew net premiums written by 11% year-over-year. We had a closeout transaction in the quarter in our casualty portfolio that benefited overall growth, but negatively impacted the accident year loss ratio. Absent this transaction, our net premiums written growth would have been in the high-single-digits. The businesses that drove growth were casualty at 9%, excluding the closeout transaction, 8% in Glatfelter and 7% in Lexington. Retention in North America was 90% in admitted lines and 78% in Lexington, which is an exceptional outcome for an excess and surplus lines business. New business growth in the quarter was simply outstanding. On a year-over-year basis, we had 22% growth in new business led by Lexington with 24% growth. And the story for Lexington just keeps ongoing. We had over 95,000 new business submissions in the quarter, up 35% year-over-year. Casualty submissions were up over 70%, Western World was up over 30% and property was up over 20%. Also, our financial lines new business was up double-digits. This was due almost exclusively to a rebound in M&A following a slow new business quarter for financial lines in the same period last year. North America Commercial accident year combined ratio as adjusted was 85.1% and the calendar year combined ratio was 95.5%, an exceptional outcome given the significant CAT activity in the quarter. The accident year loss ratio was 61.8% for the quarter, which was an increase of 250 basis points year-over-year and reflected two main variables. First, the closeout transaction in AIGRM that I mentioned earlier, while profitable and incrementally beneficial to the overall combined ratio, it carried a higher loss ratio, which resulted in a 70-basis point headwind. And second, the actual versus expected in the prior year quarter comparison was very favorable as a result of our admitted and wholesale property portfolios experiencing close to 30% rate increases last year that earned in over 2023 and the early part of 2024, creating a 180-basis point headwind. The combined ratio also benefited from a lower expense ratio, reflecting improvement in the GOE ratio. In International Commercial, net premiums written grew 3% year-over-year. Commercial property grew 6% as did Global Specialty, where international specialty grew 10% driven by Energy. Our Talbot business at Lloyd's also grew 6%, driven by 18% growth in the specialty lines, specifically political risk, energy and marine. International retention remained strong at 89%, which was very balanced across the portfolio, led by energy and property, both at 92% and casualty at 91%. International also had very good new business of over $500 million, led by global specialty with 25% new business growth in marine and 40% new business growth in Talbot year-over-year. The International Commercial accident year combined ratio as adjusted was 83.4%, another excellent result. The calendar year combined ratio was 84.3%. Given that the third quarter is usually the most active quarter for natural catastrophes, I want to provide some thoughts on the activity year-to-date and how the evolution of our underwriting and reinsurance strategy has significantly enhanced AIG's performance over time, even in light of this historical increased activity. For the first nine months of the year, preliminary industry estimates of insured losses from natural catastrophes are in excess of $100 billion, which appears to be the new normal. When considering the impact of Hurricane Milton on the industry and the remainder of the fourth quarter, Aon recently published a report that estimated that the 2024 total insured losses for the industry from natural catastrophes will likely exceed $125 billion. When analyzing large single catastrophes, the complexity of determining the initial and ultimate loss is complicated. Modeling firms produce industry loss estimates post event and there are many factors that go into estimating the ultimate losses. It is important to note that no two catastrophes are the same. Property claim services or PCS is a widely used source for independent property loss estimates in the United States. The loss figures that they provide are derived from claims activity and other factors at the time of loss rather than a judgment of the ultimate size of the loss. As a result, the actual scale of total loss is often subject to misinterpretation. Historically, if you look back at major events including Katrina, Superstorm Sandy and Ian, the final report of PCS figures were substantially higher than their original estimates, illustrating the uncertainty around determining ultimates or best estimates for catastrophe losses. At AIG, we've mitigated the impact that weather events have had on our business as reflected in our improved financial performance even as the world has seen more CAT activity. Over the last five years, our losses have dropped dramatically, both in nominal terms and also in terms of the overall market share of the losses. This is a testament to the work we've undertaken to change and evolve our underwriting strategy, reduce volatility and increase the quality of our earnings. If we use 2012 as a reference point, which was a year with meaningful activity, the total insured catastrophe losses on a nominal basis were $65 billion for the industry. That is roughly equivalent to the 20-year average and serves as a useful benchmark. Since 2012, expectations for annual industry catastrophe losses have grown substantially. The average annual industry loss from natural catastrophes from 2017 through 2023 has increased approximately 90% when compared to the average from 2000 to 2016. Since 2017, seven of the last eight years, including the 2024 forecast have had over $100 billion of annual insured losses. It's important to note, against this heightened level of natural catastrophe losses, based on published reports, we estimate approximately 50% of the insured natural catastrophe losses were absorbed in the reinsurance market from 2017 to 2022. However, following the major market reset in 2023, approximately 90% of the losses were retained by the primary insurance companies. And this is a significant change. As I have discussed several times, the work we've done to change AIG's approach to underwriting and reinsurance has resulted in dramatic improvements in our financial performance and balance sheet. Let me give you some specific points to contextualize the magnitude of this impact. Based on AIG's legacy underwriting strategy and reinsurance choices in 2012, AIG posted an initial pre-tax loss of $2 billion from Superstorm Sandy, which represented almost 7% of the estimated $30 billion market loss for that single event. And for the full year 2012, AIG recognized approximately $2.7 billion of losses or approximately 4% of the market losses. Today, AIG is forecasted to be within our catastrophe loss expectations for the full-year or more importantly, less than 1% market share of the forecasted total industry loss for 2024 of over $125 billion. Additionally, it's worth noting that our property portfolio net premiums written are approximately the same amount in 2024 as they were in 2012. However, today, we have 80% lower CAT losses and volatility. And importantly, our year-to-date 2024 commercial property combined ratio is in the low 80s compared to a combined ratio of nearly 120% in 2012. We've completely transformed our business over the past five years, and this is the new AIG. AIG's strategy to manage volatility through our gross underwriting actions and our approach to reinsurance, including our decision to maintain the lowest net retention amongst our Global competitors, has delivered significant benefits for the company and positions us well for the future in an environment with significantly elevated insured loss activity and modeling uncertainty. Let me take a minute to comment on high level expectations for the upcoming January 1 renewal season for property. The significant reset in the property CAT reinsurance market in 2023 means that reinsurers generally have higher attachment points, provide name perils and have significant retro protection and therefore are likely to make an underwriting profit on their global catastrophe portfolios in 2024, given the current loss levels and the benefit of reinstatement premiums. With this expectation of underwriting profit, the overall reinsurance market should remain healthy. Despite the strong capital position of the market, generally speaking, I would expect the market to remain disciplined at January 1, not reducing attachment points and focusing on deploying capital to the insurance companies with higher quality portfolios like AIG. Given that this has become the industry norm, as I mentioned earlier, industry losses from increased frequency and severity will continue to be realized by primary insurers and will not be solved by the reinsurance market in 2025. Let me move on to provide an update on AIG Next, which we launched in early 2024 to further position AIG for the future. Over the past several years, we've been on a journey to simplify the company by weaving the organization together to operate seamlessly across underwriting, actuarial, claims and all of our functional areas with the necessary skills and capabilities to effectively differentiate AIG for the future. In 2025, we expect to fully realize the $500 million in savings from AIG Next. These savings will impact multiple areas across other operations and General Insurance. As part of the AIG Next program, we've established a new definition of parent expense to exclusively reflect costs related to being a global regulated public company and expect those costs to be around $350 million going forward. In the future, costs currently attributed to other operations will either be eliminated or included within the General Insurance results. You can see the impact of this effort already flowing through our income statement as other operations expenses are down nearly $30 million year-over-year or $40 million sequentially. This reduction reflects the expense benefits from AIG Next and the transfer of a portion of these costs to General Insurance GOE. The ability of the businesses to absorb these additional costs with minimal impact to the expense ratio is due in large part to our significant focus on managing expenses. AIG Next has also enabled us to invest in core capabilities and the implementation of strategic innovation initiatives, notably in underwriting, claims and our data, digital and AI strategy. Let me provide you with more detail. Many companies are discussing their data, digital and AI strategies, but what is actually being done varies greatly from company to company. At AIG, we're utilizing GenAI in large language models as digital accelerators and applications that support the innovation journey, but they are not the innovation alone. This is what makes our recently announced collaborative space in Atlanta so unique. It will be the first location in our global footprint where an end-to-end underwriting process will exist from distribution, sales to data insights, underwriting, claims payments and client servicing. This location will allow us to innovate and evolve the end-to-end process, further develop our Agentic GenAI ecosystem, drive role clarity and digitize and modernize our processes. GenAI can produce meaningful gains from reducing manual inputs and driving process efficiencies. However, our GenAI ecosystem is doing much more than that. It integrates proprietary data from multiple sources with data ingestion capabilities to give us better data quality in a fraction of the time. In our early pilots, we've seen data collection and accuracy rates within our underwriting processes improve from levels near 75% to upwards of 90%, while reducing processing time significantly. We're also using our GenAI ecosystem to increase our submission response rate while enabling our underwriters to prioritize the highest value business within our risk appetite. These improvements will help drive growth and operating leverage as we deliver GenAI to our businesses at scale. It will allow our underwriters to spend more time quoting and winning business and less time manually collecting data. Our culture at AIG is one that is deeply rooted in underwriting expertise and excellence. We help clients solve complex risk issues that require judgment and a nuanced understanding of clients' needs, maintaining the underwriter at the center of decision making will continue to be paramount and a key differentiator for us. Our AI initiatives are designed to do just that, deliver better outcomes and drive operating leverage while keeping highly experienced underwriters at the core of the process. I'm now going to turn to capital management, where we continue to execute our balanced disciplined strategy. Our objectives are to preserve strong insurance company capital levels to support organic and potentially inorganic growth, maintain conservative debt leverage ratios, return excess capital to shareholders in the form of share repurchases and dividends and maintain parent liquidity. We made substantial progress over the last several years to improve the financial strength of AIG. General Insurance is well positioned for sustained profitable growth. This has been a multi-year process that's centered on executing on our underwriting strategy, while increasing profitability and reducing volatility in our portfolio through a better mix of business along with the strategic use of reinsurance. An important result of our improved profitability is our ability to receive ordinary dividends from our operating subsidiaries, which provides consistent and increasing liquidity to the parent company. Year-to-date, we received ordinary dividends or their equivalents of approximately $3 billion from our businesses. Our financial strength is also evidenced by the lower levels of debt on our balance sheet, historically, AIG had one of the highest debt-to-total capital leverage ratios in the industry at over 30%. In 2024, we have reduced debt levels by $1 billion, bringing our debt-to-total capital leverage ratio to 17.9%, including AOCI, amongst the lowest in our peer group, an achievement that requires significant discipline. Through the first nine months of 2024, we returned over $5.5 billion to shareholders through $4.8 billion of common stock repurchases and $765 million of dividends. As we've stated previously, we will continue to execute on our $10 billion share repurchase authorization over the course of 2024 and 2025, subject to market conditions and timing of the closing of pending transactions. The current authorization will bring us within our target share count range of 550 million to 600 million shares. Importantly, our anticipated parent liquidity provides the flexibility to support additional share repurchases, which we will review in 2025. Earlier this year, we increased the cash dividend to shareholders on AIG common stock by 11%. We will continue to review our dividend annually, considering additional increases as appropriate, supported by our increased earnings power. This will be an important focus for us in 2025 and beyond. We ended the third quarter with parent liquidity of $4.2 billion. With the combination of our disciplined capital management, sustained continued underwriting performance and focus on expense management, we expect to deliver a 10% core operating ROE for the full-year 2025. We recognize that with core operating equity of $34.5 billion at the end of the third quarter, parent liquidity, our capital in the insurance company subsidiaries and future proceeds from corporate sell-downs, we have excess capital for the size of the business we are today. We will proactively manage our capital over time to support growth in our business and we will maintain a capital management strategy centered on balance and patience while remaining nimble to execute, should attractive opportunities arise. In summary, I'm very pleased with our outstanding third quarter performance, as we approach year end and plan for 2025, our path forward is clear. We will continue to solidify AIG's position as a global market leader and remain focused on value creation for our customers and shareholders. With that, I'll turn the call over to Sabra."
},
{
"speaker": "Sabra Purtill",
"content": "Thank you, Peter. This morning, I will provide details on third quarter results for General Insurance, net investment income, other operations and capital. Turning to General Insurance. Adjusted pre-tax income or APTI was $1.2 billion. Underwriting income was $437 million, including $411 million of catastrophe losses. Hurricanes Beryl and Helene were the two largest losses in the quarter. Hurricane Milton made landfall on October 9 and therefore, its financial impact will be recognized in the fourth quarter. Peter commented on the complexity of determining ultimates for natural catastrophes. And at this point, we have a very wide range of estimates for modeling firms. Claims activity to date for Milton has been relatively light compared to storms of similar strength and intensity. Our current preliminary loss estimate for Milton is between $175 million and $275 million. The third quarter 2024 accident year combined ratio as adjusted was 88.3%, about 140 basis points higher than last year, principally due to changes in premium mix and reinsurance structure and favorable actual versus expected experience in the third quarter of 2023. We also had one large closeout transaction, which Peter mentioned that increased the consolidated loss ratio by about 40 basis points. Year-to-date, the accident year combined ratio is 88.1%, down 60 basis points from 2023. The accident year loss ratio was 56.4% for the quarter, including the impact of the closeout transaction and 56.4% year-to-date, flat with the first nine months of 2023. We expect the fourth quarter accident year loss ratio as adjusted, will be in line with the first nine months of this year. Turning to prior year development. This quarter, we had $153 million of favorable prior year development, including $34 million from the ADC amortization. During the quarter, we completed detailed valuation reviews or DVRs on almost $22 billion or 47% of our total loss reserves. We reviewed most of the reserves for international in addition to North America property and financial lines. Overall, we had favorable prior year development on short tail lines in global specialty and global commercial property and a modest amount in North America financial lines. This was partially offset by $181 million of adverse development in U.K. and Europe casualty and financial lines on about $8 billion of reserves. This reflects refinements in loss estimates due to recent claims emergence and settlement activity on specific exposures in accident years 2019 and prior, consistent with our reserving philosophy of addressing bad news quickly. In addition, we increased U.S. excess casualty reserves by $72 million due to a large settlement of a legacy mass tort claim also related to accident years 2019 and prior with most of the gross loss and accident years that were ceded to the ADC. We remain very comfortable with the adequacy of our loss reserves, having completed DVRs covering more than 90% of reserves year-to-date and considering the results of our monthly actual versus expected process and other claims diagnostics. While North America Financial Lines had a slight amount of favorable development from accident years 2021 and prior, we did not adjust loss reserves for more recent accident years, which have continued to show favorable indications relative to our books loss assumptions, consistent with our reserving philosophy of giving favorable experience time to mature. Turning to pricing and loss trends. Third quarter experience in Global Commercial Lines was consistent with second quarter 2024 trends. Excluding financial lines and workers' compensation, AIG's Global Commercial pricing, which includes rate and exposure increased 6%, largely in line with loss cost trends. In North America Commercial, which is about half of our global commercial book, pricing excluding financial lines and workers' compensation was up 7% with rate up more than 5%. North America casualty rate increases were strong with Lexington averaging 16% and retail casualty averaging 13%. These are well above our casualty loss cost trends, which as we've previously disclosed are at 10% or higher depending on the line, risk and attachment point. Property rates in North America Retail and Lexington were consistent with second quarter and the underwriting margin remained strong, supported by cumulative rate increases over the past several years and our disciplined underwriting approach, particularly to CAT exposed property. Pricing in International commercial, excluding financial lines was up 4%, in line with loss trend and underwriting profitability remains very strong. International property continued to achieve overall pricing in excess of loss trend. Our global footprint and diverse portfolio enable us to remain agile, focusing on lines of business with attractive risk adjusted returns while maintaining underwriting discipline. We are confident that the overall strength of our portfolio positions us to deliver sustainable underwriting profitability. Turning to investments. Our investment portfolio is of high credit quality, well diversified by asset class and match to our liability duration. The increase in interest rates since 2021 has driven higher portfolio yields even as credit spreads have tightened. Third quarter 2024 net investment income on an APTI basis was $897 million, up 19% from the third quarter of 2023, driven by increased reinvestment rates on fixed maturities, higher short-term investment income, Corebridge dividends and other operations, slightly better private equity returns and lower investment expense. Reinvestment yields on fixed maturities and loans remains above runoff yields, providing positive yield pickup in the quarter. The average new money yield on General Insurance fixed maturities and loans was 60 basis points higher than sales and maturities adjusted for one large sale in the quarter. General Insurance investment income was $773 million, including income on fixed maturities, loans and short-term investments of $718 million and alternative investment income of $43 million. Considering the current interest rate curve, we project fourth quarter General Insurance investment income on fixed maturities, loans and short-term investments to be approximately $710 million due to the impact of floating rate security resets, partially offset by higher reinvestment yields. About 11% of our fixed maturities have monthly or quarterly floating rate resets to SOFR or other short-term market indices, which began to decline in the third quarter. Alternative income is principally from traditional private equity and now includes real estate investment funds that were previously consolidated. These assets are reported on a one quarter lagged basis and based on third quarter market performance, we expect fourth quarter private equity results may be similar to the year-to-date annualized return of 3.5%. Turning to other operations. Adjusted pre-tax loss in the quarter was $143 million, a nearly 50% year-over-year improvement driven by lower GOE and interest expense and higher net investment income, which totaled $125 million in the quarter. Considering both lower short-term rates and projected parent liquidity balances before proceeds from any strategic transactions, short-term investment income could decline in the fourth quarter by about $25 million sequentially. To wrap up the quarter, the balance sheet remains very strong. Book value per share was $71.46 at quarter end, up 4% from June 30, 2024, due to the favorable impact of lower interest rates on AOCI. Book value per share increased 10% from year end 2023. Adjusted book value per share was $73.90, up 2% from June 30 due to reduced shares outstanding and was down 6% from year end 2023 due to different accounting treatment of Corebridge between the two periods. As Peter noted, our debt leverage ratios are very strong. We recently called a $400 million par zero coupon bond, which will close November 22. Core operating ROE, which measures the annualized return on AIG shareholders' equity, excluding the value of Corebridge shares and deferred tax assets, was 9.2% in the quarter and 9.3% year-to-date, reflecting strong General Insurance profitability and capital levels. To conclude, AIG delivered another excellent quarter with significant financial and operational accomplishments. We are confident in our ability to deliver sustained underwriting results and a 10% core operating ROE in 2025, and we look forward to updating you on our progress. With that, I will turn the call back over to Peter."
},
{
"speaker": "Peter Zaffino",
"content": "Thank you, Sabra. And Michelle, we're ready for our first question."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from Meyer Shields with KBW. Your line is open."
},
{
"speaker": "Meyer Shields",
"content": "Great. Thanks, and good morning. I want to start with a question about reserves, if I can. You talked about how recent accident years financial lines are emerging better than expected, but you're not booking that yet. Can you talk a little bit about what's happening in the older accident years for, I guess financial lines or casualty, we saw the one-off issues, but I'm wondering more broadly, is there the same sort of theme in the older accident years that could be getting closer to acknowledgment."
},
{
"speaker": "Peter Zaffino",
"content": "Thanks, Meyer. Good morning. I think Sabra provided quite a bit of detail in her prepared remarks, but Sabra, do you have anything to perhaps give a little bit of context on financial lines?"
},
{
"speaker": "Sabra Purtill",
"content": "Yes. And let me just make a few comments. I mean, obviously, we had very strong favorable development in the DVRs this quarter. Consistent with our approach, we have allowed favorable development to -- our favorable experience to mature. And this quarter, particularly on shorter tail lines, we had about $300 million of favorable development. I would just note that this quarter did not include workers' compensation that was done in the third quarter of last year and this year it was done in the second quarter and we'll do it in the second quarter for next year as well. What I would just comment on in terms of the -- I'll talk to the excess casualty first because I know that's been in some focus. The trigger for the action in North America casualty, excess casualty was for a particularly large settlement, growth of reinsurance, which was from very old accident years that were covered by the ADC. Absent this settlement, we would not have made any adjustments in that line because the DVRs for that line are done in the second quarter normally. Turning to financial lines. Let me just note that for the quarter in total, we had post-ADC, the adverse development on financial lines was about $28 million in total. That was driven by the adverse development on U.K. financial lines, which again was an older book with -- related to some specific exposures. We did actually recognize favorable development on the U.S. and international portfolios. And I would note that was for older accident years. The favorable development that we recognized is generally in older years where the experience has matured as the policy form is claims made, but we continue to hold reserves, obviously for those older accident years based on the existing claims or other activity within that book. And we will evaluate again in the third quarter of next year is when we'll do our deep dive on the Global Financial lines portfolio."
},
{
"speaker": "Peter Zaffino",
"content": "Great. Thanks, Sabra. Meyer, is there a follow-up?"
},
{
"speaker": "Meyer Shields",
"content": "Yes, just a quick one. Peter, you talked a lot about your expectations for a property reinsurance in 2025. And I was hoping for an update on your thought of the appropriate reinsurance program, property reinsurance program for AIG, whether you're thinking of other -- of changing your net exposure?"
},
{
"speaker": "Peter Zaffino",
"content": "I covered a lot in my prepared remarks. Again, I think the industry has become experts on reinsurance pricing. And I expect that the market will be orderly, but I don't expect attachment points are going to come down for the industry. What I was trying to outline in my comments was that most of it is retained by insurance companies today. And so therefore, how we're going to price business going forward, how we're going to understand the frequency of CAT is going to be really important to do as an insurance company and not rely on reinsurance. I don't think we're going to have a material change in our structures. Of course, we have low attachment points. It's very complex and I won't spend a lot of time on it. But we certainly have the balance sheet. We certainly have the risk appetite to take a little bit more net in the event that we want to, but we like having low attachment points on severity and we like having our aggregate that protects us from frequency. And so we manage our net according to our risk appetite. It's within expectations and I would expect us to continue the same strategic philosophy."
},
{
"speaker": "Meyer Shields",
"content": "Okay, perfect. Thank you so much."
},
{
"speaker": "Peter Zaffino",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Brian Meredith with UBS. Your line is open."
},
{
"speaker": "Brian Meredith",
"content": "Yes. Thank you. Peter, I think we're hearing a little bit from other companies about some improvement in your casualty, particularly E&S, casualty lines and maybe properties' moderating. Wonder if you could give us some color on your view of market conditions and kind of organic growth opportunities here in the fourth quarter and heading into 2025."
},
{
"speaker": "Peter Zaffino",
"content": "Thanks, Brian. And I'm going to make a comment. I'm going to have Don talk specifically about Lexington. But you're absolutely right. We see opportunities. Our clients, we have such strong retention and they're looking for us to solve risk issues. New business opportunities are very good. The rating environment is very good. So we're cautious, but we think there's opportunities to grow. In the retail casualty space, in multiple segments that we have as well as in E&S, I mentioned in my prepared remarks that our casualty submissions in E&S have been dramatic and we see great growth opportunities there. But Don, maybe you could expand a little bit on the Lexington."
},
{
"speaker": "Don Bailey",
"content": "Great. And if I could, Peter, just maybe a couple of high-level comments on North America overall and then dig deeper into the Lex growth because they are kind of balanced. So the double-digit growth in North America is balanced growth. We're growing the lines where we see attractive opportunities. And to the point of your question, we're growing in all three channels where we operate, retail, wholesale, alternative. Peter covered some of the North American growth drivers, positive rate of 3% across the portfolio, strong retention of 87%, 90% in the admitted lines and then overall strong new business growth of 22%. On Lexington, we do continue to invest in Lex across all lines. So you'll see Lex continue to show up with more resources, more products, enhanced capabilities going forward. On the third quarter performance, as Peter mentioned, 78% per retention, which is really strong, a 24% increase in new business. And to the point of your question, casualty showed up very well in the E&S space in terms of new business for the quarter. We also saw a 35% increase in submission. So the submission activity continues to be very robust in the E&S space for us. It's generated probably by two things. One is just increasing demand for E&S solutions in general and a flight to quality within E&S. For me personally, when I think about the nature of a wholesale broker today versus when I started in this industry, it's a completely different game. The brokers in the wholesale space operate at a different level today, incredibly well resourced, data driven, effectively deployed technology to drive efficiency, which is critical in wholesale. They're also increasingly being embraced by thousands of independent agents for market access and placement capabilities. So Lex will continue to benefit from that trend in terms of the growth of our book and new business. And Peter, just a couple of data points to close out on E&S, which might be helpful. Today, E&S represents 12% of the $115 billion U.S. P&C industry. In 2018, E&S was 7% of a $50 billion industry. So the pie has gotten considerably larger. And the last data point I'd give you just on distribution. The top five wholesale brokers control over 65% of the growing $115 billion U.S. E&S market. Lex is very well positioned in E&S and very well positioned with these top brokers."
},
{
"speaker": "Peter Zaffino",
"content": "Great. Thanks, Don. Brian, do you have a follow-up?"
},
{
"speaker": "Brian Meredith",
"content": "Yes, absolutely. A bigger picture question here, Peter. So I think you said that you're expecting a 10% core ROE for 2025. If I look at peer companies, they're kind of trending in the mid to even higher-teens. Yes, what's your kind of longer-term view of kind of ROE aspirations you think you can get to peer ROEs and what do you think it's going to take to get there? Is it more margin improvement, you need to kind of grow acquisitions? Just curious bigger picture, your thoughts there."
},
{
"speaker": "Peter Zaffino",
"content": "Yes, thanks, Brian. I mean, obviously, we've been talking a lot about the 10% and gave guidance in my prepared remarks about getting to that in 2025. There's a variety of ways in which we can get there. We talked about our combined ratio and the opportunities to improve that. We have such a great underwriting culture and believe that there's lots of opportunities, of course, is market dependent, but our leadership position in the market allows us to remain disciplined and focused on clients. There's -- the other variables, I mean, certainly it's our equity base. We talked about that a little bit and that we believe we can grow into it and that's of course going to generate more earnings opportunity, our net investment income, net premiums written both from a peer growth in terms of strong retention, more new business, but also reinsurance structures, how we look at proportional versus excess of loss and there's ways in which we could have some tailwinds there. Quality of our reserves, which we continue to emphasize, Sabra gave a lot of detail in her prepared remarks and on the answer just now. So we have a lot of confidence there. Capital management actions. We have lots of flexibility subject to when we close Nippon and do other capital market transactions, but there's lots of ways in which from a capital management standpoint allow us to improve. Our ability and track record to successfully manage volatility is very important. And then the last one is our expense management is very disciplined. We are executing on AIG Next. That showed itself in the third quarter. We're not looking to hit the ball out of the park every quarter leading in 2025. We pulled guidance forward that we will be able to get other operations, which was substantially higher to a $350 million lean parent, but also get the expenses either eliminated or into the business without increasing the combined ratio. We're well underway. You can see evidence of that in the third quarter. You'll see more evidence of that in the fourth quarter. So there's a bunch of ways in which I think that we can deliver it. And once we get north of the 10%, we'll provide guidance after that. But thank you."
},
{
"speaker": "Brian Meredith",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Rob Cox with Goldman Sachs. Your line is open."
},
{
"speaker": "Rob Cox",
"content": "Hi, thanks. So I think you guys had previously noted M&A potentially becoming a more meaningful consideration for capital deployment, but you also mentioned revisiting share repurchase guidance as you expect some further liquidity coming in next year. Can you give us an update on your appetite for M&A and how that might help you reach premium leverage objectives quicker than organically?"
},
{
"speaker": "Peter Zaffino",
"content": "Sure, Rob. Thanks. I'll start with the second part. The guidance we gave was that we would do $10 billion of share repurchases in '24 and '25. And so like you can see through the third quarter, we are well underway executing every quarter. We'll have more liquidity coming in. And so that's the priority with the proceeds coming in from Nippon and as I said, other marketed deals and liquidity that we currently have at the parent company. In terms of M&A, we have given ourselves lots of options. We have the financial strength, the financial flexibility to explore inorganic opportunities. We're always looking at ways in which we can add strategic relevance and something that's compelling to AIG. We already have sizable very high-quality businesses in major markets. I mean, you know about the U.S., U.K., Japan, Singapore, Europe. We believe we can grow those businesses organically, but there may be more opportunities to expand inorganically as well. We're going to remain very disciplined, but we are going to look at businesses and opportunities in inorganic that may complement our geographical footprint or product capabilities. There's opportunities maybe to go into spaces that we're not in today, maybe some of the SME or looking at ones that enhance scale of businesses that we already have market leadership that just will accelerate our ability to execute our risk-adjusted returns. So I want to remain very disciplined, very patient, but we have the financial flexibility and the strategic intent of growing."
},
{
"speaker": "Rob Cox",
"content": "Okay, great. Thank you. And as a follow-up, on GOE and General Insurance, it didn't necessarily appear like it decreased as much as the run rate in the first half of the year. So I was just hoping you could discuss kind of the puts and takes in the General Insurance GOE ratio and if this level of improvement is sort of in line with expectations."
},
{
"speaker": "Peter Zaffino",
"content": "Yes. I was actually quite pleased with the third quarter in GOE because we looked at other operations and the significant improvement that we made there on the GOE line year-over-year and then sequentially, but also we are absorbing a lot of the expenses as they get pushed into the business. And so while the personal insurance year-over-year, the nominal was down and then on commercial, it was slightly up. When you look at putting $50 million more of cost in, the run rate is actually quite attractive. And so we have two major initiatives that have begun to earn in the third quarter, but you'll start to see a lot more of that in the fourth quarter. And as we get to 2025, one was our voluntary early retirement plan that we had announced in the United States. And then we did a restructuring international that just really happened in September. And so you'll start to see more run rate as we get into the fourth quarter and next year. But I'm really pleased with what we did in the third quarter and believe we are showing a lot of sequential improvement in executing to this future state operating model that's going to be much leaner, much simpler and much easier to follow."
},
{
"speaker": "Rob Cox",
"content": "Awesome. Thanks for the color."
},
{
"speaker": "Peter Zaffino",
"content": "Thanks, Rob."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Alex Scott with Barclays. Your line is open."
},
{
"speaker": "Alex Scott",
"content": "Hi, good morning. I got a follow-up on just sort of the leverage. And I guess thinking through both leverage down at the operating companies as well as financial leverage. But when I look at the ROE, that seems to be the place where you're under index versus some of the peers, not so much like the actual combined ratio and so forth. So I was interested in, I guess on the debt leverage side, are we at a place where leverage can actually begin to come up as you see opportunities, particularly if you do engage in M&A? And then on the core operations, I mean can you frame at all like how much dry powder you see in terms of being able to lean into some of these opportunities if they get better at casualty?"
},
{
"speaker": "Peter Zaffino",
"content": "So thanks, Alex, for the question on leverage, yes, we have a lot of -- I think it goes into what I said about potential M&A where we've given ourselves a lot of financial flexibility if we find something compelling and attractive. I think the high teens of a leverage to total capital, including AOCI, we're very comfortable with, but absolutely what you were asking is a truth, which is if we find opportunities, can we increase our leverage to be able to execute on that? The answer is yes, we can. And we're going to be very mindful. Obviously, the primary use for proceeds from the Corebridge sell-down will go to share repurchase, but we could continue to work on leverage a little bit to give us even more financial flexibility over time. In terms -- I just want to make sure I understand the second part which is having -- we have a lot of capital. I don't think it's a moment in time and to quantify what we think is excess today, I don't think is something that is overly constructive just because we intend to grow into that. We have shown real opportunities in our business to acquire new business. We had a terrific new business quarter. That momentum continues. And I think look at them, property was probably the one that was sort of slowing down in terms of pricing, but Milton and Helene have changed a lot. And I think that there'll be more flight to quality and there'll be more flexibility for AIG in terms of our ability to drive property growth and on a risk-adjusted basis throughout the world. And so like I think the balanced portfolio opportunities to grow, being able to take more net and being able to hit that 10% ROE is our near-term objective."
},
{
"speaker": "Alex Scott",
"content": "Got it. That's helpful. And then maybe a quick follow-up on personal lines in North America. Can you just give us an update on sort of where we stand with that MGA structure that was put in place and over what period of time you'd expect that combined ratio to come down below 100%?"
},
{
"speaker": "Peter Zaffino",
"content": "Yes. Thank you for the question. I mean, North America personal is in transition as we as we've spoke about. It's hard in the primary high net worth business to affect change fast, but we're making great progress. In the quarter alone, the attritional loss ratio has improved on a meaningful basis, GOEs down. What you're seeing is the acquisition ratio increased quite a bit as we transition to the MGU. Now there's a few things happening that will reverse that in 2025. One is we're at scale, everything is fully put into the MGU and we expect the ceding commission that we paid to go down, I think in a meaningful way. And so the acquisition expense ratio will improve accordingly. I want to talk a little bit about like the strategy that we talked about, which is going into more non-admitted and how that's going to accelerate progress. And we announced it last quarter, but just a couple of statistics that will frame why it's early days, but it's working. The rate environment that we're in on an emitted basis in high net worth, we increased 10% in E&S. It went up 20% on our held book. Our partnership with Ryan Specialty, they're building infrastructure, building sales capacity. We're appointing a lot of retail agents that had no access to AIG or capital for high net worth before our signing up. We expect that to accelerate and continue to grow. In the third quarter, our new business, 50% of it was E&S. Again, we had good growth. I mean, the nominal is not going to move the needle, but we have momentum there. And I would expect in 2025, E&S alone in our strategy will grow the top line 10%. The demand is going to be significant. Our ability to be able to respond to that demand is there with plenty of capacity and an appetite that is going to allow us to improve the risk-adjusted returns and the overall combined ratio."
},
{
"speaker": "Alex Scott",
"content": "Thank you."
},
{
"speaker": "Peter Zaffino",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Elyse Greenspan with Wells Fargo. Your line is open."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi, thanks. Good morning. My first question was just on the North America commercial. If I adjust out the one-off -- the one-off in the quarter, right, the -- it came in at 61.1% on an ex-CAT accident year loss ratio basis. You guys are at 61.9% in the first half of the year. So I was just hoping to get more colors on what drove the improvement in the quarter and if that's sustainable into the fourth quarter and 2025."
},
{
"speaker": "Peter Zaffino",
"content": "This is not going to be like the 91.6% question, is it Elyse? Don, do you want to just give a little bit of insight in terms of what's happening with the loss ratio?"
},
{
"speaker": "Don Bailey",
"content": "So in the North American portfolio this year, we've seen some different movements, Peter. And in some of it, if you look at, we have some one-off movements that certainly moved the loss ratio on this one, which you talked about in your prepared remarks. We talked a little bit about the one-time closeout deal that we did that moved it up. So adverse implications."
},
{
"speaker": "Peter Zaffino",
"content": "I think, look, and in the commentary, Elyse, we sort of backed out the two -- they weren't headwinds, they were just anomalies relative to what the prior year was. And then the mix of business will continue to change. We see real opportunities to grow in -- in casualty and so those may have a different loss ratio relative to the overall portfolio. We think there's going to be growth opportunities in property based on the market dynamics that are shifting in 2025 and we see that the headwinds on pricing in financial lines are slowing down. We are not going to continue to ride that way down. And on lead, first excess and leading in D&O, I think Don highlighted this is that we've seen a slowdown in the rate reductions. And as we look into 2025, that's all going to stabilize. So I think that mix, if you take out the two things we talked about, which was significant outperformance in property and short tail last year in the third quarter along with the closeout that looks like a loss ratio that's sustainable."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. That's all. Yes, that's my follow-up, I guess, would be, Peter, just building upon that comment as you view the market conditions out over the next year, how do you expect the mix to shift between property and casualty relative to where it is today?"
},
{
"speaker": "Peter Zaffino",
"content": "It's hard to tell because I -- as I mentioned before, I think the property slowdown in terms of rate increases should start to reverse as you get to next year because there's so much net that's been retained by insurance companies that they're not getting the appropriate risk-adjusted returns for the cat loss at the low return periods and the increased frequency and severity. So I think that's going to reverse. Casualty is very strong, and Don went into length on excess and surplus lines. And then also you know we're seeing slowdown in financial lines. And so I think that the overall index, I think is going to sustain, but we'll see when we get into the market and see what happens within particular property, but I'm optimistic, that's why I put some time into it in the prepared remarks that we see a rate environment that's going to improve. I don't know, Jon, maybe like we -- just before the call ends, you can give a little bit of perspective in terms of where you see opportunities as we look to 2025 and international."
},
{
"speaker": "Jon Hancock",
"content": "Yes. Thanks, Peter. And I'll try not to repeat everything you've said, but you're right, the dynamic between the first-party lines and the third-party lines is there across international as well. And we've seen first-party lines, we're still seeing good rate and price on property classes. But for me, bit like Don with Lex, we've got these jaws in Global Specialty and Talbot. Global specialty, we are the number one writer of business around the world. We're number one in energy, we're number one in marine. We're top three in aviation. We're number four in credit. And we're growing that business really well. You referenced in your prepared remarks, Peter, 6% growth in the quarter, but actually huge growth in energy, 25% new business growth in marine in the quarter. We're seeing a different dynamic at the moment where we've grown our international specialty book by 10% in the quarter. Yes, Talbot, again, another 6% growth, but the specialty lines at Talbot, the products at Talbot is really renowned for political risks. Marine and energy growing by 18%. If you look at -- add that to the fact that submissions are 25%, up in both Talbot and specialty, our quote rates are higher, our bind rates are higher. And we've got huge opportunity there and we're the best of the market at it. So we'll still keep seeing the opportunity."
},
{
"speaker": "Peter Zaffino",
"content": "That's great, Jon. Thank you very much and I agree. Before I finally close, I do want to take a moment to thank Sabra for her many contributions at AIG. Over the past five years, Sabra has always been willing to take on a variety of important complex roles and in each instance, she's always done everything she can to add significant value. So thank you, Sabra, including the most recent role as CFO. We wish her nothing but the best in her future endeavors as we welcome Keith Walsh as our new CFO. I also like to thank all of our colleagues around the world for their continued dedication, commitment and teamwork and execution and I want to thank everybody for joining us today. Have a great day."
},
{
"speaker": "Operator",
"content": "Thank you for your participation. This does conclude the program. You may now disconnect. Good day."
}
] |
aig | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to AIG's Second Quarter 2024 Financial Results Conference Call. This conference is being recorded. Now, at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead."
},
{
"speaker": "Quentin McMillan",
"content": "Thanks very much, and good morning. Today's remarks may include forward-looking statements, which are subject to risks and uncertainties. These statements are not guarantees of future performance or events, and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements, circumstances or management's estimates or opinions should change. Today's remarks may also refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures is included in our earnings release, financial supplement and earnings presentation, all of which are available on our website at aig.com. Additionally, note that following the deconsolidation of Corebridge Financial on June 9, 2024, the historical results of Corebridge for all periods presented, are reflected in AIG's condensed consolidated financial statements as discontinued operations in accordance with U.S. GAAP. Finally, today's remarks related to General Insurance results, including key metrics such as net premiums written, underwriting income and underwriting margin are presented on a comparable basis, which reflects year-over-year comparison on a constant dollar basis as applicable, and adjusted for the sale of Crop Risk Services and the sale of Validus Re. We believe this presentation provides the most useful view of General Insurance results and the go forward business in light of the substantial changes to the portfolio since 2023. Please refer to Pages 29 through 31 of the earnings presentation for reconciliations of such metrics reported on a comparable basis. With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino."
},
{
"speaker": "Peter Zaffino",
"content": "Good morning, and thank you for joining us today to review our second quarter 2024 financial results. We have transformed AIG and have done the foundational work for the next chapter, and I'm excited to take you through it today. Following my remarks, Sabra will provide more detail on the second quarter. Then, our North America and International leaders, Don Bailey and Jon Hancock will join us for the Q&A portion of the call. Our prepared remarks have a lot of detail, particularly related to our deconsolidation of Corebridge. We intend to provide ample time for Q&A. I want to start with highlights of our outstanding second quarter performance. As Quentin mentioned at the beginning of the call, all figures I will reference today will be on a comparable basis, excluding the impact of Validus Re and Crop Risk Services unless otherwise noted in order to provide a clear view of our underlying performance. Adjusted after tax income was $775 million, or $1.16 per diluted share, representing a 38% increase in earnings per share year-over-year, driven by strong organic growth, a continuation of our very strong underwriting performance, ongoing expense discipline, volatility containment and a decrease in shares outstanding. General Insurance net premiums written grew 7%, led by Global Commercial, which grew over 8%. Underwriting income was $430 million. The underlying underwriting income, excluding catastrophes in prior year development improved $110 million or 17% year-over-year. The calendar year combined ratio was 92.5%, a slight increase of 10 basis points from the prior year. The accident year combined ratio, excluding catastrophes was 87.6%, a 170 basis point improvement from the prior year. The CAT loss ratio was 5.7%, or $325 million of total catastrophe related losses. Consolidated net investment income on an adjusted pre-tax income basis was $884 million, a 14% increase year-over-year. During the quarter, we returned nearly $2 billion to shareholders through $1.7 billion of stock repurchases, and $261 million of dividends. We ended the second quarter with a total debt to total capital ratio of 18%, including AOCI and we have strong parent liquidity of $5.3 billion. Overall, I'm very pleased with our ability to continue to deliver outstanding financial performance and I'm equally pleased with the progress we're making on multiple strategic initiatives. There's several things I want to cover on this call to give you a sense of where we are now, how we got here, and what the future holds. In addition to walking through our financial results, on today's call, I plan to outline the recently announced transactions for our personal travel business and private client select, provide a quick update on [Technical Difficulty] reinsurance renewals and a market update, discuss our disciplined execution of our capital management strategy and provide an update on AIG Next. I should note that our strong financial results in the quarter were complicated by the complex accounting treatment of deconsolidation. In Sabra's prepared remarks, she will explain the impact to our capital structure, including shareholders' equity, as well as details on the GAAP accounting implications to our financial statements. Before I go further, I want to take a moment to comment on the deconsolidation of Corebridge, which marked a major milestone for both AIG and Corebridge. It's important to reflect on the four year journey, the significant accomplishments along the way and the rationale behind this pivotal decision for AIG. At the height of the pandemic in 2020, we undertook a detailed analysis to explore strategic options to maximize value for AIG shareholders, including evaluating whether to separate our life and retirement business, which would eventually become Corebridge from AIG. In October of 2020, we announced our intention to separate. There were many noteworthy accomplishments along the way, and I'd like to highlight a few. In July of 2021, AIG announced that Blackstone Group would become an anchor investor in the new standalone company with its acquisition of 9.9% of Corebridge. Corebridge also entered into a long-term strategic asset management relationship with Blackstone to manage up to $92.5 billion of assets under management over the subsequent six years. At the end of March of 2022, AIG announced a strategic partnership with BlackRock, where they would manage $150 billion of certain fixed income and privately placed assets, of which $90 billion would come from the Corebridge portfolio. In mid-September of 2022, AIG floated at 12.4% of Corebridge and the largest U.S. IPO of the year, a particularly noteworthy achievement during a time of significant market volatility. During 2023, we executed three marketed deals, reducing our overall ownership to 52% by year end. In 2023, Corebridge divested with considerable strategic and transactional support from AIG, Laya Healthcare and UK Life. These sales generated over $1.2 billion of proceeds for Corebridge investors. In May of 2024, AIG announced it would sell 122 million shares at Corebridge, representing an approximately 20% stake in the company to Nippon Life Insurance Company, one of the most respected life insurance companies in the world, subject to customary regulatory approvals and closing conditions. Lastly, in mid-June of this year, AIG announced it had met the requirements for the deconsolidation of Corebridge for accounting purposes. We remain committed to fully selling down a remaining ownership stake in Corebridge over time, subject to market conditions and other considerations. It's been quite a journey and we have accomplished a tremendous amount. Now let's turn to the travel business. During the quarter, we also announced the sale of our global individual personal travel insurance and assistance business, which is another important strategic step in positioning AIG for the future to further simplify our portfolio. The transaction includes the global Travel Guard insurance business as well as its service companies and infrastructure and excludes our travel insurance businesses in Japan and our AIG joint venture arrangement in India with the Tata Group. AIG will continue to provide corporate group travel coverage through our accident and health business. The annual net premiums written for travel are approximately $750 million, most of which are reported under North America Personal Insurance. The sale is expected to close by the end of 2024, subject to customary regulatory approvals and closing conditions. And last week, we announced another significant transaction involving our high net worth business. As we've discussed in prior quarters, over the course of several years, we've been deliberately transforming our high net worth business to be better positioned for the future. We've done this through a series of strategic actions, including the most recent announcement about entering into a strategic relationship with Ryan Specialty to become our excess and surplus lines distribution partner for high and ultra-high net worth markets through our managing general underwriter, Private Client Select insurance services. We like the business and we're committed to it. We've invested over $100 million in infrastructure and digital capabilities for our high net worth business over the past several years, and we believe the business is well-positioned for the future. We're also committed to delivering solutions and growing our admitted capabilities. As we previously communicated, our plan for the portfolio has been to establish an MGU (ph) with appropriate infrastructure and core foundational capabilities, enable multiple points of distribution and eventually attract more capital resources for the MGU, all while continuing to drive exceptional value for our high net worth clients as we grow the business. AIG will provide exclusive E&S paper in all 50 states through Marbleshore Specialty Insurance Company subject to regulatory approvals. This progress reflects the momentum we've created with expanded capabilities and broader partnerships. Now turning to General Insurance results. Gross premiums written for the quarter were $9.9 billion, an increase of 7% from the prior year. Net premiums written for the quarter were $6.9 billion, a 7% increase from the prior year, with 8% growth from Global Commercial and 5% growth from Global Personal. Global Commercial had an excellent quarter with strong net premiums written growth of 8%, driven by significant new business, impressive retention and continued accident year combined ratio improvement. In North America Commercial, net premiums written grew 10%. Lexington grew 16%, led by wholesale casualty, which grew 35%; Western World, which grew 20%; and wholesale property, which grew 12%. Retail casualty grew 11%, with 21% growth in our risk management business and we had 16% growth in excess casualty, and Captive Solutions grew 30%, driven by new business. In International Commercial, net premiums written grew 6%. Global Specialty grew 8%, led by 18% growth in energy, Talbot grew 12% and retail property grew 11%. In the second quarter, Global Commercial produced record new business of nearly $1.3 billion, which is an 18% increase from the prior year quarter. North America Commercial produced new business of $753 million in the quarter, an increase of 26% year-over-year and an increase of over 60% from the prior quarter. The growth was led by Lexington, which had 31% new business growth year-over-year and 75% new business growth from the first quarter, the highest new business volume of any quarter in my tenure. Lexington also achieved a significant milestone with over $1 billion of gross premiums written this quarter, a 16% increase from the prior year quarter. This is the highest gross premiums written quarter for Lexington since we repositioned the business in 2018. In other businesses, retail casualty new business grew over 40%, led by our risk management business and excess casualty. International Commercial produced new business of $522 million for the quarter, an increase of 9% year-over-year. This growth was led by Global Specialty, which had 17% new business growth, led by energy and marine. Casualty, which had over 30% growth, and property, which had over 10% growth. In addition, Global Commercial had very strong renewal retention. International retention was 89% and North America retention was 87%. Moving on to Global Personal Insurance. Net premiums written grew 5% year-over-year. North America Personal net premiums written increased 8% from the prior year quarter, primarily driven by the high net worth business. International Personal net premiums written increased by 4% year-over-year, driven by growth in personal auto and accident health new business. Shifting to the combined ratio, as I noted earlier, the second quarter General Insurance accident year combined ratio, excluding catastrophes was 87.6%, a 170 basis point improvement year-over-year, driven by 140 basis point improvement in the expense ratio. In Global Commercial, the second quarter accident year combined ratio, excluding catastrophes was 83.5%, a 180 basis point improvement. The North America Commercial accident year combined ratio, excluding catastrophes was 84.7%, a 250 basis point improvement. And the International Commercial accident year combined ratio, excluding catastrophes was 82.1% or a 130 basis point improvement. The Global Personal accident year combined ratio, excluding catastrophes was 96.8%, a 130 basis point improvement from the prior year quarter. North America personal improved its accident year combined ratio, excluding catastrophes to 101.8%, a 530 basis point improvement. International personal improved its accident year combined ratio, excluding catastrophes by 50 basis points and 94.8%, driven by improvements in the expense ratio. Now I want to shift to provide some context around mid-year reinsurance renewals and recent conditions in the reinsurance market. As we have previously discussed, we purchased the vast majority of our treaty reinsurance at January 1. However, approximately 20% of our overall core reinsurance purchasing occurs in the second quarter. We were able to execute on all of our strategic reinsurance goals this quarter, achieving risk adjusted rate decreases and lowering or maintaining retentions across all of our major purchases. The outlook for the second half of 2024, particularly with respect to natural catastrophes is uncertain. The five leading forecasters are predicting above average hurricane activity for the 2024 season. While there was a lot of positive sentiment across the industry following modest natural CAT loss activity in the first quarter, I've learned over my career to wait until the wind and typhoon seasons are over before declaring how the year will be impacted by natural disasters. It's simply too unpredictable. When reviewing capacity in the market, it's important to analyze the available capacity from the rated market and the alternative capital market. We're all well aware of what happened with rated reinsurers in 2022. On average, they moved attachment points significantly higher to higher return periods and they restricted coverage mostly to name perils. If you were to look at the complementary alternative capital market, it has approximately $110 billion of estimated capital deployed and in many ways, more stated available capital in any individual year over the prior 10 years. However, you need to review what makes up that $110 billion to appreciate the true availability for reinsurance. The CAT bond market and ILW market make up approximately 50% of the alternative capital market, the highest nominal amount of any time in history and those products are accompanied with basis risk and in some cases, meaningful basis risk. Additionally, the collateralized market is back to 2016 levels, which is somewhere between $45 billion to $50 billion of capital. The market is deploying 90% of the collateralized limit as occurrence reinsurance or occurrence retro, leaving less than 10% of the remaining collateralized reinsurance available for aggregate covers. Why do I outline this level of detail? Because we've remain very disciplined and maintained our aggregate cover at the same attachment point and AIG utilizes approximately 50% of the globally available ILS reinsurance aggregate CAT capacity. This purchase protects us from the potential frequency of CAT and allows us to prudently manage volatility. And again, based on my experience, once insurers give up lower occurrence or aggregate attachment points, you simply do not get them back. Further, analyzing industry data from over 150 companies published by AAON between 2013 and 2024, average attachment points went up on an inflation adjusted nominal basis everywhere in the world, in some cases significantly during that period. For example, in Asia, average attachment points increased over 270%, EMEA and the UK over 250%, and in the U.S. over 280%. AIG has structured its treaties to have lower attachment points with less volatility. When examining occurrence attachment points across the world from 2022 to 2024, which is another very good measurement, AIG has maintained or reduced its attaching points, making it the lowest amongst our peer group. For the balance of 2024, we have approximately $95 million remaining on our international aggregate cover, excluding Japan and $270 million on our North America aggregate cover, excluding wind and quake. This is well within our established risk appetite and believe we remain well protected against both the frequency and severity of CAT events. Reinsurance premiums are well embedded in our original pricing and our portfolio for properties performing exceptionally well. Now I will provide a high level summary of our capital management strategy and the milestones we've accomplished. We've made enormous progress executing against our capital management goals in a disciplined manner with a focus on positioning AIG for the future and driving value for our shareholders. We have deployed over $30 billion in cash towards that capital management strategy over the last three years, which has provided AIG with maximum flexibility. To provide context on the magnitude of what we accomplished, there are some key highlights. In 2021, AIG had greater than 850 million shares outstanding and approximately $25 billion of outstanding debt and preferred stock. Using current liquidity and proceeds generated from divestitures and earnings, over the past three years, we repurchased over $13.5 billion of shares, reducing our overall share count by over 200 million shares or approximately 25%. As of June 30, 2024, we have less than 650 million shares outstanding. We expect to further reduce this in the second half of 2024 and in 2025, depending on the timing of the closing of the Nippon Life transaction, subject to regulatory approvals, as well as additional future sell downs of our remaining Corebridge shares subject to market conditions. By the end of 2025, we expect our share count to be in the 550 million to 600 million target range, consistent with the guidance that I provided last quarter, representing a total of $10 billion of share repurchases over the course of 2024 and 2025, subject to market conditions. Since 2021, we paid approximately $3 billion of shareholder dividends. We increased the dividend by more than 10% in each of the last two consecutive years. Additionally, we reduced AIG's debt outstanding from $25 billion to $9.8 billion and have achieved our target debt to capital leverage ratio range of 15% to 20% with a second quarter leverage of 18% versus 27% three years ago. Our insurance company subsidiaries are in a very strong capital position with capital ratios above target ranges, which will enable us to continue to grow profitably without having to contribute additional capital. We ended the second quarter with $5.3 billion of parent liquidity and we continue to explore compelling and strategic inorganic opportunities that are complementary to our current business. As part of positioning AIG for the future, over the past several years, we've been on a journey to simplify AIG. We're weaving the company together to operate seamlessly as one cohesive organization across underwriting, claims and all of our functional areas with the skills and capabilities to compete in the future. As a company, we've completed multiple transformation programs. These efforts, including AIG 200 have resulted in a reduction of our expense base of approximately $1.5 billion since 2018, while investing for the future. For example, over the last two years, we've invested approximately $300 million in data, digital workflow, AI and talent to accelerate our progress. If you look over the past five years, it include technology, end-to-end process workflow and foundational data investments that were part of AIG 200, our investment has been over $1 billion. Also at the beginning of 2024, we formally launched AIG Next to further accelerate the realization of additional operational efficiencies. As part of the AIG Next program, we're redefining our existing retained parent costs to reflect only expenses related to being a global regulated public company such as costs related to corporate governance, enterprise risk management and audit. Our objective is to decrease retained parent cost to $325 million to $350 million, or 1% to 1.5% of net premiums earned going forward. Expenses not defined as parent company costs will be fully embedded within the General Insurance results or they'll be redundant. All of the factors being equal, we would expect our full year 2025 calendar year combined ratio to be the same or lower than the full year 2023 metric on a comparable basis as a result of the actions were taken as part of AIG Next. We originally provided guidance that we would reach the combined ratio as the exit run rate at the end of 2025, and we now believe we can achieve it in the 2025 calendar year. Additionally, while I've not spoken in detail about AI in the past, we've been making substantial progress and I want to provide a high level overview. AIG is advancing its data and digital strategy using artificial intelligence, large language models and data ingestion applications with the objective of increasing underwriting efficiency and augmenting execution capabilities. We've spent considerable time over the past 12 months to 18 months creating a blueprint for the future that we use each of these components together, where each one is integral and connected and we redesign and refine the end-to-end underwriting workflow processes. Our primary objective is to construct an AI powered underwriting portfolio optimization capability that provides faster, more thorough, deeper analysis and improved customer service in quoting, binding and policy issuance by enabling increased underwriting productivity through the automation of manual processes. This will drive more accurate informed decisions by leveraging better data through foundational sources such as broker and agent submissions, and supplemented with validated sources of additional third-party data. We will then combine this enhanced capability with advanced modeling and amplify compute capabilities, underpinning this work is a robust governance framework designed to keep pace with the rapidly evolving global AI regulatory landscape. I will discuss two areas of focus, underwriting efficiency and underwriting management. With underwriting efficiency, we're developing a mechanism using large language models by which submissions are automatically filtered through real-time underwriting guidelines, allowing underwriters more capacity and the ability to assess many more submissions that meet our defined underwriting criteria, objectives and risk appetite. In underwriting management, we're dynamically managing the review of submission data with a disciplined application of underwriting guidelines and portfolio objectives, allowing underwriting leadership to more deeply and accurately analyze market conditions and enabling dynamic adjustments to underwriting guidelines, pricing and limit deployment. As we build our agentic ecosystem, we're using a multi-vendor technology strategy with multiple partners that is designed to evolve over-time. Our platform has been built for flexibility, configurability and adaptability to accommodate current and future technology. This includes the ability to support the expansion of generative AI capabilities for scalability globally across our platform, while keeping the underwriter at the center of decision making. This is just a glimpse into the significant work we've been doing to use generative AI and large language models as part of our overall data and digital strategy. We'll continue to advance these efforts over the remainder of this year and as we enter 2025. In summary, I'm very pleased with our performance in the second quarter and what we've accomplished not only during the quarter, but over the past several years to prepare AIG for a bright future. With that, I'll turn the call over to Sabra."
},
{
"speaker": "Sabra Purtill",
"content": "Thank you, Peter. This morning, I will provide details on AIG's exceptional second quarter financial results with a particular focus on the accounting treatment of Corebridge deconsolidation, General Insurance quarterly financial results, written premium rate trends, other operations, book value per share and ROE. I will begin with Corebridge related activity this quarter and the accounting treatment on AIG's financials. A few key dates to outline. On May 16, we announced the agreement with Nippon Life. Because that sale could close within 12 months of the announcement and reduce our ownership to well below 50%, held for sale accounting and the classification of Corebridge as discontinued operations was triggered for accounting purposes. Next, we sold 30 million shares of Corebridge on May 30, which brought our ownership to 48%. However, it did not trigger deconsolidation accounting, because AIG still had a right to majority representation on the Corebridge Board. On June 9, we raised our right to majority representation and one of our designees resigned from the Corebridge Board triggering deconsolidation accounting as well as the required filing of pro-forma financials with the SEC four days later. Discontinued operations and deconsolidation accounting principles drove significant changes in AIG's financials this quarter. We added a few slides in the investor deck to explain these changes, which I will refer to in my remarks. Let me start with the impact of held for sale and discontinued operations on Slide 15. Held for sale accounting stipulates that when you reach an agreement to sell a business, its financials must be recast in the current period with assets and liabilities each classified in one-line for both sides of the balance sheet. However, since Corebridge was a core business that we fully intend to exit, it also met the accounting criteria for discontinued operations, which requires a recast not just for the current reporting period, but also for past periods. As a result, we reclass Corebridge's assets, liabilities and net income into assets and liabilities of discontinued operations and income or loss from discontinued operations net of income tax in the AIG financials for the second quarter and prior periods. This treatment is reflected on Slide 15. While AIG total assets of $544 billion as of March 31, 2024 is the same as originally reported and following discontinued operations presentation, there is a significant movement within the line items. For example, total investments in cash of $324 billion as originally reported, decreased $88 billion with discontinued operations presentation, with $236 billion of Corebridge investments in cash now included in assets of discontinued operations. The next change in the quarter was deconsolidation, which was triggered on June 9. On the fourth quarter 2023 earnings call, I described the accounting steps related to this principle. Today, I'll walk through those steps with the final numbers. Turning to Slide 16, the first step is the fair valuing of Corebridge's assets and liabilities as of June 9. The net fair value amount was $9.7 billion comprised principally of the $8.6 billion market value of our Corebridge shares at that date and the net fair value of intercompany assets and previously consolidated investment entities. Next, we calculate the difference between the fair value of $9.7 billion and the book value on AIG's balance sheet, which was $6.7 billion. This resulted in net gain on sale of Corebridge of $3.0 billion pre-tax or $2.5 billion after tax. After that, accounting principles require the recognition of $7.2 billion of accumulated other comprehensive loss on AIG's balance sheet, which is unrealized losses on Corebridge's investment portfolio due to higher interest rates. This recognition records a $7.2 billion loss from AOCI in AIG retained earnings by booking it through the loss and discontinued operations in the income statement and then reducing AIG's AOCI on the balance sheet. This does not change shareholders' equity shown on Slide 17. To determine the income statement accounting impact of deconsolidation, the $2.5 billion after tax gain and the $7.2 billion of accumulated other comprehensive loss are added together to calculate the net after tax loss on deconsolidation of $4.7 billion. Finally, the next step is to add Corebridge's net income for the quarter prior to June 9, which was $325 million after tax to the net loss on sale, resulting in a total net loss on discontinued operations of $4.4 billion recorded in AIG's income statement for the quarter. Now, I'll cover the impact on AIG's shareholders' equity, turning to Slide 17, which has a walk of AIG's total equity from the end of March to the end of June. AIG's shareholders' equity was $43.4 billion at March 31, including Corebridge on a consolidated basis. Excluding deconsolidation impacts, the second quarter change in AIG shareholders' equity was a decrease of $1.5 billion, reflecting income from continuing operations of $475 million, offset by $1.7 billion of share repurchases and $261 million of dividends paid. This results in a pro forma AIG shareholders' equity of $41.9 billion before deconsolidation. Then, you layer in the deconsolidation impacts by adding the $2.5 billion after tax gain on sale for total AIG shareholders' equity of $44.4 billion at June 30, 2024 or a $1.1 billion net increase in the quarter, resulting in book value per share of $68.40 at June 30, a 6% increase from March 31. Please note as well that $5.7 billion of non-controlling interest in total equity, which represents the portion of Corebridge equity owned by other shareholders is also eliminated with deconsolidation through the recognition in the net book value calculation of the gain on sale. The last deconsolidation impact is on debt and leverage on Slide 18. Total debt for AIG and Corebridge at March 31, 2024 was $19.2 billion and total equity was $49.1 billion for debt to total capital ratio of 28.1%. With deconsolidation, Corebridge's debt of $9.4 billion and non-controlling interest of $5.7 billion are eliminated on AIG's balance sheet. This results in June 30 balances of $9.8 billion for total debt and $54.3 billion for total capital for a debt to total capital ratio of 18.1%, well within our 15% to 20% target leverage range. We hope this explanation in the slides are helpful in understanding the accounting treatment of Corebridge deconsolidation this quarter. I will now cover second quarter General Insurance and other operations results. Turning to General Insurance, adjusted pre-tax income or APTI was $1.2 billion, up 7% on a comparable basis due to strong underwriting results and higher net investment income. General Insurance net investment income was $746 million, up 10% on a comparable basis due to higher reinvestment rates on fixed maturities and loans. Considering current interest rates and $1.6 billion of General Insurance dividends paid to parent at quarter-end, we expect third quarter General Insurance investment income from fixed maturities, loans and short-term investments of about $700 million. Income on alternatives and other investment assets were $33 million and $52 million respectively in the quarter, up $32 million in total from $44 million and $9 million respectively in second quarter 2023. Second quarter 2024 underwriting income on a comparable basis was $430 million versus $420 million in second quarter last year, driven by lower expenses, partially offset by higher catastrophe losses. Year-to-date, underwriting results have been strong with an accident year loss ratio ex-catastrophes of 56.3%, mainly driven by changes in business mix compared to the prior year. Based on earned premium roll-forward and barring unforeseen significant changes in loss trends, we expect the accident year loss ratio ex-catastrophes will remain strong in the second half of 2024 at approximately the same level as the first half. Turning to natural catastrophes. The industry globally had another quarter of elevated losses with approximately 100 events. For AIG, second quarter catastrophe losses totaled $325 million or 5.7 points on the loss ratio, principally from secondary apparels, including severe convective storms in the United States, floods in the Middle East and Brazil, and hail in Japan with a roughly 50-50 split between North America and International. Our largest loss in the quarter totaled $90 million from exceptionally heavy rains in the UAE. Considering the forecast for hurricane season this year and secondary peril losses year-to-date, we believe that using AIG's last year total catastrophe losses is a good proxy for full year 2024. While actual losses will depend on the size and strength of events, our underwriting standards, limits and reinsurance programs, both occurrence and aggregate will help reduce the net impact of catastrophe frequency and severity on AIG's balance sheet. Nevertheless, on a global basis, the third quarter is usually by far the highest catastrophe quarter with losses averaging 40% to 50% of the total for the year. Turning to reserves, prior year development, net of reinsurance was a favorable $79 million, reflecting the net result from DVRs completed on more than $20 billion of reserves, about 45% of the total in the quarter. Overall, the DVRs, which included U.S. casualty, resulted in net favorable development on workers' compensation and modest net unfavorable development of $30 million on excess casualty, including $66 million for accident year 2021. The 2021 excess casualty reserve charges were for a few large known losses and commercial auto loss trends, reflecting the rebound in auto frequency and severity after the pandemic lockdown in 2020 when frequency was very low. We have not seen this increase in frequency and severity trends in the more recent accident years. Within the casualty and excess casualty books overall, severity trends remain generally consistent with our assumptions. While we see some favorable trends in the 2016 to 2019 accident years, we will continue to allow time for these years to mature. Pricing, which includes rate and exposure for Global Commercial Lines this quarter increased 5%, excluding workers' compensation and financial lines, while our view on loss cost trends have remained stable. In North America Commercial, renewal rates increased 2% in the second quarter or 4% if you exclude workers' compensation and financial lines and the exposure increase was 2%. In International Commercial, overall rate was largely flat or a 1% increase excluding financial lines and the exposure increase was 3% excluding financial lines. We continue to monitor our portfolio very closely and while rate in the second quarter is below trends on certain lines of business, such as property, it is above trend in others. To give more insight on property, North America retail and wholesale property saw rate increases drop below trend in the second quarter, but that's on the back of rate increases in excess of 25% in 2023 and cumulatively in excess of 150% since 2018. International property is about 100% higher. In 2023, our property portfolio had an excellent combined ratio. In North America casualty lines, in particular excess casualty, we continue to get rate in excess of loss trend. We continue to focus on writing business that has attractive returns and while the price adequacy of our portfolio, of course, varies by line, it remains strong overall and within our expectations. Turning to other operations, deconsolidation vastly simplified the income statement. Adjusted pre-tax loss in the quarter was $158 million, a 43% improvement year-over-year, primarily attributable to $68 million in Corebridge dividends and higher short-term investment income. Finally, with deconsolidation, we expect our 2024 adjusted tax rate to be about 24% before discrete items in line with our second quarter. With the deconsolidation of Corebridge this quarter, AIG's income statement and balance sheet are simpler and we no longer have the volatility of life insurance and annuity accounting. With all the changes, we took the opportunity to evaluate our non-GAAP equity metrics, which were established more than a decade ago when AIG was a vastly more complicated conglomerate. The principal change was revising our calculation of adjusted book value to only adjust for investment related accumulated other comprehensive income, which is not within management's control and which will revert to par as bonds approach maturity. Adjusted book value per share was $72.78 per share at June 30, 2024. In addition, we added a core operating shareholders' equity metric, which reflects the equity invested in AIG's go-forward business. It is calculated by subtracting from adjusted book value, the market value of Corebridge stock and GAAP deferred tax assets related to net operating losses and tax credits. Both of these assets have significant value to our shareholders, but contribute little to AATI. We believe this metric is more useful for valuing AIG's global general insurance business and also for measuring our progress towards a 10% plus ROE target. Over time, as we reduce our ownership in Corebridge to zero and monetize the DTA through earnings, core operating book value will become the same as adjusted book value. Core operating book value per share was $53.35 per share at June 30, 2024. To wrap-up, AIG delivered another excellent quarter with significant financial and operational accomplishments in 2024. Achieving the deconsolidation of Corebridge was a major accomplishment this quarter and we had continued strong profitability and growth in our General Insurance business. With our portfolio reshaping now largely behind us, we are intently focused on achieving our 10% plus ROE target driven by strong underwriting and top line growth, expense reduction and capital management. We continue to make progress on this goal with a core operating ROE of 8.9% for the second quarter and 9.3% year-to-date. With that, I will turn the call back over to Peter."
},
{
"speaker": "Peter Zaffino",
"content": "Great. Thank you, Sabra. Operator, we're ready for questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Our first question comes from Michael Zaremski with BMO. Your line is open."
},
{
"speaker": "Michael Zaremski",
"content": "Hey, great. Good morning. First question on the updated kind of combined ratio trajectory guidance for '25. So loud and clear that you'll be able to kind of hit it a bit sooner. I'm curious if you can kind of, if we focus on the loss ratio, what the guidance implies on a like-for-like basis on the loss ratio? Some of the questions we get continuously around most companies seeing some slippage in their loss ratios given lower levels of reserve releases. I'm curious if that's something that's considered within your loss ratio guidance."
},
{
"speaker": "Peter Zaffino",
"content": "Thanks, Mike, for the question. The guidance that we've given in terms of what we expect for the full year 2025 does not contemplate any improvement in loss ratio. It's all in the expense ratio. And so we're trying to guide everybody is that all the expenses that exist in other operations will transition into parent, they'll go into the business or they'll be eliminated and that we're not going to be increasing our combined ratios based on the guidance that we gave at the end of '23. So we're not anticipating any caveats on loss ratios to be able to meet that guidance."
},
{
"speaker": "Michael Zaremski",
"content": "And I guess just I'll stick on this for my follow-up. So given pricing is below loss trend in certain lines like property and understanding that the absolute, maybe this is the answer to the absolute pricing levels are still accretive to the -- to ROE or loss ratio just does it. To the extent, the current pricing environment held, why does it kind of make sense that the loss ratio should be able to kind of stay flattish, and not trying to be negative, just trying to nitpick on the margin?"
},
{
"speaker": "Peter Zaffino",
"content": "No. It's a great question. Let's take North America, for example, because you pointed out property. This quarter in terms of the overall index and rate increases, property was the headwind in that index. In casualty, we achieved mid-single digit to high-single digit rate with like 12% and excess casualty plus 2% in exposure. In Lexington, it was 11% increase in casualty, 12% in health care. So again, above loss cost trends. Property was flat this quarter. But you have to look at what's happened with the property market over the past several years. And if you look at the -- even last year in -- like excess and surplus lines, it was a 34% increase and the retail, it was 30%, that's after four years of double-digit rate increase. So I think -- look, with the low activity in CAT maybe in the first quarter, the cumulative rate increases over time, I mean, the property combined ratio fully loaded with CAT, even with giving a little bit back in the second quarter has an outstanding combined ratio. And if I can get that combined ratio for the rest of my career, I'll take it. I mean, like I don't think there's any deterioration in terms of what our overall index will be. And again, I can't really predict, that's why I kind of went into a little bit more detail about like sort of the CAT market is that we don't know. I mean, like, so property is highly driven by what happens in CAT and underlying inflation. And so I'm not going to predict what happens sort of six quarters from now, but I think we feel really comfortable with the portfolio and its profitability."
},
{
"speaker": "Michael Zaremski",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Meyer Shields with KBW. Your line is open."
},
{
"speaker": "Meyer Shields",
"content": "Thank you. First question, just I was hoping we can get a general sense of the impact of the sale of the travel insurance on underwriting results in North America Personal"
},
{
"speaker": "Peter Zaffino",
"content": "Hey, Meyer. Good morning. In terms of -- I outlined in my prepared remarks, the premium impact, which is the $750 million on net premiums written. But on the overall combined ratio, it's going to be de minimis in terms of what we would lose within General Insurance once we pro forma it out."
},
{
"speaker": "Meyer Shields",
"content": "Okay. Perfect. Second question, I guess, on the excess casualty, if I understood Sabra's comments correctly, you had favorable development even on that line outside of 2021, which was a weird year. And I was hoping you could sort of break that down for us. I assume that that's older years rather than recent years, but I wanted to confirm that."
},
{
"speaker": "Peter Zaffino",
"content": "Yeah. I'll hand it over to Sabra. But as you know, and she gave a lot of detail in her prepared remarks, and we reviewed 45% of our total book in the second quarter. And in casualty, just based on what's going on in the global market, we really drilled down on every line of business and every year and went through it in tremendous detail. So Sabra, maybe you can just give a few highlights in terms of that analysis."
},
{
"speaker": "Sabra Purtill",
"content": "Yeah. Sure. And just for everyone's benefit, I'll just start by framing a little bit what we did in the quarter for the DVRs. So this quarter, we evaluated $20.2 billion of reserves for U.S. casualty. That's comprised of 23 separate DVRs and more than 200 different lines of business, and then that aggregates to the five lines that you see on the 10-Q. So the net changes in the quarter were only about $20 million after written premiums, and that was $80 million favorable in workers' comp after the ADC, which has about $8 billion of reserves. It was $22 million unfavorable in excess casualty, which also has about $5 billion of reserves. And then in casualty, it's also about $5 billion reserve for $17 million favorable. In terms of the 2021 accident year, as we've noted on previous calls, we've increased our loss cost trends for 2020 and subsequent years. The adjustments we made in 2021 are from just a combination of known early reported claims that due to their facts and circumstances, we expect to penetrate the excess attachment level, including a rebound in the auto frequency and severity. In 2022 and 2023 accident years, we just have not had that same level of early claims experience, and therefore, we still have a high level of IBNR in the reserves. With respect to the accident year within excess casualty, I would note that while we did have the $66 million of adverse development in accident year 2021, we had $33 million of favorable development excess casualty from accident years prior to 2016, and that's where the delta comes it nets down to closer to the $22 million amount."
},
{
"speaker": "Meyer Shields",
"content": "Yes. Got it. That's exactly what you needed. Thank you."
},
{
"speaker": "Peter Zaffino",
"content": "Thank you, Meyer. Next question, please."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Elyse Greenspan with Wells Fargo. Your line is open."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi, thanks. Good morning. Appreciate all the color you guys are providing on the call. My first question, Peter, you said that the full year 2025 calendar year combined ratio would be the same or lower than the full year '23. Since you said comparable basis, I'm assuming you mean ex-Crop and Validus. Can you guys just disclose what that figure is, just so we know what you're setting the '25 baseline out? What was the 2023 adjusted figure?"
},
{
"speaker": "Peter Zaffino",
"content": "91.6%."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. Thank you. And then my second question is, you also mentioned in your prepared remarks, you said something about exploring inorganic opportunities. Can you just expand what that means? You guys have obviously taken action of divesting of certain businesses. So what would you look at on the expansion side and what criteria would any potential inorganic deals need to meet?"
},
{
"speaker": "Peter Zaffino",
"content": "Thanks, Elyse. I included that in my prepared remarks, just based on the amount of financial flexibility, strategic flexibility that we've created for ourselves. The divestitures have been really about not having like really the businesses that we divest were terrific, and they fit very well with their new owners. But some of them needed scale, like travel and crop. And we wanted to be a little bit less in the volatility business, and therefore, Validus Re was divested. I would think as we look to the future, again, we're going to be very selective, very disciplined. But there are opportunities perhaps where we have existing businesses where we feel as though, we have competitive advantages that having more scale would be helpful. There could be complementary geographies as we look to different parts of internationally, but terrific international business. But there could be places where we want to expand further that give us not only better capabilities within that geography, but also could be very good for our multinational network. There are opportunities to invest further in businesses that we have. Think about AIG TATA in India is a fast-growing large scale business that is an industry leader. And so there's opportunities there as well. So we will use the same criteria, which is to make sure it's disciplined, it's additive, its strategic and it actually furthers and accelerates the progress we can make on an organic basis. And so we will -- again, we'll keep giving updates as there's more relevant information to share."
},
{
"speaker": "Elyse Greenspan",
"content": "Thank you."
},
{
"speaker": "Peter Zaffino",
"content": "Thanks, Elyse."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Rob Cox with Goldman Sachs. Your line is open."
},
{
"speaker": "Rob Cox",
"content": "Hey, thanks. Just a question on the accident year loss ratio ex-cat guidance for approximately the same level in the back half. Can you help us think a little bit more about what goes into that and where that shakes out on a comparable basis versus the -- I think, over 100 basis points of improvement AIG has reported here in the first half?"
},
{
"speaker": "Peter Zaffino",
"content": "Sure. Thank you, Rob. It's really driven by mix of business. And if you take a look at this year compared to last year on a net premium earned basis, like the commercial and personal insurance businesses are literally identical in terms of its overall contribution to total premium. And then the commercial loss ratio largely stayed flat like a 10 basis point improvement, but largely flat. What happened was the Personal Insurance loss ratio dramatically improved, driven by North America which was well over 400 basis points. And so I think that that's really driving the first six months. And if we look at the back half, I mean, should we see the same thing? I think so. But you've seen all the tremendous new business, the momentum we have. The mix of business could be changed a little bit year-over-year when we look at the back half of the year, but that's really what's driving the improved loss ratio in the first six months. So it's really a true mix of business and also the significant improvement that North America personal is making and we expect them to continue to make."
},
{
"speaker": "Rob Cox",
"content": "Okay. Got it. Thank you. And maybe just a follow-up. The move to kind of put some more capital to work in high net worth, is that driven by a change in sort of the view in underwriting opportunities there or have they always been good for AIG and what kind of drove that decision to double down now?"
},
{
"speaker": "Peter Zaffino",
"content": "The high net worth business had the same issues that the commercial business did, which it had too much TIV and it gets more pronounced in the high net worth business, because it's more dense. And so we needed to shed aggregate for a lot of reasons. One is that we had too much exposure in certain geographies like the world changed with COVID, the pandemic and all the macro factors that affected it. And then also the evolution of more capabilities in the non-admitted market. And so what we decided, and we've been thinking about this for a couple of years, is that build out an admitted platform that is going to be very strong, the right infrastructure and have the ability to grow, but also complement that with the non-admitted market and be able to do that where you have flexibility and form rate and limits and how you can actually respond to client needs. And there's a need. And so what we've been working on is what's the best way to do that, partnering with Ryan Specialty. It's a highly fragmented wholesale market. So nobody has a real strong expertise in high net worth unless you start to build it. And I think Ryan has been doing that. And so getting access to the 40,000 independent agents with a product that's going to be saleable, and we have done such a terrific job in terms of creating opportunity for more aggregate that we want to be able to have both options. And we believe that we'll be able to grow the non-admitted property market just based on the partnership that we just announced recently. So it's always been in the plan, but we didn't want to go out and just say, we're going to do non-admitted and have it a fragmented not strategic approach. And so we believe this is going to give us great opportunities to access the market in a different way."
},
{
"speaker": "Rob Cox",
"content": "Thank you."
},
{
"speaker": "Peter Zaffino",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Mike Ward with Citi. Your line is open."
},
{
"speaker": "Mike Ward",
"content": "Thank you. Good morning. I just had one question and is somewhat related. But overall for the business and including commercial lines, curious how you guys are shifting the culture back to sort of a growth mindset, thinking about all the change that you've executed? And I guess, where are we in that part of the story? And should we think about AIG as potentially being able to grow faster than the market, all equal, just by turning some of the spigots back on?"
},
{
"speaker": "Peter Zaffino",
"content": "Yeah. It's a terrific question, and I happen to have Don Bailey and Jon Hancock here with me. So I'm going to ask them both to comment on North America and international. It's a great question. Don, why don't you start with, how we have actually been very focused on not only retention, but new business in North America."
},
{
"speaker": "Don Bailey",
"content": "Yeah. Thanks, Peter. And we have definitely pivoted to that growth mindset. Its first important to mention that we were doing this off of transforming the business over the last few years. So we come into the growth with a position of strength regarding underwriting discipline, profitability. You've heard about all that. Regarding the growth, we've been very deliberate and creating more value for our distribution partners and clients than ever before, and we're applying much more rigor in pursuing like targeted risks. All of that is what you start to see showing up in the numbers now. And I can give you a little bit more color. The retention that we're delivering high levels of retention across all of our business. I would also add that we're executing on specific market opportunities, notably retail casualty and Lexington. On the retail casualty side, we are on offense. The discipline in the excess market is a positive for us right now, and we're moving on that. Regarding Lex, the growth there comes from three places. We have strong -- continued strong retention there, new products and new customers. So it's not from bigger limits. I would describe it as healthy, horizontal growth. Regarding the sustainability of it, which I think is important, I can look at some of our Lex submission data and share that with you. Year-to-date submissions at Lex are up 42%, and that's on top of 39% growth through last year through six months. We view this as a clear flight to quality in that space. I should also add that we resourced all of that in advance. So we're well positioned to take advantage of what's coming. And Peter, I'll just say this in closing on my end, we're getting all that growth while achieving outstanding loss ratios in the core business."
},
{
"speaker": "Peter Zaffino",
"content": "Don, thank you. That was great. Jon, maybe a little bit of context on International."
},
{
"speaker": "Jon Hancock",
"content": "Yeah. I mean, I won't repeat what you've already said, Peter or Don, but I would say, this is still a very good market for us to underwrite in. We've got a really large diverse portfolio across international, gives us access to a huge amount of opportunity, different segments, different geographies, different points in time. So we can reshape and shift the book depending on what we see in each market. Similar themes to Don, this has been very planful. This is not opportunistic growth here. We've been building to this for a long time of a very, very high quality book of business. We start with retaining 89% of what we've worked really hard to build a really strong book. New business submissions are up as well. We're retaining that our own flight to quality as well as the market. Hopefully, we've done the markets flight to quality. A couple of highlights for me. We've got a world-class global specialty business. It's grown 8% in the quarter. And that's driven by some very, very good new business in all of the global specialty segments, especially in marine and energy, where we are recognized world leaders in both. We've grown new business in marine 15% over Q1 last year, especially strong in cargo in the UK and across Europe. Peter, you already referenced the energy, 13% increase in new business year-over-year. And that's in all of our global hubs and all of our products actually. So really, really strong targeted growth with one of our best performing profitability businesses. And I'll just finish on, I'll add in Talbot as well Talbot at Lloyd's another very, very good quarter of growth of 12%. And again, that's driven by targeted growth in specialty lines of marine liability that we grew at 13%, cargo and specie at 16% and upstream energy at 19%. And both of those with the market we've got the pipeline that we've got, we expect to see continued good growth."
},
{
"speaker": "Peter Zaffino",
"content": "That's great, Jon. Thanks to you and Don for that detail, really helpful. I want to thank everybody for joining us today. I do want to thank our colleagues around the world for their continued dedication, commitment, teamwork and all of their execution. I also want to extend my deep gratitude to Tom Bolt, who's retiring at the end of the year for his many significant contributions to AIG during a very important time and congratulate him on his story career. Tom was instrumental in establishing a global framework for AIG's underwriting standards, governance and structures and alignment with our refined risk appetite and has just been a terrific executive at AIG. So again, thank you for joining us today. Everybody, have a great day."
},
{
"speaker": "Operator",
"content": "Thank you. This does conclude the program. You may now disconnect. Good day."
}
] |
aig | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to AIG's First Quarter 2024 Financial Results Conference Call. This conference is being recorded."
},
{
"speaker": "",
"content": "Now at this time, I would like to turn the conference over to Quentin McMillan. Please go ahead."
},
{
"speaker": "Quentin McMillan",
"content": "Good morning, and thanks very much. Today's remarks may include forward-looking statements which are subject to risks and uncertainties. These statements are not guarantees of future performance or events and are based on management's current expectations. AIG's filings with the SEC provide details on important factors that could cause actual results or events to differ materially. Except as required by applicable securities laws, AIG is under no obligation to update any forward-looking statements if circumstances or management's estimates or opinions should change."
},
{
"speaker": "",
"content": "Today's remarks may also refer to non-GAAP financial measures. A reconciliation of such measures to the most comparable GAAP figures is included in our financial supplement and earnings presentation, all of which are available on our website at aig.com."
},
{
"speaker": "",
"content": "Additionally, note that today's remarks will include results of AIG Life and Retirement segment and other operations on the same basis as prior quarters, which is how we expect to continue to report until the deconsolidation of Corebridge Financial. AIG segments and U.S. GAAP financial results, as well as AIG's key financial metrics with respect thereto, differ from those reported by Corebridge Financial. Corebridge Financial will host its earnings call on Friday, May 3."
},
{
"speaker": "",
"content": "Finally, today's remarks as they relate to net premiums written, adjusted pretax income, underwriting income and margin in General Insurance are presented both on a reported basis as well as a comparable basis, which reflects year-over-year comparison on a constant dollar basis as applicable, adjusted for the sale of Crop Risk Services and the sale of Validus Re. Please refer to the footnote on Page 26 of the first quarter financial supplement for prior period results for the Crop business and Validus Re."
},
{
"speaker": "",
"content": "With that, I'd now like to turn the call over to our Chairman and CEO, Peter Zaffino."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"content": "Good morning, and thank you for joining us today to review our first quarter 2024 financial results. Following my remarks, Sabra will provide more detail on the quarter and then we'll take questions. Kevin Hogan will join us for the Q&A portion of the call."
},
{
"speaker": "",
"content": "Here are some highlights from the quarter. Adjusted after-tax income was $1.2 billion or $1.77 per diluted common share, representing a 9% increase in earnings per share year-over-year. Consolidated net investment income on an adjusted pretax income basis was $3.5 billion, a 13% increase year-over-year. General Insurance underwriting income was $596 million, a 19% increase year-over-year, reflecting improved accident year results, including lower catastrophes and increased 67% year-over-year on a comparable basis, if you exclude divested businesses from the prior year quarter."
},
{
"speaker": "",
"content": "The accident year combined ratio, excluding catastrophes, was 88.4%, a 30 basis point improvement from the prior year quarter and was the tenth consecutive quarter of a sub-90 combined ratio. The quarter also reflected the significant improvement we have made in controlling volatility in our property portfolio as total catastrophe-related losses in the quarter were $107 million or 1.9%, representing a 230 basis point improvement year-over-year."
},
{
"speaker": "",
"content": "Turning to Life and Retirement. The business reported very good results with premiums and deposits of $10.7 billion in the first quarter, their highest quarterly result achieved in the last decade, and strong APTI growth of 12% over the prior year quarter."
},
{
"speaker": "",
"content": "Last September, Corebridge entered into a definitive agreement to sell the U.K. Life Insurance business to Aviva plc, which calls on April 8. Net proceeds were approximately $550 million and will be used for Corebridge share repurchases."
},
{
"speaker": "",
"content": "During the quarter, we returned over $2.4 billion to shareholders through $1.7 billion of common stock repurchases, $250 million of dividends and the redemption of all our outstanding Series A preferred stock for $500 million. We repaid $459 million of debt upon maturity, lowering our total debt to $9.8 billion. In addition, we repurchased approximately $613 million of common stock in April."
},
{
"speaker": "",
"content": "Based on our strong performance, the AIG Board of Directors approved an 11% increase in AIG's quarterly common stock dividend to $0.40 per share. The AIG Board of Directors also increased the share repurchase authorization to $10 billion, effective May 1. Lastly, we ended the first quarter with strong parent liquidity of $5.1 billion. Overall, I'm very pleased with our first quarter results and the continued strong execution of our strategy to deliver sustained underwriting excellence, profitability and disciplined capital management."
},
{
"speaker": "During my remarks this morning, I will discuss 4 important topics",
"content": "first, I will provide some financial highlights in the quarter focused on the General Insurance business, including some insight into our net premiums written; second, I will talk briefly about the results in Life and Retirement; third, I will provide an update on our capital management strategy, specifically our plans for 2024 and 2025; and finally, I will discuss our path to a 10%-plus ROCE and provide more detail on AIG Next and our future state operating structure that will create value through a leaner and more unified company."
},
{
"speaker": "",
"content": "Let me take a moment to update you on our sell-down of Corebridge. Our Corebridge holdings currently stand at 324 million common shares outstanding, which represents a 53% ownership stake. We continue to explore all alternatives to reduce our ownership stake in Corebridge. Once Corebridge is deconsolidated from AIG, Life and Retirement's balance sheet and income statement will no longer be included in AIG's consolidated financial statements, and our remaining ownership stake will be reported in parent investments with dividends reported in net investment income."
},
{
"speaker": "",
"content": "Sabra went through this in detail on our last earnings call. We have been evaluating opportunities to maximize long-term value for Corebridge and have considered multiple strategic alternatives that we believe will best position Corebridge for future success. We remain committed to reducing AIG's ownership and to fully selling our remaining stake, and I will continue to provide updates to all of our stakeholders."
},
{
"speaker": "",
"content": "In terms of the use of Corebridge-related proceeds, AIG expects to continue to utilize excess capital and liquidity, with a focus on returning capital to shareholders through share repurchases and liability management, which I will discuss later when I outline our capital management strategy."
},
{
"speaker": "",
"content": "Now turning to General Insurance. Net premiums written were $4.5 billion and reflected the impact of the dispositions of Validus Re and Crop Risk Services as well as actions we've taken to restructure specific treaty reinsurance. Overall, Global Commercial had a very strong quarter. Excluding the impact of our divestitures, Global Commercial net premiums written growth was 1% year-over-year."
},
{
"speaker": "",
"content": "First, I want to reconfirm the guidance for the year. We expect high single-digit growth in net premiums written for the full year in our Global Commercial Insurance business. Now the results. In North America Commercial, net premiums written grew 4%. Lexington grew 24%, which was led by Casualty and Western World. Our Excess Casualty line grew 46% and our Captive Solutions grew 20%."
},
{
"speaker": "",
"content": "There's been meaningful commentary on the Excess & Surplus Lines market, and we continue to experience terrific fundamentals and results in Lexington. Let me provide a few examples. Our submission volume was up over 50% year-over-year. Lexington delivered strong new business, outperforming last year's record first quarter results, balanced across all lines. And retention remains strong for Lexington at 78%."
},
{
"speaker": "",
"content": "Shifting to North America Retail Property, net premiums written were negative $120 million in the quarter, driven by first quarter reinsurance purchased and had over a 600 basis point impact on the first quarter net premiums written growth for North America commercial compared to prior year. North America Financial Lines declined 4% year-over-year. In prior quarters, we provided meaningful commentary on the dynamics within Financial Lines, so I will not go through that again."
},
{
"speaker": "",
"content": "It's been a challenging market environment with continued headwinds on rate. Having said that, we continue to believe our portfolio is strong, and we remain disciplined. Sabra will give more detail in her prepared remarks."
},
{
"speaker": "",
"content": "In International Commercial, net premiums written were flat for the quarter. International Property grew 23%, and Talbot grew 18%. This was offset by a decline in our Global Specialty business of slightly over 10% due to some top line weakness in energy and the effects of the reinsurance restructuring. Also, we had a 5% decline in International Financial Lines."
},
{
"speaker": "",
"content": "Now turning to the combined ratio. Our Global Commercial business in the first quarter had an outstanding result with an 84.4% accident year combined ratio, excluding catastrophe, a 150 basis point improvement year-over-year. The accident year combined ratio, including catastrophe, was 86.6%, a 500 basis point improvement year-over-year."
},
{
"speaker": "",
"content": "This was led by International Commercial which, on a comparable basis, had an 82.8% accident year combined ratio, excluding catastrophe, which is a 140 basis point improvement year-over-year; and an 83.5% accident year combined ratio, including catastrophe, which is a 770 basis point improvement year-over-year."
},
{
"speaker": "",
"content": "North America Commercial also had an outstanding result with an 85.9% accident year combined ratio, excluding catastrophe, which is a 180 basis point improvement year-over-year; and an 89.5% accident year combined ratio, including catastrophe which is a 260 basis point improvement year-over-year. These results were simply outstanding and are a testament to our commitment and culture of underwriting excellence."
},
{
"speaker": "",
"content": "Shifting now to global Personal Insurance. Net premiums written were flat to prior year. We had modest growth in Personal Auto and Individual Travel and reductions in high net worth driven largely by reinsurance and Accident & Health, largely driven by 2 nonrenewals in China, as part of our focus on portfolio improvements in our Accident & Health business."
},
{
"speaker": "",
"content": "North America Personal had a 97.7% accident year combined ratio, excluding catastrophe. This is a 990 basis point improvement year-over-year and a 101.6% accident year combined ratio, including catastrophe, which is an 870 basis point improvement year-over-year."
},
{
"speaker": "",
"content": "As we discussed last year, we expect a material financial improvement in 2024 that will be driven by higher earned premium and a lower loss ratio from the high net worth business. We saw this manifest in the first quarter and expect this improvement to continue throughout 2024."
},
{
"speaker": "",
"content": "International parcel insurance had a 96.8% accident year combined ratio, excluding catastrophe, which increased 90 basis points year-over-year; and a 96.8% accident year combined ratio, including catastrophe, which is a 20 basis point improvement year-over-year. Overall, I'm very pleased with the financial performance of General Insurance, which delivered another excellent quarter."
},
{
"speaker": "",
"content": "Our reinsurance decisions in the first quarter had an impact on net premiums written. As we've discussed over the past several years, our reinsurance partnerships and global treaty structures have been purposeful. Our objective has been to deliver improved underwriting profitability and evolve our business portfolio to be appropriately diversified to deliver consistent results throughout the market cycle."
},
{
"speaker": "",
"content": "We believe this strategy has provided sustained value to our clients while also delivering improved risk-adjusted returns. It has significantly repositioned AIG, especially as we prepare to deconsolidate from Corebridge. Our goals with our reinsurance purchasing have been to preserve and optimize capital and enhance the quality of earnings through active management of the volatility of our underwriting results. This deliberate approach to reinsurance has helped position AIG with a very strong balance sheet and has given us the flexibility to add exposure where risk-adjusted returns are very attractive while also moderating volatility in our underwriting results."
},
{
"speaker": "",
"content": "As a result of our divestiture of Validus Re, combined with the reduction in gross limits in property through our underwriting strategy, we have reduced our PMLs and created meaningful capacity to increase our property writings throughout our global platform should they meet our expected returns. Without going through each return period by peril and region, our key zone PMLs on average, have decreased by over 40% compared to the first quarter of 2023, which provides considerable aggregate for future growth while appropriately managing the exposures we're assuming."
},
{
"speaker": "",
"content": "Our reinsurance purchasing is deliberately concentrated at January 1. As a result, any changes in purchasing tend to be more pronounced in the first quarter reporting of net premiums written. In January 2024, we also made some changes related to the allocation of catastrophe costs among the businesses, so that catastrophe costs are more accurately reflected in pricing. Historically, some of these costs have been shared with Validus Re. We reallocated PMLs and the catastrophe costs to where we believe the most attractive opportunities for growth existed in our portfolio."
},
{
"speaker": "",
"content": "It's worth noting, when considering our property catastrophe placement, we believe we have the lowest attachment point of our peer group. Over time, we have the balance sheet and perhaps the risk appetite to take more net on our catastrophe program post deconsolidation and subject to market conditions."
},
{
"speaker": "",
"content": "As a point of reference, if we chose to raise our catastrophe attachment point to $500 million worldwide, our attachment point would likely remain the lowest among our peer group with 1 in 11 attachment point in North America wind and 1 in 19 attachment in North America earthquake based on today's exposure. Importantly, our net premiums written in commercial would have been 15% greater in the first quarter if we had elected to have a $500 million attachment point across our global portfolio."
},
{
"speaker": "",
"content": "Our earnings potential is significant. And when combined with the strength of our balance sheet, it will provide us with the flexibility to continuously evaluate and refine our strategic reinsurance purchasing as we enter 2025."
},
{
"speaker": "",
"content": "Turning to Life and Retirement. As I noted earlier, the business continued to produce strong results in the first quarter. In April, Corebridge completed their Corebridge forward restructuring. $400 million of savings has been actioned or contracted, and they expect to realize the vast majority of the savings by the end of 2024 at a cost to achieve of $300 million."
},
{
"speaker": "",
"content": "Corebridge repurchased approximately $240 million of common shares during the first quarter, and they have repurchased $370 million of common shares year-to-date. Corebridge ended the quarter with a strong balance sheet with parent liquidity of $1.7 billion. This week, the Corebridge Board of Directors approved a share buyback authorization of $2 billion, which reflects their stated commitment to delivering a 60% to 65% payout ratio to shareholders, subject to market conditions."
},
{
"speaker": "",
"content": "Turning to other operations. We have made significant progress towards our future state operating model. Adjusted pretax loss from other operations in the quarter, including Life and Retirement, was $408 million, a 17% improvement year-over-year. The improvement was primarily attributable to lower general operating expense, higher short-term investment income and lower interest expense at AIG due to debt reduction actions. We expect our future state parent expenses to be in the range of $325 million to $350 million by year-end 2024. After deconsolidation, we intend to use 1% to 1.5% of net premiums earned as a benchmark of total parent expenses in the future."
},
{
"speaker": "",
"content": "Turning to capital management. In the first quarter, we continue to execute on our balanced capital management strategy. Over the past couple of years, we have significantly strengthened our balance sheet by making key decisions that have increased our financial flexibility while always planning for the long term, which has allowed us to accelerate the execution of our strategy and unlock meaningful value for AIG shareholders."
},
{
"speaker": "",
"content": "Along with establishing appropriate debt capital structures for AIG and Corebridge and diligently executing on AIG's capital management priorities, we have also completed over $40 billion of capital market transactions since 2022. We have been very disciplined in the execution of the components of our capital management strategy that we first outlined in 2022."
},
{
"speaker": "As a reminder, our objectives were",
"content": "to maintain very strong insurance company capital levels to support organic growth and a steady source of operating subsidiary dividends to service parent company needs; to reduce our total debt outstanding and improve our leverage ratios, providing a well-structured and well-laddered debt portfolio with no outsized amounts due in any given year, particularly over the next 5 years; to return excess capital to shareholders in the form of share repurchases and dividends; to increase our dividend as our earnings and financial flexibility improved; and to maintain a strong parent liquidity position."
},
{
"speaker": "",
"content": "All of our Tier 1 insurance company subsidiaries are at or above their target capital ranges and have the ability to support meaningful growth without additional capital contributions. At current profitability levels, we had approximately $3 billion of run rate dividend capacity from our global General Insurance subsidiaries with approximately $2 billion attributable to the U.S. General Insurance company's dividend capacity."
},
{
"speaker": "",
"content": "We have increased the U.S. General Insurance company dividend capacity by approximately 400% over the last 3 years. This reflects a significant increase from 2021, when it was $550 million; and in 2022, when it was $1.4 billion. Looking forward, we expect to continue positioning AIG with maximum capital flexibility for growth, including reviewing our reinsurance over time and considering compelling and strategic inorganic growth opportunities should they exist."
},
{
"speaker": "",
"content": "In addition to strong insurance company capitalization, we've continued to significantly reduce our overall debt. Outstanding debt is now approximately $9.8 billion, a reduction of over $12 billion since the end of 2021, which has been a remarkable result for AIG. We had previously provided guidance that we're targeting a 20% to 25% total debt-to-capital ratio, and we expect to be in the 15% to 20% range upon deconsolidation."
},
{
"speaker": "",
"content": "While we may do additional work on maturities, we would not expect that to take priority over share repurchases. Since 2022, we've increased our focus on share repurchase activities. We completed over $5 billion of repurchases in 2022 and approximately $3 billion in 2023. Looking ahead, we expect up to $6 billion in repurchases in 2024 and up to $4 billion in 2025, depending on the timing of future Corebridge sell-downs and market conditions."
},
{
"speaker": "",
"content": "All of the expected activity in 2024 and 2025 will be covered by the $10 billion share authorization that we announced yesterday. For the balance of 2024, we expect to be able to repurchase about $1.5 billion of common stock a quarter depending on excess parent liquidity levels, including future Corebridge sale proceeds, General Insurance dividends and market conditions."
},
{
"speaker": "",
"content": "And based on the current stock price, we would expect this to get us closer to the higher end of our target share count range of 600 million to 650 million common shares by the end of the second quarter and towards the lower end of the range by the end of 2024. Furthermore, based on this outlook and depending on the stock price and market conditions, we would expect to be between 550 million and 600 million shares outstanding by year-end 2025."
},
{
"speaker": "",
"content": "Turning to our dividend. The AIG Board of Directors recently increased the cash dividend of $0.40 per share on AIG common stock up 11%, the second consecutive year with an increase of more than 10%. I could not be more pleased with our progress. We remain confident in our ability to deliver while continuing the positive momentum in our financial performance."
},
{
"speaker": "",
"content": "We remain committed to delivering an adjusted 10%-plus ROCE post deconsolidation of Corebridge. For the first quarter, we achieved a 9.3% adjusted ROCE and a 13.3% adjusted ROCE in General Insurance. Contributing to ROCE will be AIG Next, which will focus on achieving an expense base that will generate additional savings for AIG while reducing complexity throughout our organization and simplifying how we operate. AIG Next will create clarity in our operating structure, including aligning our underwriting and claims organizations with our operations and functions while defining our parent company of the future."
},
{
"speaker": "",
"content": "This is the key objective as we weave AIG together. To be a less complex, more effective and leaner company with the appropriate infrastructure and capabilities for the business we will be post deconsolidation. AIG Next has clearly defined work streams governed by a very experienced, centralized team with significant experience in transformations and company design reporting directly to me."
},
{
"speaker": "",
"content": "As I stated on previous calls, we expect AIG Next to generate approximately $500 million in annual run rate savings by the end of 2025. Of the $500 million in run rate savings, we expect $350 million to be actioned in 2024, which is an increase of the guidance we have provided in the past, and the balance will be actioned within 2025 with a cost to achieve of $500 million."
},
{
"speaker": "",
"content": "To date, we've made meaningful progress on AIG Next across multiple work streams. In April, we announced a voluntary early retirement program available to colleagues in the United States who meet the eligibility criteria. Eligible participants will have the opportunity to accelerate their retirement from AIG with enhanced retirement benefits."
},
{
"speaker": "",
"content": "The population of eligible participants represents approximately 25% of our U.S. workforce. About half of the eligible participants are located in the high-cost New York metropolitan area. We are anticipating a 50% take-up rate, which would result in approximately $225 million of onetime cost and a net run rate benefit of approximately $150 million after reinvestment for the skills and capabilities we need for the future. The numbers I have provided for our early retirement program are included in the total numbers I provided for AIG Next."
},
{
"speaker": "",
"content": "In summary, I'm very pleased with our overall performance as we start 2024. As I said in my recent letter to shareholders, our ability to execute continues to be one of the company's best attributes. We have accomplished a significant amount in the past several years in order to position AIG for the future, and we have continued to deliver in the first quarter, which will enable us to achieve our objectives in 2024 and beyond."
},
{
"speaker": "",
"content": "I am confident that we will continue to uphold our commitment to achieving underwriting excellence and high-quality earnings over the long term, benefiting all of our stakeholders as we continue to simplify and streamline our business and create the AIG of tomorrow."
},
{
"speaker": "",
"content": "With that, I'll turn the call over to Sabra."
},
{
"speaker": "Sabra Purtill",
"content": "Thank you, Peter. This morning, I will provide details on AIG's first quarter results, including General Insurance, investment income in Life and Retirement and a balance sheet update."
},
{
"speaker": "",
"content": "First quarter 2024 adjusted after-tax income attributable to AIG common shareholders, or AATI, was $1.2 billion, flat to last year due to the reduction in our ownership of Corebridge from 77.3% to 52.7% at the end of this quarter. General Insurance adjusted pretax income, or APTI, increased $110 million year-over-year, driven by higher underwriting and net investment income. The prior year quarter included APTI of approximately $175 million from Validus Re and Crop Risk Services. On a comparable basis, excluding the divested businesses, General Insurance APTI was up about $285 million."
},
{
"speaker": "",
"content": "As Peter noted, first quarter General Insurance underwriting income was $596 million, up $94 million from the prior year quarter. On a comparable basis, underwriting income rose $239 million year-over-year."
},
{
"speaker": "",
"content": "International Commercial Lines was the primary contributor to higher underwriting profitability with $175 million increase in underwriting income. North America Commercial Lines underwriting income was down $95 million from the prior year quarter as reported but up $35 million on a comparable basis. Underwriting income includes catastrophe losses of $107 million in the quarter or 190 basis points on the loss ratio, down from $265 million or 420 basis points last year."
},
{
"speaker": "",
"content": "Prior year development this quarter was a favorable $34 million compared to a favorable $68 million in the prior year quarter. This quarter's development was solely from the amortization of the deferred gain on the adverse development cover which is recalculated each year based on prior year experience. For 2024, the amortization gain will be $34 million each quarter compared to $41 million a quarter last year."
},
{
"speaker": "",
"content": "Turning to underwriting ratios. The General Insurance calendar year combined ratio was 89.8% this quarter, a 210 basis point improvement from the prior year quarter and a 380 basis point improvement on a comparable basis. We provided additional data on Page 26 of the financial supplement on the impact of the divestitures on 2023 North American commercial combined ratios."
},
{
"speaker": "",
"content": "The accident year combined ratio ex catastrophes was 88.4%, a 30 basis point improvement over the prior year quarter and a 160 basis point improvement on a comparable basis. The accident year loss ratio adjusted for catastrophes was 56.6% this quarter, 10 basis points better than the first quarter of 2023 as reported and 70 basis points better on a comparable basis. This improvement reflects continued earn-in of rate above loss cost trend and better underwriting and risk selection, particularly in Global Commercial lines."
},
{
"speaker": "",
"content": "The expense ratio for the quarter was 31.8%, down 20 basis points from the prior year quarter as reported, with a $43 million reduction in general operating expenses. On a comparable basis, the expense ratio improved 90 basis points with 10 basis points from the acquisition ratio and 80 basis points from the general operating expense ratio, reflecting continued expense discipline as general operating expenses rose only $6 million."
},
{
"speaker": "",
"content": "As Peter covered General Insurance premium growth, I will focus on Commercial Lines new business, renewal rate, loss trends and retention as well as reserves. New business production in Global Commercial remained strong. In North America, new business was almost $450 million and balanced across all lines with excellent performance from Lexington."
},
{
"speaker": "",
"content": "International Commercial new business levels were very good, with over $500 million in the quarter, led by Talbot, Property and Casualty, offset by lower new business in energy and Financial Lines. In North America Commercial, overall rate, excluding workers' compensation, increased 5% in the quarter with exposure adding 2% for overall pricing of 7%, which is above loss cost trend. Excluding workers' comp and Financial Lines, North America commercial rate was up more than 8% in the quarter, with exposure up 2% for overall pricing over 10%, meaningfully above the loss cost trend."
},
{
"speaker": "",
"content": "North America commercial rate increase reflect strengthening pricing trends in Casualty, including Lexington Casualty, which was up 11%; Lexington Healthcare up 15%; and Excess Casualty up 16%. In International Commercial, overall rate increased 3% and exposure added 2% for an overall pricing increase of 5%, modestly ahead of the loss cost trend. Excluding Financial Lines, International rate was up 5% with overall pricing up 7%, well ahead of loss cost trend. The rate increase was driven by Property, which was up 7%; energy up 8%; and marine up 7%."
},
{
"speaker": "",
"content": "As we've discussed, Financial Lines is a notable exception to pricing trends. This was particularly the case in excess. We are taking a long-term view in Financial Lines and remain disciplined on risk selection, terms and conditions, pricing and reserving. While rate trend has been negative the past few quarters, in aggregate, the cumulative rate level in North America Financial Lines is about 50% higher than 5 years ago."
},
{
"speaker": "",
"content": "Renewal retention has improved over the past several years and remained strong. As a reminder, we calculate renewal retention using expiring premiums, excluding the impact of renewal rate and exposure changes on the ratio. Global Commercial retention increased to 89%, stable at 88% in North America and rose to 89% in International."
},
{
"speaker": "",
"content": "Turning to reserves. I wanted to provide some background on AIG's reserve review schedule for 2024 and quarterly processes. At AIG, we performed detailed valuation reviews, or DVRs, on each book once a year. In DVRs, we look at loss development and trends in prior and current accident years and consider changes in our reserving factors and approaches based on emerged experience. We do not perform DVRs in the first quarter."
},
{
"speaker": "",
"content": "In the second quarter of 2024, we will review the North America Casualty book, including excess and primary Casualty, Lexington, workers' compensation and mass tort comprising about $20 billion of reserves or 44% of our total reserves. In the third quarter, we will review International Commercial Lines, Global Financial Lines, Commercial Property and other lines, totaling about $22 billion or 47% of reserves with the balance of the DVRs completed in the fourth quarter."
},
{
"speaker": "",
"content": "Between DVRs, our actuarial team evaluates pricing, claims, loss trends and reserves across the portfolio. Each quarter, we complete an actual versus expected review, or AVE, for each book. The AVE review gives us a current look at trends and the opportunity to address issues prior to the scheduled DVR. Examples of such items include large new claims, notable changes in claims patterns or settlements, changes in attritional loss trends beyond normal ranges or significant major events."
},
{
"speaker": "",
"content": "We are aware that the industry has begun to address adverse casualty loss development trends in the 2016 to 2019 accident years. On our third quarter 2023 call, Peter provided significant detail on the reunderwriting and repricing of our casualty book that we began in 2018 with an entirely new framework and approach to underwriting. In addition, we changed our reserving assumptions on the book. And by 2021, we had increased reserves on North American Casualty, 2016 through 2019 accident years, by over $1 billion. We also continued to refine our actuarial judgments, and in 2019, we raised the loss cost trend assumption for certain Excess Casualty segments to 10%. And by 2022, all Excess Casualty segments were at or above 10%."
},
{
"speaker": "",
"content": "Our AVE reviews on North American Casualty since the second quarter 2023 DVR continue to show loss experience within the range of our expectations on the 2016 to 2019 accident years. As we have previously outlined, our reserving philosophy is to react to adverse trends quickly and to allow time for favorable trends, particularly in recent accident years, to mature. We did not make any adjustments to our casualty reserves this quarter, in total or within the 2016 to 2019 accident years. AIG's reserves and balance sheet are much stronger today, and our reinsurance is much more comprehensive, helping improve our underwriting results and reduce volatility."
},
{
"speaker": "",
"content": "Turning now to investment income. AIG continues to benefit from reinvestment rates on fixed maturities and loans that exceeded sales and maturities, helping drive higher yields and net investment income in General Insurance and Life and Retirement. This quarter, consolidated net investment income on an APTI basis was $3.5 billion, up 13% from the prior year quarter and up 2% in General Insurance and 16% in Life and Retirement."
},
{
"speaker": "",
"content": "General Insurance net investment income growth was negatively impacted by the sale of Validus Re, which had a $5 billion portfolio. Adjusted for income on that portfolio in the prior year quarter, General Insurance net investment income rose about 7%, with a 9% increase in fixed maturities and loans driven by higher reinvestment rates."
},
{
"speaker": "",
"content": "This quarter, new money rates on fixed maturities and loans averaged 5.9%, 150 basis points higher than the yield on sales and maturities in the quarter. The new money rates were about 115 basis points higher in General Insurance, and 165 basis points higher in Life and Retirement."
},
{
"speaker": "",
"content": "The annualized yield on fixed maturities and loans, excluding calls, prepayments and other onetime items, was 3.9% in General Insurance, 3 basis points higher than the fourth quarter of 2023 and 44 basis points higher than the prior year quarter. The sequential yield comparison in General Insurance was negatively impacted by the sale of Validus Re. First quarter General Insurance alternative investment income was $54 million or an annualized return of 5.2% this quarter, down $41 million from the prior year quarter."
},
{
"speaker": "",
"content": "Continuing to Life and Retirement. Sales and earnings were strong this quarter. First quarter sales remained at historically high levels with premiums and deposits of $10.7 billion driven by strong sales in fixed annuities and pension risk transfer."
},
{
"speaker": "",
"content": "Life and Retirement segment APTI was $991 million, up 12% from the prior year quarter, driven by higher base portfolio spread income due to higher reinvestment rates, higher fee income due to higher market levels and lower general operating expenses, partially offset by lower alternative investment income. Life and Retirement alternative investment income was negative $23 million this quarter for an annualized yield of negative 1.8% due to private equity losses and very low income on hedge funds and real estate compared to breakeven last year. Corebridge's total contribution to AIG's AATI, including corporate expenses, declined by approximately $100 million or 20% over the prior year quarter due to the reduction in our ownership."
},
{
"speaker": "",
"content": "Turning to the balance sheet. Book value per common share was $64.66 this quarter, down 1% from year-end 2023 and up 10% from the prior year quarter, driven mostly by the impact of interest rates. Adjusted book value per share was $77.79, up 1% from year-end 2023 and up 3% from the prior year quarter, reflecting the net impact of earnings, dividends and share repurchases."
},
{
"speaker": "",
"content": "Peter covered our capital management actions year-to-date. With respect to debt leverage, consolidated debt and preferred stock to total capital, excluding AOCI, which includes $9.4 billion of Corebridge debt, was 23.6% at March 31, down 70 basis points from year-end 2023. Excluding Corebridge debt on a pro forma deconsolidated basis, AIG debt to total capital is expected to be within the new 15% to 20% debt target range that Peter provided."
},
{
"speaker": "",
"content": "To conclude, AIG delivered another excellent quarter with significant financial and operational accomplishments. In 2024, AIG Next and the deconsolidation of Corebridge will drive significant progress towards achieving our 10%-plus adjusted ROCE goal. We are confident in our ability to achieve this goal and look forward to updating you on our progress."
},
{
"speaker": "",
"content": "With that, I will turn the call back over to Peter."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"content": "Thank you, Sabra. And operator, we're ready for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from Mike Zaremski with BMO."
},
{
"speaker": "Michael Zaremski",
"content": "Looking over the -- your prepared remarks, Peter, and you used the term inorganic opportunities should they exist in reviewing reinsurance. So you also talked about the capital management expectations. So I guess would -- should we be thinking about the repurchase program as kind of a base case, but should there be other opportunities you might look to do something organic? Or just was there anything kind of new in there, in that wording that we should -- that you're trying to get us to think about?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"content": "Thanks, Mike. It's a very good question. We are going to stay very committed to the capital management structure we outlined, which is why I gave guidance on not only '24 but '25 in terms of share repurchases."
},
{
"speaker": "",
"content": "I think we've been consistent, and I added in when we're more comprehensive in our description in terms of capital management, that should inorganic opportunities exist, and they're compelling, which just means does it add product, does it add geography? Not scale and size, but just something that does help us strategically reposition ourselves. I wouldn't want to rule that out, but it's not a priority in the short term. And so that's really the context of what I provide in my prepared remarks."
},
{
"speaker": "Michael Zaremski",
"content": "Okay. Understood. And my follow-up is just on the overall competitive environment relative to growth. So you guys have been very open. You have lots of pricing gauges. You've talked about Financial Lines being -- continue to be a soft-ish marketplace. but you've also said that you estimate pricing above loss cost trend."
},
{
"speaker": "",
"content": "But is there -- is this a conducive environment for AIG to want to kind of grow opportunistically? Or is it more just in certain pockets? I guess just for the backdrop, some of us look at the Marsh pricing index and it feels like there's, in my words, not a lot of gap or a narrow gap between kind of pricing and loss trends, potentially."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"content": "Yes. Thanks. It's a very good question. Let me start on growth. You can't -- one is you can't always look at broker index. Again, I don't know what Marsh index tracks, but sometimes, they don't catch fee business. They don't really catch the entire sort of market, which is the market we play in."
},
{
"speaker": "",
"content": "I do think it's conducive to grow. We don't look for top line growth to sacrifice profitability, and I think we evidenced that in this quarter and we've evidenced it over the past couple of years, that we continue to want to improve our combined ratios and look at businesses where the best risk-adjusted returns are. And so we have shaped the portfolio that way."
},
{
"speaker": "It's hard in any one quarter to sometimes draw conclusions like you saw in terms of the gross premium written in this quarter. It's really driven by 3 lines",
"content": "Specialty; Financial Lines; and Casualty. The first quarter was impacted in International by energy within the Specialty class. But it's a great business, we're a world leader in that class, great underwriting capabilities and global distribution. And expect us to continue to grow that, and it's a very attractive combined ratio."
},
{
"speaker": "",
"content": "So I think there's a little bit of noise. We had some captives. We had reinsurance impact the quarter, because we switched from some pro rata to excess of loss. I don't think I need to go into too much more detail on Financial Lines. It's definitely an area where we watch very carefully. Sabra provided a lot of great context in her prepared remarks. But we're going to focus on making sure we have the highest-quality book."
},
{
"speaker": "",
"content": "I mean, our retention I think, spoke volumes this quarter in terms of the portfolio we like. I mean, with 89% in International, 88% in North America, across the board, that was tremendous, good new business. And so we definitely find opportunities."
},
{
"speaker": "",
"content": "I mean, the one area I just want to just note. Because Lexington, we talk about it every quarter because it just continues to just be exceptional. But the market dynamics have changed quite a bit. And when we look at Excess & Surplus lines, we think there's great opportunities to continue to grow. Even though there may have been some slowdown in Property, there's other lines of business, like casualty that we're seeing massive submission activity. And I just wouldn't look at the E&S market as a hard market play or a soft market play. It's just a market that's going to be here to stay in a different way. And so we're very much investing in that. I think the margins are great and the growth opportunities are significant."
},
{
"speaker": "Operator",
"content": "Our next question comes from Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"content": "Peter, my first question, last quarter, you had implied that a Corebridge deconsolidation would come by the end of the second quarter. Does that time frame remain intact?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"content": "There's not a whole lot more I can offer in terms of the prepared remarks. Every sell-down has been important, but this one is particularly important just because we would likely become a seller of shares that will deconsolidate Corebridge. So we continue to focus on making certain we're looking at every option available."
},
{
"speaker": "",
"content": "And considering all of those variables, Corebridge has done a significant amount of work working with AIG and independently to position itself to be a separate public company. It's done an exceptional job. We're completed, most of our transition service agreements, which just means they're more operationally prepared to go."
},
{
"speaker": "",
"content": "And so again, subject to market conditions, I think my guidance I gave last quarter stands. We would expect to try and do something before the end of the second quarter."
},
{
"speaker": "Elyse Greenspan",
"content": "And then my follow-up is on the new share count target that you provided for the end of '25, that 550 million to 600 million. I'm just trying to get a case of -- what the base case is for just Corebridge within that. Does that assume additional secondaries? If you did an exchange offer, would that be accretive to that share count target? I just want to get a sense of when you guys came up with this 550 million to 600 million, what you're assuming for Corebridge within that share count target."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"content": "Yes. Thanks, Elyse. I think while we gave the guidance into 2025 is -- what I said in my prepared remarks is that by the end of the second quarter, if we exercise on the share repurchases that we've outlined, we would be at the higher end of the range of the 600 million to 650 million. And if we continue the $1.5 billion a quarter, which, yes, would contemplate doing a sell-down of Corebridge. But there's other forms of liquidity that come into AIG, but we would need to sell down to be able to do the $1.5 billion in the third and fourth quarter, but that gets us to the lower end of the range."
},
{
"speaker": "",
"content": "And then as we continue to do future sell-downs, we would get below the 600 million share count, which is why we decided to give a little bit more guidance as we get into 2025. It does not include a sell-down to 0, but it does contemplate several transactions that would take place in the next 4 quarters."
},
{
"speaker": "Operator",
"content": "Our next question comes from Ryan Tunis with Autonomous."
},
{
"speaker": "Ryan Tunis",
"content": "Just a follow-up, I guess, on that last question, Peter. Just, I guess, the messaging on the $10 billion share repurchase authorization. Are you trying to say that the intention is to do kind of no more than $10 billion until the end of '25? Or is that -- should we just take this as an update of what you think you can do based on what you're seeing today?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"content": "I would take it as just an update. We would have gone past our current Board authorization with the 2025 guidance and worked very closely with the AIG Board of Directors to talk about what we expected the capital management strategy to be in the next 6 quarters. And that's really how we derive the $10 billion. But I wouldn't think about it anything more than that."
},
{
"speaker": "Ryan Tunis",
"content": "Got it. And then a follow-up, I guess, just thinking about the reinsurance. And obviously, you're continuing to add more, but you're saying potentially, like in the future, maybe scaling back on that a bit could be a way you could use some of your excess capital."
},
{
"speaker": "",
"content": "Could you just talk a little bit about, I guess, how we should think about how the gross underwriting, I guess, has improved at AIG over the past few years? And yes, like what would make you comfortable -- because we only see stuff on a net basis, but like what would give you comfort in retaining more net?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"content": "Well, in terms of the portfolio, I'm comfortable today taking more net. But what we've done over this multiyear period in terms of strategically positioning the reinsurance is working very closely with our reinsurance partners, looking across multiple lines of business and multiple geographies in the placement of reinsurance. And then also making certain that we control volatility in this period of transition. That's been really important."
},
{
"speaker": "",
"content": "I want to emphasize that because we not only are looking at our accident year combined ratios, excluding catastrophe, we have kept our retentions or lowered them in a period of high uncertainty and high volatility because we don't want to have any outsized losses or surprises perhaps or an active cat season."
},
{
"speaker": "",
"content": "Also, I think we're very different than other insurance companies in terms of how we purchase reinsurance. It's not done at the business level. It is not done within just the finance function or treasury, it's done -- reports directly to me. And so I work very closely with Charlie Fry, work very closely with Sabra in terms of what our risk appetite is going to be for that particular year. And we've protected capital and had more quality earnings as a result of some of the reinsurance that we place."
},
{
"speaker": "",
"content": "A couple of examples of things that are just very good, but impacted the first quarter is switching more to excess of loss in certain segments like energy, we transitioned and proportionally signed down a little bit of the quota share. But it wasn't economic because we ended up getting a better outcome on the quota share with 200 basis points of improvement. So it's just repositioning the portfolio. Did the same thing with property cat."
},
{
"speaker": "",
"content": "And the reason I just gave the example on our earnings and sort of prepared remarks is just, on property cat, we can absolutely take more net if we decide to as we enter 2025, depending on the portfolio and depending on our appetite for volatility. We'll still have one of the lowest attachment points of any of our peers across the world."
},
{
"speaker": "",
"content": "We enhanced coverage. There's a lot more coverage in our property cat. We've enhanced our high net worth business in terms of excess of loss and more comprehensive coverage. And also -- again, and I'll stop here because I could go on for hours on this discussion, but is on casualty, we renewed or improved our overall construct across the globe based on the quality of our growth portfolio."
},
{
"speaker": "",
"content": "So to start thinking about ways in which we can do reinsurance differently will not have anything really to do with the gross portfolio because they're very much like that. It's more of where do we want volatility and where do we want to take more net? And we see opportunities as we enter 2025."
},
{
"speaker": "Operator",
"content": "Our next question comes from Rob Cox with Goldman Sachs."
},
{
"speaker": "Robert Cox",
"content": "First question on underwriting leverage. If I take comments on capital at the insurance companies with opportunities in Property post the sale of Validus, it seems like AIG could meaningfully increase underwriting leverage here, which could obviously contribute to the 10%-plus ROCE. Could you provide any additional color on how you're thinking about underwriting leverage here, and maybe some metrics you'd point us to?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"content": "Sure. I'll ask Sabra to comment on some of the leverage within the insurance company subsidiaries. We see great opportunities for us to grow within -- across the world. And you've mentioned Property and specifics. We have significantly reduced PMLs, which means we have aggregate to grow. And we have the capital to grow."
},
{
"speaker": "",
"content": "And the interesting part of AIG is that when we look at Property, we have so many different points of entry depending on the risk-adjusted returns that exist. If I start in the United States, and this is not all inclusive, but just as a few examples, we have Lexington E&S property, we have Retail Property, we have the high net worth business, and that can be done on an admitted or non-admitted basis. We have Retail Property. In International, we have Japan Property that's specific to Japan. We have Talbot. And we have Global Specialty. So there's so many different points of entry. Depending on the risk-adjusted returns, we can scale up or scale down, but believe that there's going to be great opportunities for us in the future."
},
{
"speaker": "",
"content": "Yes. I mean, the first quarter tempered on Property. But look, we're not in the cat season yet, and our industry is famous of just framing out the market at a point in time. We got a long ways to go this year in terms of where the opportunities exist, but we absolutely have the leverage to grow if we like the risk-adjusted returns."
},
{
"speaker": "",
"content": "Sabra, do you want to comment on that?"
},
{
"speaker": "Sabra Purtill",
"content": "Yes. Thank you, Peter. What I would just observe is, as we've stated in the past, and I'll reiterate today, all of our General Insurance subsidiaries or Tier 1 subsidiaries on a global basis have capital at or above our target ranges. And within the United States pool, which is the largest pool of our General Insurance capital, our risk-based capital ratios at the end of last year were around 460%, which is well higher than many of our peers."
},
{
"speaker": "",
"content": "So what I would note is that within the General Insurance companies, we're strongly capitalized to be able to support growth, obviously, protected by the reinsurance programs that we have. But I would just, as a general note, comment that premiums to surplus leverage isn't the best way to look at capital within a General Insurance company, particularly given a company like AIG, which is a leading player in Casualty and Specialty lines across the globe."
},
{
"speaker": "Robert Cox",
"content": "That's really helpful color. Yes, just a follow-up on Excess Casualty. I appreciate the comments. The premiums were up 46% in the quarter, and it seems like pricing is up meaningfully. It seems like AIG is taking advantage of market conditions where perhaps some others are pulling back. So I was hoping you could provide a little bit more commentary on the opportunities you're seeing there. And what makes AIG comfortable with the current environment?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"content": "Thank you. We do see great opportunities in Casualty. We highlighted some of the performance in the quarter. We had to start, because of the portfolio that existed, reunderwriting the Casualty portfolio well before, I think, it was discussed really in the industry. And with that, became a new underwriting philosophy, new underwriting strategy, new terms and conditions, new attachment points, net limit, gross limits, pricing, margin. And so that's been a journey for us for years."
},
{
"speaker": "",
"content": "We mentioned the 16% in Excess Casualty in terms of rate is as strong as we've seen in the past several years. And so that we do think there's a lot of capacity pulling back. We have very comprehensive reinsurance to mitigate volatility and enable us to put out limits depending on our risk appetite. And obviously, we're cautious. We're watching the different lines of business within Casualty and their trends, but absolutely see opportunities to grow."
},
{
"speaker": "",
"content": "And when you look at our premium, don't think about it as we've grown policy count or limit, it's actually the opposite. I mean, like our client count, policy count and limits are all dramatically reduced when you compare them to 3 or 4 years ago. It's just been the effect of where we participated and how we price the business. And believe that, again, we're going to be cautious, but there are real opportunities for growth in the current market."
},
{
"speaker": "Operator",
"content": "Our next question comes from Michael Ward with Citigroup."
},
{
"speaker": "Michael Ward",
"content": "I'm a little bit curious just on the potential sell-down of Corebridge. How do you weigh the options between doing several smaller chunks of sell-down from here versus maybe the potential for doing a sell-down of the remaining stake? And then another thing on the other side, right, we sort of think about this $500 million a month buyback. Is there the option to potentially do an ASR post sell-down?"
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"content": "I wish I could provide a little bit more detail on the first part of the question. We're looking at all alternatives, all size. I mean, so much is market-dependent. You have certain windows. And we want to make sure -- we have multiple stakeholders, I mean, within Corebridge shareholders, AIG shareholders, so sort of balancing that is really important for us."
},
{
"speaker": "",
"content": "But as I said in my answer and prepared remarks, we're ready to go. Everybody is anxious to move forward, but we're going to make sure we do it in a very methodical way to where we don't do anything that's not in the best interest of all that we've done so far and our stakeholders. So we will consider multiple options and keep everybody updated."
},
{
"speaker": "",
"content": "On the ASR, I mean, I think we've largely thought about this, and Sabra, if you want to comment to close out. We've done share repurchase in a methodical way. We always consider different ways in which we can do it. But maybe you can just comment, and then I'll close it out."
},
{
"speaker": "Sabra Purtill",
"content": "Yes, thanks. The thing you should keep in mind is that with the amount of shares that we can repurchase or can be repurchased by a company in any given month, whether it's an ASR or it's a 10b5-1 plan or open market purchases, it's constrained by the same factor, which is the average daily trading volume."
},
{
"speaker": "",
"content": "We have looked at doing ASRs. And to date, what we've preferred to do is just be consistently in the market every day through a 10b5-1 plan. But it's certainly something if we were to do a larger sale of a Corebridge stake where we wanted to redeploy that quickly and get the benefit of that into our share count, then an ASR is a tool that we can use to do that. But in terms of the volume per month, it doesn't really vary that different, whether it's an ASR or a 10b5-1."
},
{
"speaker": "Peter Zaffino;Chairman and CEO",
"content": "Thanks, Sabra. And in closing, I just want to thank all of our colleagues around the world for their continued dedication, teamwork, execution on all the progress we've made. And I want to thank everybody for joining us today and your questions. Everybody, have a great day."
},
{
"speaker": "Operator",
"content": "Thank you for your participation. This does conclude the program. You may now disconnect. Everyone, have a great day."
}
] |
aiz | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Welcome to Assurant’s Fourth Quarter and Full Year 2024 Conference Call and Webcast. At this time all participants have been placed in a listen-only mode and the floor will be opened for your questions following management’s prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may now begin."
},
{
"speaker": "Sean Moshier",
"content": "Thank you, operator, and good morning, everyone. We look forward to discussing our fourth quarter and full year 2024 results with you today. Joining me for Assurant’s conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release announcing our results for the fourth quarter and full year 2024. The release and corresponding financial supplement are available on assurant.com. Also on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in the earnings release, presentation and financial supplement on our website as well as in our SEC reports. During today’s call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company’s performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We’ll start today’s call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings."
},
{
"speaker": "Keith Demmings",
"content": "Thanks, Sean, and good morning, everyone. 2024 represented another strong year for Assurant. I’m incredibly proud of the performance of our teams across the company, whose commitment to delivering for our clients and customers enabled us to achieve 15% adjusted EBITDA growth and 19% adjusted earnings per share growth, both excluding reportable cats. Strategic investments in our people, client partnerships, technology and capabilities and targeted actions to drive improved performance across key areas of the business, position us to continue to outperform and deliver exceptional value through our products and services. Our people are at the center of everything we do, and our performance is made possible by our world-class culture. Our culture is how we attract and retain incredible talent to deliver for our customers. We’re extremely proud of the recognitions we’ve received, highlighting our commitment to innovation and sustainability, while supporting and empowering our employees. Our competitive advantage comes from the ongoing dedication of our global workforce and leadership team to drive new business through innovative solutions while elevating the customer experience and deepening existing partnerships. In Global Lifestyle, we had an unprecedented year of client wins and renewals, particularly within Connected Living. We continue to invest in new innovative client programs and leading-edge technology including the incorporation of automation, robotics and AI at our device care center outside of Nashville. We recently partnered to launch T-Mobile’s Protection 360 HomeTech product. This new offering provides protection for an unlimited number of WiFi-enabled devices and electronics, while providing premium tech support to consumers. This critical new product represents another strategic growth vector and underscores the long-term opportunity presented by the convergence of broadband and mobile in the connected home. By prioritizing investments in programs and capabilities, we generated significant momentum and plan to execute on additional opportunities. In Global Automotive, we made progress in stabilizing earnings through targeted actions to address elevated claim costs in our vehicle service contract business and our guaranteed asset protection product. We continue to be optimistic about the long-term outlook for this business. Before discussing Global Housing, I want to first share that our thoughts are with everyone who is impacted by the events of the last few months, including the California wildfires. In these times, we have a critical role to play in our customers’ journey. In Southern California, we’re focused on making it quick and easy for policyholders to file claims online on the phone or in-person at mobile claims centers, accelerating customer payments. We remain proud of our role in removing the risk of uninsured loss for lenders, investors and homeowners through our housing offerings. As we look at housing’s results, we delivered sustained outperformance in 2024, benefiting from the strength of our homeowners and renters businesses, including the rollout of technology innovation to enhance our customer experience. Leveraging the segment’s differentiated advantages and efficiency initiatives, we have more than doubled our adjusted EBITDA in the past two years, growing the business from just over $400 million in 2022 and to over $900 million in 2024, excluding cats. Even including cats, housing has outperformed the P&C industry. Over the past five years, we’ve achieved an average return on equity of over 22% and our increased scale and efficiency has driven a 10-year average combined ratio of 89%, compared to the broader P&C market of 95%. With clear outperformance and expected growth ahead, the business has the opportunity to be better appreciated from a valuation perspective. 2024 was a remarkable year of commercial success across Assurant, marked by significant client momentum as we enter 2025. Strong execution enabled us to capture new opportunities while solidifying and extending key client relationships. Across our global footprint, we had several key wins, including Australia’s largest mobile carrier and two major financial institutions in the U.S. We renewed client relationships and reinforced our position as a leader and preferred partner throughout our businesses. In our mobile business within Connected Living, we completed major renewals in 2024 that represent three of the top five largest mobile carriers in the U.S. More recently, we also secured a multiyear renewal with a large mobile carrier in Japan. We’ve now renewed our four largest mobile clients in the last year, who represent over 40 million mobile devices protected, a testament to our ability to execute mobile protection programs across the globe. Within housing, we renewed 10 lender-placed clients, representing over 17 million loans tracked. And in renters, we completed renewals of 2 top 10 property management companies as we continue the rollout of key technology-enabled services like Cover360 and Assurant TechPro. These help increase policy attachment while enhancing the experience of our partners and renters. Ultimately, the continuing demand for our offerings and solutions, combined with our strong competitive edge, creates commercial momentum that will extend into 2025 and beyond. We believe in the power of our unique business-to-business to consumer or B2B2C business model. At our core, we’re a premier global protection company that partners with the world’s leading brands to safeguard and service connected devices, homes and automobiles, utilizing data-driven technology solutions to provide exceptional customer experiences. The common thread across our entire enterprise is our powerful B2B2C distribution strategy in both lifestyle and housing, where we have strong leadership positions in attractive markets. Through our differentiated distribution, strong public Fortune 500 company financials and unwavering emphasis on client transparency, we create deep partnerships with leading brands across the world. In addition, our commitment to continuously enhance customer experience through customized solutions that wrap around our protection products is built on decades of investment and ongoing innovation. This allows us to deeply integrate our technology and platforms with clients, supporting long-tenured partnerships and exceptional customer experiences. Since 2019, we’ve increased adjusted EBITDA by over $630 million or a 12% compounded annual growth rate while growing adjusted EPS by over $11 per share or an 18% compounded annual growth rate, both excluding catastrophes. As we look at our performance versus the broader P&C industry, we’ve continued to outperform the S&P 1500 P&C index median, both excluding and including cats, when comparing across adjusted earnings and EPS growth. Our compelling track record of outperformance includes eight consecutive years of profitable growth, demonstrating resiliency through various macroeconomic environments. In addition, our portfolio benefits from earnings and capital diversification across geographies and business lines, positioning us to continue to invest in and achieve future growth. We believe we’ll remain an attractive investment with a compelling path ahead, and we believe we should be valued at a premium to the S&P 1500 P&C index median. Before turning it over to Keith Meier to share additional insights on our results and review business trends, I want to highlight our strong momentum heading into 2025 and how we plan to deliver future growth. First, we’ll focus on executing, optimizing and scaling significant new partnerships and program launches throughout lifestyle and housing, where we invested last year. Overall, we believe our 2024 investments should be fully earned back through 2025 with an attractive one-year payback. Next, we’ll support incremental investments for new launches in our pipeline and accelerate emerging growth opportunities. In addition to our connected home product launch, we have new opportunities with several clients particularly in global lifestyle, and we look forward to sharing more details over the coming quarters. And finally, we’ll drive financial performance and operational excellence. We believe we’re well positioned to meet our 2025 objectives given the commercial momentum we have within Connected Living, long-term tailwinds in Global Auto and sustained outperformance in Global Housing. Overall, our ability to deliver for our clients, drive efficiencies across our operations and focus on data-driven technology solutions should enhance our position as a leader in the businesses that we operate and extend our compelling track record of financial performance. I will now turn it over to Keith."
},
{
"speaker": "Keith Meier",
"content": "Thanks Keith. And good morning everyone. I’m proud of what we achieved in 2024, including the financial results delivered by our incredibly strong team. For the year, we increased adjusted EBITDA by 15% to over $1.5 billion, while growing adjusted earnings per share to over $20, both excluding cats. We have continued our long-term track record of growing earnings consistently demonstrating the power of Assurant. Our performance was highlighted by another exceptional year in Global Housing, where we delivered double digit earnings growth overall for the second consecutive year. Within Global Lifestyle, Connected Living grew 9% excluding $25 million of investments and $12 million of unfavorable foreign exchange. More importantly, we set a solid foundation for growth as we enter 2025. In Global Auto, targeted actions in our vehicle service contract and GAP products stabilized earnings in the second half of 2024 and we are excited about the trajectory of the business as we move into 2025. I’ll begin by highlighting key trends we saw in the fourth quarter. From there, I will walk through our 2025 outlook as we look to deliver our ninth consecutive year of profitable growth. Beginning with our fourth quarter enterprise results, adjusted EBITDA and earnings per share both increased 13% excluding cats led by Global Housing. Looking at capital, Global Lifestyle and Global Housing continue to generate significant cash flow, as we up-streamed nearly $250 million from our segments in the fourth quarter and over $800 million for the full year. We returned $161 million of that cash to our shareholders in the fourth quarter, which puts our total capital returned to shareholders for the year in excess of $450 million, including $300 million of share repurchases. Our buyback level was at the top end of our expectations for the year. At the same time, we ended the year in a strong capital position with $673 million of liquidity at the holding company. This past November, we increased our common stock dividend by 11%. The increase represented the 20th consecutive year we have raised our dividend since our IPO. In addition, we were just added to the S&P High Yield Dividend Aristocrats Index earlier this month. We are incredibly proud of this achievement and expect our strong capital returns to continue as part of our balanced capital deployment framework. Turning to our segment results, beginning with Global Lifestyle, fourth quarter adjusted EBITDA was down 6% compared to last year or 5% on a constant currency basis. In Connected Living, earnings were roughly flat on a constant currency basis. Fourth quarter results included $4 million of incremental investments related to new capabilities and client partnerships that are expected to drive future growth. Investments in 2024 are already paying off as earnings from recently launched clients, including card benefits within our Financial Services business have begun to contribute to Connected Living’s fourth quarter performance. As Keith mentioned, we are now focused on scaling these partnerships for growth. These contributions were offset by lower U.S. trade-in programs. Year-over-year, trade-in results were impacted by business mix and lower volumes, however, we did see sequential trade-in growth as expected. Turning to Global Auto, in the quarter, results were down 11% compared to last year. The year-over-year decline was largely driven by lower real estate joint venture partnership income of $13.8 million. Fourth quarter 2023 included a more significant real estate joint venture gain compared to a smaller gain this year. Excluding this, results in Global Auto were largely flat as higher investment income was partially offset by elevated loss experience in both our GAP product and our vehicle service contract business compared to last year. Importantly, we continue to see claims experience remain stable from last quarter as previously implemented program changes and rate increases continue to earn through our book, leading to a sequential improvement in earnings. In terms of revenue, our net earned premiums, fees and other income for Global Lifestyle grew 2%, or approximately 6% on a constant currency basis. And excluding $85 million of favorable non-run rate premium adjustments in Global Automotive in fourth quarter 2023. Moving to Global Housing, fourth quarter results were strong building on an exceptional performance for the year. Adjusted EBITDA was $225 million which included $50 million of cat losses largely from Hurricane Milton. Excluding cats, adjusted EBITDA increased 32%. In the quarter, we saw a continuation of robust policy growth in homeowners from higher placement rates given voluntary insurance market pressure. As these additional policies are placed, we benefit from the significant expense leverage we have driven in this business from our technology investments. Earnings growth in the quarter also included impacts from favorable non-catastrophe losses due to lower frequency as well as lower catastrophe reinsurance costs. While we had favorable prior period reserve development of $38 million in the quarter, it was relatively consistent with fourth quarter 2023 and did not impact year-over-year growth trends. Within our Renters business we continued to benefit from strong results in our PMC channel which achieved its tenth consecutive quarter of double digit gross written premium growth. Now let’s discuss our outlook for 2025. We expect full year adjusted EBITDA and earnings per share to increase modestly, both excluding cats. Overcoming $107 million of favorable prior year reserve development in Housing’s 2024 results. Excluding the significant favorable PYD in 2024, strong underlying growth trends are expected to deliver high single-digit earnings and EPS growth, both excluding cats. Our outlook includes our forward view of foreign exchange rates and interest rates, but does not factor in potential impacts from tariffs including those related to claims costs or consumer demand. While tariffs could potentially affect claims costs, we believe we are well positioned to react quickly to address potential impacts. Over time, our business model has had a proven ability to deliver in the face of various economic environments and cycles. Looking at our segments for 2025, we expect Global Lifestyle growth driven by higher contributions from Connected Living and Global Automotive. Growth is expected to be partially offset by an unfavorable impact from foreign exchange rates, as well as investments in new partnerships and programs in 2025. Combined, we expect foreign exchange and incremental investments to mute growth by a few percentage points. Turning to Global Housing, we expect EBITDA excluding cats to decline modestly, given the $107 million of favorable prior year reserve development seen in 2024. Excluding the impact of prior year development in 2024, on an underlying basis, we expect strong Global Housing EBITDA growth in 2025. As a reminder, our 2025 outlook does not contemplate additional year development. Underlying growth is expected to be driven by our Homeowners business which will continue to benefit from lender placed policy growth and expense leverage. For the recent wildfires in California, we remain focused on settling claims and helping our policyholders navigate through the event. Reportable catastrophes from the California wildfires are expected to approach or slightly exceed our per event catastrophe reinsurance program retention of $150 million. We’ll provide a further update in May as we learn more and continue to settle claims. In terms of other impacts to 2025, we are working through the placement of our catastrophe reinsurance program which will be effective on April 1. We expect a similar structure to our 2024 program, maintaining robust coverage at both the top and bottom end of our program. As the program terms are finalized, we will also get greater insights into our expected cat load for the year. We will provide an update in May on expectations which will be inclusive of our California Wildfire estimates. Our capital objectives for 2025 are consistent with prior years’ as we focus on maintaining balance and flexibility to support new business growth, while returning excess capital to shareholders. From a share repurchase perspective, our expected range for 2025 is between $200 million to $300 million subject to M&A, as well as market and other conditions. This range accounts for our estimated impact from the California Wildfires. Of course, we will continue to make sound capital allocation decisions over the course of the year as our track record has shown. Through February 7 we we’ve repurchased $24 million of shares. We expect buybacks to be more consistent throughout the year compared to back-end weighted in prior years driven by our confidence in our strong capital position and cash flow generation. And finally, speaking of cash flow generation, we believe Assurant is differentiated compared to the broader P&C industry given our unique lifestyle and housing portfolio, which creates strong capital efficiencies and the ability to reinvest for growth. In 2025, we expect to continue to generate meaningful cash flows aligned with our recent performance. Overall, we are proud of our consistent outperformance and feel well positioned to continue our growth trajectory in 2025. With that operator, please open the call for questions."
},
{
"speaker": "Operator",
"content": "The floor is now open for questions. [Operator Instructions] Our first question comes from Mark Hughes with Truist. Please unmute your line and ask your question."
},
{
"speaker": "Keith Demmings",
"content": "Good morning, Mark."
},
{
"speaker": "Mark Hughes",
"content": "Good morning, Keith. I muted myself and then unmuted myself. Morning. On the Homeowners business, the placement rate has been looking quite good. Can you talk about the – what is a voluntary versus the lender placed? And do you still see the same dislocation in those markets that’s been pushing the voluntary, presumably, how much momentum does that give you for 2025?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. Great question, and thanks for that. So I would say a couple of things. We’ve definitely seen really strong PIF growth on lender place throughout the year. That trend continues certainly in the fourth quarter. Year-over-year, we’re up 16% in terms of policies in force. And if I simplified that, I’d probably say a third of that is client growth and loan movement within clients. A third of that is California due to the hardening market and then the other third is the rest of the country growth from a similar dynamic. So we’ve definitely still seen hard insurance markets, creating opportunity for policy growth on our book of business. And we’ve seen a lot of diversification as well across geographies. So I think that likely continues. Certainly, the trend was pretty consistent in fourth quarter as we saw for the first three quarters. So expect some continued growth there, probably not at the same level that we’ve seen, but certainly feel good about the momentum overall in housing."
},
{
"speaker": "Mark Hughes",
"content": "Then in Global Lifestyle, how do we think about the top line growth? Just kind of broadly, you’ve given good guidance on EBITDA. You’ve given some thoughts about customer growth, that sort of thing, but how do we think about top-line growth maybe in 2025 or just more broadly in lifestyle?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. I mean if I think about lifestyle, the first thing I would highlight, and we covered it in the prepared remarks, but we are particularly excited on the Connected Living side, securing our mobile clients is really, really important and so fundamental to the business long-term. It then allows us to focus more energy with our partners to drive growth, to launch new products, to optimize customer experience. There’s a lot of energy around making sure we’re optimizing all the buy flows and touch points to serve consumers. So, I think that will be a catalyst for continued momentum certainly, on the Connected Living business, we saw Chase come on in the fourth quarter. That’s going to obviously drive financial services growth throughout the year. So I do think we’re well positioned. We’ve had pretty consistent lifestyle growth in terms of the top-line for the last few years. I think that growth continues as we move forward. And then in auto, it’s about the loss recovery and our ability to continue to see that mature and feel really good about how the second half of the year stabilized, obviously, more road to go, but feel like we’re well positioned. But Keith, anything else?"
},
{
"speaker": "Keith Meier",
"content": "No, I think it really speaks to the momentum that we have and the opportunities that we have as we look forward to 2025. We’ve talked about making some investments in 2024, and we certainly expect to do that again in 2025. It’s because of the momentum we’ve got in our markets, especially in Connected Living. So we certainly look forward to sharing more of those updates as we go through the year."
},
{
"speaker": "Mark Hughes",
"content": "And one final quick one. The ForEx headwind for 2025, I think you said, with ForEx and investments a few percentage points. How about ForEx specifically?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. I think we’d probably say, foreign exchange, a couple of points of headwind. In terms of the investments, probably one to two points. If you think about 2024, just to kind of create context, we had $25 million of incremental investments. Roughly $10 million of that was Depot automation that we’ve talked about and the other $15 million or so, roughly two-thirds was client-related launches. So as we look at 2025, probably somewhere maybe approaching a similar level of investment in clients maybe slightly below. So we’ve got given the 1% to 2% headwind relative to lifestyle overall. But we do have some good things in the hopper with clients, new clients, existing clients, new product launches. And we’re certainly excited to update as we go through the year."
},
{
"speaker": "Mark Hughes",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from Jeff Schmitt [William Blair & Company]. Please unmute your line and ask your question."
},
{
"speaker": "Keith Demmings",
"content": "Good morning, Jeff."
},
{
"speaker": "Jeff Schmitt",
"content": "Can you hear me?"
},
{
"speaker": "Keith Demmings",
"content": "Perfectly."
},
{
"speaker": "Jeff Schmitt",
"content": "Hi good morning. So the placement rate in housing, just one more question on that. Are you seeing a lot of insurers fleet, California after the fires. So could we maybe see that kind of jump in Q1?"
},
{
"speaker": "Keith Meier",
"content": "Yes. And I think overall for California, Jeff, there was a moratorium put on in California so that the insurers would not be leaving, the wildfires just taking place. So we think that will temper some of that for a while. And then I’m sure that will open back up later. But for right now, in the short term, I would say, we don’t expect a lot of exits from the state."
},
{
"speaker": "Jeff Schmitt",
"content": "Okay. And then in Global Auto, are you still seeing elevated losses in that GAAP book? And how much did that contribute to the loss ratio in the quarter?"
},
{
"speaker": "Keith Meier",
"content": "Yes. So from a GAAP perspective, Jeff, we’ve seen it stabilize. From the third quarter to the fourth quarter, it was flat to maybe slightly better. So I think from that perspective, I think that also points to why we feel good about where we’re going for 2025, and that we’ve signaled that we see growth in auto as we go through this year."
},
{
"speaker": "Keith Demmings",
"content": "Yes. And maybe just 1 add-on comment as we think about GAAP and we’ve talked about this, when we look at the written business we expect to put on in 2025 will largely be off of most – not quite all, but close to all of the risks that we write. So that will definitely change that dynamic longer term and create more stability in our approach."
},
{
"speaker": "Jeff Schmitt",
"content": "Okay. Any sense on the size of that impact that we could have just in the quarter or the last two quarters really?"
},
{
"speaker": "Keith Meier",
"content": "I would say just maybe $1 million or $2 million better for this quarter, Jeff, but pretty stable."
},
{
"speaker": "Jeff Schmitt",
"content": "Okay. All right. Thanks."
},
{
"speaker": "Operator",
"content": "Our next question comes from Tommy McJoynt with KBW. Please ask your question."
},
{
"speaker": "Keith Demmings",
"content": "Good morning. Tommy."
},
{
"speaker": "Keith Meier",
"content": "Hi, Tommy."
},
{
"speaker": "Tommy McJoynt",
"content": "Hey good morning. Yes, another question on the investment spend. You called out the $25 million last year. And I just want to understand your comments about the payback period is effectively being one year. So are you saying that those new programs are generating $25 million of positive EBITDA in 2025 to fully out that really $25 million drag in 2024. Is that – am I understanding that right?"
},
{
"speaker": "Keith Demmings",
"content": "Perfectly. That’s exactly what we’re saying."
},
{
"speaker": "Tommy McJoynt",
"content": "Okay. And the new investment spend for 2025, what types of programs are those? And are those related to the one last year, I think, related to Chase and travel benefits? Or what can you say about the new plans?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. I would say entirely separate from the clients that we signaled last year. And obviously, we had T-Mobile also roll [indiscernible] in the fourth quarter that we would have been investing in last year as well. So we’re typically telling you about the things sort of after they become public in the market. But if we look at the potential for kind of one point to two points of headwind relative to those investments in 2025, it will be net new things that we haven’t discussed yet. With marquee brands and clients that I think you would very much recognize. So we’re super excited. We don’t want to get in front of ourselves. There’s a lot of ongoing contracting with clients, launch plans, technology investment. So there’s always a lot in the works, but we have a really, really strong pipeline in 2025. And I’d say it’s similar types of things with different clients, obviously in 2025."
},
{
"speaker": "Keith Meier",
"content": "Yes. And I think, Tom, one thing you can expect is, just like we did last year, as we make those investments through 2025 we’ll be very transparent about what they were and the benefits in the clients that came as a result. So we’ll be sharing that with you and connecting that to the investments as we go through the year."
},
{
"speaker": "Tommy McJoynt",
"content": "Okay. Got it. And then switching over to the Housing side. With the higher placement rates and seemingly ever rising average matured value, that segment continues to generate a lot of scale. Does that increase scale? And I guess, just combined with really strong underlying performance on the underwriting side, does that change your outlook for the combined ratio in that segment?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. I think what I would say, if we look at 2025, even with the California fires, and we size that at slightly less than or slightly more than $150 million of overall losses. We think we’re still going to be in that mid-80s combined for the full year of 2025 and we think that’s a really, really strong result. Obviously, the dynamics changed. So we’ll see longer term what we think the right long-term target is for that. But feel really good. And again, we’ll deliver north of 20% ROEs in that business as well. And to your point, not only have we seen a lot of growth, but we’ve created a lot of expense leverage, invested a lot in technology and that’s helped us deliver pretty strong outperformance. So we’ll kind of reassess as we go forward. But if we look at 2025, we think rates will be relatively neutral to us this year. We’re not seeing big increases certainly in rate, but that will ebb and flow, and we’ll monitor that as we go."
},
{
"speaker": "Tommy McJoynt",
"content": "Great. Thanks, Keith."
},
{
"speaker": "Keith Demmings",
"content": "You bet, Tommy."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our next question comes from James Chmiel with Piper Sandler. Please ask your question."
},
{
"speaker": "Keith Demmings",
"content": "Morning."
},
{
"speaker": "James Chmiel",
"content": "Good morning."
},
{
"speaker": "Operator",
"content": "James, please unmute your line and ask your question."
},
{
"speaker": "James Chmiel",
"content": "Hello. Good morning. Thank you for the opportunity."
},
{
"speaker": "Keith Demmings",
"content": "Good morning."
},
{
"speaker": "James Chmiel",
"content": "How should we be thinking of reinsurance renewal cost and the ability to get additional rate through regulators in impacted geography?"
},
{
"speaker": "Keith Demmings",
"content": "So maybe, Keith will start on reinsurance, I’ll hit on rate."
},
{
"speaker": "Keith Meier",
"content": "Yes. So from a reinsurance perspective, we were at about $186 million for 2024 that included in the first quarter a benefit when we went to the single placement of about $15 million. So that would move you to around $200 million for the reinsurance. And then we’re going through the process right now, and we’re currently evaluating our program structure. And we expect to maintain a relatively consistent program retention, historically, a one in five probable maximum loss. So with the volumes being up a little bit, we think the pricing should be pretty favorable as well. So it will probably be up a little bit for the volumes from there, maybe slightly better on the, on level pricing. But what we’ll definitely do for you is give more details on the final program as we get into our next earnings call."
},
{
"speaker": "Keith Demmings",
"content": "Yes. And I think we’ve got a really, really strong track record. Our program has certainly outperformed the market generally for our reinsurance partners. We’ve got a really diverse panel of reinsurers, and I think our relationships are incredibly strong. So expect that to continue as we go forward. And then as we think about rate and the ability to get rate on the housing side, I’d say we obviously file our rates at a state level. Those rates are reviewed and approved, and we’ve had a really good track record of getting appropriate rates relative to the risk that we write no reason to believe that won’t continue to be true as we go forward. And I think we’ve had a long history of doing that. So not a point of concern and certainly a normal part of our process."
},
{
"speaker": "James Chmiel",
"content": "Perfect. Thank you for the color. My follow-up question is regarding tariffs. How does this impact your view on input costs for the businesses of lifestyle? And how should we be thinking of the FX impact in 2025? Thank you."
},
{
"speaker": "Keith Demmings",
"content": "You bet. Thank you. So we haven’t baked anything into our guide for the year relative to tariffs just because of the uncertainty that surrounds it and it’s ever evolving. So, but we did certainly think about foreign exchange. We thought about interest rates. We try to include assumptions around those elements, which obviously tariffs have an impact on. So that’s certainly baked into our 2025 view. And then what I would say on tariffs is certainly the bigger effects for us would be longer term, is there a drop in consumer demand with elevated pricing, that’s something we’ll monitor. It will have a longer-term effect certainly in terms of financial impact. The bigger short-term impact would be rising input costs around claims, parts and materials what I would highlight is we saw a significant amount of inflation in 2022 in housing and because our product is built with an automatic inflation guard feature, we’ve always got the ability to get rate. We took a lot of action around product and efficiency. The recovery from that has been quite strong in the last two years. So I feel really good about our long-term ability to get to a good place. And then the other side would be the auto business. We’ve seen elevated CPI on auto repairs in the last couple of years. We’ve built a really strong muscle with our clients in terms of regular reviews, monthly reviews around loss ratios, claims costs, by location, by geography, that will continue to be true. And if there’s elevated input costs around tariffs, we’ll continue to run the playbook that we’ve been running. It doesn’t change our long-term view around the strength of this business fundamentally. But what would you add?"
},
{
"speaker": "Keith Meier",
"content": "Yes. And I think going through the inflation environments for auto and for housing has really helped us develop a tremendous amount of rigor around navigating any changes in inflation. A good example is in our housing business, we used to have an inflation guard adjustment that would be – that would take place once a year. And now – and across all the 50 states now, we actually can do it quarterly, and we do it by state. So, I think those are the types of things that as you go through those times, you actually can come out of it stronger and better. And I think that’s a good example of what we’ve been able to do after the last couple of years."
},
{
"speaker": "Operator",
"content": "Our last question will come from Mark Hughes with Truist. Please ask your question."
},
{
"speaker": "Keith Demmings",
"content": "Hey Mark, you got back in."
},
{
"speaker": "Mark Hughes",
"content": "Yes, thank you. Yes, I love it. The prior year development in the fourth quarter was the driver of that similar to what you saw earlier in the year?"
},
{
"speaker": "Keith Meier",
"content": "Yes. So I think the short answer is probably yes. The key thing Mark, is it really relates to a couple of things. One, certainly, coming out of the inflationary environment for the last couple of years, that’s really what’s contributed to our prior our prior year development in 2024. And then I think there is also an element of – we also saw moments of frequencies being lower than expected. A good example is there was a quarter in the last couple of years, that was one of the lowest frequency quarters from a historical perspective for us. So there’s a couple of those dynamics that I would say we’re playing into the reserves for the last year or so. But overall, I think we’re appropriately reserved and in a good position for the future."
},
{
"speaker": "Keith Demmings",
"content": "Yes. And I think if you look at the housing business and you sort of walked out the $107 million of PYD this year and then you walked out the $54 million of PYD last year, you’re still at a 28% growth rate for the full year. So at every level, the housing business has outperformed, no matter how you look at it."
},
{
"speaker": "Mark Hughes",
"content": "Am I right in thinking the fourth quarter ex-cat prior year development, loss ratio was very good. Do you assume that will continue into the in 2025? I know you said the mid-80s combined. I assume that has – does that have cats in it or not? And should we think that 4Q? Is it something that you can run rate? Or is that an anomaly?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. I think our best view as we think about 2025 would be non-cat loss ratio in the high 30s an expense ratio in the high 30s and probably 10-ish points of cat given the California wildfires in the first quarter. So probably a little bit better non-cat loss ratio trend that we’ve seen a little bit higher cat load, probably gets you right back to a similar spot in mid-80s."
},
{
"speaker": "Keith Meier",
"content": "Yes. And maybe just to add – I’m just going to say, maybe just to add the 10 points, just the way to think about it is, give or take, $150 million on the wildfires. Last year, we did $155 million cat load in. So, we expect that to be a little higher this year with the growth. But if you add those together, we expect it to be somewhere in the low 300s, and we’ll finalize that more specifically on the next earnings call."
},
{
"speaker": "Mark Hughes",
"content": "And then you talked about the opportunity to be better appreciated, Keith, in your opening comments, and I know you gave a lot of good statistics about your performance relative to industry metrics. Anything more specific you had in mind when you think about the opportunity to be better appreciated some action on your part or positioning of the company? Just that phrase my attention."
},
{
"speaker": "Keith Demmings",
"content": "Yes. Yes, we probably used similar phrases in different ways at different times. I think certainly, the market appreciates the lifestyle business, it’s more capital-light, fee income, et cetera. And I think what sometimes gets missed is the strength – the fundamental strength of the housing business and the housing franchise over the long term. It’s been a really, really strong performer. It’s well risk managed. We’ve demonstrated considerable resiliency. It’s much less volatile. And we’re delivering – we talked about it on the prepared remarks, a 10-year combined ratio of 89% against any measure that is outperforming the market, the industry. If you look at pure homeowner’s companies, it’d even be a more dramatic differential versus just looking at a wider cross-section across P&C. So I think the business is incredibly powerful. I think it scales well. It’s deeply integrated and it’s not a traditional product. It’s the services that we deliver that complement the core insurance products that differentiate us. And I think it’s on Assurant to help tell that story and just further educate the secret sauce of what we do and how we create value because our story is consistent, whether it’s mobile, whether it’s auto or housing, how we add value for partners is really unique, super differentiated and hard to replicate. And it scales incredibly well because we’re partnered with the who’s who, the leaders in the market and the market consolidator. So, we’ve got to continue to tell that story and that’s what we’ll do as we go forward."
},
{
"speaker": "Mark Hughes",
"content": "Appreciate it. Thank you."
},
{
"speaker": "Keith Demmings",
"content": "Thank you. And I think that was the last question. So we’ll go ahead and say thank you, everybody, for joining, and we’ll look forward to providing more updates on our next earnings call in May. Thanks very much. Have a great day."
},
{
"speaker": "Keith Meier",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. This does conclude today’s teleconference. Please disconnect your lines at this time, and have a wonderful day."
}
] |
aiz | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Welcome to Assurant's Third Quarter 2024 Conference Call and Webcast. [Operator Instructions] It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may begin."
},
{
"speaker": "Sean Moshier",
"content": "Thank you, operator, and good morning, everyone. We look-forward to discussing our third quarter 2024 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday, after the market closed, we issued a news release, announcing our results for the third quarter 2024. The release and corresponding financial supplement are available on assurant.com. Also, on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties, and other factors that may cause actual results to differ materially from those contemplated by those statements. Additional information regarding these factors can be found in the earnings release, presentation, and financial supplement on our website, as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We'll start today's call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings."
},
{
"speaker": "Keith Demmings",
"content": "Thanks, Sean, and good morning, everyone. Our third quarter results further supported our strong year-to-date performance. Through the first nine months of the year, adjusted EBITDA increased by 15% and adjusted EPS grew by 21%, both excluding catastrophes. Results were led by sustained outperformance within Global Housing, as well as underlying growth within our Connected Living business, which was muted by incremental investments in new partnerships and programs and unfavorable foreign-exchange. Our year-to-date momentum has positioned us to exceed our previous expectations. Excluding catastrophes, we now expect adjusted EBITDA to increase low-double-digits for the second consecutive year and adjusted earnings per share to increase mid to high teens, led by business growth and strong share repurchases. Once again, we've outperformed the broader P&C industry, both short and long-term, reflecting the unique and differentiated nature of our combined housing and lifestyle business model. Let's begin with our year-to-date business highlights. In Global Lifestyle, year-to-date performance was relatively flat versus the prior-period, reflecting elevated claims experience in global automotive as well as impacts from unfavorable foreign exchange of 2% or $10 million, above our expectations from earlier in the year. Within Connected Living, year-to-date adjusted EBITDA increased 3% or 5% on a constant-currency basis as we continue to invest in new partnerships and programs to support future growth. Excluding investments of approximately $21 million for the first-nine months of the year, Connected Living adjusted EBITDA growth was strong at 11% on a constant-currency basis. One prime example of those investments includes our new innovation and device care center located just outside of Nashville, supporting our mobile business. In addition to repurposing millions of devices per year, the new state of the art facility employs innovative ways to leverage automation, robotics and AI. This will create greater value within our global supply-chain while driving growth in the secondary device market. The Nashville facility demonstrates our investments in innovation, allowing us to continuously improve our customer experience as we operate through end-to-end partnerships with our mobile clients, a critical competitive advantage for Assurant. Within financial services, on October 1, we launched a new program with Chase Card Services in our growing card benefits business. Beginning at program launch, we're providing end-to-end delivery for approximately 15 travel and purchase protection benefits, including underwriting, claims processing and benefit servicing to millions of Chase Card holders. We're excited about several new clients and programs targeted for 2025, adding to our growing portfolio. Similar to '24, these new opportunities may require incremental investments. Moving to Global Automotive. Our Auto business has experienced elevated claims costs in both our vehicle service contract business and our GAAP product throughout 2024. Over the past two quarters, we've started to see some positive early signs with the stabilization of underlying claims severity trends in our vehicle service contract business. Claims inflation impacts have begun to moderate and our loss ratio is beginning to benefit from rate increases we've taken over the past two years. Within our GAAP product, elevated losses have continued as anticipated, but we continue to expect higher claims to be short-term in nature in comparison to the vehicle service contract business. In addition, our proactive partnership with several clients to enable us to transition most of the risk and reduce a large portion of our claims exposure over-time. We remain focused on driving actions to improve Auto results while benefiting from moderating inflation impacts in 2025 and beyond. We're excited about the long-term trajectory of this business. Now let's turn to Global Housing. I want to begin by thanking all of our employees who supported policyholders impacted by recent weather events over the last several months, including multiple major hurricanes. We play an important role in safeguarding our policyholders as we processed approximately 35,000 claims to date associated with these events. It's an important reminder of the critical role our lender-placed product plays in the U.S. mortgage industry, removing the risk of uninsured loss for lenders, investors and homeowners. It's crucial to provide all homeowners with access to insurance. For that reason, we continue to work closely with each state to offer coverage and protection to homeowners at appropriate rates. Looking at Global Housing's year-to-date results, we've demonstrated continued strong performance, particularly within our homeowners' business. Over the first-nine months of the year, earnings increased 34% excluding reportable catastrophes. In our lender-placed business, we continue to benefit from key competitive advantages, utilizing various growth levers over the past two years to sustain results, including meaningful expense leverage, scale from new partners and product safeguards to address macroeconomic factors like inflation. Results were driven primarily by continued policy growth as the placement rate increased to 1.92%, a 12 basis-point improvement since year end and a 6 basis-point improvement sequentially. Policy growth has been led by several new partnerships and portfolios as well as from states where it's become more difficult to secure voluntary homeowners coverage. Within renters, adjusted EBITDA has also shown year-to-date growth, supported by continued expansion in our Property Management Company or PMC channel. Growth in our PMC channel has been supported by technology innovation aimed at enhancing our digital customer experience. This has included the rollouts of Assurant TechPro and our Cover360 platform, leading to higher penetration with a simplified resident enrollment process. Overall, the housing business has benefited from our unique competitive advantages throughout lender-placed and renters, showcasing its resiliency and outperformance over various macroeconomic environments. Turning to our enterprise outlook. As I mentioned earlier, given the strength of our year-to-date results, we now expect full-year adjusted EBITDA to grow low-double-digits and adjusted earnings per share to increase mid to high teens, both excluding catastrophes. This represents an increase to both metrics above our expectations, demonstrating the continued strength of our financial performance. For the year, we continue to anticipate strong growth within Global Housing with modest growth expected in Global Lifestyle as we fund incremental investments in Connected Living. Our ability to sustain profitable growth year-after-year is a true reflection of our unique and advantaged business model. Assurant's performance is the result of a multi-year transformation, which has significantly enhanced our business mix, risk profile and market positioning. We've simplified and optimized Assurant to focus on specialized attractive markets with long-term secular tailwinds within lifestyle and housing, while selling pre-need and employee benefits and exiting health and other non-core businesses. In the markets we operate in, we have leadership positions and competitive advantages through our protection solutions across devices, automobiles and homes. We are well-positioned to win due to our highly scaled and deeply integrated B2B2C partnerships where we work with our clients to innovate and create flexible solutions for their end consumers. At the same time, we've enhanced Assurant's risk profile by focusing on capital-efficient businesses within lifestyle and housing. Through purposeful transformation, we've enhanced our ability to drive long-term performance and cash generation, attracting growth partnerships with large sophisticated clients and become increasingly more capital-efficient. I'm proud of the long-term outperformance we've achieved against the broader P&C market. Slide 10 demonstrates our historical outperformance, including a five-year history of double-digit growth. Based on our current outlook for 2024, annual growth rates since 2019 are expected to average 11% for adjusted EBITDA and 17% for adjusted EPS, both excluding catastrophes. Given our historical performance and our unique and differentiated business model, we believe we have meaningful valuation upside, in particular, as compared to the S&P 1500 P&C Index, a broad index of 32 members now including Assurant. Overall, we see a compelling path for growth ahead and believe Assurant represents an attractive investment. I'll now turn it over to Keith Meier to review our third quarter results and business trends impacting our 2024 outlook."
},
{
"speaker": "Keith Meier",
"content": "Thanks, Keith, and good morning, everyone. This November marks the conclusion of my first year as CFO of Assurant. When I began this role, I outlined my key priorities, including driving growth and strong financial performance with a focus on innovation and product differentiation. These priorities have been supported by our continuous efforts to drive expense efficiencies through automation, digital and AI technologies, while improving overall customer experience as well as ensuring our capital position remains strong, providing us with the flexibility to create value and support long-term growth. Over the past year, we have made significant progress. First, looking at growth and financial performance, our B2B2C partnerships are the lifeblood of our business model and the primary driver behind our growth story. Over the past 12 months, we've spotlighted several notable client announcements, such as renewing all major U.S. mobile clients, including three of the top-five largest mobile carriers in the U.S., launching new programs and capabilities with existing clients like Spectrum Mobile and winning new partnerships with Chase, Telstra in Australia and another leading U.S. bank within our lender-placed business. Second, we have focused on expense discipline as we've continued to drive efficiencies across the organization by utilizing automation, digital and AI technologies. This has enabled us to deliver a better customer experience and invest in new capabilities while driving profitable growth. As an example, we believe our new device care center in Nashville, combined with the numerous investments we've made across the end-to-end mobile device lifecycle, will continue to support new growth opportunities in Global Lifestyle. In Global Housing, the scale we've achieved through growth and ongoing investing in our technology and compliance solutions have resulted in meaningful operational efficiencies and expense leverage as seen in the compelling expense ratios we've achieved. Global Housing's expense ratio is at a sustainable level in the high 30s, improving by approximately 3 percentage points year-to-date compared to full-year 2023 and nearly 9 percentage points since 2022, all while we improved the customer experience. And lastly, amidst a fast-changing macroeconomic environment as well as a year with multiple catastrophes, our capital position has remained very strong. Despite higher-than-average cat losses, we expect to return $300 million to shareholders through share repurchases in 2024. This is the top end of our anticipated range from the beginning of the year. The combination of our strong capital position, investments to support growth and robust shareholder returns is a testament to our balanced capital management focus and the strong cash flows of our advantaged businesses. As we look ahead, my focus will be to continue to execute against these priorities to drive growth. Turning to our third quarter results. Adjusted EBITDA grew 8% to $385 million and adjusted earnings per share increased by 9% to $5.08, both excluding reportable catastrophes. From a capital perspective, we generated over $160 million of segment dividends in the third quarter, ending the quarter with $636 million of holding company liquidity. Our strong capital position allowed us to return $138 million to shareholders in the quarter, including $100 million of share repurchases. In addition, we repurchased $20 million of shares during the month of October. This amounts to $200 million of share repurchases year-to-date. Looking at Global Lifestyle, adjusted EBITDA decreased 4%. In Connected Living, we saw another quarter of growth in global mobile protection programs, increasing devices protected by over 2 million subscribers from growth in U.S. cable operators and new Asia-Pacific clients. This was offset by investments in the quarter of approximately $8 million in new capabilities and client partnerships that are expected to drive future growth. International results were impacted by unfavorable foreign-exchange, but remained stable on a constant-currency basis as we focus on driving results across all regions. Trading results were largely flat as declines in carrier volumes and lower promotional activity were offset by volumes from newer programs. Turning to Global Auto. Earnings were down modestly year-over-year, mainly from elevated losses within our ancillary GAAP products, which was partially offset by higher investment income. Claims experienced from inflation in our vehicle service contract business was stable as previously implemented rate increases across our client base have begun to moderate the impacts of higher auto repair costs. Moving to net earned premiums, fees and other income. Global Lifestyle grew by $144 million or 7%. Growth was primarily driven by Connected Living, which was up 13%, benefiting from new trading programs and additional mobile subscribers, including the rollout of new clients. We continue to expect Global Lifestyles adjusted EBITDA to grow modestly for the year, driven by Connected Living. Growth will be offset by lower results within Global Auto and unfavorable foreign-exchange rates. For the fourth quarter, we expect a sequential increase in Connected Living from favorable seasonal trends, including higher mobile trade-in volumes from new device introductions and carrier promotions. In addition, we anticipate higher contributions from new Connected Living partners and programs as they begin to earn. Global Auto earnings are expected to remain stable sequentially. Now let's move to Global Housing's third quarter performance. Third quarter adjusted EBITDA, including $137 million of reportable catastrophes, was $92 million. Excluding reportable cats, adjusted EBITDA increased 20% to $229 million, growing $38 million. Global Housing performance was mainly driven by policy growth due to higher placement rates from the net impacts of ongoing client and portfolio transitions and increased voluntary insurance market pressure. In addition, average premiums increased from higher insured values year-over-year and filed rates. Lastly, results benefited from $30 million of favorable year-over-year prior-period reserve development. This was comprised of a $45 million reserve reduction in the current quarter compared to a $15 million reserve reduction in the third quarter of 2023. The increase in Global Housing was partially offset by a $28 million unfavorable non-run rate adjustment related to a change in earnings pattern assumptions. Within our renters business, we benefited from continued strong results in our PMC channel, where we drove double-digit gross written premium growth. We continue to expect strong adjusted EBITDA growth in Global Housing for full-year 2024, excluding catastrophes. We anticipate growth will be driven by continued top-line momentum in homeowners, expense leverage, favorable non-cat loss experience and lower catastrophe reinsurance costs. Lastly, as we look-ahead to our fourth quarter results, we continue to settle claims and serve policyholders associated with Hurricane Milton. Early estimates indicate that impacts will range between $75 million to $110 million. For Corporate, the adjusted EBITDA loss in the third quarter was $30 million, an increase of $4 million year-over-year, driven by higher third-party and employee-related expenses. For the full-year 2024, we now expect the corporate adjusted EBITDA loss to be approximately $115 million. We generated significant deployable capital year-to-date, upstreaming $556 million in segment dividends. Looking forward to the remainder of the year, we remain focused on maintaining balance and flexibility as we support new business growth and return excess capital to shareholders. Overall, we're very pleased with our strong year-to-date performance in 2024 and feel well-positioned as we exit the year and move into 2025. With that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Thank you. Our first question will come from Brian Meredith with UBS."
},
{
"speaker": "Brian Meredith",
"content": "Yes, thank you."
},
{
"speaker": "Keith Demmings",
"content": "Good morning. Brian."
},
{
"speaker": "Keith Meier",
"content": "Good morning."
},
{
"speaker": "Brian Meredith",
"content": "A couple -- good morning. A couple of questions here for you. First one, perhaps on Global Housing, all the catastrophe losses that we've been seeing, how are you thinking about pricing for that business when you head into 2025. And I'm assuming your cat reinsurance program since it doesn't appear you're going to have any kind of retention get into the program should be beneficial, should be good in 2025? So maybe you can give us a little color on that?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. Maybe I'll start and then Keith Meier can chip in. But obviously, we feel really good about the reinsurance program that we have in place. And you're right, as we look at the effect of Milton and the other storms we've had through the year, it's been an active season, but we've not touched the reinsurance tower to this point. So I think that sets us up well in terms of favorability with our reinsurance partners. We've talked about having a panel of 40 reinsurers that have been very stable over-time. So I think we feel good heading into next year as we think about reinsurance costs. And then as we think about the rate process, obviously, we'll look at all of our losses over the course of the year, cat and non-cat, expense levels, reinsurance costs. So we look at the pricing heading into next year being relatively stable to what we've seen this year. So don't think that there'll be a big shift in premium as we head into '25."
},
{
"speaker": "Keith Meier",
"content": "Yes. And I think we're certainly continuing to evaluate our program structure for our reinsurance cat tower. We'll share more of the details of that in February with our 2025 outlook. But in general, we expect to continue to approach our one in five probable maximum loss point for retention, which is $150 million this year. And we -- the good news is we haven't touched that tower this year. So, we certainly think with it not hitting the tower that that should be a positive as we look-forward to rates in 2025. And just as a reminder, we've moved to an effective date of April 1 for our one-time placement for our reinsurance programs as well."
},
{
"speaker": "Brian Meredith",
"content": "Got you. That makes sense. And then, Keith and Keith, I was wondering if you could give me -- give us maybe a little bit of a preview of what you're thinking about for 2025 and Global Lifestyles. You've got a bunch of these new programs hitting and I'm assuming they'll have a nice tailwind from a growth and margin perspective as we look at 2025. Maybe a little big picture what we may be able to expect."
},
{
"speaker": "Keith Demmings",
"content": "Sure. Yes, I'll give you a few highlights as we think about '25. Obviously, we need to close out Q4 and see where the underlying performance comes in, look at the trends et-cetera and then what we will obviously provide detailed guidance in February. But stepping back at the high-level, certainly we expect to accelerate Global Lifestyle growth in '25. I would say growth will certainly come in Connected Living. We've made a lot of investments in '24. Those investments won't continue in '25 and obviously we'll start to generate revenue and EBITDA from those client launches and the efficiency that we're driving. And then we've got good underlying strong momentum in the business overall. And then as I think about Auto, we definitely expect growth in Auto in '25 as well. We expect the business will benefit from higher earnings from the rate increases that we've implemented over the last couple of years and then stabilizing inflation levels. One thing I would mention, we do expect some additional incremental investments in '25. There are a number of things that we're actively working on similar to '24, net-new clients, net-new program launches, things that have not yet been disclosed to the market. So we'll preview that as well in '25. So think about the '24 investments really sunsetting the revenue and EBITDA flowing through. And then hopefully, if we have continued great momentum with clients, we'll have some other big exciting things that we'll be bringing to market in '25 as well. And then maybe I'll just touch on housing since we'll close out the '25 thoughts. I mean, it's been an incredible 2024, really the last couple of years in housing. As we think about '25, probably the simplest way to say it is net of the prior year development that we've seen, we do expect solid underlying growth in-housing in '25. And I'd say driven from the growth we've seen in terms of our policy counts, continued increases in average insured values and then momentum around expense leverage in the business. So more to come in February, but those are a few of the high-level thoughts."
},
{
"speaker": "Brian Meredith",
"content": "Okay, thank you."
},
{
"speaker": "Keith Demmings",
"content": "You bet. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from Mark Hughes with Truist."
},
{
"speaker": "Keith Demmings",
"content": "Hi, Mark. Good morning."
},
{
"speaker": "Mark Hughes",
"content": "Yes, thank you very much. Good morning. The voluntary business that you're picking-up, can you talk about that is the momentum still building in voluntary, the markets that you're seeing success are still dislocated, how do you see that trend?"
},
{
"speaker": "Keith Demmings",
"content": "Yes, I think when we look at - yes, and really we're highlighting the impact around the placement rate. So we look at the placement rate is up 6 basis-points sequentially, it's up 18 basis-points year-over-year. So we've seen a lot of momentum with respect to that. And I would say it's probably equal parts growth in the underlying business. We obviously onboarded a major new client earlier this year. We've seen growth within our existing client bases of acquired loans, acquired portfolios. And then the other half of that growth is a result of additional policies being placed because homeowners are being more challenged to find traditional voluntary coverage. So we've talked about that hard market factor being part of the drivers for the placement rate growth, less so challenges more broadly in the economy, challenges in terms of delinquency and those types of things, those are really not factoring in at least at this point. So that's what we've tried to highlight is it's a function of the hard market that we're seeing around the country."
},
{
"speaker": "Mark Hughes",
"content": "In the device counts, you had a nice acceleration this quarter. I think you talked about the new Asia-Pacific clients. Did they come over kind of in math or will this growth continue?"
},
{
"speaker": "Keith Demmings",
"content": "The step-change we saw earlier in the year, at this point in Q3, this is a more natural evolution. So we've seen continued steady growth both in our domestic business. We rolled-out some new products earlier this year with one of our major cable partners, that's generated a significant momentum. And then, of course, building as well in Asia-Pacific. But that was more of a natural evolution from the finish point at Q2 and those blocks had already sort of step changed earlier in the year."
},
{
"speaker": "Mark Hughes",
"content": "Yes. And then on the GAAP, higher-than-expected, the GAAP losses. When does that run-through? When do you either reinsure that away or get enough price to offset the claims experience?"
},
{
"speaker": "Keith Meier",
"content": "Yes. So we mentioned before that the impact from GAAP is shorter-term in nature versus the vehicle service contracts. Those claims are usually heavier in the first 24 months or so. And we've been partnering with our clients to eliminate or reduce the risk on those businesses. And just as an example, from a written premium perspective, in 2022, 40% of the business, we had some risk participation. And then in 2024, it's down to just 12%. So overall, as we look into 2025, with all the actions that we've taken across our vehicle service contracts and GAAP, we expect Auto to improve as we as we move forward. And I think overall, I think we get a sense that the pressure is declining, certainly for Auto."
},
{
"speaker": "Keith Demmings",
"content": "Yes. And maybe I'll just amplify. I think we talked about starting this process of looking at reshaping the risk that we hold relative to GAAP going back two years ago. So we started this process early. And as Keith highlighted, a pretty big reduction in the amount of risk that we're writing today. So really it's just a question of running off the unearned part of the business. But as Keith said, it's much shorter-term in nature. So it shouldn't be a headwind as we think about '25."
},
{
"speaker": "Mark Hughes",
"content": "Thank you."
},
{
"speaker": "Keith Demmings",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from Tommy McJoynt with KBW."
},
{
"speaker": "Keith Demmings",
"content": "Hi, Tommy."
},
{
"speaker": "Keith Meier",
"content": "Hello."
},
{
"speaker": "Tommy McJoynt",
"content": "Hi, good morning, guys. Thanks for taking my questions. When we think about the subscribers that you guys are adding, I think largely calling out the cable operators in the Asia-Pacific region, is the sort of monetization opportunity of those customers any different than the traditional sort of carrier customer that represented your in force for a long-time?"
},
{
"speaker": "Keith Demmings",
"content": "No, I think it's pretty well-aligned. I mean, obviously, every deal with clients work differently. But no, I'd say it's very much aligned with the standard operating model. Obviously, we're pleased to see the subscriber growth pretty material year-over-year and then continuing to build certainly in the quarter. But no, I wouldn't say it's dramatically different than sort of the average of the total, Tommy."
},
{
"speaker": "Tommy McJoynt",
"content": "Okay, got it. And then to clarify your comments around the investment spend in Connected Living, I think you called out $21 million of spend year-to-date. And it sounds like that investment spend is sunsetting this year, but then it's going to be replaced by sort of additional or new investment spend next year for new programs. Can you just clarify the comments around that?"
},
{
"speaker": "Keith Demmings",
"content": "Yes, that's exactly right. So we've got, to your point, $21 million year-to-date. We had about $8 million that we called out in the third quarter. We'll see a little bit more in the fourth quarter, probably moderating a little bit from kind of where we sit today. As I think about '24, two-thirds of that investment spend I'm simplifying is related to new client launches. Think about the launches with Telstra, Spectrum, Chase, some other things that we probably haven't highlighted. And then a third of it is the work that we've done to really automate and invest in our new device care center. So all of those programs are sort of delivered this year. Those don't recur and then we get all the benefit in terms of revenue, EBITDA and efficiency. And then to your point, we will have additional new investments, which I think is a really good thing, right. If we're making -- and we're only calling out investments that are meaningful and that are designed to launch net-new things in the marketplace that have strong payback and that are going to generate EBITDA and revenue once they launch. So we'll size that again in February, Tommy, to give everyone a sense of how we think about that, but there's a lot of things in our pipeline. Our commercial momentum, particularly in Connected Living is incredibly strong. So, this would be a really good thing if we've got another bucket of investment similar to what we did this year."
},
{
"speaker": "Tommy McJoynt",
"content": "Thanks. And then just lastly in Connected Living, the fourth quarter guide seems to imply some pretty good strength there. What's sort of contemplated around trade-in volumes and perhaps the sensitivity around this iPhone upgrade cycle? Should we think of this as an unusually strong fourth quarter or is this some -- is this something I can repeat in kind of future years?"
},
{
"speaker": "Keith Demmings",
"content": "Yes, I'd probably say that when we look at the sequential growth in Connected Living going into Q4, trade-in seasonality and Keith can speak to it in a second, we definitely would expect to see that. We've got benefit from the new clients that we've launched, a little bit moderating expenses, but revenues flowing through. We also see seasonal loss improvements in the retail service contract business as well. So there's a few drivers that will create a sequential improvement in Connected Living, but maybe Keith talk a little bit about trading."
},
{
"speaker": "Keith Meier",
"content": "Yes. And I think as you think about trade-in, we -- I think we saw a little bit of softness in trade-in and promotional activity, offset by some newer programs in this quarter. If you think about it, the iPhone 16 launched on September 20th, but the first set of Apple Intelligence features were rolled out on October 28. So we certainly expect more promotional activity as we come into the fourth quarter. I think it was muted a little bit in the third quarter, but we expect that to pick up here in the fourth quarter."
},
{
"speaker": "Tommy McJoynt",
"content": "Thanks."
},
{
"speaker": "Keith Demmings",
"content": "Great, thank you."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] We have no one else in the queue."
},
{
"speaker": "Keith Demmings",
"content": "Alright, wonderful. Well, thanks, everyone..."
},
{
"speaker": "Operator",
"content": "Apologies, we do. John Barnidge from Piper Sandler just raised his hand."
},
{
"speaker": "Keith Demmings",
"content": "Oh, John, just in time. Good morning."
},
{
"speaker": "John Barnidge",
"content": "Yes, good morning. Sorry. Yes, must not have captured the first star nine, but got a couple questions. Appreciate you fitting me in. Given we've got past experience of improving profitability meaningfully in Global Housing, I'm wondering if there are some lessons here that can be transferred to Global Auto? With rate increases having an impact on profitability, should we expect there to be a period of favorable reserve development in that business over-time at all?"
},
{
"speaker": "Keith Demmings",
"content": "Yes, I mean, I think -- I'd probably say a couple of things where we've been through these cycles before for a variety of different reasons where maybe losses are elevated in different periods. I think our track-record of working through this with clients is exceptionally strong. The alignment of interest, the contracting got in place. So, Auto is a little different because of the nature of the product. It's longer-term in nature. So it takes a longer effort to kind of get it back to profitability where housing is an annual policy, but there's no doubt the lessons learned through housing. If you think back to a couple of years ago, simplified the business, drove a tremendous amount of focus on the core, didn't just attack the issue from a rate perspective, but look to drive operational efficiency, expense efficiency. And I think we're doing those same things on the auto side. So we're addressing it multiple ways. We're strengthening the business at a fundamental level as a result of some of the changes we're making. And we feel confident that we'll create some longer-term tailwinds. I don't think there'll be major step changes in terms of reserving releases over-time, but I'll let Keith speak to that."
},
{
"speaker": "Keith Meier",
"content": "Yes. And I would say just in general, these types of challenges just make us stronger in terms of the rigor and the -- and the actions that we take in that business. So I think that always does provide us some positive impacts as you look-forward. Just if you think about for Auto, we implemented 16 now total rate changes with our clients. So we've been working with our clients to do that. And then we also redesign products to make them more effective for the consumer and as well. So I think being able to pull all the levers that we have, I think our examples of there's different levers, as Keith mentioned in housing versus Auto, but I think it's a lot of that similar element. And so it's not so much the reserves for auto, it's more of the earnings of those rates that will be coming through over the next few years that provides us the little bit of tailwind there for Auto business."
},
{
"speaker": "John Barnidge",
"content": "And then my other question, you've had quite a lot of success taking wins in one business and winning in another business. I think Chase was a good example of that this year. Is there an opportunity to offer mobile coverage or other coverage to clients where you've won that global housing business? I know I get Hulu, Netflix and Apple TV with my mobile device. Wondering if there can be a bundling in the card and housing in mobile?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. I mean, it's definitely an interesting thought and we always think about how do we leverage the relationships that we've got and you think about the strength of Assurant, certainly it's the B2B to see nature of the business. But the fact that we operate across a wide number of distribution channels with major brands. So as clients are looking to reinvent how they bring services to market, I think we're well-positioned to capitalize on that. So I think the logic of your question makes perfect sense. Obviously, a dramatic amount of the scale has come through partnerships with mobile operators. If we look at the U.K. market, for example, though we work with major banks in the U.K. that offer mobile protection as part of their packaged bank account. So we definitely look for those opportunities where we think we're best positioned and we can deliver at scale."
},
{
"speaker": "Keith Meier",
"content": "Yes. And I think it's definitely a positive opportunity for us to leverage these relationships that we have with these large institutions like Chase. A good example is, I was meeting with some of their executives when we -- when they were launching the program last month and they said they did check with their Chase counterparts and basically we're doing reference checks on Assurant. They came back very positive. And so those types of things certainly can go a long way and are very positive for us to expand relationships."
},
{
"speaker": "John Barnidge",
"content": "Thanks for the answers."
},
{
"speaker": "Keith Demmings",
"content": "Thank you, John."
},
{
"speaker": "John Barnidge",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "There is no one else in the queue. I will pass it back to Keith for closing remarks."
},
{
"speaker": "Keith Demmings",
"content": "Okay, wonderful. Well, thanks everybody for joining and we will certainly look-forward to another discussion in February. We'll share how we closed out the year and provide some guidance for 2025. So, thanks very much and have a great holiday season."
}
] |
aiz | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Welcome to Assurant's Second Quarter 2024 Conference Call and Webcast. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following management prepared remarks. [Operator Instructions]. It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may begin."
},
{
"speaker": "Sean Moshier",
"content": "Thank you, operator, and good morning, everyone. We look forward to discussing our second quarter 2024 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday after the market closed, we issued a news release announcing our results for the second quarter 2024. The release and corresponding financial supplement are available on assurant.com. Also on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by those statements. Additional information regarding these factors can be found in the earnings release, presentation, and financial supplement on our website as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We'll start today's call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings."
},
{
"speaker": "Keith Demmings",
"content": "Thanks, Sean, and good morning, everyone. Our strong first half 2024 results demonstrate continued outperformance from Global Housing and underlying momentum in Connected Living, positioning us to increase our full year 2024 growth expectations for Assurant overall. Excluding reportable catastrophes, adjusted EBITDA increased 20% year-to-date and adjusted EPS grew 29%. These results reflect the power of our combined housing and lifestyle business model. Starting with our first half business highlights. In Global Lifestyle first half 2024 adjusted EBITDA was $397 million, consistent with the first half of 2023. Our year-to-date performance has been driven by continued growth and momentum within our Connected Living business, particularly in the U.S. In Connected Living, adjusted EBITDA increased 6% or 8% on a constant currency basis. As we previously discussed, 2024 includes incremental spending related to the implementation of new partnerships and programs that we expect will support long-term growth for Assurant. Excluding first half investments of approximately $13 million, year-to-date growth for Connected Living was 14% on a constant currency basis. One example of our innovative new offerings included the rollout of two programs with Spectrum Mobile, anytime upgrade, and the repair and replace plan. Additionally, we onboarded the pre and postpaid device protection subscribers of Telstra, our new partner in Australia. Combined, these new programs added 1.6 million mobile subscribers, driving strong sequential growth. This year, we've also completed long-term contract extensions with all of our major U.S. mobile device protection clients, including T-Mobile and two U.S. cable operators, continuing to strengthen our position in the market. In total, these renewals represent three of the top five largest U.S. carriers by subscribers. With T-Mobile, this included a multi-year contract extension to continue supporting their postpaid and prepaid consumers beyond 2030. The renewal of T-Mobile allows us to continue to invest in this critical partnership and drive innovation for the future. In financial services, we expanded our longstanding relationship with Chase by partnering with Chase card services within our growing card benefits business. We executed a multi-year contract to provide coverage to millions of Chase cardholders. This program will provide end-to-end delivery for approximately 15 travel and purchase protection benefits, including underwriting, claim processing, and benefit servicing. We expect continued investments over the second half of this year as we move toward program launch at the end of 2024. This represents a marquee win for our card benefits business, which has gained strong momentum over the last several years. Our relationship with Chase now spans across our Lifestyle and Housing businesses, reinforcing the depth of client partnerships that we drive across the Assurant enterprise. Moving to Global Automotive. Our first half earnings have continued to be pressured by ongoing inflation impacts on motor vehicle repair costs. We expect that the effects of inflation will continue to impact our auto results throughout the second half of 2024 in our vehicle service contract business. In addition, we expect continued elevated loss experience within our ancillary guaranteed asset protection or GAP product. Our longer-term outlook, however, is bright, as we've begun to see moderation of claims inflation on our vehicle service contract business given the rate actions taken over the past 24 months. Within our GAP product, we're experiencing elevated losses driven by the combination of continued declines in used car prices from pandemic highs, higher interest rates, and the increase in the number of vehicles declared total losses by the primary insurance carrier. We expect this impact to be shorter-term in nature relative to vehicle service contracts, as the majority of GAP claims are made within the first 24 months after vehicle purchase. In addition, over the past year, we've been proactively partnering with several clients to transition the risk on the GAP business, which will reduce a substantial amount of our claims exposure over time. Lastly, we believe the auto business will continue to benefit from our position as a market leader with scale and strong partnerships across multiple distribution channels. Now, let's turn to Global Housing. For the first half of the year, Global Housing's earnings increased nearly 45%, excluding reportable catastrophes. Housing's year-to-date results have demonstrated both the importance of the business to our overall portfolio and the power of our unique and differentiated business model, which has largely outperformed the broader P&C market. Our lender-placed insurance business safeguards homes that need insurance regardless of geography, while supporting the U.S. mortgage industry by removing the risk of uninsured loss for lenders, investors, and homeowners. We review rates with each state on a regular basis to ensure that they are appropriate and that homeowners are protected. This process allows us to work together to balance risk and reward with fair and adequate rates, while creating product safeguards to address macroeconomic factors such as inflation. In addition, we benefit from our strong track record, continued investments in customer experience, and our compliance expertise, our most critical competitive advantages. These efforts have allowed us to renew existing partnerships and win new clients, including Bank of America. This in turn has contributed to increased scale, which combined with technology investments has led to significant operational efficiencies. Ultimately, this creates meaningful expense leverage, which we'll continue to benefit from going forward. Our specialized product and client base provide Assurant with differentiated advantages compared to many traditional homeowners insurance carriers. Overall, these combined advantages have led to the recovery and growth of this business within a relatively short time frame. We believe we are well-positioned and we continue to believe there's an opportunity for the market to better value our specialized lender-placed business. In renters, we benefit from an attractive financial profile that is more capital efficient compared to traditional P&C businesses. We are focused on expanding our presence as a market leader within the Property Management Company or PMC channel while providing our partners with innovative new offerings. In the first half of the year, we increased gross written premiums in our PMC channel by over 20%, reflecting strong client demand for our Cover360solution. This marks eight straight quarters of double-digit growth of gross written premium in the PMC channel. Following the initial launch of our Assurant Tech Pro resident troubleshooting service, we recently signed a partnership with the largest PMC in the U.S. to be the first to provide this service to the industry. We expect to begin rollout in the second half of this year. Turning to our enterprise outlook. Given the strength of our first half results, we now expect full year adjusted EBITDA to grow high-single-digits and adjusted earnings per share to increase low-double-digits both excluding catastrophes. This represents an increase from our initial expectation for both metrics. We anticipate strong growth within Global Housing, which is expected to lead our enterprise growth for 2024. In Global Lifestyle, we expect modest growth in 2024. Connected Living is expected to deliver another year of growth as we remain focused on driving long-term momentum through new partnerships and programs. Overall, we believe our first half performance and our increased 2024 outlook demonstrate the power of our differentiated business model with unique advantages which make Assurant attractively valued. Over time, we've enhanced Assurant’s risk profile by focusing on our capital efficient businesses within Lifestyle and Housing, which are highly cash generative. We've established a track record of winning and delivering for B2B2C clients throughout both Lifestyle and Housing, many of whom are industry leaders and market disruptors across the globe. We've created leadership positions in amplified competitive advantages through our protection solutions across devices, automobiles, and homes. Together with our clients, we've seen these deliver mutual benefit from scale and deep integration, supporting innovative and flexible solutions to differentiate the customer experience. We focus on specialized, attractive markets with growth opportunities and long-term secular tailwinds. These factors contributed to long-term outperformance versus the broader P&C market, particularly the S&P Composite 1500 P&C index. We believe this comparison better reflects our current mix of businesses and offerings as we provide insurance solutions and fee-based services to our partners and their end consumers. In June, our sub industry index classification under the Global Industry Classification Standard, or GICS, transitioned from multiline insurance to P&C insurance. A product of our multi-year transformation that included exiting pre-need, health and life insurance related businesses. Before handing it over to Keith Meier, I wanted to highlight our recently published 2024 Sustainability Report, which demonstrates our progress in advancing our sustainability strategy and initiatives. We've introduced our new sustainability vision focused on advancing a connected, respected, and protected world. We've established long-term ambitions to support a thriving society, a circular economy, and a stable climate. We believe there's an important connection between our vision and ambitions and how we deliver value for our business and for our stakeholders. These priorities strengthen Assurant for the future, including how we attract, empower, and reward a diverse workforce to drive innovation, contribute to the development and adoption of sustainable products and reduce the climate impact of Assurant operations and supply chain. Overall, we're excited about the progress we've made so far this year, continuing to drive attractive financial results and outperformance for the overall enterprise. As we look ahead, we believe we are well-positioned to continue to drive business momentum in the second half and beyond. I'll now turn it over to Keith Meier to review our second quarter results and business trends impacting our 2024 outlook."
},
{
"speaker": "Keith Meier",
"content": "Thanks, Keith, and good morning, everyone. We're proud of our second quarter performance as we continue to invest in value-added solutions for our clients and end consumers. We believe we are well-positioned to build upon our historical track record of growth, strong capital generation, and long-term shareholder value creation. Let's review the specifics of our strong second quarter results, which build upon the momentum from the first quarter. In the second quarter, adjusted EBITDA grew 10% to $369 million and adjusted earnings per share increased by 17% to $4.77, both excluding reportable catastrophes. From a capital perspective, we generated $142 million of segment dividends in the second quarter, ending the quarter with $735 million of holding company liquidity, up from $622 million at the end of the first quarter. Our strong capital position has provided flexibility to invest in future growth, while returning $80 million to shareholders in the quarter, including $40 million of share repurchases. In addition, we repurchased $20 million of shares between July 1 and August 2 and have now completed $100 million in repurchases so far this year. Turning to our business segments. Let's begin with Global Lifestyle. For the quarter adjusted EBITDA decreased 4% to $190 million, or 2% on a constant currency basis, driven by Global Automotive, which declined by 8% or $6 million. Results were impacted by higher claims costs due to inflation and elevated losses from ancillary GAP products. In Connected Living, earnings increased modestly on a constant currency basis, primarily driven by global mobile protection programs, including subscriber growth from U.S. cable operators and new Asia-Pacific clients, as well as improved U.S. financial services results. International results remain stable on a constant currency basis and have started to show signs of modest growth. Growth was partially muted by investments in new capabilities and client partnerships, which are expected to support long-term growth. Trade-in results were down from a decline in carrier volumes and business mix, including from lower promotional activity. Unfavorable foreign exchange remains a headwind and impacted Lifestyle's adjusted EBITDA growth by 2 percentage points in the quarter. Turning to net earned premiums fees and other income. Lifestyle grew by $75 million, or 4%, and Connected Living increased 6%, benefiting from contributions from new Trade-in and mobile protection programs, including the U.S. and Asia-Pacific. For full year 2024, we now expect Global Lifestyle's adjusted EBITDA to grow modestly, reflecting continued strong performance from Connected Living and ongoing elevated claims in Global Auto. We expect growth in Connected Living to be led by the continued expansion of our U.S. business. We expect investments related to new clients and programs, mainly in Connected Living to temper Lifestyle growth by approximately 3% in 2024, but will be a critical driver for business growth over the long-term. In Global Auto, we now expect adjusted EBITDA to be flat to modestly down due to continued loss pressures from inflation and elevated losses within ancillary GAP products. We continue to monitor foreign exchange impacts, inflation, and interest rates, which have and may continue to impact the pace and timing of growth. I'd like to take a moment to discuss our auto business and how we have addressed inflation headwinds. As we've discussed, we expect auto claims inflation to impact our performance over the remainder of this year. Toward the end of 2022, the industry began to see large spikes in motor vehicle repair costs, even as overall CPI trends began to stabilize. Exiting 2023, the auto industry began to see signs of inflation levels declining. However, in the beginning of 2024, motor vehicle repair costs increased once again, impacting performance in the first half of 2024. Our underwriting risk in auto is limited to just a few clients, as many of our clients choose to reinsure or share in the economics of the business, given auto's profitable returns over the long-term. There are a total of five vehicle service contract clients where we retain a portion of the claims risk that will improve over time, which is a small subset of our overall client base. Since 2022, we have implemented a total of 14 rate increases for these impacted clients, with additional increases planned over the coming quarters. In addition to rate increases, we have made changes to enhance our claims adjudication process, adjusting the product and modifying deal structures with clients to ensure mutually beneficial outcomes. Even with these vehicle service contract clients, where we do retain some risk, we are profitable as we also earn investment income and receive fees for our administrative program support. Moving to Global Housing. Second quarter adjusted EBITDA, including cats was $161 million. During a quarter that included over 25 ISO events that impacted much of the P&C industry, we fared reasonably well with $46 million of reportable catastrophes across five events and no single event incurring more than $15 million in losses. Excluding reportable cats, adjusted EBITDA increased by 23%, or $38 million to $206 million. The increase was driven by continued top-line growth in homeowners, primarily from an increase in the number of in-force policies from the onboarding of the newly added Bank of America portfolio and the net impact of ongoing client and portfolio transitions. Additionally, lender-placed policies increased due to impacts from hardening traditional insurance markets in certain states. Lender-placed continued to see average premium growth related to higher average insured values and increases in filed rates. Despite higher expenses from client portfolio onboarding and offboarding activity in the quarter, expense leverage from scale, technology investments and operational efficiencies remains a key driver of performance as reflected in the continued improvement in housings expense ratio, which was 37% in the quarter. Underlying EBITDA growth was partially offset by the unfavorable year-over-year net impact of $11 million related to prior period reserve development. Second quarter 2024 had $17 million of favorable reserve development compared to $28 million in the second quarter of 2023. We continue to expect Global Housing's full year 2024 adjusted EBITDA, excluding cats, to be the growth driver of our overall enterprise performance. We anticipate growth will be driven by continued top-line momentum in homeowners, expense leverage, and lower catastrophe reinsurance costs. Placement rate and policies in-force both key drivers of earnings are expected to be impacted by ongoing client portfolio transitions in the second half of the year. However, both are expected to have healthy growth overall for 2024. Lastly, we expect Hurricane Beryl to be a reportable catastrophe in the third quarter. While claims are still developing, our early indication is that estimated losses will be between $30 million to $50 million. We will provide an update prior to our third quarter earnings call as we finalize impacts. Moving to corporate, second quarter adjusted EBITDA loss was $27 million, which improved mainly due to higher net investment income from higher asset levels and yields. We continue to expect the 2024 corporate adjusted EBITDA loss to approximate $110 million, consistent with 2023. Turning to capital management. We generated significant deployable capital in the first half of the year, upstreaming $395 million in segment dividends. For 2024, we expect our businesses to continue to generate meaningful cash flow. Cash conversion to the holding company is expected to approximate two-thirds of segment adjusted EBITDA, including reportable catastrophes. Cash flow expectations assume a continuation of the current macroeconomic environment and are subject to the growth of the businesses, investment portfolio performance, and rating agency and regulatory requirements. As we look forward to the remainder of the year, we continue to be focused on maintaining flexibility to support new business growth and to return capital to shareholders. Given our strong capital position and robust reinsurance program, we expect to be on the high end of our $200 million to $300 million share repurchases range for the year. Our ultimate level of repurchases will depend on M&A opportunities, market conditions, and cat activity. Overall, we've had a very strong first half of 2024, and we believe we are well-positioned to achieve our increased full year financial outlook while also supporting business growth and shareholder value creation over the long-term. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"content": "The floor is now open for questions. [Operator Instructions]. Thank you. Our first question is coming from Mark Hughes with Truist Securities."
},
{
"speaker": "Keith Demmings",
"content": "Good morning, Mark."
},
{
"speaker": "Mark Hughes",
"content": "Good morning. Yes, thank you. Good morning. On the Global Auto the sustained impact of inflation, when do we kind of turn the corner on that? When does it become less negative? Understanding that it will continue to be a drag trends for the foreseeable future, when does it become less of a drag?"
},
{
"speaker": "Keith Meier",
"content": "Yes, Mark. So I think the first half this year was kind of the tale of two different stories for the first quarter and the second quarter. The first quarter was really driven by the inflation from our vehicle service contracts. And so -- but in the second quarter, what we've seen is more on the GAP side, that was really what was driven by the used car values declining, higher interest rates and more total losses declared by traditional insurers. So the vehicle service contract side was really moderated a bit in the second quarter -- in the first -- sorry, in the second quarter, the GAP was really the driver of the challenges in the second quarter. So as we look at the back half of the year, we actually expect the rates that we've been putting into place with our clients to stabilize and improve modestly as we go through the back half of the year. And I think one other key point about the second quarter as it relates to the GAP product, we've been working on this over the past year or so to reduce and transition some of that risk with our clients. So we don't see that as something that's going to sustain over a long-term. And GAP actually improves faster than the vehicle service contracts that really should improve in less than in the next couple of years, so less than two years. So overall, if we're going to have a challenge in auto, this is probably a good time to have the challenge when we're raising our outlook, and I think this is really just creating a little bit more of a tailwind for us in our auto business over the next few years."
},
{
"speaker": "Keith Demmings",
"content": "Yes. And I would just add, as we think about getting off a lot of that GAP risk over time. That process started back when our GAP was actually performing well. We know it's a volatile product line. Our goal was to strategically try to reduce volatility and make that strategic decision. And obviously, that's something that we'll continue to work on as we go forward. And as Keith said, not something that we expect to be a long-term pain point for the business."
},
{
"speaker": "Mark Hughes",
"content": "Yes. So fair to think the pain this year is already factored into your guidance when we think about 2025 would be less negative, i.e., positive year-over-year comparisons in this dimension."
},
{
"speaker": "Keith Meier",
"content": "Yes. It's definitely factored into our 2024 outlook. And then as we go through the year, we'll provide an update on 2025, but we certainly see an improvement going into the back half of the year."
},
{
"speaker": "Mark Hughes",
"content": "Yes. And then in the card benefit business, could you talk a little bit more about the opportunity there? It sounds like an interesting agreement with Chase, how important is that within the Lifestyle? And is that a new opportunity that could be a marginal contributor to growth?"
},
{
"speaker": "Keith Demmings",
"content": "Yes, definitely, and I would say a couple of things. So we've been growing successfully our card benefits business the last several years, in particular, in the U.S. And a couple of things specifically on Chase, number one, it's a phenomenal opportunity to expand our relationship. We obviously have a long-standing relationship around the lender-placed business with Chase that spans many, many years, and this is a chance to expand across product lines in between segments within Lifestyle, which is great. We definitely are investing in this launch. It's part of the investments that we've talked about relative to Q2 that will ramp as the year progresses. We're actually converting all active Chase customer cardholders in the fourth quarter of the year. So there's a lot of work to stand that up. And then it will certainly be EBITDA positive as we enter 2025 because it will be at a full natural run rate entering next year. And yes, we're very excited. And certainly, it will be one of several drivers of growth for the Connected Living business. And part of what we've been signaling to the market is specific discrete investments in long-term growth that are directly connected to new programs, new products, and what I think are clear strategic growth levers for the business."
},
{
"speaker": "Mark Hughes",
"content": "Appreciate it. Thank you."
},
{
"speaker": "Keith Demmings",
"content": "You bet. Thanks, Mark."
},
{
"speaker": "Operator",
"content": "Our next question comes from Dan Lukpanov with Dowling & Partners."
},
{
"speaker": "Keith Demmings",
"content": "Good morning, Dan."
},
{
"speaker": "Keith Meier",
"content": "Good morning."
},
{
"speaker": "Dan Lukpanov",
"content": "Hey guys, good morning. Going back to the auto, just curious, so we've been seeing the traditional insurers -- car insurers reporting a moderation in physical damage severity and just knowing your product, you don't have the liability side. You have little mostly physical damage in all the same drivers of materials side. Just curious, I get that the GAP was sort of the negative in the quarter. But on the vehicle service contract side, did you guys see any acceleration on the improvement. I did the loss cost trend year-to-date change your view on how fast you can recover the business."
},
{
"speaker": "Keith Meier",
"content": "Yes. So I think through the first couple of quarters, we saw the loss cost trends moderate. The CPI index for auto repairs went down modestly, and so it's about 9 million -- or 9% year-over-year. So we're seeing it moderate a bit, Dan. And I think we're in a good position to have those rates start coming through and improve sequentially for us as we go-forward."
},
{
"speaker": "Keith Demmings",
"content": "Yes. And I think just to amplify; I mean we talked about 14 rate increases over five clients over the last couple of years. So a meaningful amount of rate increases have been put in place. And obviously, we're starting to slowly see that earn through, combined with moderation on the inflationary side. So that momentum builds over time. It doesn't solve itself nearly as quickly as what we saw in the Housing business, but certainly excited to see progress in Q2, and we'll monitor that as we think forward through the rest of the year."
},
{
"speaker": "Dan Lukpanov",
"content": "Okay. And do you see used to new car mix normalizing, I think during the inflation of cycle, you saw more used cars in the production, do you see that normalizing at all?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. I think it's still in the range of 50:50 in terms of used and new. It's definitely moderated. There's certainly more new car volume going back into the system. But it's a pretty -- we have a pretty nice balance within the business. And to your point, it did tilt more used car during the pandemic, and I'd say it's normalized at this point."
},
{
"speaker": "Dan Lukpanov",
"content": "If I may squeeze in one more. The -- in the financial services, I think you called out a profitability improvement in the U.S. business. What was that? Can you provide any more color on that?"
},
{
"speaker": "Keith Meier",
"content": "Yes. I think that's just a continuation of the leading programs that we have in our financial services business. So we've been growing that business over the last few years. So I think that's just a continuation of that. And I think the Chase win is just another highlight of the really good momentum that we're having in our financial services business."
},
{
"speaker": "Dan Lukpanov",
"content": "Thanks, guys. I appreciate the answers."
},
{
"speaker": "Keith Demmings",
"content": "Thanks, Dan."
},
{
"speaker": "Keith Meier",
"content": "Thanks, Dan."
},
{
"speaker": "Operator",
"content": "Our next question comes from Jeff Schmitt with William Blair."
},
{
"speaker": "Keith Demmings",
"content": "Hey, Jeff."
},
{
"speaker": "Keith Meier",
"content": "Hey, Jeff."
},
{
"speaker": "Jeff Schmitt",
"content": "Good morning. So how much of the auto revenue mix is the GAP business? And how much is sort of a handful of accounts where you share writing profits? Any details you could give on the actual like what inflation is kind of currently running at for those see their plans would be helpful."
},
{
"speaker": "Keith Meier",
"content": "Yes. So for GAP, yes, it's actually a very small part of our business, Jeff, and it's actually continuing to be even less and less as we mentioned earlier, we've been working on over the last year, transitioning some of that risk. So it's becoming a smaller and smaller part. Some of the things that you're seeing now are programs that have already been transitioned for going forward contracts. So we're just working through some of the existing contracts today. So overall, not a big driver of our auto business. And that's why there's a little bit of volatility within there, and that's why we've been reducing that part of that business."
},
{
"speaker": "Jeff Schmitt",
"content": "And just in terms of the percentage of mix of the handful of accounts that you share profits with how much is that?"
},
{
"speaker": "Keith Meier",
"content": "Yes. It's only five clients. And it's actually with our rate increases that's becoming a better performing piece of our business over time, Jeff. We don't split that out necessarily of those clients. But overall, it's -- most of the business, the vast majority, we do reduce the risk and share risk with our clients. So this is really the smaller part of the business, not the main part."
},
{
"speaker": "Jeff Schmitt",
"content": "Okay. And then just a question on the renters business, I mean, I think a few years ago, you'd expect the growth to be kind of in the high-single-digits, continues to run much weaker. I'm just curious what the weakness there? And are you getting rate in that business as well? What rate are you getting?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. I think our rate is probably at a very good level right now generally. What I would say on the revenue side is, and we've talked about this a little bit in the past. Definitely, if you look at it year-to-date, it's relatively flat. I think we're up 2% on revenue. Policies are up 4%. What's probably a little bit more exciting is our year-to-date gross written premium, think of that as a leading indicator of future revenue. It's actually up 8%. And it's really two pieces. So our property management company part of the renters' portfolio is up 20% year-to-date, which is obviously pretty significant growth. And then the affinity business is relatively stable. We expect that affinity business to slowly improve over time. We expect the momentum in the PMC side of our business to continue. We've shown double-digit growth for the last eight quarters straight. We really like the business. I think we're incredibly positioned. We've been investing not just in our products, but in our platforms. And I think we're certainly set up as the market continues to find ways to drive growth, we'll be participating in that over time."
},
{
"speaker": "Jeff Schmitt",
"content": "Okay. Thank you."
},
{
"speaker": "Keith Demmings",
"content": "You bet."
},
{
"speaker": "Keith Meier",
"content": "Thanks, Jeff."
},
{
"speaker": "Operator",
"content": "Our next question comes from John Barnidge with Piper Sandler."
},
{
"speaker": "Keith Demmings",
"content": "Good morning, John."
},
{
"speaker": "Keith Meier",
"content": "Hey, John."
},
{
"speaker": "John Barnidge",
"content": "Good morning. Thanks for the opportunity. Appreciate it. My first question is on the Global Housing combined ratio. How do you view the long-term combined ratio guide? There's been consistent profitability achieved in that business, not just from underwriting improvements, but it appears to be expense leverage has been achieved over the last five quarters. I'd love to get your take on how you view the long-term combined ratio you targeted. Thank you."
},
{
"speaker": "Keith Demmings",
"content": "You bet. I think mid-80s combined is the right way to think about the business, we think about a non-cat loss ratio of around 40%. We had about 7 points for cat losses and then expenses in the high-30s. There's no doubt we've demonstrated a tremendous amount of discipline around expense management, driving efficiency through the use of technology and a lot of other things, and it's certainly showing up. And it's a scale business. So as we've grown the business, you're seeing the benefits of that flow through on the expense line. But I would say, mid-80s combined is the way to think about that business generally longer-term, and we feel incredibly proud of the growth of that business. I mean our policies are up 9% year-over-year. AIVs are up 11% and then expense leverage of more than 200 basis points if you look back. So it's performing incredibly well and very fortunate that we've got -- the team that we've got."
},
{
"speaker": "Keith Meier",
"content": "Yes. And I would just add, the expense ratio story really is a great one, and it's really sustainable as well. And it's really driven by the combination of scale the digital enhancements that we're making, the AI investments we're making, and then also our integration platforms. When you take all of that we've been doing over the last few years, it's really been an amazing journey. And I think that's really delivered an incredible customer experience through technology and it's also enabling us to differentiate versus others in the industry. And I think that's why you're seeing us win some important new clients with those investments we made that are really paying off for us."
},
{
"speaker": "John Barnidge",
"content": "Thank you for that. My follow-up question is on the Global Lifestyle business. Telstra, Spectrum really seemed to have delivered nice unit growth, $1.6 million, I think you called out there. But generally, ahead of a program launching, there's a period of investor. Are you able to quantify the level of investment for Telstra and Spectrum that impacted EBITDA in the quarter for Connected Living? Thank you."
},
{
"speaker": "Keith Demmings",
"content": "You bet. I think what we've tried to quantify is the overall level of investment. So we talked about $13 million of incremental investment year-to-date, $5 million in the first quarter, about $8 million in the second quarter and think about that trend line kind of being maintained as we think about the second half of the year. So that's probably the easiest way to think about it, not necessarily at the client level. And there's no doubt we're excited about both of those opportunities to grow in the market. And there's certainly a step up in the second quarter with subscriber counts. We took over the in-force business at Telstra, which is terrific. So we start from a pretty robust place in terms of subs. And then, with Spectrum, as well because part of the program is embedded in the top-tier rate plan that actually gave us a step up to existing subscribers in the second quarter and now we're in a more normalized period of growth. What I think you'll notice, if you unpack the subscriber counts is we actually generated net growth even separating the $1.6 million incremental that we talked about, and that's following several quarters of declines in that metric. So we're really pleased not just with the growth from these two clients but with the underlying performance around subscribers and certainly expect that growth to continue, not at that level, but to continue as we go-forward."
},
{
"speaker": "John Barnidge",
"content": "Thank you."
},
{
"speaker": "Keith Demmings",
"content": "You bet."
},
{
"speaker": "Operator",
"content": "[Operator Instructions]. Our next question comes from Tommy McJoynt from KBW."
},
{
"speaker": "Keith Demmings",
"content": "Hey Tommy, good morning."
},
{
"speaker": "Tommy McJoynt",
"content": "Hey, good morning, guys. Good morning. How much is higher investment income offsetting, I guess, the otherwise, what I'll call core weakness in the auto segment. I guess, just basically do you know what percentage of autos bottom line EBITDA is investment income. And I'm not sure what the duration of those investments are. But is there any risk that if short-term rates come down meaningfully over the next year and that potentially fits auto's bottom line before all the work you're doing on rate increases gets a chance to earn in. Is that a risk that we should be thinking about?"
},
{
"speaker": "Keith Meier",
"content": "Yes. I think we're in a good position in terms of investment income, Tommy. Our duration is about five years on our investment portfolio. We've got a very high-quality portfolio. Our book yield is up 12 basis points over the last quarter up to $5.16. New money yields are still a little bit higher than that. So overall, we feel good about where we stand for the remainder of the year and our outlook in terms of investment income. And then also with certain clients, we share some investment income. So to the extent that interest rates go down a little bit, then it actually -- there's a natural offset there for us with some of the clients. So overall, not as big of an impact in the short-term."
},
{
"speaker": "Tommy McJoynt",
"content": "Okay. Got it. Thank you."
},
{
"speaker": "Keith Demmings",
"content": "Welcome."
},
{
"speaker": "Operator",
"content": "Our next question comes from Grace Carter with Bank of America. Please unmute your line to ask a question."
},
{
"speaker": "Grace Carter",
"content": "Good morning. Can you all hear me?"
},
{
"speaker": "Keith Meier",
"content": "Yes, we can. Hi, Grace."
},
{
"speaker": "Grace Carter",
"content": "Okay. Perfect. Hi. So I was wondering on the auto risk question. I think historically, you all have said that you retain about a third of the risk across the Lifestyle book. I was just curious if that continues to be kind of the best way to think about the segment overall, just given the work that you've done in the auto book over the past several quarters."
},
{
"speaker": "Keith Demmings",
"content": "Yes. I think it's generally the right way to think about it at the Lifestyle level, maybe a little bit -- we may retain a little bit less of it on the auto side. A lot of the deals are reinsured within the dealer business and with various clients. So -- but I do think, overall, that's a good way to think about it. And the nice thing with auto, as we think about the pressure on the VSC side, it's a handful of clients, so it's somewhat manageable. We're trying to work with only five partners to make the right adjustments. And as you've seen, 14 rate increases with five clients over the last couple of years is a meaningful amount of activity and traction to try to right the ship. So I do feel like that allows it to be much more manageable because it's quite concentrated."
},
{
"speaker": "Grace Carter",
"content": "Thank you. And I guess, you mentioned expecting higher repurchases for the remainder of the year, but also gave us some guidance for how Hurricane Beryl losses might be shaping up. Just given the forecast for an active hurricane season, can you talk about what gives you the confidence to kind of increase the outlook for repurchases for the remainder of the year? And as just kind of given the seasonality of hurricane season, if we should expect those to be more weighted towards 4Q rather than 3Q?"
},
{
"speaker": "Keith Meier",
"content": "Yes. So I think, first of all, we get the confidence from our strong capital position and we've really just continued to strengthen our reinsurance program. So we feel really good about how we are positioned going into the back half of the year. I think you also highlight, Grace, the strong cash flow generation of our portfolio of businesses. And we have a very strong track record of deploying that capital back to shareholders. And we've already completed $100 million of the buybacks. And I think we're going to be on pace to deliver that higher end of the $200 million to $300 million range. And I don't think we see any reason why that wouldn't be the case, and that's why we raised our guidance there. So overall, I think being in this type of capital position is exactly where we want to be and it allows us to operate from a position of strength."
},
{
"speaker": "Grace Carter",
"content": "Perfect. Thank you."
},
{
"speaker": "Keith Meier",
"content": "You're welcome."
},
{
"speaker": "Keith Demmings",
"content": "Great. Thanks, Grace."
},
{
"speaker": "Operator",
"content": "Our last question is coming from Mark Hughes with Truist Securities."
},
{
"speaker": "Keith Demmings",
"content": "Hey, Mark."
},
{
"speaker": "Keith Meier",
"content": "Hey, Mark."
},
{
"speaker": "Mark Hughes",
"content": "Yes. Thanks for taking the follow-up. In the Global Housing, your fee income was quite strong this quarter. Anything unusual there? Is this kind of elevated fees? Is that going to continue? I think we said $53 million, if I'm looking at it properly, a big jump year-over-year. Could you talk about that?"
},
{
"speaker": "Keith Meier",
"content": "Yes. So in the fee income, there was a business change that was made. And all it really was, Mark, was a reclassification between fee income and our expense lines. So no bottom line P&L impact, just movement between expenses and the fee income line."
},
{
"speaker": "Mark Hughes",
"content": "Yes. Okay. And then you talked about a client transition in Housing that could impact the second half. I'm not sure whether you said anything more about that, but what was the import of that statement?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. So we've got -- there's a lot of ongoing activity within the lender-placed business. And at times, certain portfolios roll off, certain portfolios roll on as clients are making different acquisitions in the market, buying books of loans, et cetera. And what we've said is we'll see some movement on that over the course of the back half of the year. But overall, I would say our expectation for policy counts is relatively stable as we think about the second half of the year. So any losses relative to that transition will be offset by pickups with respect to other portfolios."
},
{
"speaker": "Mark Hughes",
"content": "Okay. Very good. Thank you."
},
{
"speaker": "Keith Demmings",
"content": "Excellent. Thank you."
},
{
"speaker": "Keith Demmings",
"content": "And if we have no other questions, then maybe just one final comment for me and then we can wrap it up. And I think we try to put some emphasis in the materials, but we do have a very strong track record of driving performance across a variety of different economic cycles. We're certainly proud of what we've delivered so far this year, excited about the raised guidance. And as we highlighted in the materials, with the current guidance, we're actually poised to deliver 10% EBITDA growth on average since 2019, so over the last five years. And we're going to more than double the absolute earnings per share with a 16% CAGR over that same five-year period. So again, we're incredibly proud of the track record that sits behind us. We've got a lot of momentum in the business. We're showing that with a number of new client launches, new wins. We're working on a number of other things that we'll talk about in future quarters. But again, just excited to be driving growth and creating shareholder value. So we'll look forward to the next call. We'll get back together in November after our Q3 and really appreciate the time. Thanks very much."
},
{
"speaker": "Operator",
"content": "Thank you. This does conclude today's teleconference. Please disconnect your lines at this time, and have a wonderful day."
}
] |
aiz | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Welcome to Assurant's First Quarter 2024 Conference Call and Webcast. [Operator Instructions] It is now my pleasure to turn the floor over to Sean Moshier, Vice President of Investor Relations. You may begin."
},
{
"speaker": "Sean Moshier",
"content": "Thank you, operator and good morning, everyone. We look forward to discussing our first quarter 2024 results with you today. Joining me for Assurant's conference call are Keith Demmings, our President and Chief Executive Officer; and Keith Meier, our Chief Financial Officer. Yesterday after the market closed, we issued a news release announcing our results for the first quarter 2024. The release and corresponding financial supplement are available on assurant.com. Also on our website is a slide presentation for our webcast participants. Some of the statements made today are forward-looking. Forward-looking statements are based upon our historical performance and current expectations and subject to risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by these statements. Additional information regarding these factors can be found in the earnings release, presentation and financial supplement on our website as well as in our SEC reports. During today's call, we will refer to non-GAAP financial measures, which we believe are important in evaluating the company's performance. For more details on these measures, the most comparable GAAP measures and a reconciliation of the two, please refer to the news release and supporting materials. We'll start today's call with remarks before moving into Q&A. I will now turn the call over to Keith Demmings."
},
{
"speaker": "Keith Demmings",
"content": "Thanks, Sean and good morning, everyone. Our first quarter results represent a strong start to 2024 reflecting the position of strength from which Assurant continues to operate. Adjusted EBITDA grew 31% year-over-year to $384 million and adjusted EPS grew 42% year-over-year both excluding reportable catastrophes. Our first quarter results were driven by the continued strength of our Global Housing segment as well as growth in Global Lifestyle. Our ability to continue to drive financial performance and operational excellence has supported strong cash flow generation and a solid capital position. Before reviewing the highlights across our business segments, I'd like to take a moment to reiterate how our unique and differentiated business model has led us to consistently deliver financial results. Assurant holds market leadership positions across a variety of attractive specialized markets, where we benefit from both scale and deep integration with our B2B2C client base. Our competitive advantages across our businesses have allowed us to be flexible and agile in executing for our partners and for end consumers. Cost savings from targeted actions, such as our previously announced restructuring plan and ongoing technology innovation including digital-first and artificial intelligence have supported reinvestment in businesses where we have leadership positions. These high-return initiatives have enhanced our capabilities and supported new partnerships laying the groundwork for continued growth. The ultimate driver of our success is our people. In March, Assurant was recognized by Ethisphere as one of the world's most ethical companies in 2024. Operating ethically is foundational to protecting our clients' brands across the globe as well as our own. This recognition is a testament to the thousands of Assurant employees who champion our values every day. Collectively, our unique advantages have led to long-term profitable growth and shareholder value creation. We've continued to drive outperformance versus the broader P&C market as evidenced by our long-term results compared to the S&P Composite 1500 P&C index. Since 2019 Assurant has delivered double-digit adjusted earnings growth including and excluding cats outperforming the broader P&C index. Now turning to the quarter I'd like to share highlights across our business segments. Global Lifestyle delivered adjusted EBITDA of $208 million in the first quarter of 2024. This reflects a year-over-year increase of 4% or 5% on a constant currency basis, which is in line with our full year growth expectation. Growth was led by our Connected Living business which delivered double-digit adjusted EBITDA growth in the first quarter. To support growth we're continuing to make several important investments in new partnerships including for recently announced new launches such as Telstra Australia's largest mobile carrier where we completed the initial launch of several offerings. We are currently offering protection upgrade and trade-in to Telstra's postpaid subscriber base. Additionally we recently completed a multiyear extension of our partnership with Spectrum Mobile demonstrating the strength of our relationship. The expanded relationship includes the launch of two new mobile programs. The first of the two programs the new anytime upgrade benefit which is now included in the Spectrum Mobile Unlimited Plus data plan at no extra cost to consumers allows new and existing customers to upgrade their phones whenever they want. The second program is the new Spectrum mobile repair and replacement plan which offers customers device protection and is supported by our dynamic fulfillment and claims management capabilities. These innovative new offerings with Spectrum Mobile are the result of our long-standing partnership and reflect our ongoing commitment to deliver market first solutions to meet the needs of end consumers. During the quarter we also enhanced our global capabilities. For example in Europe we acquired iSmash a leading independent tech repair brand in the United Kingdom offering express drop in repair services for smartphones tablets laptops with nearly 40 retail locations. This acquisition further scales our walk-in repair offerings and is a prime example of the investments we're making globally to win new business and enhance existing relationships. Moving to global automotive, similar to others in the industry first quarter results reflected persistent inflation impacts to vehicle parts and labor repair costs. We've continued to take actions to address elevated inflation including implementing additional rate increases in the first quarter that build upon those taken over the past 18 months while also strengthening and enhancing our claims adjudication process. For 2024, we expect auto earnings to be flat. Investment income growth and disciplined expense management efforts are expected to be offset by continued claims inflation. We remain confident in the long-term growth prospects of our auto business. Over the next several years, we expect rate actions to provide a tailwind for the business with the pace and timing of earnings growth dependent on broader market trends. Now let's discuss Global Housing, which drove our first quarter outperformance. Global Housing earnings grew significantly in the first quarter up nearly 75% excluding reportable cats. Following an extraordinary 2023, housing's first quarter performance reinforces the power of our unique business model which is highly differentiated versus the broader P&C market. Housing's competitive advantages have led to a compelling shift in its financial return over the past two years delivering strong financial performance with attractive returns. We have several distinct advantages in Global Housing. First, we have strong market positions in our core housing businesses. Specifically in Lender-Placed we have strong relationships with the largest U.S. banks and mortgage servicers including our new client Bank of America which we began to onboard in the first quarter. Second, as seen over the past 18 to 24 months in our Lender-Placed business we've been able to achieve rate adequacy quickly through the built-in annual inflation guard product feature designed to adjust with building and materials costs and normal course state rate filings. Third, our scale and focus on operational efficiencies have created meaningful expense leverage, which we will continue to benefit from going forward. Lastly, our lender-placed business provides a countercyclical hedge in the event of potential broader housing market weakness. While we would not expect tailwinds to be as significant as in prior recessions, we still expect policy placement increases if the housing market goes through a cyclical downturn. Similarly, in our renters and other business, we operate as a market leader across our affinity and property management company channels. The business has an attractive capital-light financial profile with limited catastrophe exposure and remains well positioned for long-term growth, as we continue to innovate with our partners and capitalize on secular tailwinds within the rental market. During the quarter, we increased gross written premiums by over 15%, driven by strong growth in our PMC channel. We've continued to leverage enterprise-wide capabilities to improve our customer experience and create value for our clients. For example, we leveraged our premium technical support capabilities from Connected Living to help us launch Assurant Tech Pro for the multifamily housing channel, providing residents access to technical troubleshooting services, which is a first in the industry. Turning to our enterprise outlook. For 2024, we continue to expect Enterprise adjusted EBITDA to grow by mid-single digits, excluding cats. Based on our strong first quarter performance within Global Housing, which included $22 million of favorable prior period reserve development, our 2024 results are trending toward the higher end of the mid-single-digit outlook. We now anticipate global housing will lead our enterprise growth. In Global Lifestyle, our full year outlook remains unchanged, driven by growth in Connected Living which is partially offset by incremental investments to support long-term growth. We continue to monitor global macroeconomic conditions, including inflation, foreign exchange and interest rate levels as well as new business investments. Looking at earnings per share, we now expect adjusted EPS growth to approximate adjusted EBITDA growth, reflecting lower expected depreciation expense as well as higher earnings within Global Housing. I'll now turn it over to Keith Meier to review our first quarter results and 2024 outlook in further detail."
},
{
"speaker": "Keith Meier",
"content": "Thanks, Keith, and good morning, everyone. With our strong first quarter performance, we continue to focus on driving long-term shareholder value with thoughtful and decisive actions to continue to grow and outperform. To achieve this, we are committed to a deep understanding of our global partners and their end consumers' needs, executing on the opportunities identified as well as disciplined capital management to enable long-term growth. Now let's review the details of our first quarter results. In the first quarter, adjusted EBITDA grew 31% to $384 million and adjusted EPS increased by 42% to $4.97, both excluding reportable catastrophes. From a capital perspective, we generated $254 million of segment dividends in the first quarter, ending the quarter with $622 million of holding company liquidity, up from $606 million at year-end. Our strong capital position allowed us to return $77 million to shareholders in the quarter, including $40 million of share repurchases. In addition, we repurchased $10 million of shares between April 1 and May 3. Turning to our business segments. Let's begin with Global Lifestyle. For the quarter, adjusted EBITDA grew 4% to $208 million, or 5% on a constant currency basis. Year-over-year growth was driven by strong performance in Connected Living, particularly in the U.S., which was partially offset by lower results in Global Automotive. In Connected Living, earnings increased 14%, or $16 million, primarily driven by continued momentum in our U.S. mobile protection programs and higher investment income. Results were partially offset by investments in new capabilities and client partnerships. In the U.S. Connected Living growth also benefited from modest improvements in loss experience within extended service contracts, resulting from rate actions taken over the last 18 months to offset higher claim severities from inflation. Trade-in results were flat, as higher margins and contributions from new US programs were partially offset by a decline in carrier volumes, including impacts from lower promotional activity. International Connected Living results included a $7 million favorable onetime extended service contract client benefit in Japan. Excluding this item international results were stable on a constant currency basis, consistent with the trends from the end of 2023. Foreign exchange remains a headwind impacting Lifestyle's adjusted EBITDA growth by one percentage point in the quarter. In Global Automotive, first quarter adjusted EBITDA declined 9% or $7 million, driven by higher claims costs due to persistent inflation impacts, as well as the normalization of select ancillary products. The impacts of inflation continue to be felt throughout the auto industry as indicated in the March Consumer Price Index where motor vehicle repair costs rose nearly 12% year-over-year and accelerated over the quarter. Elevated claims costs were partially offset by higher investment income. Turning to net earned premiums fees and other income. Lifestyle grew by $148 million or 7% and Connected Living increased 11% benefiting from contributions from new trade-in programs and North American mobile protection programs. Growth from Global Automotive net earned premiums fees and other income was 3%, which was primarily driven by prior period sales of vehicle service contracts. For full year 2024, we continue to expect Global Lifestyle's adjusted EBITDA to grow driven by Connected Living. We expect growth in Connected Living to be led by the continued expansion of our US business. In Global Auto, we expect adjusted EBITDA to be flat as higher investment income is offset by continued loss pressure from inflation. Prospective rate actions taken over the past 18 months are expected to drive improvement over time, depending on the timing and pace of claims inflation impacts. Investments related to new clients and programs will temper lifestyle growth in 2024, but will be a critical driver in the strengthening of our business over the long term. We continue to monitor foreign exchange impacts broader macroeconomic conditions and interest rates which may impact the pace and timing of growth. As we enter the second quarter, we expect our sequential adjusted EBITDA trend to be impacted by the absence of the onetime client benefit and seasonally lower mobile trading volumes, both in Connected Living. Moving to Global Housing. First quarter adjusted EBITDA was $193 million which included $13 million of reportable catastrophes. Excluding reportable cats adjusted EBITDA increased by 74% or $88 million to $205 million. Over half of the increase was driven by improving non-cat loss ratios from moderating claims trends and higher average premiums. A portion of the claims improvement was related to a $16 million favorable year-over-year net impact to prior period reserve development. This was comprised of a $22 million reserve reduction in the current quarter compared to a $6 million reserve reduction in the first quarter of 2023. The remainder of the adjusted EBITDA increase was mainly driven by continued top line growth in homeowners and an increase in the number of in-force policies, lower catastrophe reinsurance costs and higher investment income. For renters and other, earnings increased from growth in our property management channel. As Keith mentioned, expense leverage throughout housing continues to be a strong differentiator as our technology investments and innovations are enabling a superior customer experience. This has played a critical role in our outperformance. Given the strong first quarter performance, we expect Global Housing's full year 2024 adjusted EBITDA growth excluding cats to lead our overall enterprise growth. We anticipate growth will be driven by favorable non-cat loss experience continued top line momentum in homeowners and lower catastrophe reinsurance costs. Over the course of 2024, our lender-placed business is expected to be impacted by ongoing client portfolio movements. This includes the addition of multiple client portfolios including the onboarding of Bank of America, as well as expected offboarding impacts from the sale of a client to another party. Given the unique composition of each portfolio, these movements are expected to impact tracked loans and placement rate from quarter-to-quarter. However, policies in force a key driver of earnings is expected to grow overall for 2024. As we turn to the second quarter, please keep in mind the following; first, we had $22 million of first quarter prior year reserve development. Second, we expect normalized catastrophe reinsurance costs following lower costs in the first quarter, which were impacted by timing differences related to the program transition to a single placement as well as favorable 2023 exposure true-ups. Beginning in the second quarter, we expect quarterly reinsurance premiums to be modestly above $50 million, which is an increase from the $34 million in the first quarter. And lastly, the second quarter tends to be an elevated period for non-cat loss experience. Next, I wanted to summarize the placement of our 2024 catastrophe reinsurance program which has now transitioned to a single April 1st placement date. We are pleased with our increased coverage at attractive terms including cost savings realized in this year's placement. 2024 catastrophe reinsurance premiums for the total program are estimated to be approximately $190 million, a reduction in comparison to $207 million in 2023. As previously communicated, our per event retention increased to $150 million aligning with a one-in five-year probable maximum loss or PML. Our main U.S. program will provide nearly $1.5 billion in loss coverage in excess of our retention, protecting Assurant and its policyholders against the PML of approximately one-in-265-year storm an increase above the 2023 limit aligned to a one-in-225-year PML. Overall, this year's placement was diversified and supported by the strength of our relationships with 40-plus highly rated reinsurers. Moving to corporate, the first quarter adjusted EBITDA loss was $30 million, a $5 million year-over-year increase, mainly due to higher enterprise growth initiatives. We now expect the 2024 corporate adjusted EBITDA loss to approximate $110 million, consistent with 2023. Turning to capital management, we generated significant deployable capital in the first quarter, upstreaming $254 million in segment dividends. For 2024, we expect our businesses to continue to generate meaningful cash flow. Cash conversion to the holding company is expected to approximate two-thirds of segment adjusted EBITDA including reportable catastrophes. Cash flow expectations assume a continuation of the current macroeconomic environment and are subject to the growth of the businesses, investment portfolio performance, and rating agency and regulatory requirements. As we look forward to the remainder of the year, we continue to be focused on maintaining balance and flexibility to support new business growth and return capital to shareholders. From a share repurchase perspective, we continue to expect to be in the range of $200 million to $300 million, which will depend on strategic M&A opportunities, market conditions, and cat activity. Through the strength of our differentiated business model and given our first quarter results, we are increasingly confident in achieving our 2024 financial objectives. Our strong capital position provides us with the necessary resources to support business growth and shareholder value over the long-term. And with that, operator, please open the call for questions."
},
{
"speaker": "Operator",
"content": "The floor is now open for questions. [Operator Instructions] Thank you. Our first question comes from the line of Mark Hughes with Truist Securities. Your line is open."
},
{
"speaker": "Keith Demmings",
"content": "Good morning, Mark."
},
{
"speaker": "Mark Hughes",
"content": "Yes. Thank you very much. Good morning. In Connected Living, your EBITDA growth 14% super strong. When you look at your covered device count, it's relatively stable, trade-ins were stable but you're getting strong top line growth. How long can you continue to push the top line and profitability in an environment where covered devices seem to be relatively steady?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. No, it's a great question. I think we're really pleased with certainly how Connected Living started the year, largely driven by the strength of the US Connected Living business overall. And we've talked about this in the past, but we've had double-digit growth in Connected Living for probably seven or so years pretty consistently. As I look at the first quarter results domestic Connected Living again was up double-digits, high-single last year. So, I think we feel incredibly well positioned. We did see a little bit of softness in the devices covered count. A little bit of that is in Japan which we've talked about although our margins have been quite stable in that market. A little bit in the prepaid side as well. But the bulk of our US postpaid business, which drives the lion's share of the economics clients are performing incredibly well and feel really well positioned longer term."
},
{
"speaker": "Mark Hughes",
"content": "Your inflation guard in the homeowners business, when does that get updated? And what does it look like for this go around?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. It will get updated July 1. It will be a very modest adjustment, roughly 1%. I think last year was a little north of 3%, and then the year before, it was in the low to mid-teens. So fairly normalized level, I think as we look forward this year."
},
{
"speaker": "Mark Hughes",
"content": "And then the non-cat loss experience in housing was a good. How would you judge the weather of this quarter? It sounds like you're benefiting from rates better claims trends. How much of a weather impact do you think there was in Q1?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. I think if you set aside the development, which we called out at $22 million in the quarter, the non-cat loss ratio was just under 39%. I'd say that was relatively in line with our expectations in line with what we would expect for the full year around that loss ratio factor. So I would say, certainly we've seen normalized severity levels as inflation has come down. And then to your point, obviously, a lot of impact in the business from rate but then a tremendous amount of leverage in terms of the operating expenses both with scale but also the efforts that we've made to continue to drive automation. And Keith, did you want to add anything?"
},
{
"speaker": "Mark Hughes",
"content": "Thank you."
},
{
"speaker": "Keith Meier",
"content": "Yes, sure. I think a good way to think about that Mark as well is, Keith mentioned, 39% non-cat loss ratio. We have an expense ratio of about 38%, combined is 77%. If you add in some cat coverage, you're probably in that mid to high-80s that we talk about on a normal basis. So I think it was pretty well in that line maybe a little bit better than that."
},
{
"speaker": "Mark Hughes",
"content": "Understood. Appreciate the detail."
},
{
"speaker": "Keith Demmings",
"content": "Great. Thanks Mark."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line with Brian Meredith with UBS. Your line is open."
},
{
"speaker": "Keith Demmings",
"content": "Good morning, Brian."
},
{
"speaker": "Brian Meredith",
"content": "Yes. Thanks. Good morning. A couple of questions here. First, I'm just curious onboarding expenses for Bank of America and maybe Telstra. Are those largely complete at this point? Or are we going to see some more of that going forward? Your expenses were quite below where I was expecting this quarter."
},
{
"speaker": "Keith Meier",
"content": "Yes. So on Bank of America, we've been ramping them up this -- over the last quarter. And so those loans are now being tracked. And then in the second and third quarter those policies should be coming online. And then by the end of the third quarter, we should be fully up and running on Bank of America. So, I think the outlook for Bank of America should be improving as we go through the year. And then with Telstra, we just launched the rest of the program -- the main part of the program earlier this month. And so we went through a lot of investment there. There's still more to come for Telstra, but we're in a really good place getting Telstra launched in terms of the main part of the program."
},
{
"speaker": "Keith Demmings",
"content": "Maybe just add a little bit of color as well Brian in terms of the question about ongoing investments. So if I'm thinking about global Connected Living in the first quarter, I'd probably size $5 million of incremental investments in long-term growth in the quarter. We continue to think that will be 2% to 3% impact to the overall growth for the full year. So think about that trend line continuing as we move forward. And then it's just a question of at what pace and urgency do we deploy some of the solutions with not just the clients that we've talked about publicly but a number of clients and prospects that we're actively working on in real time which we'll disclose more on later in the year."
},
{
"speaker": "Brian Meredith",
"content": "Great. And my second question related to Global Auto. I know historically you said it was a couple of clients maybe that were really the issues. I'm wondering if it's become more pervasive. And is there anything that you're kind of thinking about doing with contracts to maybe mitigate -- some of this inflationary aspects here going forward?"
},
{
"speaker": "Keith Demmings",
"content": "Yes. So it's that -- first part of your question it's unchanged. So the clients that we've been monitoring and working on based on the deal structures their profit share type arrangements if losses go over 100% it creates short-term pressure in our P&L and then we look to recover that contractually with rate adjustments. So it isn't more pervasive than it was. But obviously there's a little bit of elevation in terms of the severity around parts and labor costs in the auto sector which I think everyone is seeing. I do feel -- continue to feel real good about our long-term opportunity in auto. Clients are working with us incredibly well. We've taken a number of rate increases over the last 18 months, 20 months. We took more rate adjustments in the first quarter. We'll do more in the second quarter. So really it's about getting this business to the right spot over the long term. We talk about relative stability in the P&L at auto in 2024 and then progressively getting better as we enter 2025."
},
{
"speaker": "Brian Meredith",
"content": "Great. Thank you."
},
{
"speaker": "Keith Demmings",
"content": "You bet."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] We have another question comes from the line of Tommy McJoynt with KBW. Your line is open."
},
{
"speaker": "Keith Demmings",
"content": "Hey, Tommy. Good morning."
},
{
"speaker": "Keith Meier",
"content": "Hey, Tommy."
},
{
"speaker": "Tommy McJoynt",
"content": "Hey. Good morning, guys. Thanks for taking my questions. The first one can you talk about as the Bank of America portfolio comes on board and perhaps also considering any other service or client additions or deletions. Is there anything that we should expect in the placement rate or the average insured values that would be different than what we should just see in the broader economy in terms of tracking mortgage delinquencies and home price appreciation anything different that's kind of changing about the nature of your tracked portfolio?"
},
{
"speaker": "Keith Meier",
"content": "Yes. So I think I mentioned in the opening remarks where we've got various changes that go on within our portfolio. Obviously, Bank of America we've talked about. We have another client that was added by another one of our clients. So that was a positive. We also have another client that was acquired by a third-party. So those loans will be coming off. So I think there's going to be a little bit of ups and downs. Some of those have lower placement rates than the average. Some of them have higher placement rates. But when you think about between now and the end of the year overall we should be up in our policy counts when you net those kind of movements within the quarters?"
},
{
"speaker": "Keith Demmings",
"content": "Yeah. And I think in a relatively stable placement rate as we exit the year Tommy, and it may bounce around a little bit. But to Keith's point, policy counts at the end of the year should be higher than where we sit today."
},
{
"speaker": "Tommy McJoynt",
"content": "Okay. Got it. That's good color. And then switching over, can you talk about the current level and perhaps your expectations for trade-in programs and promotional activity from the carriers? And just whether or not you think that could be a swing factor in the bottom line of Connected Living as we proceed through the year?"
},
{
"speaker": "Keith Demmings",
"content": "Yeah. I think we've done a really good job maintaining overall margins in the trade-in side of the business. You think about the first quarter, obviously devices serviced were down. But as we signaled, margins are quite stable and we're making up some of that with additional volume with new clients as well. So I think we feel really good about how we're positioned. And to your point, the promotional activity was relatively light in the quarter. I think clients were focused on other things within their portfolios, and moving customers to higher tier premium rate plans et cetera and driving upgrades wasn't a huge priority in the market, but we still performed quite well financially. So I think we're well positioned. And the dynamic environment particularly with the big three mobile operators is hard to predict. And obviously, we're well positioned should that activity pick up here in the second quarter and beyond. So it's hard to predict right now Tommy, but I think we feel really well positioned."
},
{
"speaker": "Tommy McJoynt",
"content": "Okay. Got it. And then last one, I think I may have missed it during the remarks. I think I heard you say that the reinsurance costs decreased. I didn't catch -- well, first off could you repeat those numbers? And then secondly, did you mention like what is happening to the per event retention if there were changes to that?"
},
{
"speaker": "Keith Meier",
"content": "Yeah, sure. So well, I guess first of all, we're really pleased with the outcome of moving to the single placement. It's really simplified the program. I think it was well received by the reinsurers. We mentioned that the cost of the program was down year-over-year. So we're expecting it to be approximately $190 million this year versus $207 million from last year. And overall, our per event retention stayed at one in five probable maximum loss. So that was up from $125 million. The top end of the program we actually increased from $1.4 million to $1.63 million. So moving it from 1-in-225-year to 1-in-265 year event. So a lot of good protection and lower cost. So I think overall, moving the program to the 04/01 placement date was I think a very favorable move for us. And then also, just in general in terms of the rates, the rates were favorable online given the reinsurance market. And I think that was a reflection of the quality of our book and our overall performance."
},
{
"speaker": "Tommy McJoynt",
"content": "Got it. Thanks for recapping that. Thank you."
},
{
"speaker": "Keith Meier",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "There are no more further questions at this time."
},
{
"speaker": "Keith Demmings",
"content": "Wonderful. Well, thanks everybody, and we'll look forward to the next quarter call. And please reach out to the IR team, if you have any questions. Have a great day."
},
{
"speaker": "Keith Meier",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "This does conclude today's teleconference. Please disconnect your lines at this time and have a wonderful day."
}
] |
ajg | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good afternoon and welcome to Arthur J. Gallagher and Company's Fourth Quarter 2024 Earnings Conference Call. Participants have been placed on listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute follow-looking statements within the meaning of the security laws. The Company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward-looking statements and Risk Factors sections contained in the Company's most recent 10-K, 10-Q, and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations to the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the Company's website. It is now my pleasure to introduce J. Patrick Gallagher Jr., Chairman and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Thank you very much. Good afternoon and thank you for joining us for our fourth quarter 2024 earnings call. On the call with me today is Doug Howell, our CFO, other members of the management team, and the heads of our operating divisions. Before I get to my comments about our financial results, I'd like to acknowledge the tragic wildfires in California. Our heartfelt thoughts are with all those impacted, including our own Gallagher colleagues. Our Company and industry have such an important role and responsibility, helping families, businesses, and communities rebuild and restore their lives. And like many times before, Gallagher and the industry will rise to the occasion. Okay, on to my comments regarding our financial performance. We had an excellent fourth quarter. For our combined brokerage and risk management segments, we posted 12% growth in revenue, our 16th consecutive quarter of double-digit revenue growth, 7% organic growth, reported net earnings margin of 13.5%, adjusted EBITDA growth of 17%, and adjusted EBITDAC margin of 31.4%, up 145 basis points year-over-year. GAAP earnings per share of $1.56, and adjusted earnings per share of $2.51, up 15% year-over-year. The December capital raise for the acquisition of AssuredPartners creates some noise in these headline numbers, so I will peel back the impact in his comments. Regardless, another fantastic quarter to close out another terrific year by our team. Moving to results on a segment basis, starting with the brokerage segment. Reported revenue growth was 12%. Organic growth was 7.1%. Base commission and fees were 7.8% in line with our expectations, which got offset a bit by slightly lower contingents. Adjusted EBITDAC margin expanded 168 basis points to 33.1%, which includes interest income related to funds raised for the acquisition of AssuredPartners. Excluding that interest income, margin expansion was 109 basis points. Let me give some insights behind our brokerage segment organic. With our P/C retail operations, we delivered 6% organic overall. The U.K., Australia, and New Zealand were all in the high single digits. U.S. retail organic was around 5%, and Canada was down a couple percent, impacted by lower contingents. Our global employee benefit brokerage and consulting business posted organic of about 10%, a really strong finish that includes the catch-up of the large life case sales that shifted from earlier in 24. Shifting to our reinsurance wholesale and specialty businesses, in total organic of 9%, which overcame some expected market headwinds in our global aerospace business. So very strong growth, whether retail, wholesale, or reinsurance. Next, let me provide some thoughts on the P/C insurance pricing environment, starting with the primary insurance market. Overall, the global P/C insurance market continues to grow. With fourth quarter renewal premium increases, that's both rate and exposure combined, consistent with the past two quarters. Thus far in January, renewal premium increases are ticking slightly higher than fourth quarter and are above 5%, driven by increases in casualty lines like umbrella and commercial auto. Breaking down fourth quarter global renewal premium changes by product line, we saw the following. Property and professional lines were about flat. Workers' comp up 1%, general liability up 4%, commercial auto up 9%, umbrella up 10%, and personal lines up 9%. So we continue to see increases across most lines and geographies. Carriers are behaving rationally and pushing for increases where it's needed to generate an acceptable underwriting profit. It's a great market for us to operate in because we can further differentiate ourselves with our leading tools, data, and expertise. Remember, our job as brokers is to help clients find the best coverage that fits their budget while mitigating price increases. We're becoming more successful securing lower pricing for our property customers, especially cat exposed property, which enables them to buy more limit or reduce their deductibles, resulting in more coverage for the same spend. Shifting to the reinsurance market. Overall, 1-1 renewals were orderly and reflected an environment that generally favored reinsurance buyers. Growing demand for property cat cover was met with sufficient reinsurance capacity, despite 2024 being an elevated year with more than $150 billion of estimated insured natural catastrophe losses. This resulted in property price declines that were greater at the top end of reinsurance towers, and similar to January 24 renewals, reinsurers continued to exercise discipline on terms and did not revert to attachment points that exposed them to greater frequency. Reinsurance buyers of specialty coverages saw modest price declines across many lines of coverage, but again, no softening in terms and conditions. Shifting to casualty, while there was adequate reinsurance capacity, reinsurers remained cautious on U.S. casualty risks due to elevated loss cost trends and potential reserve deficiencies. Looking forward, wildfire losses and casualty reserve increases seem to be the stories here in January, and time will tell how each of these ultimately impacts the market. Regardless, Gallagher Re had a fantastic 1-1 with some nice new business wins and should continue to excel in this environment. Moving to some comments on our customers' business activity. During the fourth quarter, our daily revenue indications from audits, endorsements, and cancellations remained in net positive territory. The same is true for full year 2024. While the activity is not quite as high as 2023, the upward revenue adjustments this past year are very close to full year 2022. So we continue to see solid client business activity and no signs of a meaningful global economic slowdown. Within the U.S., the labor market remains strong. Since April 24, the number of open jobs has remained relatively steady and at a level that is still well above the number of unemployed people looking for work. Employers are looking for ways to grow their workforce and control their benefit costs. And at the same time, faced wage increases and continued medical cost inflation, both are headwinds that our professionals are helping to navigate. Regardless of market conditions, I believe we are well positioned to take share across our brokerage business. Remember, 90% of the time we are competing against the smaller local broker that cannot match our niche expertise, outstanding service, or extensive data and analytics offerings. So with some nice momentum in net new business production across our brokerage business, a P/C market still seeing mid-single-digit premium growth, and a strong U.S. labor market, we continue to see full year 2025 brokerage segment organic in the 6% to 8% range. Moving on to our risk management segment, Gallagher Bassett. Revenue growth was 9%, including organic of 6%. Heading into 2025, we should continue to benefit from excellent client retention, increases in our customers' business activity, and rising claim counts. Adjusted EBITDAC margin was 20.6% in line with our October expectations. Looking ahead, we still see full year 2025 organic in that 6% to 8% range, and margins around 20.5%. Shifting to mergers and acquisitions. During the fourth quarter, we completed 20 new tuck-in mergers at fair prices, representing around $200 million of estimated annualized revenue, bringing the full year to $387 million. For those new partners joining us, I'd like to extend a very warm welcome to the Gallagher family of professionals. And of course, the big news in December was signing an agreement to acquire AssuredPartners with $2.9 billion of annual pro forma revenue. It's a compelling opportunity to build upon our commercial middle market focus, deepen our niche practice groups, and further leverage our data and analytics, allowing us to provide even more value to clients. It should also expand our tuck-in M&A reach and create more retail and specialty revenue opportunities across Gallagher. What is especially exciting is that the combination involves two highly innovative, entrepreneurial, and sales-based cultures. Although we will continue to operate as two independent companies until close, we have started discussions and are very impressed with the talent, professionalism, and excitement of the Assured colleagues. We anticipate we will receive necessary approvals and complete the acquisition sometime here in the first quarter. In addition to the pending Assured Partners acquisition, we have about 45 term sheets signed or being prepared, representing around $650 million of annualized revenue. Good firms always have a choice, and it would be terrific if they chose to partner with Gallagher. With a strong close of the year, let me reflect on our full-year financial performance for brokerage and risk management combined. 15% growth in revenue, 7.6% organic growth, 18% growth in adjusted EBITDAC, 48 mergers completed with nearly $400 million in estimated annualized revenue, and we signed a definitive agreement to acquire AssuredPartners. These are terrific metrics. And as proud as I am of the excellent financial performance this year, I'm more proud of the way our culture has stayed true as we continue to expand. Our culture is about our colleagues, guided by the Gallagher way and a rock-solid foundation they form based on every interaction we have, whether it's clients, carriers, future merger partners, or with our Gallagher colleagues around the globe. Frankly, our culture is unstoppable, and that is the Gallagher way. Okay, I'll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Doug Howell",
"content": "Thanks, Pat, and hello, everyone. Today I'll quickly recap some sound bites from our quarter and replay our early thoughts on 2025, most of which Pat just touched on, then use the rest of my time to unpack the impact of the AssuredPartners financing activities on our results during the quarter. Then I'll wrap up my prepared remarks with my usual comments on cash, M&A, and capital management. Okay, highlights from our fourth quarter that you'll see in our earnings release. Terrific base commission and fee organic growth of 7.8%, solid supplemental growth of 4.7%, and while contingents went backwards a bit this quarter, we don't see that as a trend by any means. As I look to 2025 brokerage organic, Pat relayed that we're in a favorable environment with rates still needing to increase to cover higher loss costs, trillions of global premiums growing and inflating, and our sales and service offerings outpacing our competitors, which should increase both new business and our retentions. So as we sit here today, we still believe our full year 25 brokerage segment organic growth should be in that 6% to 8% range. That's unchanged from what we said in October. As for brokerage margins, a little noise on page 5 of the earnings release. Please see the footnote. You'll read that the margin was aided by about $20 million of interest income earned on cash we're holding to close AssuredPartners. Adjusting for that, our margins would have been 32.5%, up 109 basis points over last year. That's nicely above our October expectation of margin expansion in the 90 to 100 basis point range. Looking ahead to 25, we are still viewing margin expansion like we have, like we've said many times before. We see margin expansion starting around full year organic growth of 4%. At 6%, maybe we could see 50 basis points, and at 8%, perhaps 100 basis points of expansion. Of course, those ranges can then be impacted by changes to interest income on our fiduciary assets, and then the rolling impact of M&A. By our March IR date, maybe we'll have a better read on where interest rates might go, and also the impact of Assured rolling into our numbers. But at this time, we don't see either having a significant impact on those ranges. So, really no change to how we're thinking about margins in 2025. As for risk management, another solid quarter posting 6% organic. Admittedly, a couple million dollars below our October expectations, all stemming from a smaller quarter of construction consulting revenues in the Northeast that can be just a little bit lumpy. So, adjusted margin expansion of 20.6% in the quarter was also in line with our October expectations. And then looking forward, we're seeing full year 25 organic also in that 6% to 8% range, with margins again around 20.5% for the year. So, a great quarter and full year by both our brokerage and risk management teams, and both have a strong outlook for 25. Turning to page 6 of the earnings release and the corporate segment shortcut table. For the interest and banking line, we are a bit better than our October forecast because we just were not into our line as much as we thought at that time. For the adjusted acquisition lines for M&A and clean energy, both were close to our October expectations. Then, when you look at the corporate line of the corporate segment, that was better than our expectation due to unrealized non-cash foreign exchange remeasurement income, which was partially offset by a return to actual tax catch-up of about $4 million. So, let's move from our earnings release to the CFO commentary document that we post on our IR website. First, an overarching statement. Please take some time to read any headers or footnotes throughout this document to understand what information has or hasn't been updated for the AssuredPartners deal. So, let's move to page 3 for our modeling helpers. Across the board, fourth quarter 24 actual numbers were fairly close to what we provided back in October. As for 25, we provided a first look of what we forecast. Again, none of these numbers include any impact from AssuredPartners. Turning to Page 4, a first look at our corporate segment outlook for full year 25. The only impact of Assured is found in the interest and banking line. It includes additional interest expense from the $5 billion debt raise. Flipping to Page 5 of the CFO commentary document to our tax credit carry forwards. As of year end, about $770 million that will be used over the next few years. So, still a nice sweetener to fund future M&A. We would not expect those numbers to move much because of the assured financing or the roll-in of assured's taxable income. That's because of the interest shield and also the amortization of the $5 billion deferred tax asset that we'll get with AssuredPartners. That should save us about $1.4 billion of taxes over the coming years. Flipping over to Page 6, the investment income table. This table includes an assumption of two 25 basis point rate cuts in 25. It includes interest income from cash we're holding to pay for Assured, assuming a late March close. But it does not include interest income from Assured's fiduciary assets after closing. When you shift down on page 6 to the rollover revenue table, the pinkish columns to the right include estimated revenues for brokerage M&A that we closed through yesterday. And below that table, we've added a separate section for AssuredPartners' revenues. Again, assuming a late March close, which of course is highly dependent on regulatory approvals. Then, just a reminder, you also need to make a pick for other future M&A. And then further down on that page, you'll see the risk management segment rollover revenues for 25 are expected to be approximately $5 million for each of the first two quarters. All right, moving to Page 7. This is a new page to help you see the impact of the assured partners' financing on our fourth quarter 24 revenues, EBITDAC, net earnings, and EPS by segment. The three items just to keep in mind. There was additional incremental interest income on the cash that we were holding to fund the acquisition. There was additional interest expense we incurred on the newly issued $5 billion worth of debt. And then the additional shares outstanding from the December equity offering. You'll see that for fourth quarter, it all nets out to nearly nothing, but it does cause a little noise in our numbers. Also, the callout box on the right of that page provides some information on shares outstanding because of the assured partners' equity rates for our first quarter. This includes the full impact of the shares we issued in December and the exercise of the green shoe in early January. Finally, if you flip to Page 8, you'll see that this page is just a repeat of what we provided in the December Assured presentation for ease of reference. There's no new news on this page. Finally, let's move to cash, capital management, and M&A funding. Available cash on hand at December 31st was more than $14 billion, of which approximately $13.5 billion will be used to fund AssuredPartners. Since year end, we received another $1.3 billion as the underwriters exercised the green shoe. So, considering this and our strong expected free cash flow, we are in an excellent position to fund our M&A pipeline of opportunities. Here in 25, it's looking like we could have $3.5 billion to fund future M&A. Then it jumps up to nearly $5 billion in 26, all while maintaining a solid investment grade rating. So, an excellent quarter and an excellent year to have in the books. As I reflect on 24, I have to say that we had a pretty terrific year. For the combined brokerage and risk management segments, we posted adjusted revenue growth of 14%, organic of 7.6%, overall margin expansion of 94 basis points, and most importantly, we grew our EBITDAC 18%. Those are terrific numbers and reflect what Pat said. That's our unstoppable culture. So, those are my comments. Back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Thanks, Doug. Rob, you want to open it up for questions?"
},
{
"speaker": "Operator",
"content": "Sure, Mr. Gallagher. We'll now open the call for questions. [Operator Instructions]. Now, our first question comes from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question."
},
{
"speaker": "Mike Zaremski",
"content": "First question is surrounding the cadence of organic growth next year. Loud and clear, 6-8, no change. I guess, yes, for both segments. I guess I'm more specifically focused on the brokerage segment. But in terms of the cadence or seasonality, anything you'd like to call out? Two of your peers called out kind of weaker seasonality in 1Q. We do know that reinsurance is overweight in the beginning of the year, too, and maybe downwards pricing there could cause some year-over-year tougher comps."
},
{
"speaker": "Doug Howell",
"content": "Let me go back to that. Let me start with the end of that. There have been some price changes on the reinsurance, but our customers are buying more reinsurance. So when you look at the total spend for us that our customers are spending, we're really not seeing a decrease, and like Pat said in his comments, we had a terrific new business quarter also. Going back to the first part of your question, yes, reinsurance is typically stronger in the first quarter, and so you could see some seasonality of better organic growth in the first quarter than what develops out for the rest of the year. I'll study in a little bit about that, as we do have a substantial amount of our health and medical benefits that renew in the first quarter that mitigate maybe a higher reinsurance on it. And then throughout the year, our retail is performing well. Our wholesale seems to be getting stronger and stronger. Our programs are doing well. But, yes, you would see a little seasonality because of reinsurance in the first quarter and our organic growth."
},
{
"speaker": "Mike Zaremski",
"content": "Okay, got it. So you're saying actually it could be higher, not lower, even if reinsurance pricing is down? Okay."
},
{
"speaker": "Doug Howell",
"content": "I'll have a chance to talk to you again on our March IR day, and we should have a better feel of the seasonality for that, too."
},
{
"speaker": "Mike Zaremski",
"content": "Okay, awesome. The last question is on, do we share investment income? I'm thinking through post the deal close, if you're able to comment. So my understanding is that the company you're purchasing kind of didn't fully leverage its fiduciary income in that it was direct pay relationships between the businesses paying directly to the insurance carriers, and you guys might be able to optimize that working capital to gain more fiduciary assets. If that's what I'm describing is correct, can you offer kind of a timeline on how that works in terms of kind of getting those asset balances onto your balance sheet?"
},
{
"speaker": "Doug Howell",
"content": "Yes, your recollection is correct, and I think that if you go back, I don't know, 10 years ago when we went through our exercise in consolidating bank accounts from around the world, this would be obviously mostly in the U.S. We did have some good success of picking up more fiduciary cash into our accounts, and I think that would be invested. So we do see that as an opportunity that we'll be better together on that metric. So, yes, there should be versus their run rate, I'm guessing together we'll be better on that going forward."
},
{
"speaker": "Mike Zaremski",
"content": "Doug, is there just any, is that kind of a one-year process, or that kind of takes many years?"
},
{
"speaker": "Doug Howell",
"content": "Listen, in 18 months we shouldn't be talking about it anymore, so I think we'd get it done. Hopefully faster."
},
{
"speaker": "Operator",
"content": "The next question is from the line of Gregory Peters with Raymond James. Please proceed with your question."
},
{
"speaker": "Gregory Peters",
"content": "I guess I'd like to start with California. Given the substantial potential loss to the insured market, I'm curious if you could give us some perspective of how it might touch your operations. I'm interested in, you know, the business going inside RPS, if there's any impact on the wholesale market that you're seeing. If you can just talk about your perspectives of that as we watch this disaster unfold, that'd be great."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Well, first of all, Greg its Pat, we reached out to thousands of clients already to make sure that they had the knowledge of how to file claims and what have you, how to get a hold of us if they're having difficulty in filing those claims. We are presently tracking, I forget the exact number today, but we have hundreds of claims that we're helping our clients with already. I think that you've got a situation that is going to continue to unfold for us. We're a big player in California. We're a big player in Los Angeles. Not huge in personal lines there, but it's going to keep us incredibly busy for a number of months. And then in terms of the impact of that, luckily, again, we've been able to stay in touch with our people. We have had our folks in some instances were evacuated. We did not lose anybody and don't have many of our folks that have lost any of their homes. So I think we'll be well in a strong place to help our clients, but I can't give you much more than that right now in terms of how it's going to impact our day-to-day activities out there."
},
{
"speaker": "Gregory Peters",
"content": "Okay. And then I guess my follow-up question is switch gears. You mentioned in your comments about the lower contingents. Just curious, given the profitability we're seeing in the industry, I would have imagined that supplementals and contingents would be up. And I think your guidance for 25 suggests that they should go back up again. But maybe you could spend a minute and give us some color on what happened with contingents in Europe, and then color on your outlook."
},
{
"speaker": "Doug Howell",
"content": "Yes, great question, Greg. Thanks for asking. Like I said, I ended in my comments. This isn't a trend, and what you said there is right. We would expect it to bounce back up again. Frankly, it's simply because as we get the final year and loss ratio estimates in from the carriers, they're coming in just a little bit higher than what maybe we had been anticipating throughout the year. And to put this in context, we see this as about maybe a $7 million shortfall to what we were thinking back in October. Two-thirds of it is spread across hundreds of contracts. And so if the loss ratios are ticking up just a little bit, that probably costs us $4 million of it. And then another third is we had about three contracts and programs in Canada that just really kind of came in here in January with really not very great results. But if you look at it on an annual basis, when you combine supplements and contingents, I think if I do the math here, mentally I think it's about 8%, even with the small blip in the fourth quarter. So it's still a terrific year. But I wouldn't over-read that there's some systemic shift in what contingents and supplementals are going to be going forward. So I would expect those numbers to grow over the blip this year considerably."
},
{
"speaker": "Gregory Peters",
"content": "Just a clarification on that answer, Doug, is there a specific line of business? Is there across a broader business set?"
},
{
"speaker": "Doug Howell",
"content": "It's across the line, Greg. I wouldn't say there's anything there. We have hundreds of these contracts, and we get a lot of this information coming in here right around the first week or two of January."
},
{
"speaker": "Gregory Peters",
"content": "Thank you for your answers."
},
{
"speaker": "Doug Howell",
"content": "I guess another way of saying it, on a $600 million number, only to have maybe $3 or $4 million of what I would say loss ratio, I think our picks have been pretty good throughout the year."
},
{
"speaker": "Gregory Peters",
"content": "I would say so."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Andrew Kligerman with TD Securities. Please proceed with your question."
},
{
"speaker": "Andrew Kligerman",
"content": "First question is around the risk management segment. Thinking back to last year, you had guided to 9% to 11% organic growth for this year, and now for next year, for 24, that is, and now for 25, you're guiding to 6 to 8, which I still think is fabulous. But what's kind of changing that your guidance isn't quite as robust as it was to start last year?"
},
{
"speaker": "Doug Howell",
"content": "Here's the thing. I think that this business, if you recall, we can get some pretty large contracts that come in. It is a little bit more elephant hunting, so to speak. So this year, I think that we've got some nice new business in the pipeline coming into 25, and so I'd leave you to go back in the history of Gallagher Bassett and the risk management segment. We have periods like this where it will grow mid-single digit, something like that, and then they'll have a couple of nice large contracts. We still see that happening. Some of our government programs that we do down in Australia have some nice opportunity, and then more and more we're proving to the carriers left and right that we can actually deliver better claim outcomes on that business. And as a carrier decides to use us for their claims payment process on work comp and general liability, we're not storm chasers, remember, but it is a little bit more of a lumpy business as we get some pretty nice size."
},
{
"speaker": "Andrew Kligerman",
"content": "I see. So like you never know, you could probably find another elephant this year, right?"
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Yes, that's right. Our process list is always filled with elephants. They're just hard to find every once in a while."
},
{
"speaker": "Andrew Kligerman",
"content": "And then I'm just kind of curious about your operations in India, the Center for Excellence, where I think you have about 12,000 employees right now, and, as you look out through this year, do you need to add people, given the AssuredPartners transaction? Can you keep it steady? And, you know, is technology making it such that you really don't need to hire that much?"
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Well, I think you got both ends of that correct. We're going to be using technology quite a bit, and as we use technology that does make that group there much more efficient, and yet at the very same time our organic growth and our acquisition growth puts a lot more demand in the structure. And so at about 12,000 employees, I think that at this time next year you'll see us up additional thousands."
},
{
"speaker": "Doug Howell",
"content": "Yes, the other thing, too, to think about this, the value that it brings is when work goes into our service centers, remember those are our folks. They're not working for anybody else. They work for us. It causes standardization. It causes process improvement. I got to tell you, that gives us a head start by years and years when it comes to implementing technologies and AI into the work that's already been standardized. And truthfully, as we develop AI technologies that replace some of that work there, all of those folks have opportunities to, because our growth, they don't lose their jobs. It's just they move up higher in the value chain on it. And so it's really a juggernaut, in my opinion, in terms of our ability to offer some of the very best service in the world."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "And unless you standardize that service, A, you can't automate it. But, B, when you do standardize it, it makes you better and better at the service for our clients. Just take certificates of insurance. We're going to issue three, four million of them pretty much error-free. There aren't any real brokers that can claim that."
},
{
"speaker": "Andrew Kligerman",
"content": "I see. So maybe with the bottom-line takeaway is, you may add a thousand or two employees, but it's still scalable. You're still getting better margins from that. Is that the right final takeaway?"
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Yes, you're right on the money."
},
{
"speaker": "Andrew Kligerman",
"content": "Thank you."
},
{
"speaker": "Doug Howell",
"content": "It won't surprise me that, like-for-like, in five years we've doubled that number."
},
{
"speaker": "Operator",
"content": "Our next question is from the line of Elyse Greenspan with Wells Fargo. Please proceed with your question."
},
{
"speaker": "Elyse Greenspan",
"content": "My first question is on the brokerage outlook for 25. So you reaffirmed the six to eight. I think when we last spoke in October, you said, maybe benefits is a five. Reinsurance is a nine. I want to confirm that's where you still see it. And then you also had said you would provide, I think, by line in a little bit more detail at the December day, right, which did not happen. Could you give us a sense even away from benefits and reinsurance, just how you see all your businesses trending organically in the 6% to 8% 25 brokerage guide?"
},
{
"speaker": "Doug Howell",
"content": "I think, yes, confirming everything you've said. So I think Pat did a pretty good job in his script of telling you how those businesses are growing right now. I think those are good guesses for next year at this point."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. That's helpful. And then my follow up question. How do you see how's their pipeline of transactions? Right. You guys also did, a good number of bolt on deals to end the quarter. And, in terms of the AP pipeline, I know when you guys announced the deal, you highlighted the fact that there was very little overlap on pipelines. So would you expect, I guess, once that deal closes, at some point at the end of the Q1, I guess that kind of just the quarterly level of M&A activity, could pick up from bringing the two firms together."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "So Elyse, this is Pat, I think that, first of all, we have to continue to operate these enterprises separately till we're closed. But we do know that there's very little overlap at all. And AssuredPartners has been very, very good at tuck-in acquisitions. And as you saw in our -- when we were making the announcement, there has not been that much overlap between things that we wanted to put on and things that they actually bought. So we view their pipeline is very, very accretive to what we're doing and not a lot of overlap. And I think that's going to be fantastic. They've got a great team doing this stuff. We're impressed with what we've seen and due diligence and the like as to what they've done, what they've bought and the pricing they're getting for that. And I think you will see us increase substantially the number of deals. Now, there's small deals. They're very good at tuck-in, bolt-ons and small, privately held firms in and about many of the parts of the country that we're not in."
},
{
"speaker": "Elyse Greenspan",
"content": "And then the 1.3. Oh, sorry."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "I'm sorry. Go ahead."
},
{
"speaker": "Elyse Greenspan",
"content": "I was just going to say the 1.3 billion from the green shoe, right, that wasn't contemplated because the financing was there without it. So is that just extra cash that you have for the pipeline, the capital that Doug was talking about in his comments."
},
{
"speaker": "Doug Howell",
"content": "Yes, that's right."
},
{
"speaker": "Operator",
"content": "Our next question is from the line of Mark Hughes with Truist Security. Please proceed with your questions."
},
{
"speaker": "Mark Hughes",
"content": "Doug, the guidance you gave for the first quarter contribution from AssuredPartners. Is there any seasonality there or is that just the timing of the deal?"
},
{
"speaker": "Doug Howell",
"content": "Right now, we've assumed that's just the timing of the deal. They will have some seasonality, especially in their benefit business. And then anything that might be a public entity type business might be skewed to July. So you'd see a little bit of seasonality. But what you see in there is a pure straight line assumption of it."
},
{
"speaker": "Mark Hughes",
"content": "And then, Pat, in the wholesale business, you gave the wholesale and reinsurance together. I think up 9%. Any detail you can provide on wholesale observations on the E&S market?"
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Let me take a look, Mark."
},
{
"speaker": "Doug Howell",
"content": "Yes, I think I've got that. I think that you've got to look at our U.K. specialty at maybe around 7%. You look at U.S. specialty, maybe on the 10%, re is pretty small in the quarter. It's just not a big quarter for us. So if you look at those two numbers, when we would get that maybe that gets us back to that that 9% number there."
},
{
"speaker": "Operator",
"content": "The next question is from the line of David Motemaden with Evercore ISI. Please proceed with your question."
},
{
"speaker": "David Motemaden",
"content": "I had a question for Doug, just trying to unpack the brokerage organic this quarter. And I don't want to nitpick too much, but you guys were looking for 8%. And I'm just wondering, so what was the entire differential? Just the contingent and the life sales came back as expected, and it was just totally offset by the contingent. I'm hoping you can unpack that a little bit."
},
{
"speaker": "Doug Howell",
"content": "Yes, you're right. The base commission and fees at 7.8% percent. That business contingents and supplementals have been running kind of consistent with that together. So the difference of the $7 million, I'd put it up in the upper 7% range, somewhere pretty close to the base contingency. So you're right. You're spot on in your observation there."
},
{
"speaker": "David Motemaden",
"content": "Okay, great. Thanks for confirming. And then I wanted to follow up just on I guess I was surprised the RPC stayed at 5%. Just given the property price was flat versus up for last quarter. So I'm wondering if maybe it's mixed, but I'm wondering if there's anything else from sort of like an increased purchasing or buy up dynamic that you guys are observing as the property rates moderate here."
},
{
"speaker": "Doug Howell",
"content": "Well, we see that across that. Yes, I mean, we've always said it's been a long time. We've talked about this as rates are going up. Customers opt out of certain coverages. And that might be by raising deductibles or reducing limits on it. Sometimes they'll drop some coverages. So remember rates are still increasing. I think it's important for everybody to realize that kind of across the board, we're still in a rate increasing environment. They're buying more insurance. And reinsurance you're seeing that from the carriers that they're buying more. And then the customers, they are buying more coverage on it. So they'll opt in."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Insurance to value is a big deal. Much more pressure on insuring to value."
},
{
"speaker": "David Motemaden",
"content": "Got it. Thanks. And then maybe just to sneak one else in, one other one in. Doug, I think you had said last call that the underlying brokerage business is running at like a 7% to 8% organic growth. Just on an underlying basis, but then the 25 range is in the 6% to 8% range. So I guess I'm wondering, is that 6% percent just sort of conservatism? Like what sort of scenario would sort of get that, get you guys out of that, 7% to 8% range?"
},
{
"speaker": "Doug Howell",
"content": "Well, listen, I think right now that, we said way back in October that, next year felt a lot like this year. And we're kind of in that mid-7% range somewhere this year. The range around it sitting and looking out over the next 11.5 months, I guess, that it's 6% to 8% is consistent, what we've said before. So we think we'd like to stick with that. I think our team's working pretty hard to always be better than the midpoint of the range, obviously. But the market's changing. We'll see what wildfires do. We'll see what casualty reserves will do. We're still digesting that. I will say on the wildfires, maybe you know this. I still don't know how the extra living expenses have been factored into the wildfire estimates for the cat loss on that. And then, you can't open up the news any day without somebody taking a casualty reserve strengthening. So those things, will cause carriers to take a really hard look at what they're doing with the rates. So within 2% is a pretty good guess as we look for the year. Isn't it nice being in that range versus years ago when we were pretty excited about 1% or 2% organic growth?"
},
{
"speaker": "David Motemaden",
"content": "No, completely agree. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question is in the line of Katie Sakys with Autonomous Research. Please proceed with your question."
},
{
"speaker": "Katie Sakys",
"content": "I guess my first question is, thinking about the last call, I think, Doug, you'd mentioned that you expect brokerage organic growth in 2025, split between the components to come from about half new business and then perhaps a quarter each to rate and exposure. Has your perspective on the components of that brokerage organic growth guide changed in the context of the AssuredPartners acquisition?"
},
{
"speaker": "Doug Howell",
"content": "No. Pat summarized it pretty quickly. That's what we're still seeing happening right now."
},
{
"speaker": "Katie Sakys",
"content": "Okay. Sounds good. And then, it looks like international retail brokerage growth kind of continues to cool off a little bit. How are you guys thinking about the environment for organic growth abroad this year versus what looks like perhaps a little bit more stable growth in the U.S.?"
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Katie, I think you got to really look at that by geography. I mean, there's parts of the world that are just really, really growing incredibly well. We set our board meeting and did a deep dive into some of our Latin American businesses, not huge in part of the whole overall enterprise, but incredibly nice growth there. And so there's -- it depends. Canada, a little bit of a slowdown this past quarter. We talked about that. But as you look across the whole patch, it's hard to put a finger on it, which is why we try to give you a guidance in terms of the overall how it should shake out. But we definitely have some geographies that are doing extremely well and just have continued future growth that is going to be fantastic."
},
{
"speaker": "Doug Howell",
"content": "Yes. Katie, one of the things I'm kind of looking at what we said this quarter versus what we said back in October. We didn't have an opportunity to update you in December. But U.K. retail especially is still in high single digits. We said that it was 6% percent before. U.K. retail, I think we said 8%, and this quarter we're saying closer to 9%. Canada, maybe the one that's poking its head out to you a little bit, we said is more flattish, and now we're down a point or so. And then Australia, New Zealand, we said is about 10% maybe in October, and we're still in the very high single digits on that. So I don't know if it's necessarily – it might be just that Canadian piece that pops out at you that's causing you to have that perspective."
},
{
"speaker": "Katie Sakys",
"content": "Appreciate the additional color there. Thanks, guys."
},
{
"speaker": "Operator",
"content": "The next question is from Meyer Shields with KBW. Please proceed with your question."
},
{
"speaker": "Meyer Shields",
"content": "I like how everyone's claiming they're Canadian. Doug, you mentioned –"
},
{
"speaker": "Doug Howell",
"content": "I'll tell you personally, Meyer."
},
{
"speaker": "Meyer Shields",
"content": "Yes, I'll try not to. You mentioned, obviously accurately, that there's a ton of adverse development that we're seeing in general liability. And I was wondering whether there's any direct impact when you've got, I don't know, more frequent claims or more attorney involvement in terms of how Gallagher Bassett grows revenues."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Well, I mean, clearly claim activity helps this far. I mean, there's no question about it. But when it comes to severity, we don't participate in our clients up or down in terms of severity. We do everything we can to manage the final outcome, and we contend, and we believe we have the data and analytics to prove this, that if you hire Gallagher Bassett, your outcomes, meaning your final settlements, will be superior. And that does not mean that we're taking advantage of the claimant. That means that we're handling the claimants actually better than you see in the general market. So if you've got some severity out there, and that creates frequency, frequency definitely helps Gallagher Bassett. We get paid essentially on a per-claim basis, as does economic growth, because with economic growth comes more employment. And remember, most of Gallagher Bassett's revenues, a good portion of them, are workers' compensation driven."
},
{
"speaker": "Doug Howell",
"content": "Yes, I think one of the things, all of those forces actually should cause clients to look at Gallagher Bassett even more. The way we can do nurse case management, the way we have our managed care offering, the way that we can understand where there are opportunities to use different physicians. We also understand the attorneys, because we deal with them so often. When claims get more complicated, Gallagher Bassett actually can show more value to the customer. And I think that's the environment we're in. They're paying $12 billion, $13 billion, $14 billion of claims, and they get pretty good at that."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "And remember, by and large, about $0.60 to $0.65 on every premium dollar turns into a claim. That's the function of the industry. We're seeing that, of course, in the West Coast. And so if you're going to have an impact on your costs, you better pay attention to that portion of the dollar that goes out the door in claims. Again, we think we do that at a level that's better than the competitors, both TPAs and carriers."
},
{
"speaker": "Meyer Shields",
"content": "Okay. No, that's very helpful, very thorough. Switching gears, I'm just looking for an update on the multiples for M&A, because we've seen not only your acquisition of AssuredPartners, but a lot of the other big brokers out there have made big acquisitions. I don't know if that speeds up or decelerates competition for tuck-ins."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Well, this, of course, is all speculation on my part. But remember, and we try to share it pretty much every quarter, what we are buying at. And you're not seeing our tuck-in acquisitions and the activity that we do on our smaller deals anywhere near the treetop levels of multiples that have been running up over the years. I do think that the AssuredPartners acquisition, we have a very smart seller. I think we were an opportunistic buyer, and I definitely think there's a signal there."
},
{
"speaker": "Operator",
"content": "Our next question is from the line of Rob Cox with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Rob Cox",
"content": "Hey, thanks. And I apologize for asking another question on brokerage organic. But when you consider the 6% to 8% organic growth range, could you give us some insight into what level of renewal premium change you're thinking about within that? Because I'm wondering if you're assuming sort of some of the acceleration that you think may be happening in the casualty market, or if you don't need that to achieve the 6 to 8."
},
{
"speaker": "Doug Howell",
"content": "Yes, I think that estimate is not assuming that there's tailwinds produced by the fires or the casualty strengthening. We kind of see that in the current environment we had. Like we said earlier, we think that net new business over loss will contribute about half of that number. We think that exposure will be about a quarter of it, and rate will be about a quarter of it. So there's not a big assumption for rates in here, nor is there a really big assumption for exposure unit growth. I mean, this is just what we're seeing in our net new business wins right now. We're showing pretty well out there in the field. And here, go back to what we said before. When there's not as much chaos in the market, we get to show our tools and capabilities shine brighter in those environments. Because when it's chaotic in the environment and customers are listening to big rate increases, they're just trying to get their insurance placed. They're already a bit stung by the fact that rates are up. We work very hard to keep those rates down for them. Now we'll be able to go in and show prospects, just in a level playing field here. When things aren't chaotic, you should be using our tools and capabilities to buy your insurance through us, or let us buy your insurance for you using our capabilities. So this is an environment where we believe our new business will shine. We think our service offering is getting better and better every day. We have insights into what clients might be a little shaky. Let's get out and talk to them and make sure that we get the renewal put to bed soon. So I think that this is an environment where I think that our folks can shine with the tools and capabilities that they have."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "I would have killed in the past, as Doug alluded to, when we were talking about up one, up two, for a 5% premium rate growth as an environment. That would be nirvana 10 years ago. So I think it's a very strong place to be. Remember, our job is to mitigate that for our clients. But it's a great place for us to show exactly what Doug was saying, which is our capabilities. In particular in the areas of data and analytics, which I want to remind the listeners, you don't get a chance to listen to the smaller brokers that we're competing with on a quarterly basis. We're pulling away from them more and more with our capabilities. And clients, I'm talking middle market clients, very much appreciate the ability to sit and talk with them about people like you buy this, or you should have this type of limit, because in our data we see losses at this size. That capability is just getting more and more attention by the buying community, and it's differentiating us every single day to a greater level."
},
{
"speaker": "Rob Cox",
"content": "That makes sense. Thank you for all the color. Pivoting to reinsurance brokerage, I just wanted to ask, because I know your growth has been a good bit stronger than your two largest competitors in the reinsurance brokerage space for a number of years now. And Gallagher has a lower revenue base, but it doesn't seem like that would be the only driver of the outperformance. So I was hoping you could remind us what's driving Gallagher's ability to deliver what's been more like double-digit organic growth in reinsurance."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Well, I think that it's just blocking and tackling. I think one of the things that we've found there is it's a great sales team. They're backed up by terrific analytics, incredible capabilities in consulting on capital management, and there's no doubt being part of Gallagher has offered them some additional opportunities."
},
{
"speaker": "Doug Howell",
"content": "Yes. I think that as they team up with our wholesalers, our program folks, and our retailers, they get to see firsthand what's going on on the street. I think that helps them provide better insights to their primary carriers. And I think that we're doing a terrific job of making them an integrated part of us, not just a unit within the holding company structure."
},
{
"speaker": "Operator",
"content": "Our next question is a follow-up from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question."
},
{
"speaker": "Mike Zaremski",
"content": "Oh, great. My thoughts on reinsurance as well, just the strong results. Just curious, maybe a mix on reinsurance? Do you potentially have a greater mix towards casualty or specialty Europe-focused that could be helping the outlook, given casualty pricing is fixed already?"
},
{
"speaker": "Doug Howell",
"content": "Yes. We have a terrific casualty bulk of business. North American casualty is a big part of our U.S. business. But we're probably a little underweighted on property, maybe, versus the others. So I think that's probably more casually weighted. I don't exactly understand their book of business, but I think that what our perception is that we're underweight on property."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "And also, where's the pain right now if it was a reinsurance buyer? It's casually. We've talked about it in these calls, and there's no question about it. That's the area that's got some pain, and our team is really, really good at that."
},
{
"speaker": "Mike Zaremski",
"content": "Got it. Maybe since it's not 6.15, I'll sneak one last one in. Just curious, health inflation for employers, at least some of the stats we've seen, it's expected to rise 25 versus 24. Maybe you disagree with that. Does that provide any uplift to the organic for employee benefits? I know there's a lot of building blocks for employee benefits."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Every time we get -- we are clearly a leader in our capabilities to consult, manage, and place health and welfare. And it's a huge problem for employers. And it's going up, as it seems to never stop doing. And so, there's all kinds of tools that you need to have in your toolbox to handle that. And we're very, very good at that. And, by the way, we're extremely good at it in the commercial middle market, where I think there's maybe not as much competition, frankly."
},
{
"speaker": "Operator",
"content": "Thank you. Our final question is from Alex Scott with Barclays. Please proceed with your question."
},
{
"speaker": "Unidentified Analyst",
"content": "Thank you all. This is Justin on for Alex. Just kind of going back into the brokerage segment in the commercial middle market, just wanted to ask. I understand, it seems like 90% of the time you guys are competing against independent brokers. I was just curious, in light of sort of the large-scale acquisitions that's been taking place, whether or not you see sort of this, 90% number to dwindle over time. And just let me think about 25 and ahead."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Oh, the AssuredPartners people are competing with those same independents in communities that we're not in today, which is only going to increase. When you take a look at our at-bats, our number of at-bats are going to go up substantially because of AssuredPartners. And 100% of those at-bats, that's not true. Ninety-five percent of those at-bats are going to be against smaller players."
},
{
"speaker": "Doug Howell",
"content": "Yes, I think the fragmented market, there's 30,000 agents and brokers, and those are companies, not necessarily those with a brokerage license. So we're competing against the other 29,950 brokers that are out there. So, I mean, AssuredPartners will be absolutely there. It does help us go after those accounts that are in cities that we're not in. So we think it's a great one plus one can equal more than two for sure."
},
{
"speaker": "Unidentified Analyst",
"content": "Sure thing. Thanks for the color."
},
{
"speaker": "J. Patrick Gallagher Jr.",
"content": "Thanks, Justin. Thanks, Rob. I think we're ready to wrap up here, and I just have a quick comment, and that is thank you again for joining us this afternoon. As you all know now, we had a great fourth quarter to finish, an excellent year of financial performance. A huge thank you goes out from this table to our 56,000 colleagues around the globe. It's your creativity, expertise, and unwavering client focus that continue to set us apart. We look forward to speaking with the investment community at our mid-March IR Day and thank you all for being with us this evening."
},
{
"speaker": "Operator",
"content": "This does conclude today's conference call. You may now disconnect your lines at this time."
}
] |
ajg | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good afternoon. Welcome to Arthur J. Gallagher & Company’s Third Quarter 2024 Earnings Conference Call. Participants have been placed on listen-only mode. Your lines will be open for questions following the presentation. Today’s call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. The company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward-looking statements and risk factors sections contained in the company’s most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company’s website. It is now my pleasure to introduce J. Patrick Gallagher, Jr., Chairman and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thank you very much. Good afternoon, everyone, and thank you for joining us for our third quarter 2024 earnings call. On the call for you today is Doug Howell, our CFO, other members of the management team and heads of our operating divisions. Before I get to my comments about our financial results, I’d like to acknowledge the damage and devastation caused by the recent storms and floods. Our thoughts are with those impacted by these events, including our own Gallagher colleagues. Our professionals are hard at work helping clients sort through their coverages, file claims and ultimately get losses paid. I’m really honored to be part of a company in an industry with such an important responsibility, helping families, businesses, and communities rebuild and restore their lives and that’s a noble cause. Okay, on to my comments regarding our financial performance. We had a great third quarter. For our combined Brokerage and Risk Management segments, we posted 13% growth in revenue, 6% organic growth, which does not include interest income. Reported net earnings margin of 15.5%, adjusted EBITDA margin of 31.9%, up 123 basis points year-over-year. GAAP earnings per share of $1.90 and adjusted earnings per share of $2.72, up 16% year-over-year. Another fantastic operating quarter by the team. Moving to results on a segment basis, starting with the Brokerage segment. Reported revenue growth was 13%. Organic growth was right in line with our expectations at 6%, which, as we forecasted, reflects about a point of timing headwind from those large life cases we have highlighted over the past couple of quarters. Doug will provide you with some good news from October related to these sales in his remarks. Adjusted EBITDA margin expanded 137 basis points to 33.6%, which was better than our IR Day expectations. Let me give some insights behind our Brokerage segment organic. Within our PC retail operations, we delivered 5% in the U.S. and 7% outside the U.S. Internationally, Australia and New Zealand led the way with organic of more than 10%. The U.K. was up 6% and Canada was flattish. Our global employee benefit brokerage and consulting business posted organic of about 4%, and a few points higher, excluding the timing differences from the large life case sales. Shifting to our reinsurance wholesale and specialty businesses, overall organic of 8%. So very strong growth, whether retail, wholesale or reinsurance. Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance market. Global third quarter renewal premiums, which include both rate and exposure were up 5% and little change from the 6% we discussed at our September IR Day update a few weeks ago. Most lines and geographies had very similar renewal premium changes through all three months of the quarter, with a couple of exceptions. September casualty renewal increases outside the U.S. were lower relative to July and August, driven by changes in business mix. Additionally, large account and E&S property renewal premium increases were a bit less in September than the first two months of the quarter. But neither of these appear to be a trend. Thus far in October, we’re seeing large account property and international casualty renewal premium increases higher than September. Breaking down third quarter renewal premium changes by product line, we saw the following. Property up 4%, general liability up 6%, commercial auto up 7%, umbrella up 10%, workers comp up 2%, D&O down about 5%, cyber was flat and personal lines up 11%. So overall, increases continue to be broad-based and rational in our view, with carriers still cautious and pushing for rate where it’s needed to generate an acceptable underwriting profit. We shine in this environment. Our job as brokers is to help clients find the best coverage while mitigating premium increases. So while not all the increases ultimately show up in our organic, a rational market allows us to further differentiate ourselves with our leading tools, data and expertise. Let me shift to the reinsurance market. The July 1st renewal season saw modest property price declines concentrated at the top end of reinsurance towers, while casualty renewals saw terms and conditions tighten, and some modest price increases concentrated in the U.S. Clearly, a lot has happened in the property market over the past month, which is now adding some complexity to January 1st property renewals. It’s still early, but we now believe a flattish renewal is more likely than the downward pressure previously being discussed. And don’t forget, U.S. hurricane season is not over for another month. For casualty risks, we believe reinsurance will remain cautious heading into next year, especially if there is more noise related to U.S. reserve adequacy. We think differentiating underwriting practices will likely be the key to a successful renewal for clients. Overall, the reinsurance industry remains adequately capitalized and is likely to meet capacity demands at the upcoming January 1 renewals. We continue to believe Gallagher Re will perform very well in 2025, regardless of how the market environment unfolds in the near-term. Moving to some comments on our customers’ business activity. Our daily revenue indications from audits, endorsements and cancellations were again in positive territory for the third quarter. While the amount of upward revenue adjustments isn’t as much as 2023, they’re running in line with 2022. So client business activity remains solid and we are not seeing any signs of meaningful global economic slowdown. Within the U.S., the labor market is on solid footing. In fact, the number of open jobs increased in August and remained well above the number of unemployed people looking for work. Overall job growth, upward wage pressure and rising medical cost inflation continue to challenge employers looking for ways to grow their workforce and control their benefits costs. Regardless of market or economic conditions, I believe we are well positioned to take market share across our Brokerage business. Remember, about 90% of the time we are competing against the smaller local broker that cannot match our client value proposition, niche expertise, outstanding service and our extensive data and analytics offerings. Putting this all together, we continue to see full year 2024 Brokerage organic around 7.5% and that would be another outstanding year. Moving on to our Risk Management segment, Gallagher Bassett. Revenue growth was 12%, including organic of 6%. We continue to benefit from excellent client retention, increases in customer business activity, rising claim counts, and new business wins. Adjusted EBITDAC margin was 20.8%, 35 basis points higher than last year, and a bit above our September IR Day expectation. Looking ahead, we see organic in the fourth quarter around 7% and full year organic pushing 9%. Margins for fourth quarter and full year should be in the 20.5% range, and that, too, would be another outstanding year. Shifting to mergers and acquisitions. During the third quarter, we remain disciplined, completing four new mergers at fair prices representing $47 million of estimated annualized revenue. For those new partners joining us, I’d like to extend a very warm welcome to the Gallagher family of professionals. Looking ahead, we have more than 100 mergers in our pipeline, representing approximately $1.5 billion of annualized revenue. Of these 100 potential partners, we have about 60 turn sheets signed or being prepared, representing around $700 million of annualized revenue. Good firms always have a choice and it would be terrific if they chose to partner with Gallagher. Let me conclude with some comments regarding our culture. As we passed our 40th anniversary as a public company, I believe our greatest differentiator continues to be our bedrock culture. It’s a culture that runs towards problems, not away from them. A culture that supports one another and embraces teamwork. A culture that is grounded in the highest standards of moral and ethical behavior. It’s a culture that will continue to guide our success for many years to come. Frankly, we love this business. We enjoy taking care of our customers and that is the Gallagher way. Okay, I’ll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Doug Howell",
"content": "Thanks, Pat, and hello, everyone. Today, I’ll walk you through our earnings release. First, I’ll comment on third quarter organic growth and margins by segment. Then I’ll provide an update on how we are seeing organic growth and margins shape up for fourth quarter and provide an early look on 2025. Next, I’ll move to the CFO commentary document that we post on our IR website and walk you through our typical modeling helpers. And I’ll conclude my prepared remarks with my usual comments on cash, M&A and capital management. Okay, let’s flip to Page 3 of the earnings release. Headline Brokerage segment third quarter organic growth of 6% without interest income. That’s right in line with our September IR Day forecast during which we signaled about a point of headwind due to the timing of large life sales. Recall that these life products are interest rate sensitive. So, as we’ve been discussing, clients were waiting for lower interest rates. Well, the good news Pat mentioned happened over the last month or so. We are now seeing clients fund their policies. In fact, here in October, we have already caught up more than half of what had slipped from earlier quarters. So, the quarterly lumpiness that we have been highlighting throughout the year is starting to swing the other way here in October. And thus, we are currently seeing fourth quarter organic towards 8% and full year pushing 7.5%. As we start to budget for 2025, our early thinking is Brokerage segment full year organic growth might be in the 6% to 8% range. If so, that could mean a 2025 similar to how 2024 might ultimately play out. We’ll provide some more on our 2025 thinking at our December IR Day. But an early read through is we remain upbeat on our ability to grow given the investments we have been making in the business from adding niche experts to rolling out new sales and support tools to expanding our data and analytics offerings. We believe these actions are leading to higher new business production and strong client retention across the globe. And as Pat described, the market environment is still a tailwind for us. Flipping now to Page 5 of the earnings release to the Brokerage segment adjusted EBITDA table. Third quarter adjusted EBITDA margin was 33.6%, up 137 basis points over last year and above the upper end of our September IR Day expectations. Let me walk you through a bridge from last year. First, if you pull out last year’s 2023 earnings -- third quarter earnings release, you would see we reported back then adjusted EBITDA margin of 32.4%. But now using current period FX rates, that would have been 32.2%. Then organic and interest gave us nearly 150 basis points of expansion this quarter. Finally, the impact of M&A and divestitures used about 10 basis points of margin this quarter. You follow that and that will get you to third quarter 2024 margin of 33.6% and that’s the 137 basis points of Brokerage margin expansion. That is really, really great work by the team. As we look ahead to fourth quarter 2024, we are still expecting margin expansion in the 90-basis-point to 100-basis-point range. And again, that would be off of fourth quarter 2023 adjusted margin for FX, which currently is estimated to be about 20 basis points lower than last year’s headline margin of 31.6%. If we do that, that would mean full year 2024 could show about 70 basis points of margin expansion and 90 basis points excluding the first quarter impact from the roll in of the Buck merger. Okay. Let’s move on to the Risk Management segment and the organic and EBITDA tables on Pages 5 and 6. It was another solid quarter. We posted organic of 6%. That’s a point lower than our IR Day guidance because we just missed qualifying for a full revenue bonus related to one large account. That said, Gallagher Bassett continues to see excellent client retention and strong new business production and still delivers an adjusted EBITDA margin of 20.8%, which is up 35 basis points over prior year and ahead of our IR Day expectation. Looking forward, we see organic of 7% and margins around 20.5% in the fourth quarter. If we were to post that, we would finish the year with organic pushing 9% and margins of approximately 20.5%. That too would be great work by the team. As for 2025, our early thinking is for organic growth similar to the Brokerage segment, call it in that 6% to 8% range. Turning now to Page 6 of the earnings release in the Corporate segment shortcut table. In total adjusted third quarter numbers for interest and banking, clean energy and acquisition costs came in within our September IR Day expectations. The corporate line of the Corporate segment was below our expectations due to approximately $9 million of additional unrealized non-cash foreign exchange re-measurement expense that developed during September and wasn’t included in our IR Day forecast. After tax, call it about $0.03. That has already reversed here in October. So it really is a non-cash nothing in our opinion. But the accounting does cause some noise. Let’s now move to the CFO commentary document. Starting on Page 3, modeling helpers. There’s no new news here other than FX. So just consider these updated revenue and EPS impacts as you update your models. Turning to the Corporate segment on Page 4 of the CFO commentary document. No change to our outlook for fourth quarter. Flipping now to Page 5 to our tax credit carryforwards shows $796 million at September 30th. While this benefit won’t show up in the P&L, it does benefit our cash flow for the next few years which helps us fund future M&A. Turning to Page 6, the investment income table. We are now embedding two 25-basis-point rate cuts in the fourth quarter of 2024 and have updated our estimates in this table for current FX rates. Punchline here is our fourth quarter estimate does not change much from what we provided at our September IR Day. Shifting down that page to the rollover revenue table, the third quarter 2024 column subtotal is $111 million and 141 million before divestitures. These are consistent with our September IR Day expectations. Looking forward, the pinkish columns to the right include estimated revenues for Brokerage M&A closed through yesterday. So just a reminder, you’ll need to make a pick for future M&A. And when you move down on that page, you’ll see the Risk Management segment rollover revenues for fourth quarter 2024 are expected to be approximately $15 million. So moving to cash capital management and M&A funding. Available cash on hand at September 30 was about $1.2 billion. Considering this balance and our strong expected free cash flow, we are in an excellent position to fund our robust pipeline of M&A opportunities here in 2024. We currently estimate capacity of around $3 billion for M&A here in 2024 and is looking like we could have another $4 billion to fund M&A in 2025, all while making solid -- maintaining a solid investment grade rating. So it’s another excellent quarter in the books. Through the first nine months of the year for our combined Brokerage and Risk Management segments, we have delivered revenues up 16%, organic growth of 8%, net earnings of up 20%, adjusted EBITDA up 18% and adjusted EPS up 17%. Those are terrific numbers and reflect an unstoppable culture. We are well on our way to another great year of financial results. Hats off to the team for all of their hard work. So back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thanks, Doug. And operator, if we could go to questions-and-answers, please."
},
{
"speaker": "Operator",
"content": "Sure. Thank you. [Operator Instructions] Our first question comes from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question."
},
{
"speaker": "Mike Zaremski",
"content": "Hey. Thanks for the questions. First one is on the bridge from, in the Brokerage segment from 3Q organic to 4Q organic to kind of at the 2-point uplift sequentially. Is -- are you saying most of that is life insurance and if not, it sounded like RPC was still kind of more muted, but are you saying RPC is kind of, is lifting off into, is trending higher into 4Q? Just trying to understand some of the pieces there?"
},
{
"speaker": "J. Patrick Gallagher",
"content": "All right. So I think when you, renewal premium changes is what you’re referring to as RPC, I’m assuming."
},
{
"speaker": "Mike Zaremski",
"content": "Yeah."
},
{
"speaker": "J. Patrick Gallagher",
"content": "We’re not seeing underlying that our rates, that what we’re seeing for rates are not different all that much in the third quarter at all compared to what we saw in the first two quarters. And I think you’re seeing that in a lot of the carrier releases right now too. So rates for the fourth quarter, we’re assuming about the same as what we’re seeing here, yeah, in the third quarter, which is the same as in the first and the second. As for the increase next quarter, yes, we are getting about a point of additional organic growth from the life insurance sales. But when you bake all this in, we think that we’re running around 7.5% in our business right now. That’s the underlying growth. When you take out the puts and takes quarter-to-quarter, yeah, we’re nicely in that 7% to 8% range."
},
{
"speaker": "Mike Zaremski",
"content": "Okay. Got it. So no other seasonality or anything there, okay."
},
{
"speaker": "J. Patrick Gallagher",
"content": "We are a little slower in the fourth quarter. It’s not as big a quarter for reinsurance for us. And that has been an organic leader over the last couple of years. So, yes, we do have a little bit of that impact because we’re not so heavily weighted in the fourth quarter to reinsurance."
},
{
"speaker": "Mike Zaremski",
"content": "Okay. All right. That makes sense. Okay. Switching gears a bit to, I guess, the margins or just if I look at the fiduciary investment income, looks like it was much better than expected. But I think you’re guiding down. What caused the spike and why is it expected to go back down?"
},
{
"speaker": "J. Patrick Gallagher",
"content": "Well, I think, you have to look at our premium funding business there. So when you take a look at the table on Page 6 of the earnings release, I don’t think we’ve changed our estimates all that much for the, excuse me, of the CFO commentary. I don’t think we’ve changed our comments all that much for the fourth quarter."
},
{
"speaker": "Mike Zaremski",
"content": "Okay. Okay. Got it."
},
{
"speaker": "J. Patrick Gallagher",
"content": "You also realize there can be some times where we have, obviously, fluctuations in our fiduciary cash balances, too, that can impact that number."
},
{
"speaker": "Mike Zaremski",
"content": "Okay. Got it. And I guess just, Doug, as a follow-up to some of the comments you made earlier on renewal price change. So actually, from a number of the carriers we’ve seen so far, we have seen an uptick on the casualty side in terms of pricing. And I know in the past, too, you guys have had a view that what you’re hearing from carriers is that they’re under earning on some of the major casualty lines. So is that still kind of in your thought process, as you think that you gave us some tidbits on how 2025 could play out, that there could be some price hardening on the casualty side?"
},
{
"speaker": "Doug Howell",
"content": "There’s definitely some price concern on casualty across the board. And I don’t know if that’ll filter into discipline on their part to continue to take it up more than we’re presently seeing. But as you heard us earlier, umbrella is presently rising at about 10%. The only line in casualty that seems to have a difficult time finding bottom is D&O. The rest, however, are showing strength."
},
{
"speaker": "Mike Zaremski",
"content": "Yeah. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Yeah. I just got one number here. Our U.S. business, our casualty lines are up a 4-point third quarter versus second quarter."
},
{
"speaker": "Mike Zaremski",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Our next question is from the line of Rob Cox with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Rob Cox",
"content": "Hey. Thanks. So appreciate all the guidance on the Brokerage organic. I was just curious about the components. I think in the beginning of this year, you guys had talked about maybe it was a third, a third, a third exposure, new business and pricing. I was just curious how you guys expect that might unfold in 2025."
},
{
"speaker": "Doug Howell",
"content": "I think it’s going to be half new business in excess of lost business and I think that it’s going to split the rest of it between exposure and rate."
},
{
"speaker": "Rob Cox",
"content": "Okay. Got it. That’s helpful. Yeah. Just curious, maybe it’s a little bit tough to go through all the comments, but it seemed like maybe international retail decelerated a little bit more than the U.S. this quarter. I guess I was just curious also on your views between international and U.S. Retail going into next year."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Well, I think you’re going to see strong international growth. That’s where our strongest component is right now and that does not seem to be backing off. So, if you look at our prepared remarks, we talked about the fact that we’re a good part of our growth this quarter was international considering finance."
},
{
"speaker": "Doug Howell",
"content": "Yeah. I mean, our Australia and New Zealand operations killed it this quarter. So, they’re up nicely. Canada’s a little flattish. I mean, if you…"
},
{
"speaker": "J. Patrick Gallagher",
"content": "Yeah."
},
{
"speaker": "Doug Howell",
"content": "… want to do that, if you look at the U.K., there was a mixed issue there in the third quarter also that you could see through. But by and large, I wouldn’t say that there’s tatters anywhere that are causing us concern."
},
{
"speaker": "J. Patrick Gallagher",
"content": "International is up 10% this quarter. And Doug’s comment’s right. The lead by New Zealand and Australia."
},
{
"speaker": "Rob Cox",
"content": "Thanks, guys. Appreciate it."
},
{
"speaker": "Doug Howell",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "The next question is from the line of Elyse Greenspan with Wells Fargo. Please proceed with your questions."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi. Thanks. Good evening. My first question, embedded within your fourth quarter guidance, the 8% Brokerage organic, is there any assumption for an impact on continued commissions from the recent storms?"
},
{
"speaker": "Doug Howell",
"content": "Yeah. We don’t think we’re going to be heavily impacted, maybe a couple million bucks from the storms. But that wouldn’t move that. Maybe it moves at 10 basis points."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. And then within the guidance, right, I think, you guys said 6% to 8% Brokerage for next year. Are you assuming -- what are you assuming for the benefits business, right? I understand there was some seasonality this year. Are you just assuming it’s kind of in line with the rest of the segment? I know you typically wait a little longer to give the bi-segment guidance, but just because that’s brought on some volatility this year, I wanted to get a sense of where you think that will head next year?"
},
{
"speaker": "Doug Howell",
"content": "Listen, if you want to pick the midpoint of that range, maybe benefits is around 5% and reinsurance is around 9%, something like that, when you’re looking for a couple points on either side of the midpoint."
},
{
"speaker": "Elyse Greenspan",
"content": "For next year."
},
{
"speaker": "Doug Howell",
"content": "Yeah. For next year."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. And then, with the M&A, I know like yield flow rate has probably been a bit lighter through the first three quarters, right, then what we’ve seen in prior years. Do you guys think, just given it’s a presidential election year, has that caused, I guess, a slowdown in just the closing of transactions and are you expecting more activity in the fourth quarter early next year? How do you guys see things on that front?"
},
{
"speaker": "J. Patrick Gallagher",
"content": "Well, I think if you take a look at -- this is Pat. If you take -- if you look at the general marketplace in terms of acquisitions, there’s been a bit of a slowdown in general across the Board for the last year. We’ve got a great pipeline. In my experience, we’ve got one of the best pipelines we’ve ever had. So I think that possibly when the discomfort, if you want to call it that or concentration on this election finally ends, clearly if the Democrats get in, I think there could be a rush for the door. I don’t know what happens in the case the Republicans win, but at any rate, I think when things settle out, we do think there’ll be continued great opportunity and I do think that there’ll be a return to a little bit more robust market."
},
{
"speaker": "Doug Howell",
"content": "Yeah. I think we are going to be -- I think if you looked at a year-to-date in 2021, we were closing around 17 and 2022, we closed 19. Year-to-date 2024, we’re at 27. Yeah, last year we closed 37 year-to-date with these tucked in deals acquisitions. So it was a little slower this quarter, but I think as you heard from Pat’s pretty detailed comments, our pipeline is terrific right now."
},
{
"speaker": "Elyse Greenspan",
"content": "And then one last one on like that corporate line within the Corporate segment, Doug. I thought you said that it was worse, right, than September IR Day because of the FX re-measurement, but that reversed in the fourth quarter, but then the Q4 guide…"
},
{
"speaker": "Doug Howell",
"content": "That’s right."
},
{
"speaker": "Elyse Greenspan",
"content": "… for Corporate did change. Are you just not modeling that in yet?"
},
{
"speaker": "Doug Howell",
"content": "Yeah. That’s a good point. We might be a little bipolar on that. We might have been able to schedule a couple extra pennies on that line for the reversal of what we saw at the end of the third quarter, but that bounces around quite a bit. So I think that we’ll see what happens again. So we just didn’t feel like for a couple pennies it was worth changing that number."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thanks, Elyse."
},
{
"speaker": "Doug Howell",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "The next question is from the line of Gregory Peters with Raymond James. Please proceed with your question."
},
{
"speaker": "Gregory Peters",
"content": "Yeah. Good afternoon, everyone. Just building on your…"
},
{
"speaker": "J. Patrick Gallagher",
"content": "Hi, Greg."
},
{
"speaker": "Gregory Peters",
"content": "Yeah. Building on your last answer on acquisitions, one of the things that struck out or stuck out to me, I should say, is when I was going through the supplement was the weighted average multiple for tuck-in pricing of acquisitions came down a lot in the third quarter. Is there any -- maybe you can just help me understand what happened, why the multiple came down, because I don’t feel like multiples are coming down in the marketplace. And Pat, in your prepared remarks, you seem to emphasize your price discipline a little bit more than usually referenced in talking about tuck-in acquisitions?"
},
{
"speaker": "J. Patrick Gallagher",
"content": "Yeah. When we prepared the remarks, Greg, we did discuss whether in the past we’d been undisciplined. What I said…"
},
{
"speaker": "Gregory Peters",
"content": "Understood."
},
{
"speaker": "Doug Howell",
"content": "Yeah. No, I think it’s just a good reminder. We have a lot of people listening to these calls, our own people included, and a lot of acquisitions, we try to maintain a good discipline around the pricing and we seem to strike a fair balance between that and the great people that join us."
},
{
"speaker": "Gregory Peters",
"content": "And the multiple for the third quarter acquisitions came down materially. It’s like I felt like…"
},
{
"speaker": "Doug Howell",
"content": "Yeah. I think…"
},
{
"speaker": "Gregory Peters",
"content": "… I took a step back in time."
},
{
"speaker": "Doug Howell",
"content": "One of those acquisitions was not priced, what I would say, it was priced a little under market because we have some opportunity to help get better."
},
{
"speaker": "Gregory Peters",
"content": "Okay. Another sort of nitpicking item, you were going through your earnings press release and I was going through the adjustments to earnings to get your adjusted EBITDA. I’m Page 5 of Brokerage. And one of the things that stuck out to me is just the huge jump up in workforce and lease termination related charges in the year, this year versus last year, and the third quarter versus the third quarter last year. Is there something going on, on a bigger scale? Is this more offshoring that’s going on or maybe you could just help, I know it’s a small item inside your income statement, but maybe you could just give us a sense of what’s going on in that place?"
},
{
"speaker": "Doug Howell",
"content": "Greg, I’m sorry. Go ahead."
},
{
"speaker": "J. Patrick Gallagher",
"content": "I was just going to say, Greg, you hit on the offshoring thing is really continues to be a very strong play for us and you’ll recall years ago, we started with a very small group. We’re 12,500 people strong there now and as we do acquisitions and go across the Board, illustrating the type of quality and the speed with which we can do things like issue certificates, there’s pretty quick adoption. It’s pretty good."
},
{
"speaker": "Doug Howell",
"content": "Yeah. I think you’re seeing -- Greg, you’re starting to see the flywheel just getting stronger and stronger as we benefit from scale, we benefit from technologies that we’re deploying and we’re benefiting from our offshore standards of excellence. It just gives us an opportunity to continue to optimize our workforce. And so, I think you’re seeing that this quarter, yeah, popped up a little bit, because we have some opportunities to optimize our workforce. So, you’ll see that from time-to-time."
},
{
"speaker": "Gregory Peters",
"content": "Great. And then just step back, macro question, and this will be the last one. I know your commercial customers set their budgets for the year. In the past, given the robust rate increases that you’ve had to sell, it seems like the market’s beginning to stabilize a little bit more than, say, for it was two years ago. How are the budgets -- when you hear from your customers, how are the budgets changing for their insurance spend? Is it -- you’re seeing more flat budgets? Are you still seeing them assume…?"
},
{
"speaker": "J. Patrick Gallagher",
"content": "No."
},
{
"speaker": "Gregory Peters",
"content": "… increases? Give us a sense of what’s going on there."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Really not flat, Greg, for two reasons. Exposure units, thankfully, are continuing to grow. This is why we go through our daily review of the things that are coming through audits, et cetera. We’re seeing a robust economy and that’s clearly in a big part of the middle market. And so, from SME all the way through large accounts, we’ve got the data on that. People are expanding their exposure units, so budgets are going up. Secondly, we’re very, very cautious. We are not leading customers to believe that there’s any kind of nirvana relative to rates. That is not what’s happening. We show them our detail that we go over with you quarterly. Property is up 4%. General liability is up 6%. You may not deserve that. That may not hit your P&L. But on the other hand, you may deserve 25%. And this is a rational market and we’ve got to talk through that, which leads us right into discussing how much you retain, what you bring back into the coverage stack that you might not have had before. And that’s where the real strength and art of being a broker is, is understanding that appetite for risk that each individual account has, working with those primary buyers to decide how they’re going to get their best spend and it’s not a discussion all around rate by any means."
},
{
"speaker": "Doug Howell",
"content": "Yeah. I think you take the chaos out of the pricing cycle and have this rational pricing cycle that we’re seeing right now. Our guys will show the tools and capabilities that we have, and that will shine through and differentiate ourselves. That’s why when I said before that I see a better new business versus lost business year next year than we’ve even seen in the last couple of years."
},
{
"speaker": "J. Patrick Gallagher",
"content": "And by the way, to that point, Greg, we can take clients into our data now and I think you know this. We can say clients like you buy this and their quotes and cover looks like this. And by the way, their costs are this. Well, why is that? Think about selling or buying a house on the street. One’s been taken care of, looks pretty darn good, has street appeal. The other looks like junk. Guess who gets the better price? Why don’t we try to get you looking more like the house on the street people want to buy? And that, back to my point of art, is what it’s all about to be a good broker and that’s why when we get a rate environment like this, I feel very confident talking to our salespeople about we better see some increased sales, folks. Let’s go."
},
{
"speaker": "Gregory Peters",
"content": "Fair enough. Thanks for the answers."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thanks, Greg."
},
{
"speaker": "Operator",
"content": "The next question is from the line of Dean Criscitiello with KBW. Please proceed with your question."
},
{
"speaker": "Dean Criscitiello",
"content": "Hi. I was hoping if you guys could provide maybe some additional color on the sequential decrease in the organic growth in Brokerage, especially in the context of that renewal premium change holding up pretty strong sequentially."
},
{
"speaker": "Doug Howell",
"content": "Well, listen, I think, I said earlier that, our first quarter is strong, because it’s a heavy reinsurance quarter, right? We’ve talked about some of the life insurance being a little lumpy. But if you bounce those two things out of there a little bit, again, we’re running around 7.5% organic growth each quarter. So while it looks like that on the face, yes, we’re at 6% now, but we warned that there was a 4-point of headwind against that. Also, we’re not seeing substantial rate differentials, rates between the quarters. So really underline it when you carve out the seasonality of a couple of our businesses, some of the mixed differences between when property renews versus when casually renews, the life lumpiness. You got to take our word for it. It’s pretty steady underlying other than that those things that I’ve said. So it’s pretty steady right now underlying."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Yeah. And if you want to go back three years or four years, D&O is up 300%. So by line, by geography, these rates do make a difference. They move. So we’re not seeing a D&O renewal anywhere near 300%. In fact, it’s off 5% or 6%. So the percentages do move. This is not an environment where you say for the next 10 years, good news is it’s 4% a quarter, bing, bang, boom."
},
{
"speaker": "Dean Criscitiello",
"content": "Got it. That makes sense. And then my second one, a few of your competitors have made some large acquisitions to help, improve their middle market capabilities. And I was wondering what implications do you think that have on the competitive environment going forward, sort of being that you guys are a dominant player in that space?"
},
{
"speaker": "J. Patrick Gallagher",
"content": "I don’t think it has any impact, to be perfectly blunt, on our business at all."
},
{
"speaker": "Dean Criscitiello",
"content": "Okay. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thanks, Dean."
},
{
"speaker": "Operator",
"content": "The next question is from the line of Mark Hughes with Truist Securities. Please proceed with your questions."
},
{
"speaker": "Mark Hughes",
"content": "Yeah. Thank you. Good afternoon. Doug, did you give early margin thoughts for 2025 for Brokerage and Risk Management?"
},
{
"speaker": "Doug Howell",
"content": "I have not. I will in December as we go through the budget. But I will say this, we post 6% to 8% organic growth next year. It’s there, Mark. There’s an opportunity for us to continue to get better. Our scale advantages are coming through our technologies, using the offshore centers of excellence. It still gives us an opportunity in an environment that we’re seeing with current wage inflation, with current inflation and in other categories of our spend, that we continue to have opportunities to get better and better. And when you’re punching out 6% to 8% organic growth, the underlying margins will absolutely have opportunity for expansion."
},
{
"speaker": "Mark Hughes",
"content": "Very good. And then, did you give organic, broken out by the wholesale components and then reinsurance? I think you might have given those collectively at up 8%. But do you happen to have the components of that?"
},
{
"speaker": "Doug Howell",
"content": "Yeah. Listen, some of like our affinity businesses might be at 12%. Some of our program businesses might be around that 6%. I think our open brokerage is somewhere around 9% -- 8% or 9%. The reinsurance is somewhere around 8% or 9% this quarter. So I would say other than a couple, maybe the affinity business just a little better this quarter and maybe the program business just a little below that 8%. But the reason why we lumped them together and it was just to shorten the script, but there’s not a lot of difference when you’re looking at around 8%."
},
{
"speaker": "Mark Hughes",
"content": "Understood. And then any comment, Pat, on the mixed shift out of admitted into the E&S line?"
},
{
"speaker": "J. Patrick Gallagher",
"content": "Yeah. I think it’s very -- it’s a really interesting one, Mark. I think we’re seeing continued tremendous submission supply into our wholesaling operation RPS that has not slowed down, which is really interesting and we are not seeing accounts flowing back to the primary market in any great extent. So the excess and surplus market, which we know has gobbled up a big chunk of the P&C market over the last five years, 10 years, seems to be continuing its growth and it’s maintaining its accounts. And I think that’s, we’ve got people in RPS that bring more than just pricing to the deal. There’s a lot of expertise there. There’s a lot of layering and structuring that goes into some of these deals that your local retailer, ourselves included, quite honestly, 50% of our wholesale business goes to RPS. That’s for a reason. So I think it’s both professional capabilities, as well as market access, and that market is still growing nicely."
},
{
"speaker": "Mark Hughes",
"content": "Thank you very much."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thanks, Mark."
},
{
"speaker": "Operator",
"content": "Our next question is from the line of Alex Scott with Barclays. Please proceed with your question."
},
{
"speaker": "Alex Scott",
"content": "Hi. Thanks for taking my question. So, I mean, when I hear what you’re saying about reinsurance and the strength and growth there, the wholesale business seems like it’s growing very nicely as well. When I look at the 6% and I guess run rating closer to 7% and change, but does that mean, I guess, it obviously means that the businesses other than reinsurance and wholesale, like the more core retail is doing something lower. Is there anything that’s causing some of the price there to not flow through? Is that just maybe some of the property deceleration we saw? I’m just trying to understand, that piece of it specifically. What are some of the trends you’re seeing and puts and takes headed into next year for the core retail piece of it?"
},
{
"speaker": "Doug Howell",
"content": "Yeah. Always keep in the back of your mind our benefits business. That business is running around 5%. Take out the large life cases and stuff that bounce around a little bit. So as that -- as you think about those that are above that, 7% range. Yeah, you’ve listed them, but you also have to remember that the benefit businesses naturally runs down below that, that level. Some of our actuarial services businesses run a little bit lower than that. But as I look across the organic, across all the operating, we mentioned that Canada was about flat. But by and large, there’s a few that offset each other. But it’s not like there’s any one particular area that is systemically running below that level right now."
},
{
"speaker": "Alex Scott",
"content": "Got it. And maybe if we can go back to reinsurance. I mean, the growth rate you’re anticipating sounds pretty robust there despite the flight pricing. And I just want to see if you could add some color around that. I mean, does that have to do with demand? Can you talk a bit about what you’re seeing in terms of your clients’ demand for reinsurance?"
},
{
"speaker": "J. Patrick Gallagher",
"content": "Yeah. I think demand seems very, very strong, which is good news for us. Also, I think our level of expertise in helping clients in a market environment where there is capacity and they can move around how they play in that capacity. It’s a very strong demand for our consulting capabilities around reinsurance. What’s the next move for the carriers that are our customers? So you have both. You’ve got demand. I think you have more utilization. There’s strong growth at the primary level and all that flows up into the funnel for reinsurance. And as one of the top three players in that business, we have a lot of good prospects on the list."
},
{
"speaker": "Alex Scott",
"content": "Great. Thanks for the responses."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Sure. Thanks, Alex."
},
{
"speaker": "Operator",
"content": "Our next question is from Katie Sakys with Autonomous Research. Please proceed with your question."
},
{
"speaker": "Katie Sakys",
"content": "Hi. I apologize. Thank you for the question. There might be some background noise. There’s a fire going on right now. I want to circle back to the subject of valuations. You’re thinking about acquisitions in the middle market that are really concentrated in excess of $15 million of revenue. We’ve seen a couple of those lately and the multiples on those deals have been a lot higher than we’ve seen in the past. I was curious how that compares to what you guys are seeing for those larger middle market deals and whether your appetite to participate in larger acquisitions has shifted at all?"
},
{
"speaker": "Doug Howell",
"content": "Listen, I think that there’s no question the larger you are, probably the higher the multiple might be for somebody that’s out there looking for an opportunity. But when we look at our tuck-in acquisitions, I think that people understand that we’ll pay a fair price. And the advantage is they get to stick with us. They come in and they get to work inside of a broker. It’s a broker selling to a broker. They understand that if they decide to take our stock, that they get to participate in equal form as you do, as I do, as Pat does, everybody else in this room. It’s one stock for every person. They get our resources. They get to put their employees and their clients into an environment where actually joining us is going to deliver considerably more career value and more insurance value to their customers. So many times they look at it and they say that they get the opportunity to continue on doing what they’re going to do and so they get excited about a 10, 11 or 12 multiple. That’s the reality about it, is they’re making a great return for their family. And they know they get to continue doing it with us for as long as they would like to do in their career and that’s valuable to them, too. Don’t forget that."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Let’s also take a look at the landscape. We don’t talk about this, I think, enough because the big deals get big headlines and they are big platforms. We estimate there’s 29,000 agents and brokers in America. Last year, business insurance -- last July, business insurance ranked the top 100 in the United States. Number 100 did $30 million in revenue. So there’s 28,900 brokers in America. That’s firms, not people, that are out there trading. And that’s why we say 90% of the time, which continues to be consistent over the last decade, when we compete in the marketplace, we’re competing with somebody smaller. And it’s probably less than 10% of the time, really, that we’re competing with Marsh and Aon, who are the only larger brokers in the world today. It’s not that we don’t compete. There’s a robust market at the top end. When you think about that, we can use our funds, as Doug says, at lower multiples. We can have 100 of these opportunities in our pipeline. We can be pricing out 70 of them and possibly put on a $1 billion of revenue with people that want to join us, haven’t joined somebody else, want to bring their culture and their people aboard a culture that fits and matches theirs. As Doug said, a Brokerage run by brokers. It doesn’t get the press, but it seems like a pretty good strategy and a good use of our cash does."
},
{
"speaker": "Katie Sakys",
"content": "Got it. Thank you so much for the comment."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Yeah. You better evacuate, Katie."
},
{
"speaker": "Operator",
"content": "Our next question is from the line of David Motemaden with Evercore ISI. Please proceed with your question."
},
{
"speaker": "David Motemaden",
"content": "Hey. Good evening. I just had a question in Brokerage and the contingents were up 24% on an organic basis. I was wondering if you could just talk about what was driving that in the quarter."
},
{
"speaker": "Doug Howell",
"content": "Yeah. Listen, I think that when you’re talking about that, it’s another $7 million or $8 million of where it developed from. We just had, between our benefits business and our U.S. Retail business, that’s where we picked up a few extra contingents in the quarter or our estimation for those contingents in the quarter. So there was nothing special in there. Again, we might give a couple million of that back next quarter because of the storms and floods, but by and large, it -- I would say around the possibility of what could have happened, it was a few million dollars in both of those businesses."
},
{
"speaker": "David Motemaden",
"content": "Got it. Okay. That’s helpful. And then I guess just a bigger picture question. I heard the commentary on the term sheets being prepared or in the process of getting signed with $700 million of revenues. Do you have any stats historically on just how many of those are closed, like what percentage of those closed in the next year? Just to help us level set how much the contribution could be going forward?"
},
{
"speaker": "J. Patrick Gallagher",
"content": "I really don’t. Here’s the thing. Every one of these is a very interesting story unto itself. You’ve heard me say, I think the longest time we spent talking to a client, talking to a prospect and getting to know each other was 20 years. Sometimes they happen in a quarter. Sometimes they take a couple of years. And but when we get to pricing and we get to putting together a letter of intent, we’re getting serious. And that’s a deal that’s going to get decided in the next six months. I don’t really have a stat on how many of those do close, how many don’t. It’s a full-on sales process. It’s just like selling insurance, frankly. If you don’t have a lot in the hopper, you’re not going to close a lot."
},
{
"speaker": "David Motemaden",
"content": "Yes."
},
{
"speaker": "J. Patrick Gallagher",
"content": "We feel very good about these 60. You can ask me this every quarter and I will try to give some color. Right now, we feel very good about the deals that we’re proposing right now. I would think we’d have a good shot at an awful lot of those."
},
{
"speaker": "David Motemaden",
"content": "Okay. That’s good to hear. And then just finally, so it sounded like the U.S. Retail, P&C organic, it sounded like that slowed a little bit. I think it was 5%, if I heard that right, and I think it was 6% last quarter. Was that just the large account property business that you were talking about that has reaccelerated here in the fourth quarter?"
},
{
"speaker": "Doug Howell",
"content": "Yeah. Listen, I’m just looking at my sheet here. If it moved, it moved a 0.5 point one way or another. We did have more. First quarter was just a little bit better than that, but second quarter is about the same number as what we’ve got right now."
},
{
"speaker": "David Motemaden",
"content": "Great. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thanks, David."
},
{
"speaker": "Operator",
"content": "Our next question is from the line of Grace Carter with Bank of America. Please proceed with your question."
},
{
"speaker": "Grace Carter",
"content": "Hi, everyone. I was hoping we could talk about the contingents a little bit more. Just given the ongoing conversation around the casualty market, I was wondering how you all are thinking about any potential risk of maybe some of the pressures from the casualty line that we saw in contingents last quarter resurfacing over the next few months?"
},
{
"speaker": "Doug Howell",
"content": "If it did, we’re talking a few million bucks. I mean, I wouldn’t call that as being a systemic issue that we’re going to have to face. Just like with the storms, it’s a few million. There are some corridors, that -- we do have caps in our contingents. And so sometimes, if there is -- if the carriers have, let’s say, maybe loss -- more losses than they had hoped, it may still let us get to our full contingent level because there’s caps on that. So, right now, we’re not seeing a lot of pressure from that, not only in our past book, but as we look forward in the book. If carriers continue to strengthen their casualty rates the way they have been and what we’re hearing from them, what we’re reading about what they’re saying, it should maintain our contingent level also."
},
{
"speaker": "Grace Carter",
"content": "Thank you. And just a quick follow-up on the lumpy life sales. If I’m understanding correctly, you all are expecting pretty much all of the timing issue to work itself out in 4Q or should we expect any sort of lagging impact from that in early 2025 as well?"
},
{
"speaker": "Doug Howell",
"content": "What I said is already here in October, we have recouped half of what had been the timing that had come out of this first quarter and second quarter, excuse me, second quarter and third quarter. So we’re going to pick up. So far, it’s half. We think that we’ve got a pipeline maybe to recover it all between now and the end of the year and then we’ll start over again. Just like every other sales organization, we got to start over next year and go out there and see if we can gin up some opportunities. But this product is becoming more and more necessary for many not-for-profits in order for them to be competitive in their executive benefit package. So this is a product that we think has long legs over the next many years -- several or many years."
},
{
"speaker": "Grace Carter",
"content": "Thank you."
},
{
"speaker": "Doug Howell",
"content": "Thanks, Grace."
},
{
"speaker": "Operator",
"content": "Thank you. Our last question is from the line of Mike Zaremski with BMO Capital Markets. Please proceed with your question."
},
{
"speaker": "Mike Zaremski",
"content": "Oh! Great. Just a quick follow-up on life insurance. So just ballpark, what percentage of your Brokerage revenues are life insurance and I don’t know if you want to break it out into this new product that might be more lumpy or just growing faster over time than traditional life?"
},
{
"speaker": "Doug Howell",
"content": "The lumpy business that we’re talking about is about $125 million business."
},
{
"speaker": "Mike Zaremski",
"content": "Okay. Okay. And -- okay, that helps explain why it could move organic that much. Okay. Thank you. That’s all. Thanks."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thanks, Mike. I think that’s it, Operator. Thank you again, everyone, for joining us this afternoon. We had an excellent third quarter and we’re well on our way to delivering another excellent year of financial performance. I’d like to thank our 55,000 colleagues around the globe for their hard work and dedication to our clients. We look forward to speaking with you again in person at our December Investor Meeting in New York City. Thank you very much for being with us this evening. We’ll talk to you then."
},
{
"speaker": "Operator",
"content": "This does conclude today’s conference call. You may disconnect your lines at this time."
}
] |
ajg | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good afternoon, and welcome to Arthur J. Gallagher & Co's Second Quarter 2024 Earnings Conference Call. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. The Company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer the information concerning forward-looking statements and risk factors sections contained in the Company's most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the Company's website. It is now my pleasure to introduce J. Patrick Gallagher, Jr., Chairman and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thank you very much. Good afternoon. Thank you for joining us for our second quarter 2024 earnings call. On the call with me today is Doug Howell, our CFO, other members of the management team and the heads of our operating business divisions. We had an excellent second quarter. For our combined Brokerage and Risk Management segments we posted 14% growth in revenue, 7.7% organic growth and 8.1% if you include interest income. We also completed 12 new mergers totaling $72 million of estimated annualized revenue. Reported net earnings margin expansion of 35 basis points, adjusted EBITDAC margin expansion of 102 basis points to 31.4%. GAAP earnings per share of $1.70, up 15% year-over-year, and adjusted earnings per share of $2.68, up 19% year-over-year, another great quarter by the team and right in line with the expectations we provided at our June IR Day. Moving to results on a segment basis, starting with the Brokerage segment. Reported revenue growth was 14%. Organic growth was 7.7% at the midpoint of guidance, and above 8% if you include interest income. Adjusted EBITDAC margin expansion was 98 basis points at the upper end of our June IR Day expectations. Let me give you some insights behind our Brokerage segment organic. And just to level set, the following figures do not include interest income. Within our PC retail operations, we delivered 6% in the U.S. and Canada, 7% in the UK, Australia and New Zealand. Our global employee benefit brokerage and consulting business posted organic of about 3%, that would have been 5% without the timing impact from some lumpy life case sales. Shifting to our reinsurance, wholesale and specialty businesses, overall organic of 12%. This includes Gallagher Re at 13%, UK specialty at 10% and U.S. wholesale at 11%, excellent growth, whether retail, wholesale or reinsurance. Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance marketplace. Global second quarter renewal premiums, which include both rate and exposure changes, were up about 5%. So no change from what we discussed four weeks ago at our June Investor meeting. Renewal premium increases continue to be broad-based, up across all of our major geographies and most product lines. For example, property was up 2% to 4%, general liability up 5% to 7%, umbrella and commercial auto up 8% to 10%, workers' comp up 1% to 3%, D&O down about 5%, cyber was flat and personal lines up over 10%. So many lines are still seeing strong increases. Moving to the reinsurance market and mid-year renewals. Property reinsurance renewals saw modest price declines concentrated at the top-end of reinsurance towers due to the increased capacity from both traditional reinsurers and the ILS market. Offsetting this was underlying exposure growth, combined with increased demand, resulting in flat year-over-year premium for reinsurers overall. U.S. Casualty renewals saw terms and conditions tightened and some modest price increases. Reinsurers continue to heavily scrutinize submissions given the industry's unfavorable prior year reserve development and reinsurers view of the current loss cost trends. In our view, insurance and reinsurance carriers continue to behave rationally. Raising rates the most where it is needed to generate an adequate underwriting profit by line, by industry and by geography. We continue to see this differentiation in our data between property and casualty lines. Carriers believe property maybe close to approaching price and exposure adequacy. And thus, we are seeing property renewal premium increases moderating, but mostly within large accounts. Underlying that accounts with premiums around $1 million or greater are seeing renewal premiums flattish year-over-year. Yet on the other hand, in the small and mid-sized client space, where we are an industry leader, we are seeing increases of 7% for the second quarter. Shifting to casualty classes, we are seeing the greatest renewal premium increases and signs of these increases advancing. In fact, global second quarter umbrella and commercial auto renewal premium increases are in the high-single digits, and there is little differentiation by client size. We have been highlighting worsening social inflation, medical expenses and growing historical reserve concerns for quite some time. And thus, we continue to believe further rate increases are to come in casualty. While renewal premium increases are rational carrier response in the current environment, our clients have experienced multiple years of increased costs. Having a trusted adviser like Gallagher can help businesses navigate a complex insurance market by finding the best coverage for our clients while mitigating price increases, and that's our job as brokers. Moving to comments on our customers' business activity. During the second quarter, our daily indications continue to show positive mid-year policy endorsements, audits and cancellations, similar with last year's levels across most geographies. So activity remains solid, and we are not seeing signs of global economic slowdown. Within the U.S., the labor market in balance remains intact with more open jobs than unemployed people looking for work. And with continued wage growth and further medical cost inflation, employers remain focused on attracting and retaining talent while controlling costs. So I see solid demand for our services and advice in 2024 and in 2025. Across the brokerage operations, I believe we continue to win market share due to our superior client value proposition, niche expertise, outstanding service and our extensive data and analytics offerings. Frankly, the smaller local brokers that we are competing against, about 90% of the time, just can't match the value we provide, and that is leading to more net brokerage wins for Gallagher. So when we pull all this together, we continue to see full-year 2024 brokerage organic in the 7% to 9% range, and that would be another outstanding year. Moving on to our Risk Management segment, Gallagher Bassett. Revenue growth was 13%, including organic of 7.7%. Adjusted EBITDAC margins were 20.6%, up 120 basis points versus last year, and in line with our June IR Day expectations. We continue to benefit from new business wins, outstanding retention, increases in customer business activity and higher new rising claims. Looking forward, we see organic in the next two quarters around 7% and margins around 20.5% that would bring full-year 2024 organic to 9% and margins to approximately 20.5%, and that, too, would be an outstanding year. Let me shift to mergers and acquisitions. We completed 12 new mergers during the second quarter, representing about $72 million of estimated annualized revenue. I'd like to thank all of our new partners for joining us, and extend a very warm welcome to our growing Gallagher family of professionals. Looking ahead, our pipeline remains very strong. We have around 60 term sheets being signed and prepared, representing around $550 million of annualized revenue. Good firms always have a choice, and we will be very excited if they choose to join Gallagher. Let me conclude with some comments regarding our bedrock culture. Last month, we reflected on the 40th anniversary of becoming a public company. Michael Bob Gallagher, Chairman and CEO at the time, knew above all, we must maintain our unique culture of teamwork, integrity and client service. Those values are captured in the 25 tenets with the Gallagher Way. Thanks to all of our global colleagues that live and breathe the Gallagher Way day in and day out. Our culture is stronger and more vibrant than ever, and it's our culture that continues to differentiate us as a firm and help to drive an average annual total shareholder return of more than 16% over the past 40 years. That is the Gallagher Way. Okay. I'll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Douglas Howell",
"content": "Thanks, Pat, and hello, everyone. Today, I'll start with our earnings release. I'll comment on second quarter organic growth and margins by segment. Punchline is we came in right in line with our June IR Day commentary. I'll also update you on how we are seeing organic growth and margin shape up for the second half of the year. Then I'll shift to the CFO commentary document that we posted on our IR website, and I'll walk through the typical modeling helpers that we provide. And I'll conclude my prepared remarks with a few comments on cash, M&A and capital management. Okay. Let's flip to Page 3 of the earnings release. Headline Brokerage segment second quarter organic growth of 7.7%. Again, that's right in line with our June IR day, where we forecasted a range of 7.5% to 8%. Notably, we would have been above 8% if a few large live sales had not shifted from second quarter to later in the year. We signaled this possible timing to our June IR Day. So again, no new news here. Recall that we also foreshadowed in late June a small headwind from contingents that adversely impacted all inorganic by about 25 basis points. And finally, just a reminder, that we don't include interest income and organic. If we did, that would have pushed organic higher by about 40 basis points. We believe the investments that we have made in people, sales tools, niche experts and data and analytics are leading to strong new business production and favorable client retention across the globe. Additionally, the insurance market backdrop remains supportive of growth. Pat said renewal premium changes 5% in the quarter. However, our July's renewal premium change thus far is above second quarter. And with an active hurricane season predicted and noise around U.S. casualty reserves growing louder again this quarter, it's not unreasonable to expect mid single-digit or greater renewal premium changes in the second half of 2024. So our organic investments, combined with the insurance market conditions, continues to support our 2024 full-year Brokerage segment organic outlook. We are still seeing it in that 7% to 9% range. So now flip to Page 5 of the earnings release to the Brokerage segment adjusted EBITDAC table. Second quarter adjusted EBITDAC margin was 33.1%, up 98 basis points over last year and at the upper end of our June IR Day expectations. Let me walk you through a bridge from last year. First, if you pull out last year 2023 second quarter, you'd see we reported back then adjusted EBITDAC margin of 32.1%. Second, you need to adjust for current period FX rates, which had a very limited impact on margin this quarter. So 2023 adjusted FX margin was also 32.1%. Third, organic and interest gave us nearly 110 basis points of margin expansion this quarter and then the impact of M&A and divestitures used about 10 basis points of margin. That gets you to second quarter 2024 margins of 33.1%, and therefore, that's nearly 100 basis points of brokerage margin expansion. That's really, really great work by the team. As we look ahead to the second half of 2024, we are still expecting margin expansion in the 90 basis points to 100 basis points range. So third and fourth quarter will look a lot like second quarter. Recall, first quarter 2024 still had the roll-in impact of the Buck acquisition. So the math for full-year 2024 will show about 60 basis points of full-year expansion, but that would be about 80 basis points full-year without Buck, which feels about right, assuming we posted organic in the 7% to 9% range. Let's move now to the Risk Management segment and the organic and EBITDAC tables on Pages 5 and 6 of the earnings release. Another excellent quarter. We saw solid new business, fantastic retention and growing claim count. We posted organic of 7.7% and margins at 20.6%, both were right in line with our June IR Day outlook. Looking forward, as Pat said, we see organic in each of the next two quarters around 7% and margins around 20.5%. If we were to post that, we would finish the year with organic of 9% and margins of approximately 20.5%. That also would be great work by the team. Turning to Page 6 of the earnings release and the corporate segment shortcut table. Adjusted second quarter numbers came in just better than the favorable end of our June IR Day expectations. All of that was due to some favorable tax items within the corporate expense line. All right. Now let's move to the CFO commentary document, starting on Page 3, a few comments. First, foreign exchange. The dollar has weakened over the past month, so please make sure you incorporate these updated revenue and EPS impacts from FX in your models for the Brokerage and Risk Management segment. Second, Brokerage segment amortization expense. Recall, while this impacts reported GAAP results, we adjusted out so it doesn't impact adjusted non-GAAP earnings. This line can also be a bit noisy from time to time. Late this quarter, we received updated third-party M&A valuation estimates on a third – or excuse me, on a few recent acquisitions and also made some balance sheet adjustments at the end of the quarter. You'll see that in Footnote two at the bottom of the page. Looking forward, we expect amortization expense of about $155 million per quarter. Again, all of that is adjusted out, but it does cause some noise in the reported GAAP results. Now it's the risk management amortization and depreciation line. Here too, we received updated M&A valuation estimates for our recent acquisition, which is also described in Footnote five. The net impact to non-GAAP results is about $0.01 to EPS this quarter. Going forward, we are now expecting a lower level of depreciation and amortization as a result of that M&A valuation report. Turning to the Corporate segment on Page 4, no change to our outlook for the third and fourth quarter. Flipping to Page 5 to our tax credit carryforwards. It shows about $800 million at June 30. While this benefit won't show up in the P&L, it does benefit our cash flow by about $150 million to $180 million a year, which helps us fund future M&A. Turning now to Page 6, the investment income table. We call this modeling help breaks down the components of investment income, premium finance revenues, book gains and equity investments in third-party brokers. And as a reminder, none of these items are included in our organic growth computations that we present on Pages 3 and 5 of our earnings release. The punchline here is not much has changed from what we provided at our June IR Day. We are still embedding two 25 basis point rate cuts in the second half of 2024, and we have updated our estimates in this table for current FX rates. When you ship down on that page to the rollover revenue table, second quarter 2024 column, the subtotal shows $128 million and $142 million before divestitures. The $142 million was better than our IR Day outlook due to a few acquisitions performing very well during June. Looking forward, the pinkish columns to the right include estimated revenues for M&A closed through yesterday. So just a reminder, you'll need to make a pick for future M&A. Moving down on that page, you'll see Risk Management segment rollover revenues have been updated for our early third quarter acquisition. For the next two quarters, we expect approximately $20 million and $15 million, respectively. Please make sure to reflect these additional revenues in your models. Moving now to cash, capital management and M&A funding. Available cash on hand at June 30 was approaching $700 million. When combined with our expected free cash flow in the second half of 2024, which is typically stronger than the first half, we are well positioned for our pipeline of M&A opportunities. In total, we continue to estimate we could have $3.5 billion to fund M&A opportunities during 2024 and another $4 billion in 2025, all while maintaining a solid investment-grade debt rating. And remember, if we don't spend it all, it opens the door for share repurchases as well. Okay. Another excellent quarter and fantastic first half of the year. Looking ahead, we see continued strong organic growth due to net new business wins, a large and growing M&A pipeline, and many opportunities for productivity improvements. Add that to a winning culture, and I too believe we are very well positioned to deliver another terrific year here in 2024. Thanks to all the hard work by the team, and back to you, Pat."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thanks, Doug. Operator, do you want to open it up for questions, please?"
},
{
"speaker": "Operator",
"content": "Yes, sir. Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is coming from Elyse Greenspan with Wells Fargo. Please proceed with your question."
},
{
"speaker": "Elyse Greenspan",
"content": "Hi, thanks. Good evening. My first question is on the wholesale organic growth. You guys said it came in at 11% in the quarter. I believe the IR Day guide was 7% to 9%, and I think that reflected the slowdown you expected in open brokerage, I think, on the property side. So what changed relative to that guidance, and how the results came in, in the quarter?"
},
{
"speaker": "Douglas Howell",
"content": "Listen, we had a terrific finish to the end of June. Submissions were up 31% during June. There is a – clearly a continued use of wholesalers. We're not seeing really any significant shift back to the primary market and the submissions were up and so our guidance is up."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. And then you – at your IR Day, you also had said when we think about next year, that it feels a lot like 2024. I think the assumption right is perhaps something still within the range of 7% to 9% organic in brokerage. I'm assuming that still remains the case, if you could confirm that. It's obviously been a few weeks. And then if that's the case next year, if this year's margin expansion was 80 basis points without the Buck and M&A noise, would that be the rule of thumb in terms of margin expansion for next year if you're in the 7% to 9% organic growth range?"
},
{
"speaker": "Douglas Howell",
"content": "Well, yes, let's reaffirm that we see next year, it could be very similar to this year. Let's see what happens with hurricane season, casualty rates, interest rates, the election. So there's some unknowns that are happening, but we still think that next year feels a lot like where this year will come in. When it comes to margin expansion, let us work on that a little bit during our budget season. We'll start that before our September IR Day. We should have a good idea in October. But there's nothing systemic out there that would cause us to believe that in a 7% to 9% organic environment, you could see margins up in that 75 basis point to 100 basis point range."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. Thanks. And then my last one. You guys said – you said you have $3.5 billion to fund M&A this year. How much did you spend in the first half of the year? And given the pipeline that you guys see, does it feel like there might be some buyback this year? Or is it still kind of TBD?"
},
{
"speaker": "Douglas Howell",
"content": "So I think we've spent around $700 million thus far this year. We have some commitments out there. Do I see us having some buybacks? Maybe. We do have the large earn-out payable that's due right after the first of the year also. That's generally – we don't include that in that number. We kind of anticipate that, but that – we'll see. I just got off the phone an hour ago with one of our M&A bird dogs here in the U.S., and he's really starting to feel upward pressure on opportunities for M&A. There are some that are sitting there thinking that we'll see what happens with the November election. If it goes Republican, there's a lot of proposals to drop the capital gains rate maybe down to 15%. So you might have people that try to push that into January. If the Democrats win, then there might be a push to get things sold before the end of the year. So we're sitting very similar to where we were before an election three and a half years ago and where we were seven and a half years ago. There is a lot of uncertainty on M&A flow that revolves around the presidential election. So I think we've got a great shot of using it all. And if not, we'll take a look at what happens on share repurchases."
},
{
"speaker": "Elyse Greenspan",
"content": "Thank you."
},
{
"speaker": "Douglas Howell",
"content": "Thanks, Elyse."
},
{
"speaker": "Operator",
"content": "Our next question is from Mike Zaremski with BMO Capital Markets. Please proceed with your question."
},
{
"speaker": "Michael Zaremski",
"content": "Hey. Thanks. Good afternoon. I hope this question makes sense. But on the pricing environment, you always give good commentary on the renewal premium changes and you kind of give it overall and by product line. And so the RPC, right, has decelerated more recently to around 5%, how is that interchanging with your organic growth? Why is there a bigger delta now between your organic and RPC versus what we saw early this year and last year?"
},
{
"speaker": "Douglas Howell",
"content": "All right. So a great thing and maybe we haven't talked about it directly for quite a few quarters, but you always have to think about the opt-in, opt-out of the buyers' behavior. When prices are going up, buyers opt out of coverages, which might mean they increase the deductible, lower a limit or just don't buy certain coverages. As prices start to moderate or slower amounts of increases, they tend to opt back in. They reduce their deductibles, they raised their limits and maybe they buy coverages and they said, we just couldn't afford before. So if you go all the way back into our investor materials, there is always a delta between rate and exposure and what our organic growth is. And so that's why in periods when you see property is up 12%, we're not growing our property lines by 12%. They're growing 7%, 8%, 9% that's actually our revenue. So you always have to remember the opt-in, opt-out impact. Then the other thing to do is you got the dynamic of large accounts versus mid-market and small accounts that can influence that. So we're giving you a feel of what's going on in the market, but the behavior of our actual customers can vary depending on – by rational buying behavior. Prices go down, I buy more. Prices go up, I buy less."
},
{
"speaker": "J. Patrick Gallagher",
"content": "As Doug said – let me hit on that as well, Mike. Let's not forget what our job is. So Doug hit right on it. When rate and exposure looks like it's up 12% and you say, well, how come you're not seeing that write in your renewal book? Our job is to mitigate that. And we start right with that promise like wait a minute, here's where we see the market coming. A good broker gets out in front of this with their clients' months. Here's what we see in the market, here is what's coming, what are we going to do about it? Let's take retentions up. Remember, you dropped to cover before now it's time to add it. So there's a lot of moving parts between those two numbers."
},
{
"speaker": "Michael Zaremski",
"content": "Got it. And obviously, it's great you guys disclosed it. And so I guess I just want to put a final point on it. So is it fair to say that you're doing a good job for your clients and on a year-over-year basis, it's putting out a little bit of, I guess, pressure on your organic year-over-year? And separately related rate [indiscernible] do clients have the same amount of flexibility as they do in other lines that would cause the RPC disconnect to continue?"
},
{
"speaker": "J. Patrick Gallagher",
"content": "Yes, definitely. Absolutely. Number one, yes, if you throw me the softball, we're doing a good job for our clients, the answer is going to be best in the business. And we think these numbers show that. And we think the growth numbers show it. Absolutely. And yes, you'll continue to see always some change between what's being reported as growth in units of exposure and premium rates based on what we do. And the tools in our toolbox are unbelievable. So do you want to look at a captive? Would you like to take your attention up? It's not just, do you buy insurance or don't. Let's start with the things that maybe are the last things you should insure and the first things you'll self-insure. There's a lot of that work going on with our people every single day. By the way, that appetite for risk is very individual. It's not prescriptive. You can't take a book, there's no AI that says, Oh, an auto dealer has this much appetite for risk based on the number of cars in a lot. It's not how it works. So that's where our profession comes in and dealing with those people, and then our advice is critical. It's not just, well, I'm pretty bold here. I think $1 million retention makes a lot of sense. Wait, wait, wait, we think it looks better this way. And that's what we get paid to do."
},
{
"speaker": "Michael Zaremski",
"content": "Okay. That's helpful. And just lastly, pivoting to reinsurance. To the extent you have a view, one of the largest reinsurers today put out some data kind of showing that reinsurance demand. I mean you guys have done a great job not only taking market share, but kind of being able to keep your organic high because of that demand, increased like mid teens-ish this year. And if we kind of think about what's going on in personal lines, there's a lot of inflation. So just curious, would you expect kind of demand for reinsurance. I don't know if you think all the way into 2025 yet, but to remain at kind of pretty high levels relative to historical and relative to this year?"
},
{
"speaker": "J. Patrick Gallagher",
"content": "It'll go up. Yes, I do for a lot of reasons. I think that you're going to see the opportunity to buy more at prices that look more reasonable. And there have been cutbacks in the purchase of certain. The other thing is that these nuclear verdicts are real, and people are seeing that and they're going, it doesn't cost us much to buy on the high-end, the top of the tower, it does downward there's a lot more activity. And I still want to be sitting here with some goofball jury comes up with a $1 billion award."
},
{
"speaker": "Michael Zaremski",
"content": "Got it. So coming as seaside too, maybe more demand. Okay. Thank you very much."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thanks, Mike."
},
{
"speaker": "Operator",
"content": "Our next question is from the line of Gregory Peters with Raymond James. Please proceed with your question."
},
{
"speaker": "Gregory Peters",
"content": "Hey, good afternoon everyone."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Hey, Greg."
},
{
"speaker": "Gregory Peters",
"content": "I guess for my first question, during your Investor Day, you spoke about net new business wins and clearly, your results reflect that. I was wondering if you could give us some more color on how the quarter shaped up and how we should think about your net new business in the second quarter versus, say, the net new business wins in the second quarter last year or some additional metrics around that?"
},
{
"speaker": "Douglas Howell",
"content": "Well, it'll take me a minute to dig it out, but I can tell you that June year-to-date, we've actually expanded the spread between new and lost by a full point. And I think that's probably the best way to look at it. The absolute numbers are kind of irrelevant. Our non-recurring is also coming back. Before some of the non-recurring revenues might have been putting just a slight drag on organic, but now they're actually being in line with just our recurring business. So you're seeing an expansion of our spread between new and lost. How do we see that going forward? Greg, it gets more and more complicated. I actually think our team will do a better job showing our wares and our capabilities in a more of a stable rate environment versus kind of some of the chaotic rate environment that we've been seeing over the last few years. We've developed – we spent so much money on resources in the last five years. Three of those were consumed with COVID. Two of those have been consumed with some chaotic market behavior. Put our guys on a field with kind of calm rate environment, a client that's not trying to just save their business and rebuilding it after COVID, I think you'd be amazed at the digital and data and analytics and expertise. And now bring our reinsurance folks into bear, stack them up with our wholesalers, I got to tell you, it is a compelling offer at the point of sale that I would think that would absolutely deliver better net new business, more new, less loss as our clients really see the capabilities that we have built over the last five years. Arguably, maybe we've spent $1 billion in capabilities over the last seven years, something like that. So that's going to come out at the point of sale and give us a little calm in the market, and I think you're going to see our new business continue to go up."
},
{
"speaker": "Gregory Peters",
"content": "Excellent color. Thank you. One of the things you've also talked expansively about in the past is the offshore centers of excellence. And this kind of dovetails with the opportunities for margin expansion. Is it your sense for Arthur J. Gallagher that you sort of maximize those opportunities? Or do you see further potential to – for more opportunities in offshoring to help drive some margin improvement?"
},
{
"speaker": "J. Patrick Gallagher",
"content": "Well, this is Pat, Greg. Let me take the operational side of that, and I'll throw the ball to Doug for the numbers and any kind of discussion there. But everywhere I look, I see opportunity and unbelievable benefits from using our centers of excellence. We started off checking policies 20 years ago with 12 people. We now have 12,000 people supporting over 400 services in 100 countries. It is unbelievable the level of professionalism that they help us attain. And that is a differentiator at the point of sale. It's a differentiator when we're recruiting. It's a differentiator in everything we do, and I don't see any sense of that slowing down or not being something that continues to expand. It's not just about replacing heads by any means. It's about having the people that should be doing things, doing them and freeing up those that should be doing other things, giving them the time to do that, which I do think feeds into retention and new business. So I think the – our centers of excellence are a unique product offering back to Doug's point about all the things we've invested in I think they are a very beneficial add to our sales list of things we provide at Gallagher. And as we grow through acquisitions alone, everyone of those people join us and we immediately start plugging them into this resource, which is another one of the reasons they join us. So to me, it's a very differentiating thing that we do. I think our team there is absolutely spectacular, and I'll let Doug address the numbers."
},
{
"speaker": "Douglas Howell",
"content": "Yes. I think if you talk about the growth path of our offshore centers of excellence, I think remember they work only for us. They're an integral part of our team. There isn't that they or we they are us. If you look at some of our outlook, if we're going to be $20 billion of revenue, there'll be almost 30,000 folks there. So the growth path of our India and other area service centers will grow faster than the headcount in our other areas. But more importantly on this is we've been on this nearly 20-year journey now to standardize, make our operations consistent. It really is going to allow us to deploy AI into that environment. AI is terrific when you have consistency of information and repeatable behaviors and processes. And we have that, and we've spent nearly 20 years doing this. We have a jump, I believe, compared to most by almost a decade. And I think that some of the tests that we're using with AI now will make our folks there better, will make the different type of job for our folks in the centers better, it will make our sales folks better, our service folks better. And I can speak, and I've got 57% of my entire global finance, worldwide finance team operating out of there, and I can see it going to 80%. So it is going to be a service and sales differentiator for us because of the hard work we've put in for the last 15 years."
},
{
"speaker": "Gregory Peters",
"content": "Thanks for the color. Just a point of clarification. And I probably should know this number, Doug, but I don't remember. On the capital management side, you said, well, listen, if we can't do the deals, you get through your earn-out, you might consider share repurchase. When was the last time you guys were active in share repurchase?"
},
{
"speaker": "Douglas Howell",
"content": "Well, let's see, it probably was maybe in 2000, when was Brexit? 2007 or 2008 years ago, whatever Brexit was."
},
{
"speaker": "Gregory Peters",
"content": "Okay. All right. No, no. Thanks for the answers."
},
{
"speaker": "Douglas Howell",
"content": "Thanks, Greg."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thanks, Greg."
},
{
"speaker": "Operator",
"content": "Our next questions are from the line of David Motemaden with Evercore. Please proceed with your question."
},
{
"speaker": "David Motemaden",
"content": "Hey. Thanks. Good evening. I just had a question. I was hoping to get a little bit more color on the July RPC acceleration that you mentioned, Doug, maybe just a little bit around the lines. Is it property moderation kind of pausing, or is a casualty acceleration? What's going on there?"
},
{
"speaker": "Douglas Howell",
"content": "Well, actually, a little bit of both. We actually saw it in property. And actually, property is a pretty heavy quarter for us here in the second quarter. If you think it's about a third of our business, I think here in the second quarter, it might comprise 50% of our mix. So property in July. We did see a slight tick up. I'm talking a point or so. I'm not talking about is five or eight points. It's one point to two. Casualty rates are showing some, I wouldn't say acceleration. We used the word advancement in terms of where they are because – but they're steady. We'll see what happens with the – with pricing here in the second half of the year coming out of the carriers. So I would expect that to advance more. So not a jump up, but certainly, again, our dailies, they come out overnight. I looked at it last night, and we're seeing a tick up on both property and on casualty."
},
{
"speaker": "David Motemaden",
"content": "Got it. Thanks. And there was a line in the press release on the adjusted comp ratio that caught my eye, just where you noted savings related to headcount controls. That's the first time I've seen that in, I can't remember how long. I'm just wondering, is that a – I guess, is that to do with – something to do with the offshore centers or is this more of a concerted effort to show some margin expansion as we think about this year and into next year?"
},
{
"speaker": "Douglas Howell",
"content": "I think that the answer is this. First of all, if you look at what we did during COVID, we actually took out quite a few folks, and we've been hiring back since then. Our business has grown into that. We haven't stopped hiring by any means, so it's not an indication of everything. I think the teams just are seeing of their workload models that we're probably okay staffed in the environment that we are right now. So I would read that into it, but nothing systemic, but just maybe that we've hired back into the capacity that we need in 2023."
},
{
"speaker": "David Motemaden",
"content": "Got it. Okay. That's helpful. And then maybe just sneaking one more in. Just on the contingent commission accruals that you guys had made the true-up to this quarter. I guess, we have seen a lot of noise this quarter on casualty reserves, particularly on the more recent years. I'm wondering how you feel about the potential for more of those reserve adjustments to come through and how that might impact the contingents?"
},
{
"speaker": "Douglas Howell",
"content": "All right. First of all, on the supplementals, we've done pretty well year-to-date. Contingents, we did have some development that happened. We're probably not accruing as, I don't want to use the word bullish, but I will for the second. And as we were – as maybe we could. Casualty, we're cautious on it. Some of our programs and some of our binding operations, you got to be a little bit careful on performance-related compensation there. But I don't see a systemic shift in how we believe that our total compensation is going to happen. Maybe some bumps a little bit per quarter, but we're talking a couple of $3 million on a $130 million number year-to-date. So it's pretty small."
},
{
"speaker": "David Motemaden",
"content": "Yes. Understood. Fair. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thanks, David."
},
{
"speaker": "Operator",
"content": "Our next question is from the line of Mark Hughes with Truist Securities. Please proceed with your question."
},
{
"speaker": "Mark Hughes",
"content": "Yes. Thank you. Good afternoon. On the risk management business, maybe we've gotten used to the elevated growth for quite an extended period of time, the 7% in the next couple of quarters. Could you maybe just talk about the growth environment there relative to what it might have been in prior years? And what's your expectation? Is this a little bit of a lull? Or is this a good number?"
},
{
"speaker": "Douglas Howell",
"content": "Right. So first of all, let's make sure you asked about the history is that I think in 2022, we posted about 12% annual organic growth, 2023, it was – excuse me, 2021 was – it was 12%, 2022 was about 13% and last year is pushing 16%. This year, if we get 9%, we did talk about a couple of very large wins that we had that incepted in mid-2023. What we're seeing in our book of business right now is actually reassuring, not that we need reassurance. This is a great near double-digit grower and has been for a very long time is we're starting to see more and more opportunities in that $2 million to $10 million type customer a year. If you look at the amount of new business sales that are happening relative to, let's say, five years ago, it's nearly doubled now. We're double the size, too, but the carriers are beginning to understand that we offer a highly customizable solution. Self-insureds are seeing that our outcomes are better. So I think that there's a market awakening that we – when we pay nearly $12 billion or $13 billion primarily workers' comp and general liability claims that would be one of the top five, six, seven tiers in the U.S. as measured by total claims paid. So the expertise customizable services is becoming more and more known in the industry. So we're getting many more trips to the plate. Maybe a couple of fewer home runs, but I think we're going to see a lot of doubles and triples out there. So I wouldn't call it a lull because we're in now 9% this year, but we did have two years of some pretty big wins in there."
},
{
"speaker": "J. Patrick Gallagher",
"content": "But we wrote all the big ones. That's not, but [indiscernible] is a lot more difficult, more lumpy than the stuff we're seeing now."
},
{
"speaker": "Douglas Howell",
"content": "Yes."
},
{
"speaker": "Mark Hughes",
"content": "Yes. Understood. And then the any way to break out the – within the wholesale to open brokerage versus the MGA and binding?"
},
{
"speaker": "Douglas Howell",
"content": "Yes. Listen, I think that right now, open brokerage is maybe in that 11% to 13% range. And I think that binding and programs might be in the low-mid-single digits, something like that."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Mark, what I'm – what I'm most impressed with and pleased with is the fact that you're seeing that open brokerage number keep moving in nice double digits. My experience with these types of markets, especially with property is that the first line you kind of see submission slow down, people sort of stay where they are. There is a – our submission count is up substantially for the quarter, for the month, for the year. We are not seeing business flow back to the primaries. So the I think change that we've seen that were excess and surplus is becoming much more of the norm and where people want to check out what a wholesaler can do, and then we earn that business, we're not losing it. So submission counts are up, retention rates are up, new business is up, and that's pretty exciting."
},
{
"speaker": "Mark Hughes",
"content": "Great. Appreciate it. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thanks, Mark."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question is from the line of Rob Cox with Goldman Sachs. Please proceed with your question."
},
{
"speaker": "Robert Cox",
"content": "Hey, thanks. Yes. Just a question going back on the opt-in, opt-out dynamics. Just curious, does that flow through net new business and that's what's kind of driving the one point higher, you said June year-to-date of net new business? Or is that something else entirely?"
},
{
"speaker": "J. Patrick Gallagher",
"content": "Yes, I think some of that flows back – well, so for instance, a good example of that is a lot of our public entity clients, and as you know, we're very, very sizable in the public entity sector. They just work off a budget. And if the primary premiums are rising, they're taking bigger retentions, they're dropping limits, and they don't – they're not necessarily comfortable with that. So when the opportunity to buy those back up comes up, and they had an extra layer, they expand their coverage, oftentimes, we will call that new business. And at the same time, we're facing the renewal reductions on the stuff that stays with us. But it is a factor of what's available and what their budget restraints are."
},
{
"speaker": "Douglas Howell",
"content": "Yes, I think it's a little tough for us. If they write a new cover and it goes through a different – if an existing client writes a new cover that goes through our wholesale business, that would be new business. If it's a change in premium level or like a slightly lower deductible or slightly low – higher retention, that would go as renewal change. It's a little tough sometimes to split that apart. But – so part of it goes to new business. Probably if I were going to guess, maybe 20%, 25% goes through new business and 75% would go through the renewal premium change."
},
{
"speaker": "Robert Cox",
"content": "Okay. Thanks for walking us through the nuances there. And then just on the revenue indications from the audit endorsements and cancellations, those are remaining positive. Just curious if the rate of change on those is either accelerating or is that decelerating at this point?"
},
{
"speaker": "Douglas Howell",
"content": "All right. Great question. So on the surface, we're about the same as they were last year second quarter. But what happened last year's second quarter, we actually had quite a bit of endorsements that came out of the mini banking crisis. You were seeing a lot of banks increasing their D&Os in April of – March, April of 2023. We didn't have that repeat this year, probably a good thing we're not having that crisis. But interestingly, flat year-over-year, carve that out, that's still up pretty nice."
},
{
"speaker": "Robert Cox",
"content": "Got it. Thank you."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Thanks, Rob."
},
{
"speaker": "Operator",
"content": "The next question is from the line of Mike Ward with Citi. Please proceed with your question."
},
{
"speaker": "Michael Ward",
"content": "Thanks guys. I was wondering if you could update us on the progress with your integrated approach where you're going to market with multiple businesses at a time? I think you talked about leveraging programs, reinsurance and Gallagher Bassett together?"
},
{
"speaker": "Douglas Howell",
"content": "All right. So yes, there's some good program development going on that combines those three together. Then also, you're having the introductions that happen across the units. I think our introductions to our reinsurance folks coming out of our carrier relations folks to the carriers is working very well. We're seeing some nice wins on that. Getting our program folks integrally involved with the reinsurers to create the capital, find the fronting market, it's going very well, at least from the CFO's chair."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Yes. Mike, I think when we talked about that, we weren't talking about taking just individual accounts and saying the way we want to do this is all together now on the XYZ manufacturing company. What we're talking about is what Doug was hitting on. We're now meeting with insurance companies quite regularly, and we're saying, let's talk about the broad base of our relationship. And at that table are our reinsurance people, our benefits people, our service people on the claims side as well as the property casualty production and marketing folks. That is working extremely well for us, and that's really what Doug was talking about. Now at the same time, in RPS, looking across a broad base of programs. We are looking at those saying, okay, we've got about 250 programs in the company. Where are we not, a, doing the reinsurance, b, doing the claims and what should we be doing to make sure that our retailers are using those programs as well. So it's kind of a mixed bag, and it's not like we just take XYZ account to the market and say now it's all or nothing, or to the client and say it's all or nothing. I hope that color gives you a little bit of reference to what we were talking about the last time around as well."
},
{
"speaker": "Michael Ward",
"content": "Yes. No, that's helpful. Thank you. And then second question was just on the political election scenario type theme. Curious if you have any other kind of tax credit generation prospects in the pipeline, and any, I guess, political risk to those in the near term that we see?"
},
{
"speaker": "Douglas Howell",
"content": "Well, most of our tax credits are already in the bank. So I think we feel pretty comfortable about that. What are we working on? I think that with 45Q that really was passed under the previous above – all above-the-line inflation reduction at, it's made the tax credit market much more common, much more defined, broader, but we're pretty well suited for tax credits for the next four to five years. I'm not – I don't think we need to plunge in to new tax credit projects right now because we just generate the credits and they sit on the shelf for four or five years. The team is working on it, and there are some exciting things that are happening out there across all forms of clean energy that are exciting. But I don't see us doing something big in the next 1.5 years. Let's burn through these credits first, and then we'll see about what we can do. And by that time, there'll be a robust market out there for tax credits. You can get insurance on it now that much more to ensure the credit. So that's a good change in the law. Right now, I think the law is pretty well suited for us to do something in a few years and probably not have to do it with a lot of capital investment into it either."
},
{
"speaker": "Michael Ward",
"content": "Okay. So maybe if I'm thinking about it right, that – this dynamic should help bolster you in terms of, I don't know, having extra leverage in the M&A scenario if rates are cut. That should help sort of bolster your competitive edge, I would think. And do you have like a sort of update on the PE interest in the market?"
},
{
"speaker": "Douglas Howell",
"content": "Well, listen not to belabor the PE update. Like I said I just got off the phone with our bird dog. And I got to tell you, my soap box is that I had during the IR Day about the new, what I call less than transparent equity structures that PEs are now doing in order to buy nice family-owned brokers. I think there's starting to be more and more of – the curtain has been pulled back on that, and I think that sellers are really looking at. They don't have the same equity. At Gallagher, you got one equity, owners, employees, people that sell into the business and you on this call own the same equity across the board. That's not how it works now with the PE structures, and it all looks okay, do the models on it, looks okay, what happens if everything goes up in a linear line. Get a little bit of a down draft on that, and the people that give their family's lifetime of work to the PE firms get very little. And I'm telling you that is something that needs to be aware out there. And I think that when I talked at one of the bird dog today, he said, it's becoming more and more apparent to sellers they're getting the last spot of the trough."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Let me take another side of that too, Mike. Second quarter, I believe it was Marsh Perry put out a reporter Optus partners. There were 62 buyers of properties in the second quarter alone. There's a lot of private equity interest in our space. That's not stupid money. I do believe that the multiples have risen, that we've been paying for these properties because of that interest over the years. Having said that, I think the quarter was 20% down in actual transactions. So you've got maybe smarter money, maybe smaller amounts of money, but the transaction count is coming down. I think sellers, as Doug said, are getting a little bit more discerning. And I do think when you take a look at what's happened with some of the roll-ups who are now at a point where it's time to go public, and I won't mention any names, you know who they are, well, let's see how that goes. It isn't an easy slog, and I think sellers are seeing that as well. And by the way, it's pretty easy to join somebody that's going to change, nothing in your shop until they want to go public. Better, I think, as Doug said, and joined me that everybody from the family to you all as investors, you have the same stack. Now one other comment on this. When we do an acquisition, we give the opportunity for everybody in that acquisition from that point on to participate in this equity. We've got an employee stock purchase plan. We have an LTIP program for management and senior producers. We've got all kinds of ways for people to participate in our success and our growth. You sell to the PE people, the owners do great, PE investors hopefully do great, and that’s it baby. Well, I like our model."
},
{
"speaker": "Michael Ward",
"content": "Awesome. Thank you, guys."
},
{
"speaker": "Operator",
"content": "Our next question is from the line of Grace Carter with Bank of America. Please proceed with your question."
},
{
"speaker": "Grace Carter",
"content": "Hi everyone. I wanted to start on the risk management guidance. I think you all mentioned maybe around 9% for the year. I think that the prior guide was maybe 9% to 11%. Could you go over maybe anything that's changed since we last spoke in June? Thanks."
},
{
"speaker": "Douglas Howell",
"content": "I think the degree of difference on a full-year on – listen, we're talking about a couple of million dollars on the difference between the 9% and 10%. So I wouldn't say that it's made $5 million. So there's nothing that's just – we think that we've got better insight for the rest of the year and so that range is coming maybe to the lower end of it than the upper end of it."
},
{
"speaker": "Grace Carter",
"content": "Thank you. And also on the brokerage organic growth guide, I think that you all had mentioned you are considering narrowing it maybe to 7.5% to 8.5% at the Investor Day. Just keeping it at a wider range of 7% to 9%, does that just reflect uncertainty in the environment? Or has anything changed since then? Or am I just reading too much into it entirely?"
},
{
"speaker": "Douglas Howell",
"content": "Maybe the latter. I think it's been four weeks since we talked to you. We just finally got one more data point, and that's the close of June. So we'll talk to you again in September. And either way, listen, anywhere in that range. Look at that, that's 7% to 9% growth on top of 9% last year, 9% before. When you go back in 2019, we grew 6% all in. anywhere in that range is a terrific year. And if we can repeat it again next year, it's another terrific year."
},
{
"speaker": "Grace Carter",
"content": "Cool. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our last question will be from the line of Meyer Shields with KBW. Please proceed with your questions."
},
{
"speaker": "Meyer Shields",
"content": "Thanks. Two quick ones, I think. First, I was hoping – hopefully, we won't need to know this, but give us a sense as to the contingent commissions exposure to hurricane season?"
},
{
"speaker": "Douglas Howell",
"content": "No, it's very small."
},
{
"speaker": "J. Patrick Gallagher",
"content": "Very small. Most of that hurricane exposed business, especially in Florida, is in the excess and surplus, Meyer, we're the largest excess and surplus broker, I think, in the state. A lot of that is – all that’s in the E&S markets and none of those are subject to contingents."
},
{
"speaker": "Meyer Shields",
"content": "Okay. Perfect. That is good news. Second question, just looking for a brief overview of your appetite for additional acquisitions in personal lines, I guess, both within high net worth and beyond that?"
},
{
"speaker": "Douglas Howell",
"content": "Well, you're talking about personal line just being a pure auto writer, that's probably not what we're going to do. We're not great at it. We're an adviser. So if somebody is going to use us to use our advice to help them buy their insurance, that's the business of what we'd like to be in. High net worth on, we do a terrific job of it. I'm telling you our folks are some of the very best in the business, and that's an important spot right now. There's planes, there's boats, there's houses on sand bars, there's – how is on views that have landslide risk, high net worth needs an adviser probably as much as any complex mid-market commercial client. Just going on and trying to buy an auto writer, auto is probably not what we're looking to do. If it's going to be one of those things that it takes advice will be there in that space."
},
{
"speaker": "J. Patrick Gallagher",
"content": "We're actually very excited about the stuff there. I think that's – it's, a Doug said, a real opportunity for us."
},
{
"speaker": "Douglas Howell",
"content": "Well take your call, Meyer. Just go ahead, we'll help you out with it."
},
{
"speaker": "Meyer Shields",
"content": "I've got a ping pong table. That's about it."
},
{
"speaker": "Douglas Howell",
"content": "Well, there's a slip and fall on that one coming."
},
{
"speaker": "J. Patrick Gallagher",
"content": "I think that's our last comment. So just our last question, let me make just a few comments on the way out here. Thank you, again, very much all of you for joining us. I know it's a little late, and thanks to all of our Gallagher colleagues around the world for their hard work and their dedication. These quarters don't just happen. Thanks to your efforts, that means our people we're in a really enviable position our net new business is up. Our M&A pipeline is growing. I'm proud of the year-to-date financial performance. And as you can tell, I'm bullish on 2024 and beyond. So 40 years, 16% TSR, compound average annual growth rate, pretty good 40 years. I'm looking forward to the next 40. Thanks for being with us."
},
{
"speaker": "Operator",
"content": "That does conclude today's conference call. You may disconnect your lines at this time."
}
] |
ajg | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good afternoon, and welcome to Arthur J. Gallagher & Co's First Quarter 2024 Earnings Conference Call. [Operator Instructions] Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws."
},
{
"speaker": "",
"content": "The company does not assume any obligation to update information or forward-looking statements provided on this call. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the information concerning forward-looking statements and risk factors sections contained in the company's most recent 10-K, 10-Q and 8-K filings for more details on such risks and uncertainties."
},
{
"speaker": "",
"content": "In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Jr., Chairman and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin."
},
{
"speaker": "J. Gallagher",
"content": "Thank you. Good afternoon. Thank you for joining us for our first quarter '24 earnings call. On the call with me today is Doug Howell, our CFO; and other members of the management team and the heads of our operating divisions. We had a great first quarter to begin 2024."
},
{
"speaker": "",
"content": "For our combined Brokerage and Risk Management segments, we posted 20% growth in revenue, our 13th straight quarter of double-digit growth, 9.4% organic; Virgin acquisition rollover revenues of approximately $250 million. We also completed 12 mergers totaling nearly $70 million of estimated annualized revenue. Reported net earnings margin of 21.5%, adjusted EBITDAC margin of 37.8%, GAAP earnings per share of $3.10 and adjusted earnings per share of $3.83, up 17% year-over-year. So another terrific quarter by the team."
},
{
"speaker": "",
"content": "Moving to results on a segment basis, starting with the Brokerage segment. Reported revenue growth of 21%. Organic growth was 8.9% and about 10% if you include interest income. Adjusted EBITDAC was up 18% year-over-year. And we posted adjusted EBITDAC margin of 39.9% a bit better than our March IR Day expectations."
},
{
"speaker": "",
"content": "Let me give some insights behind our Brokerage segment organic, and just to level set, the following figures do not include interest income. Our global retail brokerage operations posted 7% organic. Within our P/C operations, we delivered 7% in the United States, 6% in the U.K., 2% in Canada and 8% in Australia and New Zealand. And our global employee benefit brokerage and consulting business posted organic of about 8%, including some large live case sales that were completed in late March."
},
{
"speaker": "",
"content": "Shifting to our reinsurance wholesale and specialty businesses, overall organic of 13%. This includes Gallagher Re at 13%, U.K. specialty at 10% and U.S. wholesale at 13%. Fantastic growth, whether retail, wholesale or reinsurance."
},
{
"speaker": "",
"content": "Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance market. Global first quarter renewal premiums, which include both rate and exposure changes, were up about 7%. Renewal premium increases continue to be broad-based, up across all of our major geographies and most product lines."
},
{
"speaker": "",
"content": "For example, property was up nearly 10%; umbrella, up 9%; general liability, up 7%; workers' comp, up 2%; package, up 8%; and personal lines, up 13%. So many lines are seeing sizable increases. There are 2 exceptions within professional lines. First, D&O, where renewal premiums are down about 5%; and second, cyber, where renewal premiums are flattish."
},
{
"speaker": "",
"content": "These 2 lines appear close to reaching a pricing bottom, but combined, represent around 5% of our P/C business globally. So overall, our clients continue to see insurance costs increase, but our job as brokers is to mitigate these increases and deliver comprehensive insurance programs that align with their risk appetite and fit their budget."
},
{
"speaker": "",
"content": "Moving to the reinsurance market. First quarter dynamics were dominated by the January 1 renewal season where we saw stable pricing and increased demand for property cat cover. Reinsurers continue to exercise discipline and met the increased client demand with sufficient capacity. Importantly, the team was able to secure many new business wins while retaining most of our existing clients."
},
{
"speaker": "",
"content": "During April renewals, reinsurance carriers maintain their discipline, and with increased demand and stable pricing, we saw more coverage being purchased. Within property, more capacity was available at the top end of programs and the quoting of renewal process was disciplined and predictable."
},
{
"speaker": "",
"content": "The casualty treaty market saw stable pricing overall. However, carriers able to differentiate themselves through good management of prior year reserves were able to secure better reinsurance placements. Specialty class renewals were a bit more complex with some changes in terms and conditions. However, many clients were able to secure modestly lower pricing."
},
{
"speaker": "",
"content": "With that said, the tragedy in Baltimore may cause reinsurance carriers more pricing [ resolve ] throughout the rest of the year. Those interested in more detailed commentary on January or April renewals can find our first new market reports on our website."
},
{
"speaker": "",
"content": "In our view, insurance and reinsurance carriers continue to behave rationally. Carriers know where they need rate by line, by industry and by geography. We are seeing this differentiation in our data. Premiums are increasing the most, where it's needed to generate an acceptable underwriting profit. Great example of this is primary casualty, where we are seeing renewal premiums moving higher."
},
{
"speaker": "",
"content": "Global first quarter umbrella and general liability renewal premium increases are in the high single digits, including 9% increases in U.S. retail. A. M. Best recently maintained its negative outlook on the U.S. general liability insurance market due to worsening social inflation, medical expenses and litigation financing. We've been highlighting these dynamics for a while, along with hearing concerns around historical reserves, which leads us to believe further rate increases are to come in casualty."
},
{
"speaker": "",
"content": "At the other end of the spectrum, we have property. As insurance and reinsurance carriers believe they are getting closer to price and exposure adequacy, we are seeing property renewal premium increases moderating. With that said, first quarter insurance renewal premiums were still pushing double digits. As we look out for the remainder of the year, increased frequency or severity of catastrophes could again move the market in '24."
},
{
"speaker": "",
"content": "And while capacity was very challenging to come by during '22 and '23, we are now finding, when clients are looking to add coverage or limits, carriers are more than willing to provide additional cover. Notably, we are not seeing a change in the underwriting standards from our carrier partners."
},
{
"speaker": "",
"content": "While continued premium increases seem rational to our carrier partners, our clients have experienced multiple years of increased costs, having a trusted adviser like Gallagher to help businesses navigating a complex insurance market by finding the best coverage for our clients while mitigating price increases. That's what we do."
},
{
"speaker": "",
"content": "Moving to our customers' business activity. Overall, it continues to be solid. During the first quarter, our daily indication showed positive midyear policy endorsements and audits ahead of last year's levels across most geographies. So we are not seeing signs of a broad global economic slowdown."
},
{
"speaker": "",
"content": "Within the U.S., the labor market remains tight. Nonfarm payrolls continue to increase and more people are reentering the workforce. Yet there continues to be nearly 9 million job openings. Wage increases have persisted at the same time, medical cost trends are rising. With these dynamics, employers are focused on total rewards strategy to help them achieve their human capital goals while reining in costs. That's why I believe our benefits businesses will have a terrific opportunities in '24."
},
{
"speaker": "",
"content": "Overall, we continue to win new brokerage clients while retaining our existing customers. In fact, our new business production has been on an upward trend in recent quarters, and our retention is holding. We believe this is a direct reflection of our client value proposition, CORE360 and Gallagher Better Works, our niche expert service and our data and analytics."
},
{
"speaker": "",
"content": "Don't forget, we're competing with someone smaller than us, 90% of the time. These local brokers just can't match the value we provide. So putting it all together, we continue to see full year '24 brokerage organic in the 7% to 9% range, and that would be another outstanding year."
},
{
"speaker": "",
"content": "Moving on to our Risk Management segment, Gallagher Bassett. Revenue growth was 19%, including organic of 13.3% and rollover revenues of $14 million. Adjusted EBITDAC margins were 20.6%, up 140 basis points versus last year and a bit better than our March IR Day expectations. Our results continue to reflect solid new business, outstanding retention, continued increases in new arising claims across both workers' comp and liability and resilient customer business activity."
},
{
"speaker": "",
"content": "Looking forward, we continue to see '24 full year organic in the 9% to 11% range as our larger '23 new business wins have been fully onboarded. We now expect full year margin of approximately 20.5%. That would also be another outstanding year."
},
{
"speaker": "",
"content": "Shifting to mergers and acquisitions. We had an active first quarter completing 12 new mergers, representing about $70 million of estimated annualized revenue. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals."
},
{
"speaker": "",
"content": "Looking ahead, our pipeline remains strong. We have around 50 term sheets signed or being prepared, representing around $350 million of annualized revenue. Good firms always have a choice, and we'll be very excited if they choose to join Gallagher."
},
{
"speaker": "",
"content": "Let me conclude with some comments regarding our bedrock culture. It's a culture that has remained constant through the decades of incredible growth. This is largely due to the 25 tenants of The Gallagher Way, which is entering its fifth decade next month. It is deeply rooted in the values of integrity, ethics and trust, which have been guiding us since 1927."
},
{
"speaker": "",
"content": "Our culture is not just a differentiator, it's a competitive advantage. It attracts the right talent to our organization and the best merger partners and enables us to build enduring relationships. What makes me particularly proud is that I witness our culture in action every day as our employees demonstrate their commitment to our clients, and that is The Gallagher Way. Okay. I'll stop now and turn it over to Doug. Doug?"
},
{
"speaker": "Douglas Howell",
"content": "Thanks, Pat, and hello, everyone. Today, I'll walk you through our earnings release. I'll comment on first quarter organic growth and margins by segment, including how we are seeing full year organic growth and margins in each of the next 3 quarters. Then I'll provide some typical comments on the modeling helpers we provide in the CFO commentary document that we posted on our website, and I'll conclude my prepared remarks with a few comments on cash, M&A and capital management."
},
{
"speaker": "",
"content": "Okay. Let's look to Page 2 of the earnings release. Headline, first quarter brokerage organic growth of 8.9%. That's a bit better than our March IR Day expectation of 8% to 8.5%. And remember, we exclude interest income. Including such, we would have shown about 10% organic growth. Looking ahead, we continue to see strong new business production and favorable client retention."
},
{
"speaker": "",
"content": "Combine that with further rate increases, a resilient economic backdrop and sticky inflation, our 2024 brokerage organic outlook is unchanged. We are still seeing full year organic growth in that 7% to 9% range."
},
{
"speaker": "",
"content": "Moving to Page 4 of the earnings release, to the Brokerage segment adjusted EBITDAC table. First quarter adjusted EBITDAC margin was 39.9%, a bit better than our March IR Day expectations. The footnote on that page explains what we discussed in our January earnings call and again at our March IR Day. There is 90 basis points of roll-in impact from M&A, principally Buck, that naturally runs lower margins."
},
{
"speaker": "",
"content": "So on the surface, it is showing 30 basis points lower, but underlying margins actually expanded 60 basis points. Again, that improvement is a little better than what we forecasted in March. Let me walk you through a bridge from last year. First, if you were to pull out last year's 2023 first quarter, you would see we reported, back then, adjusted EBITDAC margin of 40.4%."
},
{
"speaker": "",
"content": "Second, when we update that margin using current period FX rate, gets you to an FX adjusted margin of about 40.2%. And we've done that here. So you can see that in the 2023 column in this table. Third, deduct that the 90 basis point roll-in impact. Again, that's all due to the roll-in math. And let's -- just to be clear, these are not businesses with margins that are going backwards."
},
{
"speaker": "",
"content": "So that gets you to 39.3%, Compare that to the 39.9% we show today, and that gives you the underlying 60 basis points of margin expansion. That is really great work by the team. As we look ahead to the following 3 quarters of '24, it is looking like we could expand margins in the 90 to 100 basis point range in each of the next 3 quarters. Let me give you some flavor on that."
},
{
"speaker": "",
"content": "First, as Pat said, Buck passed its 1-year anniversary, so that roll-in noise is behind us. Second, as discussed at our March IR Day, the carryover impact of raises given in 2023 is comparatively lesser over the next 3 quarters. And third, the reality is we are typically posting margins higher than most of our M&A targets."
},
{
"speaker": "",
"content": "While that slightly impacts what we report as margin expansion, we will do these mergers all day, any day. These are great businesses with terrific talent. And when we combine, we are better together. So to repeat, expansion in 90 to 100 basis points range in each of the next 3 quarters would get you to about 60 basis points of full year margin expansion. That assumes we would post organic in that 7% to 9% range and it still is allowing us to continue to make substantial investments in data analytics, sales tools, digital service and arming our sales and service folks with the best resources in the business."
},
{
"speaker": "",
"content": "Okay. Let's move to the Risk Management segment and organic and EBITDAC tables on Pages 4 and 5. Another fantastic quarter benefiting from new business wins and excellent client retention, 13.3% organic growth and margins at 20.6%. Looking forward, we are now lapping growth associated with our large new business wins from '23, and so we see quarterly organic for the rest of '24 in the 8% to 9% range. As for margins, the team has done a great job posting margins above 20% this quarter, and we believe we can hold that for the remainder of the year. That also is a bit better than our March IR Day outlook."
},
{
"speaker": "",
"content": "Turning to Page 6 of the earnings release, in the corporate segment shortcut table. Adjusted first quarter numbers came in better than the favorable end of our March IR Day expectations due to lower acquisition costs and some favorable tax items, primarily associated with stock-based compensation, and that's shown in the corporate line."
},
{
"speaker": "",
"content": "So now let's move to the CFO commentary document that we posted on our website. Not much changes at all on Page 3 or 4 other than a few tweaks to a few numbers such as FX, noncash items, et cetera. Just do a double check with your models using these numbers."
},
{
"speaker": "",
"content": "Page 5 updates our tax credit carryforwards. It shows about $820 million available at March 31, and that we would be -- that we are benefiting our cash flows about $150 million to $180 million a year. Doesn't flow through our P&L, but still a nice annual cash flow benefit to help us fund future M&A."
},
{
"speaker": "",
"content": "Turning to Page 6, the top table. Recall, we introduced this modeling helper in January. It breaks down the components of investment income, premium finance revenues, book gains and equity investments in third-party brokers. Not much has changed from what we provided in March but we are still embedding 225 basis point rate cuts in the second half of '24. And we've also updated for current FX rates."
},
{
"speaker": "",
"content": "The lower table on Page 6 is rollover revenues. Blue column subtotal of about $228 million is very close to the $224 million we provided at our March IR day. And remember, the pinkish columns only include estimated revenues for M&A through -- that we've closed through yesterday. So just a reminder, you'll need to make a pick for future M&A."
},
{
"speaker": "",
"content": "Also a little housekeeping. When you read Note 3 on that page, you'll see we had an estimate change related to some historical acquisitions that causes the gross up of revenues and expenses. It nets close to nothing, but it does flow through the P&L. We've adjusted these out, so there's no impact to organic adjusted net earnings or adjusted EBITDAC or adjusted EPS."
},
{
"speaker": "",
"content": "Moving to cash, capital management and M&A funding. Available cash on hand at March 31 was around $1 billion, which includes a portion of the proceeds from our February debt offering. So with $1 billion in the bank and expected strong future cash flows, we are still estimating we have total capacity in '24 of about $3.5 billion to fund M&A without issuing stock nor having to borrow much of any more."
},
{
"speaker": "",
"content": "As for 2025, it looks like we could fund over $4 billion of M&A with free cash and debt, all of this while maintaining a solid investment-grade rating. Okay. Another terrific quarter and start to the year. Looking ahead, we see continued strong organic growth, a growing pipeline of M&A, further opportunities for productivity improvements and a culture that makes us hard to beat. I believe we are very well positioned to deliver another fantastic year here in '24. Back to you, Pat."
},
{
"speaker": "J. Gallagher",
"content": "Thank you, Doug. Operator, I think we're ready for some questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Elyse Greenspan with Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"content": "My first question is on the brokerage segment. So organic, as you guys said, right, a bit better than what you expected in March. So close to the top end of the full year guided range, right, that you guys are maintaining that outlook, could you just give us a sense, do you expect growth to slow over the balance of the year? Is there some level of conservatism?"
},
{
"speaker": "",
"content": "I mean, Pat, you seemed positive on the pricing environment. We saw a little bit like GDP numbers today come out. I'm just trying to think about how you put that all together and how you would think growth would trend within brokerage over the next 3 quarters."
},
{
"speaker": "J. Gallagher",
"content": "Well, I'm going to let Doug do the numbers. But yes, I mean, I think you're reading me right, Elyse. I'm bullish on the environment. We are not seeing a downturn in terms of our clients. They're employing more people. We're seeing robust client activity at Gallagher Bassett. That's a very good bellwether of what's going on in the economy."
},
{
"speaker": "",
"content": "Interest rates are up. The market hates inflation, but it's good for brokers and high interest rates help us as well in terms of the growth in revenues and head count and all the rest of it. So the fundamental business environment is really, really good for us. As far as the numbers, Doug, go ahead."
},
{
"speaker": "Douglas Howell",
"content": "Yes. Listen, we don't see much difference in each quarter going forward. We think we'll be in that 7% to 9% range, Elyse. We do have a large first quarter and it is heavily weighted to reinsurance. So you would naturally expect us to -- if we're going to be in that range, that maybe the first quarter is a touch above the next 3 quarters, but I wouldn't say it's anything meaningful."
},
{
"speaker": "",
"content": "And so we're in that 7% to 9% range each of the next 3 quarters, which would bring us in, in that range for the full year. So really nothing different than what we've talked about the last couple of times we've been with you."
},
{
"speaker": "Elyse Greenspan",
"content": "And then the second one is on margin, right? So a little bit, like you said, the Q1 was a little bit better than the March guide, but you previously had said, right, 100 basis points in the -- all three quarters. Now it's 90 to 100 and the full year guide seems unchanged. Is it just maybe Q1 was a little bit better so now you're taking some of that to invest internally? I know it's a little nitpicky because it's still 90 to 100, but just trying to kind of square the updated out-quarter margin view with what you told us in March."
},
{
"speaker": "Douglas Howell",
"content": "Well, listen, I think that the CFO commentary document has kind of said 90 to 100, I think, consistently. If I said 100% of the last IR Day, I may have said towards 100 basis points. So I think our guidance feels, to us, about the same."
},
{
"speaker": "Elyse Greenspan",
"content": "Okay. And then one last one. The FTC, right, is looking to potentially remove noncompetes from -- I guess my question is two-pronged from both the ability, I guess, to bring folks into Gallagher and also considering the potential to lose talent to other players, how do you think this could impact the company if it does actually go through?"
},
{
"speaker": "J. Gallagher",
"content": "Well, let me comment on that one. First of all, I think everybody saw that the U.S. Chamber has filed a lawsuit in Texas that's challenging this, and we're supportive of the Chamber's efforts. We think it's an overreach by the executive branch."
},
{
"speaker": "",
"content": "But having said that, if the new rules actually hold up, there's a count in noncompete agreements as part of the sale of the business. And so we see that rule is having a little impact, really, on our M&A strategy. And that's -- when it first came out, that was kind of my concern. Our agreements with our production staff do not contain noncompete provisions, rather we use non-solicitation clauses."
},
{
"speaker": "",
"content": "And there is a fine line difference there, but those cover clients and employees. And from our first look, we think those are going to remain enforceable. Having said all that, we want people to want to work here. The reason, this is why culture is so important. This is a great place to work, and we attract highly motivated salespeople and entrepreneurs that are passionate about doing what they do, and they want to leverage their expertise and capabilities."
},
{
"speaker": "",
"content": "And we give them the data and analytics and the centers of excellence to work with. We arm them with way better armament that they get from being part of a local competitor. We're a great place to work. So while I don't agree with the FTC, and I do agree with the Chamber's position, we're supportive of that, for our business, I think it's a nonissue."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Mike Zaremski with BMO Capital Markets."
},
{
"speaker": "Michael Zaremski",
"content": "Just as a quick follow-up on the FTC question. One of the top 10 brokers is on record saying that their California margins are a bit lower than the rest of the rest of the regions due to a little bit higher turnover, which might be due to [ Cali ] not having non-solicited noncompetes. Just curious, have you ever sliced and diced your California margins? And are they a little bit lower than the rest of the company?"
},
{
"speaker": "J. Gallagher",
"content": "Sliced and diced every margin by every possible measure you can think of. And no, they're not a bit lower. We've been trading in California for 50 years. We love the state, we're big, big there, and our people love working there."
},
{
"speaker": "Michael Zaremski",
"content": "Okay. That's clear. Switching gears to M&A. You guys -- and I've asked this in the past, but I'll just keep asking, because these are big numbers. So Doug, you said $4 billion of capacity for next year. That's clear. But these are just big numbers, $3.5 billion this year, $4 billion next year. Does this imply, if you look at, like, the top 100 list of brokers, I know that's just U.S., there's lots of overseas stuff. But just -- should we be thinking that you guys do some chunkier size deals as time progresses to be able to kind of fully deploy cash and debt?"
},
{
"speaker": "J. Gallagher",
"content": "Mike, this is Pat. I think it's fair to say that when opportunity presents itself, we're not afraid. I mean, 10 years ago, we stepped up and bought Wesfarmers out of Australia for $1 billion. That was the biggest play we'd ever made, and had, in fact, some financing for it that's worked out incredibly well."
},
{
"speaker": "",
"content": "I think our purchase of Willis was somewhere on the order of -- Willis Re was somewhere on the order of $4 billion. And last year, we spent a good bit as well. So we're not afraid to look at chunkier deals, but you hit on it. There's 100 top 100. There happens to be 29,900 in the United States alone that are smaller than that. That's where our activity is based most of the time."
},
{
"speaker": "Douglas Howell",
"content": "Yes. I think -- Mike, this is Doug. I think that we have a chassis now that we can bring on a lot of smaller acquisitions, nice family-owned businesses that realize that they can be better together with us. I think that our M&A integration process is pretty smooth, very refined, 700 deals over the last 20 years. So we've got that down."
},
{
"speaker": "",
"content": "And I think more and more, smaller or local brokers are realizing they can get the resources from us overnight that they've been wanting to have for maybe 20 years. So I think we have an advantage right now that family-owned broker now sees that they get to join us. This is their forever home."
},
{
"speaker": "",
"content": "They don't have to sell into a different model that maybe will flip them or sell them to a different owner or break them apart in order to get value. They see that what's being talked about of capabilities is real inside of us. And sometimes when they go to another quarter for them, they're saying what they're going to do versus what they have done."
},
{
"speaker": "",
"content": "So I think that we have the opportunity to increase the volume of that nice tuck-in deals that we see out there. And I think that our story is getting stronger and stronger every day. Higher interest rate, it does not help others reinvest into their business. We reinvest so much into our business day in and day out."
},
{
"speaker": "",
"content": "There are new ideas for tools and capabilities and the others just can't say that. They haven't done it. I don't think they're going to do it in a higher interest rate. So I think the volume of our tuck-in deals will increase. Will we spend $3.5 billion this year and $4 billion next year. Yes, maybe we'll see. I think we've got a good shot at it."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of David Motemaden with Evercore ISI."
},
{
"speaker": "David Motemaden",
"content": "But Pat, I wanted to just talk about your comments you made on the property insurance side and on clients looking to add incremental coverage or limits and just how I can think about that as a potential offset to some of the moderation in property insurance pricing that you were talking about as well. Just help me think about the -- both of those factors and sort of how to think about that moderation and the impact that could have on your organic growth in the future."
},
{
"speaker": "J. Gallagher",
"content": "Well, first of all, I think that when you look at that, those were in the section of the prepared remarks that had to do with reinsurance. There's been a lot of demand the last number of years for cat covers and what have you that frankly were hard to meet. And that's why we talk about the fact that it was more orderly this 1/1. We were able to complete what people wanted more or less."
},
{
"speaker": "",
"content": "But there has been an appetite for more cover there that buyers and sellers have walked away from. But I think as we start to see pricing stabilize, become more predictable, that allows it to flow into their rating structure, et cetera. There's demand for more cover on their part, and we're meeting that demand. And I think that is offsetting some of the potential."
},
{
"speaker": "",
"content": "Now remember, we didn't see property rates come down this quarter. What we're saying is that the increase moderated. So I think that there's kind of -- on the retail side, if you're a retail buyer -- and remember, most of our book of business is the commercial middle market. Don't get me wrong, we do a lot of risk management business, but these tuck-in acquisitions and the like that we're doing are clearly middle market players. Those people don't have a lot of choice. They're buying full cover at higher prices. And if that moderates a bit, it's good for the client."
},
{
"speaker": "Douglas Howell",
"content": "Interestingly, David, we have -- we're seeing rate increases and the exposure unit increases in the middle and smaller market greater than we did in the larger account size whereas, say, you go back a year or so ago, it might have been just the opposite. So we're starting to see -- if you're talking about some rate moderation and the increase, it's starting to pick up a little bit in the middle and small market space."
},
{
"speaker": "",
"content": "The second thing is, remember, if the rate moderates, our customers are very good about opting out of coverage or as much coverage as rates go up and then opting back in for coverage to buy more when rates are coming down. So we've never captured the full increase of the rate and we won't suffer the entire give back if rates moderate a little bit. So there's that opt in, opt out. We haven't really talked about that much in the last 5 years or so. But we're seeing customers opt back in to buy more coverage if there are some moderation in the increase of the rates."
},
{
"speaker": "J. Gallagher",
"content": "Also on the property side, back to that, David, you've got -- many years were 0 interest rates, not the last couple, but 0 interest rates left the schedules pretty much untouched. So you do have underwriters now being much more disciplined around the values, and that's pushing values up. So we've got the benefit of more values being insured in the property business."
},
{
"speaker": "",
"content": "And my prepared remarks basically pointed out that property was up nearly 10% this quarter. So we're not seeing rates dropping. We're seeing rates go up in property a little less viciously. Now having said that, if the wind blows this fall, we're 1 month away from the start of the hurricane season, I'm just telling you all bets are off. I don't know what's going to happen. So for our clients sake, I hope that we have a benign season."
},
{
"speaker": "David Motemaden",
"content": "No, thanks for that. And yes, I do -- I was referring also, and you guys answered it, just the primary market, the moderation there. It is interesting to hear more about sort of that opt-in which I have not thought about. So that is helpful to hear about that. And then if I could just add 1 more, just 1 more question."
},
{
"speaker": "",
"content": "So it sounds like there were some large life sales that came through towards the end of March. Was that a pull forward from future quarters? Or I guess, sort of outlook on the pipeline of the life sales and just how that -- how you're thinking about that throughout the rest of the year."
},
{
"speaker": "Douglas Howell",
"content": "As probably more of the -- if you remember, in December, we had some push out of the fourth quarter. So I would say it might be more catch-up than it is pulling from the future. And we're talking about $5 million on a $3 billion revenue quarter. So it was -- it's not meaningful in any of our numbers. The difference. We love the business, but it's not -- it doesn't make a big difference in any of our numbers."
},
{
"speaker": "David Motemaden",
"content": "Got it. So that was in your sort of outlook range that you gave in March. So the upside this quarter was not just solely from the life sale?"
},
{
"speaker": "Douglas Howell",
"content": "That's right."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Mark Hughes with Truist Securities."
},
{
"speaker": "Mark Hughes",
"content": "Pat, did you give the breakout for open brokerage versus the MGA or binding business within the wholesale?"
},
{
"speaker": "J. Gallagher",
"content": "I did not."
},
{
"speaker": "Douglas Howell",
"content": "You got about 16% open brokerage this quarter."
},
{
"speaker": "Mark Hughes",
"content": "And then with the binding, I think it's been running mid-single digits. Is that…"
},
{
"speaker": "J. Gallagher",
"content": "Higher than that. So more like 10%, 11%."
},
{
"speaker": "Mark Hughes",
"content": "Okay. And then anything on the workers' comp side? Or just waiting for signs of life there in terms of frequencies, severity, pricing? Is it more of the same? Or do we have some reason to think it could be in selecting?"
},
{
"speaker": "J. Gallagher",
"content": "No, I think that's really interesting, Mark. In my career, that line has been, at times, pretty darn cyclical, and it is just as flat as a pancake. It's just going along. You might see 2 here, 3 there. And it's really just kind of flat."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Katie Sakys with Autonomous Research."
},
{
"speaker": "Katie Sakys",
"content": "First, just kind of wanted to touch on the margin expansion guidance for the full year. If organic revenue growth were to come in higher than the current guide, whether that comes from the wind blowing and property rates reaccelerating or for something else, how much of that would you guys kind of envision letting fall to the bottom line? Like, should we expect to see greater margin expansion? Or are there other areas of investment opportunities that you guys would kind of like to see some progress made on."
},
{
"speaker": "Douglas Howell",
"content": "Well, listen, I don't think that our investment opportunities would be rolled out fast enough in order to spend more going into if we had to pop up in organic growth and starting in August, if something -- the wind blows or something like that. So I don't think we would have the ability even to ramp up on some of the -- some big investment opportunities to offset that additional organic growth."
},
{
"speaker": "",
"content": "But I'm trying to do some mental math here. If we're up another 0.25 point in organic, it might produce another, in a quarter, to $10 million or $15 million if we had it for half a year, something like that, if I'm doing my math right. So I don't think -- it would probably naturally improve the margins a little bit."
},
{
"speaker": "",
"content": "I want to make sure we go back and clarify the question within wholesale, right? When you combine [ binding ] and programs, 11%. The programs are really more running around 2% to 3%. And open brokerage is in that 16% range. So just to make sure that we -- I answered 1 question, Pat has answered a combined question and just to break those 3 out, 16%, over 10% and low single digits on the program side."
},
{
"speaker": "Katie Sakys",
"content": "It's a helpful clarification. Just maybe as a quick follow-up. In terms of benefits from head count controls and client-related expense saves, are those things that you expect to persist as the year goes on? Or are those more specific to 1Q in particular?"
},
{
"speaker": "Douglas Howell",
"content": "Listen, I think the team does a really nice job of looking at our head count controls. We have work model that show how many people we need to have, how many do we have. Do we need to hire in July, August and September, we can kind of forecast that."
},
{
"speaker": "",
"content": "Our retention's been very good. I got to say that when you look at it, our retention is better today than it was, let's say, in '18 and '19. So I think we've done a really nice job of taking care of our employees throughout this inflation period. So we're not seeing significant terminations here."
},
{
"speaker": "",
"content": "So overall, I think our work planning models and our ability to kind of forecast retention has helped us not have to push and pull on the joystick there to see how many more we need to bring on, how many do we need to take off. So it's pretty steady right now."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Yaron Kinar with Jefferies."
},
{
"speaker": "Yaron Kinar",
"content": "I just want to touch on a couple of market questions, if I could. I think in the prepared remarks, you were talking about general liability and retail being up, like, 9%. If I go back to the investor meeting from, like, a month or so ago, I think you were talking about maybe seeing liability lines moving up to the 9%, 10% range over the course of 1 year or 2. So are you -- are we talking apples-to-apples here? Or are you surprised by the magnitude of improvement that you're seeing in liability lines right now?"
},
{
"speaker": "J. Gallagher",
"content": "I think -- let me go back to my prepared remarks. We've seen umbrella in the quarter, up 9%, which is kind of in line with what we're talking about in March. GL 7%, and that's where I think probably we've got to look at our carriers and say, are there going to be some reserve challenges going forward. So the 7% seems pretty -- it seems pretty stable. Maybe there'll be a push up a bit. And package, which is, of course, property and liability together at 8%; where comp, really not much, 2%. I think that feels like it's going to be there for the year. I think you could take our March discussions and kind of update them 6 weeks later for those numbers."
},
{
"speaker": "Douglas Howell",
"content": "There's a tone of concerns that seems to be louder today in our interactions with carriers and clients around casualty rate adequacy. So I would say that what we were chatting about in January and February seems to be louder today -- that confirms to be a little bit louder today. And so I think that -- and we're just -- I don't know if I have enough data yet to say absolutely that there was a tone shift in March in our data compared to what we were seeing in January and February."
},
{
"speaker": "",
"content": "But when you look at some isolated situations, you boil that down with what we all read. When you combine that with what we hear in meetings with the carriers, we feel that casualty rates probably are more likely going up again in the next 3 quarters -- each of the next 3 quarters than we would see going down by any means. So there is a tone shift there. I just can't quite see it 100% in our data yet, but it seems like it's coming."
},
{
"speaker": "Yaron Kinar",
"content": "That makes sense. I appreciate the color. And then -- and I apologize if you've already addressed this, and I missed it. But we saw the stamping office data come out in March around E&S flows and in the [ REITS ]. And it seems like it was a little bit of a surprise and disappointment."
},
{
"speaker": "",
"content": "How much of that do you think is noise? Are you seeing that slowdown in your wholesale business? Or is that real? And sorry, or is that just noise and you're kind of looking past that and still see a very strong E&S market?"
},
{
"speaker": "J. Gallagher",
"content": "That is noise. Our E&S business is on fire. We are seeing submissions come in. We're renewing our business. I don't have any caution on that."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Meyer Shields with KBW."
},
{
"speaker": "Meyer Shields",
"content": "I was hoping to start on the reinsurance side. I think you talked about 13% organic growth. And is there any way of breaking that down between maybe the increasing limits that are being purchased versus market share wins versus pricing?"
},
{
"speaker": "J. Gallagher",
"content": "I don't have the actual stats on that."
},
{
"speaker": "Douglas Howell",
"content": "Well, listen. I will tell you this that we had a terrific new business quarter. Our teams are working together. I think we're starting to see some nice wins of working with our retailers on that. When you go down -- we were hearing a lot of great stories about teams settled in. When we look back and see it and try to measure our success on doing that merger. Our teams are working together. We're selling more new business."
},
{
"speaker": "",
"content": "Our retention seems to be pretty darn good on that. And I think the fact is customers are buying some more cover while you're seeing a little price stability maybe. So we're checking the box on everything that we've considered to be this to be a successful merger."
},
{
"speaker": "Meyer Shields",
"content": "Okay. That's helpful. And second question, and clearly, I guess, the premise is we're not seeing any successful pressure on the part of carriers to reduce commission percentages. I was hoping you'd update us on efforts that are being made, even if they're not successful."
},
{
"speaker": "J. Gallagher",
"content": "No. I think that our partners are being very reasonable. We're not we're not having a lot of headbutting on that subject at all."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Rob Cox with Goldman Sachs."
},
{
"speaker": "Robert Cox",
"content": "So I think in March, at the Investor Day, you guys were pretty optimistic on the potential for reacceleration in RPC in the remainder of 2024 due to higher exposure to property business and less workers' comp and the potential for casualty pricing increases. Is that still the case? Or is the property rate environment, with a little deceleration in the rate of increase, made you change your view a little bit?"
},
{
"speaker": "J. Gallagher",
"content": "No, I think our view is unchanged. We're very bullish."
},
{
"speaker": "Robert Cox",
"content": "Okay. Okay. Got it. And then maybe sort of a similar question in some ways. But if we strip out reinsurance, is the touch lower organic guide for the remainder of the year the same? Or do you think ex reinsurance, what would you say, for the trend of organic growth ex reinsurance?"
},
{
"speaker": "Douglas Howell",
"content": "Well, yes, I think just because reinsurance is a little more skewed seasonally to the first quarter, it did help us, let's say, get from 8% to 8.9% this quarter, right? We do have some pretty good April 1 renewals coming in, so we'll see that in the second quarter. So I think we'll get the benefit of reinsurance a little bit in the second quarter, even though it's not as big percentage-wise as the total amount of our revenues."
},
{
"speaker": "",
"content": "And then in the third and fourth quarter, we'll see what happens. We'll see what happens with the wind. Hopefully, there's not a shake anywhere else in the world. But right now, that's why I say, I feel pretty comfortable each quarter in that 7% to 9% range because reinsurance did help, but it wasn't like it moved us from 6% to 9%. It moved us up 75 basis points, something like that this quarter."
},
{
"speaker": "Robert Cox",
"content": "Got it. And if I could sneak 1 more in. In the Brokerage segment, could you remind us how much you're reinvesting in the business annually and what you're spending it on?"
},
{
"speaker": "Douglas Howell",
"content": "Well, it's a laundry list. I mean, first, you start with our people. I think that our training, our development, our internship program, I think bringing on more producers, we are seeing lots of interest in joining Gallagher by experienced producers out there. I think they see that the organization has a lot to offer for them."
},
{
"speaker": "",
"content": "Then the next thing you'd look at is technology. We're spending a ton on technology that both enables us to sell more, right, enables us to service better. Those numbers are probably -- the projects on the sheet could be $75 million, something like that. When I look at this year's budget, some of that's capital, some of that is operating expense."
},
{
"speaker": "",
"content": "Like, [ looking ] back, we're spending about $75 million a year on cyber today. If you go back 5 years ago, we were spending about $15 million on that. So the fact that we're investing in infrastructure improvement, cyber and other infrastructure improvements. Then you get down into the data and analytics. We are hiring more and more people every day that help us slice and dice our data, look at industry statistics and bring a better delivery of that data through a digital platform to our customers."
},
{
"speaker": "",
"content": "My guess is we're spending $30 million a year on those efforts. And then you look at AI now. There's starting to be a lot of AI projects inside of the company that are starting to deliver some yield. And so we're spending $5 million a year kind of on AI-related activities out there. So you add all that up, it can get to $200 million to $300 million pretty quickly in what we think we're doing to make a better franchise going forward."
},
{
"speaker": "J. Gallagher",
"content": "I'd like to emphasize what Doug -- I've got a lot of listeners on this call. I'd like to emphasize where Doug started this. Most of that spend is, in one way or another, directly related either to making our service offering to our clients better, and we happen to know, for instance, that our digital offerings from small accounts through the risk management accounts, connectivity, things like Gallagher Go or even a middle market client can see what their policies are, what's going on with their buildings, et cetera, et cetera, are being incredibly well received."
},
{
"speaker": "",
"content": "And we're rolling things out like that literally every quarter, so that's spend. And then you get into the data and analytics. And if you'd asked me 5 years ago, clients would really care that much about being able to tell them what people like you buy? Oh my God, they care. And then they want to know the rate structure and they want to know why."
},
{
"speaker": "",
"content": "And when I started -- when I was selling insurance day to day, I tell them they had a good deal because Hartford quoted and so did CNA. Buy the cheaper one, let's move on. Or I'd have a reason why they should stay where they were, but I don't [ have ] capability of saying, here's what's happening in the world market. It's incredible."
},
{
"speaker": "",
"content": "And remember what we said in our prepared remarks, 90% of the time our people go out and they're fighting against somebody who's substantially smaller and doesn't have any of this, let alone $200 million to $300 million to reinvest in more of it. I mean, it's just -- it's an incredible advantage. I appreciate the question."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of Mike Ward with Citi."
},
{
"speaker": "Michael Ward",
"content": "Kind of a similar question, but specifically on reinsurance. Just curious where you guys are in terms of the innings of getting that business where you want it to be."
},
{
"speaker": "J. Gallagher",
"content": "It's really where we had dreamed it would be. The team is incredibly solid. We're not having defections. We've got -- what's been fun about that is that there's a remarkable interest in having continued relationships and building relationships with the retail side of the house, which is what we predicted."
},
{
"speaker": "",
"content": "We predicted it, we did it that we would be, not only getting data and analytics, but we'd be working together, and we've seen that impact on existing, for instance, pooled accounts that were the biggest and probably the longest running pooling broker in the country, especially in the public sector business, been incredibly helpful, the dialogue back-and-forth. That's just 1 example."
},
{
"speaker": "",
"content": "But -- and the business now I think they really feel like they're part of the enterprise. They're not the new kids anymore. There's always a period when you come to school and you're the new kid. You're the new kid, right? Well, that's not it anymore. I mean, you see them in the hall, they recognize the retailers, they recognize me, Doug, whatever. And the opportunities to invest in data and analytics there and the thirst for that from their clients, tremendous opportunities, and it's working out incredibly well."
},
{
"speaker": "Michael Ward",
"content": "And then maybe just one last one on group benefits. Kind of curious if you can sort of discuss how the renewals have gone and how top line is trending from your perspective. And I guess the -- what's the tone like among the customer base in terms of health of the economy and then hiring and labor?"
},
{
"speaker": "J. Gallagher",
"content": "Well, interestingly, like, the tone from our clients is there's a large amount of concern. And we're sitting with clients that, a, in some instances, don't know why they have turnover. And we're able to get in and do some data analytics around what's going on with them and where -- what's going on there. So a very deep concern about wanting to hold on to their top people."
},
{
"speaker": "",
"content": "We also have an awful lot of people just trying to attract people to fill jobs. Pick stuff off of racks, serve tables, whatever, and that's difficult. So they're trying to differentiate themselves in that regard. And there's a lot of concern on their part around cost. Medical inflation is real. Those costs get passed directly back to the employer. Then you've got the whole problem of inflation. Inflation is difficult."
},
{
"speaker": "",
"content": "So I think what it's doing is it's making our professionals far more valuable than the local person that comes out and says there are 4 of us in the office and we're really good at this, and let me show you a PPO and maybe I can get another quote for your insurance. That's just not cutting it anymore. And that's not -- I'm not talking about 5,000 live cases here. The people that are employing 100, 150, 200 people, they need this kind of help. So it's a very robust period for us, and it is a difficult time for employers. Where are they going to get the right people to fill the jobs and then how do they hold on to them."
},
{
"speaker": "Operator",
"content": "And our last question is coming from Mike Zaremski with BMO Capital Markets."
},
{
"speaker": "Michael Zaremski",
"content": "Just a quick follow-up. You guys always give color on umbrella, lots of people do. Just curious, is there any way you can dimension what percentage of your business is umbrella?"
},
{
"speaker": "Douglas Howell",
"content": "I can dig it out. Did you have a second piece of that?"
},
{
"speaker": "J. Gallagher",
"content": "Do you have another question, Mike? We'll dig on that for a second."
},
{
"speaker": "Michael Zaremski",
"content": "No, I -- that was my only question."
},
{
"speaker": "J. Gallagher",
"content": "We're looking here."
},
{
"speaker": "Douglas Howell",
"content": "So let's see, in '23, I would say, it makes up 6% of our business."
},
{
"speaker": "J. Gallagher",
"content": "Well, I think that's it for questions. If I can just make a comment here. Thank you again for joining us this afternoon. And I would like to thank our 53,000 colleagues around the world for their efforts. Their hard work and dedication is evident when we report another fantastic quarter of growth and profitability."
},
{
"speaker": "",
"content": "As I look ahead, I remain very bullish on our prospects and believe we are well positioned to deliver another excellent year of financial performance. We look forward to speaking with the investment community at our IR Day. Thank you again for being with us this evening. Have a nice evening."
},
{
"speaker": "Operator",
"content": "This does conclude today's conference call. You may disconnect your lines at this time."
}
] |
akam | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good day, and welcome to the Fourth Quarter 2024 Akamai Technologies, Inc. Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mark Stoutenberg, Head of Investor Relations. Please go ahead."
},
{
"speaker": "Mark Stoutenberg",
"content": "Good afternoon, everyone, and thank you for joining Akamai's fourth quarter 2024 earnings call. Speaking today will be Tom Leighton, Akamai's Chief Executive Officer; and Ed McGowan, Akamai's Chief Financial Officer. Please note that today's comments include forward-looking statements, including those regarding revenue and earnings guidance, along with our business outlook, three to five year goals and longer-term targets. These forward-looking statements are based on current expectations and assumptions that are subject to certain risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. The factors include but are not limited to any impact from macroeconomic trends, the integration of any acquisition, geopolitical developments, and any other risk factors identified in our filings with the SEC. The forward-looking statements included in this call represent the company's views on February 20, 2025. Akamai undertakes no obligation to update any forward-looking statements, which speak only as of the date they are made. As a reminder, we will be referring to certain non-GAAP financial metrics during today's call. A detailed reconciliation of GAAP to non-GAAP metrics can be found under the financial portion of the Investor Relations section of akamai.com. Also, as part of our ongoing commitment to transparency, we've enhanced our disclosures to provide investors with a more comprehensive understanding of our business. This quarter, we've created a new presentation available in the Investor Relations section of our website, offering a bit more information on our product portfolios, financials, and performance goals. This presentation supplements the information in our earnings release and annual filings, and we encourage you to review it. Within the presentation, you'll find an overview of select revenue and year-over-year revenue growth rates. Please note, all growth rate percentages are reported on a constant currency basis. With that, I'll now hand the call off to our CEO, Dr. Tom Leighton."
},
{
"speaker": "Tom Leighton",
"content": "Thanks, Mark. As you can see in today's press release, Akamai delivered solid performance in the fourth quarter with revenue coming in at $1.02 billion and non-GAAP earnings per share coming in well above our guidance range at $1.66. I'm also pleased to report that we made excellent progress on our multi-year journey to transform Akamai from a CDN pioneer into the cybersecurity and cloud computing company that powers and protects business online. For the first time in Akamai's history, Security delivered the majority of our annual revenue in 2024, surpassing the $2 billion threshold and growing at 16% year-over-year. Our cloud computing portfolio recorded $630 million in revenue last year, growing 25% over 2023. The portion of this revenue derived from our cloud infrastructure services was $230 million, up 32% over 2023. Our cloud infrastructure services primarily consists of the compute and storage solutions that we've developed based on Linode. They also include our edge workers product and ISV solutions running on our cloud platform. Combined, security and compute accounted for two-thirds of Akamai revenue in 2024, growing 18% year-over-year. And we exceeded all our year-end annualized revenue run rate or ARR goals for the fastest-growing areas of the business, namely for our Guardicore platform, our API security solution, and enterprise revenue for our cloud infrastructure services. These are three of the key areas that we anticipate will drive revenue acceleration for our overall business in 2026 and beyond. In the area of security, Akamai has expanded into new adjacent markets, growing beyond point solutions to provide a more holistic and comprehensive security offering. This has enabled us to expand our customer base and to better serve enterprises with a broader portfolio for protecting infrastructure, applications, APIs and user interactions in both cloud and on-prem environments. Security growth in Q4 was driven by continued strong demand for our market-leading Guardicore segmentation solution as more enterprises relied on Akamai to defend against malware and ransomware. The Guardicore platform ended the year with an ARR of $190 million up 31% year-over-year and surpassing our goal of $180 million. In Q4, we signed our largest deployment to date for Guardicore with a leading IT services company in India. The solution covers 30,000 servers and nearly 300,000 endpoints. We also displaced a competitor segmentation offering that was falling short at major banks, both Hong Kong and in the U.S. More than 80% of our segmentation revenue in 2024 came through channel partners, including one of the world's leading SIs, Deloitte, which wraps its services and implementation expertise around our segmentation and API security products to create value for customers that Deloitte knows well. Together, in Q4, we won a $5.8 million contract with Petrobras in Brazil to reduce the risk of a breach and ransomware attacks. We also partnered with Deloitte to help defend two large European banks from API risks. In Q4, Akamai also signed a large contract for API security with one of the biggest asset managers and brokerage firms in the U.S. Our API security solution ended 2024 with an ARR of $57 million, up from just $1 million at the end of 2023 and exceeding our goal of $50 million. Taken together, our API security solution and Guardicore platform ended 2024 with $247 million of ARR. As we look ahead, we expect to generate continued strong growth for these products with a goal of increasing their combined ARR by 30% to 35% during the year. We also anticipate that over the next several years, the rapid growth and more meaningful amount of revenue from these new products will help offset the slower growth of our more widely adopted and market-leading web app firewall and DDoS mitigation products. As a result and as noted in our supplemental disclosure that Mark mentioned a few minutes ago, we believe that we can maintain a CAGR of about 10% in constant currency for our security products over the next three to five years with typical M&A. This would bring us to more than $3 billion in security revenue by the end of the decade. While our security product line is performing very well, our compute product line is growing even faster and has a much larger addressable market. We've come a long way since we expanded into the cloud computing market in 2022 with the acquisition of Linode. And we made a lot of progress last year, achieving what we set out to do in revenue growth, signing new enterprise customers, infrastructure deployment, product development, partner ecosystem expansion and migrating our own applications from hyperscalers to the Akamai cloud. We continue to sign compute customers at a rapid pace in Q4 and including two financial software companies in the U.S., two of the largest retailers in the U.S., a cybersecurity provider in Europe, an enterprise software company in Asia, one of the largest banks in Southeast Asia and an intelligent transportation system provider in Latin America. When we measure the progress of our cloud infrastructure services, we've been looking at the results through two lenses. Our primary lens is the uptake of these solutions by larger enterprise customers, such as those doing over $100,000 in ARR. The second lens is looking at the performance of these products across customers of all sizes. At year-end, approximately 300 enterprises were spending at least $100,000 in ARR for our cloud infrastructure services, up significantly from the year before. Collectively, these customers finished the year with an ARR of $115 million for our cloud infrastructure services, far exceeding our goal of $100 million. When you include all customers, the ARR for our cloud infrastructure services finished 2024 at $259 million, up 35% year-over-year. This is a substantial improvement from when we acquired Linode in 2022 when the ARR from these services was approximately $127 million and was growing in the mid-teens. In addition to enabling customer growth, our work to make Linode be enterprise grade has allowed us to move some of our most important products from hyperscalers to Akamai's Cloud. This has resulted in improved performance and savings of well over $100 million per year. Many of our customers have also significantly expanded their use of our cloud infrastructure services over the last year, some by a factor of 4x or more. By year-end, 15 customers were spending over $1 million in ARR for our cloud infrastructure services, more than triple the number from 2023. And today, we announced our first customer to sign a contract committing to spend more than $100 million for our cloud infrastructure services over the next several years. We believe this is a remarkable validation of our new cloud capabilities, signaling that an extremely sophisticated buyer of cloud services is confident in our ability to execute and provide a level of service and performance comparable to or better than the hyperscalers. The recent improvements that we've made to our cloud platform will enable us to do even more for enterprise customers in 2025. For example, in the last year, we expanded Akamai's core data center footprint to 41 locations in 36 cities around the world. Next week, we plan to announce that we've enabled our new managed container service in our 4,300-plus points of presence in more than 700 cities around the world. We're currently testing this service with customer workloads in over 100 cities. We've significantly upgraded our object storage solution with a 5x increase in scalability and a 10x increase in performance, making it comparable to the hyperscalers but with much lower egress fees due to the efficiencies of our unique edge platform. We added GPUs for a variety of AI and media use cases. One customer ran a proof of concept between Akamai and a hyperscaler and then chose Akamai for text to image AI inferencing workloads. Another customer uses our cloud for AI-powered speech recognition for its in-vehicle voice assistant. And an OTT provider switched from a hyperscaler to Akamai to provide a more cost-effective platform for its ad-supported streaming TV service. We enhanced the scale and security of our Linode Kubernetes engine product. Traditional cloud providers run Kubernetes platforms from a relatively small number of core data centers. Akamai's differentiated approach will combine the computing power of our cloud platform with the proximity and efficiency of our edge to put workloads closer to users than any other cloud provider. Building on technology that we acquired from Red Kubes last year, we released the Akamai app platform to enable developers to build and deploy highly distributed applications in just a few clicks. And we added nine compute ISV partners last year, bringing our total to 23. Our ISV partners accounted for $36 million of cloud infrastructure services ARR at year-end. We're very excited about our opportunity for continued strong growth as we bring the power of compute to the edge with our broadly deployed network getting compute instances closer to end users with an open platform that ensures flexibility and portability, orchestrated resource deployment to ensure efficient scaling and operations and predictable pricing with an unmatched ability to minimize egress costs. I think our rapid progress in cloud computing has summed up well in an evaluation of public cloud platforms released last month by IDC. Their worldwide public cloud marketscape for IaaS identified Akamai as a major player relative to industry peers, saying \"Akamai has accelerated its journey into the public cloud IaaS space, transforming from a pure-play CDN provider into a formidable public cloud competitor.\" In addition, Gartner positioned Akamai as an emerging leader for Gen AI specialized infrastructure in their recent innovation guide for generative AI technologies. As we noted in the supplemental materials Mark mentioned, we're supporting a growing number of AI use cases with a special focus on inferencing. While it's still early days, we're excited about the long-term revenue opportunity, and we believe that the unique properties of Akamai's Cloud position us to be a major player in AI inferencing in the years to come. As we look forward to the rest of 2025, our goal is to grow our total cloud infrastructure services ARR by 40% to 45% in constant currency. We believe that the accelerating growth of our cloud infrastructure services revenue will be driven primarily by enterprise customers. Given the great success that we're having with our cloud infrastructure services, we plan to focus more of our compute investments in this area. In particular, we're in the process of migrating some of our older cloud applications for tasks such as visitor prioritization, image and video management, and live streaming workflow to ISV partners who specialize in these areas, and we plan to move some or all of their workloads to Akamai's cloud. In addition to converting former competitors into important ISV partners for our cloud, we believe this transition will enable us to focus more of our internal resources on further development and expansion of our cloud infrastructure services. The transition also means that we expect that the revenue from some of our cloud applications will decline in 2025. And as Ed will discuss shortly that we're projecting about 15% growth for our cloud computing solutions as a whole in 2025. As our cloud infrastructure services revenue continues to rapidly increase, we believe that we can reaccelerate the overall cloud computing revenue growth rate to achieve a CAGR of at least 20% on over the next three to five years in constant currency. This would make cloud computing our third $1 billion product line by 2027. I'll next talk about content delivery, which continues to be an important generator of profit that we use to develop new products to fuel our future growth. Our unique edge platform with over 4,300 points of presence in over 700 cities continues to be a major differentiator in terms of lowering our costs, enabling massive scale and providing superior performance. And this is true not only for delivery, but also for security and compute. In security, we use the platform to provide a massive shield against all sorts of attacks without impacting performance or raising costs. And in compute, we use the platform to provide function as a service with our edge workers product. And as we'll announce next week, we'll also use the same platform to run our new managed container service in thousands of pops across hundreds of cities. This capability is unique in the market, and it will enable our customers to get their compute workloads much closer to users. Akamai achieved substantial cost synergies by using the same physical server to support our delivery, security and now compute services in over 4,300 POPs in 700 cities. It's a unique capability and a key reason why Akamai has been so profitable, while many of our competitors have struggled. Our installed base of delivery customers also continues to be a key contributor to our growth in security and cloud computing. As we harvest the competitive and performance advantages of offering delivery, security, and compute as a bundle on the same platform. That synergy works especially well for our security and compute customers that want delivery as a feature and see it as critical to their relationship with us over other vendors. In Q4, we signed many deals that included security and compute solutions alongside our best-in-class delivery. And we won back delivery business for competitors at one of the leading tech players in AI and as a leading player in streaming media. And in December, we acquired select customer contracts from Edgio to offer their customers our market-leading delivery services and the opportunity to take advantage of Akamai's full range of security and cloud solutions. I'm pleased to report that we're beginning to see signs of improvement in the delivery marketplace with more customers willing to sign multi-year contracts with predictable pricing, a more stable pricing environment generally and early signs of stabilizing traffic growth. As a result, and as Ed will discuss in a few minutes, we now expect to see the year-over-year decline in delivery revenue shrink to about 10% this year. If the favorable trends hold, we should see the decline in delivery revenue continued to lessen in 2026 and beyond. As we noted in our call last May, our largest customer is navigating political challenges and is pursuing a DIY strategy. As a result, we expect that the revenue from this customer will produce a headwind of about 1% to 2% per year on our overall revenue growth rate for the next couple of years before stabilizing at a level similar to some of our hyperscaler customers, which would be about 2% to 3% of our total revenue. That said, I'm pleased to report that we entered into a five-year committed relationship with this customer in Q4, that includes a substantial minimum annual spend, which provides greater predictability and which reduces our exposure to their political situation in the U.S. While we're pleased with the progress that we made last year on our multiyear transformation journey, we still have work to do to reach more new customers and to cross-sell our new capabilities in security and cloud computing to our installed base. To drive greater top line growth over the next three to five years, we're transforming our go-to-market strategy to align more resources with the higher growth segments of our business and to accelerate the pace at which we add new customers. In particular, we've already begun to raise the ratio of hunters to farmers and sales and to increase the number of specialized sellers and presales resources that support sales of our Guardicore platform, API security and cloud infrastructure services. We're also investing more in partner enablement as the channel has become a major source of revenue growth for us. Based on advice from one of the world's top consulting firms, we're also embarking on a major project to optimize our sales operating model, account coverage framework, compensation structure, pricing strategy and the way that we leverage our channel partner ecosystem. As we disclosed in the supplemental forecast posted on Akamai's Investor Relations website, we believe that the combination of double-digit security growth, very fast growth in cloud computing, a stabilizing delivery business and a constantly improving product mix should enable us to accelerate revenue growth in the years ahead and to achieve double-digit revenue growth by the end of the decade, if not sooner. In fact, if you remove the impact of foreign exchange headwinds in the large customer I mentioned earlier, you can see that the acceleration is already underway. Excluding these two factors, revenue growth accelerated in 2024 over 2023. And as Ed will describe shortly, we anticipate further acceleration in 2025. We believe that improving our top line growth and product mix, combined with our continued efforts to improve efficiency, will help to improve operating margins so that we can meet and then exceed our goal of 30% over the next several years. We also believe that we can resume growing our non-GAAP EPS in 2026. While we still have much to do, we're very optimistic about the future. Our cloud computing strategy is taking hold as we envisioned. Our expanded security portfolio is enabling us to deepen and expand our relationships with customers and partners. And we continue to invest in Akamai's future growth while also maintaining strong profitability. Now I'll turn the call over to Ed for more on our results and our outlook. Ed?"
},
{
"speaker": "Ed McGowan",
"content": "Thank you, Tom. Before I begin, I want to reiterate what Mark mentioned at the start of the call, and highlight some of the new disclosures we issued earlier today. The materials we posted to the IR section of our website include a bit more detail than what we will cover in today's prepared remarks. Our aim is to provide deeper insights into our business and present our updated long-term goals. While we do not intend to provide this level of disclosure every quarter, we will occasionally offer additional context if we believe it will be helpful. Today, I plan to cover our Q4 results, provide some color on 2025, including a few new disclosures and then cover our Q1 and full-year 2025 guidance and I will close with our long-term thoughts on revenue and profitability goals. Now let's cover our Q4 results, starting with revenue. Total revenue was $1.020 billion, up 3% year-over-year as reported and in constant currency. We continue to see solid growth in our compute and security portfolios during the fourth quarter. Edgio contributed approximately $9 million of revenue in the quarter, which was in line with our expectations. Compute revenue grew to $167 million, a 24% year-over-year increase as reported and 25% in constant currency. In the fourth quarter, Compute revenue was comprised of $65 million from our cloud infrastructure services and $102 million from our other cloud applications. As Tom pointed out, one of our largest customers has committed to spending at least $100 million on our cloud infrastructure services over the next few years. We expect that their workloads will begin ramping up by the end of 2025. Moving to security revenue. Security revenue was $535 million, growing 14% year-over-year as reported and in constant currency. During Q4, we had approximately $12 million of onetime license revenue compared to $5 million in Q4 of last year. As noted in our added disclosure, our security revenue was comprised of $205 million from Zero Trust Enterprise plus API security, which grew 51% in constant currency year-over-year and $1.84 billion from all other security products, which grew 14% in constant currency year-over-year. Combined, compute and security revenue grew 16% year-over-year as reported and 17% in constant currency in Q4 and now represents 69% of total revenue. Our delivery revenue was $318 million, slightly ahead of our expectations and down 18% year-over-year as reported and in constant currency. We anticipate an improvement in delivery revenue in 2025 driven by a more positive outlook on delivery, as Tom discussed earlier. International revenue was $490 million, up 2% year-over-year or 4% in constant currency, representing 48% of total revenue in Q4. Finally, foreign exchange fluctuations had a negative impact on revenue of $8 million on a sequential basis and a negative $6 million impact on a year-over-year basis. Moving to profitability. In Q4, we generated non-GAAP net income of $254 million or $1.66 of earnings per diluted share, down 2% year-over-year, flat in constant currency and well above the high end of our guidance range. These EPS results exceeded our guidance driven primarily by slightly higher-than-expected revenue, lower-than-expected transition services or TSA costs related to the Edgio transaction, greater savings from the head count actions we announced in Q3 and lower payroll costs due to some hiring pushing from Q4 into Q1. Finally, our Q4 CapEx was $193 million or 19% of revenue. Moving to our capital allocation strategy. During the fourth quarter, we spent approximately $138 million to buy back approximately 1.4 million shares. For the full-year, we spent $557 million to buy back approximately 5.6 million shares. We ended 2024 with approximately $2 billion remaining on our current repurchase authorization. It's worth noting that over the past decade, we have not only met our objective of buying back shares to offset dilution from our employee equity programs, but we have also decreased our shares outstanding by approximately 16% over that time frame. Going forward, our capital allocation strategy remains the same: to continue buying back shares over time, to offset dilution from employee equity programs and to be opportunistic in both M&A and share repurchases. Before I move to guidance, there are several items that I want to highlight to help with your 2025 models. The first relates to revenue from the Edgio transaction. we now expect approximately $85 million to $105 million in Edgio revenue for 2025. In addition, we expect to have approximately $6 million of TSA costs in Q1 related to Edgio. Approximately $4 million of those costs will be included in cost of goods sold and the remainder in operating expense. We do not anticipate any TSA costs beyond Q1. Second, we expect our CapEx to be approximately 2 percentage points higher than last year for the following reasons. First, we plan to increase spend by about 1% of revenue to accommodate the increased traffic resulting from the Edgio transaction. Second, we anticipate approximately another 1% of revenue will be used for a geo-specific infrastructure builds to support the recently signed $100 million cloud infrastructure services contract we announced earlier today. Additionally, we expect our CapEx spend will be heavily front-end loaded with the first quarter seeing significantly higher expenditures compared to the rest of the year. This is due in part to the items I mentioned above in our plans to pull forward approximately $10 million to $15 million of CapEx into the first quarter to help mitigate the risk of potential tariffs that may be announced later this year. Third, we expect interest income to decline in 2025 due to lower cash balances resulting from recent acquisitions and our plan to retire our $1.15 billion convertible debt instrument that matures on May 1, 2025 along with expected lower investment yields as interest rates come down throughout the year. Fourth, for 2025 we anticipate continued heightened volatility in foreign currency markets driven by unpredictable timing and magnitude of Federal Reserve policy changes and their impact on interest rates. As an example of how impactful FX can be to our results. Since our last earnings call in early November, the strength of the U.S. dollar has negatively impacted our 2025 expectations by approximately $18 million in revenue on an annual basis and negatively impacted our non-GAAP operating margin by approximately 30 basis points and negatively impacted our non-GAAP EPS expectations by approximately $0.09 per share. As a reminder, related to currency, we have approximately $1.2 billion of annual revenue that is generated from foreign currency with the euro, yen and great British pound being the largest non-U.S. dollar sources of revenue. In addition, our costs in non-U.S. dollars tend to be significantly lower than revenue and are primarily in Indian rupee, Israeli Shekel and Polish Zloty. Fifth and finally, as Tom mentioned and illustrated in our supplemental disclosure, the traction that we are seeing in our business is being obscured by the challenges facing our largest customer and the significant FX fluctuations. If we exclude the effect of this customer in FX, our revenue growth rate would have accelerated year-over-year in 2024 compared to 2023. Now moving to guidance. For the first quarter of 2025, we are projecting revenue in the range of $1 billion to $1.02 billion, up 1% to 3% as reported or up 3% to 5% in constant currency over Q1 2024. We anticipate that Q1 revenue levels will be slightly lower than Q4 due to the following: lower revenue from our largest customer, as we discussed earlier, the negative impact of foreign exchange, reduced onetime license revenue in Q1 from Q4 levels. Two, fewer calendar days in Q1 compared to Q4, that's two less days of usage revenue. And finally, a significant number of delivery customers have calendar year-end dates on their contracts. Therefore, the aggregate impact of all those renewals tends to have a negative impact on Q1 revenue compared to Q4 levels. Note that we expect these items will be partially offset by a full quarter's benefit from Edgio. At current spot rates, foreign exchange fluctuations are expected to have a negative $7 million impact on Q1 compared to Q4 levels and a negative $15 million impact year-over-year. At these revenue levels, we expect cash gross margin of approximately 72%. Q1 non-GAAP operating expenses are projected to be $310 million to $316 million. We anticipate Q1 EBITDA margin of approximately 41%. We expect non-GAAP depreciation expense of $132 million to $134 million. We expect non-GAAP operating margin of approximately 28%. And with this overall revenue and spend configuration I just outlined, we expect Q1 non-GAAP EPS in the range of $1.54 to $1.59, we are down 6% to 3% as reported and down 2% to up 1% in constant currency. This EPS guidance assumes taxes of $57 million to $59 million based on an estimated quarterly non-GAAP tax rate of approximately 19.5%. It also reflects a fully diluted share count of approximately 152 million shares. Moving on to CapEx. We expect to spend approximately $237 million to $245 million, excluding equity compensation and capitalized interest in the first quarter. This represents approximately 24% of total revenue. As noted earlier, we anticipate that our CapEx spending will be heavily front-end loaded with the first quarter seeing significantly high expenditures compared to the rest of the year. Looking ahead to the full-year. We expect revenue of $4 billion to $4.2 billion, which is flat to up 5% as reported and up 1% to 6% in constant currency. We are providing a wider range than past practice due to the larger scale of our business, the uncertainty around our largest customer and continuing macroeconomic and geopolitical factors. We would expect to come in at the higher end of that range if we see significant weakening of the U.S. dollar, traffic growth materially exceeds our current levels and there is no ban in the U.S. for our largest customer. We would expect to come in at the lower end of this range if we see significant strengthening of the U.S. dollar. Traffic materially slows from current levels, and our largest customer is banned in the U.S. Moving on to security. We expect security revenue growth of approximately 10% in constant currency in 2025. In Q4 included in security of the combined ARR for our Zero Trust Enterprise and API security solutions was approximately $247 million. We expect the combined ARR of these two products to increase by 30% to 35% year-over-year in constant currency for 2025. For compute, we expect revenue growth to be approximately 15% in constant currency. Included in compute, our cloud infrastructure services delivered $259 million in ARR exiting 2024. We expect Cloud Infrastructure Services ARR year-over-year growth in the range of 40% to 45% in constant currency for 2025. At current spot rates, our guidance assumed foreign exchange will have a negative $38 million impact to revenue in 2025 on a year-over-year basis. Moving to operating margins. For 2025, we're estimating a non-GAAP operating margin of approximately 28% as measured in today's FX rates. Decline in operating margin for the full-year '25 is due mainly to depreciation expense being approximately 90 basis points higher than last year and the negative impact of foreign exchange year-over-year. We anticipate that our full-year capital expenditures will be approximately 19% of total revenue, up approximately 2 points from 2024 due to the items that I listed earlier. As a percentage of total revenue, our 2025 CapEx is expected to be roughly broken down as follows: approximately 4% for delivery and security, approximately 6% for compute, approximately 8% for capitalized software and the remainder is for IT and facilities related spending. Moving to EPS. For the full-year 2025, we expect non-GAAP earnings per diluted share in the range of $6 to $6.40. This non-GAAP earnings guidance is based on a non-GAAP effective tax rate of approximately 19.5% and a fully diluted share count of approximately 152 million shares. Before closing, I want to comment on our revenue and profitability goals for the next three to five years. Cloud Infrastructure Services is experiencing significant growth, which we believe will be the main driver of our total compute revenue in the near to medium term. Our goal is to grow total compute revenue at a compounded annual growth rate of approximately 20% over the next three to five years. Moving to security. Given the size and scale in our security business, it is natural that we will see some products reach maturity and experience slowing growth rates, while other products in emerging areas will see more rapid growth. As a result, we expect security growth over the next three to five years to be led mainly by our newer Guardicore platform and API security products. However, some of our largest security products like Web Application Firewall or WAF and Prolexic, are examples of some of our more mature products. We've been offering these products for over a decade and have reached a very high penetration rate within our customer base. As a result, we expect the growth rate for these products to begin slowing in 2025 and continue to moderate throughout the remainder of the decade. Given these dynamics in our security portfolio, our goal is to grow total security revenue at an overall compounded annual growth rate of about 10% over the next three to five years, including our typical level of M&A. We anticipate delivery revenue declines will moderate in 2025 with increasing stabilization expected over the next few years. In summary, we anticipate that the combination of double-digit growth of our security products, the rapid expansion in our compute services, a stabilizing delivery business and a continuously improving product mix away from delivery will allow us to achieve double-digit top line revenue growth by the end of the decade, if not sooner. As for profitability, we expect operating margins to reach 30% plus by the end of the decade. And with accelerating top line and expanding operating margins, our goal would be to deliver strong growth in non-GAAP EPS over the next few years. Finally, while we're not providing specific guidance for 2026, we do anticipate revenue acceleration and margin expansion compared to 2025 levels. With that, I'll wrap things up, and Tom and I are happy to take your questions. Operator?"
},
{
"speaker": "Operator",
"content": "We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Roger Boyd with UBS. Please go ahead."
},
{
"speaker": "Roger Boyd",
"content": "Great, thank you for taking my question. And congrats on the quarter. And congrats on the large cloud deal. Tom, I love if you could maybe expand a little bit on that, provide any more details on the nature of workloads as customers bringing over, and it sounds like it's probably coming off a hyperscaler, but any additional info you can provide on the competitive environment there as it relates to pricing performance edge presence. I think Ed noted there's some geo-specific conditions the customer is looking for. I know that's a lot, but thanks."
},
{
"speaker": "Tom Leighton",
"content": "Yes. They already have been using substantial cloud infrastructure services at Akamai for a variety of media applications. And we'll increase that usage. In addition, they have some special needs in Scandinavia and we are building out a data center there for them to handle substantial applications for them throughout Europe. So they're using the services in a normal way, plus we have a special situation that we're doing a build-out for them and development for them. But ultimately, we think many of our customers will use."
},
{
"speaker": "Roger Boyd",
"content": "Super helpful. Appreciate the color."
},
{
"speaker": "Operator",
"content": "The next question comes from Madeline Brooks with Bank of America. Please go ahead."
},
{
"speaker": "Madeline Brooks",
"content": "Hi, team. Thanks so much for taking my question. First is for housekeeping. I just want to clarify that the $100 million compute deal is not the same as the five year deal that you signed with your largest delivery customer? And then I have a quick follow-up to that."
},
{
"speaker": "Tom Leighton",
"content": "They are the same customer."
},
{
"speaker": "Madeline Brooks",
"content": "Got it. Okay. Thank you. And then the other one would be, can you just give us more details outside of just the geo location and why they chose Akamai. Is it -- does it have anything to do with maybe newer products that you have work on AI or intelligence, things of that nature would be helpful. Thank you."
},
{
"speaker": "Tom Leighton",
"content": "Yes, they chose Akamai for superior performance and improve better pricing. We are very well connected throughout Europe. Nobody has the points of presence that we do. And so we can handle requests for this customer throughout the continent and get it into the data center facility they'd like to have in Scandinavia and do that very efficiently at a favorable price point, because of our existing platform and capabilities."
},
{
"speaker": "Operator",
"content": "The next question comes from Amit Daryanani with Evercore. Please go ahead."
},
{
"speaker": "Amit Daryanani",
"content": "Thanks a lot. And thanks for taking my question. I guess I have two quick ones, hopefully. The first one, with your largest customer, the $60 million headwind that you talked about. I'm hoping you just maybe expand a little bit on that is that headwind going to happen irrespective of what happens with the recent executive order around their operations? I'm just trying to understand like is this more about them intending to move some of the CDN in-house? Or is it more of an executive order that $6 million headwind does it happen in respective? And it sounds like it's another $60 million in '26. Maybe just level set that kind of what's happening there and how to ring-fence that would be helpful. And then just to operating margins. What do you think it takes for Akamai to get back to a 30% operating margin number over time? Any kind of help on revenue or cost control, that would be helpful? Thank you."
},
{
"speaker": "Tom Leighton",
"content": "Yes. So the headwind is, by and large, because of their DIY build-out, as we've talked about. So they'll be taking on more of the services themselves. And there are political challenges, obviously, in the U.S. as a result of the five year agreement. Our exposure there is mitigated quite a bit. As we talked about in the disclosure last year, we had about $50 million, I have about $50 million of U.S. business with this customer that obviously would be taken away if they are banned in the U.S. However, as a result of the minimum commitments made, our exposure there is less. As Ed pointed out, if they are banned in the U.S. then we would have less revenue from them than if they continue to operate. And if they continue to operate, there would be upside to the upper end of the range. And Ed, do you want to talk about the margins?"
},
{
"speaker": "Ed McGowan",
"content": "Sure. Yes. So most of the expansion is going to come through two things. One, the mix is going to move more towards security and compute. And then just from an operating leverage perspective, with the revenue growth, we just believe we can scale the business accordingly. And a lot of that additional growth will drop to the bottom line. The changes that Tom is talking about or mentioned on the call about go-to-market, some of that has already been funded by the action that we took before, and we're very responsible with future investments. So we expect to see some scale as we grow top line."
},
{
"speaker": "Amit Daryanani",
"content": "Great. Thank you very much."
},
{
"speaker": "Operator",
"content": "The next question comes from Fatima Boolani with Citi. Please go ahead."
},
{
"speaker": "Fatima Boolani",
"content": "Good afternoon. Thank you for taking my questions. Tom or Ed feel free to chime in on this. With regards to TikTok, you talked specifically about the delivery business and some of the minimal commitment minimum commitments they've made to you to protect you. But I was actually curious if you can opine or comment on if that is a customer that has adopted other solutions in your portfolio, i.e., specifically anything in the security realm that we have to be mindful of eroding away. And then I have a quick follow-up on the good market as well."
},
{
"speaker": "Tom Leighton",
"content": "Yes. Like any large customer, they pretty much use all our services. So they're a large delivery customer. They use a lot of our security services and actually a growing amount of our compute our cloud infrastructure services. And we have factored that in to the guidance we've given, both the guidance for this year and the three to five year guidance."
},
{
"speaker": "Fatima Boolani",
"content": "Great. And just from a go-to-market perspective, Tom, you were very explicit in that there's been a lot of thoughtful change and maybe a little bit of an overhaul in the go-to-market organization by way of account segmentation, price strategy, et cetera. I'm wondering how far along are you in the process of ironing out or cementing a lot of these changes, because it does seem like there might be a couple of things that blocks from an aggregate go-to-market strategy perspective. So would love to hear kind of where you are on the journey to kind of overhaul the go-to-market organization and how we should think about you coming out the other end of that? Thank you."
},
{
"speaker": "Tom Leighton",
"content": "Yes. Great question. I think of this as sort of a two year process, roughly speaking. And we're in the beginning stages. We've already increased the number of our hunters and as I said, the ratio of hunting to farming. We've already increased and we'll do further increases in the specialized sales team. We are working now, thinking through pricing structure changes, contracts, potential contract structure changes, making progress in segmentation for the field. So a lot of work still underway. And you want to, I think, position this in the context that we're transforming the company. And you look at our product set and we're evolving substantially from what was a delivery company and then a delivery and stadium web-firewall company, where most of our revenue has been and you look at the products that are really growing and driving us forward to the future. And you're looking at some intake are core segmentation and enterprise Zero Trust security, you're looking at API security, huge greenfield there for us. And best of all, you're looking at our cloud infrastructure services, which has just really taken off. It's remarkable. I think when you see what's happened. We bought Linode about three years ago, had about $127 million ARR, growing mid-teens at best. And today, more than double now growing at 35% last year, and we're forecasting 40% to 45% this year. And I think what's really exciting about that is the addressable market for us is literally over $100 billion. And that's probably just in our current customer base. So tremendous potential, and it's really taking off now. So that changes the company. And it changes what we need from the sales force, what they need to be doing. Obviously, we want to protect and grow the revenue in our existing base, but we want to be out there selling those new products, both in the existing base and to a lot of new customers. And so in response to that, we're in the process of transforming the sales force to get the capabilities that we need to continue the very strong growth we're seeing in these new areas."
},
{
"speaker": "Fatima Boolani",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Frank Louthan with Raymond James. Please go ahead."
},
{
"speaker": "Frank Louthan",
"content": "Great. Thank you. Can you give us -- let's say, can you give us an idea of what the -- of what logo growth was in the quarter? That would be great. And is there any particular group security, compute, et cetera, that saw a better or a worse growth from new logos? Thanks."
},
{
"speaker": "Ed McGowan",
"content": "Hey, Frank, this is Ed. Actually, logo gross, obviously was probably most positively impacted from the Edgio contracts that we acquired. We added a few hundred logos there, over 100 of those were new to the company. So that was the biggest addition. As far as where the new logos are coming from, it's mostly in security in the two new areas that Tom talked about, Guardicore and API security, and also in the compute side as well. So I would say it's probably stronger than normal new acquisition quarter in Q4, just normal course and then obviously Edgio helped quite a bit as well."
},
{
"speaker": "Frank Louthan",
"content": "And what's your outlook for being able to retain those Edgio contracts? Do you think some of those will churn off? Or what's the likelihood of those converting into more permanent customers?"
},
{
"speaker": "Ed McGowan",
"content": "Yes. So we've gone through the migration at this point. So we've moved everybody off. The Edgio network has closed so or shut down at this point. So we have a good idea of who's coming over at this point. We don't anticipate significant churn from what we have today. We are very selective on what we took. We didn't take all customers. There were certain things, certain small customers that didn't make sense for us to take. There's some acceptable use policy violations that we wouldn't take and there are some economics with certain customers that we didn't want. So factoring into our guidance is what we think we'll do with that customer base. I think there's probably some upside there with upsell generally speaking, you want to land the customer, make sure they're happy and then start developing a pipeline with them. I want to just attack them right away with the sales pitch. So pretty happy with what we were able to retain. It was pretty much right in line, maybe a little bit better than we expected."
},
{
"speaker": "Frank Louthan",
"content": "Okay. Great. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Rishi Jaluria with RBC. Please go ahead."
},
{
"speaker": "Rishi Jaluria",
"content": "Wonderful. Thanks so much for taking my questions. Just two quick ones. First, going back to some of the changes in go-to-market and changes in sales, what can you do on your end to minimize the disruption from that. What are you assuming when you think about your 2025 guide. And I ask because in the history of software, we see sales regards changes to go-to-market and they always end up being a lot more disruptive than anticipated. So maybe if you could walk us through your assumptions and what you can do to minimize that disruption. That would be helpful. And I have a quick follow-up."
},
{
"speaker": "Tom Leighton",
"content": "Well, the first key is to avoid an account breakage. And so we're not doing it all at once. As I mentioned, this is a two year journey. And of course, we're adding resources with specialization on the new products. And so those folks are helping do the cross-sell and have a chance to hunt for new customers. So the key really, I think is we will minimize the breakage of the rep associations with customers in the accounts. And Ed, is there anything you'd like to add to that?"
},
{
"speaker": "Ed McGowan",
"content": "Yes, I'd just say that as a mentioned, we're working with one of the large consulting firms and bringing some expertise in to help us think through that. But absolutely, we want to be very careful with how we think about the movement from hunting to farming and how we support customers going forward. The less breakage, the better."
},
{
"speaker": "Rishi Jaluria",
"content": "Got it. No, that's helpful. And then just really quickly on Edgio. I appreciate the color and the detailed guide. As we think maybe a little bit more longer term, given Edgio's out of the fold now, and you have those contracts and assets, how should we be thinking about the pricing environment for the delivery? And can just having fewer players in the space help maybe lead to a less aggressive pricing environment? Thanks."
},
{
"speaker": "Ed McGowan",
"content": "Yes. That really comes down to the different buckets of customers. I'd say with some of the larger high volume customers, we are seeing some rationalization to some extent, longer contract terms, which is helpful. Obviously, if you have less players, you do potentially have some better pricing, but we're already starting to see that in the market. So I'd say it's getting a little bit better, but it's always been a volume driven business. So to the extent that volumes continue to drive -- go higher, we'll still see the general trend in pricing to go down, but hopefully, we'll see it moderate a little bit more in the future."
},
{
"speaker": "Rishi Jaluria",
"content": "Wonderful. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from John DiFucci with Guggenheim. Please go ahead."
},
{
"speaker": "John DiFucci",
"content": "Thank you. So Tom and Ed, I think this applies both you. Business looks to be going as planned, and we appreciate the three to five year goals and actually all the information that you gave us, this is great. But the guidance for next year implies 3% growth. And I think there's a 1% of FX headwind, so that's about 4%. I get the large customer issues, but there's always issues, right? That aside for now, how do we get comfort that growth is going to accelerate to 10%. Is it just math, because I haven't gone through it at all yet to faster growing portions of the business will more than offset the delivery business. And are you -- and/or, I guess, are you expecting improved macro backdrop in the forecast? Or does it -- I guess, also related to this, does that 10% eventual 10% exclude any impacts from that large customer?"
},
{
"speaker": "Ed McGowan",
"content": "All right. So I'll take this one, Tom. So I'll start with the back part. The large cost, what we've done is we've modeled out what their minimum spend would be for that five year contract. So Think of that as being the bottom of the potential there for that customer. So there's more upside there potentially. But in terms of what we're seeing for growth, I think you have to kind of break the business down into the buckets and why we showed you all that data. We'll start with delivery first. So delivery, obviously, has been a pretty big drag. It's starting to improve. We expect it to improve this year, continue to improve. So you should start to see some stabilization in delivery over that period of time. So that you think of that as a big drag sort of moderating significantly, so you don't have as much of a drag. So then when you take the businesses that we have, we look at security, the bigger franchises are slowing a bit, but they're still growing. So we're still getting some growth out of that. And underneath that, say, for example, in our security products, we have new fraud products and be introducing new products. So that franchise will still grow, just won't be growing as fast as it was. But the -- between Guardicore and APIs, those are very large markets. We have market-leading products we think we'll be able to -- that included with the -- some of the changes we're making in go-to-market and the investments we're making in hunting, we'll get more productivity out of the sales force. And there's still a long way to go there. So we think that that growth as it gets bigger, you get 10% growth out of security, that we think is pretty durable given those factors. And then there's compute. So with compute, we're going through a little bit of a transformation that Tom talked about with the sort of [indiscernible], I don't want to say the legacy, but some of the other older products in the other applications bucket where we're partnering with some of the ISV partners, which has a little bit of a near-term flattening of revenue in that bucket, but it gives us a much bigger opportunity to grow the market by partnering with those folks getting some of their own business, but also getting a product that's being invested in, et cetera. So we have a much more robust offering. And then again, with the go-to-market investments we're making in compute, not only just with the hunters, but also with the overlay specialists. We think that will also help drive more productivity in the field. So hopefully, that answers your question."
},
{
"speaker": "John DiFucci",
"content": "That was really good. That's really helpful. It makes you think we need to do a lot more work around, especially compute, but it's exciting to think about Guardicore and API. I guess just one thing, one last question on the compute business. And one of the things that I can help think about here is profitability. And it's always a question at anybody that's coming into this business. But you alluded to having some advantages entering this business given the delivery business. I guess, can you describe that in a little more detail? I mean, I kind of get the high level. Is it as simple as you're utilizing underutilized assets across your network? Or is there something more to it?"
},
{
"speaker": "Tom Leighton",
"content": "There are several reasons. First, we probably move around more data than pretty much anybody. And we've figured out how to do that very efficiently. And so for customers of our cloud infrastructure platform, when they compare our pricing to the hyperscalers, we're a lot less. At least for the applications where they're moving around data, they got a lot of hits. And that's a lot of the applications out there today. And so in head-to-head competition now with the hyperscalers, we can offer a much better price. Second is performance. And as we've talked about, we have the world's most distributed platform. We are in a position to get our customers' compute instances a lot closer to end users. And not only is that good for scalability, it's great for performance, because the business logic is running close to the users. And so when we do head-to-head trials now against the hyperscalers for a lot of the applications, we perform better. So we're able to offer better performance at a lower price point. And now with the managed container service, that's super exciting. We can actually support our customers' containers in hundreds of cities. Nobody is doing that today. And so again -- and those are the locations we've had already for the delivery business and the security business. So we're already there. So you get better performance and scalability at a lower price point. And then you combine that with the enormous market that we have a chance to tap into. And I think probably really important as you make the models to look at our cloud infrastructure services revenue and what's happening there. We only really started selling that to enterprises last year and went from very little revenue to $115 million ARR in the total for our cloud infrastructure services, $259 million. And we're projecting that total number to grow by 40%. At least 40% to 45% this year. So I would encourage you to keep a close eye on that because that drives a lot of growth and profitability for us going forward."
},
{
"speaker": "Ed McGowan",
"content": "John, just to add on the profitability, there's four main synergies One is the backbone. So we obviously can leverage that. Obviously, we don't kind of track that we serve there. Number two is with operations. So a lot of the folks that build out the CDN, also build out the data centers for our compute business, so we didn't have to go hire a big team. Number three is engineering. We talked earlier in the year that we moved about 1,000 people out of the engineering organization in our delivery business into the compute business, both in operations and engineering. And then the fourth thing is on go-to-market. So we can leverage our existing customer relationships and our reps. We're augmenting that a bit with some of our specialists, but we don't have to go out and hire a whole new team. So there's an awful lot of operating expenses that we can take advantage of in terms of driving profitability."
},
{
"speaker": "John DiFucci",
"content": "Thank you guys. This all makes sense. Now it's the easy part. You just have to execute. That was a joke. It's not easy."
},
{
"speaker": "Ed McGowan",
"content": "Exactly."
},
{
"speaker": "John DiFucci",
"content": "Thanks guys."
},
{
"speaker": "Operator",
"content": "The next question comes from Patrick Colville with Scotiabank. Please go ahead."
},
{
"speaker": "Patrick Colville",
"content": "Thanks for squeezing me in guys. So I guess this one is for probably Dr. Tom and Ed. I mean, in the prepared remarks, you touched on the reasons why compute slow. But I just -- I'm going to my model now and the year-on-year delta is pretty stark. And so I just want to make sure I've got them completely nailed down. So I guess just to start off, this year, 25% growth in compute next year guidance of 15%. Can you just double [indiscernible] what is driving that?"
},
{
"speaker": "Ed McGowan",
"content": "Yes, sure. So there's the two pieces. There's the caught infrastructure security, which will continue to grow and actually accelerate. So that piece, it's the smaller piece of the two businesses, but that's going to accelerate pretty significantly. When you look under the covers of the other, the application services, there's a number of things in there. For example, we have some of our legacy net storage business, which will be end of lifing that soon in the next year or two. And some customers will migrate to our cloud offering, some may decide to do something else, but that's going to be in a bit of a decline. And then we've got a lot of revenue that comes from some of these potential ISV partners. For example, we've got some of our transcoding. We announced something with a partner called Harmonic, we're partnering with them, and we're migrating some of that business over there. They're using us now for their compute. So that's going to be shifting over time. And there's probably four or five different buckets, whether it's image manager, video manager, our waiting room application or visitor prioritization. Those things were going to be moving towards ISV partners and focusing more of our efforts on the infrastructure services. So you're going to see flattening to maybe slightly down in that bucket, and you'll see most of the growth coming from cloud and infrastructure services."
},
{
"speaker": "Patrick Colville",
"content": "Okay. Okay. Helpful. And then I guess as a quick one because I've been getting this a lot from investors. In terms of Akamai's exposure to the U.S. Fed. How should we think about that? And in 2024, is there any expectations for that business embedded into guidance for 2025?"
},
{
"speaker": "Ed McGowan",
"content": "So when you say the U.S. study, you talked about the Federal Reserve interest rate policy or you're talking about the federal government slightly?"
},
{
"speaker": "Patrick Colville",
"content": "The latter."
},
{
"speaker": "Ed McGowan",
"content": "Okay. Yes. So we obviously do sell to the government. It's not a huge portion of our business. It's way too early to tell with what the cost-cutting efforts that are going on, how that would impact us. But it's not an overly material part of the business. I wouldn't expect anything material out of that. We haven't modeled anything material, just kind of regular way business for now. So I'm not anticipating anything."
},
{
"speaker": "Patrick Colville",
"content": "Crystal clear. All right, thank you so much guys. I really appreciate it."
},
{
"speaker": "Operator",
"content": "The next question comes from James Fish with Piper Sandler. Please go ahead."
},
{
"speaker": "James Fish",
"content": "Hey guys. I appreciate all the details here, and increased disclosures, I think investors will as well. Maybe just following up on something you just said first, Ed. Can you just walk us through some of that transition impact on the compute side and which of the products you plan to sort of be transitioning off and how to think about the utilization of the compute network today that we need to invest this much after two years of investing as much behind the compute business?"
},
{
"speaker": "Ed McGowan",
"content": "Yes, I mean I gave you in terms of the investment percentage of revenue that we're spending for that. 1% of that of the six that we're using compute will be specifically for that big customer. And I've always talked about how from time-to-time, if we do get large customers, you do tend to sometimes get outsized demand in a particular geo. We added an awful lot of investment this year in terms of bulking up a number of locations, et cetera. We're going to continue to add to those. We're also seeing very strong demand. So we're continuing to invest with that. But also keep in mind we did migrate over $100 million worth of our own applications. It's running well over $0.5 billion of our revenue today, and that business continues to grow. So we're still having to provide some investment to support that, which is significantly less than what we would be paying if we were to continue to use third-party cloud providers. Now in terms of the two different components of revenue, I think I discussed the cloud infrastructure service. So I think you guys get that. That's the real fast-growing stuff. And inside that other bucket is where you'll see that flattening out to declining. And it's really just the items I mentioned. We've got video management, image management, visitor prioritization and some various workflow components like transcoding that we have built from time-to-time for customers. There's not a ton of demand for it. It's grown decently, but it's not a specialty of ours. So we want to make sure that we're investing in the right areas. So as we're migrating that to partners and we shift our investment into the faster-growing infrastructure cloud services, you'll see a bottoming out here this year and then the growth will reaccelerate to 20%, led by cloud infrastructure services. And also keep in mind, I've got about -- last time we broke it out, it was about $50 million of legacy storage. So think of that as like the media companies storing like a backup origin for their video files and music file and that sort of stuff, images, et cetera. That's -- that business will be winding down over the next year or so. So that's going to have a bit of a drag on revenue as well."
},
{
"speaker": "James Fish",
"content": "Understood. And I think a lot of investors here you guys are sitting here on an earnings call, giving a three to five year framework. The last time we got this type of framework from you guys was many years ago. And I think in that framework, we had talked about a 20% constant currency security growth, for example, and we didn't hit that. So you're talking about a 10% CAGR that includes M&A from here within security. Just what's going to drive the reason that we actually achieve these results and that this is a reasonable expectation that, that actually might be conservative as opposed to hoping that we hit that number? Thanks guys."
},
{
"speaker": "Ed McGowan",
"content": "Well, I mean, to be fair, there were several years during that period of time when we did grow 20%. We always said 20% would include acquisitions. So we did some acquisitions along the way. We've -- look we just did -- put up 16%. So that business has been very healthy. We've been adding a couple of hundred million of high-margin security revenue for years now. And if you do the math, we'll continue to do that. In terms of the impact of acquisitions going forward, we're not anticipating doing significantly large acquisitions, more of what we've done in the past, whether it's tuck-ins or smaller companies that are -- got a product that's in market that's about to scale like API security, where the company is looking at making a big investment in go-to-market or raising a route or looking to exit buy something like that or like Guardicore and we scale that up, and we've shown that we've got success there. So I think we've got confidence in our M&A strategy. It's not going to be a significant portion, but maybe over time, it might be one of the faster-growing products as we exit the decade. And what we've been -- why we broke these businesses out for, you can see how well we're scaling a business now that's a couple of hundred million growing extremely fast. So I think we have pretty good confidence. And again, yes, you can -- we can quibble over the 20% and maybe a couple of years, we're in high teens. But as we said, that would have included acquisitions we've been always doing. But I thought we did pretty well over that period of time. And we just thought now that we're getting to a scale of a couple of billion it made sense to update expectations as we see some of our products that we've been in the market for over a decade, slowing down."
},
{
"speaker": "Operator",
"content": "The next question comes from Will Power with Baird. Please go ahead."
},
{
"speaker": "William Power",
"content": "Okay, great. Tom, you provided some good examples in the prepared remarks, I think of some of the applications that are being used in your network. I mean it seemed for some time that you should be well positioned for inference at the edge. And I just I wonder if you maybe update on this, just as along the lines of the tone of conversations you're having, what kind of the pipeline looks like, just kind of the activity level you're seeing in terms of taking advantage of particularly some of these generative AI applications and inference that maybe is starting to develop or you just think it's going to start to develop?"
},
{
"speaker": "Tom Leighton",
"content": "Yes, I think there's a lot AI-powered at image normalization so that the various images have the same consistent size, quality image classification even for things like detecting disease in crops. AI-powered speech recognition in cars, AI-powered chatbots, sentiment analysis, tactic image inferencing for a variety of applications. All sorts of applications already using Gen AI on the platform. And we have partners, our ISV partners. Some of them doing AI on the platform, web assembly, AI inferencing. So I would say it's early days, but all sorts of things being done on our cloud infrastructure services today."
},
{
"speaker": "William Power",
"content": "Okay. And then I mean as we look at the cloud infrastructure assumed acceleration, I think you're looking for 40% to 45% ARR growth, any further breakdown, how much is inferencing influencing that? Or is that still early? And if not, what are kind of the key drivers of the acceleration there including impact of the $100 million deal, how does that factor in?"
},
{
"speaker": "Tom Leighton",
"content": "Yes, the $100 million deal doesn't do a lot this year. That doesn't really ramp up until the end of the year. So I don't think that's a material impact on our 40% to 45% projection. That will certainly help us in '26 and beyond. And I don't think AI inferencing is a big part of the growth this year either. There could be some, but I think that will fall more into the upside category. I think it's just more of the traditional uses of compute on the platform. And keep in mind, that's a $100 billion market today, plus without getting into AI or the new large deal that we've done. And just as examples, with our ISV partners, database at the edge, observability for all sorts of applications, media workflow, things like file transcoding and live encoding, video packaging, interactive WebRTC. These are what our ISV partners have their applications doing on our cloud infrastructure platform, digital asset management, video optimization, game orchestration, fleet management, DRM, Kubernetes activity and auto scaling ad insertion, service side ad insertion. So there's just a bunch of stuff that is just good old regular compute that's running on the platform. I would say we're -- as you can see from the examples we've given, we're selling it into pretty much all the verticals. A lot of financial companies are starting to use it now. Media broadly construed is still, I think, the sweet spot and partly that's by design because those customers need to get great performance. They need to cut cost. They don't like writing a huge check to their biggest competitor. And they're big Akamai customers, and they like Akamai a lot. So that's sort of the center of mass, but it goes across verticals and across a lot of use cases. And I'd say we're excited about AI. That's upside and probably comes down the road."
},
{
"speaker": "William Power",
"content": "That's helpful. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Mark Murphy with JPMorgan. Please go ahead."
},
{
"speaker": "Mark Murphy",
"content": "Thank you very much. Tom, interested to get your view of the ramifications for Akamai of all of the technological advancements and efficiencies that we've seen with the Deep Seek model? And whether you see any signs of that opening up kind of a broader wave of experimentation for doing edge inferencing on Akamai compute. Maybe some of these AI applications are going to become more economically viable. And then I had a quick follow-up for Ed."
},
{
"speaker": "Tom Leighton",
"content": "Yes. I think the Deep Seek phenomenon or announcement or whatever you want to call it, is very consistent with what we've been saying is going to happen. I think you'll see further improvements. It's great for us because it validates what we've been saying and how we've designed our cloud infrastructure platform. In fact, there's already entities running Deep Seek on our cloud infrastructure platform along with other models. And it does mean that it is a lot less expensive. It doesn't need the giant core GPUs. It can be run on lighter weight GPUs. There'll be a lot of use cases where you want that on the edge. And I think it's great and very much what we expected to happen. And I think you'll see more developments along those lines."
},
{
"speaker": "Mark Murphy",
"content": "Okay. That's great to hear. And Ed, as a follow-up on the security CAGR where you're expecting about 10% in the next three to five years, that's fairly close, I believe to the overall market growing something like 12% to 14%. And you said that it includes a typical level of M&A. If we think about it organically, should we pencil out something like maybe mid- to high-single-digits organically? And then if you're able to find some of these tuck-ins, you've done an incredible job picking those out and executing on those recently and they're growing like a weed. And then maybe the inorganic piece gives you a couple of few points there over the next three to five years. Is that a decent framework?"
},
{
"speaker": "Ed McGowan",
"content": "Yes, I think that's a good way to think about it, Mark. I mean obviously, at the scale we're at now over $2 billion, and we talk about even the bigger revenue companies we've acquired have been $20 million to $30 million. That's insignificance about a point in total from inorganic. In terms of the near term, there's going to be mostly from organic. But yes, probably maybe one point, something like that as you get out a couple of years. And then obviously, if we picked a good company like we did with Noname or we did with Guardicore, as you get out further, we consider that organic growth at that point that might be contributing because it's a faster-growing area if we get into a hot space that's growing quickly. But in terms of like the -- to make a number in any given year, we don't anticipate getting much more than maybe 1% from an acquisition inorganically."
},
{
"speaker": "Mark Murphy",
"content": "Okay, understood. Thank you so much."
},
{
"speaker": "Operator",
"content": "I understand that we have time for one last questioner and that will come from Jonathan Ho with William Blair & Company. Please go ahead."
},
{
"speaker": "Jonathan Ho",
"content": "Excellent. And let me echo the thank you for the additional disclosure. Just one question from me. How concerned should we be with potential tariff impacts. And can you maybe pass through higher costs that are associated with that? I know you're trying to maybe accelerate some investment ahead of time particularly given your need to invest on the compute side over the long run, it does seem like there's may be some exposure here. So I just wanted to understand the implications there. Thank you."
},
{
"speaker": "Ed McGowan",
"content": "Yes. I mean it's obviously tough to call, just given we don't know what the ultimate end game is here in terms of towers. But to the extent we do have the ability to move supply chains around. And we're looking at obviously doing that. There was some talk about Canada and Mexico. We do get some server builds out of the there. But -- so we fast forward it so. I gave you the number, $10 million to $15 million. So it's not significant. In terms of can we pass some of these pricing costs along, we're certainly exploring that as part of the work we're doing with the consulting firm we hired overall pricing strategy is part of it. And to the extent that it becomes somewhat immaterial in any way, we certainly would have to bake that into our pricing. But it's tough to say at this point because we just don't know what the final end state is."
},
{
"speaker": "Jonathan Ho",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "This concludes our question-and-answer session. I would like to turn the conference back over to Mark Stoutenberg for any closing remarks."
},
{
"speaker": "Mark Stoutenberg",
"content": "Thank you, everyone. As usual, we will be attending investor conferences throughout the rest of the quarter. We look forward to seeing you there and discussing everything that we talked about today. So thanks again for joining us tonight. I know it's a long call. We hope that you have a rest nice evening. Operator, you can end the call now."
},
{
"speaker": "Operator",
"content": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
akam | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day. And welcome to the Akamai Technologies Third Quarter 2024 Earnings Conference Call [Operator Instructions]. Please note that today's event is being recorded. I would now like to turn the conference over to Mr. Mark Stoutenberg, Head of Investor Relations. Please go ahead, sir."
},
{
"speaker": "Mark Stoutenberg",
"content": "Good afternoon, everyone. And thank you for joining Akamai's third quarter 2024 earnings call. Speaking today will be Tom Leighton, Akamai's Chief Executive Officer; and Ed McGowan, Akamai's Chief Financial Officer. Please note that today's comments include forward-looking statements, including statements regarding revenue and earnings guidance. These forward-looking statements are subject to certain risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. The factors include any impact from macroeconomic trends, the integration of any acquisitions and any impact from geopolitical developments. Additional information concerning these factors is contained in Akamai's filings with the SEC, including our annual report on Form 10-K and our quarterly reports on Form 10-Q. These forward-looking statements included on this call represent the company's view on November 7, 2024. Akamai disclaims any obligation to update these statements to reflect new information or future events, except as required by law. As a reminder, we will be referring to certain non-GAAP financial metrics during today's call. A detailed reconciliation of GAAP and non-GAAP metrics can be found under the Financial portion of the Investor Relations section of akamai.com. I'll now hand the call off to our CEO, Dr. Tom Leighton."
},
{
"speaker": "Tom Leighton",
"content": "Thanks, Mark. I'm pleased to report that Akamai delivered a solid third quarter in which we achieved two significant milestones. For the first time, Akamai's total annual revenue run rate exceeded $4 billion and our security annual revenue run rate exceeded $2 billion. Our compute results were also very strong, growing 28% year-over-year in constant currency. Non-GAAP operating margin was 29% and non-GAAP earnings per share was $1.59 in line with our guidance. On last quarter's earnings call, we reviewed how Akamai is undergoing a fundamental transformation from a content delivery pioneer into the cybersecurity and cloud computing company that powers and protects business online. Security now delivers the majority of Akamai revenue and compute and security combined account for more than two thirds of our revenue. Since entering the security market a little more than a decade ago with web app firewall as a cloud service, we greatly expanded our security product set into an impressive portfolio, covering infrastructure, application and enterprise network security. We now offer market leading solutions to help protect against DDoS and DNS attacks, application and API attacks, account abuse and fraud and ransomware and data exfiltration attacks. We're already leveraging generative AI to enhance the security and ease of use of our Guardicore and WAF solutions. And we set ourselves apart from the competition with our extensive threat visibility and intelligence and our expert managed services that customers rely upon to protect their businesses. Customer interest in our security solutions remained strong in Q3 and we signed many significant contracts, including a $70 million agreement with one of the world's largest financial institutions, which included our Guardicore segmentation solution, API Security and Prolexic DDoS protection; a $6 million upgrade at one of the world's leading chemical producers that included Guardicore to increase visibility and better protect against ransomware; a $3 million expansion with one of the world's leading auto manufacturers that included Guardicore to protect their critical high performance computing clusters; a $5 million upgrade from another of the world's largest financial institutions to protect their apps and APIs from malicious activity; and a competitive takeaway for our new API security solution at one of the world's largest multinational technology companies. As a result of the strong early momentum, our new API security solution is on track to achieve an annualized revenue run rate of more than $50 million by the end of the year. And our Zero Trust segment, led by Guardicore, is on track to achieve an annualized revenue run rate of more than $180 million by year end. We're also seeing strong interest in our Prolexic service as a result of the large DDoS attacks that have been raging across Asia. Our State of the Internet report in September warned of how geopolitical tensions are increasing the risks of attacks. And we recently thwarted two of the largest DDoS attacks ever seen, one against a leading financial institution in the Middle East and the other against a popular generative AI service. In both cases, our customers didn't see any impact, thanks to our protection. The GenAI customer, a well known hyperscaler, told us that the enterprise grade protection we provide to their business is a true differentiator and it's why they partner with Akamai over competing vendors who have struggled when confronted with large attacks. As another example, a major financial institution in Australia called on us last month for emergency assistance when the competitor they were using for security failed in the face of an attack, resulting in a significant disruption to their business and painful news headlines. We also signed up one of the leading financial institutions in India as they sought to defend themselves from the increasing scale of DDoS attacks. I think it's worth noting that enterprise grade security is not just about scale and reach, which Akamai has plenty of. It's also about having the right people and expertise to partner with and support the most demanding enterprise accounts. And it's about having five nines of platform reliability. These are critical areas where Akamai excels. And there are key reasons why customers trust Akamai to keep them operating normally during even the most challenging circumstances. We've also continued to advance our security capabilities through innovation. For example, last month, we announced the availability of our new behavioral DDoS engine for Akamai's app and API protector solution. It leverages machine learning and intelligence from our global platform to analyze data from multiple sources to provide automated protection against application layer attacks. Turning now to compute. The strong momentum that we achieved in the first half of the year accelerated in Q3 with compute revenue growing to $167 million, up 28% year-over-year. We continued to add new compute customers at a strong pace and we remain on track for our new enterprise compute solutions to exit the year with an annualized revenue run rate of more than $100 million. In Q3, we saw enterprise compute wins in the US at one of the largest retailers, one of the world's largest SaaS platforms, a large e-gaming platform, a large sports gaming platform, a nationwide passenger railroad and a global weather forecaster. In Europe, we saw a large compute win with a major German travel platform. And a major telco doubled their prior commit for our enterprise compute solutions. In Latin America, one of the largest private banks in Brazil expanded their reliance on Akamai to adopt an ISV observability solution that provides insights into data to help improve user experience. And in APJ, we signed up an international domain management platform that enables domain owners to optimize and manage their domains using our compute solutions. Across the world, we're seeing strong interest in our differentiated cloud computing platform for cloud native apps, observability, better performance and lower cost. Retailers in particular have told us that they've achieved better performance and conversion rates for their mobile apps running on Akamai Connected Cloud, with one reporting $160,000 in additional revenue per day. We're also seeing more opportunities for our platform to support the use of AI for tasks such as image generation and processing, speech recognition, consumer analytics and prediction and generation of short videos for advertising. In September, we introduced new video workflow capabilities from our ISV partners that integrate our compute and delivery platforms to give media customers unprecedented flexibility to tailor media experiences to meet their user demands. And over the past year, we've greatly expanded our object storage capabilities to help customers get reliable, scalable and low latency workload performance at a fraction of the cost charged by hyperscalers. Customers have responded. For example, French premium television channel Canal+ expanded their use of our services last quarter, adding Akamai cloud computing and migrating their video assets to Akamai's object store. This enabled them to significantly reduce their costs while improving performance and reliability. And just this month, Akamai entered into a multiyear strategic partnership with a large video workflow ISV that includes a $17 million commitment for Akamai's enterprise compute services. In an evaluation of public cloud platforms released last quarter, Forrester named Akamai a strong performer and noted that Akamai offers, a market leading edge platform that provides businesses with a distributed platform to build, run and secure applications. The vision to lead as an [IAS] alternative by offering compute at the edge of networks for low latency workloads and strengths in edge development with a significant global fabric of edge locations and robust computing platform that developers can utilize to deploy applications closer to users. In summary, we're pleased with the momentum that we've achieved in compute this year and we're very excited about the enormous opportunity ahead. Now turning to delivery. As we've noted on recent calls, our delivery solutions have been weathering macroeconomic headwinds that have been felt industry wide. In the 25 years that we've been in the delivery business, we've seen numerous swings in traffic levels, such as when traffic slowed as the largest Internet companies adopted DIY a decade ago and as when traffic boomed at the start of the pandemic. Most recently, we've seen traffic growth slow as the streaming and gaming verticals have faced their own headwinds. Looking forward, we expect that traffic growth will eventually rebound just as it has in the past. Catalysts for potential future traffic growth include the analysis by Nielsen that 59% of video consumption has yet to move online, along with a lot of advertising, which will presumably follow the audience. More advanced video games and the growth of online sports, which is still in the early innings, are also catalysts to watch. When traffic growth picks up, we believe that Akamai is in a much stronger position than competitors to capture it. Given our scale and cost structure, we can add traffic very profitably, while it appears that many of our competitors are struggling to even stay in business. In the meantime, and as I've said before, our plan for delivery is threefold. First, we'll remain disciplined when it comes to the profitability of traffic that we choose to serve. Second, we'll continue to leverage our market leadership position and installed base of major enterprises to generate cross selling opportunities. And third, we'll continue to take steps to retain our market leadership while also reinvesting most of the cash flow from our delivery product line into the fast growing areas of the business. It's important to note that Akamai realizes strong synergies and competitive advantages by offering customers delivery in addition to security and compute. These synergies and advantages include improved performance and seamless integration, bundling for cross selling and strong customer retention, increased margins for all of our services, unmatched visibility from seeing enormous volumes of traffic and the capacity to quickly detect and stop massive cyber attacks at the edge. As you can see from our results, Akamai has come a long way in our evolution from the leading content delivery company into the cybersecurity and cloud computing company that powers and protects business online. We're very pleased to see our security business exceed $2 billion in annual revenue run rate and we're very excited about the enormous potential for future growth in cloud computing. But we still have more work to do to fully realize the potential of the fast growing areas of our business. As our next step, we plan to shift more investment into the development of our cloud computing capabilities and new security products, as well as into the go-to-market resources and partner ecosystem to sell these services to a broader portion of the enterprise marketplace. With the success of our new solutions in API security, enterprise security and cloud computing, we're now selling to enterprises who were not in the sweet spot for our delivery or cloud WAF services. And so we plan to add go-to-market positions for hunting as well as experienced specialists to support sales of the new products. Our new offerings are also much more partner friendly than our traditional delivery and cloud WAF solutions. And so we're also continuing to strengthen our partner ecosystem. In order to help fund these investments in the fast growing areas of the business, we've made the difficult decision to eliminate about 2.5% of the current roles across the company. This was a painful decision because it impacts our people whose innovation and drive have been an important part of our success. We believe that redeploying these resources will enable us to grow while still maintaining our near term operating margin target of about 30% and then be in a better position to climb above 30% as the fast growing areas of our business expand our profitability. Now I'll turn the call over to Ed, who will review the Q3 results in more detail and provide our outlook on Q4. Ed?"
},
{
"speaker": "Ed McGowan",
"content": "Thank you, Tom. Today, I plan to review our Q3 results, provide some financial color on our restructuring charge and then discuss our expectations for Q4. I'll start with our third quarter results. Total revenue for the third quarter was $1.005 billion, up 4% year-over-year as reported and in constant currency, marking our first $1 billion quarter. Compute revenue was $167 million, up 28% year-over-year as reported and in constant currency. These results included a $7 million onetime benefit related to the release of some deferred revenue in conjunction with the expiration of a long term legacy compute contract. As Tom mentioned, we continue to see very positive market momentum with our enterprise compute solutions and remain on track to exit the year with an annualized revenue run rate of more than $100 million. Moving to security revenue. In the third quarter, security revenue was $519 million, a 14% year-over-year increase as reported and in constant currency. During Q3, we had $3 million of 1 time license revenue compared to $6 million in Q3 of last year. During Q3, revenue from Noname was approximately $8 million in line with our expectations. It's worth noting that similar to Guardicore, our partner and channel ecosystem is the driving force behind the majority of new customer wins for our new API security solutions. Combined, compute and security revenue grew 17% year-over-year as reported and in constant currency, representing 68% of total revenue. Delivery revenue was $319 million, a 16% year-over-year decline, both as reported and in constant currency. Sequentially, delivery revenue decreased 3%, which is an improvement compared to the 6% and 10% sequential declines in the previous two quarters. As Tom mentioned, delivery has been impacted by recent macroeconomic headwinds that have been felt industry wide. As a result, we have seen a significant slowdown in year-over-year traffic growth, most notably in video streaming and gaming. While it's difficult to predict exactly when the industry will recover and growth will resume, we believe our business will be uniquely positioned to capitalize on the recovery. Our scale and cost structure enables us to attract and retain customers very profitably and our delivery business continues to generate very desirable cash flows. International revenue was $480 million, up 3% year-over-year as reported and in constant currency, representing 48% of total revenue in Q3. Foreign exchange fluctuations had a positive impact on revenue of $5 million on a sequential basis and a negative $3 million impact on a year-over-year basis. Non-GAAP net income was $244 million or $1.59 of earnings per diluted share, down 2% year-over-year and down 1% in constant currency. As a reminder, included in our Q3 results is a full quarter's worth of Noname's revenue and expense. And finally, our non-GAAP operating margin in Q3 was 29%. Moving now to cash and our use of capital. As of September 30th, our cash, cash equivalents and marketable securities totaled approximately $2 billion. During the third quarter, we spent approximately $166 million, repurchasing approximately 1.7 million shares. We now have an aggregate of roughly $2.1 billion remaining in our share buyback authorizations. As it relates to the use of capital, our intentions remain the same: to continue buying back shares over time, to offset dilution from employee equity programs, and to be opportunistic in both M&A and share repurchases. Before I provide our Q4 guidance, I want to touch on some housekeeping items. First, as part of our new go-to-market approach and subsequent workforce realignment that Tom mentioned, we took an $82 million restructuring charge in Q3. This charge was primarily driven by our workforce reduction and related severance costs, along with the write down of intangible assets related to the Neosec acquisition. We estimate the workforce action will result in approximately $45 million of annualized savings going forward. We expect to reinvest most of those savings as part of the plan Tom discussed to refocus our go-to-market efforts around our fast growing compute and security offerings. Second, in previous years, seasonal factors significantly influenced our Q4 financial performance. This year, we are seeing weaker than normal traffic trends persisting into October. As a result, we do not anticipate an improvement in traffic growth for the remainder of 2024. Finally, Q4 operating expenses tend to be higher than Q3 due to increased sales commissions for reps who exceed their annual sales quotas. And this year, our annual employee merit cycle went into effect on October 1st. So with those factors in mind, I'll move to our Q4 guidance. We are projecting revenue in the range of $995 million to $1.020 billion, which is flat to up 3% as reported and in constant currency over Q4 of 2023. At current spot rates, including the significant volatility from yesterday, foreign exchange fluctuations are expected to have a negative $7 million impact on Q4 revenue compared to Q3 levels and a negative $5 million impact on a year-over-year basis. At these revenue levels, we expect cash gross margins of approximately 72% to 73%. Q4 non-GAAP operating expenses are projected to be $321 million to $327 million. We expect Q4 EBITDA margin of approximately 40% to 41%. We expect non-GAAP depreciation expense to be between $131 million to $133 million. And we expect non-GAAP operating margin of approximately 27% to 28% for Q4. Moving on to CapEx. We expect to spend $184 million to $192 million. This represents approximately 18% to 19% of our projected total revenue. The sequential increase in CapEx is primarily due to timing, as several projects were delayed from Q3 to Q4. Based on our expectations for revenue and costs, we expect Q4 non-GAAP EPS in the range of $1.49 to $1.56. This EPS guidance assumes taxes of $54 million to $57 million based on an estimated quarterly non-GAAP tax rate of approximately 19%. It also reflects a fully diluted share count of approximately 153 million shares. Looking ahead to the full year. We now expect revenue of $3.966 billion to $3.991 billion, which is up 4% to 5% year-over-year as reported and up 5% in constant currency. At current spot rates, our guidance assumes foreign exchange will have a negative $22 million impact on revenue in 2024 on a year-over-year basis. We expect security growth of approximately 15% to 17% in constant currency in 2024. Given the continued adoption of our enterprise compute solution, we are now increasing our overall expected compute revenue growth to the higher end of our prior guidance or approximately 25% in constant currency for the full year 2024. Moving to profitability. We are estimating non-GAAP operating margin of approximately 29% and non-GAAP earnings per diluted share of $6.31 to $6.38. Our non-GAAP earnings guidance is based on a non-GAAP effective tax rate of approximately 19% and a fully diluted share count of approximately 154 million shares. Finally, our full year CapEx is expected to be approximately 17% of total revenue. In conclusion, we are very pleased with our continued progress with our enterprise compute solutions and excited about the early returns for our recently introduced API solutions. Thank you. Tom and I are now happy to take your questions. Operator?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] And today's first question comes from Rishi Jaluria with RBC."
},
{
"speaker": "Rishi Jaluria",
"content": "Maybe, Tom, in your prepared remarks, you talked a little bit about some of the traction that you're having on the AI side, including with AI companies. Can you help us understand philosophically, how you're thinking about the role that GenAI could play in security on both sides of the equation, both from what happens? How you can leverage GenAI to make security offerings better but maybe more significantly, what does that do to attack surfaces and attack vectors, especially if GenAI is going to get in the hands of nefarious actors? And then I've got a quick follow-up."
},
{
"speaker": "Tom Leighton",
"content": "GenAI is already in the hands and being widely used by nefarious actors, and that's one reason why we're seeing a lot more attacks and penetrations. Probably, you've all seen the deepfakes very compelling but it's also used to generate the malware and train it to get around defenses. So it is increasing the need for defenses, defenses and depth. I think it's a big reason why you really need segmentation now and the Guardicore solution is doing so well. On our side of the house, we've been using AI and ML really forever in our security products. We use it for anomaly detection, bot detection. If it's a human logging into an account, making sure it's the right human and not somebody who stole credentials. We also use it to -- across the company really to be more efficient in the various operations we do. We're using it in -- already in two of our products, security products with GenAI as an interface. So it helps our customers manage their deployments of our security solution, gives them greater visibility. You can interface with your infrastructure and human language. Using our capabilities, you can ask what's that device there? Are the firewall rules up to date? You can ask questions like what do I need to do to bring my firewall rules within the last couple iterations so they're not too far out of date. And it answers and tells you. It's really very compelling and very interesting capabilities. So a lot of use of GenAI, I would say, at Akamai. Still early days. But unfortunately, the bad guys are using it too, very effectively."
},
{
"speaker": "Rishi Jaluria",
"content": "And then just quickly, Tom, you alluded to this in your prepared remarks, but obviously, seeing some higher profile shakeouts, including a long awaited bankruptcy of one of your long time competitors. Maybe help us understand both near term, long term, how we should be thinking about the impact on your business from consolidation? Maybe is there an opportunity for you to gain share of wallet, especially as the kind of stable player and leader in the space? And then longer term, with one less player that had been maybe aggressive on pricing, how do you think this shakes out in the overall pricing environment, specifically on the delivery side?"
},
{
"speaker": "Tom Leighton",
"content": "Yes, I think consolidation in the delivery market is long overdue. And you've seen a lot of companies operating at losses in part funded by private equity or Wall Street. And it just didn't make sense. These companies were never going to make money. You still see some of it out there today with companies that are just really struggling, offering pricing which for them, loses money. And so I do think it makes sense to have some consolidation. And you're right, we've seen -- there was Instart Logic, StackPath, Lumen all gone. Edgio, which is the combination of EdgeCast and Limelight and Chapter 11, we'll see how that works out. But I do think this shake out makes sense. And I do think long run, it helps lead to a stabilization of the delivery market. As we talked about, we are very careful with our pricing. And we do turn away business that we don't think makes sense for us. And sometimes, other companies will step in and take that, they'll lose money in the hopes of showing some revenue growth. But I think it's not sustainable for them to do that. And I think the shakeout may be the beginning of something very positive and will help the delivery business over the medium to longer term."
},
{
"speaker": "Operator",
"content": "And the next question comes from James Fish with Piper Sandler."
},
{
"speaker": "James Fish",
"content": "You made a comment about shifting investments here on the go-to-market to investing behind hunters as well as sales specialists as well as the channel. Can you just talk about what caused you to make the shift now rather than at year end? How to think about the mix of that investment between the direct and specialists against kind of the indirect approach with the channel?"
},
{
"speaker": "Tom Leighton",
"content": "I think we are really seeing good traction now. We already had traction, I would say, in Guardicore. But now with API security, we talked about achieving an ARR of $50 million at year end versus near zero last year. So we really, I think, proved that out and we're very excited about the future. And with compute, last year, we really weren't even selling enterprise compute. The platform just wasn't at that level. And this year, as we talked about, we are now beginning to sell it and seeing great traction to the point where we think that will be a $100 million ARR by the end of the year. So we've now, I think, proved it certainly to ourselves that this is worthy of more investment. Now at the same time, the new product areas are attracted to a much broader market of enterprises than our traditional leading products, which would be delivery and cloud WAF. And so there's a lot of enterprises and verticals that do use cloud computing, do need API security, do need enterprise security that works in the sweet spot for our traditional services. And so that says we do need to invest more in hunting now. We got to go after those accounts. And in addition, I think it's very helpful for us to have specialists, people that are really familiar with selling cloud computing and that will help our traction as we accelerate the growth there. So that's why we're doing it now and we didn't do it last year and why we're growing the resources there. And of course, these new products are also very channel friendly in ways that our traditional services weren't. Delivery in cloud WAF weren't just -- we had channel partners, but they weren't as friendly and as attractive. The new products, very attractive to the channel, and there's a real role for our channel partners to play. And of course with cloud computing, we've got a lot of ISVs now getting on the platform. So that's why we're making this investment now."
},
{
"speaker": "James Fish",
"content": "And maybe Ed, for you, as we think about the advanced security package changes that you guys made almost two years ago now. How penetrated is that across the security installed base, how much more room do we have to go with cross or upselling that unit? Trying to understand the year-to-date impact on security growth and anything as it pertains to the delivery impact as we think about those bundles."
},
{
"speaker": "Ed McGowan",
"content": "So we talked last quarter a lot about this as we had anniversaried the introduction of the package and had a pretty high penetration, obviously, especially with the -- early on with the early adopters of it. We're sort of the end of that at this point. So the way to think about it is you've got year-over-year compares that have us selling in both quarters."
},
{
"speaker": "Operator",
"content": "And our next question comes from Frank Louthan with Raymond James."
},
{
"speaker": "Frank Louthan",
"content": "Since you acquired the Lumen CDN last year, you're a little over a year ago, did you get any network elements with that? And is there any aspect of their new networks that they're building to support their AI partners that they're having conversations with you about, about implementing your capabilities and layering them on top of that network to help maybe deliver some of that AI traffic?"
},
{
"speaker": "Ed McGowan",
"content": "So with the Lumen acquisition, there was no acquisition of any assets aside from the customer contracts. So there was no network acquisitions. And as far as any partnership discussions we have with Lumen, we're not prepared to talk about anything but there's nothing specific to what you mentioned there."
},
{
"speaker": "Operator",
"content": "The next question comes from Fatima Boolani with Citigroup."
},
{
"speaker": "Unidentified Analyst",
"content": "This is Mark on for Fatima. Maybe just -- great to hear the momentum that you guys are seeing on compute, but maybe just on profitability. Why aren't we seeing maybe greater evidence of operating leverage given the compute outperformance, especially since the segment commands better relative gross profit characteristics to delivery, which is declining?"
},
{
"speaker": "Ed McGowan",
"content": "So we're still in the scaling up factor within the compute business, so we haven't reached scale yet. And you're right to think that once we get to a much larger scale, we should start to see better flow through. You'll see, hopefully, gross margins expand a little bit and operating margin expand. But we're still in the investment phase of the business and haven't reached scale yet."
},
{
"speaker": "Unidentified Analyst",
"content": "And maybe just a quick follow-on. How should we think about CapEx trajectory going through '25 from sort of the '24 70% level going forward?"
},
{
"speaker": "Ed McGowan",
"content": "So we're not going to provide guidance on this call for next year. But as we talked about -- last year was a pretty heavy investment year for CapEx related to building out some of the major data centers for compute. We don't anticipate anything like that going forward. But what I've said in the past is if we do see unusually large deals that come with more revenue, there may be some additional builds. But as we've talked about this CapEx level somewhere in this range is generally where we'd like to keep the business for now. Obviously, as compute gets bigger, that may change over time. But certainly, over the next couple of years, that's about the range we'd like to stay in."
},
{
"speaker": "Operator",
"content": "And our next question is from Rudy Kessinger with D.A. Davidson."
},
{
"speaker": "Rudy Kessinger",
"content": "Ed, I want to ask on delivery. It's basically implied in Q4 that delivery revenue is down 20%, 21% year-over-year by my math. I guess, it seems kind of hard to wrap my head around that if traffic is still growing. I know you're saying traffic growth is not as strong as you've seen in the past. But if traffic growth is still growing, just help us try to understand how delivery could be down over 20% year-over-year unless you're seeing much higher pricing pressure than you've seen in the past? And then as we think about going forward, maybe '25 is it fair to assume that delivery is at least a double digit decline going forward?"
},
{
"speaker": "Ed McGowan",
"content": "So a couple of things to think about here. So if you remember, last Q4 we had the Lumen and StackPath acquisitions. And during that time, when it entered into the transition services agreement, we had all of the contracts even though we had anticipated some of those would go away. So it's a really difficult compare, Q4. And in terms of traffic growth, it is growing very slowly. So at rates that we haven't seen in the 25 plus years we've been in this business, so it's growing very, very slow. Pricing is getting a little bit better. But even if you have 5%, 10% price declines and your traffic is growing in low single digits, you're not going to see growth, you're going to see contraction. So it's just been a weak traffic environment. Pricing, as I said, is getting a little bit better. But it takes a lot longer for that to work its way through the system and we get a tough compare. So those are the factors."
},
{
"speaker": "Rudy Kessinger",
"content": "And then on compute, maybe it's a around in you CapEx. It looks like maybe at the midpoint, if you use the percent you're giving for the full year, up about $40 million for this year. Correct me if my math is wrong there. But if it is accurate, it seems like a little bit of a step up with not much of a raise in the compute guide for this year if I back out the $7 million in onetime that you had for Q3?"
},
{
"speaker": "Ed McGowan",
"content": "Yes, it's about that, maybe just a little bit less shade less than that. But it's a combination of a bunch of things. It's not all compute. There's some compute in there. There's some related to delivery in terms of some of the places where we have outsized demand. So unfortunately, delivery demand isn't all in one place. It's not just one number, you have to build out in certain geos as you get demand in certain places. And there's also infrastructure services, infrastructure that we use to run the platform. And there's always some timing between quarters so a little bit slipped out of Q3 and a little bit came in from Q1. So I wouldn't read too much into it."
},
{
"speaker": "Operator",
"content": "And the next question is from Matt Dezort with Needham."
},
{
"speaker": "Matt Dezort",
"content": "I guess within compute, could you touch on some of the early use cases and verticals and how those are performing? Any cohort metrics you can offer, especially behind some of the observability in security and media customers you guys have talked about? And any other newer tips that you guys are seeing as driving more workloads to Connected Cloud?"
},
{
"speaker": "Tom Leighton",
"content": "Yes, I would say the sweet spot early on by design in terms of revenue is media workflow but we are seeing compute sales across really all verticals and including new customers. And just to give you an idea of the range of our ISV partners who -- customers will buy solutions from them or from us on our platform. There's a couple of database partners, observability widely being sold, live encoding, transcoding, video packaging, WebRTC for interactive video, digital asset management, optimization of video, game orchestration, fleet management, DRM, Kubernetes, connectivity and auto scaling, server side ad insertion, AI inferencing and API performance and testing. And that's just the list of different ISV partners. So we really are seeing a lot of use cases across multiple verticals with a sweet spot in media workflow. And at this point, we really have a very good ecosystem media workflow partners, which is starting, as we talked about in the prepared remarks, really being well received in terms of our media customer base. They're looking for better performance, distributed compute at a lower price point and we're really in a good position to provide that today."
},
{
"speaker": "Matt Dezort",
"content": "And as a quick follow-up. Can I ask about some of the security pieces excluding Guardicore and Noname? How did some of the larger pieces perform in 3Q across WAF? It sounds like DDoS was really strong, you touched on a number of wins there. Did that drive any incremental upside in the quarter? And how do you think about that triumvirate going forward?"
},
{
"speaker": "Ed McGowan",
"content": "So we saw pretty good strength across all different products, including -- you talked about Guardicore but even within the Zero Trust space, with our Enterprise Access product, we saw some pretty good growth there. We saw continued strong growth in WAF. We saw some acceleration in DDoS. You don't really get a big burst of revenue right away when you have attacks in a quarter. Typically, you sign up new customers and that revenue comes out over time. But it was pretty strong demand, pretty similar to what we saw in Q2 across the board."
},
{
"speaker": "Operator",
"content": "And the next question comes from Mark Murphy with JP Morgan."
},
{
"speaker": "Unidentified Analyst",
"content": "This is [Erdi Wu] on for Mark Murphy. I wanted to ask a question on compute as well. It's really good to see that momentum. I think you guys specifically called out adding customers at a strong rate and now kind of getting customers outside that sweet spot, which is very interesting to hear. So I guess my question is, is that kind of rate of addition of those customers a little bit more than you expected? And are you seeing these kind of non-sweet spot customers kind of come in earlier than you expected as well?"
},
{
"speaker": "Tom Leighton",
"content": "We're very encouraged with the adoption of our compute services, substantial increase in number of customers. And even though we planned and focused early on on the big media accounts that are already Akamai customers for using our platform, we're really seeing it across the base and a lot of new customers signing up, starting with compute that didn't use our pre-existing services. So we're very pleased to see the growth in compute. And of course, you've seen all year long as we've raised our targets for the year in terms of the enterprise compute revenue and the compute business as a whole."
},
{
"speaker": "Operator",
"content": "And this does conclude our question-and-answer session for today. I would now like to turn the conference back over to Mr. Mark Stoutenberg for any closing remarks."
},
{
"speaker": "Mark Stoutenberg",
"content": "Thank you, everyone. In closing, we will be attending several investor conferences throughout the rest of the quarter. We look forward to seeing you there. Again, thanks for joining us tonight. We hope you have a nice evening. Operator, you may now end the call."
},
{
"speaker": "Operator",
"content": "Thank you. The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect."
}
] |
akam | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good day and welcome to the Second Quarter 2024 Akamai Technologies Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mark Stoutenberg, Head of Investor Relations. Please go ahead."
},
{
"speaker": "Mark Stoutenberg",
"content": "Thank you, operator. Good afternoon, everyone, and thank you for joining Akamai's second quarter 2024 earnings call. Speaking today will be Tom Leighton, Akamai's Chief Executive Officer and Ed McGowan, Akamai's Chief Financial Officer. Please note that today's comments include forward-looking statements, including statements regarding revenue and earnings guidance. These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. The factors include any impact from macroeconomic trends, the integration of any acquisitions, and any impact from geopolitical developments. Additional information concerning these factors is contained in Akamai's filings with the SEC, including our Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q. The forward-looking statements included in this call represent the company's view on August 8, 2024. Akamai disclaims any obligation to update these statements to reflect new information, future events, or circumstances, except as required by law. As a reminder, we will be referring to certain non-GAAP financial metrics today. A detailed reconciliation of GAAP and non-GAAP metrics can be found under the financial portion of the Investor Relations section of akamai.com. I will now hand the call off to our Co-Founder and CEO, Dr. Tom Leighton."
},
{
"speaker": "Tom Leighton",
"content": "Thanks Mark. I'm pleased to report that in the second quarter, Akamai delivered continued strong momentum in compute, strong growth in our security portfolio, steady operating margins and healthy earnings growth on the bottom-line. Second quarter revenue grew to $980 million, up 5% year-over-year as reported and up 6% in constant currency. Non-GAAP operating margin was 29%. Non-GAAP earnings per share was $1.58, up 6% year-over-year and up 9% in constant currency. These results were in line with or above our guidance. Before I provide more color on our performance, I'd like to review how Akamai is evolving as we grow. As most of Akamai first made its name with the invention of content delivery services, and we're still the world's leader in that market today. We stand out for providing the scale and performance required by the world's top brands as we help them deliver reliable, secure and near flawless digital experiences. Recent examples include delivering the Euros football tournament and the summer games in Paris for top broadcasters around the world. As we've said in previous calls, our delivery business has been challenged in recent quarters by macroeconomic and geopolitical headwinds. Our plan for delivery is threefold. First, we will remain disciplined when it comes to the profitability of traffic that we choose to serve. Second, we will continue to leverage our market leadership position and installed base of major enterprises to generate cross selling opportunities. And third, we will continue to take steps to retain our market leadership while also reinvesting most of the cash flow from our delivery product line into the fast growing areas of the business. In Q2, delivery accounted for one third of our revenue, or $329 million. This is quite a change from five years ago when delivery accounted for two thirds of Akamai revenue. The diversification of our revenue across new markets through continuous innovation has long been a core part of Akamai's strategy for long-term profitable revenue growth. A little more than a decade ago, we expanded our business into security with the creation of web app firewall as a cloud service. We did this to meet what we recognized as a growing customer need in a way that was complementary to what Akamai was already doing for customers with delivery. The opportunity was clear to us because we listened to our customers. We created what has proved to be a very successful cloud service for web app firewall. And now, for the first time in Akamai history, security delivered the majority of Akamai's revenue, $499 million in Q2, up 15% year-over-year and up 16% in constant currency. This amounts to an annual run rate of about $2 billion per year. Of course, we greatly expanded our security product set over the years. We now offer market leading solutions for DDoS prevention, Bot management, account and content protection app and API security, and zero trust enterprise security led by our Guardicore segmentation solution. Customer interest in our security solutions is strong and we had many significant wins in Q2. One of the world's largest energy companies became a new zero trust customer with Akamai. One of the top three airlines in the US is moving from a Legacy VPN architecture to a zero trust architecture. With Akamai, we provided Akamai app and API protector to one of the largest providers of HR management software and services in the US and to German retailers Delife, Douglas, Wagner, and Zalando. EFAFLEX, the German maker of high speed industrial doors, purchased our segmentation solution, as did a major stock exchange and a leading cybersecurity company in Latin America. We provided DDoS protection to one of the largest banks in the world and to a government ministry in the Middle east and at one major electric utility in Southeast Asia. We replaced a well known competitor in a five year deal for our web app firewall, DDoS protection, Bot management, account, takeover prevention, and API security. We're especially excited about the most recent additions to our security portfolio. In Q2, we announced our new Akamai Guardicore platform, the first of its kind to enable zero trust security through a fully integrated combination of micro segmentation, zero trust network access, multi factor authentication, DNS firewall, and threat hunting. Its single agent and unified control console, powered by GenAI, are designed to strengthen and simplify enterprise security with broad visibility and granular controls. The new GenAI interface enables our customers operations teams to ask questions in a human language to gain information about their enterprise networks. The new Akamai Guardicore platform reflects our evolution as a security vendor, growing beyond point solutions to a broader and more comprehensive security offering. Customers tell us they want to consolidate security products and tools with vendors they can trust, and we think this will appeal to their needs. In Q2, we also closed the acquisition of no name security as we accelerate our momentum in the fast growing API security market. IDC forecasts this market will grow at a CAGR of 34% to nearly $1 billion by 2027. With no name, we believe that Akamai now has one of the most comprehensive API security solutions in the industry. Within two weeks of the close, Akamai offered no name customers our new Edge connector, an integration with Akamai web app and API protector that works with a click of a button. No name saw a significant increase in closed deals in Q2, including wins at some of the largest banks and insurance companies in North America and at leading software companies in Europe and Asia. We're also beginning to see a good up-sell motion with early no name adopters. For example, one of the largest US healthcare insurers more than doubled their no name contract in Q2 to over $1.7 million annually. About a decade after we entered the security market, we again expanded Akamai's future opportunity by developing a much broader offering in cloud computing. As many of Akamai has offered function as a service in our edge platform. For many years, this kind of edge computing has been used by thousands of our customers, and it is deeply integrated into our delivery and security services. But our customers asked for more. They wanted us to offer full stack cloud computing so that they could run their VMs and containers on the Akamai platform. And they wanted us to do it in a way that would be more efficient and less costly than comparable offerings provided by the hyperscalers. They wanted Akamai to do this because they were already delivering and securing their sites and apps on our platform. They liked our track record of reliability, and they knew they could trust Akamai to be a good partner. Many of them also liked the fact that we don't compete against them. Unlike the hyperscalers, adding cloud computing to our portfolio also makes good sense for Akamai. In addition to satisfying customer demand, we can reap the advantages from offering customers delivery, security and compute on the same platform. The synergies include improved performance, seamless integration and other operational efficiencies, bundling for cross selling and strong customer retention, increased margins for all of our services, deepening relationships with carrier networks, capacity to quickly detect and stop massive cyberattacks at the edge, unmatched visibility into enormous volumes of traffic and the security insights and threat intelligence that we gain as a result. If you step back and look at how the marketplace has evolved, you can see how the hyperscalers have worked to achieve a similar suite of offerings, although they've taken a different route to get there. They started with cloud computing and infrastructure as a service and then moved into security and delivery, validating our view that there is synergy in offering customers all three together. he hyperscalers also have a more centralized architecture, while Akamai has the world's most distributed cloud platform, with more than 4100 points of presence in over 700 cities across 130 countries. We believe that being more distributed provides customers with better performance, better economics and greater reliability. As we reported in our last earnings call, the initial response from customers to our new cloud offering has been very encouraging. The strong early momentum that we achieved in Q one continued in Q2, with compute revenue growing to $151 million, up 23% year-over-year and up 24% in constant currency. New compute customers added in Q2 include one of the world's best known media and entertainment brands based here in the US, the European cybersecurity company Sekoia.io, Clara Video, the video brand of the biggest Telco in Latin America, MwareTV, a technology platform for IPTV and OTT services and a cable satellite IPTV provider that reaches almost half the households in Australia. Customers are also leveraging our ISV partners, which we call qualified compute partners, to run low latency workloads on our compute platform. These include solutions for observability into workload behavior, cybersecurity and large scale events where the need to store very large sets of data makes Akamaya more attractive and cost effective option than competitors. Our media customers can now take advantage of a full suite of media workflow offerings on Akamai connected cloud, which provides valuable synergy with our delivery platform for more efficient image manipulation, decisioning and video transcoding. And with Akamai's latest qualified compute partner and customer Yospace, media companies around the globe can leverage their advanced ad tech and ad strategies at scale across the Akamai connected cloud. Customers are also building new apps on our platform where low latency data distribution and processing provides a better user experience for their customers at significantly reduced cost. One customer is training and testing the machine learning engines that power their security scanning product. Another is building an AI powered Chatbot application to improve their customer experience and streamline operations with intelligent, conversational customer engagement. Such AI powered applications are increasingly popular with recent advances in large language models. Akamai is also a very large user of our new cloud solution. As a result of migrating most of our own apps from the hyperscalers to Akamai connected cloud, we're seeing better performance and greatly reduce cost. In fact, we expect to reduce our spending on third party clouds to less than a third of what it would have been this year had we stayed on the hyperscalers, saving us well over $100 million in annual OpEx. It sure feels good not writing a nine figure check to your competitors every year, and this is a feeling that we look forward to providing to our large enterprise customers. In summary, Akamai has undergone a fundamental transformation. We transformed from a content delivery pioneer into the cloud company that powers and protects life online. Compute and security now generate two thirds of our revenue, and we believe that they provide Akamai with excellent potential for future growth and profitability. And we've achieved this transformation while successfully maintaining robust margins. Because both of our fast growing product areas, our large security portfolio, and our rapidly growing cloud computing portfolio, are built upon and enabled by the foundation of our business, our highly efficient and massively distributed delivery platform. Our near term operating margin goal remains 30%, and we see potential margin upside over time as the fast growing areas of the business expand our profitability. Looking back at the first half of 2024. We're pleased by our strong performance in security and compute. Looking ahead, we're very excited about our potential for future growth as we integrate noname and as our fast growing compute offerings continue to gain traction with customers. Now I'll turn the call over to Ed for more on our Q2 results and our outlook for Q3 and the full year. Ed?"
},
{
"speaker": "Ed McGowan",
"content": "Thank you Tom. Today I plan to review our Q2 results and then provide some color on our expectations for Q3 in the full year. Turning to our second quarter results, total revenue for the second quarter was $980 million, up 5% year-over-year as reported, and 6% in constant currency. Compute revenue was $151 million, up 23% year-over-year as reported, and 24% in constant currency. We continue to be very pleased with the level of enthusiasm in the market as more and more customers are leveraging our enterprise compute solutions. In particular, we are seeing a broad array of enterprise compute use cases including live transcoding, secure access, observability, object storage, real time log aggregation and insight spatial computing and deep learning AI models across many verticals including media, e-commerce, software and financial services. Moving to security revenue in the second quarter, security revenue was $499 million, up 15% year-over-year as reported, and 16% in constant currency. We're very pleased by the continued performance of our Guardicore Zero trust solution and highly encouraged by the traction we are seeing in our recently launched API security solution. It's worth noting that the no name transaction closed in late June and the revenue contribution in the second quarter was less than $1 million. Combined, compute and security revenue grew 17% year-over-year as reported, and 18% in constant currency, representing 66% of total revenue. Moving to delivery revenue was $329 million, which declined 13% year-over-year as reported, and 12% in constant currency. The decline in delivery revenue was primarily related to the revenue impacting items that I outlined last quarter and was in line with our expectations. International revenue was $471 million, up 3% year-over-year and up 5% in constant currency, representing 48% of total revenue in Q2, foreign exchange fluctuations had a negative impact on revenue of $5 million on a sequential basis and a negative $10 million impact on a year-over-year basis. Non-GAAP net income was $243 million, or $1.58 of earnings per diluted share, up 6% year-over-year and up 9% in constant currency, and our non-GAAP operating margin in Q2 was 29%. Moving now to cash and our use of capital as of June 30. Our cash, cash equivalents and marketable securities totaled approximately $1.9 billion during the second quarter. We spent approximately $128 million repurchasing approximately 1.4 million shares. We now have an aggregate of roughly $2.3 billion remaining in our share buyback authorizations. We also used approximately $450 million in cash in the second quarter for the acquisition of no name. As it relates to our use of capital, our intention remains the same to continue buying back shares over time, to offset dilution from employee equity programs, and to be opportunistic in both M&A and share repurchases. Before I provide our Q3 and updated full year 2024 guidance, I want to touch on some housekeeping items. First, regarding the close of the no name security acquisition, we expect this transaction to add approximately eight to $10 million of revenue in Q3, approximately $18 to $20 million in revenue for the full year 2024. We also expect it to be dilutive to non-GAAP EPS by approximately four to $0.05 for the full year 2024, and to be dilutive to non-GAAP operating margin by approximately 30 basis points to 40 basis points in 2024. As a reminder, our updated full year guidance includes the impact of the acquisition. Second, and specific to traffic, we expect a modest uptick in year-over-year traffic in Q3, primarily due to the Paris Summer Games. This event is expected to drive approximately three to $4 million of additional revenue in the third quarter, and while Q4 is typically our strongest quarter seasonally, we saw a more muted impact of that seasonality last year, and we expect to see a similar result this year. Third, the country of India recently announced plans to eliminate its digital service tax effective as of August 1, 2024. We are working with our tax advisors to determine the full impact of this tax change on our non-GAAP effective tax rate. Based on our initial assessment, we believe this could result in a small increase in our effective non-GAAP tax rate, and we have adjusted our guidance accordingly. Finally, the macroeconomic environment remains challenging and geopolitical tensions persist. Any negative developments could have a meaningful impact on our business. So with those factors in mind, I'll move to our Q3 guidance. For Q3, we're projecting revenue in the range of $988 million to $1.008 billion, or up 2% to 4% as reported, and 3% to 5% in constant currency over Q3 2023. At current spot rates, foreign exchange fluctuations are expected to have a positive $2 million impact on Q3 revenue compared to Q2 levels and a negative $5 million impact year-over-year. At these revenue levels, we expect cash gross margins of approximately 73%. Q3 non-GAAP operating expenses are projected to be $307 million to $312 billion. We expect Q3 EBITDA margin of approximately 42%. We expect non-GAAP depreciation expense to be between $129 million to $131 million and we expect non-GAAP operating margin of approximately 29% for Q3. Moving on to CapEx, we expect to spend $166 million to $174 million. This represents approximately 17% of our projected total revenue. Based on our expectations for revenue and costs, we expect Q3 non-GAAP EPs in the range of CPs. Guidance assumes taxes of $59 million to $60 million based on an estimated quarterly non-GAAP tax rate of approximately 19% to 20%. It also reflects a fully diluted share count of approximately 154 million shares. Looking ahead to the full year, we now expect revenue of which is up four to 5% year-over-year as reported, and up five to 6% in constant currency at current spot rates. Our guidance assumes foreign exchange will have a negative $20 million impact to revenue in 2024. On a year-over-year basis, we continue to expect security revenue growth of approximately 15% to 17% in constant currency in 2024, including the contribution from the acquisition of no name. And given the strong momentum and adoption from both new and existing enterprise compute customers, we now expect enterprise compute annualized revenue run rate to double from the $50 million we reported last quarter to over $100 million as we exit 2024. As a result, we are now increasing our overall expected compute revenue growth to approximately 23% to 25% in constant currency for the full year 2024. Moving to profitability, we estimate non-GAAP operating margin of approximately 29% and non-GAAP earnings per diluted share of our non-GAAP earnings guidance is based on non-GAAP effective tax rate of approximately 19% to 20% and a fully diluted share count of approximately 154 million shares. Finally, our full year CapEx is expected to be approximately 16% of total revenue. In closing, we are pleased with the traction we are seeing in enterprise compute and look forward to helping our customers migrate services to the Yakamai connected cloud. Thank you. Tom and I would now be happy to take your questions. Operator?"
},
{
"speaker": "Operator",
"content": "We will now begin the question-and-answer session. [Operator instructions]. The first question today comes from Patrick Colville with Scotiabank. Please go ahead."
},
{
"speaker": "Patrick Colville",
"content": "Thank you so much for taking my question. Frank and Ed, really great to be part of the hack. My story I want to talk about the business makes shift. I mean, that's where you opened your prepared remarks. Specifically, I want to focus on compute. The $100 million revenue you just called out from Akamai connected cloud is really compelling and great to see that ramping. When might that hockey stick to become an even greater revenue base? What's the trajectory of Akamai connected cloud over the coming quarters? And if we think out beyond that?"
},
{
"speaker": "Tom Leighton",
"content": "Yes, great question. And I got to say, we were very pleased to see the rapid early adoption. that's a capability that we really just started selling in earnest this year. We had some very early adopters towards the end of last year. And, if we can get up to $100 million ARR by the end of the year, which we think we're going to do, that's great, for the first year of the product, and then we'll see where we are at the beginning. Next year, we'll give guidance in February for the year in compute, but we're very optimistic about strong growth in compute driven by the enterprise customers and our new capability. There's an enormous market there, obviously, and so we're really looking forward into tapping into that."
},
{
"speaker": "Patrick Colville",
"content": "Very helpful. Thank you. I guess the second part of my question I want to ask about delivery this year. You've been very clear about the headwinds to the delivery business in 2024. I appreciate you might not want to give guidance beyond 2024, wondering whether the headwinds we're seeing right now are cyclical headwinds or are they structural in nature? Thank you."
},
{
"speaker": "Tom Leighton",
"content": "Yes, I don't think what we're seeing today persists over the long term. traffic, I think, will grow, continue to grow maybe at a little bit of a slower rate, than it did certainly during the COVID times. But, delivery, I believe, is here to stay. We are intent on remaining the market leader by a good margin. It's a very profitable business for us. We're very careful about that. We're very efficient in what we do. And it's very synergistic, with our security web app firewall business and our emerging compute business. So I don't see these headwinds persisting over the long term. There are geopolitical considerations that we're worried about, for next year. But I don't think this is a long-term phenomenon. And in any case, given the very fast growth of our security and compute product lines, they've nearly trickled in revenue over the last five years. So now where they're two thirds of our revenue overall, I think the, what you see with delivery, with sometimes challenges, sometimes good, it has a lot less impact on the overall growth rate as we go forward. Ed, do you have anything you want to add to that?"
},
{
"speaker": "Ed McGowan",
"content": "No, I think you covered it well."
},
{
"speaker": "Operator",
"content": "The next question comes from Keith Weiss with Morgan family. Please go ahead."
},
{
"speaker": "Keith Weiss",
"content": "Excellent. Thank you guys for taking the question and congratulations on the solid quarter. And I wanted to ask you a little bit about kind of parsing out the guidance, particularly the full year guidance. If I'm doing my math right, the midpoint of the full year comes up by about $5 million for the full year. But we're adding or no names. It sounds like about $20 million in revenues for the full year. Is there a part of the equation that's coming down, a part of the business that you're getting more cautious on? That makes up that difference?"
},
{
"speaker": "Ed McGowan",
"content": "No, Keith? Yes. So we included no name in our guidance last quarter as well. So there's nothing that's changed. If anything, the business has gotten a little bit better. So our guidance has come up a bit to reflect that."
},
{
"speaker": "Keith Weiss",
"content": "Got it, got it. And then on the expense side of the equation, the savings from moving sort of in house from the hyperscaler is $100 million is real savings. Congratulations on that. That's quite a feat. Tom, you talked about the ability to sort of start pushing that more into operating margins in the near future. Can you give us an indication of what near future means? 2025 near future, or are we thinking two or three years out or further?"
},
{
"speaker": "Tom Leighton",
"content": "Well, Yes, the saving, operating savings we're getting, as Ed said, we've been plowing that back into the business by and large so that we can invest in growth. There's more savings to come there, but we really get the upward pressure on margins, the beneficial tailwinds on margins as the mix shift continues. As we add compute customers, that is good margin for us. And it's accretive security as we add customers there, it's accretive. Now, as Ed noted that today with the new security products, initially they're dilutive, but as we grow the revenue there, every customer we add, every deal we sign improves margins. So that over time, 30% is our goal, we're very close to that today, but over time, we think we have good potential to grow beyond that."
},
{
"speaker": "Operator",
"content": "The next question comes from John DiFucci with Guggenheim Securities. Please go ahead."
},
{
"speaker": "John DiFucci",
"content": "Thank you. I have a question on Guardicore. So, segmentation broadly seems like it's becoming more relevant in the market. Customers are more accepting of it. It's no longer like a new thing, and it has been for a while, and you guys have been there, and you bought God of a couple of years ago, but frankly, it seems like an essential component to a zero trust environment. Not everybody has it. So can you talk a little bit more about how about this business, but really about your Akamai Guardicore Zero trust platform that you just launched a few months ago, and how that sort of fits in the ecosystem of some of an enterprise when they need to protect all their assets to establish that zero trust environment. Because it always seemed to me that this was essential, like I said, for zero trust. I guess if you can also, in addition to the technologies and what else it fits in with, can you also hit on your channel efforts regarding this platform? Because I know this is sold through the channel. I think, Ed, you said this before, but it seems like a really sophisticated solution. It's not just you're buying a firewall for somebody or something like that. If you can just talk a little bit about how. I know it's only, it's early, but how that's working through the channel?"
},
{
"speaker": "Tom Leighton",
"content": "Yes. I think you characterized it very well. Segmentation is essential, I mean you got to lock the doors in the windows as best you can, but now we're still gets in. And I think really the most important thing an enterprise can do is lock down everything inside and that means Guardicore. It means having your agent on every application on every device. And you're right, most enterprises don't have it. When you go back a few years, and I think the community of large really disfavored segmentation. And that's because the way it was done back then was really crude. You did it in hardware, it's very inflexible, hard to do. And at the end of the day, if you did it at all, you had giant segments which defeated the whole purpose. You weren't very secure because the malware would get in and wipe out an entire giant segment and you had a big problem. And Guardicore solved that problem through software, very easy to manipulate, make updates much more secure, fine green controls. And so it's been an education process for us in the marketplace. We viewed it as something that was going to be essential and that, I think, is proving out, as you noted. And of course, with the ransomware headlines and disasters, it's not surprising to see why people are waking up to what they really do need this. So now the next question is with the platform. And there, what we've done is combine the Guardicore, which is protecting inside app-to-app device-to-device communication with the employee device to internal applications. And so we've combined what's called North, South and East, West. Now again, you go back a few years ago, they were different buyers and treated differently. But then we were thinking back then, boy, it's going to make sense to put this all together and sure enough, we're now seeing customers say, \"Hey, we want that on the same platform. We want a single agent, not 2 different agents and we got to deal with a single control panel so that the business logic can be applied to employee devices at the same way and the same time as it is to internal applications.\" And so that's what the Guardicore platform is all about. We actually also combine it with DNS firewall, multifactor authentication, threat-hunting capabilities so that you can tell when you've got now where it is, what's going on into a platform which customers are excited about. And I think it's important not to underestimate the importance of a single agent to do this because that's really important real estate. And the new control panel powered by Gen AI, it's actually pretty cool. You can converse in a human language, if you will, with your network infrastructure. You get much greater visibility probably much better compliance as a result, which means better security. Now your channel question, yes, Guardicore is all channel. And you're right, it is a sophisticated integration and deployment. It's not just like throw a firewall out there. And that's where the partners can really add value. And so in some cases, in many cases, the partner will derive even more revenue than Akamai will. And it's ongoing because you're growing your Guardicore, your segmentation footprint to include more applications and devices, and it's great for partners when they can add value and generate revenue. So it's a really good channel-friendly product. And of course, not easy to do per se, but a lot easier than the way segmentation used to be."
},
{
"speaker": "John DiFucci",
"content": "And if I could, Tom, because that all makes a ton of sense to me. But it also raises the question, like, what are people -- what do they do? What are the alternatives? Like I'm familiar with Illumio and as another company, I've seen called Truxport but like you said, like people don't lot of enterprises don't even have segmentation implemented. So a lot of do, but a lot don't. And so what are the -- are there other things that we're just -- that I'm just missing like I don't know, is Palo buy the whole Palo platform. Are they just saying, you don't need it? Or we have something that kind of does it? Like I'm just trying to -- because the opportunity is just seems really big here?"
},
{
"speaker": "Tom Leighton",
"content": "No, I think it is a big opportunity. And very few, relatively speaking, enterprises have it today, the early adopters are the critical infrastructure companies because they really, really have to have it. And we do compete with Illumio. They're probably our leading competitor. We believe the Guardicore solution is a lot better. We actually have our own mini firewall in the Asia. We don't have to rely on the firewall in the OS, which sometimes won't be there, it might not be consistent. We can cover a lot of the legacy systems which that's important to enterprises to get more universal coverage. I think there is a ton of greenfield. And I wouldn't be there when one of the other competitors is talking about their platforms. They probably don't spend a lot of time talking about segmentation because they don't really have a solution for it."
},
{
"speaker": "Operator",
"content": "The next question comes from Mark Murphy with JPMorgan. Please go ahead. Thank you very much."
},
{
"speaker": "Mark Murphy",
"content": "Ed, what is your latest thinking on the FX headwind to the full year revenue forecast. I'm just curious if there's been any movement there from, I think, previously, you've been looking at that as, I believe, $40 million headwind."
},
{
"speaker": "Ed McGowan",
"content": "Mark, yes, not much of a change. The dollar moved around quite a bit during the quarter, up and down, but it's pretty much exactly the same. So for the full year, it's about $40. I gave the guidance already in the quarter in terms of the impact quarter-over-quarter and for year-over-year, but it's still about the same, just around 40 for the full year."
},
{
"speaker": "Mark Murphy",
"content": "Okay. And then, Tom, as a quick follow-up, you mentioned a pretty wide array of the workload types that you're seeing on your cloud computing platform. And you mentioned toward the end, deep learning and AI models. I'm wondering if you can double-click on that, for instance. What are the types of model? Are you seeing LLM, the text models or image models or something else? And is it possible to estimate what percentage of your cloud ARR might be relating to those newer types of AI workloads?"
},
{
"speaker": "Tom Leighton",
"content": "Yes. Great question. I would say today, AI workload is probably a small fraction of the ARR. I think over time, potential for growth there. As we talked about useful in security, applications, chatbots, tailoring content for commerce companies, ad targeting, recommendation engines. I would say that the models are smaller because they're more focused. The giant models sort of are used to learn everything, your chat GPT, you can ask it any question at all, have it try to be knowledgeable about everything. Those are giant models and we're not really targeting that business. But for our customer base, they tend to be a lot more focused on what they're trying to do. Maybe it's a commerce site, maybe it's an ad site, maybe it's a security company. And they don't need to learn the whole world to really provide value. In fact, we see that with our own solution with the Akamai Guardicore platform with the control interface, powered by Gen AI. Really, it's a very specific application, which means that you don't need the gigantic model to really provide the value. And that means it doesn't have to run on this giant suite of GPUs, it can run just great on our platform, which has GPUs but primarily CPU-based, which gives us much better ROI. And that works great for what our customers are looking to do in terms of their AI applications."
},
{
"speaker": "Operator",
"content": "The next question comes from Madeline Brooks with Bank of America. Please go ahead."
},
{
"speaker": "Madeline Brooks",
"content": "Hi team, thanks for taking my questions. I want to continue on the discussion of Connected Cloud and you mentioned some nice wins in enterprise outside of your traditional CDN customers. But I guess I just wanted to double click on that and kind of get a little bit of color. What are those customers for nonmedia, non-e-commerce. What are the use cases that those customers are finding from Connected Cloud? And if you could just help us break out to growth of those customers maybe versus growth of your more traditional customers? Are they growing around the same in terms of their adoption of Connected Cloud?"
},
{
"speaker": "Tom Leighton",
"content": "Yes, we're seeing growth both within the base and outside the base. I think, for example, with our qualified compute partner program with observability, a lot of companies need that to know what's going on with their applications. Security companies would need that. Now we also have a lot of media customers. And I would say that's probably the biggest segment today. We have, by design, a full media workflow ecosystem now supported through our QCP program on the platform and so a lot of media customers starting to take advantage of that. Outside of that, for example, OS and firmware patch storage, personalized waiting room experience, improved page performance with hints and so forth. We talked about with AI tailoring the site for a user based on what they've been doing so far. Real-time log aggregation and insights into your logs, observability, kinds of things. We even have a PBX, a telephone switching system running on it, 5G Internet gateway running on it. So it does broaden the base which is, I think, exciting for us in the future. But today, probably the biggest segment would be media."
},
{
"speaker": "Operator",
"content": "The next question comes from Alex Henderson with Needham. Please go ahead."
},
{
"speaker": "Alex Henderson",
"content": "Great. First off, I think congratulations to an order on the great results out of both security and out of the compute. And I wanted to focus a little bit on the compute side of the business because I think, ultimately, that's the area that needs to be proven out to the Street more than anything else. Can you talk a little bit about the mechanics around what portion of the customer base that's converting to compute is coming from internal? What portion of the compute are true new customers? How many -- how much of the growth is coming from existing customers that are increasing their upsell? Just kind of look at it as if it was a traditional stand-alone business and give us some of those critical metrics that go into analyzing the success of that business?"
},
{
"speaker": "Tom Leighton",
"content": "Yes. I'll take our first half and turn it over to Ed. And the answer will be pretty similar to the last question. I would say our biggest users and the biggest segment for compute today is our large media customers. And that's by design. And our -- a lot of our QCP, our Quality Compute Partners are media workflow companies. So that's sort of the biggest segment. I would say observability as a capability, a very large one as well, and that spans across all verticals and would include new customers. So we do have a bunch of customers in nontraditional Akamai verticals that are using compute. And I think over the longer run, that opens up a whole new market verticals for us. But the biggest chunk today would be existing Akamai media companies is the biggest. And Ed, do you want to add some color on that?"
},
{
"speaker": "Ed McGowan",
"content": "Yes, sure. Alex, so as Tom mentioned, we're seeing growth in both existing applications for stuff that's been on the platform for a while, but the bulk of the growth is actually coming from new customers. The new customer additions is growing very, very quickly. We broke out some numbers for you last quarter, and that continues to ramp very nicely. And we're seeing a significant increase in the pipeline. We are seeing some new customers come to the platform. And what's interesting is we're probably seeing more workloads and repeatable workloads in areas even -- Tom talked about media, but outside of media. And we're seeing customers that may be relatively small CEM customers are fairly large compute customers. So I'd say it's across the board where we're seeing the growth, but it's mostly from adding new customers to the mix and then they start to ramp."
},
{
"speaker": "Operator",
"content": "The next question comes from Fatima Boolani with Citi. Please go ahead"
},
{
"speaker": "Fatima Boolani",
"content": "I wanted to be in on the delivery guidance and the expected performance in the back half. So appreciate you experienced a lot of the traffic degradation patterns in the first half. But I'm just curious why the trajectory of the business is actually worsening in the back half? And then I have a follow-up for Tom, please."
},
{
"speaker": "Ed McGowan",
"content": "Yes, sure. So I talked a little bit about the expectations for Q4. Just based on what we're seeing now in terms of traffic growth and what we saw last year, we're not expecting the normal hockey stick to any significant degree like we've seen in prior years. And also keep in mind, we closed the transaction with StackPath and Lumen last year, and that's all delivery revenue. So that makes sure Q4 tougher comparison if you're looking at sort of year-over-year growth rates, that's going to skew your perspective a bit. And as we talked about on the last call, there were some dynamics going on with one of our larger social media customers. The good news there is we've got a good handle on that. That's sort of playing out as we expected. But as we talked about, those are the factors that as you put that into your model, why it may look like it's deteriorating a little bit. But I'd say the biggest issue is the fact that you're anniversary-ing the StackPath and move contribution from Q4 last year."
},
{
"speaker": "Fatima Boolani",
"content": "That makes sense. That's very fair. And Tom, for you, I think you've been very constructive around the compute opportunity. There are so many specific examples of the momentum you've been garnering in the compute franchise. But taking a step back as a broader strategy question for you, as you think about scaling that franchise and have it becoming an even bigger part of the overall revenue story. How are you straddling this notion of not using compute as -- or essentially ensuring compute ends up being wallet share accretive against your base as opposed to potentially managing a situation in which the delivery franchise sort of bumps along and compute sort of plugging the hole? Just what are some of the mechanisms you have in place to continue to drive the actual wallet share growth and accretion within existing delivery customers from where you are extracting a lot of net new compute demand for now?"
},
{
"speaker": "Tom Leighton",
"content": "Yes. Compute is different than delivery. So it's not a situation where delivery revenue was going into compute. That's not the case here. And that compute opportunity is orders of magnitude bigger than the delivery opportunity. And so I think, over time, it becomes a much bigger business than delivery. And I think delivery does its thing and it's a very good business for us in terms of cash generation, in terms of cross-selling. And in terms of actually of the economics of the platform, so we can go out there and offer compute at and especially for chatty applications and applications where data is moving around at a much lower price point than the hyperscalers because we have the delivery platform, but it doesn't -- it's not a situation where it's plugging a hole in delivery. I think compute is a huge revenue growth driver for us in the future, independent of anything in delivery."
},
{
"speaker": "Operator",
"content": "The next question comes from Jim Fish with Piper Sandler. Please go ahead"
},
{
"speaker": "Unidentified Analyst",
"content": "This is Quinton on for Jim Fish. Maybe touching on that first question there. A competitor in the space recently talked about pricing pressures from some of the largest medium customers getting worse over the past couple of months. Are you seeing those pricing trends in the market that's maybe driving some of that second half weakness alongside, obviously, the StackPath and Lumen impact? Or are you not really seeing these pressures given your decision to move away from these kind of lower margin delivery opportunities?"
},
{
"speaker": "Ed McGowan",
"content": "Quinton, this is Ed. As we talked about, we had some large renewals this year. So obviously, those we've been through all those, and there is certain pricing pressure there. I'd say it's nothing different than what we've traditionally seen in the marketplace. I wouldn't say that it's significantly worse. I think the issue is just not as much traffic growth. So as you reprice a customer, you tend to see significant traffic growth. So the revenue declines don't persist as long as they have in a situation like this. So I wouldn't say if anything has changed in terms of the trajectory of the pricing. It's always been very competitive, it always will be. So that's really not the issue. The issue is just we're not seeing the type of traffic growth that we normally see."
},
{
"speaker": "Unidentified Analyst",
"content": "Yes. That's really helpful. And then obviously, it's still really early here with the Noname acquisition. But any update you can provide on the integration between Noname and your kind of existing Neosec API opportunity? And maybe how you balance that go-to-market of those two platforms and how you can kind of leverage a full suite to kind of grow the wallet here within a customer."
},
{
"speaker": "Tom Leighton",
"content": "Yes, we are now going to market with Noname. And as I mentioned, within 2 weeks of the close, we had a fully integrated with Akamai products, existing Akamai products, in particular, our web app firewall where a lot of the APIs would go through that. So I would say we're basically integrated today. We have some Neosec customers who we are maintaining over time, that will evolve into the Noname product with some of the capabilities from Neosec, so we get the best of both worlds."
},
{
"speaker": "Ed McGowan",
"content": "Yes. Just to add the -- just add the Noname acquisition came with a pretty sophisticated channel as well as a number of specialists. So we have both of those, so that's going to help drive some sales. And actually, from the minute we announced the close to when we closed or announced the deal ultimately closed, we saw a nice pickup in deals closed. So not no impact on the funnel and the teams already out there selling. So very excited about that. I think we've just enhanced our go-to-market capability as part of the acquisition."
},
{
"speaker": "Operator",
"content": "The next question comes from Jonathan Ho with William Blair & Company. Please go ahead."
},
{
"speaker": "Jonathan Ho",
"content": "Hi. Good afternoon. As you listen to customers and what they need or want from the compute side of things. Are there any core services or capabilities that you feel like you're missing or you're going to add pretty soon that are maybe potentially catalyst for even faster adoption?"
},
{
"speaker": "Tom Leighton",
"content": "I think probably the biggest difference today would be the size of the marketplace. Obviously, the hyperscalers have an enormous marketplace and we're getting started there. We're really excited that I think now we have a very competitive media workflow marketplace. I think we've got a very competitive observability marketplace. And that's something that we're going to be continuing to grow. We're also building out, as you know, our distributed compute capabilities so that we'll be in more locations than in many locations where the hyperscalers don't have a presence, which will give us an advantage in performance and also in countries where you've got data sovereignty laws. We'll be in a better position to handle that. But it's yes, it's ongoing. We're continuing to develop and improve the platform, including with storage, a lot of effort going on there too. So that's going to be -- that will be ongoing for the foreseeable future. But if you can tell from the results, we're in a position now, we can get out there and be selling it. And it's great to see the rapid early adoption."
},
{
"speaker": "Jonathan Ho",
"content": "That makes a ton of sense. Just in terms of the delivery business, as we continue to see this decline as a percentage of revenue, it seems to be carrying the business in terms of margins. How concerned are you over deleveraging effects and CapEx efficiency as we see sort of the two sides of the business move in opposite directions?"
},
{
"speaker": "Ed McGowan",
"content": "Yes, I said it's not a huge concern there. The margins of the new products are very high gross margin products, so that will be helpful. Sure the compute business is a bit more capital intensive. But we've been able to drive down the CapEx of the core business and delivery pretty dramatically. So you're down low single digits as a percentage of revenue for that business. That will maintain as long as the delivery, as long as traffic is not growing significantly. And part of our strategy and being more selective of the type of peak traffic to average that we're taking on the platform is by design, is to make sure that we do maintain that efficiency as we're spending more CapEx in the compute business, and we're not taking on that sort of not as profitable peak to average type traffic so that we can maintain a low CapEx posture in the delivery business."
},
{
"speaker": "Operator",
"content": "The next question comes from Tim Horan with Oppenheimer. Please go ahead"
},
{
"speaker": "Timothy Horan",
"content": "Kind of a few part question on cloud. Can you use your own platform? It sounds like you're moving a lot of legacy services on there to create kind of, you think, unique services for yourself and new services or improve legacy services on that platform. And then secondly, if you look at Microsoft, Google Cloud flare, they're kind of growing cloud in the 30% range. Do you think you can kind of get there? And are you kind of maybe CapEx constrained to do that? Or just maybe talk about how you can kind of get up to your peers there. And what do you have to do in the SMB market to hit that type of 30% growth?"
},
{
"speaker": "Tom Leighton",
"content": "Yes. On the first question, we have built capabilities for ourselves as part of our migration. So we're off of Snowflake and Data bricks which we had big spends there. Looking at over time, making our capabilities available to customers, again, a service that is more efficient, which I think is really important for customers. In terms of the growth rate, I would say that you want to compare the enterprise compute number, which we've talked about was a $50 million ARR at the end of Q1. We think that will more than double by the end of the year. That's sort of the number you want to look at that's comparable. We've got more in the overall compute number, but those are -- have products like image and video manager, legacy Akamai net storage, other kinds of things. which aren't as comparable for what you're looking at in terms of the hyperscaler growth. So if you focus on the enterprise compute, which is really going to be the growth driver for us, that's going in a very fast percentage now and, of course, on a much, much smaller number than the hyperscalers. Ed, do you have -- want to add to that?"
},
{
"speaker": "Ed McGowan",
"content": "No, I think that's exactly right. And that's something that, over time, as that number becomes more material, we'll start to break that out for folks to make it easy for you to see where that growth is coming from. But Tom is absolutely right. That's where the big market is. That's where we're seeing the explosive growth, and we see that we think that can continue. Obviously, the pipeline is growing. We're seeing a lot more use cases than we expected. I see a great participation from all of our reps across the world. It's not just one geo. So we're very excited about it."
},
{
"speaker": "Timothy Horan",
"content": "And do you think you're capital constrained at all or product constrained at all in the enterprise there?"
},
{
"speaker": "Ed McGowan",
"content": "No, I don't think there's a capital constraint problem. I mean you could envision perhaps as a customer that may come to us with a big task where you may have to do some build out if it's in a particular concentrated geography. But we got a very strong balance sheet. We produce a ton of free cash flow. So there's no issue from a capital constraint perspective. I think we can grow this business to a significant size over time, and I don't think capital is a problem right now."
},
{
"speaker": "Operator",
"content": "The next question comes from Rudy Kessinger with D.A. Davidson. Please go ahead."
},
{
"speaker": "Rudy Kessinger",
"content": "Hey, great. Thanks for taking my questions on security. I guess in the second half, if I look at it adjusting out Noname, it looks like organic growth at constant currency is just about 11% to 12%. Obviously, it's been a slowdown versus the last several quarters. And in general, the security growth rate has kind of been pretty volatile over the last 5 to 6 quarters. Could you just give us the puts and takes on maybe some tough compares in the second half. I think you had some spike in DDoS strength last year. But also just going forward, just what's the kind of right growth range that we should expect out of the security business?"
},
{
"speaker": "Ed McGowan",
"content": "Yes, sure. So just in terms of some of the puts and takes, just remember, last year, in Q3, we had little over $6 million of license revenue, that's a couple of percentage points. So that's going to make your Q3 compare a little bit more challenging. The other thing to keep in mind, too, last year, we introduced some new security bundles for web app firewall that did phenomenally well. So we've anniversaried that, so that makes sure our compare is a little bit more challenging. And then between Guardicore and API security as they start to ramp, we think APIs going to ramp very, very quickly. It's just a smaller number. So as you've talked about, the growth has bounced around a little bit over time. That happens as you bring new products into the market and they start to ramp up, think about when we brought [ Batman ] manager to the market. It was a small product and then go to hundreds of millions of dollars. I think the same thing you'll see with Guardicore and API security."
},
{
"speaker": "Rudy Kessinger",
"content": "Yes. Okay. And then on the delivery outlook, I guess, your -- I mean, fastly, I'll say it more directly, I mean, they certainly seem to indicate that outside, it was broader than just one social media customer has several large media customers that seem to be shifting traffic to lower-cost providers. It sounds like you guys aren't really seeing that dynamic or maybe it's not the year and it was already factored into the guide. Any comment on that?"
},
{
"speaker": "Ed McGowan",
"content": "Yes. No, we're not seeing a phenomenon of someone moving to low-cost providers. As a matter of fact, there's two less of them in the market today. So we're not seeing that. As I talked about earlier, we have a tough compare with a [indiscernible] Q4. And then we've just seen just a lower traffic year. Gaming has been unusually weak, video traffic isn't as robust as it normally is. That stuff happens from time to time, but we're not seeing a shift to low-cost providers or any new low-cost providers in the market."
},
{
"speaker": "Operator",
"content": "Okay. The last question today comes from William Power with Baird."
},
{
"speaker": "Unidentified Analyst",
"content": "This is Yan Samilton for Will. Ed, just going back to that more muted Q4 seasonality you're expecting for delivery again this year. If I remember correctly, last year, you were pointing to weaker trends in retail, including an uptick in bankruptcies there and then also weaker in terms of gaming. And now I know it's probably still a little early to forecast though, but is it those same verticals where you're expecting weaker traffic again this year that you're informing your expectation? Or is it some others or maybe it's more broad-based?"
},
{
"speaker": "Ed McGowan",
"content": "Yes. I'd say it's a combination of those two verticals. We've seen sort of over time the retail seasonal or to be less and less. Some of that has to do with the Zero overage product that we offer in the market. But just in general, it just hasn't been as robust as have been, say, 4 or 5 years ago. And then from gaming, yes, still weak. I haven't seen any major launches or we're not hearing anything from our customers that we leave me to believe that Q4 will be strong from that perspective. And then also, as I just talked about several times here, just traffic in general has been a bit sluggish from a growth perspective in general. So I don't see anything that tells me that, that's going to change going into Q4. So obviously, we've got a few months to go here before we get there. We'll update you when we talk again in November. But based on what I'm seeing today, just out of this worthwhile calling that out to folks as they build out their models."
},
{
"speaker": "Operator",
"content": "This concludes our question-and-answer session. I would like to turn the conference back over to Mark Stoutenberg for closing remarks."
},
{
"speaker": "Mark Stoutenberg",
"content": "Thank you, everyone. In closing, we will be presenting at several investor conferences throughout the rest of the quarter and the rest of the year. We look forward to seeing you with those. We hope everyone has a nice evening tonight. Operator, you may now end the call."
},
{
"speaker": "Operator",
"content": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
akam | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good day and welcome to the First Quarter 2024 Akamai Technologies Incorporated Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mark Stoutenberg, Head of Investor Relations. Please go ahead."
},
{
"speaker": "Mark Stoutenberg",
"content": "Thank you, operator. Good afternoon, everyone, and thank you for joining Akamai's First Quarter 2024 Earnings Call. Speaking today will be Tom Leighton, Akamai's Chief Executive Officer and Ed McGowan, Akamai's Chief Financial Officer. Please note that today's comments include forward-looking statements, including statements regarding revenue and earnings guidance. These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. The factors include any impact from macroeconomic trends, the integration of any acquisitions, and any impact from geopolitical developments. Additional information concerning these factors is contained in Akamai's filings with the SEC, including our Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q. The forward-looking statements included in this call represent the company's view on May 9th, 2024. Akamai disclaims any obligation to update these statements to reflect new information, future events, or circumstances, except as required by law. As a reminder, we will be referring to certain non-GAAP financial metrics during today's call. A detailed reconciliation of GAAP and non-GAAP metrics can be found under the financial portion of the Investor Relations section of akamai.com. I will now hand the call off to our CEO, Dr. Tom Leighton."
},
{
"speaker": "Tom Leighton",
"content": "Thanks, Mark. Akamai got off to a strong start for the year with our Security and Compute portfolios. And we continued to experience industry headwinds with our delivery product-line. First quarter revenue grew to $987 million, up 8% year-over-year as reported and in constant currency. Non-GAAP operating margin was 30% and non-GAAP earnings per share was $1.64, up 17% year-over-year and up 18% in constant currency. The fast growing parts of our business, security and cloud computing, grew to represent almost two-thirds of total revenue in Q1, and combined they grew 22% over Q1 of 2023. The continued shift in Akamai's revenue mix towards security and compute, is a clear indicator that our growth strategy is achieving the intended results. We continue to successfully leverage the market leadership and cashflow of our delivery product line to invest in our faster growing and more profitable security and cloud computing portfolios. And we are excited about the opportunities we have ahead of us, especially with our planned acquisition of Noname Security, which we announced this week. I'll say more about Noname in a minute. But first, looking at our security portfolio more broadly, security revenue grew 21% year-over-year in Q1 to $491 million, driven in part by continued strong demand for our market-leading Guardicore Segmentation Solution. Customers who purchased Segmentation from Akamai in Q1 included one of the top telcos in the US, a supermarket chain with more than 1,500 stores across Canada, and a major business management software company in Latin America. Our Zero Trust Network Access Solution, is also seeing good traction. For example, the United States Army announced last month that it selected Akamai for Zero Trust Security in Battlefield Networks. After a competitive evaluation of more than 40 vendors, the Army will use Akamai for its tactical identity, credential, and access management to enhance defenses in high-risk operational environments and limit network access to authorized users, devices, applications, and services. In response to customer requests to bring our Enterprise Zero Trust solutions together into a single platform, we've integrated Guardicore with our other enterprise security solutions to form our recently announced Akamai Guardicore platform. This new platform is the first of its kind to enable Zero Trust Security through a fully integrated combination of micro segmentation, Zero Trust Network Access, multi-factor authentication, DNS firewall, and threat hunting. All designed to strengthen and simplify enterprise security with broad visibility and granular controls through a single console. We think it will appeal to customers looking to consolidate security vendors and integrate their security tools. We also continue to see strong customer interests in our app and API security solutions. Customers who purchased Akamai API Security in Q1, included a major consumer financial services company, a US supermarket chain with more than 1,200 stores, and a leading US manufacturer of electric vehicles. Last month, one of our largest customers, a well-known hyperscaler, was hit with a massive denial-of-service attack, 24 million requests per minute. Using our rate controls and custom web app firewall rules, the customer successfully forwarded 99.999% of the attack traffic. That's five nines of protection. The customer was delighted, telling us, “that's an A-plus by just about every calculation”. Unlike some of our competitors who struggled to defend against far smaller DDoS attacks in recent months, Akamai is capable of protecting even the hyperscalers. The scale of Akamai defenses and the depth of our expertise really matter for customers, who named Akamai a Customer's Choice for the fifth-year in a row in the new Gartner Peer Insights Voice of the Customers report for cloud web app and API protection. And soon, our suite of app and API security solutions will become even stronger with the planned acquisition of Noname Security. The use of APIs has exploded in nearly every industry, driven by digital transformation, the widespread adoption of mobile phones and IoT devices, and the increased sharing of data between third-party providers. The increasing use of APIs also opens up new threat vectors for attackers and the need for API security. For example, we saw API attacks on our platform more than double from January 2023 to January 2024. And IDC Research now predicts that the API security market will grow at a CAGR of 34% to nearly a $1 billion by 2027. That's one reason why we are so excited about our plan to acquire Noname, as we accelerate our momentum in this fast growing segment. As one of the market leading API security offerings, Noname delivers visibility into API business logic abuse and contextual awareness between API requests and responses to ensure that anomalous traffic is detected, inspected, and blocked when warranted. We believe that the addition of Noname to our API security solution will offer Akamai customers enhanced attack analysis, more flexible deployment options, and extensive vendor integrations. Ed will share some financial details about the acquisition shortly. Turning now to cloud computing, I'm pleased to say that 2024 is off to a great start, with strong early momentum across multiple verticals. Customers are excited about our differentiated cloud platform, which offers superior performance through a more distributed footprint, cloud diversification, and lower costs. Examples of major enterprises using our cloud computing platform now include one of the world's largest e-commerce platforms, several global auto manufacturers, several large direct-to-consumer and OTT providers, several global SaaS providers, numerous travel and hospitality companies, including one of the world's largest cruise lines and a large airline in Asia, one of the largest credit unions in the US. A multinational financial services company. An iconic global corporation that manufactures and sells consumer electronics, computer software, and online services. A European cyber security company, and a leading ad tech company. Just this week, we signed up one of the world's best known media companies to a two-year deal worth several million dollars per year for compute. Yet another great example of major enterprises using our new cloud computing platform is Sony Group. Sony is excited about Akamai's investment into Edge Compute and has multiple latency-sensitive compute workloads that are running on Akamai. Current use cases include PlayStation.com, leveraging Edge Compute to improve search engine optimization, and PlayStation Direct, leveraging Edge Compute to ensure a fair experience for customers purchasing PlayStation Hardware. We're also seeing strong early traction with our Independent Software Vendor, or ISV, partners. They offer solutions that run on our compute platform in which our go-to-market teams co-sell to help customers solve big challenges with a better together solution. For example, a media workflow provider, which powers OTT video, now offers its live encoder solution on Akamai Connected Cloud. The solution is designed to increase efficiency for large scale streaming while also lowering egress fees, by as much as 90% according to their calculations. Joint customers of the offering include OneFootball, one of the world's biggest digital soccer platforms, backed by clubs such as Real Madrid, Manchester City, and Bayern Munich. In partnership with an observability solution provider, we won cloud computing deals in Q1 with one of the world's leading gaming companies, a leading luxury goods brand in Europe and one of India's largest conglomerates. Their solution powers observability using Akamai Cloud computing and enables real-time data ingestion at scale, lightning fast query performance, and extensive data retention at a fraction of the cost of other platforms. Another ISV partner that is providing distributed database services, enabled a well-known online travel marketplace to go live in Q1, with a geolocation implementation that uses Akamai’s Edge Computing to execute code at the edge for optimal performance. The travel site invoked more than 68 billion Edge Compute instances in March alone. By the end of Q1, we had over 200 customers spending $36,000 or more in Annual Recurring Revenue for our new compute services, with about half spending $100,000 or more, and six spending over $1 million per year, all just for compute. All of these customer counts are triple what we had in Q1 of last year. Collectively, these customers are spending over $50 million annually coming out of Q1 for our new cloud computing solutions, which is up more than 4 times year-over-year. Beginning this quarter, our global enterprise cloud sales team is now led by Dan Lawrence, who joined us from AWS, where he ran data and analytics for its private equity segment. Before that, Dan ran the Americas analytics business for five customer segments, including gaming and high-tech SaaS. Dan joined Akamai for the potential he sees to combine Akamai's trusted brand and Edge Computing platform with the large market opportunity and distributed cloud. I'll now say a few words about content delivery, which represents a little over one-third of our overall revenue. Akamai remains the market leader in delivery by a wide margin, providing the scale and performance required by the world's top brands as we help them deliver reliable, secure, and near-flawless digital experiences. That said, our delivery revenue was less than expected in Q1, due to slowing traffic growth across the industry, and a large social media customer that is now optimizing their business to reduce costs. As a result, and as Ed will discuss shortly, we now expect our delivery revenue to decline at a higher rate this year. As we've noted before, delivery continues to generate profits that we use to fuel our future growth. It also helps our security and cloud computing portfolios, as we harvest the competitive and cost advantages of offering delivery, security, and compute on the same platform. Of course, we are not happy to see the declining revenue in our delivery portfolio. And while it remains difficult to predict exactly when that business will begin to stabilize, we believe that Akamai’s CDN remains a critical enabler of doing business on the internet. This has been the case for the past 25 years, and we remain convinced that businesses will continue to need Akamai's superior scale, reliability, and security in the future as they migrate more workloads to the cloud, seek to secure their internal and external applications, and look to unlock the promise of AI, often while also leveraging Akamai security and compute capabilities. Moreover, given the exciting growth we're seeing in our security and compute portfolios, we believe it is only a matter of time before these businesses drive accelerating revenue growth for Akamai as a whole. In summary, we are pleased by the strong performance of our security and compute portfolios to start the year. And we are very excited about our potential for future growth and profitability, as we add Noname to our security portfolio and as our fast-growing compute portfolio contributes a larger share of revenue. Now I'll turn the call over to Ed for more on our Q1 results and our outlook for Q2 in the full year. Ed?"
},
{
"speaker": "Ed McGowan",
"content": "Thank you, Tom. Today I plan to review our Q1 results and then provide some color on our Q2 expectations in our updated full year 2024 guidance, along with the financial impact of our recently announced acquisition of Noname Security. Before we get into that, I wanted to address a few items, including what Tom mentioned in his remarks, that have caused us to reduce our guidance for the remainder of the year. First, the US Dollar has strengthened significantly since the start of the year. As we have noted on many prior calls, foreign exchange fluctuations can significantly impact our top and bottom lines. Based on the strength of the US dollar, we now expect FX to have a negative impact of approximately $40 million on our top-line outlook for the full year 2024. That translates to a negative impact of approximately $0.12 to our expected non-GAAP EPS for 2024. In addition, we expect this will negatively impact our full year 2024 non-GAAP operating margin by approximately 30 basis points. Second, as Tom mentioned, a large social media customer has recently taken steps to lower its costs through a series of optimizations across its platform. As a result, they have reduced their overall traffic. Therefore, we now expect approximately $40 million to $60 million less revenue from this customer for the full year than we previously thought. This change will primarily impact our delivery product line. Finally, as Tom mentioned in his remarks, in addition to the large social media customer, we have seen lower than expected traffic in our delivery business over the past two months, most notably in gaming and video. This is in-line with similar patterns that were cited earlier this week in a research note from a leading Wall Street bank that stated, video streaming services were seeing a drop in downloads, in active users during April. The note also mentioned that weakness was coming from streaming service providers pushing for ad-supported versions and password sharing crackdowns to stay ahead in the streaming wars. As a result of these recent market conditions, it's prudent to assume that this traffic weakness will continue for the remainder of 2024. This lower traffic outlook would translate into approximately $20 million to $30 million less delivery revenue for the remainder of the year than we previously expected. The good news is that in contrast to some other competitors in the industry, both our delivery business and the overall company continue to be highly profitable. As a result, the significant cash flows we generate give us the financial flexibility to execute strategic acquisitions, return capital to shareholders, invest in our future growth, and further diversify our business away from delivery and into the faster growing and even more profitable areas of security and compute. Turning now to our first quarter results. Total revenue for the first quarter was $987 million, up 8% year-over-year as reported and in constant currency. Our two fastest growing offerings, Compute and Security, grew 22% year-over-year on a combined basis and now represent 64% of total revenue. Compute revenue was $145 million, up 25% year-over-year as reported and in constant currency. As Tom mentioned, we have more than 200 enterprise customers using our cloud computing solutions. Our offerings clearly resonate well with customers and we remain optimistic about the early traction we see from large enterprise businesses. It's worth noting that the annual run rate of our enterprise compute revenue is now over $50 million and is growing at over 300% year-over-year. Security revenue was $491 million. Security revenue grew 21% year-over-year as reported, and in constant currency. We are very pleased by our continued performance with our Guardicore Zero Trust Solution and highly encouraged by the traction we are seeing in our recently launched API security solution. Moving to delivery. Revenue was $352 million, which declined 11% year-over-year as reported and 10% in constant currency. International revenue was $475 million, up 7% year-over-year and up 8% in constant currency, representing 48% of total revenue in Q1. Foreign exchange fluctuations had a positive impact on revenue of $2 million on a sequential basis and a negative $4 million impact on a year-over-year basis. Non-GAAP net income was $225 million or $1.64 of earnings per diluted share, up 17% year-over-year and up 18% in constant currency. And finally, our non-GAAP operating margin in Q1 was 30%. Moving now to cash and our use of capital. As of March 31, our cash, cash equivalents, and marketable securities totaled approximately $2.3 billion. During the first quarter, we spent approximately $125 million to repurchase approximately 1.1 million shares. We now have roughly $400 million remaining on our previously announced share buyback authorization. As noted in today's press release, our board authorized a new buyback program of up to $2 billion effective today in running through the end of June, 2027. Combining the two authorizations, we currently have roughly $2.4 billion available for share repurchases. Our intention is to continue buying back shares to offset dilution from employee equity programs over time and to be opportunistic in both M&A and share repurchases. Earlier this week, we announced our intent to acquire Noname security for approximately $450 million. We believe this acquisition demonstrates our continued balance approach to capital allocation by opportunistically buying back shares over time, while maintaining sufficient capital to deploy when strategic M&A presents itself. Before I provide our Q2 and full year 2024 guidance, I wanted to touch on some housekeeping items. First, regarding our planned acquisition of Noname Security. We expect this transaction to add approximately $20 million in revenue for the full year, to be diluted to non-GAAP EPS by approximately $0.10, and to be diluted to non-GAAP operating margin by approximately 50 basis points in 2024. We expect that the acquisition will close sometime in June. We do not expect the acquisition to have a material impact on Q2 results. And as a reminder, our updated full-year guidance includes the impact of the acquisition. Finally, specific to traffic, we expect a modest uptick in media traffic in Q3, primarily due to the Olympics. This event is expected to drive approximately $3 million to $4 million of additional revenue in the third quarter. And while Q4 is typically our strongest quarter seasonally, we saw a more muted impact of that seasonality last year. We expect that we will see a similar result this year. So with those factors in mind, turning to our Q2 guidance. We are now projecting revenue in a range of $967 million to $986 million or up 3% to 5% as reported, and 4% to 6% in constant currency over Q2 2023. At current spot rates, foreign exchange fluctuations are expected to have a negative $5 million impact on Q2 revenue compared to Q1 levels and a negative $9 million impact year-over-year. At these revenue levels, we expect cash gross margins of approximately 72% to 73%. Q2 non-GAAP operating expenses are projected to be $302 million to $307 million. We expect Q2 EBITDA margins of approximately 41% to 42%. We expect non-GAAP depreciation expense to be between $126 million to $128 million. And we expect non-GAAP operating margin of approximately 28% to 29% for Q2. Moving on to CapEx, we expect to spend approximately $175 million to $183 million. This represents approximately 18% to 19% of our projected total revenue. Based on our expectations for revenue and cost, we expect Q2 non-GAAP EPS in the range of $1.51 to $1.56. The CPS guidance assumes taxes of $56 million to $59 million, based on an estimated quarterly non-GAAP tax rate of approximately 19% to 19.5%. It also reflects a fully diluted share count of approximately 155 million shares. Looking ahead to the full year, we now expect revenue of $3,950 million to $4,020 million, which is up 4% to 5% year-over-year as [reported now] (ph) 4% to 6% in constant currency. We now expect security revenue growth of approximately 15% to 17% in constant currency in 2024, including the contribution from the acquisition of Noname. With a strong start for our compute offerings in Q1, we now expect compute revenue growth to be approximately 21% to 23% in constant currency for the full year 2024. We are estimating non-GAAP operating margin of approximately 28% to 29%. We now estimate non-GAAP earnings per diluted share of $6.20 to $6.40. Our non-GAAP earnings guidance is based on the non-GAAP effective tax rate of approximately 19% to 19.5%, and fully diluted share count of approximately 155 million shares. Finally, our full year CapEx is expected to be approximately 16% of total revenue. This updated CapEx is higher than our original expectations outlined last quarter due to our lower revenue outlook, slightly higher software capitalization rates across the business as more work is being done on capitalized projects and higher than expected server component costs, driven primarily by NAND storage pricing in certain servers that support our cloud computing buildup. In closing, we are pleased with our progress in security and compute to start the year. Tom and I would be very happy to take your questions. Operator?"
},
{
"speaker": "Operator",
"content": "Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Madeline Brooks from Bank of America. Please go ahead."
},
{
"speaker": "Madeline Brooks",
"content": "Hi, team. Thanks so much for taking my question, and great to see compute kick up in terms of the guidance. One question for me on the delivery side of the house. Last quarter you had mentioned that first quarter and second quarter of this year we were going to see a few renewals. I just wanted to see how those renewals were going if there was any updated outlook in your guidance from the renewal side of the house. Thank you."
},
{
"speaker": "Ed McGowan",
"content": "Hey, Madeline, this is Ed. Yeah, so the renewals are going as planned in terms of the pricing expectations. We've got a few of them done now. We'll have about five of the seven completed by the end of this quarter, and the other two will be done in early Q3. As far as expectations go, like I said, pricing is coming in-line. Volume a little bit lower than we expected normally when we do these large renewals. We tend to see an uptick in traffic. We just haven't seen that. So that's all been reflected in our guidance."
},
{
"speaker": "Madeline Brooks",
"content": "Great. Thanks. Let me ask you one more question if I could. For those renewals [or financing] (ph) your larger deals, are you seeing any type of offsetting with compute growth for maybe some larger customers where you are seeing lower volume?"
},
{
"speaker": "Ed McGowan",
"content": "I'm sorry, could you just repeat that again?"
},
{
"speaker": "Madeline Brooks",
"content": "Are you seeing a lower customers, larger customers who are coming in maybe with lower volume than expected? Are you seeing that offset at all by any type of compute growth or growth in other areas of the business?"
},
{
"speaker": "Tom Leighton",
"content": "Yeah, they're not directly tied, but as we talked about, several of the world's largest media companies are starting to use our compute capabilities for a variety of tasks. So that's a good new story. It's not tied to the traffic levels in any way. Of course, these big media companies still use Akamai for a large fraction of their delivery needs, but traffic in the industry as a whole, especially media and gaming, is lower than we had initially expected."
},
{
"speaker": "Madeline Brooks",
"content": "Great, thank you so much."
},
{
"speaker": "Operator",
"content": "The next question comes from Keith Weiss from Morgan Stanley. Please go ahead."
},
{
"speaker": "Joshua Baer",
"content": "Thank you, this is Josh Baer on for Keith. The Question was on margin guidance. It was lowered I think by 150 basis points at the midpoint, 50 from the Noname acquisition. You mentioned 30 base points from FX. I was hoping you could just walk through the rest of the move lower on the margin guidance?"
},
{
"speaker": "Ed McGowan",
"content": "Yeah, I think just the rest of that would just be due to the lower delivery revenue as a whole."
},
{
"speaker": "Joshua Baer",
"content": "Okay, got it. I guess as a follow-up related to margins, is there any structural change in reaching, I guess, the low 30s type of long-term target and just asking given the lower guidance for this year but also because from a mixed perspective you've actually moved faster to the higher margin security and compute versus delivery. Thank you."
},
{
"speaker": "Ed McGowan",
"content": "Yeah, sure. So there's really no structural change. Obviously, we're making some pretty big investments in R&D, and you can see that in the R&D line. And also just the acquisitions, we made an acquisition last year, made an acquisition now. So we're investing in growth. But there's also a fair bit of investment that goes into the cost of goods sold-line as we build out our compute platform. So you can see that in the higher co-location costs. And there is some accounting that you have to do when you enter into some of the long-term agreements for co-location. So we should start to see that, get some benefit of that as compute grows even faster."
},
{
"speaker": "Joshua Baer",
"content": "Great, thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from James Fish from Piper Sandler. Please go ahead."
},
{
"speaker": "James Fish",
"content": "Hey guys, just on the social media customer here, I think I may know what's going on, but you know, it does seem as though traffic has been slowing for the last, you know, two years or so from what we can tell. But on some of these renewals and specifically on the social media customer, I guess what's the confidence that this isn't just tied to kind of DIY efforts picking back up in the space?"
},
{
"speaker": "Tom Leighton",
"content": "Yeah, for the large social media customer we talked about, there's a few components generally tied to their efforts to reduce costs. You know, they are using less bits per transaction and end-user experience. They're optimizing their doing less prefetching. They do have a very large DIY component as well and we haven't seen the impact of that yet but we do think that they may use that more throughout the rest of the year and that's factored into our lower guidance for this particular customer. So we haven't seen that yet, but we anticipated at this point as part of their overall cost reduction efforts."
},
{
"speaker": "James Fish",
"content": "Got it. And then on the security side of the house, I mean, what did Noname have that [sure] (ph) Neosec was smaller in scale, but that Neosec didn't. And so why isn't this just kind of a role of strategy of kind of the API space? And Ed, if you could just walk me through the security guidance? You guys had a pretty good beat here. And I get FX is kind of moving against you on this, but why wouldn't we see further upside given the strength you saw in Q1? Is it just because some of the security revenues tied to some of these delivery renewals or why the conservative security guide?"
},
{
"speaker": "Tom Leighton",
"content": "I'll take the first part and then let Ed to answer the second part. Yeah, Noname is a market leader. And they have a lot of capabilities that we don't have yet. And it's actually very synergistic with what we have. They have an on-prem and hybrid-solution. Our solution has been SaaS-only. They have a great channel partner ecosystem, market-leading presence, very easy to use and to integrate. And by the time we get the acquisition closed later this quarter, we anticipate we'll have full integration with Akamai Security Services, which is the piece they were really missing. And great user experience and console. So really strong capabilities and of course much bigger business. And with our solution, we can add to that I think stronger forensics and threat hunting with our data lake capabilities and by putting the pieces together, really a very compelling solution. I was just out at RSA earlier this week and I got to say the news was incredibly well received. A lot of customers, both ours and Noname customers, very happy about the acquisition and what we're going to be able to do for them. Also, the partner ecosystem, Noname is very partner friendly. That will really help our go-to-market motion and they were very excited about the news as well. And Ed, I'll turn it over to you for the second part there."
},
{
"speaker": "Ed McGowan",
"content": "Yeah, sure. So first of all, just a great quarter for security, great sequential growth, strength across the board really in terms of pretty much all of our solutions, obviously seeing great growth with API security and expect that will accelerate now that we have Noname in the mix. But I think as you look at last year, we had very, very strong sequential growth, sort of unusually strong, including some license revenue in the back half of last year. So the compares get a little bit tougher. I don't think there's anything structurally that we're seeing that would cause us to be less bullish. I think one thing, just to keep in mind, we introduced some bundles last year. We had identified about 3,000 customers or so. Obviously, we had great success with that. That's going to have less of an impact this year as we start to anniversary that. But we are very excited about what we're seeing with Guardicore, which is starting to become more material, and the growth from API security. So we're very bullish with the growth going forward. I think just getting it to tougher comps in the back half, which is going to perhaps cause the percentages to be a little bit lower than what we saw here in Q1."
},
{
"speaker": "James Fish",
"content": "Thanks Ed."
},
{
"speaker": "Operator",
"content": "The next question comes from Fatima Boolani from Citi. Please go ahead."
},
{
"speaker": "Fatima Boolani",
"content": "Good afternoon. Thank you for taking my question. Just one on delivery. You know, I can appreciate how difficult it is to sort of parameterize some of the trends that are playing out in the industry. I think both of you sort of laid that out in the prepared remarks. But how should we think about the floor in terms of declines in this business and what type of GuardRails you're anticipating and putting around this business? And essentially what I'm trying to get around is how confident are you that this recalibration lower does take into consideration everything that's happening in them? And then I have a follow-up."
},
{
"speaker": "Tom Leighton",
"content": "Yeah, I'll start and then Ed will give us some more color on this. Of course, you know, when we give guidance, we do it based on the best available information we have at the time. Obviously, we don't like to see, the revenue decline and you never like to be in a position of taking down the guidance for one of your portfolios. We do believe that, you know, our delivery business is critical for major enterprises to operate on the Internet. That said, delivery is a very competitive environment And we are subject to overall traffic levels on the internet, which we now believe will be in a lower state than we had thought before. And you know, this is typical. We've been doing this as the market leader now for 25 years, and there's times, when traffic accelerates more than you might have thought and times when it doesn't. And I think we're in sort of the latter mode right now. Now we do believe the business will get back to par. I can't tell you exactly when that will be. It's important for us to do that. I should add though, it's not our top priority. We are not out there doing whatever price it takes to go grab all the business. In fact, I think we've been pretty clear that's not the case. There's traffic that we are not taking because we don't feel that it's profitable or really strategic for us. Our primary goal is using delivery for very strong cash flow that we can invest in security and compute, which we think are much more lucrative markets in the long run, offering much more growth. And also we use it with our customers to introduce, for example compute. The [big-bit] (ph) customers, big media, gaming, are big prospects in compute. And the largest customers there are over $1 billion in third-party cloud spend, typical large media customer, hundreds of millions. And we want to get a share of that business which is much more profitable and ultimately much larger than delivery. So that is our focus here. Obviously we want to get back to PAR. We don't like to see a declining business but it's a bigger picture. And of course we are competing with a lot of companies that are very desperate just to get a little bit more growth in delivery, and even if they are doing it at a very unprofitable level, and that makes it more challenging. And Ed, maybe you want to talk a little bit more on the details of the guidance and the confidence?"
},
{
"speaker": "Ed McGowan",
"content": "Yeah, as Tom talked about, we use the best information we possibly can. We obviously work with a lot of the big telcos. We try to get feedback from them to see what they're seeing. We talk to our large customers to get an understanding of what they have planned in terms of the big events or if they're doing downloads, how big the downloads are going to be, what sort of share we should expect as we go through things like our large renewals and that sort of stuff. When we see a trend like we saw in March where traffic was lower than we expected and then continued into April, it did cause us to go back and relook at our forecasts and be a little bit more cautious. But those forecasts, it's unusual to see traffic decline month over month. It doesn't generally happen. But there is a big pressure in the industry to save costs, especially in the streaming business. Gaming tends to be very seasonal and a little fickle in terms of different titles being popular and not. We're just sort of in the downtrend in gaming. But as Tom mentioned, we've seen these trends before. We're usually pretty good at predicting when things will turn around. But when we do see something that is concerning, we're going to call it out and reset our forecast."
},
{
"speaker": "Fatima Boolani",
"content": "I appreciate that. And just with regards to the new go-to-market leadership on the compute side, I'm just curious if there are going to be any material changes or is this a deepening of the bench that's going to allow for an ongoing, ideally, acceleration of the compute business? We'd love to just get a little bit more detail on that go-to-market change for someone with a pretty excellent category. Thanks so much."
},
{
"speaker": "Tom Leighton",
"content": "Yeah, it's more of the latter and getting really solid experience and expertise as we increase our investment in the go-to-market effort around compute. And we think Dan is an excellent addition to our leadership."
},
{
"speaker": "Operator",
"content": "The next question comes from Mark Murphy from JP Morgan. Please go ahead."
},
{
"speaker": "Mark Murphy",
"content": "Thank you very much. I wanted to congratulate you on the strength in the Compute and Security and the US Army win the Sony -- win, obviously good things happening there. Going back to the social media company that you referenced, is that a typical kind of [garden variety] (ph) case of cost optimization or is there perhaps anything unusual like a corner case where The clock might be ticking on legislative proposals and they are moving in advance of that. Could it be a social media company that is struggling and shrinking? Anything along those lines?"
},
{
"speaker": "Tom Leighton",
"content": "No, I think you described it pretty well in the first two descriptions you gave. And they just are a very large customer for Akamai, and a very good customer. They are looking to cut costs and they are looking at potential, geopolitical challenges. And so that, I think a lot of companies look to cut costs, particularly these days in media and maybe they have additional concerns."
},
{
"speaker": "Mark Murphy",
"content": "I understand. Okay. And then Ed, the security company you're acquiring, I forget the name of it, can you provide any metrics on the headcount or their growth rate in the last 12 months or the gross margins? And I'm just wondering, does it focus on API security that aligns any more or less across any of the particular hyperscalers?"
},
{
"speaker": "Ed McGowan",
"content": "Yeah, I'll take the first part, Tom. You can take the second part about the product. Now in terms of growth rates and stuff like that, I hesitate to give growth rates because we obviously have to translate everything they're doing into GAAP revenue ASC 606. But needless to say, they were growing pretty quickly. We talked about we think it will contribute about $20 million of revenue, but again growing very fast as we introduce them into the mix. We think we can accelerate that growth rate quite a bit as we introduce them to our customer base. Gross margins I would say is pretty typical of what you see in a software company. It's called like high 70s, maybe low 80s. There are some people cost that go into your cost of goods sold. As far as people go, right around 250 people, give or take, 60% or so is in R&D, 30% in go-to-market and the rest is sort of mixed in kind of your back-office support."
},
{
"speaker": "Tom Leighton",
"content": "Yeah, in terms of the question on the hyperscalers and API security, they don't offer API security. They have API gateways, which is something totally different. In our competition, in API security is more startups or younger companies smaller. It's an emerging field and really we feel Noname as a leader there."
},
{
"speaker": "Mark Murphy",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Frank Louthan from Raymond James. Please go ahead."
},
{
"speaker": "Frank Louthan",
"content": "Great, thank you. Just to go back on the delivery side, was there a price that they would have been willing to stick with? There was just pretty much a business decision there. And Tom, you mentioned get back to PAR. What do you mean by that? Is that a level of revenue? How should we think about what it would be to kind of getting back to PAR?"
},
{
"speaker": "Tom Leighton",
"content": "Well, PAR, we don't want to see revenue decline in our portfolio. We'd like to see it to grow. And we're declining, obviously, now in delivery. And in the particular case of the large social media company, I don't think, this is a price-related issue, really. And as Ed mentioned, I think pricing, obviously very competitive out there. And we don't go and chase the bottom stuff that's not really profitable for us. But you know, pricing is sort of as we expect and more of it's a traffic, overall traffic in the industry right now."
},
{
"speaker": "Frank Louthan",
"content": "Okay, and at what level do you see the delivery business sort of bottoming it out that would be considered sort of flat for you."
},
{
"speaker": "Ed McGowan",
"content": "Yeah, you know as Tom talked about, it's hard to predict. I mean, I think what you need to see for that to happen is traffic growth to improve, to see pricing rationalize a bit more than where it is now, and less concentration of big renewals. But that's really the formula that you would need to see a sort of a stabilized delivery business."
},
{
"speaker": "Frank Louthan",
"content": "Okay, great. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Amit Daryanani from Evercore. Please go ahead."
},
{
"speaker": "Unidentified Analyst",
"content": "Hey, guys. Thanks for taking the question. This is [Chant] (ph) on for Amit. I just had a quick one on the delivery business. You know, given this is an election year, do you think we could see a step up in the delivery business, maybe in the back half? I think normally elections tend to drive some sort of benefit as well as kind of the Olympic benefits you mentioned earlier."
},
{
"speaker": "Tom Leighton",
"content": "Yes, we talked about the Olympics as a decent event for us. Our estimate is $3 million to $4 million this year. As far as the election goes, really hard to tell. You know, we saw back in [2016] (ph) a bit more traffic, [2020] (ph) didn't really drive a ton of traffic. I'd say this is probably closer to what we saw in 2020, so we're not really anticipating a significant amount of traffic as a result of this year's election, but we'll see."
},
{
"speaker": "Unidentified Analyst",
"content": "Got it. And then just as a follow-up, I think free cash flow is really strong during this quarter, but if I look back historically, Q1 is kind of the low, and then sequentially in the June and September quarter it's much greater. So could you talk about maybe any changes to your CapEx and free cash flow expectations for fiscal 2024?"
},
{
"speaker": "Tom Leighton",
"content": "Yeah, so I would think that next year should play out, or excuse me, 2024 should play out like it's done in the past. Q1 was a little bit stronger than normal. As we talked about on several calls back last year, we did move some folks to a stock-based bonus program. So we used to have a cash-based bonus program that would play out in Q1 that would drive cash flow down a little bit in Q1, but in terms of the progress throughout the year, it should look like the other years."
},
{
"speaker": "Unidentified Analyst",
"content": "Great. Thanks for that."
},
{
"speaker": "Operator",
"content": "The next question comes from Jonathan Ho from William Blair & Company. Please go ahead."
},
{
"speaker": "Jonathan Ho",
"content": "Hi. Good afternoon. Just wanted to understand the Zero Trust platform that you announced today. Can you talk a little bit about how customers are thinking about purchasing the assembly of products that you're talking about and how that compares with maybe some of the other views on how SASE and other Zero Trust platforms will evolve over time."
},
{
"speaker": "Tom Leighton",
"content": "Yeah, this is a really good platform for Zero Trust for enterprise applications. So you get your micro segmentation and your employees Zero Trust Network access which is your employee access. That's your North, South and East, West now combined. Same agents, you don't have to have two different agents, same console and [plane of class] (ph). And on top of it, you get your MFA, your DNS security, and your threat hunting service, all packaged in a platform. And that's something customers have been asking for. It makes their lives a lot easier than having what seem to be different products with different agents and different interfaces. On top of it, at RSA we demonstrated a very cool new capability that actually uses a GenAI, LLMs, to give a very nice human interface into your enterprise infrastructure. It identifies what your various applications and devices are, and you'd sort of think, oh, well people would know, but they don't. Enterprise, major enterprises just have zillions of applications and devices on the internal network and they don't even know what they all are. And this tells you, in actually a human language form, can actually tell you what is not sufficiently protected or if the firewall rules, the agent rules are out-of-date. We've got a lot of positive feedback about that at RSA. And it's something that over time we want to take to our entire suite of security services, which I think will be pretty exciting. So yeah, so this helps because customers want to see, really have a few basic platforms of which Akamai is one and simplification of interface and control, both for the control plane and for the agent that's on their applications and service."
},
{
"speaker": "Jonathan Ho",
"content": "Excellent, excellent. And just in terms of a follow-up, with compute, you obviously spoke about a number of large wins here, large types of customers. Can you talk about the potential to take that larger share of the pie over time as you grow within these customers and help us understand, are you landing in sort of a small footprint to begin with and then growing from there? Are you just sort of taking everything up front? I'm just trying to understand what that net retention opportunity looks like over time. Thank you."
},
{
"speaker": "Tom Leighton",
"content": "Yeah, great question. It very much is a land small. Somebody will try out a single app with a little of the traffic forward and then grow it, and then add more apps. And you see that with our profile of customers, starting with the ones that $3,000 a month, then half of them now up to [$100,000] (ph) a year, [$60 million] (ph), [$100 million] (ph) a year. And Akamai is actually our first $100 million a year customer on the platform. And that's the same progression we went through over the last year-and-a-half. And we expect, and that's what we're trying to do with all of our accounts. These customers I talked about I couldn't give you most of their names, but you would recognize them. And they are -- what they're spending now with us is a tiny fraction, even the big ones, of their overall cloud spend. And they are finding the platform is easy to use, performs very well, and is saving them a boatload of money. And I think that's why we're seeing such good early traction. And now the goal is to grow those accounts, both in terms of the number of use cases and the scale of a use case, and then to add more customers. And again, they will come in at the lower revenue volumes to start."
},
{
"speaker": "Operator",
"content": "The next question comes from Alex Henderson from Needham. Please go ahead."
},
{
"speaker": "Alex Henderson",
"content": "Great, thanks. First off, congratulations. Picking off Noname was a real coup for you. I think that's an outstanding acquisition. So congratulations on that. I wanted to ask some content around the compute piece. First, you moved a bunch of your internal apps from other compute platforms to internal. Where are you on that? What does that look like in terms of the cost savings? And what has been the variance relative to what you'd expected when you started it, I assume you probably got better results, not worse results. And I was hoping you could, within the context of the compute platform, talk about gross retention as opposed to net retention. Obviously your net retention looks very good with these upticks, but I was wondering if there was any churn of people who were on the platform before that may have fallen out of the equation?"
},
{
"speaker": "Tom Leighton",
"content": "Yeah, we're more than halfway through the migration of our third-party cloud spend onto Akamai Connected Cloud. And as I mentioned, seeing really dramatic savings and also performance improvements. So we're more than $100 million a year in on the platform now, which is really fabulous for us. And maybe, Ed you want to take the second part of that question?"
},
{
"speaker": "Ed McGowan",
"content": "Yeah, so if you think about where you see that, Alex, is there some absolute savings if you look at our – in our cost of goods sold line, you can see that on that network build and support sub-line, sub-category. It's offset a little bit by what you see in [colocation] (ph) fees. So you're not seeing a ton of margin expansion. But what doesn't show up there is that that line was growing at 30%, 40%, or 50% a year. Now, probably we'd be growing 30%, 40% if we hadn't done it. So the cost avoidance is pretty significant. As Tom said, we're finding this to be much better than we had expected. We should get the rest of the expected applications moved over here between now and the early part of next year, end of this year into the early part of next year. So I'm very, very pleased with that. And again, a lot of cost avoidance and some absolute cost savings, like I said, being a little bit [massive] (ph), investments we're making in the platform. And then you also asked a question on gross retention, I think was the term you used in terms of are we seeing any churn. On the enterprise side, we're not seeing any churn so far. We haven't seen any customers that have left the platform. We do see a little bit of churn in the legacy retail node business which was pretty common when you talked about the SMTs. But where we're really aiming to grow the business, we're not seeing any of that yet."
},
{
"speaker": "Alex Henderson",
"content": "Okay, great. And just one last question on this subject. Can you talk about whether you're seeing any potential around inference AI on this platform because it hasn't been mentioned yet. Thanks."
},
{
"speaker": "Tom Leighton",
"content": "Oh yeah, we already have several customers doing all sorts of AI, but inference AI on our platform, and we have partners, our ISV partners. Some of them, that's their product capability. So yeah, we foresee substantial use of the platform for inference."
},
{
"speaker": "Alex Henderson",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Rudy Kessinger from DA Davidson. Please go ahead."
},
{
"speaker": "Rudy Kessinger",
"content": "Hey, Thanks for taking my questions. Ed, just given the quicker than expected mix shift of the higher gross margin revenue lines, why aren't we seeing gross margins at least hold steady, if not expand? It's been compressing for the last few years."
},
{
"speaker": "Ed McGowan",
"content": "Yes, so if you look back a few years ago, they've been compressing a bit. We had some pricing pressure as we always do in the delivery business. But I talked a little bit about this a few questions ago, and even a little bit with Alex in the last question. As we invest in the platform to build out compute locations, we're doing the GECO build out. We built out 25 core locations last year. We entered into these long-term leases for colocation. And where there's underlying [commits] (ph), you have to straight line that. So there's some non-cash colocation expenses. So if you look at our [co-loc] (ph) cost line, that's been growing pretty substantially. So that's masking a lot of the savings that you're seeing from our third-party compute costs. There's also additional build out and support costs that go along with it as well. So that's why you're seeing that margin sort of holding flat to where they've been over let's say the last year or so, but I don't expect them to decline. Hopefully over time they should start to expand a bit, but as we're building out aggressively in the compute platform that does put a little bit of pressure on margins, but as we start to fill up those locations, we should start to see expansion in margin."
},
{
"speaker": "Rudy Kessinger",
"content": "Yeah, okay. And then on delivery, could you just talk about where some of the repricings came in with some of those contracts? And if I look at kind of what's implied for delivery in the rest of the year on an organic basis adjusting for some of those contracts you acquired, it looks like it kind of probably gets down to down 20%-ish year-over-year on an organic basis. What is the mix of price compression versus traffic growth? Is it flat kind of traffic on the network given all the things you talked about and 20% price compression or what is the combination there?"
},
{
"speaker": "Ed McGowan",
"content": "Yeah, so we don't share those numbers for obvious reasons with the price compression because obviously there's customers that get certain discounts, others don't get as high discount because they don't have as much traffic. And also it's a competitive number. I'd want to know what my competitors are doing with that number as well. But if I think about sort of the mix of what's driving it. Pricing is always a factor. And if you don't get the commensurate traffic growth offset that, then you're going to decline. And that's what we're seeing. It's really the back-half story is a lower than expected traffic. Now, couple that with your, some of your largest customers renewing at the same time. You don't have that, that volume offset. It just exaggerates the impact at the back half of the year. So like I said, it's really more of a volume issue than it is an overall pricing issue."
},
{
"speaker": "Tom Leighton",
"content": "Okay, operator, I think we've got time for one last question."
},
{
"speaker": "Operator",
"content": "The next question comes from Tom Blakey from KeyBanc Capital Markets. Please go ahead."
},
{
"speaker": "Tom Blakey",
"content": "Hey, Mark and guys, thanks for squeezing me in here. I just wanted to go back, I think maybe to dive a little deeper on Rudy's question about gross margins. You talk about moving to more profitable solutions longer-term and made some headway here in one queue. In the past, you've kind of given us a framework about lowering CapEx, as a percentage of revenue for CDN. Essentially, 0% CapEx is needed, theoretically anyway, for security. Can you just walk us through what the -- not the near-term manned price components are, but longer-term structurally, what does compute look like at scale for Akamai? And have a follow up."
},
{
"speaker": "Ed McGowan",
"content": "Yeah, so good questions. What -- I'll start with what the components of CapEx are today. So we said 16%. About 8% of that is Software CAP, so that's probably going to be 7%, 8% sort of going forward. Don't expect much of a change there. That's kind of been historically in that range. Compute this year is about 4%. CDN and securities around 3%, and then there's always 1% call it first. You know, you're [back-off](ph) if there's your IT systems and your facility related stuff. So in terms of how that's going to go throughout the years, we've obviously driven down our CapEx on the CDN business pretty dramatically. That used to be sort of 8% to 10% is what we used to talk about. So we've more than cut that in half. And I expect that -- that kind of low single-digit range will probably be where we stay unless we see just a dramatic increase like we saw during the pandemic. But there's no reason to believe that is to happen with what we know about the industry right now. In terms of the compute business, it's really a question of growth. Now we're expanding in terms of the number of locations right now. Obviously, revenue is growing very fastly, we made a big investment last year, and we talked about having room for revenue growth. And obviously, that enterprise revenue growth is quite substantial in terms of year-over-year and getting to more material numbers. Tom and I talked about being on a $50 million run rate just for that and growing it over 300%. Now, we've used kind of a metric of about a $1 of CapEx for a dollar of revenue. Not a perfect metric, but it's not a bad one to use. I've actually looked at some of the hyperscalers and some of the other public information that's available. It's a fairly decent proxy, obviously, as you're making major investments like testing an AI now. But I think that's a fairly decent place to put it for now and then obviously as we get more experience we'll update you from there."
},
{
"speaker": "Tom Blakey",
"content": "Okay thanks again for that review and update there. Back to Noname and the kind of setup here so we model it correctly and look at organic growth. Did that $20 million for the back half includes like a cross-sell or uplift from being on the Akamai platform? Is that just kind of annualizing what Noname's revenues are today? And maybe from a strategic perspective for Tom, like is with Noname also purchased to be more of a -- strategic asset in the context of not just API related posture management and bundling there, or is Noname going to be in -- its code base going be more of a hub for bundling more additional security services for Akamai?"
},
{
"speaker": "Tom Leighton",
"content": "Yeah, I'll just do a quick answer on the second part there. Yeah, Noname is strategic, API security is strategic, and we're looking forward to integrating that more deeply in the Akamai platform and then building on top of it with new capabilities. And Ed, I'll let you talk about the financial."
},
{
"speaker": "Ed McGowan",
"content": "Yeah, so what we've baked in really is just essentially what we expect their contribution to be without a significant increase in sales from our revenue synergy. So there's an opportunity to drive additional revenue synergy throughout the back-half of the year. Assumption there is it closes sometime in June. Going to train our sales reps up. It always takes a little while for an acquisition to settle, and then you start opening up sales campaigns and we'll start closing some deals towards the latter part of the year. Hopefully we can do better than that but in terms of our thinking we just sort of layer in what that contribution will be and hopefully we can drive some revenue synergy in addition to that."
},
{
"speaker": "Tom Blakey",
"content": "Thanks. Thank you."
},
{
"speaker": "Tom Leighton",
"content": "Okay. Thank you, everyone. In closing, we'll be presenting at several investor conferences throughout the rest of the quarter. We look forward to seeing you at those. And thanks again for joining us tonight. We hope you have a nice evening. Operator you can now end the call."
},
{
"speaker": "Operator",
"content": "Conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
alb | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Hello, and welcome to Albemarle Corporation's Q4 2024 earnings call. I will now hand it over to Meredith Bandy, Vice President of Investor Relations and Sustainability."
},
{
"speaker": "Meredith Bandy",
"content": "Thank you, and welcome, everyone, to Albemarle's Fourth Quarter 2024 Earnings Conference Call. Our earnings were released after the market yesterday, and you'll find the press release and earnings presentation posted to our website under the Investors section at albemarle.com. Joining me on the call today are Kent Masters, Chief Executive Officer; and Neal Sheorey, Chief Financial Officer. Netha Johnson, Chief Operations Officer; and Eric Norris, Chief Commercial Officer, are also available for Q&A. As a reminder, some of the statements made during this call including our outlook, guidance, expected company performance and strategic initiatives may constitute forward-looking statements. Please note the cautionary language about forward-looking statements contained in our press release and earnings presentation, which also applies to this call. Please also note that some of our comments today refer to non-GAAP financial measures. Reconciliations can be found in our earnings materials. And now I'll turn the call over to Kent."
},
{
"speaker": "Jerry Masters",
"content": "Thank you, Meredith. For the fourth quarter, we reported net sales of $1.2 billion and an adjusted EBITDA of $251 million with year-over-year EBITDA improvements in all of our business segments. Turning to the full year of 2024. We achieved an adjusted EBITDA of $1.1 billion in line with our outlook considerations due to significant productivity and cost improvements, higher volumes and strong contract performance. Our Energy Storage segment delivered a 26% year-over-year increase in sales volumes, surpassing our initial guidance of 10% to 20% growth, driven by successful project ramps and increased spodumene sales. We also generated $702 million in cash from operations with an operating cash conversion rate exceeding 60%, which is above our target of 50% and in line with our long-term objective. Albemarle continues to act decisively across four key areas: optimizing our conversion network, improving cost and efficiency, reducing capital expenditure and enhancing financial flexibility. We'll touch on each of these areas in more detail later in the call. As part of these initiatives, today, we're announcing new measures to further optimize our global conversion network, including placing the Chengdu lithium conversion facility into care and maintenance by midyear of 2025 and shifting capacity at our Qinzhou lithium conversion facility somewhat from hydroxide to carbonate. As we did last year, we are providing our outlook based on a range of lithium market prices, including a new $9 per kilogram scenario and updated $12 to $15 per kilogram and $20 per kilogram scenarios. Compared to 2024, we have improved our outlook across these ranges due to our ongoing efforts to enhance productivity and reduce cost. Additionally, we have further decreased our full year 2025 CapEx outlook by an additional $100 million, we now expect to spend in the range of $700 million to $800 million. Thanks to these and other measures, we now have line of sight to achieve breakeven free cash flow in 2025. Now I'll turn it over to Neal, who will provide more details on our full year and fourth quarter performance, outlook considerations and market conditions. Then I'll conclude our prepared remarks with updates on our long-term competitive position, strategic framework and execution."
},
{
"speaker": "Neal Sheorey",
"content": "Thank you, Kent, and good morning, everyone. I will begin with a review of our fourth quarter and full year 2024 performance on Slide 5. In the fourth quarter, we reported net sales of $1.2 billion, which represented a year-over-year decline primarily due to lower lithium market pricing. Fourth quarter adjusted EBITDA was $251 million, an increase year-over-year driven by improvements across all 3 businesses as well as reduced corporate costs. Note that last year's adjusted EBITDA included a $604 million lower of cost or market pretax charge. Earnings per share for the fourth quarter were $0.29. Adjusted earnings per share reflected a loss of $1.09, excluding gains on asset sales, reduced restructuring charges and discrete tax items. For the full year 2024, net sales were $5.4 billion, marking a year-over-year decrease primarily related to lower lithium pricing, partially offset by robust growth in lithium volumes. Full year EBITDA reached $1.1 billion, in line with our outlook considerations. Slide 6 shows the drivers of our year-over-year EBITDA performance. Our Q4 adjusted EBITDA of $251 million surpassed last year's result due to higher volumes, productivity and lower COGS. The EBITDA volume benefit was driven by higher volumes in specialties and the conclusion of the MARBL JV marketing agreement at the end of 2023. The COGS improvement was split between lower spodumene costs and reduced lower of cost or market adjustments. These benefits were partially offset by lower pricing and pretax equity income, mainly from reduced lithium and spodumene market prices. As Kent mentioned, adjusted EBITDA improved year-over-year in all 3 business segments, and we also reported lower corporate overhead costs. Moving to Slide 7. We present our outlook considerations for 2025. As we did last year, we are providing ranges of outcomes for our energy storage business based on recently observed lithium market pricing, including year-end 2024 market pricing of about $9 per kilogram lithium carbonate equivalent, or LCE, the first half 2024 range of $12 to $15 per kilogram LCE and the fourth quarter 2023 average of about $20 per kilogram LCE. Within each scenario, we have provided ranges based on expected volume and mix. We anticipate that energy storage volumes will be slightly higher year-over-year. All three scenarios reflect the results of assumed flat market pricing across the year in conjunction with Energy Storage's current book of business. These scenarios illustrate the improved stability of our Energy Storage business. Given our extensive resource positions worldwide and our cost and productivity actions, we can sustain margins even with lower year-over-year lithium pricing. Additionally, we have maintained significant operating leverage with potential to benefit if pricing increases. For example, if market pricing were to average $12 per kilogram LCE, similar to last year, we would expect to see margin improvement rising from the mid-20% range that we delivered in 2024 to the mid-30% range. Moving to Slide 8. We present modeling considerations for Specialties, Ketjen and Corporate. Specialties 2025 net sales are projected to be $1.3 billion to $1.5 billion with adjusted EBITDA of $210 million to $280 million. Ketjen's 2025 net sales are projected to be $1 billion to $1.1 billion with adjusted EBITDA of $120 million to $150 million. The Corporate outlook shows a planned decrease in capital expenditures, which are now expected to total $700 million to $800 million in 2025, down from $1.7 billion in 2024. Corporate costs in 2025 are expected to range between $70 million and $100 million. We are seeing the benefits of our nonmanufacturing cost improvements and the changes in our operating structure. Corporate costs in 2025 are expected to decrease year-over-year, excluding favorable FX and interest income in the prior year. Adding it all together, slide 9 presents Albemarle's comprehensive company roll-up for each energy storage market price scenario. Recall that the full year 2024 included approximately $100 million of pretax equity income from onetime additional offtake by our JV partner at Talison. Notably, assuming a consistent average lithium market price of $12 per kilogram LCE in 2025, we expect cost and productivity improvements to more than compensate for the reduced equity earnings. Turning to Slide 10 for additional outlook commentary by segment. For Energy Storage, we anticipate volumes to be slightly higher year-over-year primarily due to the ongoing ramp of the Salar yield improvement project in Chile. In addition, we continue to ramp our conversion sites, including Meishan and Kemerton, which helps improve fixed cost absorption and result in reduced tolling volumes. Last year, we indicated that about 2/3 of our lithium salts volumes were sold on contracts, including both long-term agreements with floors and other contracts. For 2025, we've indicated that 50% of our lithium salts volumes are sold on long-term agreements with floors. This number now excludes other contracts to help simplify modeling. Our contracts continue to perform, and we have no significant contract renewals this year. We continue to have additional sales on contracts with volume commitments, giving us greater confidence in our volume expectations for this year. We foresee a modest volume-led recovery in Specialties year-over-year driven by strength in pharma, autos and oilfield applications. Finally, in Ketjen, we expect modest improvements in 2025 results related to product mix, cost and productivity improvements and continued execution of our turnaround plan. Please refer to our appendix slides in the deck for additional modeling considerations across the enterprise. Turning to our balance sheet and liquidity metrics on Slide 11. We concluded the fourth quarter with available liquidity of $2.8 billion predominantly comprising $1.2 billion in cash and cash equivalents and the full $1.5 billion available under our revolver. The measures we have implemented to enhance our cost structure and operational efficiency have also increased our financial flexibility. As a result of our proactive actions to reduce costs and optimize cash flow, we ended Q4 with a net debt to adjusted EBITDA ratio of 2.6x, favorable to previous expectations. For additional information on covenants, please refer to the appendix. We have a single upcoming maturity, which is our EUR 372 million Euro notes at 1.125% 8 percent due in November of this year. Given the favorable rate, there is no immediate urgency to refinance, and we continue to evaluate our options for managing this maturity. Slide 12 shows our focus on execution and converting our earnings into cash, evident in improved operating cash flow conversion due to operational discipline and cash management. For 2024, operating cash conversion was 62%, surpassing our target of 50% and aligning with our long-term target range. This was driven by increased Talison dividends from higher Greenbushes sales volumes and inventory and cash management improvements across operations. Looking to 2025, we expect our cash dividends from Talison in the year to remain below historical averages as Talison completes the CGP3 project at the Greenbushes mine. Nonetheless, we expect operating cash flow conversion to exceed 80% in 2025, above our long-term target range, due to ongoing working capital improvements and a $350 million customer prepayment. This prepayment relates to a recently signed contract for delivery of spodumene and lithium salts over the next 5 years at market index prices. As you see here, our efforts to enhance operating cash flow and cash flow conversion are paying off. This focus is evident in our free cash flow expectations this year. We now have line of sight to breakeven free cash flow through new capacity ramp-ups, inventory management, bidding events, cost and productivity measures and other cash conversion enhancements. Turning to Slide 13. I will provide some comments on the current conditions of the lithium market. We are in the process of updating our longer-term supply-demand forecast in light of recent policy and market developments. We expect to provide a more comprehensive update with our first quarter results. Lithium remains crucial to the energy transition and the long-term drivers of our business remain strong. The global energy transition is undoubtedly progressing. It is a matter of when, not if. In 2024, electric vehicle registrations increased by 25% year-over-year. Sales reached a new quarterly record in Q4 with December achieving all-time highs for both BEVs and PHEVs. Sales are influenced by customer preferences and the availability and cost of different models. As early as next year, we anticipate that consumers will find EV prices comparable to those of internal combustion engine vehicles. Global battery costs have fallen below the critical $100 per kilowatt hour pack average, which supports the relative EV affordability. Plus, EVs represent only a portion of the broader picture. Grid storage demand is also performing exceptionally well, increasing by nearly 50% year-over-year in 2024 driven by installations in the United States and China. Grid storage demand now constitutes nearly 20% of global lithium demand, up from less than 5% a few years ago. On the supply side, there have been several announced curtailments both upstream and downstream. Nonintegrated hard rock conversion remains unprofitable and larger integrated producers are facing pressure. Our estimates of pressure on the global cost curve are unchanged. We think that at least 25% of the global resource cost curve is either at or below breakeven. Slide 14 details 2024 global EV growth by region. China's demand was the key global driver by far, with demand increasing 37% year-over-year driven by balanced subsidies for battery EVs and plug-in hybrids. China now represents about 65% of the market demand. Europe had the weakest demand due to reduced subsidies and economic challenges, but potential price cuts and emissions targets may boost growth in 2025. North America grew 14% year-over-year with U.S. trends improving due to more model availability and affordability. Overall, these trends reinforce confidence in the industry's long-term growth potential but continue to highlight that the regional dynamics are important factors to consider as the industry expands. I'll now hand it back to Kent."
},
{
"speaker": "Jerry Masters",
"content": "Thank you, Neal. Moving on to Slide 15. I will discuss the major initiatives we are implementing to reset our cost structure. These measures will enable us to sustain our leadership position and be competitive across the cycle. Moving to Slide 16. It is essential to place our recent initiatives within the context of the measures we have been implementing over several quarters as we navigate the current business environment. This year, we are optimizing our conversion network, including new actions at Chengdu and Qinzhou, improving cost and efficiency with significant progress toward our $300 million to $400 million target for cost and productivity improvements, reducing capital expenditures as we refine our 2025 execution plans and enhancing financial flexibility. Taken together, we now have greater confidence in our ability to achieve breakeven free cash flow as early as this year at current price levels. Our initiatives are comprehensive and designed to sustain our long-term competitive advantages in response to market conditions. As the dynamic environment persists, we are continually adding to our list of potential actions so that we can adapt as necessary. Turning to Slide 17 for additional details. The shifting market underscores the need for a globally diversified conversion network with product flexibility. As previously mentioned, we are optimizing production from both our carbonate and hydroxide assets. achieving record production at the La Negra lithium carbonate plant in Chile and the Meishan lithium hydroxide plant in China. As we have reviewed our conversion network for improvement opportunities, we have made the decision to place our Chengdu plant on care and maintenance due to market conditions and shifting product mix. Chengdu is a relatively small plant with a capacity to produce approximately 5,000 tons of lithium hydroxide annually. We will continue to service those customers through the ramp of newer, larger plants in Chile, China and Australia. This approach will enable us to provide high-quality secure supply to our customers while driving network efficiencies and better leveraging our scale. Moreover, we have identified a highly capital-efficient project at Qinzhou to shift conversion capacity partially from hydroxide to carbonate in response to strong market demand. In Australia, performance of our Kemerton lithium hydroxide facility continues to improve, and the site recently commenced its first battery-grade commercial sales. On the resources front, we are focused on preserving and maximizing the value of our advantaged low-cost resources. The Salar yield improvement project has exceeded a 50% operating rate milestone and is progressing towards nameplate capacity. We are leveraging our brine expertise, for example, in hydro geological mapping, to maximize recoveries at every stage of the resource. At Greenbushes, CGP3 is expected to produce its first ore in the fourth quarter of 2025, providing additional feedstock for increased lithium salts volumes in 2026. The Talison team, together with our JV partners, has undertaken technical studies to optimize Greenbushes' operation over the life of the mine. Please refer to Slide 18 for more details on cost and capital considerations. We've achieved over 50% of the $300 million to $400 million cost improvement announced the last quarter as we moved quickly to execute on our plans. Our goal is to reach a full run rate by year-end, possibly sooner. Additionally, we're reducing 2025 capital expenditures by $100 million to $700 million to $800 million, down more than 50% from 2024. This result stems from a more detailed review of our projects. Full year 2025 CapEx will focus on core assets with priorities on health, safety, environmental improvements and cost reductions. Moving to Slide 19. The actions being taken are intended to preserve Albemarle's competitive advantages and position the company for long-term value creation as outlined by the strategic framework on Slide 20. Our strategic framework continues to guide how we operate Albemarle as we lead the world in transforming essential resources into critical ingredients for modern living. Our vision is still the same. We want to lead with impact and be purpose-driven. The markets we serve are unchanged. Both of our core businesses have enormous secular growth opportunities across mobility, energy, connectivity and health, including the energy transition, electrification, population growth and shifting demographics. I want to feature on that next row of boxes, which highlights our strategic and competitive advantages. And they're highlighted in more detail on Slide 21. First, our industry-leading resources are unmatched with large-scale, high-grade and therefore low-cost assets. This core advantage is enhanced through our innovation and advanced process chemistry capabilities. We've used this for growth in the past and now are increasingly aiming these capabilities toward cost savings and incremental growth opportunities. Customer centricity is key. We stay focused on both the customer and end user, integrating from the resource to the final product. Close collaboration with customers lets us understand market trends and technology shifts, allowing us to adapt in our dynamic markets. We continue to get positive feedback that our customers seek to work with Albemarle for our capabilities, scale and reach. Lastly, our commitment to people and planet stewardship is fundamental. It underscores our value proposition by supporting our team and promoting sustainability across all our business lines and in the communities where we operate. There is no question that while our strategic framework has not changed, our execution has certainly adapted. We have implemented several key initiatives to enhance our operational efficiency and agility. Our commitment to innovation is evident in the strategic investments we have made in research and development. We are exploring cutting-edge technologies and sustainable practices to ensure that we remain at the forefront of the industry. This includes developing next-generation polymeric flame retardants and optimizing lithium conversion to meet shifting market demand. Innovation is also core to preserving our resource advantage with projects like the Salar yield improvement project in Chile and an innovative process upgrade in Jordan that we call NEBO, both of which allow us to increase production more sustainably without incremental brine pumping. We're also driving out cost and reducing capital intensity. For example, by leveraging advanced data analytics and digital tools, we are improving our ability to monitor and optimize production processes in real time. Throughout these changes, we remain dedicated to safety, sustainability and operational excellence, aiming to create long-term value for our stakeholders while fostering a more sustainable future. In summary, on Slide 23, Albemarle delivered solid 2024 performance while acting decisively to preserve long-term growth optionality and maintain the company's industry-leading position through the cycle. Our full year 2025 company outlook considerations build on the progress we've made to drive enterprise-wide cost improvements, strong energy storage project ramps and contract performance. We are focusing on taking broad-based proactive steps to control what we can control and ensure we are competitive across the cycle. Albemarle remains a global leader, and I am confident we are taking the right actions to maintain our competitive position and to capitalize on the long-term secular opportunities in our markets. I look forward to seeing some of you face-to-face at upcoming events listed here on Slide 24. And with that, I'd like to turn the call back over to the operator to begin the Q&A portion."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question is from Patrick Cunningham at Citi."
},
{
"speaker": "Patrick Cunningham",
"content": "I guess my first question is on the contract mix. That remaining 50% piece not on long-term agreements, should we assume most of those follow spot mechanisms? And then was there any significant tranche of those long-term agreements that came up for renegotiation recently and had any respective reset in floors?"
},
{
"speaker": "Jerry Masters",
"content": "Yes. So your comment about the other 50% pretty much at index is -- that's a good assumption. And the shift that we've moved, I mean, we've reported previously that it was about 2/3 on contracts. So now we're reporting contracts only with floors. We had some long-term contracts that didn't have floors, and we pulled that out of that definition now. So that 50% has floors. I don't think we've had any we renegotiated in the near term recently or that have come up."
},
{
"speaker": "Patrick Cunningham",
"content": "Understood. That's helpful. And if I'm reading the chart correctly, it seems like most of the CapEx reduction was CapEx previously devoted to the resource base. So where are you cutting back investments in resources? And given the current program, how quickly can you repossession and invest in additional brownfield to maybe support higher volume growth 2027 and beyond?"
},
{
"speaker": "Jerry Masters",
"content": "Yes. I'm not sure that's right. I mean, if you go back, I mean, the capital we pulled back a lot of it was conversion initially, and then we've gotten a little bit more focused, and we have pushed out on some resources and we're getting very focused on kind of the highest-quality, lowest-cost resources and we're not out pursuing as many resources as we were at one time. So I think the big piece, if you look at the capital that we've cut from our plans, a big piece of it was on conversion, at least initially. And then now we're getting a little bit more focused on operations, sustaining capital, and we have to cut back on resources as well. And I think, I mean, we've said a number of times that we can -- we think we can grow at 15% kind of a CAGR over a period from '22 to '27. And we start running out of the theme a little bit. So those growth rates come down after '27. And a lot of that -- most of that is about resource."
},
{
"speaker": "Operator",
"content": "Our next question is from Rock Hoffman with Bank of America."
},
{
"speaker": "Rock Hoffman Blasko",
"content": "Could your actions including cutting CapEx and placing Chengdu under care and maintenance influence the broader market? And how might your actions adjust further if pricing stays at the low end of the scenario analysis?"
},
{
"speaker": "Jerry Masters",
"content": "So I think you said do we think our actions at Chengdu will influence the market. So no, it's -- I don't think so. I mean, we're doing that because of market conditions and product mix. So we have an opportunity to shift some product from hydroxide to carbonate at Qinzhou. And Chengdu is one of our smallest facilities, which is why it's probably not that -- wouldn't influence the market that much. And then we make up that capacity because we're still ramping other larger assets at Xinyu, Qinzhou as a small investment and then Meishan and Kemerton as well."
},
{
"speaker": "Rock Hoffman Blasko",
"content": "Got it. And would you be able to explain the wide range in the tax guide for 2025?"
},
{
"speaker": "Neal Sheorey",
"content": "This is Neal. Yes, so the wide range is really driven by the variety of scenarios that we have on the page or in the deck here. One of the reasons why we had kind of an odd tax rate in the fourth quarter and really in 2024 overall is that, as you've seen over the last few quarters, we've been reporting losses in a couple of jurisdictions where we took tax evaluation allowances. So therefore, we didn't get to recognize the tax credits in our tax expense line. Those two jurisdictions in particular are China and Australia, where we have some particulars that require us to take those tax valuation allowances. So why there's a wide variety on the tax ranges, it's really about where the lithium price is and that influence on our pretax income. Obviously, at the lower end of the range, what our guidance has said is go to a tax rate very similar to what we did in 2024. And if you're at the higher end of the range, you kind of come more to our run rate kind of statutory rate that we have based on our geographic mix."
},
{
"speaker": "Operator",
"content": "Our next question is from Ben Isaacson from Scotiabank."
},
{
"speaker": "Apurva Kilambi",
"content": "This is Apurva on for Ben. So you've discussed the line of sight to being free cash flow breakeven in 2025. So is that -- is achieving that really just the case of all the dominoes falling in place? Is there anything that could put this at risk beyond just pricing collapsing?"
},
{
"speaker": "Jerry Masters",
"content": "Well, I just -- we have to execute against our plan, right? So that is our plan to do that. We have to execute against that. And pricing would be one of those. But we have -- look, they're a pretty aggressive plans. You see the actions that we've taken. We think we've executed pretty well against it so far. So -- but we just need to execute to accomplish that."
},
{
"speaker": "Apurva Kilambi",
"content": "Perfect. And then as a follow-up, at this stage, with all of the kind of revised plans that you've laid out, do you foresee any need for a capital raise in 2025? And if so, is there any sense of what magnitude or what form that could look like? I know last year, you folks did the preferred convertibles. Is that kind of no longer in the picture given all of these actions that you've planned?"
},
{
"speaker": "Jerry Masters",
"content": "Yes. So we're taking all these actions so we don't do that, right? So -- and we are -- again, that we have to execute against that but we see ourselves being free cash flow positive through the year, and we don't have plans to do an equity raise."
},
{
"speaker": "Operator",
"content": "Our next question is from David Begleiter from Deutsche Bank."
},
{
"speaker": "David Begleiter",
"content": "Kent, on your realized lithium prices in Q4, what was the difference in spread between your spot sales and your contract sales?"
},
{
"speaker": "Jerry Masters",
"content": "So we don't normally report on the exact pricing and particularly on our contract piece. So I'm going to decline to respond to that."
},
{
"speaker": "David Begleiter",
"content": "Understood. I believe back in Q4, you were saying that roughly 10% to 12% of global lithium supply was shut down and curtailed due to lower prices. Is that still a good estimate? Or has it moved up since then?"
},
{
"speaker": "Jerry Masters",
"content": "Yes. So I think we were saying about 25%, we believe, is underwater. And we still think that's the case."
},
{
"speaker": "David Begleiter",
"content": "But how much is actually curtailed or shut down?"
},
{
"speaker": "Jerry Masters",
"content": "Yes. So probably about -- it's about half of that 25%, I would say. And I think that both those numbers still hold."
},
{
"speaker": "Operator",
"content": "Our next question is from Jeff Zekauskas from JPMorgan."
},
{
"speaker": "Jeffrey Zekauskas",
"content": "On Slide 7, where you provide different scenarios, is the meaning of this slide that you're -- if there were no change in lithium prices today, the energy storage adjusted EBITDA would be between $0.6 billion and $0.7 billion? Or because of your contract prices, it's more complicated than that?"
},
{
"speaker": "Neal Sheorey",
"content": "Jeff, this is Neal. I think my answer is probably going to be towards the latter part of how you described it that, look, the prices that you see at the top of that slide are observed market prices, not our price -- what our realized prices are but market prices. The numbers below that then is if you take those market prices and move that through our book of business, you get these kinds of EBITDA ranges."
},
{
"speaker": "Jeffrey Zekauskas",
"content": "Okay. Great. And then what you do on the right-hand column is you have some assumption, and you say we assume spodumene market pricing average is 10% of the LCE price. But aren't spodumene prices already below that? And you say you assume full Talison sales volumes. Are you currently receiving full Talison sales volumes? And what does that mean? What has to happen for you to receive full Talison sales volume?"
},
{
"speaker": "Neal Sheorey",
"content": "Yes, Jeff, let me take the second one. What we mean by full Talison sales volumes is that all the partners at Talison are taking their full allocation. That is the assumption that we've made. That hasn't always been the case if you go back over the years, but our assumption going forward is that's the case. As -- where I sit right now promptly is that is also the case right now. We're taking our full allocation in this environment. With regards to the spodumene average of 10% of LCE price, look, to your point, it has moved around over time, anywhere from -- in the 5% to 10% kind of range. So what we wanted to do was at least just put a mark in, in terms of how we've done these considerations, and we picked 10% because that was something that we sort of recently observed in 2024. But to your point, it can and it does shift around with the market dynamics."
},
{
"speaker": "Operator",
"content": "Our next question is from John Roberts at Mizuho."
},
{
"speaker": "John Ezekiel Roberts",
"content": "I believe IGO guided for essentially flat 2025 volume at Greenbushes. Can you confirm that? And then where is your growth, the 5% to 10% growth for 2025 coming from?"
},
{
"speaker": "Eric Norris",
"content": "John, it's Eric. That's correct. CGP2 was fully utilized, which was the last expansion at Talison in 2024. CGP2 does not come on until the very end of this year. So there is no growth capacity at Talison until that comes on. That's sort of the, as you know and appreciate the lumpy nature of bringing on capacity. Our 0% to 10% guidance on growth is all coming out of Chile, where the Salar yield project continues to ramp and drives debottlenecking effectively over the La Negra plant to march towards nameplate."
},
{
"speaker": "John Ezekiel Roberts",
"content": "And then on Slide 18, you're targeting sustaining CapEx of 4% to 6%. Is the percent of sales the right way to think about targeting sustaining CapEx given the volatility that you get in pricing?"
},
{
"speaker": "Jerry Masters",
"content": "Yes. So we -- that's the right point. So we -- and we say that on a stabilized market, right? So -- and it's aspirational at the moment for us because we're not there, but we're also at what we think is the bottom of the market. So it's a good benchmark. We say a mid-cycle pricing is where we go to that. We're not at that level today. We still have some work to do around that. But we're getting focused on it and we wanted to have a benchmark out there that we can aim at."
},
{
"speaker": "Operator",
"content": "Our next question is from Joel Jackson from BMO Capital Markets. ."
},
{
"speaker": "Joel Jackson",
"content": "I want to follow up a little bit on Ben's associate's prior question. So can you talk about what -- if you go to 2026, how much of the half of your sales here that are contracted floors? Do we expect the floors have to be negotiated? And how do you think about the balance sheet leverage if spot prices stick around where they are and we are renegotiating floors for 2026?"
},
{
"speaker": "Jerry Masters",
"content": "Yes. So look, we provided guidance for '25, not '26. But the way our contracts work is they don't -- and they don't usually end and then get renegotiated. They get adjusted over time as our customer wants something, we want something, they have adjusted. That's how they worked over time. And we expect that to happen. You see our portfolio of contracts has become a little bit more spot oriented in the recent past. That's because China is the biggest market. It's a spot market. It's growing. We've got new capacity coming on there with Meishan ramping. So that's really why that has shifted. Our contracts simply don't just come to an end. We negotiate terms somewhere along that and extend them out a year or two, and we've done that over time. And I suspect that's how it's going to play out going forward."
},
{
"speaker": "Joel Jackson",
"content": "Okay. And then talking about 0.25% -- in your estimates 0.25% of lithium supply is underwater, maybe half of that's curtailed. We just -- it seems like CATL is bringing back lepidolite production in the last bunch of weeks. There's some maybe some rational behavior going on, although those mines are downstream with cathode and the battery. So I mean it seems like there are actors in this industry that are maybe manipulating price, maybe don't have the same objectives as Albemarle and other public companies. I mean, how do you act in this market? And is there any hope for material recovery if such behavior by such actors continue?"
},
{
"speaker": "Jerry Masters",
"content": "Okay. So I don't know if I can comment on all of that. I would say that we're pretty focused on making sure we can compete at the bottom of the cycle. And so when you see us taking actions and have targeted at that. So the capital that we pulled back on our growth to reduce capital as a result of that, driving cost out of the business, getting more focused on cost, not as much on growth and making sure that we can compete at that cycle and then pivot when the market comes back to take advantage of more growth and higher prices. So that's the approach that we're taking."
},
{
"speaker": "Operator",
"content": "Our next question is from Vincent Andrews with Morgan Stanley."
},
{
"speaker": "Vincent Andrews",
"content": "I wanted to follow up on the $350 million customer prepayment. And just a clarifying question to start off with, which would be, I assume that's included when you talk about the 80% conversion as well as being free cash flow neutral this year. I assume you're including the $350 million. And all else equal then, does that mean next year cash flow would be $350 million less?"
},
{
"speaker": "Neal Sheorey",
"content": "So Vincent, on the -- this is Neal. On the first part of your question, you are correct. So the $350 million is included in our cash conversion number of 80% for 2025. And with regards to looking over to 2026, let me just give you maybe two things to think about here. You are correct that, that $350 million won't recur again in 2026. But also remember that there are a lot of other things from a cash standpoint that will actually start to benefit us in 2026 and beyond. One of the key ones that I'll point out is that from a Talison JV perspective, right now they're obviously going through a large investment program. That program is going to be done at the end of this year. So we would expect, even in this low environment, as you would expect, Talison is a very competitive asset. So we would expect a return to dividend payouts from the JV as we get into 2026."
},
{
"speaker": "Vincent Andrews",
"content": "And then just as a follow-up on your cash flow statement, for starters, thank you for the increased disclosure on working capital. But I have a reconciliation question. You have a new line item that says inventory net realizable value adjustment. And this year, it's a negative $500 million. Last year, it was a positive $604 million. So I'm just wondering, does that line reconcile somewhere else within cash flow from operations? Or what is that? Or any more detail you can provide would be helpful."
},
{
"speaker": "Neal Sheorey",
"content": "Yes. So that line, Vincent, is predominantly going to be a reflection of the lower of cost or market adjustment that we took in fourth quarter of 2023. And so that's why you see those adjustments, and so that's the best -- the most of that line is related to that."
},
{
"speaker": "Operator",
"content": "Our next question is from Aleksey Yefremov from KeyBanc."
},
{
"speaker": "Aleksey Yefremov",
"content": "If you look at your CapEx, you're talking about maintenance level. Assuming market prices don't change, can you get to that maintenance level in 2026? And would you be willing to do so under these conditions?"
},
{
"speaker": "Jerry Masters",
"content": "Yes. So I'm not going to make a commitment for capital for '26. But those are -- our aspirations is that we want to get to like maintenance capital at that particular level. So we still have in our capital opportunity -- growth opportunities, say, growth or cost saving opportunities, smaller investments. So the Qinzhou investment that we talked about on the call is a good example of that, low single-digit millions of dollars. We were able to shift from hydroxide to carbonate about 10,000 tons a year. So that -- and that's great return project and pretty low capital. So we continue to look for those. Those tend to be more focused on cost savings now and maybe incremental growth, like what we're doing at Qinzhou. But the 4% to 6% at mid-cycle, that's an aspiration that we work to, and we continue to focus to try and drive to that. Whether we get there in '26 or not, we've not laid out plans in that detail for '26, so I can't answer that."
},
{
"speaker": "Aleksey Yefremov",
"content": "And on CGP3, it's an important project for your cash flow this year and next year especially. Any comments on risk assessment for delays, cost overruns, that kind of thing? Like how is the project going from your point of view?"
},
{
"speaker": "Jerry Masters",
"content": "Yes. I think we're on schedule and around budget. I don't know exactly whether we're right on budget or not, but it's pretty close from a budget and a schedule perspective."
},
{
"speaker": "Operator",
"content": "Our next question is from Kevin McCarthy at Vertical Research Partners."
},
{
"speaker": "Kevin McCarthy",
"content": "Kent, you talked a little bit about the grid storage growth in your prepared remarks. Can you comment on your outlook for 2025 in that end market? And is your share in grid storage higher or lower or about the same as it is in your customers in the EV arena?"
},
{
"speaker": "Jerry Masters",
"content": "Yes. So the grid storage has been one that's been a positive surprise for us for a few years now as it's been growing. I think it was up almost 50% this year. And we anticipate that continuing to grow. And a couple of years ago, we probably would have thought lithium may not be the best solution for grid storage, but I think the way battery costs have come down and the popularity of LFP, it looks like grid storage is going to be lithium-based and LFP-based going forward. So it's a good opportunity. And it's on -- it's kind of, I think, everywhere. So the U.S. is starting to play out. You see that in Europe, and then China has been really strong around that. So it's a positive. It's a bright spot and it's offset a little bit of the little less growth that we saw in EVs and some of the shifts between plug-in hybrids and BEVs as well. So it's covered that and build in nicely."
},
{
"speaker": "Eric Norris",
"content": "And Kevin, as for the market share, first of all, it's largely an LFP market. So if you look at our share in LFP on EVs, PHEVs, et cetera, can be similar to our share in grid storage. It's the same companies. It's deepened back into the supply chain that are providing the cathode and battery materials into that. So that's what determines our share of those relationships, not necessarily the end markets."
},
{
"speaker": "Kevin McCarthy",
"content": "Understood. And then secondly, if I may, Kent, as the tariff regimes continue to evolve here. Are you managing the company any differently today than you were last year as it relates specifically to tariffs?"
},
{
"speaker": "Jerry Masters",
"content": "So are we managing the company differently? Look, we're paying very close attention to see what happened. It's evolving. I'm not sure, no one knows exactly what the final impact will be. But the direct impact on Albemarle is not going to be that significant. I mean, we're not -- we don't ship from China to the U.S., I mean, significantly. There is some, but it's not a big part of our business. It will impact our customers more than it will impact us directly. So the knock-on effect of us is some -- is what we're really paying attention to."
},
{
"speaker": "Operator",
"content": "Our next question is from Laurence Alexander from Jefferies."
},
{
"speaker": "Laurence Alexander",
"content": "So a couple of questions. First, on Energy Storage, how much of your capacity is under long-term contract compared to the EV market?"
},
{
"speaker": "Jerry Masters",
"content": "Laurence, I'm sorry, you said -- that was a fixed storage question?"
},
{
"speaker": "Laurence Alexander",
"content": "The Energy Storage side of your business, how much of that is under long-term contract? ."
},
{
"speaker": "Jerry Masters",
"content": "It's about 50%."
},
{
"speaker": "Eric Norris",
"content": "Yes, it's the same, Laurence. Yes, the other 50% -- we talked about 50% being under floor-based contracts. The 50% that's not is the pricing mechanism of spot in the contracts. It's a mix of contracts that are shorter in duration and spot."
},
{
"speaker": "Jerry Masters",
"content": "Okay. Sorry. Just to clarify there. So what we -- when we said the 50%, so those are long-term agreements, and we have floors on those agreements. There are some other longer-term agreements, we don't have floors. So we're now categorizing that in the same category as spot."
},
{
"speaker": "Laurence Alexander",
"content": "Okay. Perfect. For the $350 million of cash inflows, just to be clear, if -- would the net effect be that the EBITDA related to that would show up in 2026 or '27 but then the cash conversion suffers? Or is there also an EBITDA -- is there also an impact on the EBITDA bridge?"
},
{
"speaker": "Neal Sheorey",
"content": "Yes. Laurence, I think you're circling on kind of the right mechanism here. So we have taken the prepayment upfront and already received it here in the first quarter. You'll see that with our first quarter results. And then we satisfy our obligation through product deliveries over actually the next 5 years. So -- and that's at prices that are indexed to market. So you are right. We will then recognize EBITDA in increments as we make those deliveries, but it is over the course of the next 5 years."
},
{
"speaker": "Operator",
"content": "Our next question is from David Deckelbaum at TD Cowen."
},
{
"speaker": "David Deckelbaum",
"content": "I was hoping to follow up just on the plans at Qinzhou to convert some of the capacity to carbonate versus hydroxide, mainly just being is this decision really just to capture the discrepancy in margin? Or do you have very differentiated views now over time on just the appetite for hydroxide? Are you seeing customer resistance for hydroxide volumes in the market and then you're seeing this pivot as a necessity to sell product at this point? And are there further plans? Should we expect further plans to pursue more conversion from hydroxide to carbonate?"
},
{
"speaker": "Jerry Masters",
"content": "Yes. So look, it is -- I mean, the hydroxide, there's a market hydroxide, it's growing. Carbonate is growing faster. So there's a stronger demand for carbonate. And this was kind of a unique opportunity for us because the plant was designed in this way. And we had -- there's a few things we have to execute against to take advantage of that. It's very small capital, as I said before. It's low single-digit millions in order to make that shift. It gives us more flexibility in the market. The market is stronger around carbonate now, so we can take advantage of that. Over time, we can shift this back either way. Once we make this investment, we'll be able to go -- we could go back to hydroxide if we wanted to or stay on carbonate. At the moment, it makes more sense to be on carbonate. It's about the market and the fact that this was designed in upfront, and we had to kind of finish some work in order to leverage the capability."
},
{
"speaker": "David Deckelbaum",
"content": "If beyond sort of this year and the next you wanted to lean more heavily into carbonate, is there tolling capacity available in China that would enable you to do that? Or would that have to be a more significant investment on your part?"
},
{
"speaker": "Jerry Masters",
"content": "No, there's tolling capacity that's available and that -- we've taken advantage of that in the past, and it gives us flexibility in our supply chain. And then the growth you see from us in Chile as well at La Negra has allowed us to grow with that market, particularly around kind of on the back of the work at La Negra, but particularly Salar yield in the Salar."
},
{
"speaker": "Operator",
"content": "Our next question is from Benjamin Kallo with Baird."
},
{
"speaker": "Ben Kallo",
"content": "I wanted to follow up to an earlier question and maybe frame it just slightly different. There's capacity coming off-line, utilization going down and demand going up for EVs even at a slower rate than maybe we predicted a couple of years ago. At the same time, with all of that happening, which should indicate prices going up, prices have been coming down. So can you talk to anything to help us understand what that is and then anything that would change that? And then my follow-up question is, I do see a lot of reports around recycling in China. It seems like that's becoming a bigger industry there. I'm just wondering your thoughts around the impact of that on pricing as well."
},
{
"speaker": "Jerry Masters",
"content": "Yes. So there are a lot of moving pieces in your question, but also in the market, right? So it is -- I mean, there's capacity that has come off, higher cost capacity. There is new capacity that has come on. There's excess conversion that sits in China as well. And then the recycling part. I mean, recycling has been growing over time. We actually -- with prices come down, we've seen recycling drop off a little bit in China because it's just not economic given where prices are for new material. All of that is going to work its way -- has to work its way through the system. It's a dynamic market. It's hard to say. But I would anticipate higher cost assets coming out, particularly. We've got -- we're still growing. This market is still growing 20% plus, right? So it's just not quite as high growth rates as we had anticipated, but it is still growing significantly. And China is the main driver of that, but North America and Europe are kind of coming from there. So there's going to be growth in this market for a long period of time. Capacity comes on in chunks and you get an imbalance, prices are going to be down. I don't know if I can explain it more than that. It's a very opaque market and particularly because a lot of it happens in China, but it is -- it relies basically on the supply/demand."
},
{
"speaker": "Operator",
"content": "Our next question comes from Josh Spector with UBS."
},
{
"speaker": "Joshua Spector",
"content": "I wanted to just ask on the prepayment that you got. Is there any requirement there to make further investments or some preemptive expectation around CapEx spending? Or was that just something you decided to do given your needs for cash and the customer focus on volumes?"
},
{
"speaker": "Neal Sheorey",
"content": "Yes. Josh. No, there's no further requirement on our side. We have everything we need to be able to satisfy that contract. And I would just say the last part of what you said, I'd say it a little bit differently. We have discussions with customers all the time. We've done these kind of prepayments actually in the past, and this was just a unique opportunity that came across our desk. And it was one that we went after. So I think it's just a sign of how we work with our partners in many different ways."
},
{
"speaker": "Joshua Spector",
"content": "Understood. And I guess just to follow up on some prior questions, so specifically with the CATL restart, I've heard some mixed things around supply maybe being temporarily tighter versus their cost being more in line, I guess, closer to where the market prices have moved towards driving their restart. Do you guys have any view internally about why that's happening against the low price environment?"
},
{
"speaker": "Jerry Masters",
"content": "No. Look, I would say, I mean, look, we'd modeled more lepidolite coming in. So we weren't exactly targeting this particular asset, be the one that came back on. But we had lepidolite volume. China it's a strong market. It's growing. They're short of resource, not surprising. They're trying to get more domestic resource. So I think it's -- I think it's no more complicated than that."
},
{
"speaker": "Operator",
"content": "Our last question comes from Andres Castanos from Berenberg."
},
{
"speaker": "Andres Castanos-Mollor",
"content": "Of the 2025 lithium volumes, how much of it would be spodumene sales and how much would be lithium salts sales? Are there any significant tolling volumes left?"
},
{
"speaker": "Jerry Masters",
"content": "So I don't have that split, but it's mostly salt, right? There's -- the spodumene sales that we do are really more for transparency in the market, understanding that. We do sell some of that, other than we've shifted a little bit from a prepaid perspective. There's spodumene in that. There's not a lot of that in '25."
},
{
"speaker": "Eric Norris",
"content": "Yes. It's under 10%, 15% of total LCEs this year roughly in that order of magnitude. It's basically the production coming out of Wodgina."
},
{
"speaker": "Operator",
"content": "Thank you. That's all the time we have for questions. I will now pass it back to Kent Masters for closing remarks."
},
{
"speaker": "Jerry Masters",
"content": "Okay. Thank you, operator. In conclusion, Albemarle's strong operational execution and strategic framework have positioned us to successfully navigate dynamic market conditions and maintain our long-term competitive edge. We are dedicated to delivering value for our stakeholders and driving sustainable growth. Thank you for joining us today, and we look forward to continuing on our journey together. Stay safe and take care."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. Thank you for your participation. You may now disconnect. ."
}
] |
alb | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Hello, and welcome to the Albemarle Corporation's Q3 2024 earnings call. We ask that you please hold all questions until the completion of the formal remarks, at which time you will be given instructions for the question and answer session. Also, as a reminder, this conference is being recorded today. I will now turn the call over to Meredith Bandy, Vice President of Investor Relations and Sustainability."
},
{
"speaker": "Meredith Bandy",
"content": "Thank you, and welcome everyone to Albemarle's third quarter 2024 earnings conference call. Our earnings were released after the market yesterday, and you will find the press release and earnings presentation posted to our website under the investor section at Albemarle.com. Joining me on the call today are Kent Masters, Chief Executive Officer, and Neal Sheorey, Chief Financial Officer. Netha Johnson, Chief Operations Officer, and Eric Norris, Chief Commercial Officer, are also available for Q&A. As a reminder, some of the statements made during this call, including our outlook, guidance, expected company performance, and strategic initiatives, may constitute forward-looking statements. Please note the cautionary language about forward-looking statements contained in our press release and earnings presentation, which also applies to this call. Please also note that some of our comments today refer to non-GAAP financial measures. Reconciliations can be found in our earnings material. And now I will turn the call over to Kent."
},
{
"speaker": "Kent Masters",
"content": "Thank you, Meredith. During the third quarter, Albemarle continued to demonstrate solid operational execution, delivering volumetric growth in energy storage and specialties, year-over-year EBITDA growth in specialties and kitchen, strong operating cash conversion of over 100%, and leverage metrics well below our covenant limits. We also continued to progress our cost improvement plans, further ramp our new facilities, and deliver higher volumes. As a result, we are maintaining our full-year 2024 corporate outlook considerations. In a few moments, Neal will give more detail on our third quarter performance, key results, and actions we are taking to preserve our financial flexibility. My focus today will be on addressing the outcomes that we are now driving as a result of the comprehensive cost and operating structure review we progressed over the past few months. In conjunction with this review, we are implementing a new operating structure, transitioning to a fully integrated functional model designed to deliver significant cost savings and maintain long-term competitiveness. We are targeting $300 to $400 million of further cost and productivity improvements by eliminating redundancies, reducing management layers, and optimizing manufacturing costs. These savings are due in part to the difficult but necessary decision to reduce our global workforce by an additional 6% to 7%. In total, we have eliminated nearly 1,000 roles, including all the actions announced this year. We also are now driving a year-over-year reduction in our full-year 2025 capital expenditures by at least $800 million or about 50%, with a disciplined focus on critical health, safety, environmental, and site maintenance and a phased approach to maintaining our world-class resource base. We are confident these actions are the right steps to adapt to market conditions while serving our customers and pursuing long-term value creation. I will have more to say about our cost-out and productivity plans later on the call. I will now hand it over to Neal to discuss our financial results during the quarter."
},
{
"speaker": "Neal Sheorey",
"content": "Thanks, Kent, and good morning, everyone. Beginning on slide five, I will summarize our third quarter performance. We recorded net sales of $1.4 billion compared to $2.3 billion in the prior year quarter, a decline of 41% driven principally by lower pricing, particularly for lithium. During the quarter, we recorded a loss attributable to Albemarle of $1.1 billion and a diluted loss per share of $9.45. Adjusted diluted loss per share was $1.55. Our GAAP result included a pretax charge of $861 million related to capital project asset write-offs at Kemerton 3, and putting Cameron 2 into care and maintenance, of which about 10% is cash outflow in the second half of the year. This charge was below our initial estimate that we provided on the last earnings call of $900 million to $1.1 billion. Turning to Slide six, our third quarter adjusted EBITDA of $211 million was lower than the prior year period, also primarily due to lower lithium pricing. This was partially offset by lower cost of goods sold primarily related to reduced spodumene pricing. Other positives include higher volumes in energy storage related to delivery of our growth projects, and in specialties related to stronger end market demand. Our cost and efficiency initiatives also provided productivity which more than offset inflation. Looking at adjusted EBITDA by operating segment, we saw improved year-over-year profitability in specialties, due to productivity improvements and better end market demand. Catch in EBITDA also improved year-over-year as we continue to execute our turnaround plan during the quarter. Moving to slide seven, as Kent mentioned, we are maintaining our full-year 2024 outlook considerations thanks to the execution of cost and productivity improvements, continued strong volume growth, including higher sales volumes at Artalison JV, and contract performance in energy storage. As a reminder, these scenarios are based on historically observed lithium market pricing, and represent a blend of relevant market prices including both China and ex-China pricing, for lithium carbonate, and lithium hydroxide. Turning to slide eight for additional commentary on outlook, we expect corporate full-year 2024 net sales to be near the lower end of the $12 to $15 per kilogram scenario primarily due to weaker second-half pricing for lithium, offset by contract performance. Full-year 2024 adjusted EBITDA is expected to be in the middle of that same scenario range thanks to successful cost-cutting and productivity improvements. In energy storage, we now expect full-year volume growth to be more than 20% year-over-year, as we have continued to benefit from solid demand particularly in China, and ongoing ramps of our new facilities. Fourth-quarter volumes are expected to be down sequentially primarily due to timing of spodumene sales volumes, reduced tolling, and planned outages. Margins are expected to be slightly higher sequentially as the benefit of lower-priced spodumene in cost of goods sold offsets the impact of unabsorbed fixed costs as our new plants continue to ramp. At both specialties and kitchen, we continue to expect modest sequential improvements in the fourth quarter, thanks to better end market conditions and productivity benefits. Please refer to our appendix slides in the deck for additional modeling considerations across the enterprise. Moving to our balance sheet and liquidity metrics on slide nine, we ended the third quarter with available liquidity of $3.4 billion, including $1.7 billion of cash and cash equivalents and the full $1.5 billion available under our revolver. Actions we have taken to improve our cost structure and enhance operational efficiency have also provided enhanced financial flexibility. Thanks to our successful actions to reduce costs and optimize cash flow, we ended Q3 with net debt to adjusted EBITDA of 3.5 times, or two turns below the covenant limit in the quarter. To navigate market conditions, we took proactive measures in the quarter around our covenant waiver. The outcome of our action is shown on slide ten. In October, we proactively extended our covenant waiver through the third quarter of 2026 and reshaped it to ensure we have the financial flexibility needed as we execute our new operating structure and cost reduction actions. Moving forward, our goal remains to stay well within these limits through solid financial and operational execution, as we have shown throughout 2024. Slide eleven highlights our execution focus which is demonstrated by the continued improvement in our operating cash flow as a result of operational discipline and cash management actions. Our operating cash flow conversion defined as operating cash flow as a percent of adjusted EBITDA, was greater than 100% in the third quarter, primarily due to timing and management of working capital. We continue to expect full-year operating cash conversion to be approximately 50%, at the higher end of our historical range and above our expectations at the beginning of the year. This is driven by increased Talisin dividends with higher sales volumes at green bushes, and working capital improvements, including a significant focus on inventory and cash management across our operations. This means that we expect fourth-quarter cash conversion to be lower than recent quarters due in part to cash outflows associated with the workforce reductions we announced today as well as the timing of JV dividends. As a reminder, we account for our 49% interest in the Taliesin JV via the Equity method. Therefore, the impact to cash flows is in dividends received. As we have said before, we expect dividends to be lower than normal year, and into 2025 as Taliesin completes the CGP3 capital project at the Greenbushes mine. I'm pleased to see that our efforts to improve operating cash flow conversion are yielding results. We will continue driving toward free cash flow breakeven through our ongoing ramp of new capacity, inventory management, bidding events, cost out and productivity measures, and other cash conversion improvements. Turning to slide twelve, we will provide a few comments on current lithium market conditions, which have shown some positive signs. On the supply side, there have been several announced upstream and downstream curtailments. Non-integrated hard rock conversion is unprofitable, and larger integrated producers are under pressure. We estimate that at least 25% of the global resource cost curve is unprofitable or operating at a loss. On the demand side, grid storage demand continues to surprise to the upside, up 36% year-to-date led by installations in the US and China. Global electric vehicle registrations are up 23% year-to-date, led by China, and demand growth in the United States is also up double digits. Slide thirteen breaks down global EV demand growth by region. China represents 60% of the overall EV market with continued strong year-to-date demand growth of more than 30% in line to slightly ahead of initial expectations. In terms of demand mix, we have seen stronger growth in plug-in hybrid sales in China, as current subsidies are more balanced between battery EVs and plug-in hybrids. Chinese plug-in hybrids include range-extended vehicles with battery sizes somewhere between traditional battery EVs and plug-in hybrids. Meanwhile, the softest demand region globally is Europe, where EV sales growth is down slightly year-to-date due to reduced subsidies and weaker economic conditions. Potential price cuts and the drive toward EU emission targets represent rebound opportunities in 2025. North American sales are up 13% year-to-date, far stronger than suggested by recent headlines. US EV sales trends have strengthened in the back half of the year benefiting from increased model availability, and affordability. Looking further out on slide fourteen, longer term, we continue to expect lithium demand growth to expand by 2.5 times from 2024 to 2030. The global energy transition remains well underway, supported by consumer preferences, government policies, and technological advancements. From an affordability perspective, the global EV supply chain is on track to achieve the critical $100 per kilowatt hour tipping point, where EVs are at purchase price parity with ICE vehicles. The Chinese industry has likely surpassed that target with the rest of the world not far behind. Overall, these trends continue to reinforce our belief in the long-term growth potential of the industry. With that, I will now hand it back to Kent."
},
{
"speaker": "Kent Masters",
"content": "Thanks, Neal. Turning to slide fifteen, I will cover the significant yet necessary actions we are taking to re-baseline our cost structure while allowing us to maintain our leadership position and preserve future growth. Let me start with our new operating structure on slide sixteen. Over the past several months, we have evaluated multiple models, balancing cost with an agile go-to-market approach. Following this review, we announced a new operating structure transitioning to a fully integrated functional model to deliver significant cost savings and maintain our long-term competitiveness. This slide shows our leadership team with several title and role changes to reflect our new structure. From a financial reporting perspective, we will continue to report across our three segments of energy storage, specialties, and kitchen. Our fully integrated organizational structure is designed to flex with the complexities of our markets and to strengthen our core capabilities in a cost-effective way to maintain our leadership position. Turning to slide seventeen, it's important to put our latest actions in context of the series of self-help steps we have been progressing for several months as we navigate the current business environment. Albemarle continues to act urgently across four key areas: optimizing our conversion network, improving cost and efficiency, reducing capital expenditures, and enhancing financial flexibility. Our actions are broad-based and designed to maintain our long-term competitive advantage in light of market conditions. And given the dynamic environment we continue to face, we are always adding to our list of potential actions so that we are ready to pivot as necessary. I'm confident in the team's ability to deliver these improvements based on our performance to date. We highlight that on slide eighteen. Here is a summary of our progress on the cost savings and cash flow initiatives introduced in January and July of this year, as well as the additional actions we are announcing today. All these programs are in execution, and the January and July actions are on track or ahead of plan, demonstrating our sharp focus on operational efficiency and proven ability to execute. Regarding the $300 million to $400 million of cost improvements we announced today, we expect to achieve a $40 million to $50 million run rate by the end of this year. Additionally, we plan to reduce our 2025 CapEx to between $800 million and $900 million, down about 50% versus 2024. How we got to these cost-out and CapEx targets was through rigorous analytics that involved a combination of robust peer benchmarking and bottoms-up project planning to estimate target savings. Over the quarter, we analyzed spend across three categories: non-manufacturing costs, specifically SG&A and R&D, manufacturing cost, and capital expenditures. Our levers to deliver the non-manufacturing and manufacturing cost and productivity savings are detailed on slide nineteen. Our total cost-out opportunity of $300 million to $400 million includes approximately $150 million in manufacturing opportunity split between cost reductions, like energy and maintenance efficiencies, and increased volume through plant ramps, yield improvements, and other areas. The $150 million to $250 million of non-manufacturing cost improvement follows a robust benchmarking review with the assistance of a third-party consultant. We evaluated and analyzed our non-manufacturing cost structure against like-sized peers in lithium and other related industries like specialty chemicals and mining. The biggest driver of these non-manufacturing savings is the change to our operating structure. The integrated model we made effective November first allows us to consolidate activities and reduce duplicative work, optimizing management layers, and increasing efficiency. Other key drivers include shifting more activities to established hubs and low-cost jurisdictions and leveraging technology to reduce manual work. We will continue to internally track our actions and progress through an established program management office, which will be laser-focused on these initiatives and leveraging our ability to execute. Slide twenty breaks down the third leg of our work, which is the reduction of our 2025 capital expenditures by more than $800 million versus 2024. Overall, we are targeting sustaining CapEx of 4% to 6% of net sales, in line with historical performance and specialty chemical averages. Though we have pulled down our spending, we will continue to invest in critical health, safety, environmental, and site maintenance projects. Through our disciplined capital allocation, we will maintain our industry-leading resource base at a phased manner. Additional growth capital will be limited to primarily high-return brownfield expansions and productivity improvements. Moving to slide twenty-one, the actions we are taking are designed to maintain Albemarle's significant competitive advantages and position us for long-term value creation, which is encapsulated by our strategic framework shown on slide twenty-three. Our strategy is unchanged but as always, we will adjust our execution to pivot and pace with the dynamic markets we serve. Our strategic framework continues to guide how we operate Albemarle as we lead the world in transforming essential resources into critical ingredients. The resources we provide play a critical role in areas where a compelling long-term growth profile. And we have competitive strengths that will allow us to navigate the environment highlighted in more detail on slide twenty-three. First, our world-class resources are arguably the best in the industry, with large-scale, high-grade, and therefore low-cost assets. In energy storage, we have access to some of the highest-grade resources in both Hard Rock in Australia and brine in Chile. Similarly, in specialties, we are the only producer with access to both tier-one bromine resources globally in Jordan and the United States. Second, our leading process chemistry know-how is key to achieving further productivity and cost improvements, safely and sustainably. At both the Salar and Magnolia, we have evaluated a wide range of direct lithium extraction options and are piloting solutions. Third, we have a pipeline of high-impact innovative in both bromine and lithium. Our research testing, and piloting facilities in North Carolina, Louisiana, and Germany allow us to participate in differentiated high-margin segments and support our customer-specific requirements. Fourth, Albemarle's leading industry position as a partner of choice is demonstrated through our partnerships with iconic pioneering companies. Both our businesses have high net promoter scores with significantly positive gaps relative to competitors, reflecting long-standing successful relationships with major customers. And we are increasingly recognized for the good work we do and the good that our work is doing. For example, we were recently named as one of the world's best companies by Time, demonstrating our commitment to creating a more resilient world and advancing the sustainability objectives of our customers. In summary, on slide twenty-four, Albemarle delivered another solid performance in the third quarter, including higher volumes in energy storage and specialties, and year-over-year improvements and adjusted EBITDA for specialties and kitchen. We've maintained our full-year 2024 outlook considerations thanks in part to enterprise-wide cost improvements, strong energy storage project ramps, and contract performance. We are focused on taking broad-based proactive steps to control what we can control and ensure we are competitive across the cycle. Albemarle remains a global leader with a world-class portfolio and vertical integration strength. I am confident we are taking the right actions to maintain our competitive position and to capitalize on the incredible long-term opportunity in our markets. I look forward to seeing some of you face-to-face at upcoming events listed here on slide twenty-five. And with that, I'd like to turn the call back over to the operator to begin the Q&A portion."
},
{
"speaker": "Operator",
"content": "We will now move to our Q&A portion. If you would like to ask a question, please press star five to raise your hand. Our first question is from Aleksey Yefremov from KeyBanc. Aleksey, your line is open."
},
{
"speaker": "Kent Masters",
"content": "Thanks. Good morning."
},
{
"speaker": "Neal Sheorey",
"content": "Was lower fixed cost next year and some volume growth, can you keep your EBITDA at least flat if prices do not change? Or do you expect an increase or decline? So I okay. So that's a 2025 question as we go into a total and to be clear, we are not we are not gonna give an outlook for 2025 on this, but we can give you some kind of puts and takes off 2024. Neil, you wanna take that."
},
{
"speaker": "Neal Sheorey",
"content": "Yeah. Sure. Good morning, Alexei. So, yeah, just a we're we're obviously working through our 2025 outlook right now, so it's a little premature for for us to talk about that. We'll talk about that on the next earnings call. But just to give you a couple of puts and takes here, so obviously, where pricing is today, that's something something that you can observe and and relative to the lower end of our guidance range today, we're probably 20% to 25% market pricing is below the average that we have achieved in in 2024. And so you can kinda build that if you if you assume today's prices kinda roll into next for in terms of a headwind for pricing. I'd also point you to all remember that in Q2, we had a bump up in our equity earnings from the Taliesin JV because we had an unusually high offtake by our partner at the JV and so we had about a $100 million uplift in the second quarter, and I do not expect that to repeat in 2025 as well. Now on the opposite side of that, is, as you mentioned, our fixed cost, we you should expect our fixed costs are gonna come down. We've, had the actions that we've announced today, the $300 to $400 million of cost and productivity action. We expect at the end of this year that we'll be at that 40% to 50% run rate. So that is savings that you can start to build into 2025 and, of course, we'll continue to build on those savings as we go through the through the year. And then, of course, we're also still ramping our our plants. Especially in the lithium business. And so you should you should expect that our fixed assets are are gonna continue to ramp as we go through 2025. So just a few puts and takes to think about things as you go through through 2025."
},
{
"speaker": "Kent Masters",
"content": "And, Neil, I I need to follow-up on the on on the last point, you you cut your CapEx for 2025. How how is it affecting your your volumes next year? And and if you can provide any comments about volume growth right here in lithium."
},
{
"speaker": "Neal Sheorey",
"content": "Yes. I do not I mean, the CapEx cuts were doing now won't impact volume our forecast for volume for next year. Those are it's adds further out and then us getting just tighter. On our CapEx program. So we're we're still we look at I think we previously talked about 20% growth through 2027. Some of the CapEx cuts we've done in taking some volume out, that's probably 15% CAGR through 2027. So that it's a little bit but it's longer term. It's not so much in 2025. Yeah. And, Alexei, maybe just to to pile on to that. The growth that I'm talking about for 2025 is is obviously driven by assets that are already built and and continuing to ramp. So, like, the Salar yield improvement project, Maishan in China, and will continue to ramp in 2025."
},
{
"speaker": "Operator",
"content": "Our next question is from John Roberts with Mizuho. John, your line is open."
},
{
"speaker": "John Roberts",
"content": "Thank you. On slide eight in that fourth quarter improved margin guidance for energy storage, what are you assuming for Talos and equity income in the fourth quarter? And what's the Talis and CapEx for 2024 and 2025?"
},
{
"speaker": "Neal Sheorey",
"content": "Yeah. So, John, this is Neil again. So when you think about equity income for next quarter, I think your assumption should be I mean, basically, spod pricing has been pretty flattish if you look at third quarter into into fourth quarter. So I think you should think about something kind of similar to what we've experienced in the in the third quarter, all things being equal. And then I think the second part of your question can you repeat that again? The budget for 2025 yet? And what what you think their 2024 CapEx comes in at? Yeah. So it it it is definitely premature for me to talk about the CapEx budget for 2025. For sure, there is capital that the JV continues to need to spend with regards to the CGP3 asset. That's an asset that will continue to be built. It will be finished up in 2025, and we expect it to be actually starting up as we get towards the end of 2025. But, John, we're literally working through the talisman budget with the JV and with the partners right now. So it's a little premature speak to that. We should have more to say okay. On the next earnings call. And what did you have to agree to or pay order to get the revised financial covenants?"
},
{
"speaker": "John Roberts",
"content": "Yeah."
},
{
"speaker": "Neal Sheorey",
"content": "John, I won't I won't give you the exact number, but it was it was a very small amount. You should think about it being far less than a million dollars."
},
{
"speaker": "Operator",
"content": "Our next question is from David Deckelbaum with Cowen. David, your line is open."
},
{
"speaker": "David Deckelbaum",
"content": "Thanks for your time this morning. I was curious. You've received some questions on the impact of the CapEx cuts on your long-term growth profile. The reduction of that $800 to $900 million as you go through this strategic review, is that where we should think of approximately maintenance capital or as we get into 2026 and beyond, could we see numbers, you know, quite a bit below those levels?"
},
{
"speaker": "Kent Masters",
"content": "Yeah. So we're look, we're getting we're we're tightening down on maintenance capital, and we're targeting a range of 4% to 6% of revenue at some at a normalized level. So you'll see it's a little bit above that this year because we think pricing is below a normalized level. So we're a little above that, but we're also working working to tighten that up. And then you see growth capital in there for high return projects, productivity type projects, brownfield type expansions, which are high return and quick payback. So that's kinda how what we've got built into that that $800 to $900 million. And look, we'll continue to work on that. It depends on the opportunities that that we have, but we'll we'll continue to focus. But we're from a maintenance capital standpoint, we're trying to be in that range of 4% to 6% on a normalized basis. And we're we're a little ahead of that for this year. Or for next year. Sorry. Appreciate that."
},
{
"speaker": "David Deckelbaum",
"content": "Yep."
},
{
"speaker": "Kent Masters",
"content": "And then, you know, just continuing with just the theme of of cash. Preservation, what's what's the outlook for the next several quarters in terms of of cash conversion? Obviously, this quarter, there was some working capital management that really helped that conversion and and and helped kind of fortify the balance sheet. So I'm curious how you think about you know, the the next the next several quarters ahead of us here."
},
{
"speaker": "Kent Masters",
"content": "Yeah. So Neil can give us some specifics on that. But but we're we're we're very focused on it. Some of our key metrics around that is is cash conversion. So up cash flow, everything around that, but a key management metric that that we're focused on is cash conversion. You saw a big number this quarter. We obviously can't we can't repeat that, so it it will come off that. We're we're above historic levels that oh, where we've operated historically, but we're focused on driving that conversion number up. Neil, do you wanna make any specific comment?"
},
{
"speaker": "Neal Sheorey",
"content": "Yeah. Just to just to add to that, Ken. So absolutely, I'll double down on what Kent said that we obviously have a very strong focus internally on cash generation, cash conversion, and driving to that free cash flow breakeven point in the future. And we're continuing every quarter to work on this. Several things that we're we've got in flight is obviously working capital management is is very much front and center. We have the cost and productivity that we are already doing, but obviously, today, we've announced even more that we're doing, and so we continue to drive on that. The the other piece that will be very important for our overall cash flow generation is how we think about the dividends coming off of the Taliesin joint venture. One of the reasons that we mentioned in the deck that our our cash conversion is going to be lower in the fourth quarter is that at the moment, we see those those dividends from the Talison joint venture in the fourth quarter coming down. They're right now, our assumption is they'll be zero. But obviously, as we get into 2025 and as we work through things with the JV, it will be very important to as we think through the dividends that that JV can can throw back to the partner."
},
{
"speaker": "Operator",
"content": "Our next question is from Ben Isaacson with Scotia Capital. Ben, your line is open."
},
{
"speaker": "Ben Isaacson",
"content": "Good morning. This is Apurva on for Ben. So my question for you is that so you've discussed your leverage covenant providing substantial offer. We thought kind of two x spread in Q3. Is there any color that you can provide on the shape of those limits as they evolve through to 2026? Moving specifically at Q2 and Q3 2025 where that lever the covenant limit rises to kind of 5.75 times. So any color there?"
},
{
"speaker": "Neal Sheorey",
"content": "Yeah. Perva. So, you know, essentially, the the shaping of that covenant waiver sort of follows recall that our covenant waiver is calculated on a trailing twelve month EBITDA. And so you can imagine that we've kind of shaped this based on how we look backwards at the the the shape of the EBITDA that we've generated so far in in 2024 as well. So that's really how we we've thought through how the trailing twelve months might look like as we go forward and then shape covenant waiver accordingly."
},
{
"speaker": "Ben Isaacson",
"content": "Perfect. Thank you."
},
{
"speaker": "Operator",
"content": "Our next question is from Steve Byrne with Bank of America. Steve, your line is open."
},
{
"speaker": "Steve Byrne",
"content": "Hi. I'm Rob Hoffman on for Steven. In 3Q, realized pricing energy storage has seemingly come in at a lower premium relative to the lithium market price versus prior quarters. Was there any meaningful shift in the percent of contract price with one quarter lags and pricing floors? And what percent of the two-thirds contractors figure has pricing for us?"
},
{
"speaker": "Kent Masters",
"content": "Yeah. So I don't there's there's real no change in the contracts that that rolled off during the quarter. So that I'm not sure. So that that is a little different than the way that I think about it. But the contracts really, they they haven't changed. So it's the mix of where those customers are and where that volume gets taken is is how your average moves. Price."
},
{
"speaker": "Steve Byrne",
"content": "And and we're I don't think we're gonna say anything more than we have said before about the contracts and the floors that we have. So we've got contract volume on about two-thirds of it. And some have floors and ceilings and and others don't. But not gonna but it hasn't changed."
},
{
"speaker": "Rob Hoffman",
"content": "I could just ask. This is Eric that that that during during the quarter, we did see our highest volumes that we'll see any quarter. This to date and be hired in the fourth quarter as well. A lot of that was due to the timing of spot sales and spodumene sales. Which would buy us a mix and in a quarter and and has. So, I mean, I think I think you're noting something that is that is is on target that there's a mix effect there. That's not a reflection of contract that I would wash out on a full year basis and we can guidance. Makes sense. And then just a follow-up, given a look lower pricing being sustained, might you consider cutting operating rates to tighten the market rather than the aforementioned guided 15% year term catered growth and volume."
},
{
"speaker": "Kent Masters",
"content": "So we we look at everything. It's probably it's less a little bit about tightening the market, but where it makes sense for us to what our customer demand is, what we see volumes growing to and the mix about where we produce most cost-effectively. So but but we we look we're looking at everything. Including operating rates at plants, but it it's really more about the mix of our customers, the demand growth, than it is about thinking about tightening the market."
},
{
"speaker": "Operator",
"content": "Our next question is from Vincent Andrews with Morgan Stanley. Vincent, your line is open."
},
{
"speaker": "Vincent Andrews",
"content": "Thank you, and and good morning. Neil, can I ask you on the $300 to $400 million, you know, 40% to 50% run rate by the end of this year? What then you know, gives you such a wide range for I guess, you're gonna finish all off by the end of year. But what would make it $300 and what would make it $400?"
},
{
"speaker": "Kent Masters",
"content": "I think that's I mean, it's just it's a range that we're giving and some of the things that we're working through around that. So it's not all completely detailed out. So and, that that dime there's a dynamic of around that. As we go. Some of it is around overhead, some of it's around operating cost, productivity improvements, and things that we're doing at plant. So there there's a range to give us a little bit of breathing room because we're the lower end would be fairly conservative, and the upper end would be a bit of a stretch. I don't think it's any more sophisticated than that."
},
{
"speaker": "Vincent Andrews",
"content": "Fair enough. You can't if I could ask you, know, as we as we look ahead, we're obviously at the bottom of the cycle. Let's let's assume the cycle turns. Let's assume prices go back and I'll make up a number $25,000 a ton. You know, and you clean up your balance sheet issues. What what is Albemarle's strategy in gonna be? Is it just gonna be a reversion to what you were doing prior to last down cycle where you wanna get back into conversion and you wanna go out by resources? Or you're gonna do something different, or are there things you're not gonna do? You know, how are you how are you and how's the board thinking about, you know, sort of the where the company wants to be strategically going forward?"
},
{
"speaker": "Kent Masters",
"content": "Yeah. So we've said I actually said our prepared remarks that our strategy has not changed but the way we're executing against it has. So if we so when when we'll react to the market. So prices come back, to be honest, I think we're gonna be a little conservative to make sure that they are gonna stay there. Before we shift our our plans around that. So we'll be we'll be we wanna make sure if they move up, that they're gonna stay up and we're just not in another cycle. And I think right now, we're focused on making sure that we put the cost structure in place to compete through the bottom of the cycle and we'll be able to we're trying to create the flexibility to pivot up if the market returns, but we're gonna be a little conservative to make sure it really changed and we're just not in a cycle."
},
{
"speaker": "Operator",
"content": "Our next question is with Kevin McCarthy from Vertical Research Partners. Kevin, your line is open."
},
{
"speaker": "Kevin McCarthy",
"content": "Hi. This is Matt Hower on for Kevin McCarthy. During your cost structure review, what new processes did you learn from benchmarking lithium peers? And how do you plan to implement those at Albermaril? On slide nineteen, it looks like there's a gap between the current non-manufacturing costs."
},
{
"speaker": "Kent Masters",
"content": "Yeah. Albemarle."
},
{
"speaker": "Matt Hower",
"content": "And out of your meeting peer group? What did you identify as the source of that difference?"
},
{
"speaker": "Kent Masters",
"content": "So on the benchmarking, I'll take that. Sorry. We got a phone going off in the room. So I on the benchmark, I'm not sure we learn any new processes from benchmarking our peers, but it's more about a the cost the cost of overhead where people were operating and not it's less about lithium peers than it was just about broad corporate cost structure. With people that have a footprint that looks a bit like ours, very global, with heavy manufacturing those type of pieces. So I'm not sure we picked up any big process changes that we learned from our lithium peers. I I think it's just more about the the aspiration we took from a cost-saving standpoint based on what we saw other corporates doing. And maybe this is Neil. Just to just to add to a couple of things. Look, as an organization standpoint, we were obviously for for growth historically and now in this new environment, we're we're moving to more of a co cost-focused organization. Time and again, that that model that works is the functional model that we announced. And so I think one of the key things that we saw is that there are ways to achieve what you need to from a a strict functional model standpoint. So that's one of the the key things as we functionalize the company. There are naturally gonna be cost and simplification opportunities. And then the other thing I'll I'll point out too is that we have two up and running and and very well very well running back offices and those are areas that we can use much more efficiently especially in functionalized model as well. So those are just a couple of examples. You see them on on slide, I think it's nineteen as well. But those are really some of the core areas where we are finding cost-out opportunities."
},
{
"speaker": "Matt Hower",
"content": "Thanks. And then could you comment on some of the recent supply curtailments that you've seen? There been any significant downward movement in lipidolite supply out of China or Africa? And given that, you know, you estimate 25% of the supply curve to be unprofitable, why do you think it's taken so long to see a a significant downward momentum in supply?"
},
{
"speaker": "Eric Norris",
"content": "Yes. Good morning. This is this is Eric. So speaking on lapelite, it was announced during the quarter and we've we've since been able to get corroboration although it's it isn't always clear in China, but that but the lopetalite one of the largest lopetalites suppliers had gone down into care and maintenance, taking some capacity offline, but there's still a pet light in the market. It's obviously, that's all in China. We've also seen continued growth in supply coming that's replacing that serving that growing China market coming out of Africa. We've seen a lot of the shutdowns have been some of the or modulations in some cases, has been out of the western Australian? Sites and some delays on some of the the the Brian projects that were more either Greenfield or significant brownfield expenses have been pushed out. I'm we could get in more detail, but that's a that's a quick summary. As to why more has not come out, it's it it is a little little puzzling. It is a fragmented market. It is a market with significant Chinese presence today. And it's it's a market where you have a lot of young companies whose sole reason for for existing is to to raise a lithium project. They may have cash on their balance sheets, and as long as they can continue to operate, they will do so. They don't have alternative. So I think it's the maturity, maybe one way putting up this market is such it's gonna take a little longer and that is reflected in our lower for longer view on pricing potentially, which is driving us our need to be competitive for the cost the cycle that that and then all these actions that we have talked about taking today."
},
{
"speaker": "Operator",
"content": "Our next question is from Joel Jackson from BMO Capital Markets. Joel, your line is open."
},
{
"speaker": "Joel Jackson",
"content": "Hi. Good morning, everyone. Just following up on that for my first question. Don't you think that more supply needs to come out of the market, like real supply? Not some projects three years from now, but real spodgy, I mean, real hard rock, real brine out of the market now. To get prices going, or what do you think needs to happen to get prices to recover? And it seems like it can't just be demand. It's gotta be supply at this point. Would you agree?"
},
{
"speaker": "Kent Masters",
"content": "Well, I think it's both. Right? So we we we do think more supply needs to come out, and then these and these prices persist as it will come out. It's a matter of how long it takes. And then and demand is still pretty strong. Right? It's over 20%. It's it's buck we've it it's been ticked up a little bit by some of the fixed storage volumes. That that in the last few quarters. A little stronger than we had anticipated, but it it is both. It's both demand and supply, and we we do we need more supply to come out, and we expect it to work at prices at these levels."
},
{
"speaker": "Joel Jackson",
"content": "There have been a lot of stories in the media the last few months about Altima maybe looking at the massive sales whether it be your stake in Greenbushes or or Talosin, which I think you refuted publicly or had a retraction in the media, got a retraction made from that report in the media, but also maybe speculation you'd be considering selling your stake in Wajna you just generally talk about if you're looking at any asset sale."
},
{
"speaker": "Kent Masters",
"content": "But we're always looking at from a port so Ketchum is an example of that that we talked about that and said that's a non-core asset that we look to sell. But Greenbush is something we are not when we're not we wouldn't speculate on rumors around that, but and we but we did clarify green bushes do not something we're thinking about selling."
},
{
"speaker": "Operator",
"content": "Our next question is from Michael Sison from Wells Fargo. Michael, your line is now open."
},
{
"speaker": "Abigail",
"content": "Hi there. This is Abigail on for Mike. Just wanted to ask about the status of Kings Mountain, if there's any update in terms of cost or plans or anything like that."
},
{
"speaker": "Kent Masters",
"content": "So King's Mile is a project we continue to push and invest in. So we're we're going through the permitting process that and that process is on track. There there's a a number of permits that are necessary for that, and it's a pretty long time frame to secure all of those, but I would say we we continue to pursue that from a permitting standpoint. And it and the process is at this point, it's on track."
},
{
"speaker": "Abigail",
"content": "Got it. Thanks."
},
{
"speaker": "Operator",
"content": "Our next question is from Christopher Parkinson with Wolfe Research. Christopher, your line is now open."
},
{
"speaker": "Harris Fein",
"content": "Hey. This is Harris Fine on for Chris. Thanks for taking my question. For my first one, it'd be helpful to hear some of your thoughts on the implications from the election how you're thinking about tariffs and EV subsidies, and and maybe how you're adapting strategy for that kind of environment. Thanks."
},
{
"speaker": "Kent Masters",
"content": "Yeah. So it is well, it's a little early to to talk about what a Trump administration may do. We know what they've talked about. We'll have to see what they do. But this the energy transition is kind of a global phenomenon that that is happening. It's really driven first by China. Europe, probably the second largest market in that, and then North America. And I don't wanna speculate on what Trump administration might do. We'll have to wait see. I will say that we've we've worked across the aisle in, around the the US, and we have contacts there. We we know what they had talked about, but I think we just have to wait and see what they do, and then we'll we will adjust to that. But it is a global market. And this energy transition is happening. And we're pretty well positioned around the globe to take advantage of that. We we were a strategy had been to pivot to the west. We've kinda backed off that given that prices have been so low and economics are building that supply chain out in the west. We still hope to do that, but we have to wait and see what Trump administration wants to do."
},
{
"speaker": "Harris Fein",
"content": "Got it. That that's helpful. And then for my second one, in slide seventeen, you mentioned, potential upside actions. Accelerating productivity and and reducing capital intensity even more. I guess maybe could you provide a little more detail to what's on the table right now? Anything you can share as to what that might entail? Thanks."
},
{
"speaker": "Kent Masters",
"content": "So look, I think we're work we're working through this and we and as we said before, there we we've given a range because and we're we're being pretty aggressive around that and and it and it covers everything from overhead to R&D, part of that and our manufacturing base. So there's some opportunities to to take cost out of there. So I don't know that we wanna speculate on those. We need to do the work, and then we'll come back to it. Because I think first you'll see, hopefully, we'll be narrowing the range to the upside. As we go through and execute against this. And then if we have anything new to report, we'll do that in time, but I'm not I don't wanna get out in front of."
},
{
"speaker": "Operator",
"content": "Our next question is from Joshua Spector with UBS. Joshua, your line is now open."
},
{
"speaker": "Chris Parela",
"content": "Yes. It's Chris Parela on for Josh. Good morning, everyone. I wanted to follow-up on the contract outlook for lithium next year. I know it's two-thirds under contract, for this year, what are your expectations for the mix in 2025? And then I had a follow-up on use of cash in the fourth quarter."
},
{
"speaker": "Kent Masters",
"content": "So I I guess as we go through this, so as the we're not our our mix won't change materially. Other than the fact that a lot of the growth will come on at spot volumes. It may and it may be under a contract, but it would be probably not with the same level of floors that we have in our current contract. So the growth kind of creates additional mix, if you will, so it's not really a change in those contracts, that the existing contracts per se, but new ones either that come on or we the volume that we sell is on a spot basis. It's more reflective of the spot market."
},
{
"speaker": "Chris Parela",
"content": "Oh, thanks, Kent. And then I guess for Neil, the use of cash in the fourth quarter from an operational standpoint, quite large. Could you just bucket or size out and expand upon what the cash outflow or the use of cash is going to be from an operational standpoint in the fourth quarter?"
},
{
"speaker": "Neal Sheorey",
"content": "Yeah. Let me let me maybe give you a couple of things to to think about. So first of all, in the fourth quarter as I mentioned on a on a previous Q&A, we're right now not expecting a dividend from the Taliesin JV. If you go back and and look at what we did in the third quarter or what we got in the third quarter, you'd probably find that that that dividend was in the, let's call it, $70 million to $80 million kind of range in the third quarter. And so that's that's one piece that we won't we're not expecting on in the in the fourth quarter. The other piece is is as we mentioned in the prepared remarks, one of the one is that we there are two things behind our working capital performance in the third quarter. The first we said was working capital management working focused on on driving those to an efficient point by the end of the year. But we also talked about timing of working capital and what that was specifically is we had some items in a pay that moved from the third quarter into the fourth quarter. So we'll eventually have to obviously make those payments. And I I won't give you the exact number here but you can imagine that that's gonna be in the tens of millions of dollars. As we finish up those payments. And then the last one is these the payments related to the cost reduction actions that we announced today. If you go and look in our queue, I'm I I don't know if you've had time to look at that, but we've bread boxed that and it's kind of in that $40 million to $50 million kind of cash outflow range as well. So that that maybe gives you a few key buckets to think about from an operating cash flow perspective."
},
{
"speaker": "Operator",
"content": "Our next question is Patrick Cunningham from Citi. Patrick, your line is now open."
},
{
"speaker": "Eric Zang",
"content": "Hi. Good morning. This is Eric Zang on for Patrick. On the 2025 CapEx guide, can you walk us through the actions you guys taken to bring down CapEx and what is contemplated? And are there any assets under consideration that could potentially go into care and maintenance? Thank you."
},
{
"speaker": "Kent Masters",
"content": "So okay. Midwoth Capital first. So and then know, you can help me on this a little bit. But we've looked up a across the organization and we've taken out there's some growth projects that we have taken out about of capital. We've tightened others up. And from a maintenance capital standpoint, we've gotten tighter on that, a little more rigorous, and I as always said before, what we've kept in, we've got maintenance capital, what we think is minimum that we need. And again, we're targeting that 4% to 6% of revenue for rain in the range for maintenance capital and we're a we're a little ahead of that for 2025 because we used that's on a normalized revenue basis and we think we're below a normalized level given lithium prices. And we've got projects around either oh, pretty short payback investment projects whether they're for cost improvement or additional product that would be a high return short payback type projects. We're still doing those and those larger growth projects, which is why we're we pulled back on our growth forecast out into the future because we're not doing some of those bigger projects that we had planned. And then the the second part of the question, I'm sorry."
},
{
"speaker": "Eric Zang",
"content": "Oh, asset oh, sorry. Another question. So we."
},
{
"speaker": "Kent Masters",
"content": "Yep. Yep. So we've done alright. Yep. I got it. So sorry. So we've we've done the train to at Kimberton and Cara then and depending on where prices go, we will look at other assets both from a resource and conversion standpoint across the portfolio. It's something that that we are that we will look at. We've not made decisions around that. And some of those are are require like say b decisions as well. So Woden is one where we're we're deciding about the number of trains that we operate at Wajina. It's something we have to agree with our joint venture partner."
},
{
"speaker": "Eric Zang",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. That's all the time we have for questions. I will now pass it back to Kent Masters for closing remarks."
},
{
"speaker": "Kent Masters",
"content": "Okay. Thank you, Jimmy. Albemarle continues to deliver solid operational results due to our execution across the company. With proactive steps underway to reduce cost and drive performance, we are well positioned to take advantage of the long-term growth opportunities across our end markets. Thank you for joining us today. And please stay safe."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. Thank you for your participation. You may now disconnect."
}
] |
alb | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Hello and welcome to Albemarle Corporation's Q2 2024 Earnings Call. I will now hand it over to Meredith Bandy, Vice President of Investor Relations and Sustainability."
},
{
"speaker": "Meredith Bandy",
"content": "Thank you and welcome everyone to Albemarle's second quarter 2024 earnings conference call. Our earnings were released after the market yesterday, and you'll find the press release and earnings presentation posted to our website under the Investor Section at albemarle.com. Also posted to our website is yesterday’s additional press release announcing our initiation of a comprehensive review of our cost and operating structure which we will also reference during our comments today. Joining me on the call today are Kent Masters, Chief Executive Officer; Neal Sheorey, Chief Financial Officer; Netha Johnson, President of Specialties; and Eric Norris, President of Energy Storage are also available for Q&A. As a reminder, some of the statements made during this call, including our outlook, guidance, expected company performance and strategic initiatives may constitute forward-looking statements. Please note the cautionary language about forward-looking statements contained in our press release and earnings presentation which also applies to this call. Please also note that some of our comments today refer to non-GAAP financial measures. Reconciliations can be found in our earnings materials. And now, I'll turn the call over to Kent."
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Thank you Meredith. During the second quarter Albemarle continued to demonstrate strong operational execution. We recorded net sales of $1.4 billion and sequential increases in adjusted EBITDA and cash from operations, thanks in part to successful project delivery, productivity, and restructuring initiatives and working capital improvements. We continued to capture volumetric growth driven by our energy storage segment which was up 37% year-over-year, highlighting successful project ramps and spodumene sales in that segment. For example during the quarter we achieved first commercial sales from Meishan ahead of our original schedule by approximately six months. During the second quarter we also delivered more than $150 million in restructuring and productivity improvements consistent with our efforts to align our operations and cost structure with the current market environment. We are on track to exceed our full-year targets on this front by 50%. Looking to the rest of this year, our operational discipline allows us to maintain our full-year 2024 outlook considerations. Notably, we expect our $15 per kilogram lithium price scenario to apply even assuming that lower July market pricing persists. This is due to higher volumes, cost out and productivity progress, and contract performance. We have made great progress in strengthening our competitive position and enhancing our financial flexibility. However, industry headwinds that began last year have persisted longer than the sector anticipated, making it clear that we must proactively take additional steps. Building on the actions we announced this past January, we announced yesterday that we are taking a comprehensive review of our cost and operating structure with the goal of maintaining Albemarle’s competitive position and driving long-term value. As part of the initial review, we announced the difficult but necessary decision to immediately adjust our operating and capital spending plans at our Kemerton site in Australia. These actions showcase our deeper focus on cost and operating discipline. There's no question that the global energy transition is underway, however, the pace of the industry changes our dynamic and we must remain agile as well. Later on the call, I will spend some time diving deeper into the cost and asset actions that we continue to take in this environment to maintain our competitiveness. And I will also highlight the strategic advantages that remain proof points of Albemarle’s competitive and operational strengths. I'll now hand it over to Neal to talk about our financial results during the quarter."
},
{
"speaker": "Neal R. Sheorey",
"content": "Thanks Kent and good morning everyone. Beginning on Slide 5, let's move to our second quarter performance. In Q2 2024, we recorded net sales of $1.4 billion, compared to $2.4 billion in the prior year quarter, a decline of 40% driven principally by lower pricing. During the quarter, we recorded a loss attributable to Albemarle of $188 million and a diluted loss per share of $1.96. This result included an after-tax charge of $215 million, primarily related to capital project asset write-offs for Kemerton 4. Adjusted diluted EPS was $0.4 per share. Moving to Slide 6, our second quarter adjusted EBITDA of $386 million was down substantially versus the year ago period, as favorable volume growth was more than offset by lower prices and reduced equity earnings due to soft fundamentals in the lithium value chain. Compared to the first quarter, second quarter adjusted EBITDA rose 33%, driven by higher sales volumes across all businesses and higher income from increased Talison JV sales volumes. As a reminder, on last quarter's earnings call, we said that we expected an approximately $100 million sequential lift to our EBITDA from higher than normal off-take by a partner at the Talison JV, and that's what we saw in the quarter. Turning to Slide 7. As we've done in prior quarters, we are providing full year 2024 outlook considerations based on historically observed lithium market pricing scenarios. The price scenario shown represent a blend of relevant market prices, including both China and ex China pricing for lithium carbonate and hydroxide. The numbers you see here on this slide have not changed since our last earnings call. What is new is what Kent mentioned at the top of the call. We now expect the $15 per kilogram price scenario to be applicable even assuming lower July market pricing persists for the balance of the year. We are able to maintain this scenario due to the success of our enterprise-wide cost improvements, continued strong volume growth, higher sales volumes at our Talison JV, and contract performance in energy storage. Moving to Slide 8. We continue to prioritize our financial flexibility and strong liquidity to navigate the dynamic market environment. We ended the second quarter with available liquidity of $3.5 billion, including $1.8 billion of cash and cash equivalents and $1.5 billion available under our revolver. Our net debt to adjusted EBITDA was 2.1 times which was well below the quarter's covenant maximum of 5 times. We continue to add new liquidity resources such as our AR factoring program, and from a long-term debt perspective, we are well positioned and have no significant maturities due until late 2025. Turning to Slide 9, which shows our improved operating cash flow performance and considerations. Our focus on cash generation and efficiency continues to drive important benefits. Our operating cash flow conversion in the second quarter was 94%, which was unusually high, primarily due to increased Talison dividends. We also continued to drive volume growth, cost and productivity improvements, and working capital efficiencies, all of which contributed to our cash conversion. As we look forward, we now expect our full year operating cash conversion to be approximately 50%, which is at the higher end of our historical range. I'll now hand it back to Kent."
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Thanks, Neal. Turning to Slide 10, for more details about the actions we announced yesterday to streamline our operations, build on the cost out and productive actions we already have underway, and maintain Albemarle's competitive position across the cycle. Now on Slide 11, I'll first cover the fundamentals in our market. On the demand side, EV registrations are up more than 20% year-to-date through June, led by strong growth in China. However, the pace of growth in Europe and the U.S. has moderated substantially versus the industry's expectations. Across the value chain, we are seeing meaningful mix shifts. First, stronger growth in plug-in hybrid sales, which has translated to smaller batteries with less lithium per vehicle and second, we see a continuation in the trend towards more carbonate-based batteries. Both of these developments are still positive for overall long-term lithium demand, however, they highlight the shifting nature of this value chain as it develops and matures. These demand changes are occurring at the same time as we see dynamic conditions on the supply side. We have yet to see significant changes at the mine level as existing and new supplies continue to come to market. And on the conversion side, there is still oversupply predominantly in China. At current Chinese spot pricing, we believe and are hearing from the market that many nonintegrated producers are unprofitable with some operating at reduced rates or idling production. And we're hearing that even producers who are integrated into cathode or batteries are under pressure. Moreover, current pricing is well below the incentive pricing required for Western greenfield lithium projects. At the same time, geopolitical developments are also adding uncertainties to our business. This includes escalating trade tensions and ongoing armed conflicts. Challenging Western supply chain dynamics are also at play. Notably, the IRA's 30D consumer tax credit has yet to benefit upstream producers like Albemarle. And specific to our position, as written the Final U.S. Department of Energy Foreign Entity of Concern or FEOC rule will impact the eligibility of our Australian product, and we suspect that others could be impacted as well. While current dynamics add challenging uncertainties, there is no question that the energy transition remains well underway, and the long-term growth potential of our end markets is strong, as you can see on Slide 12. The global EV supply chain is on track to achieve the critical $100 per kilowatt hour tipping point where EVs are at cost parity with internal combustion engine vehicles. The Chinese industry has likely surpassed that target with the rest of the world not far behind. Taking all these changes into consideration, we continue to anticipate 2.5 times lithium demand growth from 2024 and to 2030. Additionally, we see battery size growing over time, driven by technology developments and EV adoption. These factors all translate to significantly higher long-term global lithium needs. Turning to Slide 13, in January, we announced a series of proactive actions to preserve growth, reduce cost, and optimize cash flow. Our teams have successfully executed on many of those actions, including ramping in-flight projects at Xinyu, Meishan and the Salar on or ahead of schedule, delivering cost out and productivity actions and we are now tracking to deliver 50% ahead of our initial targets, reducing 2024 estimated CAPEX by between $300 million and $400 million year-over-year, and enhancing our financial flexibility including improving cash generation and conversion. While these steps have served us well, the industry dynamics I just described require us to do more to ensure our competitiveness across the cycle. Building on the actions we announced in January, we announced yesterday that we were embarking on a comprehensive review of our cost and operating structure, pushing deeper into our playbook to further pivot and pace to maintain our leading position. We are focused on the four key areas you see on the slide: optimizing Albemarle's global conversion network to preserve our world-class resource advantages, improving our cost competitiveness and efficiency, continuing to reduce capital expenditures and future capital intensity, and enhancing Albemarle's financial flexibility. The middle section of this slide highlights that we've already taken the next set of actions across these four focus areas. And the bottom of the slide details additional opportunities that we'll closely evaluate as part of the process. The comprehensive review of our cost and operating structure has just begun, and we plan to provide additional details with our third quarter earnings. That said, we took the difficult but necessary decision to bring forward the first step in the review, which is to further optimize our Australian network as we show on Slide 14. As one of the first steps in this comprehensive review, we announced yesterday immediate adjustments to our Australian lithium hydroxide footprint. These changes follow our previously announced decision not to proceed with the construction of Kemerton Train 4. Specifically, we will idle production at Kemerton Train 2 and place the unit in care and maintenance. Additionally, we will stop construction activity on Train 3. Notably, we estimate that stopping construction on Train 3 will save at least $200 million to $300 million of capital spending over the next 18 months. These changes allow us to focus on optimizing and ramping Kemerton Train 1 to preserve optionality and diversity across both product type and geography. In the coming weeks, we'll be identifying other ways to optimize our global conversion network with a focus on the highest priority and highest return options. Our global portfolio of convergent assets and our extensive holding network provide the flexibility to maximize the value of our high-quality resources and to provide either carbonate or hydroxide to meet the needs of our customers as their demands and technologies evolve. Turning to Slide 15. As we deliver these initial savings and begin the next phase of our review, our operating model, the Albemarle Way of Excellence remains the standard by which we operate. By executing our operating model, we are building a culture of continuous improvement to identify best practices at every point in the cycle. We are on track to exceed our initial goals for restructuring and productivity savings through manufacturing, procurement, and back-office initiatives. Much of the better-than-expected performance to date is in manufacturing improvements. For example, optimized PON management at the Salar and overall equipment effectiveness improvements at La Negra have maximized production at one of our lowest-cost assets. These manufacturing benefits in Chile are in addition to the increased efficiency and volume we expect as the Salar yield improvement project continues to ramp. Moving to Slide 16 and our capital spending profile. As I mentioned earlier, we expect 2024 CAPEX to be $300 million to $400 million below 2023 levels. Moving forward, we are evaluating opportunities to further reduce our capital intensity and total capital spending. This will provide enhanced optionality, improve free cash flow, and put Albemarle in a stronger competitive position long term. Our capital spending profile is another element of our comprehensive review and we'll have more to say about our near-term spending plan on future calls. Moving to Slide 17. With all these near-term factors shifting and requiring us to take action, I think it's important to remember that Albemarle continues to have significant competitive strengths. And so I will end with a review of our framework and the core advantages we continue to prioritize as drivers of our long-term value creation. Slide 18 provides our strategic framework, which informs our planning and gives us confidence that we will achieve our growth ambition to lead the world in transforming essential resources into critical ingredients for modern living. This framework defines where we play, how we win, and how we deliver. Albemarle remains uniquely positioned to enable operational excellence during this dynamic period thanks to our competitive strengths, including our globally diverse portfolio of world-class resources, leading process chemistry, deep innovation, and technical know-how, customer-centric approach to the market, and responsible stewardship. Each of our competitive strength will help us right now and well into the future in ways that we summarize on Slide 19. First, our world-class resources are arguably the best in the industry with large-scale, high-grade and, therefore, low-cost assets. In energy storage, we have access to some of the high-grade resources in both hard rock and brine. In Australia with Greenbushes and Wodgina and one of the largest known hard rock assets in the U.S., Kings Mountain. And in Chile with our long-standing position in the Salar de Atacama. Similarly, in specialties, we are the only producer with access to both of the two best bromine resources globally. In Jordan, on the Southeast side of the Dead Sea, the source is the largest concentration of bromine in the world. And in the smack over formation in Arkansas, the only source of commercial bromine in the United States. In both of our core businesses, we maximize the value of our world-class resources by converting and flexibly derivatizing into higher value and use products in our conversion assets or in the case of energy storage, through our extensive tolling network. Second, our leading process chemistry know-how is key to achieving further productivity and cost improvements, safely and sustainably. For example, the Salar yield improvement project utilizes a proprietary technology to enable up to 20% higher yield. At Magnolia, we've leveraged advanced process controls to increase production while lowering costs and improving sustainability. And at both the Salar and Magnolia, we have evaluated a wide range of direct lithium extraction options and are piloting proprietary and third-party solutions in order to be prepared for technology shifts that could be important and more sustainable Salar yield options for this industry. Third, we have a pipeline of high-impact innovative solutions in both bromine and lithium. Our research, testing, and piloting facilities in North Carolina, Louisiana, and Langelsheim, Germany, allow us to participate in differentiated high-margin segments and support our customers' specific requirements. Fourth, Albemarle's leading industry position as a partner of choice is demonstrated through our growing number of partnerships with iconic pioneering companies. Both our businesses have high Net Promoter Scores with significantly positive gaps relative to competitors, reflecting long-standing successful relationships with major customers. And last but not least, our responsible stewardship, strong values and high-performance culture are increasingly recognized by leading organizations. For example, we recently earned an EcoVadis gold medal placing us in the top 5% of global companies and demonstrating our commitment to creating a more resilient world and advancing the sustainability objectives of our customers. In summary, on Slide 25, Albemarle delivered another strong quarterly performance in the second quarter, including sequential improvements in adjusted EBITDA and cash from operations. Despite lower market pricing, we've been able to maintain our full year 2024 outlook considerations, thanks in part to enterprise-wide cost improvements, strong energy storage project ramps, and contract performance. However, we understand these positive actions may not be sufficient given ongoing industry headwinds. Our entire organization is focused on delivering operational excellence while positioning the company to capitalize on the incredible long-term opportunities in our markets. That's why we are taking the proactive steps to control what we can control and ensure we are competitive across the cycle. Albemarle is a global leader with a world-class portfolio and vertical integration strength. We are uniquely positioned to win. I am confident we are taking the right actions to maintain our competitive position and ensure we execute with agility today and in the future. I look forward to seeing some of you face-to-face at upcoming events listed here on Slide 26. And with that, I'd like to turn the call back over to the operator to begin the Q&A portion."
},
{
"speaker": "Operator",
"content": "[Operator Instructions]. Our first question comes from Aleksey Yefremov. Your line is now open. Please go ahead."
},
{
"speaker": "Unidentified Analyst",
"content": "Thanks and good morning everyone. This is Ryan on for Aleksey. My first question would just be kind of around your EBITDA outlook for the year, right. So I understand that you are kind of maintaining the base case or the low case in the $15 per kilo scenario, even though prices currently are, let's say, $11 to $12 per kilogram. Is there the potential that EBITDA could improve if prices were to recover to that $15 per kilogram scenario here in the back half, I mean, you guys talked a lot about improved costs, so just wondering what you think about that?"
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "So let's say you characterize what you've said. So even as we've moved that from $15 to, say, $12 to $15. And then we commented that even at July prices, those hold for the rest of the year, we'll make that forecast. And so if there's a chance it could be higher. If prices moved up or there are a number of reasons we're able to hold that forecast is around the volumes that we're selling contract terms, things like that. So it could move up if prices are stronger, it's not collared, so to speak. So if things work in our direction, it could be a number of different things. It could be higher than that. But that's the best visibility we have at the moment."
},
{
"speaker": "Unidentified Analyst",
"content": "Okay, helpful. And then I know it's early, but just kind of initial expectations on volume growth for maybe 2025 and 2026, just after these actions that have just been taken at Kemerton now? Thanks."
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Yes. So okay, you're right, it's early. But I think our volume and what we indicated in the beginning of the year, our volume growth shouldn't be significantly different than that. I mean we are changing some of our -- we're taking out conversion capacity, but we still have the resource that should align to that. So it's not significantly different than we had indicated at the last call."
},
{
"speaker": "Operator",
"content": "Our next question comes from Steve Byrne. Steve, your line is now open. Please go ahead."
},
{
"speaker": "Stephen Byrne",
"content": "Yeah, thank you. Kemerton has some more meaningful freight costs than some of your Chinese conversion. But roughly what is the cash margin for Kemerton 2 and where would you put it on the cost curve, what quartile?"
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Yes. So I guess we've never put any of our assets and given that type cost out there. So it is -- I guess it's a combination of -- so you're talking about 2. So 3 is really about some of the money that we're spending in growing that. And Kemerton 1 and 2 gives us a couple of things. So it's closer to the resource, but it gives us diversity just geographic diversity. So we would have Chile, we would have -- we have Australia, 1 and 2 help us with that, we have China. And then we still aspire to have conversion in the U.S. at some point if prices come back to that. So I'm not going to give you what our marginal cost is or our cash cost is at Kemerton, but that's some of the thinking that goes into the decisions we've made."
},
{
"speaker": "Stephen Byrne",
"content": "Okay. It seems like there's more than just a cost cut. It's a supply cut. But with respect to the roughly $1 billion -- sure. Go ahead, Kent."
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "No, I was just going to say that it is on conversion. It is capacity cut on conversion. The resource is still available."
},
{
"speaker": "Stephen Byrne",
"content": "Right. Understood. The $1 billion charge in 3Q, can you put that into buckets and how much of it is cash?"
},
{
"speaker": "Neal R. Sheorey",
"content": "Yes, hi Steve, good morning. This is Neal. So let me answer the second part of your question and maybe the two kind of go together. So roughly speaking, at this time, we've only had a very small group of people working on this. So we'll obviously refine this number quite a bit in the third quarter. But you should think about of that roughly $1 billion charge we announced today, somewhere at least 60% of that is noncash. And similarly, you can expect that kind of on that order represents what's already on our balance sheet that we're writing off. And then we'll give you a better assessment when we get to third quarter in terms of how much of the rest of that is actually cash. But I'd say at least 60% is noncash."
},
{
"speaker": "Operator",
"content": "Our next question comes from Patrick Cunningham. Patrick, your line is now open. Please go ahead."
},
{
"speaker": "Patrick Cunningham",
"content": "Hi, good morning. Thanks for taking my question. Maybe just trying to square the comments last time, cash conversion expectations expected to be well below historical averages versus strength in the outlook here. You had the $400 million to $600 million in headwinds. Was there any improvement in some of those items, whether it's deferral of discrete tax items or other things, some of the working capital ramp for projects, I'm just trying to understand cash drag for the remainder of the year?"
},
{
"speaker": "Neal R. Sheorey",
"content": "Yes. Yes. This is Neal, again. So yes, thanks for asking that question because we are -- as we said in our considerations in the prepared remarks, we're taking that range now up to a 50% conversion, which is towards the high end of our historical range now. And there's -- I'd say there's two things that I would point to that where we're doing better than expected. The first is from a dividend perspective from our equity companies, that was certainly better than we expected coming into the year. You heard in our prepared remarks and you know about the additional offtake that we saw at Talison. So that definitely boosted dividends in the second quarter and helped our cash conversion. And then the other part is, yes, on the working capital side, we are highly focused on it, and we have a lot of initiatives around this, and we're seeing some of those come through already in the first half of the year and are continuing to work on that in the back half of the year. So working capital was another nice tailwind to cash in terms of the release of cash from there."
},
{
"speaker": "Patrick Cunningham",
"content": "Understood, very helpful. And then just generally on how we should think about 3Q sequentially for energy storage. Can you help us triangulate how much lower volumes will be sequentially based on some of this onetime benefit, where we should stand for pricing if we kind of hold the July averages here? And then is the remaining sensitivity in your numbers mostly around volume or is there something else?"
},
{
"speaker": "Neal R. Sheorey",
"content": "Yes. So I can maybe take the second part of that. We are obviously, from a volume perspective, we're obviously tracking towards the higher end of the 10% to 20% volume growth range that we gave you at the beginning of the year. And I think at this point for the visibility we have, we're probably going to keep tracking towards the high end of that range. So I wouldn't say our earnings corridor or our outlook considerations are really driven by volume per se. It's really around the pricing range that we've given you, that kind of $12 to $15 range today."
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Yes. Just -- but the first part of the year was strong from a volume standpoint and that was fine [ph], the upper end of that range, 20%, Neal is saying it's going to be less year-on-year growth in the second half. But that's just because it's so strong in the first half, and we've had a mix of spodumene sales in there as well that's pulled some of that forward."
},
{
"speaker": "Operator",
"content": "Our next question comes from Vincent Andrews. Vincent, your line is now open. Please go ahead."
},
{
"speaker": "Vincent Andrews",
"content": "Thank you and good morning everyone. Last quarter, you had a slide on capital allocation priorities and it had a couple of things in it. I just would like to revisit. One was a commitment to investment-grade rating, the second was your ultimate long-term net debt to adjusted EBITDA target of less than 2.5 times, and then thirdly, the continuation to support and grow the dividend. How are you thinking about those three things as part of the comprehensive review?"
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Yes, I don't think our view has changed, right. So that will -- as we go through this, I mean, we'll reiterate that, but I suspect it will stay the same."
},
{
"speaker": "Vincent Andrews",
"content": "And as a follow-up, could you speak a little bit about the factoring and how that process works for you and how we'll see it, I guess, in the working capital results?"
},
{
"speaker": "Neal R. Sheorey",
"content": "Yes. So Vincent, to your question, that's right. We put in place an AR factoring program. It's an initial program. We'll continue to evaluate that and add to it as we can as we go along. But essentially, that factoring program is currently untapped. We will use it when we need liquidity if and when we need liquidity. And so basically, at that point, that's when you'll see it, and we'll talk about it. But at this point, it's an untapped resource available to us."
},
{
"speaker": "Operator",
"content": "Our next question comes from Chris Parkinson. Chris, your line is now open. Please go ahead."
},
{
"speaker": "Harris Fein",
"content": "Hey, good morning. This is Harris Fein on for Chris. So we walked through that the $15 per kilo scenario still holds at $12. I guess how much of that is because of higher Talison shipments and cost improvements and I guess, like where would EBITDA be absent those items if we were just isolating the contract component and I am just kind of trying to get a sense of what that looks like if prices go down to, let's say, $10 per kilo through the back half of the year?"
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Yes. So we've said at July pricing, it basically holds the same, right. So $12 to $15 on the slide, but we've said in the remarks that, that July pricing it holds. If July pricing extends throughout the balance of the year, it still holds. So you can work out exactly what that number comes to. And there are a number of pieces that allow us to do that. So it's the volume mix, it is a little bit of additional volume from Talison, it's our contracts. It's a lot of things. It's the cost savings things that we're putting in place. So it's a number of things that go into making that statement true. So it's not one particular thing."
},
{
"speaker": "Neal R. Sheorey",
"content": "Yes, maybe just to add on to that, just a reiteration that those outlook considerations we provided were always a view on the average pricing across the year. And so with the last couple of earnings releases, we've given you -- you obviously know the sales that we've had in energy storage, and we've given you the volumes that we've sold. So you can look at what our average realized price has been. It's been above $15 for the first half of the year. And so when you -- you can take your -- whatever lithium price you'd like to in the back half of the year and do the averaging. But that's why we say when you take July pricing and roll it forward, it falls within that range that we've given you. With regards to Talison, I think the best way to answer that is just to go back to what we've said before. We told you that in the second quarter, we expected about $100 million sequential lift related to the Talison offtake, the additional Talison offtake, and that's exactly what we saw. So maybe that gives you an idea of how to think about that part of your question."
},
{
"speaker": "Harris Fein",
"content": "Got it, that's helpful. And then for my second question, in Slide 12 you show that the global average EV is on track for cross parity with ICE in the next year or two. It would be nice to hear your take maybe on what you make of some of the recent challenges that Western OEMs are having in making a profitable EV and also the fallout from European tariffs on Chinese EVs, kind of how that is playing into your demand outlook?"
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Okay. So -- I mean, the cost on -- the cost curve that you see, Neal said on Slide 12. I mean that's a curve that we've been -- that the industry has been looking at for some time. That $100 per kilowatt hour has been a benchmark or a tipping point we call it that people have been looking for, and we're below that in China today. Now some of that fair enough is on -- is because lithium prices are low, but the majority of it is just on the experience curve, the technology and the battery technology. So we think that maintains itself. And then the rest of the world will follow China and they've hit that hurdle. It's not there in the West yet, but we believe that it comes shortly. I'm not -- I don't think I want to comment on the OEMs' cost position. I think a lo1t of it goes into it, including batteries is a big part of it, but it's the rest of the vehicle as well. But we're not -- I'm not going to get into the comment on auto cost positions. But I think the battery technology is hitting those benchmarks we've been looking for, for a long time, and it's only going to get better."
},
{
"speaker": "Operator",
"content": "Our next question comes from David Begleiter. David, your line is now open. Please go ahead."
},
{
"speaker": "David Begleiter",
"content": "Thank you and good morning. Kent, what does the Kemerton capacity curtailments mean for Wodgina production, if anything?"
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "I don't think it means anything for Wodgina production. So that there -- as we had said, so we're taking conversion capacity out and the resource piece we continue to operate from both the Greenbushes and a Wodgina standpoint. It's not really related to Kemerton."
},
{
"speaker": "David Begleiter",
"content": "Very good. And just on what's happening in China, how much LiFePo production do you think is shut down and has that number changed at all in the last couple of months here?"
},
{
"speaker": "Eric W. Norris",
"content": "David, this is Eric, good morning. I would say in the last couple of months, it hasn't changed materially. There's some that's come off a bit. I'm going to guess tens of thousands of tons or less that is related to where we are in the cost, where price has gone. I think Kent in his remarks talked about the considerable pressure that anybody who is -- particularly anybody is not integrated in buying either spodumene or LiFePo [ph] is under. And in fact, most are operating at a loss, if they're not fully integrated inside of China. And so that's a factor. Another thing that happens this time of year is seasonal production of brine starts to ramp up in Western China. And so that's rising to sort of substitute that drop in LiFePo [ph]. I think overall, though, we're seeing rising inventories of lithium salt. So that is a concern to watch. And obviously, the price pressures I talked about, so I think -- we'll have to see how the industry responds. Obviously, there's a need for some caution in the market given where we see demand versus supply."
},
{
"speaker": "Operator",
"content": "Our next question comes from Stephen Richardson. Stephen, your line is now open. Please go ahead."
},
{
"speaker": "Stephen Richardson",
"content": "Hi, good morning. I was wondering Kent, appreciating that the review is ongoing, but I was wondering if you could talk a little bit more about your efforts on defining and lowering your sustaining capital. It seems like from the slide that you put forward on 16 that you're suggesting that sustaining capital is a little bit lower than it was previously and that there's a range here of minimum required capital that's sub-$1 billion. And I guess in an environment where current prices are sustained into 2025 do you envision corporate CAPEX below $1 billion next year, is that a feasible number?"
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Yes. So we are -- I mean look, we're going through this, we'll be cautious around that, right, to see what we can. As we are operating, we're not growing as fast. We're ramping some of these assets, but we have a view of sustaining capital, and we're challenging that. But we're going to push on that. We'll be rigorous about it. It might take risk, but we're going to be more aggressive around that than others. It's a big piece. Most -- a lot of these assets are still ramping and they're pretty new. So we've been conservative on our estimates around the sustaining capital. So we're going to dig into that and change our approach a little bit, but we see that as an opportunity."
},
{
"speaker": "Stephen Richardson",
"content": "Okay, appreciate that. And maybe just a follow-up, if you did indeed kind of reduce a lot of your growth CAPEX and appreciate that you're outperforming growth on the ramping assets this year, would anybody be willing to hazard of guess as to if you -- on this plan what kind of remaining growth do you think you'd have in the program in 2025 just in terms of thinking about Salar and just the different projects that are out there that are still in flight in terms of growth, would that be still -- is it safe to assume you'd still be growing absolute volumes into 2025 just based on those ramps?"
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Yes. No, I think that's right. And I go back to the comments we've said earlier. So what we had said previously in the call or in the previous quarter's call, around the changes we did in January. We've got a couple of years of growth in the assets that we have on the ground and ramping. So we'll continue to do that at 2025 and into 2026, but then it starts to -- without further investment, we start to maximize on that. But we -- and Kemerton doesn't really change that. Again, the resource is there and the investments that we've made in there continue to ramp up. And -- but it's the conversion capacity. Actually changing Kemerton gives us a little more flexibility on product mix, but it limits us a little bit more, we're less diverse geographically around that. And that's the trade-off we're making."
},
{
"speaker": "Operator",
"content": "Next question comes from Laurence Alexander. Laurence, your line is now open. Please go ahead."
},
{
"speaker": "Laurence Alexander",
"content": "Good morning. Two questions. First can you just give a sense, not so much about kind of the next round of restructuring, but how you think about the longer-term objective. I mean if, for example, prices were to just stay at the current range, where would you expect energy storage margins to go over four, five, six years, however long it took for you to right size or how much do you think you can bring down the cost structure, so that's the first one, just how you think about the longer-term objectives for the business if market conditions do not improve? And secondly, can you just give a bit of a spotlight comments on sort of the state of play for DLE projects in Latin America, what do you need to see either in terms of partnerships or government support for anything to move forward in current conditions?"
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Okay. So the first one on the restructuring. So our goal is to put the company within the cost structure and the supply chain that we can compete at the pricing that we see today, and if it stays that way long term. So that's the hypothetical question you're asking, but that's what we're planning for. And we don't know when prices are going to rebound. We know they -- we think a lot of players are operating below cash cost. We think they have to come up. We just don't know when. So we're going to structure the company to operate and be competitive and profitable in that range. So what that margin -- what the margin looks like I'm not going to hazard a guess on that, but it is -- we're going to put ourselves in a position to be profitable and being able to compete where prices are today. Yes, so that's the first question. And the second one, DLE, and you said in South America, I'm going to talk about our view of DLE and our projects, not so much the industry. I mean I don't know -- I mean we are -- we're working on deal. We've got two projects, both going into pilot phase. We've done a lot of work around that for quite some time. One focused on the brines we have at the smackover formation at Magnolia and Arkansas in the United States where we process bromine. And we have that -- we can take that stream and process that. So we have a pilot that is in start-up at the moment around that. And then we'll do a similar pilot at the Salar de Atacama. One, I think we've said this in the remarks, one of the technologies is proprietary. The other is kind of commercial. So we're doing it in a couple of different ways. But I think the key to the -- I mean, DLE is the whole system, not just the extraction piece. There's a lot of focus on the absorption or a solvent extractor and whatever technology used to actually get the lithium molecule out. But the real art in it is the overall system and the integration in making it operate consistently day in, day out. You can do it in the lab, a lot of people can do it in a lab. You need to be able to do it in the field and do it all the time, and that's -- we're doing scale pilots that will prove that out. And so we'll see. So -- and what do we need from a government standpoint around that, I mean, for us, specifically, I don't think we're looking for government necessarily. I mean, funding would help that, but we are moving both of those projects forward. And its important technology for the industry and for us, for us to really leverage the lowest cost resource in the world in Salar de Atacama and get growth from that, we'll need DLE. So it is important. But I don't -- we're not we're not waiting on governments to help us fund it or do anything like that. We're moving forward."
},
{
"speaker": "Operator",
"content": "Our next question comes from Kevin McCarthy. Kevin, your line is now open. Please go ahead."
},
{
"speaker": "Kevin McCarthy",
"content": "Yes, thank you and good morning. Kent, in your prepared remarks, I think you commented that you're seeing an ongoing trend for carbonate-based batteries. Can you discuss why that's the case and whether that trend is intensifying or not and does it have any bearing on your decision to idle Kemerton 2?"
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Okay, so I'll go at a high level. If it gets deeper, Eric will jump in. But I mean, this is -- I mean, it is carbonate is usually the preferred chemistry for LFP technology, and there's been a shift toward LFP. And I would say that's the preferred technology in China. Because China is on such a growth rate and the West is slowing down a little bit. That's -- there's more of a shift of -- a little bit of a portfolio mix toward carbonate. Now the West is looking at carbonate or LFP as well. Therefore, our view from a year or two ago, we always expected a mix. It was a little more hydroxide heavy. Now it's probably carbonate heavy in that view. And then that product mix, I mentioned product mix earlier when I was talking about Kemerton, that does play into that. Kemerton is hydroxide, and we can toll that same resource for carbonate if we need to, and that gives us more flexibility. So it was a consideration in our decisions around 2 and 3."
},
{
"speaker": "Kevin McCarthy",
"content": "Thank you for that. And then as a follow-up, what would you need to see specifically to make a decision to restart Kemerton 2 and how quickly might you be able to do that and is there a meaningful cost to restart?"
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Yes. So there's a cost to put it in care and maintenance, right and it would be a cost to come back, but I don't know that it's not dramatic. It would be ordinary course I think if we brought it back. There's a number of things we have to do. Part of the decision about focusing on Train 1 and not 2 is to really optimize that asset, get it to work. We've all -- we have struggled with workforce in Australia and we struggle to ramp the two of them together. So we're going to focus on one, ramp that up to make that really operate, really understand the technology and process. And we think we can bring it back faster and more efficiently to Train 2 when the conditions make that right. So we've got do a few things before we would do that, we would get the plant to operate, really understand the technology and the process chemistry that's unique to Kemerton. And then we can bring that to Train 2. It will be -- but we'll need the market to improve before we do that. And then there would be a time frame in order to bring it back. So it's not going to turn on a dime, but we'll plan for that. And it is not dramatic from a -- not big from a capital standpoint, but there would be cost to bring it back on, and we'd have to bring people back on to do that as well."
},
{
"speaker": "Operator",
"content": "Our next question comes from Colin Rusch. Coli, your line is now open. Please go ahead."
},
{
"speaker": "Colin Rusch",
"content": "Thanks so much guys. As you're working through enforcing these contracts, can you talk about some of the dynamics with the customers and any sort of compromises that you might be making to adjustments. Historically, you've kind of enforced some pricing and you reallocated volumes. Just want to get a sense of how those dynamics are playing out?"
},
{
"speaker": "Eric W. Norris",
"content": "Yes. Good morning Colin, it's Eric. As you point out, it's obvious with where market pricing is going. It is a discussion certainly around helping our customers remain competitive through this period of time, while at the same time, respecting the contracts we have and the thresholds that we have there in order to continue to invest on their behalf. I would tell you that all of these contracts are performing to date and it's our expectation that we'll continue to do so. And we'll keep working with our customers. There are things we can do in terms of source. Some of these contracts have a little bit of flexibility, and we can work around spodumene supply versus salt supply. We can look at sourcing points that are different that helps them with their supply chains while at the same time, respecting the core fundamentals of our contracts. So that's basically the nature of the discussions to date."
},
{
"speaker": "Colin Rusch",
"content": "Thanks so much. And then just a little bit more on the technology side. As we see more silicon-based anodes, whether it's increased levels of doping or silicon, I know it's completely -- the challenge of lithiation is pretty substantial. Can you talk a little bit about how much leverage you're getting out of the R&D center and helping folks figure out process and approaches to the lithiation challenge?"
},
{
"speaker": "Eric W. Norris",
"content": "Well, this remains an area of focus for our growth. And when we talk about some of the advanced materials that are lithium-based looking at prelithiation materials that will support the adoption of silicon anodes or silicone doped anodes as you point out, for higher-capacity batteries that can lend themselves, obviously, to longer battery life or range. And furthermore, there is sort of the next journey -- step on that journey is moving towards a lithium metal anode as well, whether that's a solid state or even a liquid electrolyte used with lithium anodes. So these are areas of growth. These areas we see, frankly, having a faster adoption in technologies outside of electric vehicles, whether there's a smaller format battery and perhaps less risk involved in the customer base as a first step, on the one hand. On the other hand, if you speak to some of the more progressive vehicle producers, OEMs who are looking at future technologies, there's a lot of investment they're doing in this area as well. So it's part and parcel of the overall partnership we have with customers. I mean it's the reason that relative to the earlier question, maintaining a contract relationship and supporting us when prices are low, we support them throughout the cycle as well, is if we got to respect and have strong contracts -- contract relationships because they're more than just supply. They deal with things like technology as well that you're pointing out."
},
{
"speaker": "Operator",
"content": "Our next question comes from David Deckelbaum. David, your line is now open. Please go ahead."
},
{
"speaker": "David Deckelbaum",
"content": "Hi, thanks for the time today and for taking my questions. Maybe for Neal. I just wanted to understand, I think, the remarks with the Kemerton move, it saves $200 million to $300 million over the next 18 months or so. Can you talk about that in the context of where you expect next year's CAPEX to be And more just is $1 billion of sustaining CAPEX, is that a reasonable target for what you could get to next year or still have to take sort of a multiyear progression?"
},
{
"speaker": "Neal R. Sheorey",
"content": "Yes, I think I'm going to answer this probably very similar to the way that Kent did. So obviously, as we look at CAPEX into 2025 and 2026, this decision that we're sharing today around Kemerton will absolutely factor into lowering our CAPEX in those out years. And we've always talked about our focus on doing that in this environment. Just as Kent mentioned to an earlier question, we're working through that with our teams right now. And obviously, we understand that what the current environment looks like and that we need to spend a lot of hard time looking at our CAPEX spending and how we can -- where we can bring that down and how we can bring that down as quickly as possible without taking unnecessary risk. So I would just say like we're working on that equation now, and we'll have more to share, I think, in the next couple of quarters."
},
{
"speaker": "David Deckelbaum",
"content": "I appreciate that. And then my follow-up is just -- on going forward now, with CGP 3 ramping at Greenbushes and volumes growing there. On the back end now with Kemerton having less capacity, is the commercial profile going forward just all going to be reliant on tolling or do you have flexibility to sell spodumen concentrate into the market? And will you be able to satisfy all of your customer contracts through tolling alone?"
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Well, it's not -- well, not just totally. So we've got a network of conversion assets today. And so Meishan is up and operating and ramping as we speak. And we've got first sales from Meishan in this quarter. And we -- as we said, ahead of schedule, we have multiple other facilities in China that we own and operate for conversion. So Kimberton is a portion of it, of our Hard Rock conversion assets. And it will be a blend. We will use some tolling to supplement our conversion assets, but we have significant conversion assets and the Kemerton 3 and 4 is just a portion of it. And again, we'll have 1 operating and 2 to bring on after that. So it's still a significant portfolio of conversion assets that we have, and then we don't want to forget about the carbonate that we bring from Chile as well. So it's a pretty good portfolio of conversion assets. And I would say this is a tweak, not like a big wholesale change in that network with the change to Kemerton."
},
{
"speaker": "Operator",
"content": "Our last question comes from John Roberts. John, your line is now open. Please go ahead."
},
{
"speaker": "John Roberts",
"content": "Thanks and who would have thought that [indiscernible] would be the good performing business here in the portfolio. I'll ask a question on the specialties business. Is some of the weakness in specialties temporary channel destocking or had those -- had your channels already destocked like many others have and the weakness you're seeing actually is reflective of the end market weakness?"
},
{
"speaker": "Netha N. Johnson, Jr.",
"content": "Yes, John, this is Netha. We are seeing some end market weakness. And rather than weakness, maybe not as quick as a recovery as we expected, particularly in electronics. We did have volume growth of 9%, but price declined. And if you look at the spot price, which is our only public spot price we have in the market in Q1, the Chinese bromine spot price was $3.11 per metric ton and in Q2 was $2.86 per metric ton, and that explains the pricing. But we are seeing green shoots and we are seeing that electronics recovery come, continuing strength in oil and gas, pharma and ag, and we expect to see that growth continue, maybe a little slower than what we thought, but throughout the rest of the year AND sequential growth in our financials as a result of that ."
},
{
"speaker": "Operator",
"content": "That's all the time we have for questions. I will now pass it back to Kent Masters for closing remarks."
},
{
"speaker": "Jerry Kent Masters, Jr.",
"content": "Okay. Thank you, and thank you all for joining us today. We continue to adapt and move Albemarle forward to better position ourselves in the current market environment, enhance our company's profitable organic growth trajectory, and create long-term value for shareholders. I remain confident in the long-term secular growth opportunities in our end markets and that we are taking the right steps to position Albemarle for value creation. Thank you."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. Thank you for your participation. You may now disconnect."
}
] |
alb | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Hello and welcome to Albemarle Corporation's Q1 2024 Earnings Call. I will now hand it over to Meredith Bandy, Vice President of Investor Relations and Sustainability."
},
{
"speaker": "Meredith Bandy",
"content": "Thank you. Welcome everyone to Albemarle's first quarter 2024 earnings conference call. Our earnings were released after the close of market yesterday, and you'll find the press release and earnings presentation posted to our website under the Investor Section at albemarle.com. Joining me on the call today are Kent Masters, Chief Executive Officer; and Neal Sheorey, Chief Financial Officer. Netha Johnson, President of Specialties; and Eric Norris, President of Energy Storage are also available for Q&A. As a reminder, some of the statements made during this call, including our outlook, guidance, expected company performance and timing of expansion projects, may constitute forward-looking statements. Please note the cautionary language about forward-looking statements contained in our press release and earnings presentation that same language applies to this call. Also note that some of our comments today refer to non-GAAP financial measures. Reconciliations can be found in our earnings materials. And now, I'll turn the call over to Kent."
},
{
"speaker": "Kent Masters",
"content": "Thank you, Meredith. During the first quarter, our team demonstrated its ability to navigate dynamic market conditions with actions that position Albemarle for profitable growth and deliver on the operational steps that we have set out to achieve this year. We recorded net sales of $1.4 billion and adjusted EBITDA of $291 million. We saw continued volumetric growth, driven by Energy Storage segment highlighting the demand growth in the segment and our ability to capture it. We also ramp new conversion facilities, executed on our productivity plans and strengthened our competitive position and financial flexibility. During the quarter, we delivered more than $90 million in productivity and restructuring cost savings consistent with our efforts to align our costs with the current market environment. We are on track to deliver more than $280 million in productivity improvements in 2024, demonstrating our excellent execution. To drive lithium market transparency and discovery, we held several successful bidding events for spodumene concentrate and lithium carbonate in March and April. We are encouraged by the results and level of participation to date and plan to continue these efforts. We continue to advance our in-flight growth projects that are near completion or in start-up to deliver near-term volume growth and cash flow. In particular, we've reached important new milestones at Kemerton I and Meishan. Finally, the year so far has developed as we expected and we are reaffirming our full year 2024 outlook ranges that are based on observed lithium market price scenarios that we included for the first time last quarter. Our operational and strategic playbook positions us well to serve our customers today and for the future. With our focused execution and our continued confidence in the elements we provide, Albemarle is well-positioned to drive sustainable growth and create value. I'll now hand it over to Neal to talk about our financial results during the quarter."
},
{
"speaker": "Neal Sheorey",
"content": "Thanks, Kent, and good morning, everyone. Beginning on Slide 5. Let's jump into our first quarter performance. In Q1 2024, we recorded net sales of $1.4 billion, compared to $2.6 billion for the prior year quarter, a year-over-year decline of 47%, driven principally by lower pricing, partially offset by volume growth. Adjusted EBITDA was $291 million significantly down from the same period last year, when pricing and margins across our Energy Storage and Specialties businesses were at peak levels. Diluted EPS was negative $0.08. Adjusted diluted EPS was $0.26, which excludes primarily restructuring charges and mark-to-market losses on public equity securities held or sold in the quarter. Our earnings decline was driven mostly by margin compression on lower pricing, especially within our Energy Storage segment. Additionally, we had some margin pressure due to timing of higher cost spodumene flowing through cost of goods sold and reduced equity earnings at the Talison joint venture. These factors were partially offset by volumetric growth, primarily lithium carbonate and hydroxide, and we also recorded spodumene sales at favorable pricing. Also, the Ketjen business recorded increased net sales and EBITDA driven primarily by higher volumes. Looking at Slide 6, we'll break down the company's first quarter adjusted EBITDA by driver. Compared to the prior year quarter, the decline in EBITDA was $1.4 billion related to lower lithium pricing in both Energy Storage and Specialties, $90 million in cost of goods sold due to timing of higher priced spodumene inventories built in prior periods and $270 million related to pretax equity income primarily from our Talison JV. Offsetting these declines were improvements of $251 million related to higher volumes as our Energy Storage projects continue to ramp as well as better Clean Fuel Technologies volumes at Ketjen, and $80 million of net improvements mainly due to restructuring and productivity benefits across multiple areas, including procurement, manufacturing and back office spend. This demonstrates our team's agility and focus on delivering higher volumes and productivity improvements in the current market environment. Turning to Slide 7. As we did last quarter, we are providing outlook ranges, based on historically observed lithium market pricing scenarios. We are reaffirming our outlook considerations published last quarter. There are two notable updates here related to our tax rate and share count expectations. We are updating our adjusted effective tax rate guidance to reflect the range of lithium price scenarios as well as our updated expectations for geographic income mix. At the $15 lithium price scenario we expect a modest tax expense benefit in our P&L. At higher pricing we expect a more typical tax rate in the mid to high 20% range. We have also accounted for the adjusted change in the diluted share count to reflect our $2.3 billion public mandatory convertible preferred stock offering. Moving to Slide 8, where we provide some operating cash flow considerations. We had previously highlighted that, our cash flow conversion would be constrained this year, and I want to provide some additional color on those drivers. As you see here, our cash flow conversion in 2024 is expected to be below historical averages for four reasons. First, Talison is progressing its chemical grade plant, or CGP3 expansion, resulting in lower dividends from the JV. Second, working capital release related to lower lithium pricing is expected to be mostly offset by increased working capital investments for our new plants at Kemerton, Meishan, Salar Yield and Qinzhou. Third, cash tax is expected to be similar to last year, primarily reflecting jurisdictional mix. For example, we will pay Australian cash taxes in mid-year, based on earnings estimates from the prior year period. Finally, we expect to have higher interest expenses year-over-year. Turning to Slide 9. I'll provide further details on trends in each segment's outlook. First, in Energy Storage, we continue to expect approximately two-thirds of our 2024 volumes to be sold on index referenced variable price contracts. The remaining one-third of the volume is still expected to be sold on short-term purchase agreements, including our recently announced bidding events, which Kent will discuss in a moment. Year-over-year energy storage volume growth is trending toward the high end of our expected 10% to 20% range, driven by timing of project ramps and spodumene sales. We continue to anticipate increased year-over-year volumes in the second half of the year due to the ramp of our expansions. All else being equal, we continue to expect improving margins through the year, as lower cost spodumene offsets new facility ramp costs. However, we expect some quarterly variance in EBITDA and margin due to the timing of Talison shipments. Specifically, in Q2, we expect a lift to our EBITDA margin of about 10 points from higher offtake by our partners at the Talison JV. Next, on Specialties. Our outlook reflects continued softness in Consumer Electronics, partially offset by solid demand in Oilfield Services, Agriculture and Pharmaceutical Applications. Furthermore, we are seeing higher costs for logistics as we manage through regional challenges, notably at our site in Jordan. We anticipate higher sales in the second half of the year, on the expectation of modest end market recovery and improved pricing in Bromine Specialties. Taking together, we now expect Specialties adjusted EBITDA to be toward the lower end of the outlook range. Finally, at Ketjen, we are seeing the building success of our turnaround program. We are optimistic about increased volumes driven by high refinery utilization. In Q1, we have seen end market strength primarily in clean fuel technology and expect higher volumes across each of the Ketjen businesses in 2024. Turning to Slide 10 and our financial position. As you know, during the quarter, we took action to maintain a solid investment grade credit rating and further enhance Albemarle's financial flexibility as we navigate this market down cycle. In March, we closed a $2.3 billion public preferred stock offering to fortify our competitive position and stay ahead of dynamic market conditions. Together, with the amended credit facility we discussed in February, these actions put Albemarle in a position to invest in and finish our last mile expansion projects, as well as capitalize on the secular growth trends we see in our core end markets of Mobility, Energy, Connectivity and Health. Following the offering, we repaid our outstanding commercial paper resulting in improved leverage. We ended the quarter with larger than normal cash balance and a primary of that cash will be to complete our in-flight capital project. Our balance sheet management highlights our focus on adopting to changing market condition and controlling the things in our control. Finally, turning to Slide 11 for a reminder of our capital allocation strategy. This is a slide you've seen before and we're touching on it briefly to acknowledge that our capital allocation priorities have not changed. We'll continue to selectively invest in high return growth, but we'll be patient and disciplined. Our near-term focus remains on operational execution and you can expect that our actions will be aligned with driving cost and productivity improvements, ramping our assets to full contribution and preserving our financial flexibility. While we believe current lithium prices are unsustainable for most of the industry in the long-term, we are managing to the current environment. To support our ability to reinvest and grow for the future, we are taking the prudent steps to right size our capital spending and cost structure, focusing on ramping our plants to full contribution and volume growth capture and taking steps to boost cash flow and enhance our financial flexibility. With that, I'll turn it back over to Kent to provide more details on the proactive actions Albemarle is taking in the current market to preserve long-term growth and value creation."
},
{
"speaker": "Kent Masters",
"content": "Thanks, Neal. Moving to Slide 12. We continue to believe in the EV transition and the growth in lithium demand, as well as the opportunity it creates for Albemarle. Despite a downshift in demand growth in Europe and the United States, global EV sales were up 20% year-to-date, led by strong growth in China, which represents over 60% of the global EV market. We continue to anticipate 2.5x lithium demand growth from 2024 to 2030. Additionally, we see battery size growing over time, driven by technology developments and EV adoption. These factors all translate to significantly higher global lithium needs. To put all this in perspective, we expect that this industry needs more than 300,000 metric tons of new lithium capacity every year to satisfy this growth. This means, we need more than 100 new lithium projects across resources and conversion between now and 2030 to support this demand. Moving to Slide 13. Albemarle is actively contributing to the progress of price discovery and efficiency in the lithium market. We have conducted four successful bidding events for chemical grade spodumene and battery grade carbonate. These events inform the market of real time physical trading dynamics and promote greater transparency in the evolving lithium market. While the majority of our sales will continue to be on long-term agreements with our core strategic customers, bidding events give us another sales channel to expand our market access. We have partnered with Metals Hub, an industry-leading source-to-contract platform to host efficient and transparent bidding events. On the slide, you can see a few of the ways we've designed these events to promote transparency and efficiency while meeting customer needs, including zero cost to participate, sealed bids and better confidentiality as well as the winning price disclosed to all bidders following the events conclusion. Going forward, you should expect that we will have a regular cadence of these bidding events, including additional products for sale in various jurisdictions. The primary reason for holding these bidding events is to drive fair and transparent price discovery, something that is good for all market participants. Looking at Slide 14. The Albemarle Way of Excellence remains our operational standard and continues to serve us well. Within the operating model, our focus continues to be on efficiency and ensuring our costs reflect the current environment. As I mentioned earlier, we remain on track to exceed our 2024 target of $280 million in productivity benefits through manufacturing, procurement and back-office initiatives. Recently, we've added cash management to our tracker to enhance cash flow with particular emphasis on optimizing our cash conversion cycle. Looking beyond our cost actions, we also remain focused on the other elements of our model. This quarter, we plan to publish our sustainability report and host our Fourth Annual Sustainability Day featuring key highlights of our sustainable approach and updates on our environmental targets. Moving now to Slide 15. We've said that our focus this year is on getting our in-flight projects to completion and full production, allowing us to drive near-term volume growth and cash flow. We're making solid progress on multiple fronts. The Salar Yield improvement project in Chile is ramping well and has achieved over 50% operating rates. This project allows us to increase lithium production while reducing carbon and water intensity through the application of innovative proprietary technology. It also allows us to capture the full benefits of the capacity expansion at the La Negra conversion facility. In Australia, the first 2 trains, Kimberton I and II are in start-up, ramp and qualification phases. Kemerton I recently achieved a key milestone of 50% operating rates for battery-grade product, and that product is currently in qualification. The remaining capital spend for these facilities is modest and our focus is on continuing to ramp the facilities and get production qualified with customers. At train 3, we are progressing through construction in a prudent way. In China, the Qinzhou plant is ramping on schedule and is expected to achieve nameplate capacity by mid-year. Meishan marked its grand opening in April and is progressing through commissioning having achieved a 50% operating rate for battery-grade material. The remaining capital spend on Meishan is relatively small and related to the ongoing start-up activities. Looking at Slide 16. Our in-flight projects put us in a position to deliver volumetric growth of approximately 20% per year from 2022 to 2027. First quarter sales volumes were recorded at 40,000 tons LCE. We expect 2024 total volumes weighted toward the second half of the year due to demand seasonality and project ramp. We also have the flexibility to toll or sell excess spodumene to maximize economic returns depending on market conditions as we exercise that ability in the first quarter by selling some chemical grade spodumene. Moving on to Slide 17. It's important to highlight the unique advantages that Albemarle has today and how we see those advantages translating to significant margin expansion and earnings generation in the near term. It all starts with our high-quality, low-cost resource portfolio, including the Salar de Atacama, Greenbushes, Wodgina and Kings Mountain. Our global portfolio is arguably the best in the industry. Large-scale, high-grade assets are also low-cost assets and the advantages they provide are not insignificant, as you can see on the left-hand side of this slide. Access to world-class assets is, in turn, one key factor to help us maintain robust energy storage margins across the cycle. For example, at the $15 per kilogram lithium price scenario, we estimate energy storage margins would normalize above 30% after adjusting for the temporal impacts from lower partner offtake at Talison and lower fixed cost absorption at our new plants. And that's before the tailwind of price upside. We estimate that every $1 per kilogram of LCE price improvement would translate to more than 200 basis points of margin expansion. We are also diversified across resource types and finished products, vertically integrated and able to source product from free trade agreement jurisdictions such as Australia, Chile and the United States. Turning to Slide 18. Our comments today reflect the competitive strengths that position Albemarle for success. Beyond our world-class resource base, additional competitive advantages include our process chemistry knowledge and manufacturing expertise allow us to efficiently operate large-scale assets and drive down operating cost. Our targeted innovations, product reliability and reputation for quality make us a trusted partner of choice for our customers and our people and stewardship are a point of pride and competitive strength. We have a proven management team that has operated through cycles and continues to lead with a disciplined mindset. On Slide 19, these factors give Albemarle a strong value proposition and position us to win in the market. Our strategy and path to capitalize on the opportunities align with attractive trends in mobility, energy, connectivity and health is clear. We will continue to lead with discipline and to scale and innovate, accelerate profitable growth and advance sustainability to drive value for shareholders. I hope to see some of you face-to-face at these upcoming events listed here on Slide 20. And with that, I'd like to turn the call back over to the operator to begin the Q&A portion."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question is from Aleksey Yefremov at KeyBanc Capital."
},
{
"speaker": "Aleksey Yefremov",
"content": "I just wanted to ask about your lithium volumes projection on Slide 16. If current prices don't change, can you get to these volumes and capacities, -- was that raising more equity or debt?"
},
{
"speaker": "Kent Masters",
"content": "Yes. So -- well, we forecast for the year looking out for the year, so 10% to 20%, and we've said we'd probably be at the upper end of that and those -- the volumes that we show are based on the capital program that the long-term volumes we show are based on the capital program that we have in place and the projects that we're executing currently and no need for additional capital for that."
},
{
"speaker": "Aleksey Yefremov",
"content": "And just as a follow-up, I mean you gave us scenarios for your EBITDA based on pricing. And I was hoping to get a similar idea for your medium-term CapEx. If say prices stay where they are today, would you be able to sustain your current level of CapEx in 2025? Or does CapEx need to come down to balance your cash needs?"
},
{
"speaker": "Kent Masters",
"content": "Yes. So if prices stayed where they were today, you'd see us ramping CapEx down. It takes us a little bit of time. So it's not -- we have a run rate that we think is kind of a minimum CapEx level of about -- to maintain assets about $1 billion a year. We wouldn't get there in '25, but kind of a run rate in line with that toward the end of '25, we could if we felt prices were going to stay where they are today."
},
{
"speaker": "Operator",
"content": "Our next question is from Arun Viswanathan of RBC Capital."
},
{
"speaker": "Arun Viswanathan",
"content": "I just want to get your thoughts on maybe fundamentals that you're observing in the lithium markets. These days, it sounds like there was some disruption in some spodumene production. There was some, I think, curtailments in China related to disposal waste altogether that has taken some production off the market and may potentially stabilize the price environment. Could you maybe highlight some of those issues for us and maybe describe the inventory side as well, what you're observing in both the downstream cathode manufacturers and upstream lithium producers."
},
{
"speaker": "Netha Johnson",
"content": "So let me start -- I'll start with that Eric can give you a little bit more detail on inventories. But I mean, you described the situation reasonably well. We've seen, as we expected, some production come offline, [indiscernible] in China and some higher cost spodumene resources. And we've seen price respond to that marginally, I would say, 15% or so change in price as a result of that. But that's what we thought the market would do. We don't really see it running dramatically up, and we still expect to see other resources coming off if prices stay where they are. So it's going to balance as the market kind of figures out exactly what price is doing and how production responds to that. So I think you'll see new projects that are planned coming off and struggling to get capital if we stay at prices like they are. So I think we're in a balancing mode at the moment. And we do expect to see additional resources come out. Eric, you want to talk about inventories?"
},
{
"speaker": "Eric Norris",
"content": "Sure. First of underneath that the other factor as important is demand. China stands as a market and start -- first of all, the majority of demand in the world, over 60% of the demand and start contrast to the U.S. or Europe with very strong growth you may have seen reported even in April growth that was quite significant for various automotive producers, BYD being up 49%. So there's very strong growth in China coming off of very low inventory levels. And that's obviously a favorable indicator for price in light of the pressure on producers at these price levels that Kent described. And the inventory more specifically, what we're seeing is inventory is pretty much at very low levels, ending in March, relatively speaking. So less than 2 weeks from a lithium producer standpoint, and about a week for downstream cathode company. That's in China. It's a little higher for battery producers -- or excuse me, for battery inventories. But again, at levels that are very low compared to the average we saw in 2023. So that, coupled with this demand signal we're getting from China, we see it as a positive signal for price going forward. And obviously, we'll have to -- we don't know for sure, but we'll watch that carefully. And should that happen, that will benefit our earnings going forward."
},
{
"speaker": "Arun Viswanathan",
"content": "And I know there's going to be a lot of other questions about lithium. So maybe I'll ask one on specialties. Do you see any risk maybe to given we're geographically where some of your resources are in Jordan, I know there's been some activity there, obviously. So -- maybe you can just give us your thoughts on -- is that part of what's leading you to the lower end of guidance for specialties? Or what else would you cite, I guess?"
},
{
"speaker": "Netha Johnson",
"content": "Yes, I think it's a fair assumption. There's always risk in the Middle East. But in terms of our operational, we've seen limited operational impact year-to-date, but the logistics is where the challenge is and we are incurring additional costs to secure those logistics out of that part of the world. So that's what's impacting our business. But that's different than what it was last year. So yes, that's definitely a risk in the second half. As we move into that for specialties."
},
{
"speaker": "Operator",
"content": "Our next question is from David Deckelbaum at TD Cowen."
},
{
"speaker": "David Deckelbaum",
"content": "I wanted to just follow-up on the outlook if prices were to stay the same. You've obviously seen the impact of lower near-term production at Greenbushes. And then obviously, you have CGP3 which is still under construction and ramping. We've heard from Wodgina with the third train kind of being deferred a bit. Do you anticipate any more I guess, corrective actions or responses under some of the JV spodumen facilities that you're involved with, if prices were to remain where they are today?"
},
{
"speaker": "Kent Masters",
"content": "So the -- look, the resources that we operate, and we have made adjustments just to the market condition, but I don't think we make further ones. These are world-class resources and the lowest cost position. So we still operate and make money at the pricing level there. These were investments that were kind of happening in the near term when we had opportunities to adjust the execution profile as we have our own conversion assets as well, and our partners agreed to that. So we've made some adjustments. But Long term, we still expect to exploit these resources because they are some of the best in the world."
},
{
"speaker": "David Deckelbaum",
"content": "I appreciate that. And I'm curious on the second question, just I think you've highlighted some EBITDA margin recovery in the second quarter with increased partner offtake at Talison and some variability there throughout the year. But as we think about your EBITDA margins in '24 versus '25, is there a ballpark range that you would estimate that commissioning new facilities has a sort of a drag on EBITDA margins this year versus next year? ."
},
{
"speaker": "Neal Sheorey",
"content": "Yes. David, this is Neal. Yes, absolutely. That's actually one of the reasons why we put that slide in the deck that showed that our range found that. I think that's Slide 17. So the way that we think about it, it's about a 500 basis point drag this year from the ramp-up of these new plants. Now you won't get all 500 basis points back in 2025 because obviously, we will still be working through the ramp of these facilities. But certainly, you can expect over the next couple of years as these facilities come up to full rate that you should start to see that margin expansion from those plants running full."
},
{
"speaker": "Operator",
"content": "Our next question is from Steve Byrne, Bank of America."
},
{
"speaker": "Rob Hoffman",
"content": "Rob Hoffman on for Steve Byrne. Out of the $280 million productivity benefits goal that you have set for 2024, given that you're already, I guess, above of $90 million in Q1, is this faster pace of Ketjen results and guidance."
},
{
"speaker": "Kent Masters",
"content": "So I think we're using the $280 million and as we forecast that out. It's still early in the year. We're probably a little ahead of schedule, but not ready to call it and build into our forecast that will beat that. But we'll be -- we're optimistic. We're comfortable with the program and the target is a pretty big target for us across the organization, and we feel pretty good on a run rate that we can meet that or maybe beat it, but we've not built that into our forecast."
},
{
"speaker": "Neal Sheorey",
"content": "Yes. And this is Neal. To the point of, can you see it in the financials, maybe just one example I'll give you is if you look at our SG&A line. So -- just remember that on the face of the income statement, our SG&A line includes about $35 million of onetime charges that was related to our restructuring activities that we announced in the first quarter. When you back that out and then look at our SG&A line versus the fourth quarter versus where we ended 2023, you will see about a $20 million to $25 million decline in our SG&A costs. So that gives you an idea that we are starting to see some traction on the productivity and restructuring savings that we already announced."
},
{
"speaker": "Rob Hoffman",
"content": "That's helpful. And just a follow-up in terms of your longer-term volume growth chart here, -- why doesn't the potential tolling volume go down over time? Wouldn't you generate higher margins at your own conversion plants?"
},
{
"speaker": "Eric Norris",
"content": "Actually your question, just to make sure I'm clear on it. This is Eric speaking. Why would we see tolling volume go down over time?"
},
{
"speaker": "Rob Hoffman",
"content": "Why volume go down."
},
{
"speaker": "Eric Norris",
"content": "Oh, I'm sorry. Yes, I think -- fair enough. You wouldn't -- it's all a factor of ramp of plants. Right, what it comes down to -- we have a plant in China Meishan that's ramping at a faster speed than the plant in Australia, and that has to do with operating experience. But if you look at this over a long-term basis, ultimately, we will -- our intention is to be fully integrated and to take all the available resources and convert them with company-built assets as opposed to tolling assets. Increasingly, those -- we would target those to be outside of the U.S., we have a considerable basis, as you know, today in China. But again, depending upon the speed with that, tolling always remains a flywheel, an option for us to go on the speed of branch to go to another alternative. But you're right, I mean, in time, that's why there's a plus/minus on that, it should come down. The [indiscernible] for the most part is a bridging strategy for us, sorry."
},
{
"speaker": "Operator",
"content": "Our next question is from Andres Castanos at Berenberg."
},
{
"speaker": "Andres Castanos",
"content": "I wanted to understand better why are you running spodumene auctions now? And to have a sense on what is the percentage of volume that goes in these options? Are in deals with dollars somewhat impacted by this."
},
{
"speaker": "Kent Masters",
"content": "Yes. So I'm not sure that is the last part of the question. Let me start on the front and you catch that in the follow-up if I don't answer your question. So we're doing the auctions, both on spodumene and on salts, the health transparency in the marketplace, price discovery to really understand, make the market a little clearer, a little more transparent. We get good information for it. And then we've decided to include spodumene as part of that just more transparency in the market, more knowledge that we get around that. And it's an opportunity for us to participate in a different part of the value chain. So it's not a change in our strategy of being an integrated producer. We'll sell most of our products through these long-term agreements on a salt basis as we have historically. So that strategy didn't change, but it's just it's an adjustment to take -- to try and get more transparency in the marketplace and then to sell spodumene a different value, a different product at a different value in the marketplace. So if there are dislocations, we can take advantage of that."
},
{
"speaker": "Andres Castanos",
"content": "Right. So I think it's a small percentage of the total volumes that essentially the deals with the tollers are still in place and they take the majority of the excess spodumene. My second question would be on the level of cost of inventory that you have at the moment for spodumene for the ones you take on board from Wodgina? Can you comment on that more or less where you sit versus the index?"
},
{
"speaker": "Eric Norris",
"content": "So I think the question was the cost of our spodumene inventory versus the index. So as we showed in our first quarter results, we are still working off a little bit of spodumene that went into inventory in prior periods, that is at a little bit higher cost than where it is today, and we documented how much of that was in our first quarter results in our EBITDA bridge. You can expect that there'll be a little bit more of that spodumene that we'll have to work off. But for the most part, you will start to see a spodumene costs rolling through our COGS that is consistent with what is in the market as we get towards the middle of the year and in the back half of the year. And that's built into the outlook scenarios that we've been publishing."
},
{
"speaker": "Operator",
"content": "Our next question is from John Roberts at Mizuho Securities."
},
{
"speaker": "John Roberts",
"content": "Last quarter, Slide 13 on Greenbush has discussed the lag and the lower cost of market issue. It projected a spodumene inventory cost for the March quarter of about $4,000 a ton. Does that play out the way you projected last quarter?"
},
{
"speaker": "Neal Sheorey",
"content": "John, so this is Neal. We would have to check your numbers. One of the big adjustments we made in the fourth quarter was that LCM, which really collapsed the gap that we previously had, that sort of 6-month lag that we had in the spodumene cost and how it rolls through cost of goods sold. Now even after taking the LCM, we did still -- prices did still come down as we started the first quarter. So we did still have a little bit of higher-priced spodumene that rolled through our P&L. But I think the numbers you're referring to maybe are before we took the LCM adjustment, and we collapsed a lot of that gap with that adjustment."
},
{
"speaker": "John Roberts",
"content": "Yes. All right. And then have your thoughts on the role of catching in the portfolio changed at all since the last call?"
},
{
"speaker": "Neal Sheorey",
"content": "I would -- no, I would say. But look, we're -- we've said it's not a core business for us. So we would look to divest that at some point. But -- and we went through a process, which we talked quite a bit about didn't get the value wanted. So we're doing a turnaround. That program is going pretty well, but we would still anticipate doing a transaction on that business when the timing is right."
},
{
"speaker": "Operator",
"content": "Our next question is from Christopher Parkinson at Wolfe Research."
},
{
"speaker": "Harris Fein",
"content": "This is Harris Fein on for Chris. So I'm not sure if I'm reading too much into this. You left the EBITDA sensitivity is unchanged, but also volumes seem like they're trending towards the high end of the guide. Is it wrong to think that EBITDA will trend to the higher end of those ranges as well, all else equal?"
},
{
"speaker": "Kent Masters",
"content": "Yes. Actually, it's a fair assumption. Basically, the way that we constructed those EBITDA ranges reason their range is driven by that volume consideration that we have, the 10% to 20%. So I think all things being equal, that's a fair assumption to make."
},
{
"speaker": "Harris Fein",
"content": "Then for my follow-up, there are a lot of moving pieces in the cash flow guide. I guess when I look at the reasoning for the lower conversion rate this year, it doesn't seem like those things are necessarily going away after this year, like you'll always be ramping projects. So how are you thinking about the operating cash conversion going forward?"
},
{
"speaker": "Neal Sheorey",
"content": "Well, actually, I have a little different viewpoint on that. I do think that our cash conversion should be improving in 2025 for a few reasons. Number one, as I mentioned or as we mentioned in the prepared remarks, our cash taxes are very similar this year to what we had last year, and that's primarily because of Australia, and we're paying taxes based on income from last year. If you assume that pricing is sort of flat for the rest of the year, I think you should assume that our cash taxes will be lower next year, all things being equal. The other part is that our facilities are so far, as you heard in Kent's remarks, ramping quite well. And so we would expect that those will start to contribute as we get into the back end of this year and into 2025. And as Kent mentioned, right now for where we are, the ramp that you see in our volume growth is just based on the projects that we are finishing up right now and are ramping right now. So we won't be ramping plants forever, that will most certainly come to an end and those plants will begin contributing and the back half of this year and into 2025. So I do anticipate our cash conversion to get better."
},
{
"speaker": "Eric Norris",
"content": "Yes. And just a little finer point on Neal's point, I mean we are those -- the new plants that are ramping will be as we grow, our business grows, they become a smaller part of the portfolio. So we'll still be building new plant and ramping over time, but they become a smaller percentage of the portfolio. And then at the moment, we have a lot of plants ramping in that particular phase. I didn't necessarily plan it that way, but that's how it's worked out. We've got, I think, 4 plants actually ramping now at the same time. And that's not the plan. Going forward, it won't be that many. And if they were, it would be a smaller part of the portfolio just because we've grown."
},
{
"speaker": "Operator",
"content": "Our next question is from Kevin McCarthy at Vertical Research Partners."
},
{
"speaker": "Matt Hettwer",
"content": "This is Matt Hettwer on for Kevin McCarthy. Regarding the spodumene and carbonate auctions that you just touched on, what does the customer feedback been like? And how has the auction participation rates trended?"
},
{
"speaker": "Eric Norris",
"content": "Matt, this is Eric. We've got very good participation. We're very early in our process. And so we're very -- with a qualification process to make sure we're -- we're inviting people to these auctions that meet certain standards, but that's growing over time. The participation rate we received and the corresponding conversion of those invited versus those who put in a bid has been strong. The interest has been, therefore, good and the outcome has been well received what we think about the market, particularly from a price reporting agency, we found that these through the normal surveying process, the results of these bids have found their way into the price reporting agencies. Of course, they determine how they use that in their next calculations, but it's our anticipation that they're lending there as well. And then as we turn to the -- to our sort of contracted customer base, they appreciate that what we're doing is better understanding in what is a pretty immature market how -- what the drivers are, as Kent was referring to different types of prices, whether that's inside the country, outside of country or an IRA compliant, non-RA compliant product or a spodumene versus a better grade carbonate. It's giving us better intelligence to better segment, understand what's happening in the market and a lot of the same for our customers in the contract side ultimately because that would be reflected in the indices they referenced."
},
{
"speaker": "Matt Hettwer",
"content": "And then as a follow-up, I believe in the prepared remarks, you mentioned expanding the auctions to other geographies and products. What other geographies are you looking at? And in the future, might you include hydroxide in the auctions?"
},
{
"speaker": "Eric Norris",
"content": "Yes. So I touched on a little bit when I talked about IRA compliant. But just as reference, almost -- actually, all 4 auctions that we've done today have all been inside of China with available inventory on the ground there. We'll be looking for product outside of China shipped on a CIF basis, for example. We'll be looking at that certainly for our Australia product. We'll be looking at it for [indiscernible] compliance ship to the U.S. and across our product range, including hydroxide."
},
{
"speaker": "Operator",
"content": "Our next question is from Ben Isaacson at Scotia Capital, Inc."
},
{
"speaker": "Apurva Kilambi",
"content": "This is Apurva on for Ben. So we're heading into what has historically been a peak buying season in China just off of the earlier comments on demand, are you starting to see this restocking materialize?"
},
{
"speaker": "Eric Norris",
"content": "Yes, this is Eric. As I pointed out, we've seen inventories at a fairly low level, ending in March, and I do think a part of the demand is to restock in anticipation of the midyear and into later year seasonality of EVs. It's one reason why it's very hard to look at Q1 sales of EVs and correlate that to real on-the-ground demand because the EVs that are being sold in the first quarter this year were lithium for that was sold late last year -- middle of the late of last year. And we are seeing -- I think it's a part of the demand that I referred to earlier, it's not only fundamental demand for what our increased EV sales that are coming in that -- we see in April and we expect in May and June, but also it's a result of some restocking because some of the levels of which inventory gone to, it just weren't sustainable for these operations to run without taking considerable risk of not being able to meet demand."
},
{
"speaker": "Apurva Kilambi",
"content": "Great. And as my follow-up, looking back with your 10-K, you actually published an updated technical report on Greenbushes. With that report, we saw something of a step down in both grades and recoveries and concurrently, costs have moved upwards. Given those technical effects, where do you see the next phase of resource growth coming from for Greenbushes."
},
{
"speaker": "Eric Norris",
"content": "Well, that's you're correct. You're referencing a report that we published on our SEC guidelines, which are have a different standard. It's not uncommon in mining for different standards around the world and different standards are more strict and how they should be exercised and that produced some of the results you're describing. This is still even in that report on a relative basis the best spodumene resource reported in the world. And our aims are to continue, as we've described to -- we are now executing with our joint venture partners at CGP3 expansion. There is the possibility long term, although we have not announced this formally or committed to it for further expansion of CGP4 and continued operation of that operation at its current grid reported for quite some years, decades to come. So our intention is to maximize that resource given its low cost potential."
},
{
"speaker": "Operator",
"content": "Our next question is from Michael Sison at Wells Fargo Securities."
},
{
"speaker": "Michael Sison",
"content": "Good start to the year. You have a slide on sort of minimum capital and I think the line looks like billion. So if hiking kind of stays here, is that where CapEx will go in '25. And what would that mean to your capacity potential in longer term if that has to be the case."
},
{
"speaker": "Neal Sheorey",
"content": "Yes. So I think we've commented on that earlier. So we can -- we would look at the billion that's kind of maintenance capital for us around to maintain our assets and continue to operate there. And we could -- if we -- if prices stay where they are, we could get to that kind of on a run rate by the end of '25, so '26 number, so to speak. '25 would be a little bit higher, but we get to the run rate by '25. That would impact our long-term growth if we went to that level. So the current planning that we have, the projects we're executing at the moment, get us kind of a 20% growth rate through '27 or so. And if we were to cut back to those levels, we'd impact that materially beyond that."
},
{
"speaker": "Michael Sison",
"content": "And as a follow-up, your EBITDA margins for any storage, they're pretty good. And I know you think we need -- you need higher pricing for the industry. So I mean, what price do you think lithium needs to be at to support the growth that is expected for the end of the decade, and maybe any thoughts on where you think others around the world who are -- where their margins are because yours are again, from a -- are pretty good, not as good as it used to be, but I think there's still a pretty good margin."
},
{
"speaker": "Eric Norris",
"content": "Right. So I'm not going to comment on other people's margins. But if we stay where we are, we can operate at about -- at a 30%-ish type margin rate once we get the noise out of the P&L, that kind of the transition from the big prices and some of the spodumene costs. So on a run rate we could get to around 30% and still grow our business for us. I think that's the good margins that you're talking about. We've had stronger margins than that, and they would be stronger if prices move up. The issue with price is really about returns on new investment projects more than it is about our existing business, P&L and the margins that we can deliver. So prices need to move up in order to develop new projects to get the growth the industry needs to support the EV transition. I'm not going to comment on because it's different by every project and every geography as to what price you need and you need to believe that for 10 or 15 years in order to get a return on the project when you go through FID. So I can't say a number and if I had one, I probably wouldn't say it, but they are different by geography, by region, by technology, what the resource looks like. So it's quite different. There's no way to pick one particular number."
},
{
"speaker": "Operator",
"content": "Our next question is from Joshua Spector of UBS."
},
{
"speaker": "Chris Perrella",
"content": "It's Chris Perrella on for Josh. I just wanted to follow up on Neal, the 2Q Energy Storage EBITDA margin that you guided to, given the puts and takes, you have the higher cost spodumene inventory, which is maybe a $50 million drag in the second quarter, but you also have the one-off from Talison. So how does that bridge together to get to your 2Q margin? And then does it step down with the absence of the Talison one-off in the second half of the year?"
},
{
"speaker": "Neal Sheorey",
"content": "Yes. So I think if I -- let's talk about the second quarter first. So basically, the way to think about this, I think your numbers are probably all in the right kind of range. If you do the math based on the first quarter and what we said in the prepared remarks that we expect about a 10-point bump in energy storages, EBITDA margin in the second quarter. You probably will get into the range of about $100 million bump to EBITDA Q2 versus Q1. And that's really just driven primarily by the expectation that all partners are taking their allotment off of Talison plus we have that additional 200,000 tons that is getting offtake in the second quarter as well. And so that's basically what serves as the basis for the 10 percentage point bump. In terms of then going forward, it is sort of a onetime bump up. And then what you should expect in the third and the fourth quarter is that we'll come back down to again, pretty healthy margins. It won't be as healthy as the second quarter. But you can expect that we will, as our plants continue to ramp up and we continue to absorb fixed cost, that will continue to get some margin expansion versus the first quarter, for sure, in the third and the fourth quarters as we exit the year."
},
{
"speaker": "Chris Perrella",
"content": "That's perfect. And then a quick follow-up. Sequentially into the second quarter, do you expect volumes to be up? I'm just trying to bridge the seasonality to get to the 190 [indiscernible] for the full year?"
},
{
"speaker": "Neal Sheorey",
"content": "Yes. So we will have volume -- at least sequentially, what you're asking about is, yes, we will have some higher volumes as we get into Q2 versus Q1. Remember that the peak for energy storage demand is usually in the third quarter. So we're building to that peak. So it won't be the highest quarter of the year. But yes, I would expect that you'll see a little bit higher volume in Q2 versus Q1."
},
{
"speaker": "Operator",
"content": "Our next question is from Colin Rusch at Oppenheimer."
},
{
"speaker": "Colin Rusch",
"content": "Given the dynamics around geopolitical positioning on manufacturing for batteries and some of the evolution of the tariffs that we're seeing on the solar side and other areas. Can you talk a little bit about the importance of refining and your thought process around that importance in North America as you enter into the balance of this year and next year?"
},
{
"speaker": "Netha Johnson",
"content": "Yes. So okay, interesting question. So the politics is playing into the market significantly, and we've got the integrated strategy. So we've got a good resource position, and it's spread around the world, so we have nice diversity around that. And we've built conversion. So we have conversion in Chile, in the U.S., lower scale at the moment. And Australia and China. So we're spread around the world, and we've got nice diversity around that and it allows us to kind of plan for some of these aspects. So our goal would be to have larger scale conversion in North America to satisfy the North American market and we are -- but we've paused on that a little bit, just on some of the issues that you've described, price being a big one, how geopolitics plays into it. And we're going to use that pause to figure out exactly what we do around that."
},
{
"speaker": "Colin Rusch",
"content": "Okay. Great. And then in terms of some of the evolving cathode chemistries, obviously, we're seeing some activity around Delta LFP, and I'm assuming that the precursor materials are evolving a little bit. Can you talk a little bit about some of the specific adjustments that you're making around some of the refining processes to meet those cathode needs in a more tangible way as you go through the balance of this year and into next year?"
},
{
"speaker": "Neal Sheorey",
"content": "Yes. I'll start on that. Eric can fill in the gaps. I think -- I mean the biggest thing for us at the moment is with the primary products around hydroxide and carbonate is balancing that. So as LFP has become more prevalent. It's got stronger demand on carbonate and we've been a stronger -- a larger percentage of our portfolio is carbonate historically. We've been building out hydroxide and then balancing those 2 is understanding where those chemistries go. And then long term, it's going to be about solid state and then how you shift from so much -- be more about carbonated hydroxide to about lithium metal. But that's a longer-term scenario. The carbonate hydroxide is playing out in the assets we're building now."
},
{
"speaker": "Eric Norris",
"content": "Yes. So Colin, just a little shed more color around that. I would say that we still see a market that is for hydroxide, high nickel is favored outside of China versus in with carbonate and supporting LFP being a very big part of the China market. The innovations that have been coming out of -- largely out of China and LFP chemistries for higher energy density and efficiencies as well as the cost profile of that cathode are obviously very increasingly now interesting to the West. And so we expect that. Certainly, our Chile position is in a position of power in which we can supply into that opportunity. We'll watch that carefully. As Kent talks about -- had talked about earlier about pausing the investment here in the U.S. or North America to figure out in this uncertain market direction and develop our own strategy there. One of those -- one of the components of that has to be on the assessment of LFP in the U.S., and that will be will be part of that equation as well."
},
{
"speaker": "Operator",
"content": "Our final question is from Patrick Cunningham at Citi."
},
{
"speaker": "Patrick Cunningham",
"content": "In the past, you've talked about the marginal cost of production being $20 [indiscernible] and maybe new projects pushing that curve up over time. Do you still believe that to be the case given we've seen relatively tepid supply response at current prices?"
},
{
"speaker": "Kent Masters",
"content": "Yes, it changes -- it changes over time with volumes in the industry. But most new projects come on are going to be higher on the cost curve and moving that up. So we still think that within a $1 or $2, the accuracy of that. But I think we still believe that fundamentally is about the target of marginal cost today."
},
{
"speaker": "Patrick Cunningham",
"content": "Got it. And then just a quick follow-up. Did price floors play a meaningful impact with price levels in the low teens for a good part of the quarter?"
},
{
"speaker": "Eric Norris",
"content": "I'm sorry, your question was -- the price floor impact on our realized price for the quarter? Or was that the question?"
},
{
"speaker": "Patrick Cunningham",
"content": "Yes, yes. Was there meaningful impact."
},
{
"speaker": "Eric Norris",
"content": "Let's put it this way. We don't disclose a lot of our price floors, and they tend to range because often based on age of contracts. At current prices, some of those floors, some are being tested, floors have held. And so we certainly are seeing the floors come into play for some of our business."
},
{
"speaker": "Operator",
"content": "Thank you. That's all the time we have for questions. I will now pass it back to Kent Masters for closing remarks."
},
{
"speaker": "Kent Masters",
"content": "Okay. Thank you, and thank you all for joining us today. We continue to innovate, adapt and lead the world in transforming essential resources into the critical ingredients for modern living with people and planet in mind. We are focused on continuing to be the partner of choice for our customers and investment of choice for both the present and the future. Thank you for joining us."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. Thank you for your participation. You may now disconnect."
}
] |
algn | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Greetings. Welcome to the Align Fourth Quarter and Full Year 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to your host, Shirley Stacy with Align Technology. You may begin."
},
{
"speaker": "Shirley Stacy",
"content": "Good afternoon, and thank you for joining us. I'm Shirley Stacy, Vice President of Corporate Communications and Investor Relations. Joining me for today's call is Joe Hogan, President and CEO, and John Morici, CFO. We issued fourth quarter and full year 2024 financial results today via Business Wire, which is available on our website at investor.aligntech.com. Today's conference call is being audio webcast and will be archived on our website for approximately one month. As a reminder, the information provided and discussed today will include forward-looking statements, including statements about Align's future events and product outlook. These forward-looking statements are only predictions and involve risks and uncertainties that are described in more detail in our most recent periodic reports filed with the Securities and Exchange Commission available on our website and at sec.gov. Actual results may vary significantly, and Align expressly assumes no obligation to update any forward-looking statement. We've posted historical financial statements with corresponding reconciliations, including our GAAP to non-GAAP reconciliation, if applicable, and our fourth quarter and full year 2024 conference call slides on our website under Quarterly Results. Please refer to these files for more detailed information. With that, I'll turn the call over to Align Technology's President and CEO, Joe Hogan. Joe?"
},
{
"speaker": "Joe Hogan",
"content": "Thanks, Shirley. Good afternoon, and thanks for joining us today. On our call today, I'll provide an overview of our fourth quarter and full year results and discuss a few highlights from our two operating segments, System Services and Clear Aligners. John will provide more detail on our financial performance and comment on views for 2025. Following that, I'll come back and summarize a few key points and open the call to questions. I'm pleased to report that Q4 total revenues, Clear Aligner volumes, Systems and Services revenues were in line with our Q4 outlook, and both GAAP and non-GAAP operating margins were better than our Q4 outlook. Q4 Clear Aligner ASPs were lower than our Q4 outlook due primarily to the impact of unfavorable foreign exchange from the strengthening the US dollar against major currencies from late October through December, as John will explain in his remarks. On a year-over-year basis, fourth quarter revenues of $995 million increased 4%, reflecting 14.9% growth from Systems and Services revenues and 1.6% growth from Clear Aligner revenues. On a year-over-year basis, Clear Aligner volumes grew 6.1%, driven by increased shipments across all regions with strength in EMEA, APAC and LatAm regions and stability in North America. From a channel perspective, Clear Aligner volumes in the ortho and GP channels were up a year-over-year basis with a number of submitters and utilization amongst the highest in the past few years. On a sequential basis, fourth quarter revenue growth of 1.8% reflects continued momentum from sales of iTero Lumina scanners and increased Invisalign Clear Aligner volumes in the EMEA region, especially from teens and growing patients as well as growth from the LatAm regions. Across the orthodontists and GP dentists offset by clear aligner seasonality in in APAC, mostly China, which had a strong teen quarter in Q3. For the Americas, Q4 Clear Aligner volumes reflect a seasonally soft orthodontic channel, offset somewhat by strength in the GP channel in the adult segment. For the full year 2024, total revenues of $4 billion and Clear Aligner volumes of 2.5 million cases were both up 3.5% year-over-year. We delivered fiscal 2024 non-GAAP operating margin of 21.8%, above fiscal 2023 and in line with our 2024 outlook. As of Q4 2024, we achieved several cumulative milestones, including 272,000 active Invisalign trained practitioners, 19.5 million Invisalign patients, including over 5.6 billion teens and kids and over 2 billion clear aligners manufactured worldwide. For clear aligners in Q4, year-over-year volume growth in the Americas reflects strength in Latin America as well as improving trends in North America, especially for GP dentists. In the EMEA region, Q4 year-over-year Clear Aligner volume growth reflects increased volumes from core Europe as well as strong growth from EMEA, Eastern Europe, Middle East and Africa markets. From a channel perspective, EMEA Clear Aligner growth reflects strength in both ortho and GP as well as teens, kids and adult patients. In APAC region, Q4 year-over-year Clear Aligner volume growth was driven by China and Japan, as well as strong growth from our emerging APAC countries led by India, Thailand and Korea. For Q4, APAC growth also reflects increased utilization and submitters in both doctor channels and growth in both patient segments. Q4, we had 85,700 doctors submitters worldwide, a record total in the fourth quarter, primarily reflecting a sequential increase in clear aligner volume for adults and non-comprehensive cases. In the adult clear aligner segment, we're pleased to see both year-over-year and sequential growth across all regions. In the teen and growing kids segments, approximately 216,000 teens and kids started treatment with Invisalign Clear Aligners during the fourth quarter, a decrease of 8.6% sequentially off a record Q3 teen season and an increase of 9.8% year-over-year, reflecting growth across regions, especially from Invisalign First in the APAC and EMEA regions. For Q4, number of doctors submitting cases starts for teens and kids was up 6.2% year-over-year, led by continued strength from doctors treating young kids or growing patients. For fiscal 2024, Total Invisalign Clear Aligner shipments for teens and kids reached a record total of 868,000 Invisalign cases and shipped up to -- a year up to 7.7% compared to the prior year and comprising approximately 35% of the 2.5 million total Clear Aligner case shipments for the year. Teen-specific consumer marketing and sales programs, along with the continued momentum for Invisalign First for kids as young as six and Invisalign Palatal Expander systems help drive adoption globally. During the quarter, we continued to commercialize the Invisalign Palatal Expander with steady momentum for doctor's submitters and shipments. In its first full year of availability in North America, Invisalign Palatal Expander adoption was followed by similar trajectory in Invisalign First, which launched 2017. But Invisalign First did not require regional or country-specific regulatory approvals like Invisalign Palatal Expander is required. In Q4, we received the CE mark under the medical device regulation to market the Invisalign Palatal Expander system in most of Europe and also completed registration with the Medicines and Healthcare Products Regulatory Agency for the United Kingdom and overseas territory. Both approvals are for broad patient applicability, including growing children, teens and adults with surgery or other techniques. These approvals mark a significant milestone in our efforts to enhance clinical outcomes and efficiency in orthodontics and enable us to commercialize the Invisalign Palatal Expander across most of the major EMEA region in 2025. We are continuing to make progress in establishing the clinical efficacy and improved patient experience of Invisalign Palatal Expander, which recently made to cover of the Journal of Clinical Orthodontics, or JCO, and an article published by Dr. Jonathan Nicozisis. There have been multiple peer review studies published on the effectiveness of the Invisalign Palatal Expander as well as mandibular advancement. We also are receiving positive parental feedback, as reflected in the article, 7 Reasons Parents Love the Invisalign Palatal Expander System. Overall, the Invisalign Palatal Expander system is gaining traction among orthodontists and patients due to its innovative design and user-friendly feature. As more clinical data becomes available and practitioners gain experience with the device and parents become informed, we believe adoption will continue to grow. Q4 non-case revenues were up year-over-year, primarily due to continued growth in retainers and our Doctor Subscription Program, or DSP, including non-Invisalign patients at getting retainers. Non-case revenues, including our Vivera Retainers, retention aligners ordered to our Doctor Subscription Program, clinical training, education, accessories and e-commerce. DSP also includes Invisalign touch-up cases, which includes up to 14 stages and is currently available in North America and certain countries in Europe and was most recently launched in Brazil. For Q4, total Invisalign DSP touch-up cases were up nearly 37% year-over-year to more than 27,000 cases. For fiscal 2024, total DSP touch-up cases shipped were over 100,000, up 37% compared to 2023. 224 Clear Aligner volume from DSO customers increased sequentially and year-over-year, reflecting growth across all regions. The DSO business continues to outpace our retail doctors globally. And in the U.S., it's driven by our largest DSO partners, Smile Doctors and Heartland Dental, and also had strong growth in iTero scanner sales as DSO invested in their members' practices end-to-end digital workflows. In December, we completed $30 million equity investment in Smile Doctors, the largest orthodontic focused DSO in the U.S. with more than 450 locations in 32 states. Smile Doctors has a rich history of developing and growing affiliated practices by providing tools and technology that allow their orthodontists to focus entirely on patient care, and we are continuously exploring collaboration with DSOs that share our vision of furthering the adoption of digital dentistry. Each DSO has a different strategy and business model. We're focused on working and with encouraging the DSOs aligned with our vision strategy and business model goals. Those DSOs that recognize the benefits of digital workflows enabled by our portfolio of products and services that make up the Align digital platform, including increased practice efficiency and profitability, as well as delivering a better patient experience for shorter cycle times and proximity to their customers. Turning to Systems and Services. Q4 was another strong quarter, with year-over-year revenue growth of 14.9%. On a sequential basis, Q4 Systems and Services revenues were up 5.2%. In Q1 2024, we launched the iTero Lumina with orthodontic workflows as a new stand-alone scanner, or as a wand upgrade from our iTero Element 5D Plus scanner. Overall, we continue to be very pleased with the ongoing adoption of iTero Lumina scanner, and we're looking forward to building on its success with the launch of the iTero Lumina scanner with restorative capabilities. During the fourth quarter, we began a limited market release of our restorative software on the iTero Lumina scanner, and doctor feedback has been outstanding. Our iTero Lumina innovation represents continuous advancement in our mission to deliver unparalleled value to customers and dental professionals worldwide. Doctors can continue to purchase the current version of iTero Lumina scanner today, knowing that it will automatically update to the new version free of charge once it becomes available at the end of March. With that, I'll now turn the call over to John."
},
{
"speaker": "John Morici",
"content": "Thanks Joe. Now, for our Q4 financial results. Total revenues for the fourth quarter were $995.2 million, up 1.8% from the prior quarter and up 4% from the corresponding quarter a year ago. This reflects an increase in clear aligner volumes up 1.9% sequentially and 6.1% year-over-year and revenue growth from Systems and Services of 5.2% sequentially and 14.9% year-over-year. On a constant currency basis, Q4 2024 revenues were favorably impacted by approximately $0.8 million or approximately 0.1% sequentially and were unfavorably impacted by approximately $0.9 million year-over-year or approximately 0.1%. For Clear Aligners, Q4 2024 revenues of $794.3 million were up 0.9% sequentially, primarily from higher volumes, geographic mix shift to higher-priced countries, and lower net revenue deferrals, partially offset by product mix shift to lower-priced products and higher discounts. Q4 Clear Aligner revenues were favorably impacted by approximately $0.7 million or approximately 0.1% from foreign exchange sequentially. Q4 2024 Clear Aligner per case shipment of $1,265 was lower by $10 on a sequential basis, primarily due to product mix shift and higher discounts, partially offset by favorable geography mix and lower net deferrals. Even though FX had a minor impact on our reported quarter-over-quarter results, our Q4 guidance did not forecast any substantial change from the October spot rate foreign exchange rates. However, the U.S. dollar unexpectedly strengthened in November and December. If foreign exchange rates in October had remained constant for November and December, then Clear Aligner ASPs would have increased approximately $10 quarter-over-quarter, or the equivalent of $14 million. On a year-over-year basis, Q4 Clear Aligner revenues were up 1.6%, primarily from higher volumes, lower net deferrals, price increases, and higher non-case revenues, partially offset by lower ASPs, reflecting the impact from unfavorable foreign exchange of $0.7 million or approximately 0.1% product mix shift to lower-priced products and geographic mix. Q4 2024 Clear Aligner per case shipment of $1,265 was down $55 on a year-over-year basis due to the impact of U.K. VAT of $13, product and geographic mix, and higher discounts, partially offset by lower net revenue deferrals and price increases. During Q4, we reached a favorable outcome with the U.K. tax authorities regarding cumulative assessments of approximately $100 million for unpaid VAT related to certain Clear Aligner sales made during the period of October 2019 through October 2023. In Q4, we received a full refund of this $100 million from U.K. tax authorities. This settlement also relieved us of any potential assessments for sales through mid-October 2023. As a result, we have approximately $7 million of VAT paid for periods up to December 2023 that are still in dispute. We expect a ruling by the UK courts in the first half of 2024 for this remaining VAT amount. This ruling will also give clarity whether a 20% VAT is required to be applied to all Clear Aligner sales in the UK going forward. We believe that Clear Aligner should continue to be exempt from that. Clear Aligner deferred revenues on the balance sheet as of December 31, 2024, decreased $51.3 million or 4.1% sequentially and decreased $92.1 million or 7% year-over-year and will be recognized as the additional aligners are shipped under each sales contract. Q4 2024, Systems and Services revenues of $200.9 million were up 5.2% sequentially, primarily due to higher scanner volumes, higher non-systems revenue, driven by iTero Lumina upgrades, partially offset by lower scanner ASPs. Q4 2024, Systems and Services revenue were up 14.9% year-over-year, primarily due to higher scanner volumes, higher ASP and increased non-systems revenues, mostly related to upgrades and leasing rental programs. Q4 2024, Systems and Services revenue impact by foreign exchange was approximately $0.1 million, flat sequentially. On a year-over-year basis, Systems and Services revenues were unfavorably impacted by foreign exchange of approximately $0.2 million or approximately 0.1%. Systems and Services deferred revenue on the balance sheet was down $4.1 million or 1.8% sequentially, and down $40.3 million, or 15.5% year-over-year, primarily due to the recognition of service revenues, which are recognized ratably over the service period. The decline in deferred revenues, both sequentially and year-over-year, primarily reflects the shorter duration of service contracts applicable to initial scanner purchases. Moving on to gross margin. Fourth quarter overall gross margin was 70%, up 0.3 points sequentially and flat year-over-year. Overall, total gross margin was not significantly impacted by foreign exchange sequentially or on a year-over-year basis. Clear Aligner gross margin for the fourth quarter was 70.2%, down 0.1 points sequentially due primarily to lower ASPs and restructuring costs, partially offset by lower manufacturing costs. Clear Aligner gross margin for the fourth quarter was down one point year-over-year, primarily due to lower ASP and restructuring costs, partially offset by lower additional aligners. Overall, Clear Aligner gross margin was not significantly impacted by foreign exchange sequentially or on a year-over-year basis. Systems and Services gross margin for the fourth quarter was 69.4%, up 1.9 points sequentially due to lower manufacturing and freight costs, partially offset by lower scanner ASPs. Systems and Services gross margin for the fourth quarter was up 4.7 points year-over-year due to manufacturing efficiencies and lower freight costs and service cost and higher scanner ASPs. Overall, Systems and Services gross margin was not impacted by foreign exchange sequentially or on a year-over-year basis. Q4 operating expenses were $552.8 million, up 6.4% sequentially and up 11% year-over-year. On a sequential basis, operating expenses were $33.3 million higher due primarily to restructuring costs. Year-over-year operating expenses increased by $54.8 million, primarily due to restructuring, advertising and marketing expenses. Q4 restructuring charges related to severance for impacted employees were higher than anticipated. On a non-GAAP basis, operating expenses were $474.7 million, up 0.4% sequentially and up 6.3% year-over-year. Our fourth quarter operating income of $144.1 million resulted in an operating margin of 14.5%, down 2.1 points sequentially and down 3.4 points year-over-year. Operating margin was favorably impacted by foreign exchange of approximately 0.1 points sequentially and unfavorably impacted by 0.2 points year-over-year. The effective restructuring on GAAP operating margin was approximately 3.7 points. Q4 non-GAAP operating margin was 23.2%, up 1.1 points sequentially and down 0.6 points year-over-year. Interest and other income and expense net for the fourth quarter was an expense of $3.4 million compared to income of $3.6 million in Q3 2024, primarily due to unfavorable foreign exchange movements of $15.3 million, partially offset by higher interest income and gain on investments. On a year-over-year basis, Q4 2024 interest and other income and expense was unfavorable compared to income of $1.3 million in Q4 2023, primarily due to unfavorable foreign exchange movements, partially offset by higher interest income and gain on investments. The GAAP effective tax rate in the fourth quarter was 26.3% compared to 30.1% in the third quarter and 28.3% in the fourth the fourth quarter of prior year. The quarter GAAP effective tax rate was lower than the third quarter effective tax rate primarily due to the release of uncertain tax position reserves, partially offset by onetime deferred tax adjustments in certain foreign jurisdictions. The fourth quarter GAAP effective tax rate was lower than the fourth quarter effective tax rate of the prior year, primarily due to the release of certain tax position reserves, partially offset by one-time deferred tax adjustments in certain foreign jurisdictions. On a non-GAAP -- our non-GAAP effective tax rate in the fourth quarter was 20%, which reflects our long-term projected tax rate. Fourth quarter net income per diluted share was $1.39, down $0.16 sequentially and $0.25 compared to the prior year. Our Q4 2024 EPS was unfavorably impacted by a stronger US dollar, which amounted to approximately $0.14 per diluted share to net foreign exchange losses related to the revaluation of certain balance sheet accounts. On a non-GAAP basis, Q4 2024 net income per diluted share was $2.44 for the fourth quarter, up $0.9 sequentially and up $0.02 year-over-year. Moving on to the balance sheet. As of December 31, 2024, cash and cash equivalents were $1,043.9 million, up sequentially $2 million and down $106.4 million year-over-year. Of our $1,043.9 billion balance, $188.7 million was held in the US and $855.2 million was held by our international entities. During Q4 2024, we initiated a plan to repurchase $275 million of our common stock through open market repurchases. As of December 31, 2024, we had purchased approximately 0.9 million shares at an average price of $222.94 per share for an aggregate of approximately $202.9 million. The remaining $72.1 million of the $275 million was completed in January of 2025. As of January 30, 2025, $225 million remains available for repurchases of our common stock under our stock repurchase program approved in January of 2023. As Joe mentioned earlier, during the quarter, we completed a $30 million equity investment in Smile Doctors, the largest ortho-focused dental support organization in the US. Q4 accounts receivable balance was $995.7 million, down sequentially. Our overall days sales outstanding was 90 days, down approximately three days sequentially and up approximately five days as compared to Q4 last year. Cash flow from operations for the fourth quarter was $286.1 million. Capital expenditures for the fourth quarter were $23 million, primarily related to investments in our manufacturing capacity and facilities. Free cash flow, defined as cash flow from operations less capital expenditures, amounted to $263 million. Before I turn to our Q1 and fiscal 2025 outlook, I'd like to provide the following context around pricing and potential new tariffs. On March 1, 2025, we will raise the list price of clear aligners by about 3% on average in the Americas and EMEA regions. At the same time, we will remove the $10 to $15 per order processing fee for all new clear aligner orders, all new clear aligner refinement orders from past cases and non-DSP Vivera cases. We expect the net effect from these two actions on ASPs to be zero for 2025. We currently manufacture clear aligners in Mexico and ship them to the US primarily for our US customers, with the remainder eventually shipping to other international locations. The US-Mexico tariff situation remains very fluid, and we are unable to predict whether new tariffs will go into effect in the future. We are monitoring events closely. Our Clear Aligner COGS include material, labor, overhead and freight costs. We expect an incremental tariff if implemented, to be applied to transfer prices from Mexico shipments to the US. These transfer prices would not include treatment planning costs, freight and other overhead and similar costs. Align's global operations have evolved significantly over the past several years, and we have greater flexibility to support our global business. However, assuming a new 25% tariff on shipments the US from Mexico, we believe it still would be more economically viable to ship clear aligners from the US -- to the US for Mexico due to a variety of factors, including the incremental additional freight costs incurred, where we shipped from our Polish facility. Regarding China, we currently manufacture our products in China for the benefit of our customers China. With that as a backdrop, assuming no circumstances occur beyond our control, including foreign exchange and new tariffs, for Q1 2025 and fiscal 2025, we provide the following outlook. We expect Q1 worldwide revenues to be in the range of $965 million to $985 million, down sequentially from Q4, primarily due to the impact from foreign exchange rates at current spot rates and lower capital equipment sales, reflecting historical Q1 seasonality. We expect Q1 Clear Aligner volume to be up slightly sequentially and expect Q1 Clear Aligner ASPs to be down sequentially, primarily due to unfavorable foreign exchange at current spot rates as well as continued product mix shift to non-comprehensive Clear Aligners. In addition to seasonality, we expect Q1 Systems and Services revenue to be down sequentially due to the timing of commercial availability of our iTero Lumina scanner with restorative software, which is expected at the end of March. We expect our Q1 2025 GAAP operating margin to be below Q1 2024 GAAP operating margin by approximately 2 points, primarily due to unfavorable foreign exchange at current spot rates. We expect our Q1 2025 non-GAAP operating margin to be below Q1 2024 non-GAAP operating margin by approximately 1 point, primarily due to unfavorable foreign exchange at current spot rates. For fiscal 2025, we expect 2025 year-over-year revenue growth to be in the low single-digits, which reflects approximately 2 points of unfavorable foreign exchange at current spot rates. We expect 2025 Clear Aligner volume growth to be up approximately mid-single-digits year-over-year compared to up 3.5% year-over-year in 2025. We expect 2025 Clear Aligner ASPs to be down year-over-year due to unfavorable foreign exchange at current spot rates and continued product mix shift to noncompetitive, non-comprehensive Clear Aligners. We expect 2025 Systems and Services year-over-year revenues to grow faster than Clear Aligner revenues. We expect 2025 GAAP operating margin to be approximately 2 points above 2024 GAAP operating margin, and we expect 2025 non-GAAP operating margin to be approximately 22.5%, which both reflect the impact of unfavorable foreign exchange at current spot rates, partially offset by the benefits from restructuring actions we took in Q4 to improve profitability and give us margin accretion in 2025, even as we scale our next-generation direct 3D printing fabrication manufacturing. We expect our investments in capital expenditures for fiscal 2025 to be between $100 million and $150 million. Capital expenditures primarily relate to building construction and improvements, as well as manufacturing capacity in support of our continued expansion. Overall, I am pleased with our fourth quarter and fiscal 2024 results, particularly the year-over-year Clear Aligner volume growth, the record number of submitters, the continued momentum from our Systems and Services business, and our operating margin improvement. After repurchasing $353 million of our Align common stock during 2024, we continued -- we concluded the year with no debt and approximately $1.044 billion in cash and cash equivalents. Our goal, as always, is to deliver value to our shareholders. Now, I'll turn the call -- now I'll turn it back over to Joe for final comments. Joe?"
},
{
"speaker": "Joe Hogan",
"content": "Thanks John. In closing, 2024 was a year of solid progress across the business. Record full year total worldwide revenues of $4 billion, record full year total worldwide System and Services revenue of $769 million, record teen shipments and growth in both teens and adult markets, record 130,400 doctors shipped to, 19.5 million total patients treated, with 5.6 million teens in kids. We ended the year with over $1 billion in cash and equivalents after repurchasing 1.5 million shares for $353 million. In another year where the dental industry is down and we continue to grow, I feel good about where we ended the year, and I'm excited to kick off 2025 with a team focused on building the innovations introduced in 2024 that drive efficiency and growth for practices and that are committed in delivering the best customer and patient experiences in the industry. I want to highlight just a few of the Align innovations that we introduced in 2024 that we believe will continue to drive adoption and utilization. In January 2024, we unveiled a breakthrough technology, the iTero Lumina intraoral scanner with 3x wider field of capture and a 50% smaller wand that delivers faster scanning, higher accuracy and superior visualization for greater practice efficiency and with orthodontic workflows. We look forward to introducing at the end of Q1 2025, the iTero Lumina intraoral scanner with software capabilities to enable efficient restorative and ortho restorative workloads to help general practitioner dentists deliver exceptional restorative outcomes. The iTero scanner is the front end of Align digital platform, designed to give doctors the capability to run simulations and communicate with patients, so the patients can see their smiles and the time that it would take them to get that outcome. It's also a big part of our growth algorithm, and we've had good accretive margin on the iTero Lumina scanner product since its launch. We also started rolling out ClinCheck in minutes, delivering treatment plans based on doctors building personalized treatment preferences for almost touchless digital workflows, which we'll expand to more doctors this year, bringing an unprecedented level of speed and customization to digital treatment planning. Changing the paradigm for how doctors can treat growing patients is one of our biggest opportunities. As we continue to deliver innovations that help doctors achieve more of a treatment at younger ages, potentially decreasing the amount of orthodontic treatment that younger and teen patients need overall. As we continue to commercialize the Invisalign Palatal Expander system, Align's first direct 3D-printed device that provides doctors with a solution set to treat the most common skeletal and dental malocclusions in growing children, we anticipate introducing the next in a series of direct 3D-printed devices with a pilot for Invisalign First direct printed retainers in the first half of 2025. We have also Invisalign mandibular advancement with the occlusal blocks now in limited market release, giving doctors and patients a better option for Class II correction in younger patients while simultaneously strengthening their team. We're also excited about the future of digital orthodontics focused on growth opportunities as a company while driving margin improvement and our unique ability to leverage aggregated and anonymized data from approximately 19.5 million Invisalign cases to continue to gain more knowledge about the science of orthodontics to move the industry forward. And while we're now in our 28th year, in the same way, we're just at the beginning. It's that motivating and exciting for the whole Align team. With that, I thank you for your time today. I look forward to updating you on our continued progress over the coming quarters. Now I'll turn the call back to the operator for your questions. Operator?"
},
{
"speaker": "Operator",
"content": "At this time, we will be conducting a question-and-answer session. [Operator Instructions] And our first question will come from the line of Michael Cherny from Leerink Partners. Your line is open."
},
{
"speaker": "Michael Cherny",
"content": "Good afternoon, and thank you for a ton of detail already. Maybe if I could just dive in a bit to the guidance, especially on the Clear Aligner side. Is there any way to give a little bit more of a breakdown as you think about the dynamics on volume versus price? Hear you loud and clear on the ASP impact from FX. But curious how to the growth dynamics on aligners as a whole, especially coming off of the mix of, obviously, easier comps in 2024 versus what's still an uncertain macro environment? Thank you."
},
{
"speaker": "John Morici",
"content": "Yeah. Michael, this is John. When we talk about the -- kind of give picture for the total year, we're looking at volume for Clear Aligners at up mid-single digits, and that's how we look at that. It varies like it does across different regions and different times of the year and so on. But we've looked at it that way, and that's the perspective that we have for year. We were pleased with how we exited in 2024 with the volumes that we had, and that's the overall guidance that we have for the year."
},
{
"speaker": "Michael Cherny",
"content": "And just along those lines and the volumes, mid-single digits, obviously, a really solid number. How do you think about the competitive dynamics in the market now? And are there opportunities either in terms of other competitors exiting? Or how do you think about the components of what drives that in terms of market dynamics, competitive dynamics, share gains, anything more to break down that obviously strong number would be great as well. Thank you so much."
},
{
"speaker": "Joe Hogan",
"content": "Yeah. And Michael, it's Joe. I think on the competitive dynamics, I don't see a big change in the dynamics when you look at 2024 and 2025. Overall, we feel our new innovation all continues to put us ahead. Obviously, the Minute ClinCheck really drives our super users to a level of productivity they haven't had before. So I feel really good about our competitive ability all around the world, including China, including some specific areas about it. So as we move into 2025, I really feel that we're gaining momentum in that sense."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for next question. Our next question will come from the line of Elizabeth Anderson from Evercore ISI. Your line is open."
},
{
"speaker": "Elizabeth Anderson",
"content": "Hi, guys. Congrats on the quarter, and thanks so much for the question. I was wondering, if you could talk about two things. Maybe as regards to the Lumina and the scanner business more broadly, it looked like you were -- you obviously have the launch coming up in the first quarter. So if you could talk a little bit on your expectations for that, maybe given what you've learned on the ortho side for Lumina? And then two, you talked about sort of the impact, obviously, of more leases and things like that versus perhaps capital equipment sales. Can you talk about, sort of, help us understand maybe on a unit basis, how you're thinking about the growth in that business? I think that would be one thing that would be helpful. And then maybe if you could also help us understand a little bit better that maybe some of the growth dynamics, particularly in North America, DSO versus non-DSO customers? Thank you."
},
{
"speaker": "Joe Hogan",
"content": "Elizabeth, it's Joe. I'll take the first part of your question. When you look at what we learned in the orthodontic release of Lumina was a product was everything we hoped it would be. I talked about the wider field of view, the speed. I didn't talk a lot the optics. So image quality is fantastic on the product line. The lightness of the one and all that was really important for the technicians that that use wand day in and day out because in the past, we had a lot of complaints in the sense of the heaviness and kind of bulkiness of the wands that are in the marketplace right now, particularly on the confocal imaging side. So as we move that into more of the restorative marketplace, remember, we had a good take-up of GPs using that product line last year, too. This will complete the -- the whole system for GPs because they can do the restorative work they had on it and not just the orthodontic side. So we're excited about it. We're looking forward to it. Obviously, we'll talk about it coming up at the IDS, and we look forward to launching it in March and then bringing you through the second quarter."
},
{
"speaker": "John Morici",
"content": "And as Joe said, kind of to your second part of the question, Elizabeth, look, this rounds out our portfolio. We've got a complete portfolio from the most advanced scanner and the latest with Lumina to all other types of products that we have, all the way down to certified pre-owned. And so that portfolio is rounded up, but we also, as you mentioned, the leasing and other rental, we offer a lot of options for our customers. Some customers want to buy, and they want that legacy equipment, that's great, and they'll buy that new equipment, do trade-ins or just add another scanner and so on. But some also don't want to put that capital up, especially in this environment. So we offer them a lot of different opportunities to lease that equipment to use external financing that gets them at a good rate for external financing to purchase, or some just want to rent it. And so we feel like we can offer that customer any which way that they want to be able to utilize our equipment. And as we continue to release new products, keep we surf pre-owned in and so on. We're just expanding our base, which is helpful for our overall business."
},
{
"speaker": "Shirley Stacy",
"content": "Thanks, Elizabeth. Next question,"
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. Next question will come from the line of Glen Santangelo from Jefferies. Your line is open."
},
{
"speaker": "Glen Santangelo",
"content": "Hi. Thanks for taking my question. Hey, Joe, I also want to follow up on this volume issue because it seems like in the fourth quarter and into 2025, you're forecasting some pretty decent volumes. And I'm kind of curious, could you put that in the context of where you think the overall ortho industry is now? Do you feel like you're kind of getting some share back because in 2024, in 2023, the theme was macro uncertainty, but you're not really talking about that anymore? And I'm just kind of curious if you think maybe the industries get a little bit better? Or is some of these DTC offerings that may be faded into the background, like what's enabling you to improve your volume, you think? And then I just had a follow-up for John."
},
{
"speaker": "Joe Hogan",
"content": "Yes, Glen, it's a good question. I think we've been talking about stability for a while now, too. And again, I think we stand on that platform also. Each one of these regions are different from what we've seen. We felt good about Europe in the fourth quarter. We saw some momentum there, felt reasonable about APAC in a sense, I mentioned China and Japan. And increases in Thailand and different in China and different -- I mean, in different parts of the APAC region. When you come to the United States, the orthodontic marketplace, Glen, has really been flat for the last three years. Now, I think we made progress, good progress with the new products that we've had. But we've been challenged in that segment. And I wouldn't call it so much competition as I would -- it's been a wires and brackets kind of regression in that marketplace because of when doctors are seeing less patient throughput, they're looking to save margin, and it's difficult to really appeal to them with clear aligners when they're not at capacity in that sense. But on the counter of that, Glen, we've seen really good progress in GPs and good growth in GPs, not just in the US but all over the world, and that's really helped us. And so remember, we changed our channel strategy years ago to make sure that we went to the GP channel with the GP sales force and ortho, with ortho sales force, too. And I think that's really helped us to give us insight into the industry and position our products properly for both those areas. So I hope that helps to answer your question. I think our new technology, too, gives us a lot of confidence. Specifically in the orthodontic channel since offering differentiation, those early patients that we talked about. We feel we have the three products I mentioned in my script, we feel we have something that's special in the orthodontic community in a sense of that younger patient piece, and you'll see us push that really hard as we move into 2025."
},
{
"speaker": "Glen Santangelo",
"content": "That's awesome. And John, maybe if I could just follow up with you on this ASP issue, right? I mean, obviously, everyone is focused on the fact that ASPs will be down. And you highlighted FX and you highlighted mix shift. I was wondering if you could just unpack that a little bit to tell us -- and I'm sorry if I missed this, exactly how much FX is playing a role here on that ASP number in 2025?"
},
{
"speaker": "John Morici",
"content": "Yes. Yes. That's a good question, Glen. Overall, when we look at 2025 in terms of how we've guided, we have about 2 points of FX headwind on a year-over-year basis. It's just the strengthening of the dollar. We saw that as it came out October and it continues to be strong November, December, January. We're basically forecasting what we see now on a spot rate standpoint and expecting it to be strong, and that impact is about 2 points unfavorable on a year-over-year basis."
},
{
"speaker": "Glen Santangelo",
"content": "Okay. Thank you very much."
},
{
"speaker": "Operator",
"content": "One moment for our next question. Our next question will come from the line of Jon Block from Stifel. Your line is open."
},
{
"speaker": "Jon Block",
"content": "Thanks, guys. Hey, Joe. First one, the 1Q 2025 revenue guidance is down around 2% at the midpoint. The full year revenue guidance is up low-single digits. And I think some of that is the 1Q comp, I believe also the scanner timing, if you would, due to the Resto launch. But I think it's an important question, Joe. Can you talk about other reasons why the rest of the year, you're arguably up, call it like low to mid-single digits versus the down 2% and 1Q 2025, again it's a guide? And then I think what people are going to be worried about is, is there an embedded assumption that things pick up in the guide? Or is it just sort of the moving parts again of the comp, the Resto launch, et cetera? And I'll sort of pause there and then I'll ask my follow-up."
},
{
"speaker": "Joe Hogan",
"content": "John, I'd say we obviously introducing the restorative scanner in March, we don't get the full benefit of that in the first quarter, and you're accurate in the sense of reflecting that in your comments overall. I would say we're not talking about a build as we go through the year. I think you have to look at exchange on a whole thing, and John can explain that in a sense of how we've baked that in overall. But obviously, you have a full year of IPE coming in this year. We have the regulatory approvals for that going into Europe and different parts of Asia, too, and we think we'll hit mainstream in that end too. And may deal with advancement with a plus of blocks too is another one that we think is going to be a specific grower for us also. So I mean, that's how I'd pretty much tackle that is that we have new technology rolling in. You have the iTero restorative coming in also. And John, what would you add?"
},
{
"speaker": "John Morici",
"content": "Yes. And we're not expecting, Jon, any overall improvement in the macro economy. If it happens, great, that will be good for the entire business. But we're not expecting an overall improvement there. We did see as we came out of Q4, I mean, just the 6% growth in volume in Q4, that's the highest growth that we've seen in three years on a year-over-year basis. So that's good to see. We want to continue to see that that momentum. And like Joe said, we're doing everything we can with new products, new innovations, new ways to go to market to be able to continue that."
},
{
"speaker": "Jon Block",
"content": "Yes. No, beat on balance, got it ahead on balance for 1Q, I get that. And then just second question is, I think, Joe, this one is for you. But for a couple of quarters now, at least two, maybe more, we've heard you detail, call it, the faster growth from the DSOs. And so a couple of questions here. Joe, what is are the DSOs, call it, as a part of your North American business, if you could just give us a rough number? But more importantly, the plays that you run with the DSOs -- and we've heard of some those, the marketing support -- pardon -- this is my language, not your -- they might be more sophisticated with your help. Are those transferable to the fragmented GP market? And if so, how long does that take to go ahead and manifest on your part? Because clearly, if you could extrapolate that faster growth to the individual practices, that would be -- certainly, I'm positive and something to get excited about. So, maybe your comments on, again, the percent of their weighting of your bids? And more importantly, can you see yourself running the same plays with the individual practices?"
},
{
"speaker": "Joe Hogan",
"content": "Hey Jon, it's a great question. Really, first of all, I look at -- I talk about it internally, too. I look at DSOs as a force multiplier. They can actually take our technology, what we learned in a sense of a sense of efficiency, what we learned from brand, from a demographic zone brand you can apply to. And they just have an ability to be able to disseminate that within their teams. Much better than doing that individually door-to-door like we do with our normal sales force, which is kind of obvious. But that doesn't preclude us from what we're taking to the DSOs in the sense of what we know and what they incorporate. Our salespeople are -- many of them have been with us many years, they understand that also. They just have to find the right orthodontists and the right general dentists to really want to implement those procedures in their marketplace. That's why I -- talking about the sales kickoff the other day down in Dallas. And it said that we have the longest or the hardest last mile of any company I've ever worked with because you are calling on these individual family-driven practices. And not that they're stupid or anything, they are very smart. But they're very -- not necessarily business minded always. They're clinically minded, and it takes a while to gain their confidence and move it forward. DSOs help to accelerate that, Jon, is the best way I can explain that. Jon, you've got--"
},
{
"speaker": "Jon Block",
"content": "Thanks for the color guys."
},
{
"speaker": "Joe Hogan",
"content": "Jon, thank you."
},
{
"speaker": "Operator",
"content": "Our next question comes from the line of David Saxon from Needham. Your line is open."
},
{
"speaker": "David Saxon",
"content": "Great. Good afternoon Jon and John. Thanks for taking my questions. Yes, I had a couple of follow-ups on the guide for Clear Aligner. So, mid-single-digit volume growth for Clear Aligners. Joe, based on your answer to a previous question, it sounds like U.S. volume growth should probably be slower than international, but I just wanted to confirm that's how you're thinking about it? And then on the ASP side, to down year-on-year for the full year, first quarter ASPs look be to down high single-digits year-on-year based off of the first quarter ASP guidance. But you have this price increase starting in second quarter. So, just I'd love to hear how we should think about pricing in quarters two through four on a year-over-year basis?"
},
{
"speaker": "Joe Hogan",
"content": "Hey David, I'll take the first part of your question, which, yes, our forecast for next year does imply a slower U.S. than the rest of the world. And that's -- to me, that's -- we're just projecting what we saw in 2024 into 2025. But we don't have any data right now that would make us change that in some way from a consumer confidence. And to see or any kind of change in the last several quarters, I would say that it would be different going. As far as ASPs go..."
},
{
"speaker": "John Morici",
"content": "Look, ASPs, they're heavily impacted with our business, over 50% of it outside the U.S. They're impacted by a stronger dollar. And I just tried to make it very clear in terms of our guidance based on what those spot rates are as of now and saying this is how it's going to play out in the future. Obviously, it changes. And -- but at least give you a reference point to jump off of. So when you look at Q1, you'd see that ASPs will be down. It's a reflection of the foreign exchange, and that's the primary driver of that. It will change as it goes through each of the quarters. I mean, by the end of the year, it kind of catches up, and that strength of the dollar that we saw in November and December won't have as much a year-over-year impact. But in Q1, it has that impact."
},
{
"speaker": "David Saxon",
"content": "Okay. All right. That's helpful. And then maybe sticking with you, John. So operating margin down year-on-year in the first quarter, but guiding to expansion for the full year. So I'd love to just hear kind of the puts and takes that drive that ramp? And maybe it would be great if you could talk about quarterly cadence. Thanks so much."
},
{
"speaker": "John Morici",
"content": "Yes. When you think of the op margin that we'll have, we did actions last year to be able to get our op margin in a place from a cost standpoint to be able to provide that margin accretion. The first quarter is one where, as you start to ramp up, usually first quarter op margin is and at a rate standpoint, the lowest or one of the lowest for the quarters as you -- it builds as you go through year. It's based on volume. As we have more volume coming through our facilities, we generate additional productivity, and that shows up. We have new products, as Joe described, with the Lumina Restorative, different products where we're expanding out and so on that help us drive additional margin as we go through. So we've got the levers that we can pull and adjust as we go through the year to be able to generate that margin accretion on a year-over-year basis. And that is margin accretion that we talked about at 22.5%, that's despite unfavorable FX on a year-over-year basis. So you can tell some of that margin accretion that that we're talking about. But it's -- it's all about driving productivity through volume you have and being smart about the other investments that you're making."
},
{
"speaker": "David Saxon",
"content": "Great. Thanks so much."
},
{
"speaker": "John Morici",
"content": "Thanks, David."
},
{
"speaker": "Operator",
"content": "One moment for next question. Our next question will come from the line of Jeff Johnson from Baird. Your line is open."
},
{
"speaker": "Joe Hogan",
"content": "Hi, Jeff."
},
{
"speaker": "Jeff Johnson",
"content": "Hi, thanks. Hi, Joe, how are you? Good afternoon, guys. So look, we're all going around kind of this 1Q, trying to understand it relative to the rest of the year. The one thing I haven't heard and maybe I just missed it, but you guys are talking about a 200 basis point headwind for the year from currency. I think that is pretty much flow through to ASP as to ASP as well, about a two-point headwind for the year well on the Clear Aligner side. But I haven't heard you quantify Q1. My math and my currency math is terrible, but my math would put currency at almost a 3, 3.5 point headwind in 1Q to both ASPs and global revenue. Am I close on that? Is it bigger in 1Q?"
},
{
"speaker": "John Morici",
"content": "Yes. That's the right way to phrase it, Jeff. It is bigger just based on what the dollar was doing last year compared to this year. So there is a bigger currency effect in Q1 than on average for the year."
},
{
"speaker": "Jeff Johnson",
"content": "Ballpark, am I close on that 3, 3.5?"
},
{
"speaker": "John Morici",
"content": "Yes. You're close on that."
},
{
"speaker": "Jeff Johnson",
"content": "Okay. And then just my other question is really kind of the same kind of FX question, but on the gross margin side -- sorry, on the company margin side, on the operating margin side. You're guiding to 70 basis points of year-over-year improvement at the op margin line on a non-GAAP basis. How much is currency weighing on, I don't care if it's gross margin or operating margin, however you want to provide the answer. But how much is currency weighing there? And then how much of the incremental direct fab investments potentially weighing this year on gross or overall margin? It seems like this could have been a year if currency neutral and you didn't have the direct fab incremental investments that we really would have started to see a recapture back towards those pre-COVID numbers. So just trying to understand all those moving pieces? Thank you."
},
{
"speaker": "John Morici",
"content": "Yeah. Jeff, when you talk about the FX impact on op margins, its over one point, you're right, it's two points at revenue on a year-over-year basis, falls to just over one point on an op margin basis. So a large part of that falls through. So, you're right, calling 70 basis point improvement year-over-year. That's despite having one point of op margin pressure from an FX standpoint. And then, of course, all the other things that we're doing to invest in. So and there's some offsets to that in terms of scaling up our growth platforms and so on. But that's all in the number that we have at the 22.5%. So if FX was going the other way, you would see even more margin accretion, and we'll see how that foreign exchange plays out as we go through the rest of the year."
},
{
"speaker": "Jeff Johnson",
"content": "Understood. Thank you guys."
},
{
"speaker": "Joe Hogan",
"content": "Thanks Jeff."
},
{
"speaker": "Operator",
"content": "One moment for next question. Our next question will come from the line of Brandon Vazquez from William Blair. Your line is open."
},
{
"speaker": "Brandon Vazquez",
"content": "Hi, everyone. Thanks. Hey guys, thanks for taking the question. Joe, maybe for you on the IPE side, I think we're a little bit over year after the launch of that product now. Curious if you could comment on maybe two things. One, what's the adoption curve looking like relative to your expectations now that we're about a year in? And then two, is this a product that could maybe be a catalyst within the teen market to let you get that next incremental leg of adoption given that that's kind of the third year end market that you guys are underpenetrated in?"
},
{
"speaker": "Joe Hogan",
"content": "Yeah. Brad, first of all, I mean, the adoption curve has been good, as I mentioned in my script, it follows Invisalign First. Invisalign First is what we call a dental expansion product. It's kind of moving your teeth, but it's not moving bone in that sense. In this case with IP, we're moving bone. And so that's why the regulatory things and all that I mentioned that we have to go through each region in order to move that through. I feel really good about it. It's such a breakthrough product and a different product. It takes doctors a while in a number of cases to become comfortable with it. We have a wonderful feedback from patients in the sense of the comfort of the product line. And many of the patients or parents have gone through the Hi-Res [ph] device and the wrench and those kind of things. And that makes parents a little more susceptible to wanting Invisalign Palatal Expander too. So I feel good about it. We've had some things too on the release. We didn't have full visualization from a scanning standpoint when we first started. There were some attachment pieces that we had to improve in the sense of how you attach. And then there's also some just wearability aspects about how long you wear this. But we've come over those and we're making good progress in it. So I'm very optimistic about it. And it's great to see it really go from a regional standpoint to a global standpoint now. But we have a great one, two punch in that marketplace with Invisalign First. And that's also worth mentioning, too, we're seeing many doctors, as they do the upper palate expansion, they use Invisalign First on the bottom in order to expand the teeth to be -- to make sure that they're in line with the sense of the bite as they're setting in their upper arch, too. So it's good to see a synergistic effect on those two products. I hope I answered your question, but that's the momentum that we're talking about."
},
{
"speaker": "Brandon Vazquez",
"content": "Yeah. Maybe as a quick follow-up on a separate note. International has been more durable for you guys in the Americas these days. Is that simply a result of just being earlier in the adoption curve and so things are doing a little bit better there? Or is macro and international just doing a little bit better than the Americas? Just trying to understand how durable international outperforming should be as we go into 2025 even if macro and Americas stays relatively muted? Thanks."
},
{
"speaker": "Joe Hogan",
"content": "It's hard to be discrete on that answer. Overall, Brandon, I would say there are certain areas where, obviously, it's the initial penetration of our product line in certain area, but I certainly wouldn't say that about Latin America. We've been now for many years and we see continued growth in that sense. Middle East, Africa in those areas too, some of the places of Africa are new, and they'll hit a certain inflection point. But overall, I feel like we face better economies in those regions. They didn't necessarily, I think, overextend their economies, the way we saw in the Western world and which has affected a large part of Western Europe and also in the United States. And specifically in Asia, outside of China, the other countries in Asia just came back out of COVID in a better position than we were before. But some of those countries are penetration. Some of those countries are just expansion too. So I think overall, it's just a good mix there, Brandon. And I like that. It's good to have. And then as you roll out these new technologies, remember it offers you new opportunities in those countries, too. So that expansion piece can continue."
},
{
"speaker": "Shirley Stacy",
"content": "Thanks, Brandon. Operator, we want to try and get through the covering analysts that are still on the line. So -- and if I can ask folks to limit to one question so we can get through everyone's questions, please."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. Our next question will come from the line of Jason Bednar from Piper Sandler. Your line is open."
},
{
"speaker": "Jason Bednar",
"content": "Hey, good afternoon. Thanks for taking the question. I'll try be an quick here. I really want to ask on just maybe thematically reducing frictions -- I'm sorry, trailing to pack kind of a combo in here, but this is -- is there a way to reduce frictions within the teen channel and really address what has been maybe a bit of a challenge or sluggish ortho environment? Anything that you can do from a marketing initiative to really create better demand pull effect? And then also on the friction side, maybe help with the business rationale, removing that $10 to $15 process, and you see you all neutralizing it with price increases. Is that -- have you had pushback on the processing fees? Has this caused friction with doctors that you're trying to remove? Thank you."
},
{
"speaker": "Joe Hogan",
"content": "Yeah, Jason, that's a good question. First of all, the friction in teen channel is -- a lot of it has to do with the economics in the orthodontists office today. We talked about the orthodontic offices in the United States haven't really -- in North America haven't seen really any substantial growth in the last three years. And so again, there are individual practices, and I think they're trying to maximize their bottom line as much as they can. And so I think they've been very cautious from a business standpoint. The friction you talked about with our processing fees and all, those are real. We have a pushback, not as much in Asia. We had a lot of pushback in Europe and in the US on that. And we decided to roll that back with that aggregate price increase. And we have a good response from our doctors in order to do that. And that is a friction piece. And it was -- to me, it was an annoyance to the sales team to have to kind of fight through that when they had to talk to doctors in either joining what we were doing or having been with us for a while and explaining those things. So I think that's very helpful. John, I'm sure you have some ideas to it."
},
{
"speaker": "John Morici",
"content": "I mean, in the end, we want to focus on driving this driving this business, category, driving our products too and less about some of the other minor things like this with processing fees and so on. So this is a good opportunity to kind of put this together, get it in the right place and talk about the future of the business versus some of the other past expenses like this."
},
{
"speaker": "Shirley Stacy",
"content": "Yes. Thanks."
},
{
"speaker": "Jason Bednar",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "One moment for our next question. Our next question will come from the line of Steven Valiquette from Mizuho. Your line is open."
},
{
"speaker": "Steven Valiquette",
"content": "Thanks everyone. Thanks for taking the question. So obviously, there's a lot of puts and takes related to the evolving tariff situation. But one area I was just hoping to get your thoughts on is given that there's a large competitor Chinese base as some investors are watching closely as that competitor tries to establish a larger market share in the US market, really, with this new political backdrop for the next four years under the new administration, I'm wondering whether some practitioners in the US may be a little more hesitant to want to buy into the ecosystem of really any competitors that are headquartered or based outside the US, just given the heightened risk of trade wars, et cetera. So perhaps I could play into your hands favorably, at least in the US market, which I think it's still your biggest market. So just a high level, just curious to get your thoughts on that potential dynamic? Thanks."
},
{
"speaker": "Joe Hogan",
"content": "Hi, Steven, it is, just to confirm, US is still our biggest market in the world in that sense. Remember, I just talked about the orthodontic market not really growing for the last three years, too. So we have had competition. Obviously, we know that your comments really refer to Angel Aligner or maybe some other Chinese suppliers coming in. I think overall, you first win with customer service and you win with technology, you win with relationships, and that's what our sales force is really talking about. We felt that the Chinese have come in on unsustainable prices. When you look at -- we kind of know the prices you have to charge in order to have a decent return. And we think that always takes care of itself one way or another, and we've seen that with other competitors in the marketplace also. So I don't – I can't really speak for 10,000 orthos or GPs that are around the United States and how they feel about international politics or anything they do. But our job is to make sure that we keep our heads down. We deliver the best technology, best productivity, the best brand, all those things to make sure we win in the marketplace, and we'll let that other piece decide for itself."
},
{
"speaker": "Steven Valiquette",
"content": "Okay. Got it. Thanks."
},
{
"speaker": "Operator",
"content": "One moment for our next question. Our next question comes from the line of Kevin Caliendo from UBS. Your line is open."
},
{
"speaker": "Q – Unidentified Analyst",
"content": "Thanks for the question. This is Dylan on from – Dylan Kim on for Kevin. Thanks for the question. A quick question on direct fabrication. You guys previously have talked to potentially commercializing products this year, I believe, starting with the retainer product. So any update there on commercialization of products? And maybe detail on the P&L too into both revenue and investment into costs, into the manufacturing capabilities that you can call out?"
},
{
"speaker": "Joe Hogan",
"content": "First of all, I'd say our IPE device is 3D printed, but it's not the Cubicure process and it's not the resin that we'll used in the Cubicure process. So as I mentioned in my script, we will begin to -- just with limited release, an Invisalign First retainer. Invisalign First retainer is a very complicated. It has to have a high modulus. It has to have a huge amount of variability in the sense of how you structure that depending on where that person's arch is at that point in time. And it's the perfect fit for us as we try to ramp up and we ramp up our new our new Cubicure process with resin too. So again, like I mentioned, you'll see just the beginning of that in the first half of this year. And in the second half of this year, we should begin to get ourselves more ready for general release in third and fourth quarters of that product line. That's the beginning. After that, we'll move into what we call mandibular advancement. But any kind of aligners that have auxiliary types of things that you would have to have printed on those or difficult cases where wall thicknesses need to be different in some ways. So, we're really excited about the efficiency of that particular technology, but also the design and incredible design capability and design freedom orthodontists will have in order to do that. So, that's about as well as I can do for you now."
},
{
"speaker": "Shirley Stacy",
"content": "Thanks. Next question please."
},
{
"speaker": "Operator",
"content": "Our next question from the line of Michael Ryskin from Bank of America. Your line is open."
},
{
"speaker": "Michael Ryskin",
"content": "Hey, thanks for squeezing me in guys. Just one quick one for me, hopefully. John, I appreciate the commentary you had on tariffs to Mexico and realize there's still a lot of moving pieces, but I just want to make sure I understood that. Just a comment on transfer prices. I mean, I hear you on overhead and freight cost, treatment planning not being included. How should we think of it as a percent of your COGS? I think if you just go through the P&L with something like $375 COGS per case roughly? Is the transfer -- like how much would be impacted? Is it 50% to 75% of that? And just walk us through the transfer price math, just so we can--?"
},
{
"speaker": "John Morici",
"content": "No, it's a good question, Mike. And you're right. I tried to give a perspective of, look, you start with COGS and then there's some hard COGS that have nothing to do with what we're doing in Mexico freight and treatment planning and other things, specifically the value add and the work that's being done there than that transfer price. I guess to put it in perspective in terms of -- there's been a lot of people thinking about what this could be, just based on your question and so on. But like on an average month, that tariff, if it's that 25%, might impact us $4 million to $5 million of cost or that might be the cost perspective of this. So, that gives you an idea of like how this kind of fits into this. This is something, as I said in my prepared remarks -- look, if at that amount of tariffs, 25%, if that ever was implemented, it's not a big enough cost on tariff for us to switch some of the manufacturing and move from perhaps manufacturing in Mexico to Poland. But we'll evaluate that as we go forward. But I just want to kind of size that for you. We'll evaluate as we go forward, we'll understand more as these days come about. We hope there's not anything, but we have a perspective in terms of what it means from a cost standpoint, and we will make decisions based on that. And that will impact us what we do in the short and long-term."
},
{
"speaker": "Michael Ryskin",
"content": "Thank you. Thanks."
},
{
"speaker": "Shirley Stacy",
"content": "Operator, we'll take one last question."
},
{
"speaker": "Operator",
"content": "And our last question will come from the line of Erin Wright from Morgan Stanley. Your line is open."
},
{
"speaker": "Erin Wright",
"content": "Great. Thanks for squeezing me in. Just a follow-up on that last one. Just to clarify, so there's no buffer kind of embedded in your guidance as it stands today from a tariff perspective? And just on China, just the environment there, not necessarily from a tariff perspective, but just more so from demand trends? And even China from a competitive standpoint, I guess, expectations for the balance of the year, if you could touch on those? Thanks."
},
{
"speaker": "John Morici",
"content": "That's great, Erin. I'll take the first one on tariffs. So we're not in our forecast and what we've given for guidance at that margin of 22.5%. There's no additional new tariffs that we've contemplated in that number. So, we'll see how things come about. But in the framework, if there is a tariff, and it should be 25% from Mexico to the U.S., it's $4 million to $5 million depending on volume per month from an expense standpoint. And then on China, I don't know if you want to give -- Joe, any other perspective on the kind of the market there?"
},
{
"speaker": "Joe Hogan",
"content": "I'd say the China market, we were pleased with the third quarter. The fourth quarter, obviously, is always less in China what the third quarter was. There was nothing in that that quarter made me think that anything was different in China and since its trajected the business, from what we've seen. So overall, I'd call China stable right now."
},
{
"speaker": "Erin Wright",
"content": "Okay. Thank you."
},
{
"speaker": "John Morici",
"content": "Thank you."
},
{
"speaker": "Joe Hogan",
"content": "You’re welcome."
},
{
"speaker": "Operator",
"content": "And I will now turn the call over back to Shirley Stacy for any closing remarks."
},
{
"speaker": "Shirley Stacy",
"content": "Well, thank you, everyone, for joining our call today. We appreciate it. If you have any follow-up questions, please reach out to Investor Relations. We look forward to seeing you at our next industry events, including the Chicago Midwinter Dental Show coming up here later in February. I hope everyone has a great day."
},
{
"speaker": "Operator",
"content": "This concludes today's conference. You may now disconnect your lines at this time. Thank you for your participation. Everyone, have a great day."
}
] |
algn | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Greetings. Welcome to the Align Third Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to your host, Shirley Stacy with Align Technology. You may begin."
},
{
"speaker": "Shirley Stacy",
"content": "Good afternoon, and thank you for joining us. I'm Shirley Stacy, Vice President of Corporate Communications and Investor Relations. Joining me for today's call is Joe Hogan, President and CEO, and John Morici, CFO. We issued third quarter 2024 financial results today via Business Wire, which is available on our website at investor.aligntech.com. Today's conference call is being audio webcast and will be archived on our website for approximately one month. As a reminder, the information provided and discussed today will include forward-looking statements, including statements about Align's future events and product outlook. These forward-looking statements are only predictions and involve risks and uncertainties that are described in more detail in our most recent periodic reports filed with the Securities and Exchange Commission available on our website and at sec.gov. Actual results may vary significantly, and Align expressly assumes no obligation to update any forward-looking statement. We've posted historical financial statements with corresponding reconciliations, including our GAAP to non-GAAP reconciliation, if applicable, and our third quarter 2024 conference call slides on our website under Quarterly Results. Please refer to these files for more detailed information. With that, I'll turn the call over to Align Technology's President and CEO, Joe Hogan. Joe?"
},
{
"speaker": "Joe Hogan",
"content": "Thanks, Shirley. Good afternoon, and thanks for joining us today. On our call today, I'll provide an overview of our third quarter results and discuss a few highlights from our two operating segments, Systems and Services and Clear Aligners. John will provide more detail on our Q3 financial performance and comment on views for the remainder of the year. Following that, I'll come back and summarize a few key points and open the call to questions. Overall, Q3 '24 results were mixed and reflect strong Systems and Services year-over-year revenue growth, as well as good Clear Aligner volume in the Asia Pacific, EMEA and Latin America regions, partially offset by declines in the U.S. As recently reported by many analysts and third-party research firms, the underlying dental market in the United States remains sluggish and our doctor customers cite similar trends. Q3 '24 revenues of $978 million increased 1.8% year-over-year and Clear Aligner volumes of 617,000 were up 2.5% year-over-year. Despite strong growth from Systems and Services revenues, a record [87,400] (ph) doctor submitters, a record 236,000 teens starting treatment, driven by record teen case starts in China, and a record 25,000 of DSP Invisalign Touch-Up cases, total revenues for Q3 were slightly below our Q3 revenue outlook in part due to more pronounced seasonality for Clear Aligners than expected, as well as continued weak consumer sentiment and a soft dental market, especially in the U.S. Q3 '24 non-GAAP operating margin of 22.1% was better than expected and increased year-over-year compared to 21.8% in Q3 of '23. For Clear Aligners, Q3 volumes were up year-over-year and down slightly sequentially. Year-over-year volumes were driven by strong growth in APAC, especially China, as well as growth from the EMEA and Latin American regions. On a sequential basis, Clear Aligner volumes were down from Q2, reflecting more pronounced seasonality and soft dental markets in the U.S., offset somewhat by strength in APAC and Latin American regions. In the teen and growing kids' segment, a record 236,000 teens and younger patients started treatment with Invisalign clear aligners during the third quarter, an increase of 9.1% sequentially and up 6.7% year-over-year, reflecting growth across regions, especially from Invisalign First in the APAC and EMEA regions. In Q3, the number of doctors submitting teen or younger patient case starts was up over 6% year-over-year, led by continued strength from doctors treating young kids, also known as growing patients. During the quarter, we continued to commercialize the Invisalign Palatal Expander, Align's first direct 3D printed orthodontic appliance. Q3 reflected steady momentum for doctor submitters and shipments in the United States and Canada. We recently announced commercial availability in Singapore, and we're excited to extend the availability of the transformative Invisalign Palatal Expander System to even more doctors and their patients in markets across the Asia Pacific region. We expect it to be available in other markets, pending future applicable regulatory approvals. Non-case revenues include our Vivera retainers, retention aligners ordered through our Doctor Subscription Program, or DSP, clinical training and education, accessories and ecommerce. In Q3, non-case revenues were up year-over-year, primarily due to continued growth in retainers and the DSP program, including non-Invisalign patients getting retainers. DSP includes Invisalign Touch-Up cases up to 14 stages and is currently available in North America and certain countries in Europe. For Q3, total Invisalign DSP Touch-Up cases were up nearly 30% year-over-year to more than 25,000 cases. Q3 '24 Clear Aligner volume from DSO customers increased sequentially and year-over-year, reflecting growth across all regions. The DSO business in United States continues to outpace our retail doctors, driven by our largest DSO partners, Smile Doctors and Heartland Dental. We also had strong growth in iTero scanner sales from DSOs investing in their member practices and end-to-end digital workflows. Q3 was another strong quarter for our Systems and Services business, and year-over-year revenue growth was up 15.6%, reflecting higher scanner ASPs and non-systems revenues, driven by iTero Lumina, wand upgrades, increased scanner rentals and certified pre-owned or CPO leasing programs, as well as increased services revenues, partially offset by lower scanner volumes. On a sequential basis, Q3 Systems and Services revenues were down 2.9%, reflecting lower scanner ASPs and non-systems revenues, particularly offset by higher scanner volumes. The iTero Lumina's new Multi-Direct Capture technology replaces the confocal imaging technology in earlier models and has a 3x wider field of capture and a 50% smaller and 45% lighter wand, delivering faster scanning speed, higher accuracy, super visualization and a more comfortable scanning experience. Lumina is currently available with orthodontic workflows as new standalone scanner or as a wand upgrade from the iTero Element 5D Plus scanner. Overall, for Q3, we continue to be very pleased with the ongoing adoption of iTero Lumina scanner, with ortho workflow and response from customers. We currently expect to begin a limited market release for the restorative software on the iTero Lumina scanner in Q1 '25, followed by full commercialization by the end of Q1. Today, we announced new iTero scanner products innovations to further enhance digital dentistry workflows and integrated treatment options in oral health, restorative and aesthetic treatment in general dentistry. Align Oral Healthcare Suite with new comparison tools that aid in multimodality assessments and personalized oral health records and reports. Invisalign Outcome Simulator Pro in multiple treatment simulation to drive chairside patient education about treatment options, and iTero Design Suite with intuitive design capabilities for in-practice 3D printing now commercially available in selected markets. We believe the iTero intraoral scanner innovations introduced today enable doctors to present a variety of treatment options to their patients, supporting chairside education and communications. That helps deliver a great patient experience and supports patients in making more informed choices about their dental treatment and consultation with their doctors. We're also pleased to share that Invisalign Japan was recently awarded the [Golden] (ph) Design Award for 2024 for the iTero Lumina Intraoral scanner, making this the second time we received this prestigious award in the past two years. The Good Design Award is globally known and recognized by domestic and international designers and is the only comprehensive evaluation and recommendation system of design in Japan. The award designation increases the recognition and reliability of awarded works of -- and companies, promotes problem solving through design and focuses on the significance of design to people and society. Before I turn the call over to John, I want to comment on the employment actions we announced today resulting from a global reorganization and restructuring. As part of Align's 2025 annual operating plan process, we identified positions to be eliminated or transferred to other locations. These are difficult actions, and valuable employees will leave the company. As part of this restructuring, Raj Pudipeddi's position as EVP and MD Americas and Chief Marketing Officer has been eliminated and he will leave in the fourth quarter. We thank Raj for his contributions to Align over the past five-plus years in leading our marketing and product innovation and management as well as overseeing the APAC and Americas regions. We wish Raj well. I'm pleased to welcome Frank Quinn back to Align. He is a well-established leader with a customer focus and proven track record in orthodontics and digital dentistry. Frank's deep experience, understanding and insights into what digital means for our doctor customers is key and he is excited to be rejoining Align. With that, I'll now turn the call over to John."
},
{
"speaker": "John Morici",
"content": "Thanks, Joe. Now, for our Q3 financial results. Total revenues for the third quarter were $977.9 million, down 4.9% from the prior quarter and up 1.8% from the corresponding quarter a year ago. On a constant currency basis, Q3 '24 revenues were not significantly impacted by foreign exchange sequentially and were unfavorably impacted by approximately $14.6 million year-over-year or approximately 1.5%. For Clear Aligners, Q3 '24 revenues of $786.8 million were down 5.4% sequentially, primarily from lower volume, higher discounts, product mix shift to lower-priced products and geographic mix, partially offset by lower net revenue deferrals. Q3 Clear Aligner revenues were not significantly impacted by foreign exchange sequentially. Q3 '24 Clear Aligners per case shipment of $1,275 was lower by $20 on a sequential basis due to higher discounts, product and geographic mix, partially offset by lower net revenue deferrals. On a year-over-year basis, Q3 Clear Aligner revenues were down 1%, primarily from lower ASPs, reflecting the impact from unfavorable foreign exchange of $11.7 million or approximately 1.5%, a 20% price reduction in the UK to offset a 2024 ruling by the UK tax authorities in Q1 of '24 that requires a 20% VAT be applied to Clear Aligner sales in the UK, product mix shift to lower-priced products, geographic mix and higher discounts. This decrease was partially offset by lower net deferrals and price increases, along with higher volumes and higher non-case revenues. Q3 '24 Clear Aligner per case shipment of $1,275 was down $45 on a year-over-year basis due to unfavorable foreign exchange of $18, impact of UK VAT of $12, product and geographic mix, higher discounts and partially offset by lower net revenue deferrals and price increases. Our Invisalign Comprehensive [3-and-3] (ph) product is available in North America, EMEA and in certain markets across APAC. We are pleased with the continued adoption of the Invisalign Comprehensive 3-and-3 product and anticipate adoption will continue. Comprehensive 3-and-3 provides doctors the flexibility they want while allowing us to recognize more revenue upfront, with deferred revenue being recognized over a shorter period compared to our traditional Invisalign Comprehensive product, which in turn allows us to benefit from a more favorable gross margin. Clear Aligner deferred revenues on the balance sheet decreased $6.2 million or 0.5% sequentially and decreased $25.8 million or 2% year-over-year and will be recognized as additional aligners are shipped under each sales contract. Q3 '24 Systems and Services revenue of $191 million were down 2.9% sequentially, primarily due to lower ASP and decreased non-system revenues mostly related to fewer upgrades, partially offset by higher scanner volumes. Q3 '24 Systems and Services revenue were up 15.6% year-over-year, primarily due to higher ASPs, increased non-system revenues, mostly related to upgrades in our leasing rental programs, and higher services revenue, partially offset by lower scanner volumes. Q3 '24 Systems and Services revenues impact by foreign exchange was approximately flat sequentially. On a year-over-year basis, Systems and Services revenues were unfavorably impacted by foreign exchange of approximately $2.9 million or approximately 1.5%. The Systems and Services deferred revenues on the balance sheet was down $1.5 million or 0.7% sequentially and down $40.6 million or 15.4% year-over-year, primarily due to the recognition of services revenue, which are recognized ratably over the service period. The decline in deferred revenues, both sequentially and year-over-year, primarily reflects the shorter duration of service contracts applicable to initial scanner purchases. Moving on to gross margin. Third quarter overall gross margin was 69.7%, down 0.5 points sequentially and up 0.7 points year-over-year. Overall gross margin was not significantly impacted by foreign exchange sequentially and was unfavorably impacted by approximately 0.4 points on a year-over-year basis. Clear Aligner gross margin for the third quarter was 70.3%, down 0.5 points sequentially due primarily to lower ASPs and higher mix of additional aligners, partially offset by lower manufacturing spend. Clear Aligner gross margin for the third quarter was down 0.5 points year-over-year due primarily -- due to lower ASPs, partially offset by lower manufacturing spend. On a constant currency basis, Clear Aligner gross margin was unfavorably impacted by foreign exchange by 0.4 points year-over-year. Systems and Services gross margin for the third quarter was 67.5%, down 0.7 points sequentially due primarily to mix, partially offset by lower manufacturing spend and freight costs. Systems and Services gross margin for the third quarter was up 6.5 points year-over-year due primarily to higher ASPs, partially offset by higher service and freight costs. On a constant currency basis, Systems and Services gross margin was unfavorably impacted by foreign exchange by 0.5 points year-over-year. Q3 operating expenses were $519.5 million, down 9.7% sequentially and up 4.6% year-over-year. On a sequential basis, operating expenses were down $56.1 million due primarily to non-recurring legal settlements, advertising and marketing and employee compensation. Year-over-year, operating expenses increased by $22.7 million, primarily due to employee compensation. On a non-GAAP basis, excluding stock-based compensation, amortization of acquired intangibles related to certain acquisitions, restructuring, legal settlements and other charges, operating expenses were $472.7 million, down 5.4% sequentially and up 3.1% year-over-year. Our third quarter operating income of $162.3 million resulted in an operating margin of 16.6%, up 2.3 points sequentially and down 0.7 points year-over-year. Operating margin was favorably impacted from foreign exchange of approximately 0.1 point sequentially and unfavorably impacted by 0.8 points year-over-year. On a non-GAAP basis, which excludes stock-based compensation, amortization of intangibles related to certain acquisitions, restructuring, legal settlements and other charges, operating margin for the third quarter was 22.1%, down 0.2 points sequentially and up 0.3 points year-over-year. Interest and other income and expense net for the third quarter was an income of $3.6 million, primarily due to foreign exchange compared to an expense of $3.2 million in Q2 of '24 and an expense of $4.2 million in Q3 of '23. The GAAP effective tax rate in the third quarter was 30.1% compared to 32.9% in the second quarter and 25.1% in the third quarter of the prior year. The third quarter GAAP effective tax rate was lower than the second quarter effective tax rate primarily due to adjustments related to tax return filings, partially offset by a small increase in uncertain tax position reserves. The third quarter GAAP effective tax rate was higher in the third quarter -- than the third quarter effective tax rate in the prior year primarily due to recognizing a one-time benefit related to the application of tax guidance issued during the third quarter of the prior year. Our non-GAAP effective tax rate in the third quarter was 20%, which reflects our long-term projected tax rate. The third quarter net income per diluted share was $1.55, up sequentially $0.27 and down $0.03 compared to the prior year. Our EPS was favorably impacted due -- primarily due to foreign exchange by $0.03 on a sequential basis and unfavorably impacted by $0.08 on a year-over-year basis. On a non-GAAP basis, net income per diluted share was $2.35 for the third quarter, down $0.06 sequentially and up $0.21 year-over-year. Moving on to the balance sheet. As of September 30, 2024, cash and cash equivalents were $1,041.9 million, up sequentially $280.5 million and down $197.1 million year-over-year. Of our $1,041.9 million balance, $285 million was held in the U.S. and $756.5 million was held by our international entities. We have $500 million available for repurchase of our common stock under our January 2023 repurchase program. Beginning in Q4 2024 and continued into Q1 '25, we expect to repurchase up to $275 million of our common stock through either a combination of open market repurchases or an accelerated stock repurchase agreement. Q3 accounts receivable balance was $1,010.6 million, down sequentially. Our overall day sales outstanding was 93 days, up approximately four days sequentially and up approximately eight days as compared to Q3 last year. Cash flow from operations for the third quarter was $263.7 million. Capital expenditures for the third quarter were $29.8 million, primarily related to investments in our manufacturing capacity and facilities. Free cash flow, defined as cash flow from operations less capital expenditures, amounted to $233.9 million. Turning to our 2024 outlook. Assuming no circumstances occur beyond our control, including foreign exchange, we expect the following business outlook for the fourth quarter. We expect Q4 '24 worldwide revenues to be in the range of $995 million to $1,015 million. We expect Q4 '24 Clear Aligner volume and ASPs to be slightly up sequentially. We expect Q4 '24 Systems and Services revenues to be up sequentially, consistent with typical Q4 seasonality. We expect Q4 '24 GAAP operating margin to be slightly lower than 14%, primarily due to restructuring charges related to severance for impacted employees. We estimate these restructuring charges will impact Q4 '24 GAAP operating margin by approximately 3 points. We anticipate Q4 '24 non-GAAP operating margin to be slightly up sequentially. For fiscal 2024, we expect investments in capital expenditures to be above $100 million. Capital expenditures primarily relate to building construction and improvements as well as manufacturing capacity in support of continued expansion. As we have said many times, we continually evaluate and evolve our business model to provide doctors with the best tools and resources that they need to help them treat their patients while managing our operations responsibly. Today's restructuring action is designed to adjust our business to more closely align with the existing business environment. We expect the restructuring actions we announced today will give us margin accretion for full year in 2025 even as we scale up our next-generation direct 3D printing fabrication manufacturing. With that, I'll turn it back over to Joe for final comments. Joe?"
},
{
"speaker": "Joe Hogan",
"content": "Thanks, John. In closing, for Q3, I was pleased to report another strong Systems and Services quarter, and I'm excited about our next-generation Lumina scanner and its continued positive impact on our customers' digital workflow, with ortho software today and restorative software expected to be released in Q1 of next year. Q3 was also strong for our Invisalign Clear Aligner business in the Asia Pacific, EMEA and Latin America regions. For -- those markets are our fastest-growing regions and help to balance outperformance in other geographies. We understand that operating environment is more challenging, and we are adapting and driving our growth strategy despite continued weak consumer demand trends. especially in the United States and a sluggish dental market. In the face of inflation, high interest rates, less patient traffic and longer conversion cycles, especially for adult patients, orthodontists and dentists are facing challenges in practice growth and profitability that impacts the way many of them approach orthodontic treatment. It is more important than ever that we differentiate our products and services and become the best partner for our customers by creating solutions that drive more patients to their practices, accelerates treatment conversion and improves their experience and bottom line. As the innovation leader in digital dentistry technology, it's our job to ensure we have the organizational structure, focus and rigor to help doctors realize the full potential of this opportunity by doing more to engage our doctor customers and support their practice growth and to help consumers and potential patients connect with these practices to get to smiles that they love. We continue to evaluate and evolve our business to provide doctors with the best tools and resources they deserve. Align is the leader in digital orthodontics, and we are committed to supporting doctor customers and the future of digital innovation. We're committed to supporting doctor customers and the future of the digital innovation and are excited the next wave of growth drivers that we believe will revolutionize the orthodontic industry in scanning software and direct 3D printing. We're in the midst of several key technology developments that are critical for the business. We will take the needed actions to get us through this, while at the same time investing in the key areas that we know will transform our industry and our business. The restructuring actions we announced today focused on ROI investments and activities that drive revenue and enable margin expansion, while making room for investments in critical future technologies, including scaling our direct 3D printing operations. With that, I thank you for your time today. I look forward to updating you on our continued progress over the coming quarters. Now, I'll turn the call back over to the operator for questions. Operator?"
},
{
"speaker": "Operator",
"content": "Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Brandon Vazquez with William Blair. You may proceed."
},
{
"speaker": "Brandon Vazquez",
"content": "Hey everyone. Thanks for taking the question. I wanted to start on a little bit just the macro backdrop. Last year, the year-over-year comp also had a little bit of weakness in the September period, if I remember, in 2023. So, things are a little bit worse now. I'm just curious if you can talk about did things get worse from last year, which was already a little bit of -- a little weak. And in case that doesn't make sense, the crux of the question is essentially just talk to us about where macro is going into year-end? Is it stable? I think you guys have used that phrase before. Is it worsening? Just any thoughts you guys are seeing on end markets?"
},
{
"speaker": "Joe Hogan",
"content": "Yeah, Brandon, it's Joe. I'd say, first of all, third quarter is always a tough quarter because of the discontinuities we have with Europe shutting down and different countries being on vacation at different times. So, I wouldn't say that the third quarter this year was worse in some way than the third quarter last year. I'd just say that it was the kind of seasonality in a difficult market. What we try to call out, as you could see, is that United States market seems to be one of our the most affected and it's really one of our largest markets, too. And so that's been a challenge in that sense also. John, do you want to add anything?"
},
{
"speaker": "John Morici",
"content": "No, that's accurate."
},
{
"speaker": "Brandon Vazquez",
"content": "Okay. And then, as my follow-up just quickly, as we look towards 2025, right, and if we just assume end markets are stable, right, let's say things remain stable, how should we think about what the top-line on this business could do and what the P&L could look like in a year where things are stable, right? You guys are somewhat macro hindered right now. So, is it a continuation of what we're seeing in '24? Are there reasons to get a little bit more excited and accelerate the business? Any expectations around that would be helpful. Thank you."
},
{
"speaker": "Joe Hogan",
"content": "Hey, Joe, again. I'd just say we'd like to see some increased consumer confidence obviously in the United States and just an economy that feels better to consumers. We feel that this is more of an external issue than it is an internal issue when you look at Align overall in our growth rates, particularly in United States. And so, any kind of increase in economic activity and increase in consumer confidence, we think would be really positive for our customers and then for Align in turn."
},
{
"speaker": "Shirley Stacy",
"content": "Thanks, Brandon. Next question, please?"
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Jon Block with Stifel. You may proceed."
},
{
"speaker": "Joe Hogan",
"content": "Hey, Jon."
},
{
"speaker": "Jon Block",
"content": "Hey, guys. Good afternoon, Joe. Joe, maybe just to start with you, and it sort of picks up on that last question, anything to call out with the different results in the U.S. versus international? In other words, I think I've got this right, but cases up 2.5% globally, but as you mentioned, down in the U.S. So, is it just the consumer? Is there anything to focus on from a go to market strategy? Do we have to think about incremental competition that might be more acute in the U.S. versus OUS? Just would love your thoughts on that dynamic."
},
{
"speaker": "Joe Hogan",
"content": "Yeah, Jon, it's a good question. I'd say it's mainly external when I look at it. I don't think there's been any dramatic changes from a competitive standpoint in the marketplace. If I look at our ortho channel and our dental channels, they're both challenged in the sense of patient throughput and their ability to close. I was just talking to some of our largest DSOs this morning and the comparison is similar. This is -- and these are -- the close rates at our customers are more difficult, too. It's customers come in, we know they want teeth treatment, but they're not really confident in the sense of their ability to pay for it or wanting to pay for it right now in the economic situation. So, I wouldn't call out anything externally from a competitive standpoint or whatever. This is more what we feel is external economics and consumer confidence issue in the United States. Look, we see, Jon, the same thing in Europe, but Europe has been a little better and a little different, because all those countries have different situations, but it's more pronounced in the United States because it's so large and so uniform in that sense."
},
{
"speaker": "Jon Block",
"content": "Got it. Okay, thanks. And then, second question will be sort of a famous two-parter, but John, just to start, I just want to be crystal clear, you guys are committing to overall op margin expansion in '25. If that's correct, it will be somewhat neutered by the direct 3D printing fabrication initiative. Maybe if you can verify that? And then, any thoughts on the top-line? That would just be first question or I'll call it Part A. And Part B -- sorry go ahead, John."
},
{
"speaker": "John Morici",
"content": "I was going to give the op margin. The op margin, yes, we made the restructuring actions, given us room, so that we can get the year-over-year margin accretion, while still investing in all the things that we've talked about with direct fab and five-minute ClinCheck and Lumina and so on. So, we're going to continue making those investments. The restructuring gives us some room to show that margin accretion."
},
{
"speaker": "Jon Block",
"content": "Okay. And again, the other part of that question was, any thoughts on the top-line? If you're committing to the OM expansion, what does that mean from a top-line perspective? And the second one, Joe, just if I can pivot and if you can talk to some of the initiatives out there? In other words, it seems like Costco is off to a slow start, [per our] (ph) checks. Do you need to be in the store? And then, more recently, we picked up on a new financing initiative that it seems like you're rolling out and sort of guarantees the case approval, denials have been a problem. Where are you with that initiative? And when do you expect it to have a more sort of prominent impact on the overall P&L? Thanks, guys."
},
{
"speaker": "Joe Hogan",
"content": "Yeah. Hey, Jon, I'll just kind of just frame your question. The first one like Costco, we've had some success in Costco, but it's nothing as material for the business right now, but I think you have to look at that as we do internally. It's a brand strategy. We have the number one brand in the world. We're looking at different areas of how we can leverage that brand to try to encourage consumers more in the sense of entertaining Invisalign treatment. As far as financing, we know that customers right now are challenged in the sense that they do want a treatment from an orthodontic standpoint, but they're really challenged from a financial standpoint. And John and the team are doing all they can. And also our DSO -- big DSO partners are doing what we can to offer the type of financing that would give consumers more confidence to move forward."
},
{
"speaker": "John Morici",
"content": "And on overall revenue, Jon, we'll give more of an update as we get closer into 2025. But as we've said and as we've made the adjustments, we're committed to driving growth, investing where we can find that growth, balancing our investments on some of the new technologies that we have that we know will transform this business. So that's all at stake now and things that we're mindful of, but we'll give more of an update on 2025 as we get closer."
},
{
"speaker": "Jon Block",
"content": "Thank you."
},
{
"speaker": "Joe Hogan",
"content": "Yeah, you're welcome, Jon."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Elizabeth Anderson with Evercore ISI. You may proceed."
},
{
"speaker": "Elizabeth Anderson",
"content": "Hi, guys."
},
{
"speaker": "Joe Hogan",
"content": "Hi, Elizabeth."
},
{
"speaker": "Elizabeth Anderson",
"content": "Hi. I'm also going to try my hand at a two-parter as well, [since that's the theme] (ph). One, I mean, as you talk about the restructuring and sort of Frank coming back to the organization, I think you hinted at it a little bit. I know it's obviously a little bit early, so just sort of high-level quality of thought would be fine on this too. Like, what do you mean when you're -- what are you sort of -- like, what is he going to sort of drive or what do you -- is there sort of like an inflection that you're thinking about how he operates the business differently? And sort of as a corollary to that, like, I think you talked about getting closer to the consumer. If you could talk maybe about that portion of it? And then secondarily, it was nice to hear the positive commentary about China. So, I'd love to hear a little bit more about that market and sort of how you're thinking about the consumer outlook for that market as well. Thank you."
},
{
"speaker": "Joe Hogan",
"content": "Hey, Elizabeth, it's Joe. On Frank coming back, Frank was -- had been in the business from 2013. I think he left us in 2022 for another type of venture. Look, this business is about -- it's about three things. One is relationships. This is not a transactional business. This is one where you want to have good relationships and good trust with doctors, and Frank really brings that from a leadership standpoint. Secondly is, you would need a good understanding of the technology and types of programs that can help to drive growth. Frank is really an expert in that area. He's shown that over the years. When you look at our DSO program today, it's been really effective. Frank happened to put that together back when I first arrived, back in 2015, 2016 and really made that happen. Thirdly is, you need someone with scope in the sense of understands the industries, understands the competition, knows what really makes doctors make decisions, and orthodontists and how they make decisions versus the general practitioners. Frank has all that, and he's a trusted commodity within the business. So, we're excited to have him back."
},
{
"speaker": "John Morici",
"content": "And then, the last part of your question, Elizabeth, on China, we're pleased with China results, sold to more doctors, pleased with the utilization. It's a great teen season for us in China. We saw good adoption of various products, including Invisalign First and others, where we saw good utilization there. So, China, for us, from a teen standpoint, especially, played out really well for us."
},
{
"speaker": "Elizabeth Anderson",
"content": "Got it. Thank you."
},
{
"speaker": "Joe Hogan",
"content": "You're welcome."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Jason Bednar with Piper Sandler. You may proceed."
},
{
"speaker": "Joe Hogan",
"content": "Hi, Jason."
},
{
"speaker": "Jason Bednar",
"content": "Hey there. Yeah, good afternoon. I'm going to come back and follow-up on one of Jon's questions. I know a lot of us have been trying to estimate the margin upside or the margin impact from 3D printing over time, just given the cost benefits you can realize from the initiative. But the comment today here with the restructuring offsetting some of the -- maybe some of the investments you're making, it would seem like that this initiative may be dilutive to gross margins in '25. So, maybe just help us bridge the thinking that you're making in these comments today, reconcile some of those comments, and if you can, quantify kind of the puts and takes?"
},
{
"speaker": "John Morici",
"content": "Yeah. I'll take my best at this. So, overall, we're talking op margin. We think that the restructuring that we're making is going to be op margin accretive on a year-over-year basis despite all the investments. You're right, from a gross margin standpoint, as we scale things, the direct fab printing, while gives us a lot of capability and a lot of benefits for our doctors, there is a higher cost initially until we start to scale that. But we're committed to that op margin accretion on a year-over-year basis for next year despite that. And then, as we have new products that come and we know the doctors are going to love what we're bringing to market, that will scale up. And as that scales up, then that really drives the overall productivity that we will see on the gross margin side, primarily from the materials and the less material that we need to go into the product."
},
{
"speaker": "Jason Bednar",
"content": "All right, understood. And I guess maybe one follow-up to there and then another separate follow-up. But just any timeline on when we might see the gross margin benefits or expansion off of historical norms once that 3D printing does scale? And then, just with the teen season maybe now mostly complete, just what's your assessment of that part of the market, Joe, inside the U.S., outside the U.S.? The data we see has been a bit more mixed between kind of the clear aligner and bracket and wire part of the markets the past several months. Your business has grown decently the past year and a half. So, just -- do you have better visibility on this part of the market? I'm just trying to understand this again in the context of the broader comments you're making on the U.S. being a little bit softer. Thanks."
},
{
"speaker": "John Morici",
"content": "So, Jason, this is John. I'll take the first part of your question on gross margin. Look, we've talked about it being like a two- to three-year journey to be able to help scale this up. I can say this, we're very pleased with the progress that we're making around resin and being able to scale that and get it at the right cost. So that's good progress there. As well as on the equipment side, we're making good progress around being able to scale up the actual manufacturing of this. But in terms of when you scale this and get it to a larger extent, it's really two to three years, but you will see some new products that we have on the direct fab showing up next year and in doctors' hands to give them those capabilities."
},
{
"speaker": "Joe Hogan",
"content": "Jason, on the teen market, I mean, when you look at the international teen market, obviously, we had really good success in Asia in the quarter. We have really a terrific portfolio when you think about our Invisalign First product. Now, we have Invisalign Palatal Expander. With that also, it's what we call mandibular advancement with occlusal blocks, which are used for Class IIs, usually for patients between 10 and 11 years old. So, when you look at those pre-teen ages, we have a really good portfolio to line up in that sense. So, I think you're seeing that come through with our sales overall. When you reflect back on the United States, obviously, our orthodontic customers are really challenged. And 80% on an average, 75% of what they do are teens. And some of the close rates on teens, just talking to some of the DSOs and different doctors that we have on the orthodontic side, the close rates are even tougher on the teen segment than what it's been in the past, too. And so, times like this, where they're pressed for traffic and they're pressed for margin, they will reflect back to wires and brackets to support the profitability of their practice. We know that. We understand it. It's our job to communicate to consumers and to orthodontists what the benefits are, particularly this early treatment and what we can do. And so, this is a doctor-to-doctor situation, but again, it's an external environment where consumers are concerned with their pocketbooks right now, and they're reluctant to make decisions and close at times. And obviously, the orthodontists are responding from an individual practice standpoint accordingly."
},
{
"speaker": "Jason Bednar",
"content": "All right. Very helpful. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from David Saxon with Needham & Company. You may proceed."
},
{
"speaker": "David Saxon",
"content": "Great. Good afternoon, and thanks for taking my questions. I'd like to start on iTero actually. I'd love to get some color around how we should think about iTero growth with the ongoing Lumina rollout, particularly with the restorative workflow coming out early next year, but then in the context of interest rates remaining high and then lapping comps from the initial ortho launch?"
},
{
"speaker": "Joe Hogan",
"content": "Yeah, David, I think you have to start with, and I think I get the gist of your question, there's a lot of pressure on capital equipment sales in the marketplace given what we're talking about with customers being challenged in that way. I think what you have to do with the Lumina and think about it, it's truly a brand new platform. It's not an iteration of old technology like the next phase of our older technology. It's something that's really new, and it's captured doctors' attention. And I think it's the size of our sales and how well we've done, particularly in a traditional third quarter, it's a little bit slower, I think it surprised a lot of people. So, I think this is a testimony to the technology we've brought forward and the uniqueness of that technology, why we've been able -- to be able to have those kinds of sales at this point in time. We're excited about the restorative coming on in the first quarter. The team is making good progress on that. So, overall, it's just a great foundation to grow from. And what's wonderful about that platform, too, is we'll iterate from that platform going forward in different areas that will really help us to diversify the product line and target certain applications in the future."
},
{
"speaker": "John Morici",
"content": "And two things that really have helped iTero and kind of go through this, especially with the new product and so on, it's really given us a lot of opportunity on other products that we sell within the iTero kind of family. So, all the way from CPOs that we have certified pre-owned, all the way to the 5D. We actually sold a lot of 5Ds this past quarter. So, that really helps us. And then, the added part, in a tougher economy, we're giving a lot more flexibility to doctors to kind of sell the way they want to buy. Some don't want to purchase outright because of the economic conditions and so on. So, we see a lot more leasing or in other places we see more rental. And for us, that's a great trade. It will get that recurring revenue off of those different selling options, but then it's great when a doctor uses iTero because we know they'll do use more Invisalign."
},
{
"speaker": "David Saxon",
"content": "Great. Thanks for that. And then, on the U.S. side, on the Clear Aligners, can you give more color on kind of where that weakness is actually coming from? Is it the ortho channel or is it with GPs? And then, anywhere specifically from a portfolio perspective? Thanks so much."
},
{
"speaker": "Joe Hogan",
"content": "Yeah. I mean, it's almost equal in both. We see pressure on the ortho side. I mean, if you look at any kind of industrial data right now as far as patients entering the dental industry right now, the GP space, it's challenged overall. So, we see pressure in both of those areas for the same reasons we talked about before."
},
{
"speaker": "Shirley Stacy",
"content": "Yeah. Thanks, David. Next question, please?"
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Jeff Johnson with Baird. You may proceed."
},
{
"speaker": "Joe Hogan",
"content": "Hey, Jeff."
},
{
"speaker": "Jeff Johnson",
"content": "Thank you. Hey, Joe. How are you? Good afternoon, guys. So, Joe, let me ask one high-level question and then maybe just a modeling question for John. But from a high level, your R&D was down 4% year-over-year this quarter. You're making the headcount reductions. CapEx at $100 million is well below even the last couple of years, closer to $250 million those years. You're talking about increasing the buyback margin improvement next year. All of these comments kind of just point to a more mature company and that's not a critique at all. I think that's where we all know you are and see where you are. So, I guess my question is, how does this change your management style, your management objectives over the next few years? Obviously, you came into this business really pushing the top-line, but is there an evolution that's happening to go on with how you lead this company and lead this organization as well?"
},
{
"speaker": "Joe Hogan",
"content": "Hey, Jeff. I think it's a really good question. I'd say we're responding to the times here. Don't make it a reflection on what the opportunity the company is at all. We're so underpenetrated, not just in United States or North America or whatever, but all over the world. And there's hundreds of millions of people that need to have their teeth straightened. And the only way you could ever do that in a broad sense is with digital orthodontics. So, don't miss that point, Jeff. We are going through a spell right now. And what you see with the R&D down and CapEx and different things like that, CapEx is, you know we're not putting on any more manufacturing right now. We have enough manufacturing, and we're still bringing up our Poland plant, right? We're being responsible from a business leadership standpoint for our shareholders in this specific situation, but at the same time, Jeff, we're pouring a lot of money into 3D printing, five-minute ClinCheck, next phases of Lumina. All these things will really enter into just another growth cycle when this market starts to come back with brand new tech. This is the technology of the future if you really want to play in digital orthodontics. So, what we're doing is funding that, being responsible to our shareholders, but not losing our enthusiasm and what we think our opportunity is in the future."
},
{
"speaker": "Jeff Johnson",
"content": "Yeah. No, that's all fair. You are holding a sell-side event or at least an investor event a week from Saturday. Would that be a time to evaluate though that LRP, that 20% to 30% intermediate longer-term top-line growth expectation?"
},
{
"speaker": "Joe Hogan",
"content": "I think until we get a better read on what the economy is going to do, Jeff, I think that 20% to 30% represents how we feel that market could grow in the future, but we have to have the right economic conditions, particularly in the biggest markets in the world like the United States that we participate in."
},
{
"speaker": "Jeff Johnson",
"content": "Okay. And John, one modeling question. Just when I listen to the ASPs, I think the quick math on that is, it sounds like between the VAT issue that should anniversary at the start of next year, just remind me if I've got the timing on that correct, but should anniversary at the start of next year, currency headwinds should be -- we'll see what the U.S. dollar does post-election year, but should be reasonably moderating from here? So, I think ex currency and ex VAT, you had about 1.1% down ASP year-over-year. One, is that math correct? And two, is that about what we should be thinking about as we head kind of into '25 once VAT and hopefully FX normalizes a bit?"
},
{
"speaker": "John Morici",
"content": "You're right about FX hopefully normalizes, it's hard to predict. VAT does anniversary at the beginning of next year. And what we've said in the past that that ASPs would be flat to slightly down. So, your percentage you're talking about is in that range."
},
{
"speaker": "Jeff Johnson",
"content": "Thank you."
},
{
"speaker": "Shirley Stacy",
"content": "Thanks, Jeff."
},
{
"speaker": "Joe Hogan",
"content": "Thanks, Jeff."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Kevin Caliendo with UBS. You may proceed."
},
{
"speaker": "Joe Hogan",
"content": "Hi, Kevin."
},
{
"speaker": "Kevin Caliendo",
"content": "Hey, thanks. Hi, Joe. Thanks for taking my question. This is maybe a little bit off, but just wondering if you guys have ever done this analysis in terms of thinking about the Venn diagram between people purchasing GLP-1s and people going and getting Invisalign treatments, because the cost for adults anyways might be close. And I'm just wondering if there's any -- if you guys have seen any correlation to maybe that's part of the weakness in the adult market as the shortages have -- in GLP-1s have come down or people may be investing $5,000 that way as opposed to into Clear Aligners. Have you done that analysis or seen anything?"
},
{
"speaker": "Joe Hogan",
"content": "I can't say that we've been -- we've overly quantified it, Kevin. We hear that a lot. There's a lot of medical device companies that kind of talk about that that might be corollaries in the sense of what you're seeing with the GLP marketplace overall. I can't say that it's not a factor because it's obviously a high expense and something that's kind of on an annual basis in line to what it would cost to do an Invisalign treatment. But I haven't wanted to lean into that as one of the drivers here. I think it's just overwhelmed by an economy right now where consumers don't have a lot of money in their pocket or confidence about what it's going to be in the future. And GLP might play a role in it, it might not. I think also you can look around the world also in some of the markets, like Continental Europe, that's not necessarily as affected by it as maybe United States is. And I can't say I've seen that piece, too. So, there's an old saying that correlation doesn't mean causation, right? And so, I would stay with that right now."
},
{
"speaker": "Kevin Caliendo",
"content": "Fair enough. That's helpful. And just I know you don't want to talk about '25, but let's just think about the fourth quarter and sort of what you're implying for your guide in exiting the year sort of a midpoint of like 5%. Should we just sort of take that as a starting point, adjust for whatever we think the economy might do that might impact the adult side of the marketplace more and then think about Lumina as an add on to that? I mean, is that sort of how you're thinking about the business?"
},
{
"speaker": "John Morici",
"content": "Yeah. I think we'll obviously give more as we get closer to this, Kevin, but I think -- look, you come out of the year, that's probably a good starting point to be able to build off of that and say, look, what do you think is going to happen to the economy, we're going to know more, maybe about interest rates and election and other things will kind of come about and we'll have a better view of that. But I think it's a good starting point as you think about next year, you're going to add in some of the things that we've talked about with, Lumina restorative and other things and then build off of that, but we'll give more details as we get closer, obviously."
},
{
"speaker": "Kevin Caliendo",
"content": "Appreciate it guys. Thank you."
},
{
"speaker": "Shirley Stacy",
"content": "Thank you."
},
{
"speaker": "Joe Hogan",
"content": "Yeah, thanks, Kevin."
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Michael Cherny with Leerink Partners. You may proceed."
},
{
"speaker": "Michael Cherny",
"content": "Hi, good afternoon. Maybe just one, following up on a question earlier on the some of the 3D printing work in the fab-related products that you're going to be pushing out. As you think about the potential for introduction to those products, how are you thinking, given that this is a bit of a obviously different manufacturing approach that you've taken before, about what the rollout will look like? Will it look any different in terms of the types of beta customers that you're going to be pursuing? How should we think about tracking -- I mean, tracking is not the right word, but making sure that you're hitting on the right customer experience, the right overlap, the right introduction process as you get what obviously could be a very scalable set of products, set of new opportunities out to market?"
},
{
"speaker": "Joe Hogan",
"content": "Hey, Michael, it's Joe. Just taking your question is, as you think about it, when you think of what we do today, when you [indiscernible], obviously, you lose a huge amount of opportunity to differentiate the geometry of that particular product and how it can help a doctor. The one sector of our business that would I think will appreciate this the most will be the orthodontic community that do a lot of Class IIs, difficult cases, young teens, and we'll be able to produce products that are more and more tailored to consumers in that specific condition than what we could do today. And so, we would offer the product that way, and we think it'd be very appealing to them. Secondly, from a general dentistry standpoint, it's a big part of our marketplace, too, there's a lot that we can do to help them with this product line also. So, I hope I'm answering your question, but the design freedom that we have here in the end and we have to prove it when you can use relatively different thicknesses, you can do different configurations for different kinds of clinical issues that a patient might have, we expect to have more predictability in the sense of how fast you can move those teeth and more certainty and how long those cases will take. And I think doctors are going to appreciate that, but I think as we're certain of that, patients will appreciate that too, and we certainly would communicate that to patients."
},
{
"speaker": "Michael Cherny",
"content": "No, that certainly does help. And then maybe just one quick question, I promise it's not an attempt to go at '25 guidance specifically, but obviously, you've mentioned numerous times the UK VAT that's impacting ASPs internationally this year. Is there any outliers or one-time dynamics that we should be thinking about or contemplating relative to next year, something that like the UK VAT or anything else that could factor into the modeling that's non-normal?"
},
{
"speaker": "John Morici",
"content": "Michael, this is John. Nothing that we would say is non-normal. I mean, the nice thing about the anniversary of the UK VAT is, it does anniversary. Obviously, we're doing things to try to work with that government there to explain and ideally not have a VAT on our products, because it affects what goes to doctors and how much they pay and then passing it on to potential patients. But there's nothing like that, that we would see on the horizon as that type of impact."
},
{
"speaker": "Shirley Stacy",
"content": "Thanks, Michael. Next question, please?"
},
{
"speaker": "Operator",
"content": "Thank you. Our next question comes from Erin Wright with Morgan Stanley. You may proceed."
},
{
"speaker": "Erin Wright",
"content": "Great. Thanks. Can you speak a little bit more on just the nature of the restructuring outside of the executive change today, I guess the timeline, scope, magnitude and anything that you can give us in terms of quantifying that benefit from a profit perspective into 2025 and what that translates into just broadly speaking, but also just what -- how this kind of came about in terms of what's on the table, what were your changes that you were thinking about in terms of the business outlook or backdrop that really changed in your view since it's been a sluggish kind of consumer backdrop for some time? Now, I guess what else has changed? Thanks."
},
{
"speaker": "John Morici",
"content": "Yeah, Erin, I could try to give you kind of an overview of where things are at. Just as part of a normal AOP process, you're always evaluating where you're going to make investments, where you're going to fund it, how you're going to fund it and so on. So, this is part of our process that we go through where we're planning out where we're going to end up for the year and what does it mean for next year and how do we grow and do all the things that we want to talk through. This type of restructuring, this is about 2x of what we did last year. Last year, we did about 350 or so, just over 300. This is close to 700 people. There's some restructuring charges, we've talked about that, this year. But really what it does and what -- I'll go back to what Joe was talking about, we want to be focused in on what we can drive as our business, what we can do from a growth platform standpoint, whether it's the direct fab, five-minute ClinCheck, Lumina restorative. We want to fund those, but we've got to also show some margin accretion and we want to be margin accretive on a year-over-year basis. So, we can fund what we need to fund to really be driving our business and we'll fund it based on some of these changes here, but it really set us up for a position to be able to show that margin accretion next year."
},
{
"speaker": "Erin Wright",
"content": "Okay, great. And then, as we head into the fourth quarter, I guess, does your guidance assume a continuation of the same in terms of the sluggish environment in the U.S.? Or does it have any sort of changes across other regions that you anticipate either continued acceleration or deterioration across other kind of markets or geographies here? Thanks."
},
{
"speaker": "John Morici",
"content": "Yeah, Erin, it just kind of assumes what we've seen. I mean, like as we pointed out, U.S., North America not great, we kind of assume the same. Other places we actually saw good improvement, in parts of Asia, Latin America, Middle East, other places, and we continue to invest and expect to grow in those areas. So, like any forecast, you take the best information you have at the time, you try to translate to what that's going to mean for the upcoming quarter, and that's what we did for fourth quarter."
},
{
"speaker": "Shirley Stacy",
"content": "Thanks, Erin. Next question, please?"
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Our next question comes from Mike Ryskin with Bank of America. You may proceed."
},
{
"speaker": "Mike Ryskin",
"content": "Hey, thanks, guys. Just a couple of cleanup follow-up questions. One, I think just kind of following up on what Erin touched there and John you touched on this as well. Two years in a row now, and again part of that is just natural attrition, natural cleanup of the business, but should we expect this to be sort of the normal going forward in terms of the restructuring? You guys famously kind of held off on that for a while. And very famously during COVID, you actually reinvested and you refused to cut when others were cutting. So, just help us think in terms of how we should factor that in going forward."
},
{
"speaker": "Joe Hogan",
"content": "Hey, comparing this time with COVID is a stretch, Michael, overall. When we didn't lay anybody off during COVID, our expectation was that wouldn't last as long as it did, but fortunately, that was a decision to pay off well when the market came back so strongly. Right now, we're looking at just a sustained economic malaise, I would call it, in the United States, and we're responding accordingly. We haven't lost our enthusiasm and our belief in how this business can grow and this market potential of this business. What you're seeing in the restructuring is we're responding to external pressures that we see and being responsible from a business standpoint and being sure that we fund these key three technologies that we know will lead into the future from an overall digital orthodontic standpoint."
},
{
"speaker": "John Morici",
"content": "And that's the key point of it now. It's being able to make space and have a budget to be able to fund these key technologies, because we know that's going to drive the future and it's doing things that we know no one else can do, no other company can do what we're trying to do with this. So, it's really important for us now to keep that focus through these budget changes and so on. It's what companies do to be able to push the future and do it in a responsible way where we could show margin accretion. We know we always talk about levers that we could pull or not pull. This is a part of it, and it just comes about it on a more annual basis as you assess the current environment."
},
{
"speaker": "Mike Ryskin",
"content": "Okay. And then, quick cleanup, if I could, on the ASPs. You talked about earlier, I think, in the Q&A, you touched on some of the factors that impacted you in the quarter and your thoughts about next year, but just on 4Q, I think you guided up ASP sequentially, and you've had some of these mixed dynamics, some of the discounting and FX for a number of quarters in a row. Just what are you seeing so far through October that's giving you confidence that you'll be able to reverse that? Because I think some of those headwinds don't fade till next year."
},
{
"speaker": "John Morici",
"content": "Yeah. Well, I think part of -- really all our Advantage programs kind of go from -- they end in at the end of June and then they reset as you come into that second half. So, third quarter kind of took the Advantage changes. So, that shows up in discount. So, I don't expect that to continue. And then, where you do have the benefit and in our case where Europe becomes a bigger part of our business in the fourth quarter and China and some of the other businesses become less, that's good from a mix standpoint. We have a higher ASP in Europe and a lower ASP in China. So, whereas that mix hurt us from a country standpoint, in a lower ASP in the third quarter, we actually get the benefit on that in the fourth quarter based on seasonality."
},
{
"speaker": "Mike Ryskin",
"content": "Okay. That's helpful. Thanks."
},
{
"speaker": "Shirley Stacy",
"content": "Thank you, Michael."
},
{
"speaker": "Joe Hogan",
"content": "Yeah. Thanks, Mike."
},
{
"speaker": "Operator",
"content": "Thank you. And we have reached the end of our Q&A session. I'll now turn the call back over to Shirley Stacy for closing remarks."
},
{
"speaker": "Shirley Stacy",
"content": "Great. Thank you, operator, and thanks, everyone, for joining us on the call today. We look forward to speaking to you at upcoming financial conferences and for those of you who we'll see at the Invisalign Ortho Summit in Las Vegas next week. If you have any other questions, please feel free to contact Investor Relations, and have a great day."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation."
}
] |
algn | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Greetings. Welcome to the Align Technology Second Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I would now like to turn the conference over to your host, Shirley Stacy with Align Technology. You may begin."
},
{
"speaker": "Shirley Stacy",
"content": "Good afternoon, and thank you for joining us. I'm Shirley Stacy, Vice President of Corporate Communications and Investor Relations. Joining me for today's call is Joe Hogan, President and CEO, and John Morici, CFO. We issued second quarter 2024 financial results today via Business Wire, which is available on our website at investor.aligntech.com. Today's conference call is being audio webcast and will be archived on our website for approximately 1 month. As a reminder, the information provided and discussed today will include forward-looking statements, including statements about Align's future events and product outlook. These forward-looking statements are only predictions and involve risks and uncertainties that are described in more detail in our most recent periodic reports filed with the Securities and Exchange Commission available on our website and at sec.gov. Actual results may vary significantly and Align expressly assumes no obligation to update any forward-looking statement. We have posted historical financial statements with corresponding reconciliations, including our GAAP to non-GAAP reconciliation, if applicable, and our second quarter 2024 conference call slides on our website under Quarterly Results. Please refer to these files for more detailed information. With that, I would like to turn the call over to Align Technology's President and CEO, Joe Hogan. Joe?"
},
{
"speaker": "Joe Hogan",
"content": "Thanks, Shirley. Good afternoon, and thanks for joining us on our call today. I'll provide an overview of our second quarter results and discuss a few highlights from our two operating segments, System and Services and Clear Aligners. John will provide more detail on our Q2 financial performance and comment on our views for the third quarter and for 2024 in total. Following that, I'll come back and summarize a few key points and open the call to questions. Overall, I’m pleased to report solid second quarter results. Total Q2 '24 revenues of $1,028.5 million were up 3.1% sequentially and 2.6% year-over-year, reflecting growth in both Clear Aligner volumes and Imaging Systems and CAD/CAM Services revenues. Q2 '24 total revenues were unfavorably impacted by foreign exchange of approximately $11.6 million or 1.1% sequentially and unfavorably impacted by approximately $18.1 million or 1.7% year-over-year. For Clear Aligners, Q2 '24 volumes increased 6.2% sequentially and 3.2% year-over-year, driven by growth from adult patients, and strong teen case starts across the regions, led by strength in Asia Pacific, EEMA, and Latin America. Our Q2 results also reflect a record number of doctors submitting cases, and record doctors shipped to for the quarter. Q2 '24 Clear Aligner ASPs were down sequentially and lower than anticipated in our second quarter outlook, due in part to greater impact of unfavorable foreign exchange across multiple currencies, especially the Japanese yen, Euro, and Brazilian real, as well as discounts, and product mix shift to lower ASP products. As a result, total Q2 revenues were slightly below the expected range for our Q2 quarterly revenues. Notwithstanding these factors, non-GAAP operating margin for the second quarter was 22.3%, up 2.5 points sequentially, and up 1.0 point year-over-year. For Imaging Systems and CAD/CAM Services, Q2 '24 revenues increased 9.2% sequentially and 16.1% year-over-year reflecting continued adoption of our next-generation iTero Lumina scanner, which made up the majority of our equipment sales, iTero Lumina wand upgrades, iTero Element scanner trade-ins, as well as increased iTero scanner leases. For Q2 '24, adult patient case starts were up 5% sequentially and 1% year-over-year, reflecting our highest number of adult shipments in 8 quarters, driven by strength in the GP channel, led by North America and APAC dentists. In teen and growing kids’ segment, over 216,000 teens and younger patients started treatment with Invisalign clear aligners during the second quarter, an increase of 8.8% sequentially and up 8% year-over-year, reflecting growth across regions, especially from Invisalign First in the EMEA and APAC regions. In Q2, the number of doctors submitting teen or younger patient case starts was up 8% year-over-year, led by continued strength from doctors treating young kids also known as \"growing patients. The response from doctors and their patients to Invisalign Palatal Expander System continues to be positive. We believe that Invisalign Palatal Expander System is a better option for expanding a growing patient's narrow palate compared to traditional appliances used today. The Invisalign Palatal Expander System is currently available in the U.S., Canada, Australia, and New Zealand. We expect it to be available in other markets pending future applicable regulatory approval. Non-Case revenues include our Vivera retainers, which include retention aligners ordered through our Doctor Subscription Program or DSP, as well as clinical training and education accessories in eCommerce. Q2 Non-Case revenues were up 3.5% sequentially and up 5.1% year-over-year, primarily due to continued growth in retainers and DSP. For Q2, total Clear Aligner shipments include approximately 25,000 Invisalign DSP touchup cases, a record high quarter of 37% year-over-year. DSP continues to drive growth and is currently available in North America and certain EMEA countries. During the quarter, we extended DSP into more countries in Europe and we anticipate expanding into additional markets going forward. DSP is also now available in 14 stage touch up aligner offering across all markets where it's available. As a result, Touch-Up cases increased significantly in Q2. Q2 '24 Clear Aligner volume and DSO customers increased sequentially year-over-year reflecting growth across all regions. DSOs represent a large and growing opportunity to help drive adoption of digital technology across the dental industry. We have well-established relationships in many DSOs globally that recognize the benefits of digital workflows enabled by our portfolio of products and services that make up the digital platform. Including increased practice efficiency and profitability, as well as delivering a better patient experience from shorter cycle times and customer proximity. Smile Docs and Heartland Dental are two of our largest DSO partners. We are continuously exploring collaboration with the DSOs that can further the adoption of digital dentistry. Each DSO has a different strategy and business model, and our focus is working and encouraging DSOs aligned with our vision strategy and business model goals. Today, Invisalign is the most recognized orthodontic plan globally and Invisalign, Clear Aligner treatment is faster and more effective than traditional metal braces. Yet the underlying market opportunity to remains huge and untapped. We continue to invest in consumer marketing and demand creation initiatives that raise awareness and drive potential patients to Invisalign practices globally. In Q2, we had more than 17 billion impressions in 50 million visitors to our websites globally. Below are additional highlights from Q2 and more information is available in our Q2 '24 earnings webcast slides. To increase awareness and educate young adults, parents and teens about the benefits of Invisalign brand, we continue to invest and create campaigns in social media platforms such as TikTok, Instagram, U2, Snapchat, WeChat, [indiscernible] across the markets. Reaching young adults as well as teens and their parents also requires the right engagement through Invisalign Influencers and creator-centric campaign. In the Americas, our influence in social media campaigns, featured Olympic athletes such as Rebeca Andrade from Brazil, Andre De Grasse from Canada, Jordan Chiles from the United States and Paralympic athlete Lizzi Smith from the United States. To bolster T demand -- teen demand, we launched new activations with teen high school sports, social media platform, Over Time, including several programs focused on showcasing elite high school athletes across boys' football, girls' basketball, girls' soccer. We highlighted why they chose to transform their smile with Invisalign aligners and showcase their results. In the EMEA region, we partnered with influencers to reach consumers across social media platforms, including TikTok and Meta, and launched our global consumer campaigns for teens and parents. In APAC, we continue to invest in consumer advertising across the region and expanded our reach in Japan and India via meta and YouTube and partner with key social media influencers. Finally, adoption of my Invisalign consumer patient app continued to increase with over 4 million downloads to date and over 384,000 monthly active users and 8% year-over-year increase. Usage of our other digital tools also continued to increase. ClinCheck live update was used by almost 50,000 doctors on more than 692,000 cases, reducing time spent and modifying treatment plans by an average of 16.3%. Invisalign practice app is increasing in its adoption with 85,000 doctors who actively are using the app and 5.9 million photographs were uploaded in Q2 via the Invisalign practice app. Year-over-year growth in Q2 system and services revenue were up 16.1%, reflect higher scanner ASPs and non-system revenues driven by a terra luminal wand upgrades increased service revenues in a larger basis, scanner sold. On a sequential basis, Q2 systems and services revenues were up 9.2%, reflecting higher scanner volumes, higher scanner ASPs and higher non-system revenues driven by a iTero Lumina terra wand luminal wand upgrades. The iTero Lumina is new multi direct capture technology replaces the confocal imaging technology in earlier models and has a 3x wider field of capture and a 50% smaller and 45% lighter wand, delivering faster scanning speed, higher accuracy, superior visualization, and a more comfortable scanning experience. Lumina is currently available with orthodontic workflows as a new standalone scanner or as a wand upgrade from iTera element 5D Plus scanner. During the second quarter, we had a record number of competitive trade-ins demonstrating the continued success of the iTera Luminous Scanner in the marketplace. We're also seeing a halo effect with Invisalign scans. We're pleased to see more doctors coming into the digital ecosystem with an increase in first time Invisalign case submitters as well as return of lapse submitters. Overall, Q2 we're very pleased with the continued uptake of iTero Lumina Scanner with ortho workflow and response from customers. We're looking forward to a limited market release for the restorative software on Lumina in Q4, followed by full commercialization in Q1 '25. Today we introduced the iTero design suite, offering doctors an intuitive way to facilitate designs for 3D printing of models, bite splints, and restore restorations and practice. This software innovation is designed to help doctors increase their practice efficiencies and elevate patient experiences by shortening the time to treatment through an intuitive way to design for in-practice 3D printing. The Align digital platform provides an innovative portfolio of customer-focused technologies that enable seamless end-to-end workflows for dental professionals. iTero Design Suite is now available through an early access program. Doctors using an iTero scanner can submit their interest via their scanner, or my iTero portal. Software is expected to be available later this year in selected markets. With that, I'll turn it over to John."
},
{
"speaker": "John Morici",
"content": "Thanks, Joe. Now for our Q2 financial results. Total revenues for the second quarter were $1,028.5 million, up 3.1% from the prior quarter and up 2.6% from the corresponding quarter a year ago. On a constant currency basis, Q2 '24 revenues were impacted by unfavorable foreign exchange of approximately $11.6 million or approximately 1.1% sequentially and were unfavorably impacted by approximately $18.1 million year-over-year or approximately 1.7%. For clear aligners, Q2 revenues of $831.7 million were up 1.8% sequentially, primarily from higher volumes, partially offset by lower ASPs. On a year-over-year basis, Q2 Clear Aligner revenues were flat, primarily due to higher discounts. A product mix shift to lower ASP products and the unfavorable impact from foreign exchange offset by lower net revenue deferrals, higher volumes and price increases. Q2 '24, Clear Aligner revenues were unfavorably impacted by foreign exchange of approximately $9.5 million or approximately 1.1% sequentially. On a year-over-year basis, Clear Aligner revenues were unfavorably impacted by foreign exchange of approximately $14.7 million or approximately 1.7%. For Q2 Invisalign ASPs for comprehensive treatment were down sequentially and year-over-year. On a sequential basis, the decline in a SP primarily reflects higher discounts, a product mix shift to lower a SP products and the unfavorable impact of foreign exchange. On a year-over-year basis, the decline in comprehensive ASPs primarily reflects higher discounts, a product mix shift to lower ASP products and the unfavorable impact from foreign exchange, mostly offset by lower net revenue deferrals and price increases. For Q2, Invisalign ASPs for non comprehensive treatment were down sequentially and year-over-year. On a sequential basis, the decline in ASPs reflects the unfavorable impact from foreign exchange, higher net revenue deferrals, and a product mix shift to lower ASP products partially offset by price increases. On a year-over-year basis, the decrease in non-comprehensive ASPs reflects higher discounts, a product mix shift to lower ASP products, the unfavorable impact of foreign exchange and the unfavorable impact of a price adjustment in the UK to make the recently mandatory application of VAT to our liners cost neutral to customers. Our Invisalign comprehensive three and three product and anticipate adoption will continue to increase is available in North America, EMEA and its certain markets across APAC. We are pleased with the continued adoption of the Invisalign comprehensive [3-in-3] product and anticipate an adoption will continue to increase. Comprehensive [3-and 3] provides doctors the flexibility they want while allowing us to recognize more revenue upfront with deferred revenue being recognized over a shorter period compared to our traditional Invisalign comprehensive product and benefiting us with a more favorable gross margin. Clear Aligner deferred revenues on the balance sheet decreased $7.8 million or 0.6% sequentially and decreased $5.2 million or 0.4% year-over-year. Ambo will be recognized as the additional aligners are shipped. Q2 '24 systems and services revenues up $196.8 million were up 9.2% sequentially, primarily due to higher volumes, higher ASPs and non-system revenues mostly related to upgrades Q2 24 systems and services revenues were up 16.1% year-over-year, primarily due to higher ASPs, increased non-system revenues, mostly related to upgrades and our leasing rental programs and higher service revenues. We are pleased to be able to leverage our operational and financial capabilities to provide different types of go-to-market models for our customers such as leasing and rental options. In the end, we are focused on selling the way our customers want to buy. Q2 24 systems and services revenues were unfavorably impacted by foreign exchange of approximately $2.1 million or approximately 1% sequentially. On a year-over-year basis, systems and services revenues were unfavorably impacted by foreign exchange of approximately $3.4 million or approximately 1.7%. Systems and services deferred revenues on the balance sheet was down $20.4 million or 8.3% sequentially and down $43.4 million or 16.2% year-over-year, primarily due to the recognition of services revenues, which are recognized ratably over the service period. The decline in deferred revenues both sequentially and year-over-year primarily reflects the shorter duration of service contracts applicable to initial scanner purchases. As our scanner portfolio expands and we introduce new products, we are increasing the opportunities for customers to upgrade and make trade-ins. In addition to our scanning, leasing and rental programs. Developing new capital equipment opportunities to meet the digital transformation needs of our customers and our DSO partners is a natural progression for our equipment business with a large and growing base of scanners sold. The structural programs we have implemented across both of our operating segment benefit our customers by providing them with more options to choose what they need. In some cases at a reduced price that may impact our ASPs, but the cost of service for us is, is lower and the benefit is then reflected in our gross margins. Moving to gross margin. Second quarter overall gross margin was 70.3%, up 0.3 points sequentially and down 0.9 points year-over-year. Overall gross margin was unfavorably impacted by foreign exchange by approximately 0.3 point sequentially and unfavorably impacted by approximately 0.5 points on a year-over-year basis. Clear aligner gross margin for the second quarter was 70.8%, down 0.1 point sequentially due primarily to lower ASPs, partially offset by lower additional aligners and leverage manufacturing spend. Clear aligner gross margin for the second quarter was down 1.7 points year-over-year due primarily to lower ASPs and higher manufactured spend as we continue to ramp up Poland manufacturing facility and the impact of unfavorable foreign an exchange. Systems and Services gross margin for the second quarter was a record 68.2% up 2.3 points sequentially, primarily due to higher ASPs and manufacturing efficiencies. Systems and services gross margin for the second quarter was up three points year-over-year for the reasons stated above. Q2 operating expenses were $575.6 million, up 5.9% sequentially and 6.3% year-over-year. On a sequential basis, operating expenses were up by $31.9 million due primarily to about $31 million in legal settlements year-over-year. Operating expenses increased by $33.9 million, primarily due to legal settlements and higher employee compensation, partially offset by lower outside services, advertising and marketing expenses. On a non-GAAP basis, excluding stock-based compensation. Amortization of acquired intangibles related to certain acquisitions, restructuring, legal settlements and other charges, operating expenses were $499.5 million, down 1.3% sequentially and down 1.1% year-over-year. Our second quarter operating income of $147 million resulted in an operating margin of 14.3% down 1.2 point sequentially and down 2.9% year-over-year. Operating margin was unfavorably impacted from foreign exchange of approximately 0.6 points sequentially and unfavorable impacted by 1.2 points year-over-year. On a non-GAAP basis, which excludes stock-based compensation, Amortization of intangibles related to certain acquisitions, restructuring legal settlements and other charges. Operating margin for the second quarter was 22.3%, up 2.5 points sequentially and up 1 point year-over-year. Interest and other income expense net for the second quarter was an expense of $3.2 million, primarily due to unfavorable foreign exchange compared to an income of $4.3 million in Q1 of '24, and an expense of $0.3 million in Q2 of '23. Recall that Q1 '24 included a non-recurring gain on our equity investments. The GAAP effective tax rate in the second quarter was 32.9% compared to 33.7% in the first quarter, and 34.8% in the second quarter of the prior year. The second quarter GAAP effective tax rate was lower than the first quarter effective tax rate, primarily due to discrete tax events is recognized in Q1 of '24 that did not reoccur in Q2 of '24, and that benefit was partially offset by an increase in non-deductible expenses. Our non-GAAP effective tax rate in the second quarter was 20%, which reflects our long-term projected tax rate. Second quarter net income per diluted share was $1.28, down sequentially $0.11 and down $0.18 compared to the prior year. Our EPS was unfavorably impacted by $0.11 on a sequential basis, and $0.17 on a year-over-year basis due to foreign exchange. On a non-GAAP basis, net income per diluted share was $2.41 for the second quarter, up $0.27 sequentially and up $0.19 year-over-year. Moving on to the balance sheet. As of June 30, 2024, cash, cash equivalents and short and long-term marketable securities were $782.1 million, down sequentially, $120.4 million, and down $251.7 million year-over-year. Of our $782.1 million balance, $140 million was held in the U.S and $642.1 million was held by our international entities. During Q2 '24, we repurchase approximately 0.6 million shares of our common stock at an average price of $250.73 through $150 million of open market repurchases. As of June 30, 2024, $500 million remains available for repurchases of our common stock under the January 2023 big purchase program. During the quarter, we completed a $75 million equity investment in Heartland Dental, a multidisciplinary DSO with GP and Ortho practices across the United States. Q2 accounts receivable balance was $1,020.1 million, up sequentially. Our overall day sales outstanding was 89 days, up approximately 3 days sequentially and up approximately eight days as compared to Q2 last year. Cash flow from operations for the second quarter was $159.8 million. Capital expenditures for the second quarter were $53.5 million, primarily related to our continued investments to increase aligner manufacturing capacity and facilities. Free cash flow defined as cash flow from operations, less capital expenditures amounted to $106.4 million. Now turning to our outlook, assuming those circumstances occur beyond our control, we provide the following business outlook for Q3 and fiscal 2024. For Q3 2024, we expect our Q3 worldwide revenues to be in a range of $980 million to $1 billion. We expect Clear Aligner volume to be down sequentially as a result of Q3 seasonality and clear aligner ASPs to be down sequentially, primarily due to foreign exchange and product mix. We also expect systems and services revenues to be down sequentially because of Q3 seasonality. We expect our Q3, 2024 GAAP operating margin to be below Q3, 2023, GAAP operating margin and Q3' 2024 non-GAAP operating margin to be flat to Q3 2023 -- non-GAAP operating margin For fiscal 2024, we expect fiscal 2024 total revenue growth to be up 4% to 6% year-over-year. Doing part to lower Clear Aligner ASPs year-over-year from continued unfavorable foreign exchange and product mix. In addition, our revised revenue outlook reflects our anticipated commercial launch of iTero Lumina with restorative capabilities to occur in Q1 of 2025 instead of 2024 as previously of 2025 instead of 2024 as previously anticipated? We expect fiscal 2024 GAAP operating margin to be slightly below 2023 GAAP operating margin and 2024 non-GAAP operating margin to be above 2023. non-GAAP operating margin, we expect investments in capital expenditures for fiscal '24 2024 to be approximately $100 million. Capital expenditures primarily relate to building construction and improvements as well as manufacturing capacity in support of continued expansion. With that, I'll turn it back over to Joe for final comments, Joe. Thanks."
},
{
"speaker": "Joe Hogan",
"content": "Thanks, John. In summary, I'm pleased with our overall performance for Q2 and the growth we delivered across the business for clear aligner volumes as well as strong revenues from scanners and services. Notwithstanding the impact of unfavorable foreign exchange on our revenues, we believe the end markets are stable overall and we're committed to supporting our doctor customers in the future of digital innovation. Our purpose is to transform smiles and change lives with the goal of being the standard of care and orthodontics with Invisalign Clear Align of treatment. Clinically, we believe that we can treat the vast majority of orthodontic cases today. From the simplest to the most complex clinical efficacy is no longer a question. We now focus on the treatment experience for patients and on efficiency and growth for our doctor customers. The orthodontic case start market is vastly underpenetrated and there are millions of consumers who would benefit from digital orthodontics. We continue to evolve to better meet the needs of doctors, potential patients who increasingly seek convenient, elevated digital experiences. Our digital platform of integrated technologies, software and services has helped improve orthodontic treatment from millions by delivering seamless workflows and dental practices on mobile devices and through remote monitoring, and are designed to help doctors and patients realize the benefits of a truly seamless end-to-end digital workflows and patient experiences. But the journey from analog to digital has proven difficult for practices. The orthodontic practice of the future requires full digital transformation to truly realize the promise of digital. And there is no other med tech company in the world that can help practices meet this challenge. With that, I thank you for your time today. We look forward to sharing our continued progress as we move the industry forward through digital orthodontics. Now I'll turn the call over to the operator for your questions. Operator?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Michael Cherny from Leerink Partners. Your question please."
},
{
"speaker": "Michael Cherny",
"content": "Good afternoon. Thank you for taking all the question. Maybe if I can just dive in a little bit on the guidance change and some of the moving pieces. In particular, I want to get a sense from you of what you view as within your control versus outside. Obviously, FX is something that management can't control, but you think about the guidance in particular on the ASP side, how do you think about the flow through of what isn't within your control on mix? Is there something you do on promotion? Is there anything else that can come from a pricing competition that you should be worried about? Just want to dive a little bit more into that number given that it seems to be the biggest fulcrum point relative to the guidance change."
},
{
"speaker": "John Morici",
"content": "Yes, it's a good question, Michael. This is John. Look, when we looked at the total year when and based on what we're seeing now, we see the unfavorable foreign exchange impact. We saw it in Q2 and we continue to see and project that that will continue for the rest of this year. So that's in our outlook. Just over a point of our reduction in our total year is related to foreign exchange. The mix effect that you talked about, that's really the way our customers want to buy. In some cases, they're buying lower price products, it's part of our portfolio. We see that as incremental in cases like doctor subscription program. They're just at a lower ASP. But what we end up seeing then is a better gross margin. Our cost to serve in many cases is lower than that, but it really is a reflection of what doctors want to do with the cases that they buy."
},
{
"speaker": "Michael Cherny",
"content": "Okay. Thank you."
},
{
"speaker": "John Morici",
"content": "Thanks, Mike."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Elizabeth Anderson from Evercore ISI."
},
{
"speaker": "Elizabeth Anderson",
"content": "Hi guys. Thanks so much for the question. I was wondering if you had just regarding the guidance, if you had any insights that you could share on whether any of the iTero restorative scan revenue was originally contemplated in the 2024 guidance and now with the push out on the launch, if that was sort of an impact on the guidance as well? And then as a follow-up, if you could talk a little bit more about the acceleration in the teen revenue, or sorry, in the teen cases, which accelerated off a tougher comp, that would be helpful to also get some more additional perspective there. Thanks."
},
{
"speaker": "John Morici",
"content": "Yes. Hi, Elizabeth. Yes, you're right. The Lumina restorative that we expected to launch in the fourth quarter, now the full launch in -- into next year. That revenue was expected for this year. So that's part of the reasoning for taking down our overall guidance, in addition to the FX as I said on the previous question. And then your question on teen, look, we're pleased with our teen growth. We saw good over 8% growth on a quarter-over-quarter basis, 8% growth on a year-over-year basis. We saw good adoption in many places around the world. And it's a further reflection of the various products that we have, the adoption that doctors have. A lot of new doctors coming into the ecosystem to get trained and then actually become customers of ours. So we're pleased with the progress that we're seeing within teen."
},
{
"speaker": "Elizabeth Anderson",
"content": "Great. And any chance you want to quantify that iTero restorative contribution change or no?"
},
{
"speaker": "John Morici",
"content": "Yes, We're not getting it directly, but its less than a 1%, slightly less than a percentage of the total."
},
{
"speaker": "Elizabeth Anderson",
"content": "That's helpful. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Jon Block from Stifel. Your question please."
},
{
"speaker": "Jonathan Block",
"content": "Hey, Joe, good afternoon. Yes, where to start? Everyone was nervous about cases and then you come in and you beat cases handling, and obviously the focus is going to be on the ASP. So John, maybe let me know if I have these numbers right. But it looks like the aligner ASP was down roughly 4% Q-over-Q. The FX hit was about a 1%. So can you talk in detail as much as possible, the other 3% decline in the ASP Q-over-Q, if I've got that right, it seems like a big deviation from where your head was at 3 months ago. How much of it was mix versus discounts? And if it was a lot of mix, why did mix become so pronounced over the past 3 months? And maybe we can start there please."
},
{
"speaker": "John Morici",
"content": "Yes, Jon, when you look at mix that we have, we see doctors utilizing DSP more and more as a record amount of DSP that we had in a quarter that's at a lower ASP. We saw a lot of GP growth. We talked about adult cases being up, and the best volumes that we've seen in several quarters, and many times that's lower stage products, that we end up seeing come through. And so when we see the ASP, it's just a reflection of the different products that are being sold and those doctors are taking those up, at that. But you also know, and we've talked about where margins in many cases are better at those lower stage products, and we end up seeing this as a benefit to be able to see show up in gross margins and also off margins."
},
{
"speaker": "Jonathan Block",
"content": "Okay. So I, I guess to maybe just as a follow-up to that, are you saying that discounts weren't more aggressive, call it in 2Q '24 than maybe what we've seen historical? And just tack on to that follow-up, you brought down the midpoint of the rev guide from about 7% to 5%. You said FX was a 1%, you said the GP restorative push on Lumina was slightly less than 1%. I mean, are you sort of implying that clear aligner revenue by and large for 2024 is somewhat unchanged or maybe down a smidge and, and then I'll ask my quicker follow-up. Thanks."
},
{
"speaker": "John Morici",
"content": "Yes, Clear Aligner revenue down a little bit for the total year because of the ASPs that we spoke about not necessarily due to any volume changes. Like you said, we are pleased with the Q2 volume that we have. But that’s how we’ve look at the change. Mostly the FX for the total year as we've described, and then some mix, but then the rest of it due to iTero changes from this year to next year."
},
{
"speaker": "Jonathan Block",
"content": "Okay. And last question for me. I guess online, just John, if I've got this right, it looks like the revenue comes down a little bit, the midpoint, but I believe the non-GAAP EBIT margins came up slightly, I think before it was like flat to slightly up, and now you're saying slightly up. So maybe just talk through the dynamics where you're able to arguably increase the non-GAAP EBITDA margin assumption for '24 even off the more modest revenue base. And thanks for the time, guys."
},
{
"speaker": "John Morici",
"content": "Yes, no, it's a good question. And so as we looked at and as we talk about some of the -- I know ASP gets a focus, but really when you look at the margin that we get on all of these products is as they go to some of the lower stage products, we end up with a better margin. Our cost to serve is lower, which shows up in gross margin and flows its way to op margin. And I think the rest of it as you saw with this quarter from an OpEx standpoint and how we think about the levers that we could pull or not pull, we're very mindful of that in this environment and want to be able to deliver as much volume and as much top line as we can, but be very mindful of the operating profit that we need to deliver."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Jeff Johnson with Baird. Your question please."
},
{
"speaker": "Joe Hogan",
"content": "Hey Jeff."
},
{
"speaker": "Jeff Johnson",
"content": "Hey Joe. Good afternoon, guys. Wanted to start maybe on your doctor ship to number in the quarter. You shipped to a little over 86,000 docs this quarter. I think for 3 straight years you've kind of been in that 82,000 to 85,000 range. So maybe not a big breakout, but at least some of these underlying numbers on utilization is doctors ship to and that are starting to perk up a little bit. So I guess what I'm trying to understand on that doctor ship to number, are you starting to see some benefits of some of the investments Jon has been talking about the last couple quarters on getting that doctor prescribing base to expand? Is it expanding that base? Is it slowing the outflow of that base? As we know you've had some competitive losses here over the last couple years. Just maybe help us understand the inflow and the outflow rates and what's moving between those two pieces. Thanks."
},
{
"speaker": "Joe Hogan",
"content": "Hey Jeff, Joe. First of all, we're pleased with that. It's good to see a utilization go up. It's also great to see the doctors go up too. And obviously there's a strong concerted effort. We talk about that underserved marketplace out there and we know there's still a lot of doctors to train and there's still doctors do a lot more cases. So it's a big focus for the business. When you ask that question, are we loser in fewer or gaining few? There's always a mix and a change in those kinds of things, Jeff. But overall you can see here that we're gaining, it's not saying that we don't lose some docs sometimes, but you know, we often bring them back too. The whole story with what we've been through as competitors have entered the marketplaces, sometimes we'll lose some doctors, they often come back and one of the things about our business too, sometimes it takes 18 months for doctors to figure out if those competitive cases are actually going to work. And obviously I think we’re -- we're making good progress in the sense of convincing doctors to move ahead with us. And this growth in doctors and utilization occurred across the globe, which is great. It wasn't like it just came out of one region."
},
{
"speaker": "Jeff Johnson",
"content": "Yes, understood. All right. And then maybe just a follow-up on the manufacturing side. We saw the news maybe a couple months ago of Emory's new role leading Direct Fab. He's going to stay in that role it sounds like through 2026 when he is going to write off into the sunset. So does that tell us anything about timelines on Direct Fab? I mean, Emory just doesn't seem like the kind of guy that would want to walk away in the middle of something. So is that kind of drawing a line in the sand that by 2026 you should be up and running fairly well, fairly maybe not efficiently, but fairly completely in getting that Direct Fab plans all put together and rolling out some of that 3D printed stuff in a bigger way?"
},
{
"speaker": "John Morici",
"content": "Hey Jeff, it's a good question. We have a lot of faith in Emory. He's been here for so long and he's the only guy that's ever scaled, aligners to the point, that he has. And so it's really fun to have him in this role because he gives us great feedback in a sense of where we are. Jeff, the best I can say what we've talked about with the analyst is we're looking at 2 to 3 years on this scale. And don't think of it as a linear line. This is one where you have to do a lot of equipment work at first to get the efficiencies, to have this equipment work 24/7. And then secondly, this is a brand new resin [ph], it's never been sourced before. And so finding the source of the resin, making sure you have the reactor capacity, all those things take time. So I look at over the next year, we do a lot of that groundwork and then you'll start to see products and different things that will roll from that. So, but it's best to fix in your mind that it's a 2 to 3 year kind of a rollup."
},
{
"speaker": "Jeff Johnson",
"content": "Understood. Thank you."
},
{
"speaker": "John Morici",
"content": "Okay."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Brandon Vazquez from William Blair. Your question please."
},
{
"speaker": "Brandon Vazquez",
"content": "Hi everyone. Thanks for taking the question. I'll ask two upfront because it's kind of guidance related. One a little near-term, which is basically, I think if you do the sequentials and the implied numbers on the guidance that you've given us, there's maybe like a high single digits revenue increase going into Q4. I think, correct me if I'm wrong, but that's kind of like pre-COVID levels of seasonality, back when the business was a little more normal. So the question near-term being, given the uncertainty in the market, what kind of gives you the confidence that you guys can kind of return normal seasonality within this year? And then the follow-up to that on kind of a long-term guidance question is like, okay, we look with [indiscernible] three years out, what's kind of the growth expectations of this business sort of growth algorithm? Any color you can give us around that, assuming that, we're, it seems like we're stuck in somewhat of a an uncertain end market stable, but not exactly where you want it. So talk about the opportunity to accelerate if even possible, in an end market like this over the couple plus three plus years. Thank you."
},
{
"speaker": "John Morici",
"content": "Yes, Brandon, this is John. I could take the question kind of on the remaining part of this year and so on. So we've guided to what we can see, based on how the quarter played out. We actually saw in the second quarter. I mean, I'm not saying it's a return to normal seasonality, but it was much more seasonal in the second quarter in terms of how our volume progressed and how it changed quarter-over-quarter to more normal seasonality. And so our reflection of what we tried to do for the rest of this year based on what we see. In terms of volume, takeout FX and some of that noise that gets caught into Q2. But from a underlying volume standpoint, we saw, um, more normal seasonality. And as we play out the rest of this year, we expect that to continue with teen season that comes in, that we're in now. China in the third quarter is a strong quarter for them because of team season, Europe, not so much. We expect that to, uh, play out more normally as it moves from Q3 to Q4. When we think of the total and looking out into 3 years, and so look, we're in an underpenetrated market and we've talked about a lot about that. We think we have the products and the go-to-market capabilities to really move this market forward. And it's up to us to be able to help drive this market forward. And when we look out and we look out in our long-term model, we believe in, in the opportunity revenue growth is 25% plus percent and up margin 25% plus. And that's how we are positioning things for growth, for whether it's Direct Fab, and the growth opportunities that we have there and the efficiencies that we can drive as well as the standard production that we have now. That's how we're building from an investment standpoint. We're mindful of changes that can happen short-term and economy and so on. And that's why we give you kind of the guidance that we have, at least now in short term, but in longer term we believe in, in our model. And, and that's how we're investing in the future."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Our next question comes from the line of Jason Bednar from Piper Sandler. Your question please?"
},
{
"speaker": "Q - Jason Bednar",
"content": "Good afternoon everyone."
},
{
"speaker": "Joe Hogan",
"content": "Hey, Jason,"
},
{
"speaker": "Jason Bednar",
"content": "Hey, there, I wanted to touch on one near-term item with third quarter guidance, some of the spend discussed already, but clearly over the -- lower than where you'd probably model things out internally 3 to 6 months ago. And I guess I'm just reminded of maybe where we were a year ago in the third quarter, you had higher expectations than where ended up finishing. So I guess I'm curious maybe how much of that experience from last year informed your view on volumes and product mix versus, say, the trends and macro data points that you've seen develop the last few months? And then maybe include here if you could just how you're seeing that team season develop since we are in the thick of that right now."
},
{
"speaker": "John Morici",
"content": "Yes, Jason, I can take that on, on the Q3. Some of those specifics, certainly we look at last year, we look at the 2022, you know, you got into those COVID years, they're tough to call and then you have to jump before COVID. So now you're talking almost 5 years ago. So, you look at what you see at the time knowing that most recently you have, we know we have Europe, has a summer kind of shutdown, comes back into September. We want to be able to see in September that they do come back. USS is in team season, China to get into the teen season as well. And we want to see how that plays out. So we call based on based on what we expect, both from a volume standpoint and we are really trying to give the foreign exchange that we see, that started the quarter, in July, where that FX is and not make an assumption as to whether things are going to get better or worse. We want to put that out there and really try to give you more of the underlying performance for the business. Joe, you want to talk about purchase?"
},
{
"speaker": "Joe Hogan",
"content": "Yes, on the teen side, Jason as I said in my script, and we were pleased with the team growth. It was over 8%, which is great to see. A lot of that was supported by Asia and also Europe when you really got to get into team numbers. Again, IPE is part of that. It's -- we look at that as obviously pre-teen and we watching the ramp up of that, that is obviously pre-teen and we were watching the ramp up of that and the acceptance in the marketplace. So hope I'm answering your question, but overall, we feel good about the team now. There's a big team season in China in the third quarter, we're watching it closely. We expect be able to perform in that side too. So I'm optimistic as it stands."
},
{
"speaker": "Jason Bednar",
"content": "Okay, great. Then just for my follow-up, I'm going to pack a few in here. Maybe bigger picture, if we step back and look at some of the recent developments. I know there's a lot of initiatives, different initiatives, marketing programs, menu expansion, customer incentives, so on and so forth. Those all help contribute to expanding that utilization line, improving doctor productivity. You've got the Costco relationship that's been discussed. We uncovered what looks to be one of the larger changes to your advantage program in at least a few years. So I'm curious how you'd have us think about these in the broader context of your commercial efforts. Would you consider things like the Costco and Advantage changes, either are both more impactful than what you typically do? Have you seen any change maybe in doc behavior, just in response to these advantage changes? And then what's the right way to think about each of these influencing that ASP line that's now coming to focus more significantly with today's results? Thank you."
},
{
"speaker": "John Morici",
"content": "Yes, that's a good, great question, Jason. I look at -- just to answer it a couple different ways, because I think one is like on the advantage you brought up, that's really a reflection of trying to put some structure, a little added structure to our Advantage program where many of our promotions we're trying to get to. And in the end for an Advantage program is trying to get new doctors in, give them a progression of, how they can get discounts as they do more and more cases drive utilization. So that's, that's good for new doctors, that's good for existing doctors. So the Advantage changes really we're trying to put more structure into that, into the second half and then carrying forward because they really had better refreshed, like, what we've got now. But it's all about driving utilization, getting doctors to do more and more cases. Programs like we're testing or piloting with a Costco is really just trying to drive more conversion. Find ways where those consumers or those potential patients are out there, they're shopping around, they're looking at, you see the economy, you see inflation, you see other things. We know those potential patients are out there. We just have to find ways to be able to connect them with a great product that we have with our customers, with our doctors. And Costco is an example of that, that we'll test and we'll see. But it's really that specifically is designed around conversion drive as much conversion as we can."
},
{
"speaker": "Jason Bednar",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Michael Ryskin from Bank of America. Your question please."
},
{
"speaker": "Michael Ryskin",
"content": "Hey, thanks for taking the question, guys. Joe or John, I want to follow-up on a point that you touched on a couple times already in terms of the ASPs. You talked about part of it is the mix shift and a lot of it is how your customers want to buy, whether that's different products within portfolio, whether or DSP, things like that. But what I want to get at is, are you concerned by that trend itself at all? Is that, that customers want the lower products? I guess that gives you the option to still meet them in the air and that still drives the volume, but is that something that you expected. This shift down? As you say, the market's still very unpenetrated. It's a big untapped market, so you'd think that you wouldn't be seeing the demand elasticity type of price that you are. So is this temporary because of the current macro environment and consumer sensitivity, or does it say something deeper that the rest of the market that's out there really doesn't exist at that, 1,300 plus ASP maybe it's lower and lower and lower."
},
{
"speaker": "Joe Hogan",
"content": "Hey Michael, it's Joe. Look, I think the ASP piece to try to explain as much as we can is, we're always staring at the margin side to make sure that our margins are good. We find out that all over the world, I mean, if you're in India, they ask for a different product and they ask in the United States at different areas, and some people want a 5x5, someone want 3x3, all these things are different products for different kinds of applications. And GPs [indiscernible] at times too. So what we're seeing and there's varying ASPs on it, but we always have -- you see, our margins have actually moved up on that. So you're seeing not necessarily the market just driving price down, you're just seeing us having a variation of options that customers or doctors want around the world and making sure that we supply those well. One -- we talk about 25,000 cases came through DSP. Remember, those are cases that, that doctors used to mold these things in their offices in order to address those, right. And now they're buying three or four of ours now, yes, we're getting great margin on that product line, but overall it's a lower ASP in that sense as part of the DSP program. So what you're seeing is just us responding to a market. It's a good market out there with varying degrees of price and value, and you'll see us continue to do that in order to grow the marketplace."
},
{
"speaker": "Michael Ryskin",
"content": "Okay. And then much quicker follow-up hopefully, sorry if I missed it, but did you call up why the Lumina restorative was pushed out to 1Q '25? Was this commercial decision or something on the development side?"
},
{
"speaker": "Joe Hogan",
"content": "Yes, Michael, well, there's like five areas of restorative that you have to be very good at as you go through this. And truth of reviews, we made extremely good progress on most of them. But we just -- we wanted to take a little extra time to make sure we get this right and we want to make sure that we run it through our doctors who are actually going to use it, the luminaries out there that help to promote the product and make sure that they're comfortable with it too. So we just feel it's diligent and responsible to make sure that we take a few more months here, launch it in the first quarter so that we have the world's best product."
},
{
"speaker": "Michael Ryskin",
"content": "Okay. Thanks. Makes sense."
},
{
"speaker": "Operator",
"content": "Thank you. And one moment for our next question. And our next question comes from the line of Erin Wright from Morgan Stanley. Your question please."
},
{
"speaker": "Erin Wright",
"content": "Thanks for taking my question. So did you see any recent changes, for instance, in the adult case volume dynamics throughout the quarter? And just what are you seeing so far in the third quarter in terms of adult cases? I guess, has anything changed in terms of your view on the macro environment and for the remainder of the year? And I hate to belabor this, but also for the Americas too, but on the macro question, are you generally expecting stability in your guidance or are you anticipating a range of outcomes from a consumer and macro environment standpoint for the remainder of the year?"
},
{
"speaker": "Joe Hogan",
"content": "Aaron, we -- I mean, we had that in our script and we talk about it as we're expecting stability. I mean, obviously not stability and exchange rates, right? We can't, we're not that smart. We'd be working somewhere else if we knew exchange that well. But as far as the market overall and how we want to go about it, we still feel we're dealing in a stable environment. The last thing I'll say about this, this is a very global business. You saw that the Japanese yen, Brazilian real, the business is growing substantially that way, and there's a certain amount of stability that we have that plays across geographies too."
},
{
"speaker": "John Morici",
"content": "And that adult piece we saw growth. We saw highest quarter in many quarters. So we're pleased with it. I think it's a reflection of our GP business, growing GPs, growing with DSOs and so on being able to, to get some of that volume through. Like Joe said, it's more of a stability that we're seeing, but we're pleased with that adult growth. And some of that contributes to some of that lower ASP product. It's great if that's how doctors want to buy to be able to treat those adults, we're happy to sell it to them. And as Joe said, it -- it's a better margin for us."
},
{
"speaker": "Erin Wright",
"content": "And you mentioned China too and the key market there, but just generally speaking, can you give us an update on kind of China, the underlying demand trends and market dynamics there?"
},
{
"speaker": "Joe Hogan",
"content": "It's Joe again, Erin. China performed the way we wanted China to perform, just as we predicted. Overall, I mean, the market is challenging. I think that Tier 3 and 4 cities are actually challenged more than the private and one and twos. But overall there's no surprise we have a good team there. Juno [ph] is a great leader for us there and we like the results and we're looking forward to a good team quarter there, which is third quarter is always the biggest quarter for China."
},
{
"speaker": "Erin Wright",
"content": "Okay. Thank you."
},
{
"speaker": "Joe Hogan",
"content": "You're welcome."
},
{
"speaker": "Operator",
"content": "Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Shirley Stacy for any closing comments."
},
{
"speaker": "Shirley Stacy",
"content": "Thank you, operator, and thank you everyone for joining us on the call today. We look forward to speaking to you at upcoming financial conferences and industry events. If you have any questions, please follow-up with our investor relations team. Have a great day."
},
{
"speaker": "Operator",
"content": "Thank you, ladies and gentlemen, for your participation at today's conference. This does conclude the program. You may now disconnect. Good day."
}
] |
algn | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Greetings. Welcome to the Align First Quarter 2024 Earnings Call. [Operator Instructions] Please note, this conference is being recorded."
},
{
"speaker": "",
"content": "I will now turn the conference over to your host, Shirley Stacy, with Align Technology. You may begin."
},
{
"speaker": "Shirley Stacy",
"content": "Good afternoon, and thank you for joining us."
},
{
"speaker": "",
"content": "I'm Shirley Stacy, Vice President of Corporate Communications and Investor Relations. Joining me for today's call is Joe Hogan, President and CEO; and John Morici, CFO."
},
{
"speaker": "",
"content": "We issued first quarter 2024 financial results today via Business Wire, which is available on our website at investor.aligntech.com. Today's conference call is being audio webcast and will be archived on our website for approximately 1 month."
},
{
"speaker": "",
"content": "As a reminder, the information provided and discussed today will include forward-looking statements, including statements about Align's future events and product outlook. These forward-looking statements are only predictions and involve risks and uncertainties that are described in more detail in our most recent periodic reports filed with the Securities and Exchange Commission available on our website at sec.gov. Actual results may vary significantly and Align expressly assumes no obligation to update any forward-looking statement."
},
{
"speaker": "",
"content": "We have posted historical financial statements with corresponding reconciliations, including our GAAP to non-GAAP reconciliation, if applicable, and our first quarter 2024 conference call slides on our website under Quarterly Results. Please refer to these files for more detailed information."
},
{
"speaker": "",
"content": "With that, I'll turn the call over to Align Technology's President and CEO, Joe Hogan. Joe?"
},
{
"speaker": "Joseph Hogan",
"content": "Thanks, Shirley. Good afternoon, and thanks for joining us on our call today."
},
{
"speaker": "",
"content": "I'll provide an overview of our first quarter results and discuss a few highlights from our 2 operating segments, System Services and Clear Aligners. John will provide more detail on our Q1 financial performance and comment on our views for the second quarter and 2024 in total. Following that, I'll come back and summarize a few key points and open the call to questions."
},
{
"speaker": "",
"content": "I'm pleased to report better-than-expected revenue and earnings for the first quarter and a solid start to the year. For Q1, total worldwide revenues were up 5.8% year-over-year, reflecting 3.5% growth from our Clear Aligner segment and 17.5% growth from Systems and Services. On a year-over-year basis, Q1 revenue growth was up across all regions and was driven by strong Clear Aligner volumes, primarily in the Asia Pacific region. Year-over-year growth also reflects strength in the orthodontic channel with total Invisalign case starts from teens and younger patients up 5.8% year-over-year, driven by continued momentum across all regions from Invisalign First, as well as Invisalign DSP touch-up cases."
},
{
"speaker": "",
"content": "On a sequential basis, Q1 total revenues were up 4.3%, reflecting a sequential increase in Clear Aligner revenues. Especially for North American orthodontists, as well as strong Systems and Services revenues, primarily driven by iTero Lumina wand upgrades in North America. During the quarter, we achieved several significant milestones. We completed the acquisition of Cubicure, a leader in direct 3D printing solutions, which is the foundation for our next generational aligner manufacturing. We successfully launched the iTero Lumina intraoral scanner, our next generation of digital scanning technology. We launched the Invisalign Palatal Expander or IPE system in the U.S. and Canada and received regulatory approval for the Invisalign Palatal Expander in Australia and New Zealand."
},
{
"speaker": "",
"content": "Q1 Systems and Services revenue year-over-year growth reflects nonsystems revenues driven by iTero Lumina wand upgrades and higher scanner volumes and increased services revenue from a larger base of scanners sold. On a sequential basis, Q1 Systems and Services revenue were up 3.1%, reflecting growth from nonsystems revenues and higher scanner ASPs, partially offset by lower volumes due to seasonality, a strong fourth quarter. The iTero Lumina intraoral scanner is available now with orthodontic workflows as a new standalone scanner or as a wand upgrade to iTero Element 5D Plus. The restorative workflow is expected to be available in the fourth quarter of 2024."
},
{
"speaker": "",
"content": "In the meantime, GP practices can benefit from the iTero Lumina's new multi-direct capture technology that replaces the confocal imaging technology in earlier models. The iTero Lumina intraoral scanner has a 3x wider field of capture and a 50% smaller and 45% lighter wand, delivering faster scanning speed, higher accuracy, super visualization and more comfortable scanning experience."
},
{
"speaker": "",
"content": "Overall, we're really pleased with the launch of iTero Lumina scanner. Customer feedback has been positive, and we're really excited about the feedback from doctors. So we've included some great verbatims in our webcast slides."
},
{
"speaker": "",
"content": "Q1 total Clear Aligner revenues were up year-over-year reflecting revenue growth across the regions from strong year-over-year volume growth across APAC markets, as well as the EMEA region. For the Americas region, Q1 Clear Aligner volume was consistent with prior year. For Q1, total Clear Aligner shipments were up 2.1% sequentially, reflecting seasonality with increased volumes in the Americas regions, offset somewhat by EMEA and APAC regions."
},
{
"speaker": "",
"content": "For Q1, Clear Aligner shipments include over 23,000 Invisalign Doctor subscription cases or DSP touch-up cases, primarily from North America ortho channel, an increase of approximately 49% year-over-year from Q1 '23."
},
{
"speaker": "",
"content": "The DSP touch-up cases are a component of the overall DSP program, which consists of retainers and touch up cases or aligners, and it continues to be an important offering for our customers and their patients. DSP is currently available in the United States, Canada, Iberia, Nordics, the U.K. and most recently, in Italy, France and Poland. We expect to continue expanding DSP into other country markets and EMEA in Q2 including a 14-stage touch-up aligner offering."
},
{
"speaker": "",
"content": "For non-case revenues, Q1 was up 7.5% year-over-year, primarily due to continued growth from Vivera Retainers along with Invisalign DSP retainer revenues. In a teen market, nearly 200,000 teens and younger patients started treatment with Invisalign Clear Aligners in Q1, up 5.8% year-over-year. This represents a record number of teen cases shipped as compared to prior quarters, reflecting strength in APAC and EMEA. Teen starts were up sequentially 1.2%, reflecting strength in EMEA and North America, offset by seasonally fewer teen starts in China. While the teen market tends to be less susceptible to consumer demand around discretionary spending and more resilient than adult orthodontic case starts, we're pleased that in Q1, our Clear Aligner volumes for both adults and teens were up sequentially and year-over-year."
},
{
"speaker": "",
"content": "We believe the Invisalign Palatal Expander system is one of the most exciting innovations we've developed in our 27-year history and is a better option for expanding a growing patient's narrow pallet. Initial response from doctors and patients for Invisalign Palatal Expander system is positive. The Invisalign Palatal Expander system is not a traditional Invisalign aligner. It's a series of direct 3D-printed orthodontic appliances based on proprietary and patented technology that has 4 systems designed for skeletal expansion. Clinical data shows that Invisalign Palatal Expander system is safe, effective and proven to deliver skeletal expansion."
},
{
"speaker": "",
"content": "Specifically, our clinical data is based on 49 patients across the United States and Canada between the ages of 6.9 and 11 with a mean age of 8.8 years. In this group, the mean expansion of 6 millimeters was achieved with minimal tipping with ranges between 3.4 and 10.7 millimeters as measured using the change in intermodal width between the initial and post-expansion scans with a mean expansion efficacy of 97%."
},
{
"speaker": "",
"content": "In addition, we found that survey doctors agree the Invisalign Palatal Expander is less painful than traditional expanders and facilitates better oral hygiene compared to traditional metal expanders. Phase I or early intercepted treatment includes both skeletal, orthopedic and dental orthodontic arch expansion and makes up to 20% of the orthodontic case starts each year. Combined with Invisalign First aligner treatment, Invisalign Palatal Expanders provide doctors with a full early interceptive treatment solution that allows doctors to treat all Phase I patients. We expect Invisalign Palatal Expander to be available in other markets pending future applicable regulatory approvals."
},
{
"speaker": "",
"content": "Today, Invisalign is the most recognized orthodontic brand globally, and Invisalign Clear Aligner treatment is faster and more effective than traditional metal braces. Yet the underlying market opportunity remains huge and untapped. We continue to invest in consumer marketing and demand creation initiatives to raise awareness and drive potential patients to Invisalign practices globally. Below are several highlights from Q1 and more information is available in our Q1, '24 earnings webcast slides."
},
{
"speaker": "",
"content": "In Q1 '24, we delivered 14.5 billion impressions and had 43 million visits to our websites globally. To increase awareness and educate young adults, parents and teens about the benefits of the Invisalign brand, we continue to invest and create campaigns in top media platforms such as TikTok, Instagram, YouTube, Snapchat and WeChat across markets, reaching young adults as well as teens and their parents also requires the right engagement to Invisalign influencers and creator-centric campaigns."
},
{
"speaker": "",
"content": "Our teen Invis is Drama Free campaign was recently recognized by the Association of National Advertisers with a silver award in the REGGIE Awards for creative and strategic excellence. In the U.S., in addition to our ongoing influencer campaigns, we partner with athletes such as Maxx Crosby, TikTok Gen Z influencer, Overtime Meg and the famous fashion designer, Kristin Juszczyk to create a compelling brand activation at the Super Bowl. Our campaigns delivered more than 6.1 billion impressions and 18.1 million unique visitors to our consumer websites across the Americas. In the EMEA region, we partner with influencers to reach consumers across social media platforms, including TikTok and Meta, and launched our global consumer campaigns for teens and parents. Our campaigns delivered more than 1.6 billion media impressions and 8.9 million visitors to our website."
},
{
"speaker": "",
"content": "We continue to invest in consumer advertising across the APAC region, resulting in more than 6.6 billion impressions and 16 million visitors to our websites, a 195% increase year-over-year. We expanded our reach in Japan and India via Meta and YouTube and partnered with key influencers to reach consumers across social media. We saw increased brand interest from consumers as evidenced by a 285% year-over-year increase in unique visitors to our website in India and a 129% increase in Japan."
},
{
"speaker": "",
"content": "Finally, digital tools such as My Invisalign consumer and patient app continue to increase with 4 million downloads to date and over 381,000 monthly active users, 15% year-over-year growth rate. Q1 '24 Clear Aligner volume from DSO customers increased sequentially, reflecting growth in the Americas and the EMEA regions and increased year-over-year reflecting growth across international regions."
},
{
"speaker": "",
"content": "Dental service organizations, or DSOs, represent a large and growing opportunity to help drive adoption of digital technology across the dental industry. We have established relationships with many DSOs globally, that recognize the benefits of digital workflows enabled by our portfolio of products and services that make up the Align digital platform, including increased practice efficiency and profitability, as well as delivering a better patient experience from shorter cycle times and proximity to their customers."
},
{
"speaker": "",
"content": "Smile Docs and Heartland Dental are some of the largest DSO partners and are continuously exploring collaboration with DSOs that can further adoption of digital dentistry. Each DSO has a different strategy and business model and our focus is on working with the encouraging DSOs aligned with our vision, strategy and business model goals."
},
{
"speaker": "",
"content": "Today, we announced an additional $75 million equity increase in Heartland, following the previous $75 million equity investment a year ago. Heartland is a multidisciplinary DSO with GP and ortho practices across the United States. Their growth strategy includes Heartland's de novo dental practices, which feature modern technology, located in areas with a strong community need for dentistry where Heartland provides practices with opportunities for mentorship, leadership training and continuing education. In the last 4 years, Heartland opened 240 state-of-the-art de novo practices across the U.S. and are planning to continue investing through more de novo openings. We have a shared sense of purpose with Heartland. Their mission is to help doctors and their teams deliver the highest quality digital dental care to the communities they serve."
},
{
"speaker": "",
"content": "With that, I'll now turn it over to John."
},
{
"speaker": "John Morici",
"content": "Thanks, Joe."
},
{
"speaker": "",
"content": "Now for our Q1 financial results. Total revenues for the first quarter were $997.4 million, up 4.3% from the prior quarter and up 5.8% from the corresponding quarter a year ago. On a constant currency basis, Q1 '24 revenues were impacted by favorable foreign exchange of approximately $10 million or approximately 1% sequentially and were unfavorably impacted by approximately $4.8 million year-over-year or approximately 0.5%."
},
{
"speaker": "",
"content": "For Clear Aligners, Q1 revenues of $817.3 million were up 4.5% sequentially, primarily from higher ASPs and higher volumes. On a year-over-year basis, Q1 Clear Aligner revenues were up 3.5%, primarily due to higher volumes and ASPs and increased non-case revenues. For Q1, Invisalign ASPs for comprehensive treatment were up sequentially and up year-over-year."
},
{
"speaker": "",
"content": "On a sequential basis, ASPs primarily reflect higher additional aligners and price increases and the variable impact of foreign exchange partially offset by a product mix shift to lower ASP products. On a year-over-year basis, the increase in comprehensive ASPs primarily reflect higher additional aligners and price increases partially offset by a product mix shift to lower ASP products and higher discounts and the unfavorable impact from foreign exchange."
},
{
"speaker": "",
"content": "For Q1, Invisalign ASPs for non-comprehensive treatment were down sequentially and year-over-year. On a sequential basis, the decline in ASPs reflect unfavorable country mix shift and higher discounts, partially offset by the favorable impact from foreign exchange. On a year-over-year basis, the decrease in non-comprehensive ASPs reflect the product mix shift to lower ASP products, unfavorable country mix shift and higher discounts, partially offset by lower net revenue deferrals."
},
{
"speaker": "",
"content": "As a reminder, we announced about a 5% global price increase for some Invisalign products across most markets effective January 1, 2024. This price increase did not include Invisalign Comprehensive Three and Three products. Invisalign Comprehensive Three and Three product is available in North America and in certain markets in EMEA and APAC, most recently launching in French territories and in the Middle East."
},
{
"speaker": "",
"content": "We are pleased with the continued adoption of the Invisalign Comprehensive Three and Three product and anticipate it will continue increasing, providing doctors the flexibility they want and allowing us to recognize more revenue upfront with deferred revenue being recognized over a shorter period of time compared to our traditional Invisalign Comprehensive product."
},
{
"speaker": "",
"content": "Q1 '24 Clear Aligner revenues were impacted by a favorable foreign exchange of approximately $8.4 million or approximately 1% sequentially. On a year-over-year basis, Clear Aligner revenues were unfavorably impacted by foreign exchange of approximately $3.9 million or approximately 0.5%."
},
{
"speaker": "",
"content": "Clear Aligner deferred revenues on the balance sheet decreased $26.7 million or 2% sequentially and increased $15.8 million or 1.2% year-over-year and will be recognized as the additional aligners are shipped. Q1 '24 Systems and Services revenue of $180.2 million were up 3.1% sequentially, primarily due to increased nonsystems revenues, mostly related to upgrades and higher ASPs, partially offset by lower volumes."
},
{
"speaker": "",
"content": "Q1 '24 systems and Services revenue were up 17.5% year-over-year primarily due to increased nonsystems revenues, mostly related to upgrades, higher scanner volumes and higher services revenues from our larger base of scanners sold. CAD/CAM and Services revenue for Q1 represents approximately 51% of our Systems and Services business."
},
{
"speaker": "",
"content": "Q1 '24 Systems and Services revenues were favorably impacted by foreign exchange of approximately $1.5 million or approximately 0.9% sequentially. On a year-over-year basis, Systems and Services revenues were unfavorably impacted by foreign exchange of approximately $0.9 million or approximately 0.5%. Systems and Services deferred revenues on the balance sheet was down $14.3 million or 5.5% sequentially and down $25.3 million or 9.4% year-over-year primarily due to the recognition of services revenues, which will -- which is recognized ratably over the service period. The decline in deferred revenues both sequentially and year-over-year reflects the shorter duration of service contracts with initial scanner purchases."
},
{
"speaker": "",
"content": "As our scanner portfolio expands and we introduce new products, we increased the opportunities for customers to upgrade and make trade, in addition to other scanner leasing and rental programs. Developing new capital equipment opportunities to meet the digital transformation needs of our customers and our DSO partners is a natural progression for our equipment business with a large and growing base of scanners sold. We're pleased to be able to leverage our technological innovations and operational capabilities and efficiencies to provide different types of go-to-market models to our customers, such as rentals and leasing, selling the way that our customers want to buy."
},
{
"speaker": "",
"content": "Moving on to gross margin. First quarter overall gross margin was 70%, approximately flat sequentially and year-over-year. Overall gross margin was favorably impacted by foreign exchange by approximately 0.3 points sequentially and unfavorably impacted by approximately 0.1 points on a year-over-year basis."
},
{
"speaker": "",
"content": "Clear Aligner gross margin for the first quarter was 70.9%, down 0.3 points sequentially due -- primarily due to higher manufacturing spend, partially offset by higher ASP. Clear Aligner gross margin for the first quarter was down 0.8 points year-over-year, primarily due to higher manufacturing spend, partially offset by favorable ASP."
},
{
"speaker": "",
"content": "Systems and Services gross margin for the first quarter was 65.9%, up 1.1 points sequentially due to higher ASP partially offset by manufacturing variances. Systems and Services gross margin for the first quarter was up 4.3 points year-over-year, primarily due to higher ASP, lower service and manufacturing costs."
},
{
"speaker": "",
"content": "Q1 operating expenses were $543.7 million, up 9.2% sequentially and 3.1% year-over-year. On a sequential basis, operating expenses were up by $45.7 million from higher incentive compensation and consumer marketing spend, partially offset by restructuring and other charges not recurring in Q1. Year-over-year, operating expenses increased by $16.5 million, primarily due to our continued investments in sales and R&D activities and higher incentive compensation."
},
{
"speaker": "",
"content": "On a non-GAAP basis, excluding stock-based compensation, amortization of acquired intangibles related to certain acquisitions and restructuring and other charges, operating expenses were $506.1 million, up 13.3% sequentially and up 3.2% year-over-year. Our first quarter operating income of $154.1 million resulted in an operating margin of 15.5% down 2.5 points sequentially and up 1.3 points year-over-year."
},
{
"speaker": "",
"content": "The sequential decrease in operating margin is primarily attributed to investments in our go-to-market teams and higher incentive compensation. The year-over-year increase in operating margin is primarily attributed to operating leverage and proactively managing our costs, partially offset by unfavorable impact from foreign exchange of approximately 0.7 points."
},
{
"speaker": "",
"content": "On a non-GAAP basis, which excludes stock-based compensation, amortization of intangibles related to certain acquisitions and restructuring and other charges, operating margin for the first quarter was 19.8%, down 4 points sequentially and up 1.3 points year-over-year. Interest and other income expense net for the first quarter was an income of $4.3 million, compared to an income of $1.3 million in Q4 of '23 and an income of $1.1 million in Q1 of '23, primarily driven by a gain on our equity investments and net interest income and offset by unfavorable foreign exchange."
},
{
"speaker": "",
"content": "The GAAP effective tax rate in the first quarter was 33.7% compared to 28.3% in the fourth quarter and 34.8% in the first quarter of the prior year. The first quarter GAAP effective tax rate was higher than the fourth quarter effective tax rate, primarily due to discrete tax benefits recognized in Q4 of '23, partially offset by increased earnings in low tax jurisdictions in Q1 of '24. Our non-GAAP effective tax rate in the first quarter was 20%, which reflects our long-term projected tax rate."
},
{
"speaker": "",
"content": "First quarter net income per diluted share was $1.39, down sequentially $0.24 and up $0.26, compared to the prior year. Our EPS was not impacted on a sequential basis from foreign exchange. Our EPS was unfavorably impacted by $0.09 on a year-over-year basis due to foreign exchange. On a non-GAAP basis, net income per diluted share was $2.14 for the first quarter, down $0.28 sequentially and up $0.32 year-over-year."
},
{
"speaker": "",
"content": "Moving on to the balance sheet. As of March 31, 2024, cash, cash equivalents and short term and long-term marketable securities were $902.5 million, down sequentially $78.2 million and down $18.9 million year-over-year. Of our $902.5 million balance, $217.5 million was held in the U.S. and $685 million was held by our international entities."
},
{
"speaker": "",
"content": "In January 2024, we received approximately 37,000 shares of our common stock upon final settlement of the $250 million accelerated share repurchase from Q4 of '23. In total, we repurchased approximately 1.1 million shares at an average price per share of $230.13 under the Q4 ASR contract. We have $650 million available for repurchase of our common stock under our January 2023 repurchase program. During Q2 '24, we expect to repurchase up to $150 million of our common stock through either a combination of open market repurchase or an accelerated stock repurchase agreement. Q1 accounts receivable balance was $950.7 million, up sequentially."
},
{
"speaker": "",
"content": "Our overall days sales outstanding was 86 days up approximately 1 day sequentially and up approximately 3 days as compared to Q1 last year. Cash flow from operations for the first quarter was $28.7 million. Capital expenditures for the first quarter were $9.4 million, primarily related to our continued investments to increase aligner manufacturing capacity and facilities. Free cash flow, defined as cash flow from operations less capital expenditures, amounted to $19.3 million."
},
{
"speaker": "",
"content": "We're continuing to use our healthy balance sheet to drive growth and profitability. During the quarter, we continued to make disciplined investments in our strategic growth drivers. We completed the acquisition of Cubicure, which will enable us to scale our 3D printing operations to eventually direct print millions of custom appliances per day, and we exited the quarter with a healthy cash flow position and no long-term debt, maintaining a strong position to support our additional $75 million investment in our DSO partner Heartland Dental and our $150 million stock buyback."
},
{
"speaker": "",
"content": "Now turning to our outlook. Assuming no circumstances occur beyond our control, we provide the following framework for Q2 and fiscal 2024. For Q2 '24, we provide the following business outlook. For Q2 '24, we expect worldwide revenues to be in the range of $1.030 billion to $1.050 billion. We expect Clear Aligner volume to be up sequentially and Clear Aligner ASP to be down slightly sequentially, primarily as a result of unfavorable foreign exchange. We expect Systems and Services revenue to be up sequentially as we continue to ramp iTero Lumina in Q2 2024. We expect Q2 '24 GAAP operating margin and non-GAAP operating margin to be slightly above Q1 '24 GAAP and non-GAAP operating margins, respectively."
},
{
"speaker": "",
"content": "For fiscal '24, we provide the following business outlook. We expect fiscal '24 total revenue to be up 6% to 8% versus 2023, which is higher than our prior outlook of up mid-single-digit growth compared to 2023. The increase in our 2024 revenue outlook reflects our Q1 results, Q2 outlook and continued execution of our growth strategies. We anticipate that the incremental revenue reflected in our 2024 outlook will be roughly split 50-50 between our 2 operating segments."
},
{
"speaker": "",
"content": "We expect fiscal 2024 Clear Aligner ASPs to be slightly up year-over-year. We expect fiscal 2024 GAAP operating margin and non-GAAP operating margin to be slightly above the 2023 GAAP operating margin and non-GAAP operating margin, respectively. We expect our capital -- our investments in capital expenditures for fiscal 2024 to be approximately $100 million. Capital expenditures primarily relate to building construction and improvements as well as manufacturing capacity in support of our continued expansion."
},
{
"speaker": "",
"content": "With that, I'll turn it back over to Joe for final comments. Joe?"
},
{
"speaker": "Joseph Hogan",
"content": "Thanks, John."
},
{
"speaker": "",
"content": "In summary, Q1 was a good start for the year. While I'm pleased with our results, I'm even more excited about Align's innovation in 2024 on our next wave of growth drivers that we believe will continue to revolutionize the orthodontic and dental industry in scanning software and direct 3D printing."
},
{
"speaker": "",
"content": "Our focused execution of our product road map and innovation pipeline has resulted in the largest introduction of new products and technologies in our history, further advancing our software scanning and 3D printing capabilities. We're excited about the potential for these strategic investments to enable a new phase of growth to transform the orthodontic industry again."
},
{
"speaker": "",
"content": "The iTero Lumina intraoral scanner has the potential to set a new standard of care for dental practices by simplifying the scanning of complex oral regions while offering superior chairside visualization and a more comfortable experience for patients, especially kids. The Invisalign Palatal Expander increases the clinical applicability of the Invisalign system to nearly 100% of orthodontic case starts. It is a revolutionary removable 3D-printed appliance that is clinically proven to be safe and effective. It is less painful than traditional metal expanders and promotes better oral hygiene."
},
{
"speaker": "",
"content": "And our recent acquisition of Cubicure, a pioneer of 3D printing solutions for polymer additive manufacturing, brings a talented team and unique cutting-edge technology into Align to help us scale our 3D printing operations, providing ultimate design freedom and highly customized outcomes from a customer and patient standpoint as well as operational benefits to the business."
},
{
"speaker": "",
"content": "We see incredible opportunities in this business and continue to make the Invisalign system the standard of care in orthodontics. By continually innovating and developing digital technologies and services that enable more doctors to easily diagnose and treat patients with crooked teeth and help them retain their healthy beautiful smiles. We're increasing access to care for millions of people, who might not otherwise receive orthodontic treatment."
},
{
"speaker": "",
"content": "With that, I thank you for your time today. We look forward to sharing our continued progress in leading the digital transformation of the orthodontic and restorative dental industry."
},
{
"speaker": "",
"content": "I'll now turn the call over to the operator for your questions. Operator?"
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from Elizabeth Anderson with Evercore ISI."
},
{
"speaker": "Elizabeth Anderson",
"content": "I was wondering if you could talk about how you're seeing the overall demand environment? I guess, I'm particularly curious about the U.S. sort of how you're seeing it from like a consumer demand perspective, especially and any comments you could make on the SmileDirect impact on volumes in the quarter? And then secondarily, if you could comment a little bit more on the broader demand environment in China, that would be super helpful."
},
{
"speaker": "Joseph Hogan",
"content": "Elizabeth, I'll start off and have John jump in on anything. First of all, we describe the business right now as stable. The same things that we talked about as we came out of the fourth quarter, and we see that stability broadly around the globe. And you saw in our script that we just read to, that it's good from an adult standpoint and also a teen standpoint, too, which, again, led to that kind of stability that we talk about."
},
{
"speaker": "",
"content": "If I look around the world, I mean we've -- that stability exists, whether it's in Asia, whether we've seen it in parts of Europe and we see it in the United States and the Americas also. So I -- it's hard for us to call out a particular region or whatever that is dramatically down or dramatically up. We just see them moving pretty much in unison in the first quarter."
},
{
"speaker": "",
"content": "John, would you add anything?"
},
{
"speaker": "John Morici",
"content": "No, I agree. And that's -- we're driving the growth strategies. As we've said, we've seen that stability in the environment and we're executing against that."
},
{
"speaker": "Joseph Hogan",
"content": "And Elizabeth, last thing on your SmileDirectClub comment, them not being advertising like they were before or whatever, we can't attribute any part of the demand equation up or down as part of that. And obviously, that was more pronounced in the United States than it was anywhere else in the world, but I can't attribute any change in the marketplace because of them not advertising at this point in time."
},
{
"speaker": "Operator",
"content": "Our next question comes from Brandon Vazquez with William Blair."
},
{
"speaker": "Brandon Vazquez",
"content": "I wanted to focus for a second on the -- on the teen side, you have the Palatal Expander out there now getting great reviews, and it seems like it closes, if I'm understanding the numbers correctly, maybe 20% of that market that you haven't been able to hit before. This is such a big opportunity. I'm curious if you can just reflect on like how does commercialization within teens look in the next couple of years now that you have kind of a broader and more fuller portfolio here compared to the prior couple of years? And what does that mean for growth rates within that teen section and adoption within teen that's underpenetrated relative to teens as we look forward the next couple of years?"
},
{
"speaker": "Joseph Hogan",
"content": "That's a good question, Ben. I think we -- as we mentioned, it's 20%. And there's -- we don't -- we call them tweens, really. They're young students before they really hit the teen years and have a mature dentition. With Invisalign First and now with IPE, we can handle the 20% that's out there on the Phase I. And some teens just need -- tweens just need dental expansion and some of you really have to split the suture and widen the pallet overall. We feel in both those cases, with IPE and Invisalign First, these are very unique products specific to that area. And we think it will actually make doctors that aren't comfortable with the Phase I, may be even more comfortable now because of the impact on patients is not what it was before when you tried to work these kinds of cases with wires and brackets or higher risk expanders and those kinds of things."
},
{
"speaker": "",
"content": "But like anything in the orthodontic community, it takes time. It takes time for acceptance. And the good thing about this is IPE is about a 30- to 35-day kind of an episode. So our feedback loop is really good. You can tell from my transcript also is right now, we're approved in the United States and Canada and recently in ANZ. And right now, we're throttled by the regulatory procedures we have to go throughout the world. So we'll be able to give you more specificity on this brand as we go forward. But as I mentioned in my closing too, we're really excited about that technology. And we didn't tie together the new Lumina scanner has such a broad kind of a bandwidth from a scanning standpoint, it scans that palate that you have to cover with Invisalign First extremely well. So those technologies thread together very well out there. So we're excited about it and more to come."
},
{
"speaker": "Operator",
"content": "Next question comes from Jon Block with Stifel."
},
{
"speaker": "Jonathan Block",
"content": "Hoping to ask 2, maybe just the first one, throughout the quarter, there was sort of like an obsession or a big focus from investors on month-to-month trends. There was talk about February strength, March weakness. I don't think if anyone really knew if it was the consumer or the calendar or both. So maybe you guys can talk a little bit about how it played out for you guys, elaborate on February and March? And as much as you can, just touch on April here for the first 2 to 3 weeks. And then I'll ask my follow-up."
},
{
"speaker": "John Morici",
"content": "Yes, Jon, this is John. Look, from -- as we talk about the quarter and think about -- we're very pleased with our results in Q1, we saw stability, as Joe mentioned, and that really continued from the end of the year into the quarter, less about month-to-month. I mean it was the stability and then the execution that we had throughout the quarter with our products."
},
{
"speaker": "Jonathan Block",
"content": "Okay. And then I'll just shift gears. John, I might stick with you. I believe the wording is slightly above the 2023 OM, which I think is 21.4% unchanged. Despite the higher revenues, the midpoint going from roughly 5% to 7%. So can you talk about where that extra spend is going? Do we see the returns on that this year? Or will that aid and give you some more tailwinds into 2025?"
},
{
"speaker": "",
"content": "And then just to tack on to that, the new higher guidance doesn't -- implies at a 6% in the back part of this year, year-over-year growth, which isn't too dissimilar from 1H, but the comps get more difficult. So the stacks need to accelerate. Why should we be comfortable with that? Is that just an accelerating contribution from some of those new products like Lumina and IPE?"
},
{
"speaker": "John Morici",
"content": "I think that latter point is how I would look at it, Jon. We're making investments. We make investments throughout the year. We get the shorter longer-term investments that we make different returns on whether they're short or long term. But what we see is a stable environment, continued investments in go-to-market activities, we have new products coming. So that helps us accelerate with things that we'll have on the iTero side, as well as IPE and others that Joe talked about, where we really get the approval later in the year. So it's about a stable environment, making investments into that environment and then executing on our growth strategies, and that should give us the benefits that you described in the second half."
},
{
"speaker": "Operator",
"content": "Our next question comes from Jeff Johnson with Baird."
},
{
"speaker": "Jeffrey Johnson",
"content": "John, maybe following up on Jon's question there and just a little finer point on the guidance itself. You've taken that guidance from mid-single digits to 6 to 8 scanner and CAD/CAM services came in obviously strongly in the double digits, upper teens. Should we think about kind of that double digits, maybe not in the upper teens, but double digits is kind of where the scanner and services continues this year? And your Clear Aligner revenue guidance kind of still in the mid-single digits. I think last quarter, we were talking about both those segments being mid-single-digit growers. It seems like to me now, maybe the raise here is being driven more by the scanner and CAD/CAM services. And as Joe calls the market stable, then maybe the Clear Aligner revenue still kind of expected to be in that mid-ish single digits. Is that a fair kind of way to look at guidance?"
},
{
"speaker": "John Morici",
"content": "That's a fair way to look at it, Jeff. I mean, you would see, given the new products that we have with Lumina and iTero, we'll see a little bit faster growth. We're very pleased with what we saw in the first quarter. Typically in the first quarter, you don't have a sequential gain in revenue from the fourth quarter being an equipment business. So we're very pleased with what we saw there. But then we also look at the Clear Aligner business, and we expect to be able to grow and continue to grow there, both in terms of the investments that we're making in a relatively stable environment and some of the new products that should help supplement that growth."
},
{
"speaker": "Jeffrey Johnson",
"content": "Yes, that's helpful. And then one other follow-up. I think it's been asked in the past maybe at an Analyst Day or something. I don't remember if you've given a clear answer. But it's something I keep getting asked here more recently, and that's a percentage of your patient base of maybe orthodontic cases that get financed through some sort of third-party patient financing company. We have seen in areas like full arch implants, some of the aesthetic procedures outside of dental, where lending standards have gone up, FICO scores have gone from the 500 to 700, something like that to qualify for patient financing in this cost of capital and tougher capital environment. So what percentage -- do you know a percentage or round about of what cases get financed? And if those lending standards have changed at all and put an incremental pressure on patients here more recently?"
},
{
"speaker": "John Morici",
"content": "Yes. What we see, Jeff, is it varies country by control say U.S. is maybe the most -- and I'll combine ortho and GP together, roughly 1/3 of the cases that we see get some type of external financing. Remember, many patients or parents will pay in advance. That's great for doctors. Many doctors, especially orthos will do some type of kind of internal financing where you kind of pay as you go and so on. And many doctors are continuing to do that, especially in the tougher environment. And we're doing things to help doctors to try to give them a little bit more extension in payments so that they can provide and pass that on to their patients as well. And we'll work with DSO partners to really try to help them work with these external companies to try to give better financing rates to try to get these patients to go into treatment."
},
{
"speaker": "",
"content": "So we're well aware. We know we can help. We have the balance sheet and the cash to be able to help with our customers, so that they can pass that on. And that's something that we want to keep working towards."
},
{
"speaker": "Jeffrey Johnson",
"content": "John, any change to note over just the past few months even in those lending standards getting tougher? Or do you feel like that's stable as well as just kind of the overall environment as you've described that way?"
},
{
"speaker": "John Morici",
"content": "I look at that as more stable. I think there was a lot of things. If you go back to last year, people are really getting a bit of sticker shock in terms of the higher interest rates, when they came to try to go into treatment. I think people are past that."
},
{
"speaker": "",
"content": "I think when I see this or what I hear from doctors or see from our customers that it's a little bit more stable. There's not a big change."
},
{
"speaker": "Operator",
"content": "Our next question comes from Michael Cherny with Leerink Partners."
},
{
"speaker": "Michael Cherny",
"content": "Can you hear me okay?"
},
{
"speaker": "Shirley Stacy",
"content": "Yes, we can hear you fine."
},
{
"speaker": "Michael Cherny",
"content": "Okay. So just relative to the spend, I want to dive in a little bit more, if possible. You talked about the investment growth. Can you delineate relative to that investment, how you're thinking about the growth into, call it, your core markets or some of the new product launches? And especially with regards to the ramp on the printing side, how much incremental printing spend, so to speak, is coming now versus where you think it's going to grow, what the run rate should be on ramping that over time?"
},
{
"speaker": "John Morici",
"content": "Yes. I think we have a core business that we're running. And obviously, there's a certain amount of investment that you have to be able to grow around sales, sales and marketing and the go-to-market activities that we have."
},
{
"speaker": "",
"content": "There's also R&D spending that we've had throughout the time. And now as that R&D in the case of acquiring Cubicure and now turning this into more of a platform to be able to build our 3D printing. There's a certain amount of spend that we have. How that lays out, it varies over time that we'll have. But rest assured, we know how to scale products. We know how to scale 3D printing. We'll make the right investments to be able to start scaling up that direct fab printing while making sure that the core business has the right investments for growth, and we'll balance that as we go forward."
},
{
"speaker": "Operator",
"content": "Our next question comes from Jason Bednar with Piper Sandler."
},
{
"speaker": "Jason Bednar",
"content": "First I want to build on some of the macro questions that have been asked. I don't want to belabor the point, but other consumer discretionary companies called out a downtick in March. It doesn't sound like you saw any of that, but just wanted to confirm that's the case with respect to Invisalign demand. And maybe speak to your confidence to drive Clear Aligner volumes going forward, now that comps turn a little bit tougher. How much do you think you might need to fund that growth with investments to drive more traffic into the office?"
},
{
"speaker": "Joseph Hogan",
"content": "Jason, on the first part is, we talk about the stable environment that we've seen that stability of it. We read and I read, what's going on there with the consumer investment, some concerns, particularly in the luxury goods or what's going on out there."
},
{
"speaker": "",
"content": "But honestly, I think often what we see and analysts who follow us here just really pick up the U.S. data. And what we see is differences all around the world, and that's what's great about having an international business. You have some counter cycling in the sense of the demand patterns and what goes on out there. But I would say there's nothing that we would highlight right now. I would say that we think something has changed in what we saw in the second half of 2023, to what we saw in the first quarter of this year."
},
{
"speaker": "",
"content": "John, you?"
},
{
"speaker": "John Morici",
"content": "And in terms of investments, we make the investments that we need go to market and manufacture and other expansion as we continue to grow. We'll continue those investments. But as we've talked about, not only for the -- now the second quarter when we're talking about that sequential improvement in op margin and what we've talked about in total year where we expect the year-over-year improvement in margin. We're making sure that we're investing with that right amount of profitability. To still be able to grow into our market and expand the opportunity -- expand on the opportunities that we have, but then being respectful in terms of what margin we need to be able to deliver for the company."
},
{
"speaker": "Jason Bednar",
"content": "All right. Very helpful, Joe and John. And maybe one follow-up here to maybe a multi-partner on teen. So bear with me. But this might be a nuanced look. It seems like a lot of emphasis here just recently in product development and marketing that's really trying to tap into that much younger market, that Phase I opportunity. IPE fits in there, your new marketing branding plans and emphasis there. There seems to be some benefits for younger patients with Lumina. So it's really -- it seems intentional, but wondering if you could bifurcate for us, how your Invisalign business is performing in this younger patient population relative to the teen as a whole? Where does your penetration sit in those younger patients versus the broader teen channel? And maybe what kind of outsized growth you're expecting from this part of the channel as we look out over the near to intermediate term?"
},
{
"speaker": "Joseph Hogan",
"content": "Jason, just I'll back up on your question, just to give you a kind of a conceptual view. When you think of Phase I, it's actually been controversial in the orthodontic market for years, some orthodontists don't want to do Phase I because as I mentioned before, the kind of devices that have been used, have been kind of difficult from a consumer standpoint. And so those wait for all permanent dentition and move on to there."
},
{
"speaker": "",
"content": "We feel confident that within this Invisalign First now for dental expansion and then for palate expansion or a morphological change, IPE will do that. And we think a little track more orthodontists to begin Phase I treatment, but this is an industry that takes a while for things to bake in and for them to gain confidence and I understand it because you're working with kids' teeth and mouths and their dentition."
},
{
"speaker": "",
"content": "But we actually think that a significant amount of growth could come from this area, but we think it will take time, but it's been a great focus for us. And it's going to be interesting to watch how orthodontists in the future actually focus on Phase I, Phase II because these kinds of devices make it simpler for them and for patients in the future. So right now, I can just kind of give you the ground rules on that, that we've changed those roles. In a sense, but I can't project exactly where it's going."
},
{
"speaker": "Jason Bednar",
"content": "Any sense penetration-wise or maybe where you're at relative to the broader teen market?"
},
{
"speaker": "Joseph Hogan",
"content": "I'd say we're just in that story. I mean even Invisalign First is used sometimes on more permanent dentition too. So it's hard -- we'd have to split our cases out of Invisalign First is what the age of patients are or whatever. But as we get more data and we really get through with IPE and some more specificity around this, we'll share it with you and the rest of the...."
},
{
"speaker": "Shirley Stacy",
"content": "The only thing that -- I mean if you've tracked us for a while, you know that our average age of teen patients gets younger and younger, I think we're 14 now versus 15 plus before. So I mean that's a reflection of just being able to go after those younger patients with First."
},
{
"speaker": "Operator",
"content": "Our next question comes from Nathan Rich with Goldman Sachs."
},
{
"speaker": "Nathan Rich",
"content": "Great. I wanted to go back to the guidance. I know it's kind of been touched on a few different times. But I wanted to ask on the Clear Aligner revenue outlook. It looks like you're raising the outlook for the full year by about 1%. I guess could you maybe just touch on what changed specifically with respect to that outlook? It sounds like maybe it's expectations around IPE and DSP versus market improvement. But I'd be curious, any color you could share there? And maybe anything on teen versus adult within the updated guidance would be great."
},
{
"speaker": "John Morici",
"content": "Yes, I'll start, Nate. So overall, we went from -- we had talked about mid-single digits, so call it 5% to raising it to the midpoint of 7% on a year-over-year, so up 2 points. And really, that's a reflection of a few things. One is the continued stability that we're seeing. We're operating in an environment that's more stable. We saw that coming into the fourth quarter and now into this quarter as well. So that's good if we want that stability there."
},
{
"speaker": "",
"content": "And then you look at the execution that we have about -- on our core business to be able to grow with a lot of the innovations that we have, the promotions and other things that we have as we get into further into teen season, supplemented with the various new products that we talked about. We feel really good about Lumina and the launch that we have on iTero and the further expansion that that can drive as well as some of the new products like IPE and others to really not only help those unit sales there, but then as Joe described, we had to pull in other products around Invisalign First and others to really help drive some of that growth that we can see in the teen business."
},
{
"speaker": "",
"content": "So it's a combination of things, Nate, but it's what we're seeing in stability, how we're executing on our core strategies and then some of the new products really supplementing the extended growth to help us. And that's why we adjusted our total year."
},
{
"speaker": "Nathan Rich",
"content": "Okay. That's helpful. And then, John, maybe just sticking with you. The 2Q operating margin, I know up slightly sequentially, but down year-over-year. And I think historically, it's been a little bit variable, but you've seen more of a step-up in the second quarter than I think what the guidance implies. Anything to call out with respect to FX? Or I think you mentioned some manufacturing cost spend, but just anything there that we should keep in mind as it regards the margin cadence?"
},
{
"speaker": "John Morici",
"content": "Well, and certainly, we are seeing a stronger dollar. So that's something that we talked about when we think about our guide too, we see a stronger dollar coming out of -- out of the first quarter into the second quarter. Our guide reflects that as well."
},
{
"speaker": "",
"content": "But then you look at the continued investments that we're making to be able to drive more submitters, more doctors into our ecosystem and then ultimately drive more and more utilization. Some of it's that core business that we have to be able to drive growth. And some of it's some of the new products where there's a certain amount of OpEx spend that we have with that."
},
{
"speaker": "",
"content": "But we're being very mindful of what we can do to be able to drive growth. And then what it also means from an operating margin standpoint. And we're delivering that sequential improvement from 1Q to 2Q in operating margin and then talk to the total year of being up on a year-over-year basis."
},
{
"speaker": "Operator",
"content": "Our next question comes from Erin Wright with Morgan Stanley."
},
{
"speaker": "Erin Wilson Wright",
"content": "Great. I'll ask me 2 upfront here, but follow up on the guidance, and I don't want to belabor this too much, but do you think you have better visibility now just on the underlying demand trends globally? Or would you say that there's still an element or a healthy element of macro uncertainty that's still embedded in your guidance and some conservatism there?"
},
{
"speaker": "",
"content": "And then second would be on Lumina and the launch. And just can you talk about where you're seeing the most success with the launch in the target markets and promotions that where you're focused in terms of expanding share and upgrades as well?"
},
{
"speaker": "John Morici",
"content": "Erin, this is John. I'll talk a little bit about visibility and guidance. I think what we -- what we enjoy now and what we want to be able to have in an operating environment is more stability, and that stability is there. Markets are open. There's a higher overall higher inflation and interest rates, but people are operating in that environment."
},
{
"speaker": "",
"content": "That stability transcends it to other things that we have. We see the Michigan index or other indices that kind of point to that stability. Based on that stability, the investments that we're making, how we're going to market, some of the new products that we have, other things that we know that could, on a core basis, drive our business as well as the new products and initiatives that we have, that's what gives us confidence to be able to have a guidance that we gave for Q2 and what it means for the total year."
},
{
"speaker": "Joseph Hogan",
"content": "And Erin, on the Lumina piece, it's Joe, obviously, is -- as I mentioned in the closing of my script, we're really excited about that technology. We've been working on it for 6 years. It is a true new platform. It's not a derivative of the old confocal imaging platform. And there's really no other scanner in the world that's like that and how we've built it."
},
{
"speaker": "",
"content": "So -- and it will take a while for the, I think, the market to absorb that as you have to do this doctor by doctor and place by place. But we've had a very enthusiastic response from the orthodontic community, but also the general dentistry community too, even though we're not completely ready for the restorative piece, and we mentioned it will be the fourth quarter this year we'll have that capability out. It's just the speed of that one, the simplicity of being able to scan, the dimensional tolerances and all that's used in the sense of both comprehensive and orthodontic cases are really unmatched."
},
{
"speaker": "",
"content": "So we're excited about that, but we just have to take this thing. We've only had it out now for roughly a couple of months, but we are expecting to have a really strong year, but more importantly, to have that really be the set of standard from a scanner standpoint for the industry going forward."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our next question comes from Michael Ryskin with Bank of America."
},
{
"speaker": "Michael Ryskin",
"content": "Congrats on the quarter. I want to follow up on something, I think, Joe, you touched on in the prepared remarks. If I caught it correctly, you kind of pointed to a little bit of strength in U.S. ortho or Americas ortho in the quarter stood out for us."
},
{
"speaker": "",
"content": "It seems like it's one of the stronger results in a number of quarters. Just wondering if you could expand on that a little bit. Is it the Lumina launch? Is the fact that you're moving into younger teens and younger kids, which obviously is going to be a little bit more ortho-focused? Just any structural change you're seeing there with that group of dentists? Or am I just reading too much?"
},
{
"speaker": "Joseph Hogan",
"content": "Michael, I understand your question. I'd say it's -- we feel it's -- we've seen more stability in that market this year than we have last year. We've always known that the teen segment of that much more solid than the adult segment, but the adult segment held up for us in the quarter 2. And so that aspect of the adults was good for us also."
},
{
"speaker": "",
"content": "But I'm very cautious about projecting this market going forward because as you can see with a lot of the surveys that are done, this moves pretty dramatically from month to month. But again, it's not just the United States market we're focused on, the global market has been good for us too in that sense."
},
{
"speaker": "",
"content": "So we're going to take this thing a month at a time, but we're confident enough to say this is stable, that we have products in here that are very helpful from an orthodontic standpoint in new, like you mentioned, Lumina and also IPE that gives us more ground to stand on the sense of those orthos. And so we're excited about that. But in no way do I think there's a phase change between what we saw last year and this year in ortho. It's just more stable and we have more continuity is another word that I'd use to describe it."
},
{
"speaker": "Michael Ryskin",
"content": "Okay. And if I could squeeze in a follow-up if there's time. Again, also impressed by the DSP touch-up progress. You called it out in the deck. You got some additional launches later this year. You got the 14-stage touch-up aligner offering you're talking about. Any way you can start framing in terms of would you incorporate that into guidance at some point in terms of where you think that can go in terms of volumes and revenues or any update longer term, how you see DSP and touch up evolving over time?"
},
{
"speaker": "John Morici",
"content": "Yes, Mike, I'll take that one. Look, DSP is very popular because it really serves the needs that doctors have. They want to be able to buy things kind of the way they want to buy. They want to be able to instead of making things or doing things themselves, they can use our aligners as part of that DSP and be able to treat those touch-up cases."
},
{
"speaker": "",
"content": "And we like that, that's incremental for us in terms of what we see there. And they can also then use a lot of the aligners that they have for retention. And that's great too because that's typically incremental volume that we have. So I think when we see us rolling this out, like we said a few years ago, it was U.S. and North America and now into Europe, it continues to do what we expect it to do."
},
{
"speaker": "",
"content": "Doctors start. They adopt it more and more because part of their workflow and we see positive volume from that. And in success for projects -- programs like that, we'll continue to expand those out."
},
{
"speaker": "Shirley Stacy",
"content": "Operator, we can take one more question."
},
{
"speaker": "Operator",
"content": "And our last question comes from Kevin Caliendo with UBS."
},
{
"speaker": "Kevin Caliendo",
"content": "I have 2 questions. So the first one is on Heartland. Can you talk a little bit about the benefits of the Heartland investment operationally? And also Heartland is -- my understanding is a pretty profitable business and now with 2 separate investments there, how does their profits or how does the accounting work for that from your perspective at this point? ."
},
{
"speaker": "",
"content": "And then secondly, if you can provide -- I guess, with regards to the guidance, I think we understand it. But was that in any way based on the trends that you've seen so far in April? Or if you can elaborate on those in any way, that would be great."
},
{
"speaker": "John Morici",
"content": "I can start with the guidance part of that, Kevin. Look, we use a lot of factors to look at where our guidance is. So we're using data from Q1 and the most recent information. But it goes back to the stability that we've seen. You can see it in a lot of the surveys and other things that a lot of people do, but what we see is that stability, coupled with what we're trying to do to go to market to drive the initiatives we have and the new products that we have. So that's a key part of what we factor in into our guidance. No change from what we normally do. This is how we've come together in terms of a guidance standpoint."
},
{
"speaker": "",
"content": "In terms of Heartland, we look at Heartland as this is a great investment from investing in a company that shares a digital orthodontic mindset that we have, to be able to do things in a similar mindset, to be able to expand like they're expanding, to be able to get into markets that in some cases, we don't have much market share with or a big presence there. And they share that same mindset, that expansion."
},
{
"speaker": "",
"content": "They've been around for a lot of years as well. With this investment, it's less than 5%. There's no consolidation or anything else that's required. And we'll evaluate going forward on whether there's any mark-to-market that we have to do going forward. But it's a continuation of that investment the expansion that they're doing, and we're pleased with the results that we've seen over the last year."
},
{
"speaker": "Shirley Stacy",
"content": "That actually concludes -- sorry, go ahead, operator."
},
{
"speaker": "Operator",
"content": "And we have reached the end of our question-and-answer session. I will now turn the call back over to Shirley Stacy for closing remarks."
},
{
"speaker": "Shirley Stacy",
"content": "Thank you so much, and thank you, everyone, for joining us today. We look forward to speaking to you at upcoming financial conferences and industry meetings, including the American Association of Orthodontics meeting in New Orleans, May 4 and 5. If you have any questions, please give us a call. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation."
}
] |
all | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "And thank you for standing by. Welcome to The Allstate Corporation's third quarter earnings investor call. At this time, all participants are in a listen-only mode. To ask a question during this session, you'll need to press star one one on your phone. If your question has been answered and you wish to remove yourself from the program, it is being recorded. And now I'd like to introduce your host for today's program, Alastair Gobin of investor relations. Please go ahead, sir."
},
{
"speaker": "Alastair Gobin",
"content": "Thank you, Jonathan. Good morning. Welcome to The Allstate Corporation's fourth quarter 2024 earnings conference call. Yesterday, following the close of the market, we issued our news release and investor supplement and posted related material on our website at allstateinvestors.com. Our management team will provide perspective on our strategy and an update on results. After prepared remarks, we will have a question and answer session. As noted on the first slide of the presentation, our discussion will contain non-GAAP measures for which there are reconciliations in the news release and investor supplement, and forward-looking statements about The Allstate Corporation's operations. Allstate's results may differ materially from these statements, so please refer to our 10-K for 2023 and other public documents for information on potential risks. Our 10-K for 2024 will be published later this month. And now, I'll turn it over to Tom."
},
{
"speaker": "Tom Wilson",
"content": "Good morning. We appreciate you investing time at The Allstate Corporation. I'll start with an overview, and then Mario and Jess will go through the operating sales. Let's begin on slide two. So as you know, Allstate's strategy has two components: increased personal property liability market share and then expand protection provided to customers, which is shown in the two o's on the left-hand side. On the right hand, you can see Allstate's strong performance in 2024 and the topics we're gonna cover this morning. Total revenues were $16.5 billion in the fourth quarter, up 11.3% compared to the prior year quarter. Allstate generated net income of $1.9 billion in the fourth quarter, and $4.6 billion for the full year. Adjusted net income return on equity was 26.8%. Let me just repeat that, 26.8% over the last twelve months. Successful risk return management resulted in excellent underwriting and investment. Transformative growth has strengthened our competitive position. We'll spend a few minutes on that today. The sale of our group health and employee voluntary benefits to companies with greater strategic alignment will generate $3.25 billion of expected proceeds representing attractive valuation multiples. Let's move on to slide three. That shows the operational execution produced excellent financial results in the quarter and for the full year. Revenues increased to $64.1 billion in 2024. Property liability earned premiums were up 10.6% in the quarter and 11.2% for the full year. Net investment income was up 37.9% about the prior year."
},
{
"speaker": "Tom Wilson",
"content": "And up almost 25% for the full year. Income was $1.9 billion in the quarter and $4.6 billion for the full year. Adjusted net income, which, you know, we make a few changes on amortization of intangibles, things we just can walk you through. The amount was $7.67 per share for the fourth quarter. On the lower right, you can see the adjusted net income return to that equity was 26.8%. So 2024 was an excellent year for Allstate both financially and strategically. Let's move on and talk strategically about transformative growth at slide four. We launched this project in December of 2019. So five years have gone by, so that'd be a good time to give you a five-year look as to where we are. And as you know, there's five components at the plan to increase market share and property liability, two of which we'll cover today. Improving customer value requires us to lower our cost and provide differentiated products. As you can see on the right-hand side, the adjusted expense ratio, which excludes advertising cost, has improved almost five points since 2019 by eliminating work outsourcing and digitizing activity using less real estate and lowering distribution. That's just lower cost enable us to offer more competitive prices."
},
{
"speaker": "Tom Wilson",
"content": "Without impacting margins. Substantial progress has also been made in introducing products. New products. So affordable simple connected auto insurance is now in thirty-one states. And the new homeowners product is in four states. Differentiated custom three sixty middle market standard and preferred auto and homeowners price have also been introduced to the independent agent channel in thirty states. One of the most significant changes is the expansion of customer access to improve growth. So this effort has three components. Improve Allstate agent productivity, expand direct sales, and increase independent agent distribution, all of which have been successful. Allstate agency productivity has increased. Enhancement to direct capabilities, lower pricing, and increased advertising is attracting more self-directed customers. The National General acquisition significantly expanded our presence in and capabilities in the independent agent channel. As you can see on the right, in 2019, more than three out of four new business policies came from the Allstate agent. Last year, new business was 9.7 million items. Seventy-six percent higher than 2019, significant contributions from each channel. Policies in force have increased from thirty to set from the two thirty-seven point three million despite the negative impact of those pandemic price increases. Transformative growth has positioned us for personal profit liability, market share growth, you'll hear more about from Mario. So now let me move on to Mario on property liability."
},
{
"speaker": "Mario Rizzo",
"content": "Thanks, Tom. Let's turn to slide five. At the top of the table, you can see fourth quarter property liability underwriting income of $1.8 billion improved by $507 million compared to the prior year. Auto insurance generated $603 million of underwriting income, an improvement of $510 million compared to the prior year quarter and reflecting the successful execution of the profit improvement plan. Homeowners insurance underwriting income was also strong at $1.1 billion. This was $99 million lower than the prior year quarter due to increased catastrophe losses. The bottom half of the table, you see the strong margins delivered during the quarter. With the total property liability recorded combined ratio of 86.9 reflecting a 2.6 point improvement compared to the prior year. Auto and homeowner combined ratios in the quarter were both better than the targets for those businesses of mid-nineties for auto and low nineties for homeowners. Now we'll expand on the auto insurance margins on slide six. We you can see how successful execution of the auto profit improvement plan has restored profitability back to target levels. The fourth quarter auto insurance recorded combined ratio of 93.5 was 5.4 points below prior year quarter as average earned premium outpaced loss cost. As a reminder, we regularly review claims severity expectations throughout the year. If the expected severity for the current year changes, we record the year to date impact in the current quarter even though a portion of that impact is attributable to previous quarters. For 2022 through 2024, the bars in the graph reflect the updated average severity estimates as of the end of each of those years to remove the volatility related to entry year severity adjustments. The table at the bottom of the graph shows actual reported combined ratios. In the fourth quarter of 2024, the full year claims severity estimate went down there was a benefit from prior quarters included in the fourth quarter's reported results. This benefit was worth 1.5 points in the fourth quarter with the adjusted quarterly combined ratio of 95 shown in the furthest bar to the right. Let's turn to slide seven where you can see that homeowners insurance produced attractive returns and group policies in force in 2024. With an industry leading product, advanced pricing, underwriting, and analytics, broad distribution capabilities, and a comprehensive reinsurance program we will continue to win the homeowner's business. On the left, you can see some of the key factors that contributed to strong results. Including increased written premium of 15.3% in the fourth quarter compared to prior year. Reflecting higher average gross written premium per policy and policy enforced growth of 2.4%. For the full year 2024, the homeowners insurance business recorded a combined ratio of 90.1 in line with our low nineties target, while generating total underwriting profit of $1.3 billion."
},
{
"speaker": "Mario Rizzo",
"content": "So the combined ratio for 2024 improved by 16.7 points primarily driven by lower catastrophe losses and strong underlying loss performance. The chart on the right shows Allstate's strong track record of profitability in homeowners insurance. Allstate produced a recorded combined ratio of 92 over the past ten years which compares favorably to the industry which experienced an underwriting loss a combined ratio of 103 over that same time period. Now let's go to a homeowner pertinent topic on slide eight. And discuss the California wildfires. So Allstate responded quickly empathetically to help customers and communities after the tragic wildfires in Southern California. Deployed mobile claim centers and over nine hundred team members to assist customers. Helping our customers recover from the fires, is our principal priority. The financial impact of the wildfires reflects the comprehensive risk and return approach we've taken to managing the homeowners insurance business. Allstate made the decision to reduce California exposure beginning in 2007. Our homeowners market share has been reduced by over fifty percent since that time, as you can see on the chart on the left. While it is early and we have not been able to adjust many claims, current gross losses are estimated at $2 billion which includes loss adjustment expenses, and an estimated California fair plan assessment. Reinsurance recoveries of $900 million net of reinstatement premiums would reduce the net loss to $1.1 billion which will be reflected in first quarter 2025 earnings. Each additional $100 million in gross losses above our current estimate would result in $10 million of net losses since we are above the reinsurance attachment point of $1 billion. We will continue to monitor the development of this event and provide any updates with our January catastrophe release which we'll make on February twentieth. Looking forward, let's discuss policy and force trends in the property liability business on slide nine. The chart to the left shows the composition of property liabilities thirty-seven point five million policies in force. Auto is the largest at twenty-four point nine million. Homeowners represents approximately twenty percent of policies enforced. As you can see on the right side of the page, auto insurance policies in force declined by 1.4%. A decline in customer retention particularly in states with large recent rate increases more than offset a nearly thirty percent increase in new business applications in the quarter. Auto policies enforced did increase in thirty-one states representing approximately sixty percent of countrywide written premium on a year over year basis."
},
{
"speaker": "Mario Rizzo",
"content": "In the middle column on the right, you can see that homeowners insurance policy is enforced increased by one hundred and seventy-three thousand or 2.4% driven by strong retention and a 20.5% increase in new business. We view homeowners as a growth opportunity across all distribution channels. Our objective in 2025 is to grow property liability policy and continuing strong new business sales. We are proactively contacting customers to lower the cost of protection to increase retention. Completing the rollout of affordable simple, and connected auto and homeowners products will also enable growth. In addition to improving the customer experience, these products contain our most sophisticated rating plans and telematics offerings. Which will deliver profitable growth and position us to compete effectively in a market where more carriers are looking to grow. We will also continue to invest in marketing and leverage broad distribution to grow property liability market share. To provide transparency to investors on our progress on growth, monthly disclosure of policies in force will be provided beginning with our next monthly release in a couple of weeks. Now I'll turn it over to Jess."
},
{
"speaker": "Jess Merten",
"content": "Alright. Thank you, Mario. Slide ten provides insights on performance and asset allocation. By taking a proactive approach to portfolio management, Allstate optimizes return for you to the risk across the enterprise. This disciplined approach includes comprehensive monitoring of economic conditions, market opportunities, interest rates, and credit spreads. The chart on the left shows a quarterly trend of net investment income our fixed income earned yield. Market based income of $727 million, which is shown in blue, was $123 million above the prior year quarter, reflecting a higher fixed income yield and increased assets under management. Fixed income yields shown below the chart has steadily increased as we repositioned into higher yielding longer duration assets. Increasing forty basis points from point zero percent to 4.4% over the past year. Performance based income of $167 million shown in black was $107 million above the prior year quarter where reflecting higher private equity and real estate investment results. We've mentioned previously, our performance based portfolio is intended to provide long term value creation and volatility on these assets from quarter to quarter is expected. Pie chart on the right shows our asset allocation as of year end 2024. As you can see, our portfolio is largely comprised of high quality, liquid, interest bearing assets. Public equity holdings were increased by $2.4 billion in the fourth quarter and now comprised $3.3 billion or approximately 5% of the total portfolio. Fixed income duration was 5.3 years, which is in line with prior year quarter and up from 4.8 years at the end of last year. Let's turn to slide eleven and discuss protection plans business which is a key component of protection services and advance our strategy to expand protection while generating profitable growth."
},
{
"speaker": "Jess Merten",
"content": "Protection plans offers protection that prepares or replaces a wide range of consumer products, including electronics, computers and tablets, TVs, mobile phones, major appliances, and furniture that are either damaged or broken. The products are distributed through strong retail relationships. Revenues of $528 million in the fourth quarter grew 20.3% prior year, driven by both domestic and international expansion. Profitable growth resulted in adjusted net income for the quarter of $37 million, which is consistent with the prior year quarter, and an increase for the full year of $40 million to $157 million reflecting the benefit of higher revenues and claims cost improvements. The business has profitably grown to approximately 160 million policies adding 60 million since 2019 through broad distribution and protection offerings as well as geographic expansion. Additionally, revenue has increased to nearly $2 billion in 2024, reflecting 23.9% in annual compounded growth since 2019 while generating more than three quarters of a billion dollars in adjusted net income 2019 to 2024 as growth offsets expansion investments. We continue to invest in this driving business as evidenced by the recent acquisition of Kingfisher, which enhances our mobile phone protection capabilities. I would like to transition slide twelve into discuss how the sale of the employer voluntary benefits and group health businesses create shareholder value. As a reminder, the decision to pursue the sale of health and benefit was based on the assumption that these businesses would have greater strategic value to other companies and selling them would maximize shareholder value. The transactions we've announced support this assumption. In August, we agreed to sell the employer voluntary benefits business to Stancorp Financial for $2 billion. We expect to close that in the first half of 2025. Last week, we marked another major milestone with our agreement to sell the group health business to Nationwide for $1.25 billion which we expect to close sometime in 2025. Both of these transactions are economically and financially attractive for our shareholders, The combined proceeds of these sales are $3.25 billion with an expected book gain of approximately $1 billion. Using trailing twelve months adjusted net income, the combined estimated impact of the transactions on adjusted net income return on equity then a decrease of about 180 basis points due to lower income and higher equity resulting from the gains on sale. As a reminder, the Group Health business is part of National General, which we acquired in January of 2021 for $4 billion. The proceeds from this divestiture combined with about a billion dollars in dividends that we received from National General statutory legal entities represents a return of more than half of the original purchase price while the sides with the National General Property Liability business approximately doubled. Touching briefly on the results of health and benefits for the quarter. Premium and contract charges for the segment increased 3.2% or $15 million compared to the prior year quarter, Individual and group health business saw strong growth with premiums and contract charges up 8% and 9.8% respectively. This growth was partially offset by a modest decrease in employer voluntary benefits. Adjusted net income for the segment of $35 million in the third quarter was $25 million lower than the prior year quarter as increased benefit utilization across all three businesses impacted profitability. Underwriting and rate actions are being taken to quickly address benefit ratio trends and restore margins to historical levels. Options for the individual health business, which has adjusted an income of $30 million for 2024, are being evaluated and the business will either be retained or combined with another company. Let's close on slide thirteen by reviewing Allstate's strategy to create shareholder value. As you can see on this page, we create value by delivering attractive financial returns executing transformative growth to increase property liability market share, expanding protection offerings, completing the sales of employee voluntary benefits and group health businesses. So with that context, I'd like to open up the line for your questions."
},
{
"speaker": "Operator",
"content": "Certainly. And our first question for today comes from the line of Rob Cox from Goldman Sachs. Your question, please?"
},
{
"speaker": "Rob Cox",
"content": "Hi. Good morning. Thanks for taking my question. So first question for you, I had on advertising. I think you all had previously said that you were pretty comfortable with the 3Q 2024 level of advertising spend. Was hoping you could talk about the decision to ramp it up here in the fourth quarter. And I'm curious, what your measures of ad spend efficiency are telling you in the current environment, and how does that compare to history?"
},
{
"speaker": "Tom Wilson",
"content": "So, Rob, we're comfortable with our advertised spending. We adjusted obviously, by quarter to point out, and it also depends which markets we're after. Sometimes we do some heavy up tests in particular months to see what the sense is. I can assure you we have state of the art analytics on that. It's everything every kind of lead we bid on leads automatically. We just to make sure we were good last year, we had a number of outside people come in and look at our analytics. And we appear to be at least contemporary, if not industry leading. Now, you know, some of these are people you're buying ads from, they're not gonna come tell you stupid. But when we look at it in total, we think we're really good at it. And we have all kinds of allowable acquisition cost measures that look at everything from quote to close ratios to lifetime value."
},
{
"speaker": "Rob Cox",
"content": "Got it. Thank you. Secondly, I wanted to ask a question on the comment in the press release about expecting growth in total property liability PIF in 2025. You know, we've been thinking that you could certainly grow PIF in both home and auto in 2025. Is there any reason why you would be hesitant to commit to growing in both of the segments, or am I looking too deeply into that statement? Let me make a comment and then turn it over to Mario."
},
{
"speaker": "Tom Wilson",
"content": "So first, as you know, we don't give forward-looking projections on PIF growth. So what we've said to help bring some clarity to it is we're just gonna give you the numbers every month like we do with cats, and you can decide what you wanna do with that. We're obviously already growing at home, and we have plans we talked a little bit in the press release on where we're growing at auto. But in total, we're not growing in auto. So Mario is working on that. Mario, you wanna talk about what you got going?"
},
{
"speaker": "Mario Rizzo",
"content": "Yeah. Thanks for the question, Rob. Look, I'd say look, the objective of transformative growth is to grow policies in force and gain market share in the property liability business. That's our goal. That's our objective. Having said that, as Tom mentioned, we're currently growing the homeowners business. We think there's a real opportunity in the market. We're gonna continue to lean in on that one. A, because we've got really strong capabilities. B, there's disruption in the market that we can take advantage of, and we like the prospects of continuing to grow homeowners. On the auto side, we think despite the fact that policies are declining, we're really well positioned to lean into growth going forward for a variety of reasons. I think the first is, you've seen the new business momentum build over the course of 2024. In part due to your first question, our advertising investment that we've increased throughout the year, but we've also been doing things like unwinding underwriting restrictions and looking to accelerate growth across all distribution channels. We're gonna continue to fully leverage our broad distribution capabilities alongside that marketing investment continue to roll out new affordable, simple, and connected product. We are currently in thirty-one states. We'll continue to expand that. Over the course of this year. That has our most sophisticated pricing our most contemporary telematics offerings included in that. We're gonna continue to leverage capabilities on the Allstate side. International General just talked about the growth that we've seen in National General. We're gonna leverage middle market capabilities in Allstate to grow National General in a part of the market that they have less penetration in. We're also gonna use National General's capabilities in the nonstandard auto space and leverage the Allstate brand to begin to accelerate growth in that space. So we've got a lot of things that we've both been doing and expect to do in 2025 to accelerate growth and, really, that was the genesis of the statement. Oh, yeah. One last point I should have brought up is retention. Yeah. Everything I talked about was on the new business side. You know, we've seen the adverse impact of retention as we've been having to raise prices over the last couple of years. To improve margins. The good news is auto margins are back where we would want them to be in the mid-nineties range. The downside of that is, retention. Has taken a hit. Some of that will come back as we are less active in taking prices going forward because of where margin sits. But additionally, and more importantly, we're gonna proactively lean into reaching out to customers, helping them save money, by making sure they're getting all the appropriate discounts, they've got the right coverage levels that meet their specific needs, and the objective there is to improve affordability, improve customer satisfaction, and retention and that will be added into our growth trends."
},
{
"speaker": "Rob Cox",
"content": "Very much for the answers."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Gregory Peters from Raymond James. Your question, please."
},
{
"speaker": "Gregory Peters",
"content": "Good morning, everyone. So for my first question, feedback on the last answer there, Mario. And you know, you said on slide nine here for the auto policies, you said that you're proactively contacting existing customers. You mentioned that in your answer. Can you give us an updated perspective on how you think your pricing is on a competitive positioning basis versus your peer group and as you shift gears and proactively contact existing customers, does that mean that there's gonna be some sort of corresponding adjustment in agent compensation that's gonna give more weighting to retention versus just flat out new sales?"
},
{
"speaker": "Tom Wilson",
"content": "Right. Let me the pricing was complicated, so I'm gonna let Mario do that one. But I would make one point on the retention part. I think having branded agents who work exclusively with you is the best channel to be able to do what we're talking about. So, you know, we've raised some people's prices thirty, forty percent. We had to do it quickly because we're losing money. Now we can go back in and help them get the absolute right coverage. That could be deductibles. It could be coverage limits. It could be using telematics. It could be paying differently. So there's lots of different ways we can help them do that. And that would be very difficult to do in through an independent agent channel. It would be harder to do with a direct channel because you don't have the skills and capabilities built in your call centers necessarily do that. Our agents the Allstate agents are used to doing this all the time. They certainly did it when we were raising rates. But now Mario has a new program going on, which is a safe program to which has specific goals, numbers. We are not planning on changing agent comp. Margaret, do you wanna talk about competitive position in?"
},
{
"speaker": "Mario Rizzo",
"content": "Yes. Thanks, Greg. The and competitive position, I'd say a couple of things. First, when you look at the ramp up in new business over the course of the year, and, you know, we made a comment that we're growing in thirty-one states currently. I think that's indicative of having competitive prices and being able to, you know, fully leverage the marketing investment that we're making. It is a complicated question. It's hard to answer it on a national basis because, obviously, we compete market by market, state by state, and we're constantly looking at our competitive position and making tweaks to, you know, the tiers within our pricing plan to adjust prices when we think it's appropriate to adjust prices. Good news is, you know, we've achieved target margins. So we're comfortable with where our rate level is currently. And we would expect that we would need to take less price going forward. But when you look at our new business trends, we feel good about competitive prices. We've taken a lot of cost out of the system over the past several years, as Tom mentioned earlier, which is helpful. We're gonna continue to pull that lever going forward. But we think we're priced competitively and we have the broad distribution capabilities to continue to grow in the auto space. The only other point I'd make on your second question about the proactively contacting customers and agency compensation a meaningful portion of the agent compensation currently relates to renewal. So they've got a strong economic vested interest in retaining as many customers as they possibly can. And as Tom mentioned, they've been doing that. This is a way through the same program where we're gonna really scale it and do it much more broadly. To help drive retention proactively versus just relying on less instability in the market from rate increases."
},
{
"speaker": "Gregory Peters",
"content": "Thanks for that information. Tom, in as my follow-up question, Tom, in your opening comments, when you were going through the information on slide two, you emphasized the ROE of 26.8%, which I could believe is one of the best results I've seen from your company in recent history. Can you provide some view of how you are thinking about the ROE going forward and maybe what the board how the board's viewing it. I guess the reason why I'm asking is, you know, you've disposed of some underperforming assets, you know, over the last decade, and it feels like there's just a natural migration that the ROE objectives for the organization can be moving up certainly this result for last year sort of puts an explanation point on that."
},
{
"speaker": "Tom Wilson",
"content": "Good question, Greg. And with longitudinal perspective on it. So as you remember, I don't remember how many years ago it was. At one time, we put out a target of fourteen to seventeen percent. But I would say that was a different company and a different time. It was a different company and that we had a life business. It was a different time and that interest rates were a lot lower. People were thinking it was low for bond. Since then, of course, as you point out, we've made a bunch of changes. We've sold the life business. We bought back a substantial amount of stock, which takes some of our investment earnings down. Our premiums are up substantially. Not just because we've grown total policies, but also because there's just higher cost per policy which I think the market isn't really affected and that that includes requires more capital. So when you look all through it, we feel really good about where we're at. When we put that fourteen to seventeen percent out there, it was really because investors were not sure given the time and given the nature of the company where our returns would be and would they be acceptable. We never said it was capped. And so, obviously, now we're doing better than that. I would say the most important thing for us to do now is to increase growth. So increasing returns won't drive that much more shareholder value. What will drive more shareholder value is growth. And we've obviously growing and are growing a bunch of our other businesses. So whether that's our homeowners business, whether that's for growing premiums, which people kind of get all focused in on auto pay, and AutoPIP is important, and we're gonna grow AutoPIP. But when you look at just growth in premiums, you know, we're up double digit single low low teens percent depending which measure you wanna look at last year. So we feel good about overall growth think and the key to unlocking the value we've already created through growth is to get auto unit growth up."
},
{
"speaker": "Gregory Peters",
"content": "Got it. Thanks for the answers."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Michael Zaremski from BMO. Your question please."
},
{
"speaker": "Michael Zaremski",
"content": "Hey. Thanks. Good morning. And my first question is on the expense ratio and kudos to to kinda, you know, lowering it over time and and meeting your goal. Curious. I think in the in the past, Tom, recent past, you said that you have plans to to improve it even further. Maybe I'm maybe that's the expense ratio x add expense. If that's the case, are you able to kind of elaborate on what the building blocks are going forward to to to continue the improvements."
},
{
"speaker": "Tom Wilson",
"content": "So yeah. So the answer is yes. We always expect to keep reducing expenses, and we think we have an opportunity to even lower them farther from where they are now. We're not done. I would say, you know, maybe we're sixty percent of the way done. And, you know, and I but I wouldn't, like, take that and multiply that by some percentage change because part of that percentage change just to be completely transparent is because premiums have gone up faster than general inflation. So you kinda can't count can't count that as as much. So we are constantly work I think the where is we're after will be digitization. Leveraging the new technology platform we built the affordable simple connected is all designed around doing that increasing our marketing effectiveness. So even though we carve marketing out from that number, that doesn't mean, like, we're just gonna spend wild on marketing. It needs to have the same level of precision and to it that everything else does. And we also still need to lower distribution cost. You know, the distribution costs are still higher than we would like them to be, so we have work to do there as well."
},
{
"speaker": "Michael Zaremski",
"content": "Great. And my final follow-up is just more high level on the devastating tragedy in California. I know it's kinda still a fluid situation, but I think a few of your competitors have, you know, expressed as a vet they might need to retrench even more in California given the payback the potential payback on the losses are going to be many, many, many years. Curious if you think this could cause Allstate to also rethink its ambitions of growing or or just just overall growth in in California might might My My a different direction. Thanks."
},
{
"speaker": "Tom Wilson",
"content": "Well, every state's different. We don't have any growth aspirations in homeowners in California at this point. And we haven't since 2007, really. We had a small window in there where we thought we had some arrangements where it would make sense for us to grow, that didn't turn out to be the case. So we had turned off the spigot for new customers. We didn't go nav for new people, but we just said we're not gonna take add new customers. Starting in 2007. Then in about 2017, eighteen, I'm looking at my here. Yeah. We said, you know, we think we can take on a few new customers to That didn't turn out to be true, so we stopped that then in 2022. But we've been at this a long time. And so we don't have any growth aspirations in California right now. That said, we're really good at homeowners. We make more than half of the industry's profits. We've got a good business model. We think it's a great growth opportunity. And it doesn't have to be the way it is in California. So Texas has just as many types and dollar amount of losses as California does, yet the homeowners market works there. And so we believe that there's a way to make that work. We'd like to work with a state to make it work because people want to insure their homes. They need to ensure their homes. And we just need to make sure it's done on a basis that is fair to consumers, but also gives our shareholders an appropriate return for the risk. So example, we don't wanna have to do things like in California. Mario talked about the numbers. We have a substantial amount of reinsurance recoveries. We're a cost plus business. We did not the cost for that reinsurance that we just now got back to with lower losses. Which means that, you know, we need to have a structure. The departments talked about that. They're open to that. So I would say that these things you know, they happen over a long time, and it takes a while for them to get. So I don't think anything's gonna change in the next you know, it's not like in twelve months. Everybody's gonna be rushing into California to write homeowners. It just doesn't happen that fast."
},
{
"speaker": "Michael Zaremski",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Christian Getzoff from Wells Fargo. Your question, please."
},
{
"speaker": "Christian Getzoff",
"content": "Hi. Good morning. My first question is on retention. I didn't see any retention numbers in the press release for supplements. I was wondering if you could provide that. And then you say the majority of the headwinds on retention just from, like, know you guys called out Esurance migration and then the New York, California, New Jersey rate hikes. Are those is the majority of that headwind paid it by now, or do you expect some further headwinds kind of in the first half?"
},
{
"speaker": "Tom Wilson",
"content": "I'll make a couple comments then, Jess. May wanna comment. So at first, we've paid a lot of attention to attention in it. In more granularity than you just even mentioned, whether it's this book of business, this state, his risk cover, his whatever, you know, his price changes. We're like, we're all over retention. Just made the decision that rather than give you the components which are complicated and we spend a bunch of time helping you spend a bunch of time trying to figure out retention on this much and how much policy too. Just just so why don't I just give you the numbers? I'll just give you the fifth numbers every month. You'll know what the numbers are. You don't have to get caught up into what's your projections on new business, what's your projection on retention, presurience policy. So the our goal was to increase transparency and give you more information you can use to make your investment in recommendation decisions rather than less into an So that that's what we've set out to do. Maybe Jess or Mario, you guys wanna talk about the retention and how you're feeling about it and other ways to measure it. Maybe I'll just touch on this round out the disclosure, and then, Mario, you can talk about your thoughts. You know, I think the other thing, you know, to keep in mind is, as Tom mentioned, we gave you component a component. We didn't even give you all of the components. We believe by giving you tip on a monthly basis, you'll have more transparency. Recall, what we gave you was Allstate brand, gift or Allstate brand retention rather. So it was a piece of the puzzle and we spent a lot of time explaining movements between brands which we wanted to move away from. So I really believe that that what we're giving you now on a monthly basis will be much clearer and actually, you know, reduce a lot of the complication that came from our disclosure. And as Tom said, put you in a better position to understand new business and retention trends and frankly with the total policy in force trend is. So it was definitely a move to increase transparency by taking away and really completing that move away from brand to line of business and distribution channel."
},
{
"speaker": "Mario Rizzo",
"content": "Yeah. The only thing I'd add on on retention, I think it's important to take a step back and look at what we've really been saying over the last several years, which our principal focus would say, you know, heading into 2024, was to improve auto margins. I think we were pretty clear on that. That was our principal priority. We had to take prices up a lot to do that over forty percent when you look over the past several years. The good news is, you know, margins are back to where we want them to be and where they need to be. And as from a new business perspective, as best kind of played out, you've seen us kind of lean back into the market and really accelerate new business growth over the course of last year. The downside to that approach and that strategy with retention as you mentioned, which has stabilized in a number of states as we've cycled through what we needed to do to improve profitability. But as we talked about before, there were a handful states that were a little later to the game in terms of getting margins back to where they needed to be. We talked extensively about California, New York, New Jersey, The good news is we've been making good progress in those three states. We've been making it by implementing some pretty meaningful rate increases. That is having a drag on retention as we cycle our way through that. We should see that stabilize. I will say though, New York and New Jersey, we still got some work to do. We're our margins are better, but they're not where we'd like them to be. We're gonna continue to pursue rate in those states. But we, you know, believe we can overcome that. Because we got a lot of growth opportunity in the rest of the country."
},
{
"speaker": "Christian Getzoff",
"content": "Gotcha. Thank you. And going back to the California wild losses, I know you provided a $2 billion gross s You provided some sensitivity, but what are you assuming in terms of the industry losses so we could, like, flex that sensitivity up or down depending on how the losses develop."
},
{
"speaker": "Mario Rizzo",
"content": "Yeah. Look. And the this is Mario. The way I'd answer that question is, obviously, there's a lot of moving parts in in our estimate. We know our data with a lot of specificity because we have that. We've made assumptions around a fair plan assessment just given the, you know, the the the magnitude of the of the losses we've seen and also when you when you look at the fare plan surplus level as of the end of the third quarter, their reinsurance and their co participation in that, we think it's pretty likely that they're gonna you know, kind of exceed their their surplus levels and there will likely be an assessment. We've got that in there. And we you know, our our our number includes a view of what the industry loss is. I really don't wanna to kind of disclose what our view on that is, but there's I will say we've made certain assumptions to come up with our number both in terms of ourselves and the fair plan. We'll keep looking at those because it's a pretty fluid process and we'll update it as we get more information. If we need to update."
},
{
"speaker": "Tom Wilson",
"content": "So here's if you want a sensitivity. For every hundred million, it's ten million bucks. So for every five percent or often total, it costs us ten million dollars. So if we're off by fifty percent, so it's another billion dollars, it costs us a hundred million. Right? So the I don't think you need to worry about sensitivity on the gross loss."
},
{
"speaker": "Christian Getzoff",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Timmy Peller from JPMorgan. Your question please."
},
{
"speaker": "Timmy Peller",
"content": "Hey. Good morning. I had a question first on just the auto business. You mentioned PIF turning positive in thirty-one states, I think. And I'm assuming what's unique about those states is just the fact that you're not raising prices as much. And advertising more. So if that is true, then could you talk about of the remaining that you're not growing in, should that begin, happen throughout the year gradually, or is there more of a cliff event? Some point later in the year? When you will lap those comps and you're not gonna be raising prices just to sort of be able to assess when those stocks, states will begin to show better growth."
},
{
"speaker": "Tom Wilson",
"content": "Timmy, I'll let Mario talk about the pace, but I don't think he's gonna give you an answer by quarter. Alright. I got it. It's more complicated though than just those two factors. Alright? So it's not just, are we not taking price? And how much are we advertising is what's everybody else doing? What kind of coverage are we offering, where are we with our ASC roll out, where are we with our custom three c. So it's a really complicated machine that Mario's running. And but the goal is sometimes attribution helps explain why you are you're on Sometimes attribution leads to excuses. And we're not interested in excuses. We're interested in results, which grows. So Mario can talk about how these thinking about that maybe you wanna talk about both the impact of retention and the impact of new business over the course there, but we can't give you, obviously, a per quarter PIP number. Just watch for Jess's monthly number."
},
{
"speaker": "Mario Rizzo",
"content": "Yeah. Timmy, thanks for the question. Look, at lower where I'd say is like, we wanna grow in every state where it makes economic sense for us to grow and where we believe we can grow profitably. That happens to be thirty-one states now. We think the opportunity is beyond that level. And as Tom mentioned, there's a lot of components that factor into our ability to grow price is part of it, competitive position, and where our price hits relative to competition. The growth investments we're making, our risk appetite, there's a lot of factors that play into that. Retention is a key component of our ability to grow. Right? So what you saw in total this year was we had really good new business trends, and in the quarter, they kind of peaked in 2024. At almost thirty percent. Yet despite that, our units declined year over year. Because of the drag of retention. So we're focused through the same program on not just waiting for retention to bounce back because of less rate disruption in the system, gonna proactively do things to work with customers help them save money, improve affordability, and drive retention up. We think doing that well alongside all the other things I mentioned earlier new product rollout, new technology, distribution, and continued investments in marketing and all the things that helped us drive new business volume. That's the key that will drive growth broadly, and that's the plan we're executing on."
},
{
"speaker": "Timmy Peller",
"content": "And then maybe just following up on capital. Like, the business is obviously profitable now. I think you'll make money even with the California buyers. In one queue, and then you've got the money coming in through the sales of the benefits and the health business. So how should we think And I'm assuming capital is not a constraint for growth given how much money you're gonna get from the sales, but should we think about capital deployment between growth, m and a, and share buybacks. And is it unreasonable to assume that you wouldn't be in the market buying back stock at some point assuming results come in as expected over the course of the CVA."
},
{
"speaker": "Tom Wilson",
"content": "Timmy, if we consider proactive capital management to be a significant strength of Allstate. And it's added tremendous amounts of shareholder value. So and you're right. Share repurchase are obviously one of those. And we've used that extensively. But would encourage you to hold us accountable as you started to mention on really a broader basis. Right? So there's organic growth, there's risk and return on economic capital, there's inorganic growth, and then there's capital structure, which includes the share repurchases. And so let me just go through each of those. First, organic growth is a twofer. And based on the returns we're getting in our business today? It generates absolute dollar growth in earnings. Secondly, with that higher growth rate and we should have a higher PE, because if you look at our price earnings ratio versus any other insurer, and you look at our top line growth, the average premium growth is getting discounted, and it's basically all hung on auto unicorns. You can start whether that's right or wrong, but we think that that the unlock of in deploying capital to grow the property liability business both in units and premiums is will drive growth. So we think that's really important. Marketing, we talked a lot about that this morning, so I don't wanna And We don't need to go back through that. If you look at risk and return on economic capital, we have a really sophisticated way in just talked about this a lot within the last couple of years of how we manage capital, and associate a risk and return on that. That helps us do things like leverage our investment our investments, and that capability generates good returns. And I think it needs to be valued in its own right. It's but for example, the duration calls we made used additional economic capital. We knew that. We decided on it. It was part of the enterprise decision, and it's clearly generated good returns. Same thing is true with the reinsurance in California. We look at all those things economically. I think acquisitions also need to be assessed on the actual return on capital. So National in general and Square screen, both both both on the standpoint. When you look at National General, it's more than double its size on apples to apples basis from when we bought three years ago. SquareTrade is substantially bigger as maybe ten times bigger and making a hundred and fifty million bucks a year when we paid a billion four four nine. Just when you look at what was the net cost of National General and SquareTrade?"
},
{
"speaker": "Jess Merten",
"content": "Tell me, you take a look at you know, both of them, the net cost is about half of what we paid. So as I mentioned in my prepared remarks, we paid $4 billion for National General. When you add up the recently announced group health transaction, and the dividends we've been able to take out of the statutory entities which are about a billion dollars, we've reduced that purchase price by about $2.25 billion. So to $1.75 or less than half. The same will be true if you look at SquareTrade in the $1.4 billion acquisition. Since owning it, we've taken about half that back in, dividends based on earnings. While also and this is important, investing in growth, doing acquisitions. So we've gotten about half of it back and still invested. In growth on SquareTrade."
},
{
"speaker": "Tom Wilson",
"content": "So and and then, of course, share repurchase is is an also thing, but you have to really look at how you manage your capital. Stack better. So for example, We issued a perpetual preferred stock. I don't remember how many years ago. We we issued two billion of stock. We bought back two billion in common, swapped fixed equity cost and left all the remaining upside with our common equity. Today. Preferred just has a what's current cost on the preferred?"
},
{
"speaker": "Jess Merten",
"content": "Oh, we have three different issuances, Tom. So we're our lowest is about 4.75% and then we have a tranche that was more recently issued at 7.375%. So we've got a range, but most of it the largest issuance actually is a 5.1%. Fixed for life. So, you know, obviously, and it the math is not exactly right because you got gap, capital, and gap. But if you look at our returns, On equity, on just actual market equity, it's substantially above that. So that's a that's a good trade. The we also look obviously, look at dividends and everything else. Share repurchases, we've done a lot of. And so so just you wanna just go through the numbers of what we've done on share repurchases. We have been a lot of time. So I took a look back and went all the way back to when Allstate went public. Since going public, we've repurchased about $41.5 billion of our stock, and that represents about 83% of the outstanding shares. If you bring that time frame in a little bit, I have over the last ten years, the number is closer to $17.5 billion. And about half of the outstanding shares over the last ten years. Bringing in again five year period, $7.8 billion of repurchase is about 25% of our outstanding shares and in all cases, at an average cost, it's very attractive. We even go through and look at the returns in all cases over any period, whether it's thirty years, five years, the return is significantly above our cost to cap. So we've had really good returns. And to your point, Tom, you know, buying back 83% since going publish public just shows our commitment to reverse."
},
{
"speaker": "Tom Wilson",
"content": "Yeah. So, I mean, we've got plenty of things we do. And I would just you know, like, don't like, yes, share repurchases are important. I know it's a number of analysts wrote that up over the evening of, like, when you're gonna be back. I'm like, you should hold us accountable for manager and capital to drive shareholder value. And if that means growing faster, and using our capital to grow faster, then holds accountable for that. If we if we have extra capital, we don't hold on to it. And we buy back stock because we think, you know, when you look at our our value relative to our growth potential, the size of our business, our our PE. We still think it's cheap."
},
{
"speaker": "Timmy Peller",
"content": "Yeah. Still better to get those questions and questions about adequacy of capital, I guess. So"
},
{
"speaker": "Tom Wilson",
"content": "And I thought those those were those were thoughts for sure."
},
{
"speaker": "Timmy Peller",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Bob Huang from Morgan Stanley. Your question please."
},
{
"speaker": "Bob Huang",
"content": "Yeah. Good morning. I'm gonna stay away from capital. So the first question is on auto. And I mean, an investor astutely pointed out that on your first quarter 2024 slide, you talked about 64% of your total premiums were profitable. So fast forward today to today, then we're talking about about 60% of that premium is now growing. Is this fair to kind of make some type of causal correlation between the time you achieve profitability and the time that you you start to grow the business? In other words, is it fair to say that six to nine months from now, essentially, California, New York, New Jersey, they're only state you're unable to grow and everything else should be growing and that rather than the 60% of total premium is growing. Probably call it eighty or ninety percent of it should be. Is that a fair way to think about this?"
},
{
"speaker": "Tom Wilson",
"content": "I think the construct is right. I don't know if I would automatically extrapolate that extrapolate that into the future. I mean, it is true when we were losing money, we shut down advertising, shut down growth, be intentionally, because we said there's really no sense going to get a bunch of new customers we're gonna have to raise their price by fifteen percent relatively quickly, and it maybe then lose them. So what's the point to spend the money to getting a new customer to lose a bunch of money on, and you know you're gonna lose money on. So that is was true, and that's what we did. We also know that by driving that and going your crush we that it was going to her retention. And so now we're about so there it is a there are, you know, pieces you rolled in. I don't think you could automatically go to say, like, like, do an analysis of two line lines on a graph going up, and they would follow each you know, each sit each state's different, each position's different. You know, if if if if Mario wish to get adequate prices in New York, tomorrow, we have a great agency plant there. We have we got pretty we got huge share down in the in the New York area. And we could really leverage it to grow fast. When that will happen, who knows? So I think you should just hold us accountable for growing auto units, and I keep coming back to auto units is the unlocked A lot everything else is growing and it's like, so let's you know, it is it is an important part of our business. But we've got we got higher premiums, the reserve balances are up, the investment balances are up. That's all driving increase you know, protection plans is back in and out of the park. So we got lots of growth. We are focused on the unlock of auto unit growth."
},
{
"speaker": "Bob Huang",
"content": "Got it. No. That's that's helpful. If I can just have a follow-up on that. I I I don't know if you'll address this, so apologies if you did. The question is really around adverse selection. Right? As we go into 2025. More and more auto carriers are profitable, and more and more auto carriers are talking about growth. Should we expect your current level of combined ratio to hold for auto as you head into a environment where everyone is looking for growth? Like, how do you feel about the the broader competitive environment as a whole?"
},
{
"speaker": "Tom Wilson",
"content": "Well, you're you're talking well, the auto market has obviously been competitive. And both Progressive, GEICO, State Farm, the big carriers that we compete with all the time have been out in the market and competitive this year. So people are advertising. It's it's last year, 2024. So it's not like it wasn't competitive and it's suddenly turning into competition. We think we have the capabilities to compete and grow. I would say that's a different market in homeowners where most people are backing out. There is a secular trend there. Where we have an opportunity to grow, and as we look at capital, one of the things we like to do is get a higher valuation on our homeowners growth. So when you look at our homeowner business and I said, jeez, if you have a business that's growing, you know, revenues in the mid-teens, it's it's picking up, not huge market share, but it's got you real unit growth. It's an industry leading model. It's earned money good money eleven out of twelve years. And and it has high returns on capital you probably wouldn't put it at the kind of PE that we have for our overall enterprise. And I suspect that if you actually looked at analysts, they might even give it a lower p e than our total. So we need to figure out how to have that fully recognized in our valuation. And it might mean doing something differently in reinsurance and lowering the volatility of that line. But just know that our goal is to increase shareholder value. Maybe we're close. I think we're in time. Our goal is to increase shareholder value, whether that's buy shares back grow, manage our capital structure differently, figure out how to compete differently, do more advertising. We're all about driving growth for shareholders. We think we have the tools and capabilities to do that, and we have a track record that shows we know how to get. Got So thank you all. We'll see you next quarter."
},
{
"speaker": "Operator",
"content": "Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day."
}
] |
all | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good day, and thank you for standing by. Welcome to Allstate's Third Quarter Investor Call. At this time, all participants are in listen-only mode. After the prepared remarks, there will be a question-and-answer session. [Operator Instructions] As a reminder, please be aware this call is being recorded. And now, I'd like to introduce your host for today's program, Alastair Gobin, Head of Investor Relations. Please go ahead, sir."
},
{
"speaker": "Alastair Gobin",
"content": "Thank you, Jonathan. Good morning. Welcome to Allstate's third quarter 2024 earnings conference call. Yesterday, following the close of the market, we issued our news release and investor supplement, filed our 10-Q and posted related material on our website at allstateinvestors.com. Our management team will provide perspective on our strategy and an update on our results. After prepared remarks, we will have a question-and-answer session. As noted on the first slide of the presentation, our discussion will contain non-GAAP measures, for which there are reconciliations in the news release and investor supplement and forward-looking statements about Allstate's operations. Allstate's results may differ materially from these statements, so please refer to our 10-K for 2023 and other public documents for information on potential risks. And now, I'll turn it over to Tom."
},
{
"speaker": "Tom Wilson",
"content": "Good morning. We appreciate you investing your time in understanding the value creation potential at Allstate. I'm going to provide an overview of results. Mario and Jess will walk through the operating performance, and then we'll address your questions. So let's begin on Slide 2. Allstate's strategy has two components, increased personal Property-Liability market share, and expand protection provided to customers, which are shown in the two ovals on the left. We now have more than 200 million policies in force. On the right hand side, you can see Allstate's performance for the third quarter. Total revenues of $16.6 billion were up 14.7%, compared to the prior year quarter. Allstate generated net income of $1.2 billion and adjusted net income of $3.91 per share. Return on equity was 26.1% over the last 12 months. The Property-Liability business, is now positioned for growth. Execution of the auto profit improvement plan has restored auto margins, near term auto insurance policy growth will require us to improve customer retention and increase new business levels, both of which Mario will discuss. The homeowners business had good returns and is growing. The transformative growth initiatives, to build a low cost digital insurer with affordable, simple and connected protection, will ensure that this growth is sustainable. Proactive investing also benefited income as the decision to lengthen duration at the right time increased portfolio yields. In addition, higher insurance prices, and increased reserve levels create a much larger investment portfolio, which also raises income. Protection plans continues to profitably grow, and we recently did a small acquisition to expand mobile device protection capabilities. Let's move to Slide 3. Here you can see the operational execution generated excellent financial results. Revenues increased to $16.6 billion. As you can see in the upper left, Property-Liability earned premiums were up 11.6%. Net investment income for the quarter was $783 million that's 13.6% higher than the prior year quarter. Net income was $1.16 billion. Adjusted net income as I mentioned was $3.91 per share. And then, you can see in the lower right that the return on equity was 26.1%. This shows that Allstate's operational excellence enabled us to dramatically improve results from last year. Now let's hear from Mario on Property-Liability results."
},
{
"speaker": "Mario Rizzo",
"content": "Thanks, Tom. Before I go into my remarks on the quarter, I want to call out a change we made to our disclosures. You'll notice that we simplified our Protection segment disclosures this quarter, to focus on product and channel instead of brand. For the past several years, we've provided detail on both the Allstate and National General brands separately, to create transparency into National General's performance and allow you to evaluate the acquisition. National General has been a highly successful acquisition, since it is now twice its size, generates excellent returns and gives us strong competitive positions in both independent agent distribution and non-standard auto risk. We're now building on this success by combining operations, such as expanding the sale of non-standard business under the Allstate brand. As a result, performance should be evaluated for the protection business in total, and by distribution channel versus by brand and that's why we made the change. So in keeping with this approach, my commentary today will be focused on performance on total auto and homeowner lines, and production by distribution channel. With that as background, let's start on Slide 4. On the top of the table on the left, you can see Property-Liability premiums of $13.7 billion, increased 11.6% in the third quarter driven by higher average premiums. Underwriting income of $495 million improved by $909 million, compared to the prior year quarter, as improved underlying margins more than offset higher catastrophes. The expense ratio of 21.5 was 0.3 points higher than prior year, due to increased advertising. As we continue to accelerate growth investments in rate adequate states and risk segments. The chart on the right depicts the components of the 96.4 combined ratio. The loss ratio shown in light blue includes losses of $1.7 billion and was 2.8 points higher than the prior year quarter. The underlying combined ratio of 83.2 in dark blue improved by 8.7 points, compared to the prior year quarter. The improvement was driven by higher average earned premium, and improved loss cost strengths. Prior year reserve reestimates excluding catastrophes had only a minor impact on current quarter results, as favorable development in personal auto and homeowners insurance, was more than offset by increases in personal umbrella and runoff business, primarily related to asbestos related claims, which was recorded this quarter, as a result of our annual third quarter discontinued lines reserve review. Now let's dive deeper into auto insurance margins on Slide 5, where you can see the success of the auto profit improvement plan. The third quarter recorded auto insurance combined ratio of 94.8 improved by 7.3 points, compared to the prior year quarter as average earned premiums outpaced loss costs. Average underlying loss in expense was 4.8% above prior year quarter, reflecting higher current year incurred severity estimates, primarily driven by bodily injury coverage offset by lower accident frequency, as well as higher advertising investments to drive new business growth. Physical damage severity increases continue to moderate, while bodily injury severity continues to trend above broader inflation indices. Our claims team continues to focus on operational actions, to mitigate the impact of inflationary trends. As a reminder, we regularly review claim severity expectations throughout the year. If the expected severity for the current year changes, we record the year-to-date impact in the current quarter, even though a portion of that impact is attributable to previous quarters. For 2022 and 2023, the bars in the graph reflect the updated average severity estimates, as of the end of each of those years to remove the volatility, related to intra-year severity adjustments. Similarly, in the third quarter of 2024, the full year claim severity estimate went down, so there was a benefit from prior quarters included in the third quarter's reported results. This benefit was worth 0.8 points in the third quarter, with the adjusted quarterly combined ratio of 95.6 as shown on the far right bar. Now let's review homeowners insurance on Slide 6, which generates attractive returns and growth opportunities. Allstate is an industry leader in homeowners insurance, generating a low 90s combined ratio over the last 10 years. As you can see in the chart on the left, this performance compares favorably to the industry, which experienced an underwriting loss and a combined ratio of 103 over the same time period. Moving to the table on the right, Allstate Protection homeowners written premium increased by 10.8%, compared to prior year reflecting higher average gross written premium per policy, and policy enforced growth of 2.5%. The third quarter combined ratio of 98.2 resulted in $60 million of underwriting income, compared to a $131 million loss in the prior year quarter. The underlying combined ratio of 62.1 improved by 10.8 points, due to higher average premium and lower non-catastrophe loss costs. For the first nine months of 2024, homeowners insurance generated an underwriting profit of $249 million, despite $1.2 billion of catastrophe losses in in the third quarter. Let me provide insight into the growth potential of the Property-Liability business starting on Slide 7. In the chart on the left, you see the composition of the Property-Liability book. Homeowners in medium blue represents approximately 20% of policies in force. Homeowners' insurance policies in force increased by 2.5% as retention has improved by close to half a point, compared to last year and new issued applications are close to 20% above prior year. As you can see in the right hand column. We view homeowners as a growth opportunity. Auto policies in the dark blue account for approximately two-thirds of Property-Liability policies enforced. As you can see on the right side of the page, overall policies enforce declined by 1.5%. This reflects a decline in customer retention to 84.7%, which is 2/10th of a point below the prior year quarter, but much lower than historical levels. We did have a 26% increase in new issued applications, which offset some of the retention losses. Now let's go through each of these components to give you insight into how to assess growth prospects. Let's start with customer retention on Slide 8. This chart shows Allstate brand auto insurance retention over a 10-year period which is primarily standard auto insurance risks. There is a couple of key points I want to make on this slide. First, raising prices leads to lower retentions as customers shop for other options. Second, the large increases in the last several years have led to a significant decline in retention since 2022, which has negatively impacted policies in force. This has, however, recently leveled off as price increases have moderated. Let's look at the three periods with the arrows. In 2015 and 2016, we raised auto insurance prices, which you can see from the dotted line because of an increase in the frequency of accidents. The graph shows how this led to lag declines in retention from 88.2 in 2014 to 86.7 in 2017. Over the next three years, price increases were relatively modest and retention recovered reaching 88.3 by 2019. Now, there are lots of factors impacting retention, such as the amount of new business you write, the risk type of that business, number of bundled policies and specific actions taken in big states like California and Florida, as well as customer satisfaction levels. But the biggest driver is price. Increased advertising and price competition had a modest negative impact over the next several years with retention hovering around 87%. You can see this in the most recent period where retention has declined by 2.7 points over the last 10 quarters, which reflected rate increases of 36% on a cumulative basis. Looking forward, we expect lower rate increases given the profitability of auto insurance. This year, for example, Allstate brand rates have been increased by 6.3% compared to 9.5% in the first nine months of last year. Lower price increases should translate into higher retention. To help you model this out, every point of retention is worth approximately 350,000 policies enforced each and every year, or 1.4% of the current policy count. Moving to Slide 9, let's discuss the success we've had in increasing new business levels this year. We continue to invest in transformative growth while we executed the profit improvement plan. These foundational investments enable us to go to market with a multichannel distribution strategy that serves customers based on their personal preferences and has resulted in a 26% increase in new business in the third quarter shown in the far right column at the bottom. While profit actions previously restricted our new business appetite, rate adequacy has now been achieved in the vast majority of states. Third quarter advertising spend was roughly 60% higher than the same quarter in 2021. In the Allstate agency channel, the compensation structure was also changed to improve growth and agent productivity at lower distribution costs. Allstate Agency new business was up 16% over the prior year quarter with bundling rates at point of sale at all-time highs. The national general acquisition enabled us to grow independent agency new business by 14% over the prior year quarter. In the direct channel, we are back to 2022 levels with fewer underwriting restrictions, increased advertising and the new affordable, simple and connected auto product which is currently available in 25 states. New business is 56% over prior year and we expect to increase to continue increasing volume in this channel which now represents 31% of total auto new business. This level of new business will drive future growth. Every 5% increase in new issued applications above the current run rate increases policies enforce by approximately 250,000 items or 1% of policies in force. Looking forward, the property liabilities business is positioned for growth. Margins are attractive, fewer rate increases should improve retention and the components of transformative growth are working, including new products, increased advertising, lower expenses and expanded distribution. This will enable us to achieve our strategic goal of increased Property-Liability market share. And now, I'll turn it over to Jess."
},
{
"speaker": "Jess Merten",
"content": "Thank you, Mario. Let's shift to Slide 10 to review investment performance. A proactive approach to portfolio management that optimizes return per unit of risk across the enterprise generated strong returns this quarter. Our disciplined approach includes comprehensive monitoring of economic conditions, market opportunities, interest rates and credit spreads. The chart on the left shows the fixed income, portfolio yield and assets under management trend over the last several years. Fixed income yield shown with the orange line has steadily increased as we repositioned into higher yielding longer duration assets. Based on interest rates in the third quarter our fixed income yield is now generally in line with market yields. In the gray bars you can see growth in the portfolio book value. Since the fourth quarter of 2021, book value has increased by 14% or $9.1 billion, reflecting the impact of higher underwriting cash flows attributable to increased premiums and reserve levels as well as portfolio cash flows that increased because of higher coupon rates. Growth in assets and higher yields benefited net investment income as shown in the chart on the right. Net Investment income totaled $783 million in the quarter, which is $94 million above the third quarter of last year. Market based income of $708 million, which is shown in blue, was $141 million above the prior year quarter, reflecting the impact of a fixed income yield that is 60 basis points above the third quarter last year. Performance based income of $143 million shown in black was $43 million below the prior year quarter, reflecting lower real estate investment results. While this quarter's result is lower than our long term expectation, our returns continue to be strong and volatility on these assets from quarter-to-quarter is expected. Slide 11 highlights strong results in the protection plans business, which is one of the five companies in the protection services segment that also includes Arity, Roadside, dealer Services and identity protection. The Protection Plans business provides warranties for consumer electronics, computers and tablets, TVs, mobile phones, major appliances and furniture through strong domestic and international retail distribution relationships. Revenues for this business totaled $512 million in the third quarter and increased 23.1% compared to the prior year, reflecting growth in international markets. Profitable growth resulted in adjusted net income of $39 million, a $19 million increase compared to the prior year quarter, as strong operational execution increased margins and enabled successful implementation of the strategy to expand distribution relationships and product offerings. We continue to invest in this fast growing business. In October, Allstate Protection Plans acquired Kingfisher to enhance capabilities in mobile phone protection. Now let's Transition to Slide 12 to focus on the terms and accounting treatment of the sale of the Employer Voluntary Benefits business. As we announced in August, Allstate finalized an agreement to sell the Employer Voluntary Benefits business, which I will also refer to as the EVB business for a purchase price of $2 billion to StanCorp Financial. The transaction is expected to close in the first half of 2025, pending regulatory approvals. As a reminder, the EVB sale is the first step in a strategic decision to pursue divestiture of the Employer Voluntary Benefits, group health and individual health businesses to capture value through greater strategic alignment. The EVB transaction is economically and financially attractive for shareholders. Allstate retains the economics of the business until closing and results continue to be reflected in net income and adjusted net income. In the quarter $3.2 billion of assets and $2.2 billion of liabilities related to the EVB business have been classified as held for sale. As you can see on the right of the slide, we're estimating a $600 million gain and had previously disclosed that we expect the transaction to generate approximately $1.6 billion of capital. Moving to health and benefits results for the quarter, Premium and contract charges for the segment increased 5.2% for $24 million compared to the prior year quarter. The individual and group health businesses saw strong growth with premiums and contract charges up by 8.1% and 20.2% respectively. This growth was partially offset by a modest decrease in the EVB business. Adjusted net income for the segment of $37 million in the quarter was $32 million lower than the prior year quarter as increased benefit utilization across all three businesses impacted profitability, underwriting and rate actions are being taken to quickly address the benefit ratio trends and restore margins to historical levels. The process to evaluate disposition of the group and individual businesses is progressing. Let's wrap up with Slide 13 to recap Allstate's strategy and path to value creation. Operational excellence ensures that we react to changing business conditions and maintain margins at target levels. Transformative growth investments are being made to create sustainable growth and Allstate delivers attractive returns. With that as context, let's open the line for questions."
},
{
"speaker": "Operator",
"content": "Certainly. And our first question for today comes from the line of Jimmy Bhullar from JPMorgan. Your question, please."
},
{
"speaker": "Jimmy Bhullar",
"content": "Hi, good morning. So first, just had a question around your confidence and outlook for PIF growth in the auto business, and what you're seeing in terms of competitor behavior, both on prices and on advertising. Seems like most competitors are - shifting to a growth mode now that margins have recovered. But are you confident that we can see PIF growth turn positive over the next few quarters?"
},
{
"speaker": "Tom Wilson",
"content": "Jimmy, let me make a couple of comments and Mario can jump in. First, we don't give growth projections, so we're not going to comment on that. We gave you. We put the numbers in there, so you can do your own analysis of how you think we'll do in retention, and how you think we'll do in new business. We obviously believe we can grow market share, which is what our whole strategy is about. When you look at the competitive environment, you continue to see progressive advertising aggressively GEICO has gotten back into the market, but perhaps not as aggressively as they have in the past. And State Farm continues to try to grow, but as you know, they have an underwriting profitability challenge that they're I suspect they will take out, but we'll only see. But I would also not just focus on those big players, but there's a whole bunch of other players that are more moderate size or smaller that either don't have the firepower in advertising to compete, or don't have the pricing sophistication. Mario, do you want to make comments about how you're feeling about growth?"
},
{
"speaker": "Mario Rizzo",
"content": "Yes, thanks for the question, Jimmy. At its highest level, obviously to turn positive, PIF growth requires that we keep more of our existing customers, which is the retention component, and then we drive increased levels of new business. Maybe I'll talk about each of the pieces individually. Like we pointed out in the presentation, obviously a lot of the rate actions in the profit improvement plan that we've implemented over the last couple of years has had a pretty negative impact on customer retention. Now going forward, we would expect, just given where our margins are in auto, all other things being equal, we would expect to take less rate going forward, which will have a positive impact on retention, as it has in the past as we create less disruption in the book. But the other side of it is, we're not just going to rely on that. We've got actions in place in a number of areas, both in terms of improving the customer experience. Working with our customers, both through our agents, and our contact centers to help identify opportunities to improve affordability, and really kind of mitigate shopping activity from our own customers. So, we're focused on retention improving going forward, both kind of organically, I'll say through less rate, but we're also not sitting back. We're taking proactive actions to help offset some of the headwind that we've seen in retention. On the other side. On the new business standpoint, just to give you some context, we talked about the vast majority of markets being open for business somewhere between 75% and 80% of our premium volume. When you look at it nationally, those are markets that we are open for business. We're accelerating investments, and we've really seen some good production trends across all distribution channels. Our agents are productive, they're bundling at all-time high levels, which also will help retention. We believe over time we're continuing to see really good traction on the direct business and we think there's ongoing opportunity there. And then as I mentioned earlier, the National General acquisition and what we've been able to do both in the non-standard auto market, as well as in the independent agent space more broadly, is generating some good production trends. So, we feel good about that. We're focused on improving retention, while continuing to build on the growth momentum from a new business perspective, which has improved sequentially over the course of the year. And when those two things come together, that that's what will drive positive growth."
},
{
"speaker": "Tom Wilson",
"content": "Jimmy, let me add just a couple of things. On a longer term perspective, what Mario talked about. So when auto profitability went negative, we said first priority, get the rate, don't be too specific about it. And what Mario is talking about is going back in now and saying, okay, well we got the total rate. How many more people should be using Milewise? How many more people should be using telematics? Those are great opportunities for us to leverage our innovation and keep more customers. So there's a bunch of good work going on there. So the priority that we gave to the team was we need to make money in auto insurance. We've done that. Now we're ready to go back in and, which should drive retention. The other thing I would say is on distribution. If you look at our historical growth, this is the first time really we have three fully functioning channels. Like, we've got three horses here, all ready to run. You can see the growth. And direct is up a lot this versus last year. But that's, because direct was the first place we shutdown, too. When it came to how do we get profitability up in auto insurance, we said well, first, if we're losing money on it, we shouldn't write it. Rather than take that hit in volume to the Allstate aging channel, which needs to be maintained in terms of its revenue and growth, we said, let's just do it to direct. So the direct bounce back, is just where we are now. But in that pause, we really built out our capability. So, we're feeling good about having three horses to drive growth."
},
{
"speaker": "Jimmy Bhullar",
"content": "Okay. And then on capital, obviously, your balance sheet's a lot stronger with the improved profitability. You've got the pending sale of the benefits business as well. How should we think about uses of capital, as profitability continues to recover and once the sale closes between sort of your priorities for acquisitions, potential buybacks, dividends?"
},
{
"speaker": "Tom Wilson",
"content": "A very appropriate question. I'll channel Jess for a minute here, and just say, we've always had a lot of capital. So I know not everybody believed that, but we've always been financially very strong. But as we think about capital, it is something we take very seriously. It's really one of the key things we do for shareholders, and we feel like we've been good stewards of that. As you look forward, we think the best and first place to put our money, is organic growth. Particularly when you look at the kind of ROEs we're running at. And if you look at our growth in premiums, you look at the growth potential, we think that will be the first and best place to maximize shareholder value. There's lots of other ways we use it, right. So share repurchases. I know a number of analysts brought that question up. Let me just go right to that. So we're no stranger to share repurchases. Since we went public, we bought back 83% of our shares outstanding for about $42 billion. Last 10 years, it was $20 billion in the last five years it was about $10 billion and a quarter of the shares outstanding. So we know how to and do share repurchases, when it makes sense. In this particular case, we think the growth opportunities outweigh the value of doing share repurchases. And that's because the returns are so high on that. Now if we don't, if you're keeping extra money around and you put it in the bond portfolio, and you're getting 5%, then obviously you should not be doing it. We do have other places we've used the money historically, and places we might use it in the future. So as we dialed down our equity allocation back when, we didn't think the risk and return was right. If we feel like that's appropriate, we'll dial that equity allocation up again. That uses capital. If we've also looked at acquiring growth. So the National General acquisition, Mario talked about it. And the reason we kept breaking it out so you could all see it, is that business just rocked it's twice its size. And the same thing is true with our protection plans business, which is nine or 10 times its size since we bought. And that was a little longer ago, it was seven years, but we paid $1 billion for it, and it's making over $120 million a year. So, we're feeling really good about that business, and its growth potential. So just know we always have our shareholders best interest in mind. We think about it broadly and we'll continue to do that."
},
{
"speaker": "Jimmy Bhullar",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Greg Peters from Raymond James. Your question please."
},
{
"speaker": "Gregory Peters",
"content": "Good morning, everyone. I'd like to, for my first question, focus on Slide 8, which is your retention slide. And in your comments you mentioned changing of agent compensation. If I'm not mistaken, some time ago you lowered agent compensation on renewals. And I'm wondering if that's having any spillover effect on retention. Obviously, the new shoe daps are doing strong, so your competitive position looks good. Also, as part of transformative growth, I think you've been streamlining some claims costs, some claims functions. Curious if you're seeing any impact of that on retention?"
},
{
"speaker": "Mario Rizzo",
"content": "Thanks, Greg. This is Mario. Let me take your questions in order. First, on retention, when we isolate and look at, we look at retention a whole bunch of different ways. When we look at retention in the agency channel, it's actually up year-over-year. So what's happening and what you see on Page 8 is predominantly a function of price increases, which I think have the biggest impact on retention. Just from an agent compensation perspective as you mentioned, we kind of changed and have been transforming the model for them to really align with what both we want to do strategically, but also the value that customers see from agent. So we've incented agents to drive more new business, deepen relationships with customers and we see that with kind of all-time high levels of bundling. And agents, we're really pleased with the performance of our agency force and how productive they are and they're going to be a key part of our growth plan going forward. But that's really not the driver of retention that you see on the page. In terms of the claims organization, that's an area where even though the -- when you look at the ratio, it's pretty flat, that's a function of just having higher average premium. We're investing in claims. We actually have been adding staff so that we can continue to build on our claims capabilities, pay what we owe, drive a higher level of customer satisfaction. And again, we look at those as growth levers every bit as much as profit and severity management levers, but nothing really from a claim standpoint driving the retention numbers. And as I said, as a matter of fact, we're adding resources and dollars in claims to help both support the growth that we want to achieve going forward, but enhance customer satisfaction and effectively continue to manage severity levels."
},
{
"speaker": "Gregory Peters",
"content": "Thanks for that additional information. I guess as my follow up question, just looking at the homeowners business, it looks like it's really performing well at a 62.1% underlying combined ratio. You're growing that business. I assume you're not growing just your standalone homeowners business with the policy force growth. It's part of a bundle. But maybe you can provide us some perspective on how you're able to grow that business considering all the rates you've thrown in that line of business?"
},
{
"speaker": "Tom Wilson",
"content": "I'll start and then Mario can jump in. So first, you're right and Mario called that we're just really good in homeowners. And we've made a lot of money at it. And because we've repositioned the business really over almost a 10-year period, everything from how do we underwrite to what's covered by the policy, to how we price, to our specificity and sophistication and pricing and the way we settle claims. So we're doing quite well there. You see, we are growing. Some of that is, as Mario talked about, our agents are really good at bundling and that leads to better lifetime value for us and cheaper prices for customers. So that's good on both sides. We do think that there's more growth potential there. Some of that is many people, because of the industry numbers that Mario quoted, have now decided not to grow in homeowners. And that gives us more opportunity, not just through the Allstate agents, but in particular through the independent agents. And I think we should be able to crack the code on direct. Nobody's really cracked the code on direct yet in selling homeowners, but I think there's great potential there. So I think there's growth in homeowners across all three channels. Obviously Allstate agents are doing well. The independent agent business, Mario might want to talk about what we're doing with custom 360. And then direct, I think we could be an industry leader. And my logic is, people buy houses off the web. Like if you buy a house off the web, you should buy your homeowners insurance off the web. So we'll have to sort that one out. So we're feeling good about it. I would just -- the other thing I would say is not really yet in market, but coming soon is ASC Affordable Simple Connected Homeowners. Mario has talked about Affordable Simple Connected Auto, which is in market in 25 states."
},
{
"speaker": "Mario Rizzo",
"content": "Yes, 25 states now."
},
{
"speaker": "Tom Wilson",
"content": "And ASC homeowners is even better. And it's got some really nice features to it, sophistication which will leave us behind in our classic product. And our classic product is far ahead of the industry. So we think it's another leap forward. You want to talk about like 360 or how you view homeowners, maybe by state or something?"
},
{
"speaker": "Mario Rizzo",
"content": "Yes. So Greg, again I just reiterate where Tom started. We're really good at homeowners and we think there is a real opportunity for us to grow homeowners in part right now because of the disruption that exists in the market. There's just fewer competitors out there that are wanting to write new business and we want to take advantage of that opportunity. We feel good about where our pricing is. As you mentioned, average premiums have gone up pretty consistently at a double digit clip over the last several years to keep pace with inflation. But when you look at our profit trends and you pointed out our underlying combined ratio which is currently in the low 60s, I think that's reflective of our ability to stay on top of loss trends and write new homeowners business at an attractive margin. We target low 90s which generates really strong returns on capital. We think we can do that and grow the business across all the distribution channels. And I'll just end with the opportunity with Custom360 in the independent agent channel because I think that becomes additive to our Allstate agents and our ability to grow direct in the Allstate brand. We're in I believe 24 states with Custom360. Currently, that's a standard and preferred auto offering along with homeowners that leverages Allstate's data and mid-market capabilities to price and really design that product. So it's intended to be the same product that we go to market with in the Allstate brand. As you can imagine, in the independent agent space we're getting really good traction on our ability to lead with homeowners which enables us to not just write the homeowners but also capture the auto opportunity from a packaged perspective. So we feel really good about the go forward opportunity in the independent agent space, which I think from a National General perspective becomes additive to the great success we've had in growing the nonstandard auto business and is really another way that we can leverage our homeowner capabilities broadly across all three horses, I'll use Tom's term, to really grow that business and generate really attractive returns going forward."
},
{
"speaker": "Tom Wilson",
"content": "And Greg, let me make sure we fully answer your question. Price sensitivity, you referenced the rate of increase and it is high, it's higher than auto insurance right at this point. Not necessarily over the last three years, but pretty high. But that's -- it's just less price sensitive than auto insurance is. There are a whole bunch of reasons. Some of the people like their house a lot. Second, people know their house is actually worth more and so when we're charging more, they know their house is worth more."
},
{
"speaker": "Mario Rizzo",
"content": "Not so much on cars. So, we had to raise auto insurance prices because the houses or the cars became worth. But people didn't really think about it that way. They do think about their home value. So we're comfortable with where we're at."
},
{
"speaker": "Gregory Peters",
"content": "Thanks for the additional information."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Yaron Kinar from Jefferies. Your question please."
},
{
"speaker": "Yaron Kinar",
"content": "Thank you. Good morning. I actually have two on renewal ratios. First, maybe conceptually just looking at the slide eight, as the company grows in nonstandard auto and in direct, two areas where I think, and then correct me if I'm wrong, renewal rates for the industry have tended to be a bit lower. Is it fair to think of a run rate renewal rate that would be a bit lower than the call it through cycle 87.5 or so that I see in the slide?"
},
{
"speaker": "Tom Wilson",
"content": "Insightful question, Mara, you want to take that?"
},
{
"speaker": "Mario Rizzo",
"content": "Yes. The first just to be clear, the numbers you see on the page are Allstate brand. So there's just not that much nonstandard auto. There's more direct, but at least currently, again, not a meaningful impact in the trends. On a go forward basis, I guess, I'd broaden the statement a little bit, Yaron and say, the more new business we write, that first renewal period or the first policy period tends to be lower than the book overall. So the more new business volume we write, there will be some downward pressure on the overall retention rate. Current volumes aren't meaningful enough to really drive a significant impact. But you're right from that perspective. And then certainly in the non-standard auto space, we've seen it with National General as we broaden the risk appetite in the Allstate brand and kind of do the opposite of what we're doing in homeowners, take advantage and leverage National General's non-standard auto capabilities in the Allstate brand that will have an impact on retention. Again, magnitude, we'll have to call that out for you when we see it. But certainly that business tends to retain at lower levels because those customers just tend to shop more. So those things will have an impact on retention going forward. But I would say what you see in Page 8, pretty much a muted impact on those items at this point."
},
{
"speaker": "Yaron Kinar",
"content": "Great. And then just think about the renewal ratio from here on. I think at times you see a little bit of a breakdown of that inverse correlation between rate increases and the renewal ratio. And we saw a little bit of that a bit earlier in this current cycle. Obviously we're seeing that pick up now. But I guess bottom line, is there a bit of a lag currently between the rate increases and the renewal ratio? One that we -- I don't think we was as pronounced in prior years?"
},
{
"speaker": "Mario Rizzo",
"content": "Yes. Yaron, it's Mario, again. There is almost certainly a lag when you think about implementing a rate increase in auto. It takes six months for that to be implemented across the entirety of the book and then you'll earn it over the six months after that. So there is a lag in terms of the rate we've taken or the industry takes and the impact on retention. And you see that in our numbers. One of the things though that I point out is and we've been clear on this. We believe we will need to take less rate given where profitability is. But again, this is a state-by-state, market-by-market business. So when we need to take prices up to keep pace with loss trends, we're going to do that. And what you saw in the third quarter, about 70% of the rate that we took was in three states. It was in New York, New Jersey, and an increase we implemented in Texas. So we're going to continue to take rate where we need to. We just think there's going to be less of it. And again, we'll look to manage retention alongside that."
},
{
"speaker": "Yaron Kinar",
"content": "But I guess what I'm trying to get at here is I think the big rate increases that we saw in the beginning of the year were really first quarter weighted. California, New York, New Jersey. I would have thought that the full impact of those rates taking effect in the first quarter would have been in the second quarter. And by the time we came out of the third quarter, call it August, September, we'd see a little less of that pressure?"
},
{
"speaker": "Mario Rizzo",
"content": "Yes, the California rate was in the first quarter. New York and New Jersey were actually implemented in the third quarter. So -- and I believe it was over 18% in New York and 13.7 or 13.4 in New Jersey. So again, there's some pretty meaningful rates that we've implemented currently, again, to get those markets back to where they need to be from a margin perspective so we can open up to right new business."
},
{
"speaker": "Tom Wilson",
"content": "So, Yaron, I would just say that the leg is muted and it kind of goes up and goes down, right? Like, not everybody shops, the minute they get the price, it's late, they get the bill, they just pay the bill. Then they decide after a couple of months, geez, I should really think about this. So it's not a simple on renewal that happens."
},
{
"speaker": "Yaron Kinar",
"content": "Got it. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Bob Huang from Morgan Stanley. Your question, please."
},
{
"speaker": "Bob Huang",
"content": "Good morning. My question also kind of follows around that line of business. So if we think about your combined ratio and growth, right. In auto, you typically target a mid-90 combined ratio, understanding that pricing has a lagging effect and then retention and growth also does. But if we just look at the combined ratio, is the current level good enough for you to really step on the gas for growth? Or do you feel you probably need a one or two point more on the auto combined ratio side before you're fully comfortable with fully ramping up that growth going forward?"
},
{
"speaker": "Tom Wilson",
"content": "We think that the auto profit improvement plan has been successfully completed. That's why we dialed up advertising by 60% from 2021. That's not just up, that's way up over last year. It's like we're not even in the same zip code. So yes, we spend the money and are investing the money because we think it will -- there are good returns. And there's like things happen in every state. So, Bob, sometimes you got a state, sometimes you back off. Mario's team is constantly doing that. But when you just look in total, we're feeling good about it in total. If you look at a couple of states, yeah, there's still some work to do."
},
{
"speaker": "Bob Huang",
"content": "Okay. That's super helpful. Thank you for that. Second question is around the homeowner side. Understand that you kind of said there are a few competitors now. The technology really makes it easier potentially for homeowner insurance to really grow from here. But isn't it fair to say that the states where there are opportunities, there are also states where people are trying to pull out. So growth, wouldn't that be geography related? Can you maybe talk about what regions do you think is more attractive on the homeowner front or where do you think the opportunity lies in the growth on that space?"
},
{
"speaker": "Tom Wilson",
"content": "So let me go up a minute and then turn it over to Mario. First, we think homeowners is a good business. There is the challenge of increased severe weather and what it does to increase catastrophe losses, which you referenced. Like why go right where there's a bunch of catastrophes? I mean if you can get the right price, its fine. And then you just buy reinsurance for a risk you don't want. And when you look at increased losses from weather related events, there are three drivers. One just more storms and more severe -- mostly more severe storms actually. Two is houses are worth more and three people are building houses in places that are risk. To your other point, those latter two you can know, like those are known knowns. You can factor those into your pricing effect. You can factor those into your growth opportunities. You can factor that into where you try to get new customers. It's the third one. But the third one tends to be the -- is the smallest according to a couple of external studies of the dry attribution on increased catastrophe losses. So the unknown known of what will happen to the severity of storms is the smallest driver of the increase in catastrophe losses. So we feel good about it in total from a macro standpoint. And then we execute it obviously at a not even at a much below a state level. You get east of Sunrise Highway, we get different standards and if you're west of Sunrise Highway on Long Island. So Mario, do you want to talk about where you see growth opportunities?"
},
{
"speaker": "Mario Rizzo",
"content": "Yes. Maybe I'll start with where we don't, because I think it gets to the first part of your question. And two states in particular, Florida and California obviously really challenged homeowner markets that there's been a lot of pullback across the industry. Those are not states that we're looking to get bigger in. So certainly those would not be where we focus our growth efforts and then we'll continue to manage PML and coastal exposure to be within our risk appetite. But then once you kind of get away from that, really the rest of the country, particularly the middle part of the country is -- there's real opportunity for us to continue to grow homeowners. And that's not where you get the hurricanes or necessarily the wildfires. It's more severe weather, tornadoes, hail and so on. And what we found is a lot of competitors have pulled back in those states given severe weather experience. I think that's where our capabilities from a product, a pricing, a risk management perspective really enable us to take advantage of the disruption in the market and grow pretty broadly geographically and not have to kind of grow where, I guess where we can, because nobody else wants it, but actually grow where we think we can generate attractive returns. And that geographically is the vast majority of the country. And again, that's why I think being good at homeowners and having an effective system and operating model to write it and write it profitably is a real competitive advantage for us. And I think you see that in the growth trends really over the course of this year."
},
{
"speaker": "Tom Wilson",
"content": "And I just said, we grew 2.5% from the last year, and we did grow in two giant markets that Mario talked about, which I'm going to guess are 15% to 20% of the homes in the United States. So, we did quite well there."
},
{
"speaker": "Bob Huang",
"content": "Excellent. Really appreciate the answer. Thank you very much."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of [Christian Gitzoff] from Wells Fargo. Your question, please."
},
{
"speaker": "Unidentified Analyst",
"content": "Hi, good morning, Mario. You said a 75% to 80% of your auto premiums are currently open for new business. So is it safe to assume that auto policies grew quarter-over-quarter in those states in the Q3?"
},
{
"speaker": "Mario Rizzo",
"content": "Yes. I won't go into any state specific detail, but what I will say is we're open broadly. The 26% increase in new business that you saw was not concentrated in a handful of states. It was pretty broad as well, but so -- were the retention decline. So really it's a combination of all those things kind of working together. There's markets that grew in total. There's others that did not. But we're focused on having all of them turn positive at some point."
},
{
"speaker": "Unidentified Analyst",
"content": "Got you. And then so with the auto retention being down a point sequentially, and then PIFs were down 50bps, this is auto. Like, is the majority of the declines in those metrics driven by California, New York, New Jersey, just given, like the big rate increases we saw, that were implement, I guess approved in December. They were kind of implemented throughout the year. And then when would you kind of expect in, I guess excluding those three states, right? That PIF improved quarter-over-quarter. Trying to get a sense of how big of a drag those three states have?"
},
{
"speaker": "Tom Wilson",
"content": "Yes. The quarter-over-quarter change in retention, I know came up across a number of reports that came out. Let me just comment on that because there's really two things going on. Some of the decline, probably about 40% of the decline is attributable to a handful of states. It's California as well as New York and New Jersey that are having a meaningful impact quarter-over-quarter. And again that's driven by some of the larger rate increases that we've implemented this year. There's another portion of it that I think reinforces why we made the disclosure change. We did, which is about 60% of that sequential decline in retention is attributed to -- we're migrating some legacy encompass books of business in some reasonably large states to National General. One of those states is California. And what that does is it drags down the Allstate brand renewal ratio. But as those policies -- as those customers opt to take a National General policy, it shows up in National General's numbers. So that's where looking at it by brand is -- I'm sorry, it was insurance. I misspoke. I said encompass, their legacy assurance customers. But that's why looking at it by brand, you just see -- as we operate the business in total with multiple brands, some of those brand metrics get distorted. So we just think it's more constructive to look at the total."
},
{
"speaker": "Mario Rizzo",
"content": "And I think look at the long term number. We're down 2.7 points. We think it should be able to go up from there. So quarter-to-quarter we'll do full attribution on it. We're happy to talk about it. But it's the real drivers who just raise prices a lot, so a lot of people wouldn't shop."
},
{
"speaker": "Unidentified Analyst",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of David Motemaden from Evercore ISI. Your question please."
},
{
"speaker": "David Motemaden",
"content": "Hi, thanks. Good morning. I was wondering if you could just comment on your expectations for the timing of the retention ratio improvements. I know that you mentioned leveling off of rate increases should help retention. So I'm wondering, are you seeing any evidence of that here in October or is it still too early to tell?"
},
{
"speaker": "Tom Wilson",
"content": "First, obviously sooner is better than later. So we're all on it. The whole team's on it. There's a whole bunch of stuff we're doing that Mario mentioned to make it move and you can see benefits in individual states. So we have some pretty large states that it's actually up. So we have confidence that we know how to manage our way through this. But we haven't really done a projection on that. We're comfortable giving to everybody to say here's the number you should count on. What we do know is as Mario pointed out is we expect to grow market share and personal profit liability and that's by doing transformative growth. In the near term we have to get retention up and continue to expand our new business. But then longer term all the work we're doing there is just even more sustainable. So rolling out ASC auto, ASC homeowners, all that work will drive long term growth."
},
{
"speaker": "David Motemaden",
"content": "Got it, thanks. It definitely feels like you guys are pretty confident around just the -- or feel optimistic that the tempering rate increases should help improve that retention. I mean from your standpoint is it really just -- we're sort of just having this timing impact from these three big states that need to just sort of work their way through, and like we're on the cusp here of a turn, or I mean I'm just trying to understand how you guys are thinking about it internally?"
},
{
"speaker": "Tom Wilson",
"content": "We're thinking about we need to do a better job for our customers. So, we're charging them a lot more, they expect more, they deserve more. Some of that's because their cars and stuff and Bob the injury claims are higher, but like we need to do a good job for them. So it's not just oh let's wait this out and not take a bunch of price increases and it'll bounce back. We're actively working on this year alone we have a goal on double-digit millions of improving the customer experience individual transactions. We'll have another goal for next year that will be similar, but different. We're working on how do, we get more precise on the price. So if you're an elderly person, you don't drive much, you should have Milewise you'll cut your price in half. So we're not, we're not, it's not like we just think oh we're through this. I think this is just provide our - we use our operational excellence and capabilities, to go back in now and fine tune the fact that we had to raise prices a lot, so we can keep more customers."
},
{
"speaker": "David Motemaden",
"content": "Great, thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Josh Shanker from Bank of America. Your question, please."
},
{
"speaker": "Josh Shanker",
"content": "Yes, thank you for getting me at the end. Two questions, one whimsical and one numbers. You talked about sort of cracking the code, on how to get people to buy homeowners insurance online. How far away are we from being able to call Allstate and getting into an AI conversation with Dennis Haysbert or Dean Winters that knowledgeable about what you can do to save money, by switching to Allstate and what you can do for your policy?"
},
{
"speaker": "Tom Wilson",
"content": "I love whimsical questions, but I would say that one's probably not whimsical really. We have a - I'd say let's call sales sidekick, which will help people do a better job of interacting with customers. It's going to dramatically change the way that the people interact with other people, which is why Mario was talking about how we have to reposition the off-site agents. It gives us an opportunity to do that at lower cost. So work they had to do before where they couldn't do, or they had lower close rates, because they didn't know some stuff will increase their productivity, and make them even better. So, we're feeling really good about where that might go. And I think, if you look at our web stuff on ASC, that's quite sophisticated too. So Mario, what would you add?"
},
{
"speaker": "Mario Rizzo",
"content": "Yes, the only other thing I'd add, Josh, that makes it not as whimsical as you might think, is we have a lot of data on homeowners, both in terms of customers we've insured in the past and just on the homes across the country in general, which I think facilitates our ability to do what you described, and be really efficient - intelligently being able to price and manage the homeowner risk. So that's the other component I think that gets us and creates the ability to do what you, what you suggested"
},
{
"speaker": "Josh Shanker",
"content": "And then numbers look, ad spend is way up as you look to grow the business. I'm multiplying your number on that buy premium and seeing it up substantially. You also gave us a lot of data around new issued applications, and we can make some guesses around gross new customers. The ad spend is up significantly more than the new customer acquisition. Can you talk a little about what is sensible acquisition cost per customer, how we should think about it. And clearly are you getting the kind of pack on new business that you can make a return over a two or three year period on that investment?"
},
{
"speaker": "Tom Wilson",
"content": "A bunch of questions in this, and let me end on this one first. Advertising is a little bit like driving a car when you first, when you hit the gas pedal it doesn't take off right away. It takes a while to get to 60. So you've seen us do that. We like the performance we see in terms of brand consideration. We like the number of quotes that have gone up, and we like our close rate. So but if you said, did we get back every dollar we spent economically as we're ramping it up? No you, you're kind of investing some for the future. That said, we have highly sophisticated metrics around it and it's both upper and lower funnel. If you break it into upper funnel being, kind of brand image stuff, lower funnel being, I send you, I got a specific lead and I buy that lead and I know you're shopping. So we have highly sophisticated math around that. It continues to be a sophistication game. We think we're pretty good at it. Outside people tell us we're pretty good at it. That said, you can always be better. And when you're spending billions of dollars, you ought to be really good at it. So, we're feeling good about the investment to-date. We think we can continue to spend more, and that will drive economic growth. But if it doesn't, we have the ability to just dial it down whenever we want. It's not really that complicated. So thank you all for this. Our goal, of course, is to increase personal profit, liability and market share, which we talked a lot about today. Also broaden our Protection offerings, well capitalized, we have good shareholder returns, and we look forward to seeing you next quarter."
},
{
"speaker": "Operator",
"content": "Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day."
}
] |
all | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good day, and thank you for standing by. Welcome to Allstate's Second Quarter Earnings Investor Call. [Operator Instructions] As a reminder, please be aware that this call is being recorded. And now, I'd like to introduce your host for today's program, Brent Vandermause, Head of Investor Relations. Please go ahead, sir."
},
{
"speaker": "Brent Vandermause",
"content": "Thank you, Jonathan. Good morning. Welcome to Allstate's second quarter 2024 earnings conference call. Yesterday, following the close of the market, we issued our news release and investor supplement, filed our 10-Q and posted related material on our website at allstateinvestors.com. Our management team will provide perspective on our strategy and an update on our results. After prepared remarks, we will have a question-and-answer session. As noted on the first slide of the presentation, our discussion will contain non-GAAP measures, for which there are reconciliations in the news release and investor supplement and forward-looking statements about Allstate's operations. Allstate's results may differ materially from these statements, so please refer to our 10-K for 2023 and other public documents for information on potential risks. As some of you know, this will be my final earnings call as the leader of our Investor Relations team since I will be transitioning to a new role. Investor Relations will be in the capable hands of Alastair Gobin, who will be a great partner for you all. And now, I'll turn it over to Tom."
},
{
"speaker": "Tom Wilson",
"content": "Well, good morning. Thank you for investing your time at Allstate. I'll provide an overview of results. Mario and Jess will go through operating performance, and then we'll address questions. Let's start on Slide 2. Allstate strategy has two components: increase personal property-liability market share and expand protection provided to customers, which are shown in the two ovals on the left. On the right-hand side, you could see highlights in the second quarter. Net income was $301 million in a quarter with elevated catastrophes. The auto profit improvement plan is being successfully executed. National General continues on a 4-year profitable growth trajectory. The Homeowners business had good results with an improved underlying combined ratio and underwriting profit for the first six months of the year. Net investment income was up almost 17% over the prior year quarter as the fixed income portfolio continues to benefit from repositioning into longer duration and higher yielding assets. Protection Services has had another good quarter led by profitable growth in protection plans. Let's move to Slide 3 and show how that operational execution improved underlying results in the quarter. Revenues increased to $15.7 billion, reflecting higher average property liability earned premiums and that was mostly from rate increases in auto and homeowners insurance and increased net investment income. Net investment income for the second quarter was $712 million higher than the prior year quarter, reflecting that fixed income duration extension in 2022 and 2023. And then which also included lowering public equity holdings to take advantage of higher fixed income yields. Adjusted net income was $429 million or $1.61 per diluted share. Now, I'll turn it over to Mario for Property-Liability results."
},
{
"speaker": "Mario Rizzo",
"content": "Thanks, Tom. I'll start by covering Slide 4. On the top left of the table, you can see Property-Liability earned premiums of $13.3 billion increased 11.9% in the second quarter, driven by higher average premiums. The underwriting loss of $145 million improved by $1.9 billion compared to the prior year quarter due to improved underlying margins and lower catastrophes. The expense ratio of 21.3 was 0.8 points higher than prior year due to increased advertising as we continue to accelerate growth investments in rate adequate states and risk segments. The adjusted expense ratio, which excludes advertising costs and other non-core expenses was down 1.6 points in the quarter. The chart on the right depicts components of the 101.1 combined ratio. Catastrophe losses of $2.1 billion were 6.7 points favorable to the prior year quarter. The underlying combined ratio of 85.3 improved by 7.6 points compared to the prior year quarter with the improvement driven by higher average earned premium and moderating loss cost trends. Prior year reserve re-estimates, excluding catastrophes, had only a minor impact on current quarter results as favorable development in personal auto and homeowners insurance offset increases in personal umbrella liabilities and commercial auto reserves related to the transportation network contracts we began exiting in late 2022. Turning to Slide 5. You can see that we continue to successfully execute our profit improvement plan. The second quarter recorded auto insurance combined ratio of 95.9 improved by 12.4 points compared to the prior year quarter. The bars in the chart show consistent improvement in the quarter underlying combined ratio. I will note that we have adjusted 2022 and 2023 reported quarterly figures to reflect the updated average severity estimates as of the end of each of those years to remove the volatility related to intra-year severity adjustments. You can see that the auto business has seen six sequential quarters of underlying combined ratio improvement with an underlying combined ratio of 93.5 in the second quarter of 2024. The dark blue line in the chart shows how rate increases throughout 2022 and 2023 pushed average premiums above underlying losses and expenses represented by the light blue line starting in the second half of 2023. As average premium increases have outpaced loss and expense profitability has improved. Relative to the prior year quarter, average underlying loss and expense was 5.5% higher, as you can see in the second row of the table. This reflects higher current year incurred severity estimates primarily driven by bodily injury coverage, offset by lower accident frequency as well as higher advertising investments. Physical damage severity increases continue to moderate, while bodily injury continues to trend above inflation. Our claims team is focused on operational actions to mitigate the impact of inflationary trends, including identifying injuries earlier in the claims process to improve overall cycle time and focus on fast and fair resolution. Let's review Homeowners insurance on Slide 6 which had improved underlying performance. Allstate is an industry leader in Homeowners insurance, generating low 90s combined ratios over the last 10 years, as you can see in the chart on the right. This performance compares favorably to the industry, which experienced an underwriting loss and a 103 combined ratio over that same time period. Moving to the table on the left. Allstate Protection homeowners written premium increased by 13.7% compared to prior year, reflecting both higher average gross written premium per policy and policy in force growth of 2.2%. The second quarter combined ratio of 111.5% resulted in $375 million of underwriting losses compared to the $1.3 billion loss in the prior year. The underlying combined ratio of 63.5 improved by 4.1 points due to higher average premium and lower non-catastrophe claim frequency, which more than offset modest increases in non-catastrophe severity. For the first six months of 2024, Homeowners insurance generated an underwriting profit of $189 million. Moving to Slide 7. Let's discuss Transformative Growth our multiyear strategy to create a low-cost digital insurer with broad distribution. The 5 components of Transformative Growth are shown in the blue panels on the left side of the page, and we continue to make good progress on all of them. On the right-hand side, we show the tangible outcomes and proof points that we're delivering through this transformation, which improve the customer experience and support our objective to profitably grow market share over time. Two examples of those tangible outcomes that I'd highlight are the new affordable, simple and connected auto insurance product that was built on our new technology platform is now available in 19 states. And that in the second quarter, we increased our advertising investment by approximately $300 million to support growth efforts in states with attractive returns. Moving to Slide 8. We'll double-click on the multichannel distribution strategy, which enables us to serve customers based on their personal preferences. Our exclusive agents are available for local customers seeking personalized advice to fulfill broad insurance needs. Agency productivity has increased and bundling rates at point of sale are at all-time highs. Enhancements to direct capabilities and increased advertising attract more self-directed customers with new business production in the direct channel in the second quarter, nearly double that of the prior year. The National General acquisition significantly expanded the independent agent channel. If you look at the distribution of new business we write, shown in the pie charts on the bottom of slide, you can see the power of expanded customer access. The combination of broader distribution capabilities, increased advertising greater pricing sophistication and product expansion has resulted in a 90% increase in new business applications since 2020 with a much more balanced split across distribution channels. Now let's turn to Slide 9 to delve deeper into how the National General acquisition has allowed us to better serve customers who prefer to engage with independent agents. The $4 billion acquisition included a number of businesses, including personal auto insurance, group health, individual accident and health, and digital marketing platforms. Prior to the acquisition, we offered insurance in the independent agent channel through both the Allstate and Encompass brands, with the Encompass brand solely dedicated to selling through IAs. With the acquisition of National General, we now go to market in the independent agency channel, primarily through the National General brand. Through the ownership of National General since January of 2021, we have significantly increased the number of customers we protect through independent agents, having added almost 1.7 million policies in force reflecting a compound annual growth rate of 8% in policies over the past four years and bringing premiums written to over $5.1 billion for the first six months of this year. Underwriting margins remain attractive and National General is now one of the largest independent agent personal lines insurers with expansion into lower risk customer segments supporting additional growth going forward in the IA channel. Slide 10 reviews property liability policies in force for all brands. Given the successful execution of the Auto Insurance profit improvement plan, investments in growth will made in Allstate that offer attractive return opportunities. These higher growth investments led to a 17% increase in Personal Auto new business applications in the second quarter, as you can see at the top of the chart on the left. The green bars show the components of that growth in new policy sales. The first two bars reflect the drivers of the 23% increase in new business volume in the Allstate brand. Higher productivity per exclusive agents drove a 9% new business increase compared to prior year and advertising investments and enhancements to direct operations resulted in a 92% increase in the direct channel compared to the prior year. The last two green bars reflect national general growth in both the non-standard auto business and higher sales volume from the Custom360 middle market offering that we continue to roll out. On the right, you can see that total protection auto policies enforced decreased by 1.6% compared to prior year as the Allstate brand decrease was partially offset by growth at National General. Allstate brand auto policies in force decreased by 4.5% compared to prior year as policies lost from customer defections more than offset the increase in new policy sales. Allstate brand auto retention of 85.7 did improve by 0.2 points compared to prior year as the negative impact of large rate increases in 2022 and 2023 continues to moderate. National General growth of 548,000 policies in force offset almost 60% of the Allstate brand decrease. While margin improvement actions have negatively impacted policy growth, the were necessary to mitigate loss cost trends during a period of rapid loss cost inflation. And now I'll turn it over to Jess."
},
{
"speaker": "Jess Merten",
"content": "All right. Thank you, Mario. Slide 11 details profitable growth in Protection Services. In the second quarter, revenues in these businesses increased to $773 million, which was 12.7% higher than the prior year quarter. This result was primarily driven by growth in Allstate Protection Plans. Revenues in our Roadside business decreased 22.7% compared to the prior year quarter, reflecting the impact of exiting a large unprofitable wholesale account. In the table on the right, you will see adjusted net income of $55 million in the second quarter increased $14 million compared to the prior year quarter, with most businesses showing improvements. Profitable growth in Allstate Protection plans resulted in adjusted net income of $41 million, a $10 million increase compared to the prior year quarter as revenue growth and improved claims trends continue to benefit the bottom-line. Slide 12 provides additional insight into the shareholder value created by protection plans. Since acquiring SquareTrade in 2017 for $1.4 billion, this has become a significant growth platform with scale and attractive profitability. Protection Plans provides warranties for a wide range of products, including consumer electronics, computers and tablets, TVs, mobile phones, major appliances and furniture. The power of the Allstate brand has helped to secure partnerships with large retailers in North America. We sell Allstate Protection Plans at point of sale through successful retailers such as Costco, Home Depot, Sam's Club, Target and Walmart, all under the Allstate brand. We're also expanding internationally into Europe and Asia. As you can see from the charts to the right, broad distribution and customer-focused operational execution has resulted in rapid growth in this business. Revenue grown 20% compared to the same 12-month period in 2023, while returns have been strong. Adjusted net income over the last 12 months totaled $139 million and almost $700 million cumulatively since 2017. Now let's shift to Slide 13 to discuss investment results. Result again benefited from active portfolio management that seeks to optimize return per unit of risk across the enterprise. Net investment income, shown in the chart on the left, totaled $712 million in the quarter, which is $102 million above the second quarter of last year. Market-based income of $667 million, which is shown in blue, was $131 million above the prior year quarter as the fixed income portfolio continues to benefit from repositioning into longer duration and higher yielding assets. Performance-based income of $107 million, shown in black, was $20 million below the prior year quarter due to lower real estate investment results. The performance-based portfolio is constructed to enhance long-term returns and volatility on these assets from quarter-to-quarter is expected. On the right, you can see our annualized portfolio return in total and by strategy over a short-term and long-term horizon. The market-based portfolio delivers predictable earnings while the performance-based portfolio enhances risk and return and diversifies the $71 billion investment portfolio. Moving to Slide 14. The Health and Benefits business continues to perform well. Revenues of $620 million increased by $45 million compared to the prior year quarter, driven by premium growth in group and individual health. Adjusted net income of $58 million in the second quarter was slightly higher than the prior year quarter, reflecting increased group health and employee benefits adjusted net income that was partially offset by a decrease in individual health. As a reminder, the decision to pursue a divestiture of these businesses was based on a belief that potential buyers with complementary products and capabilities will unlock value beyond what is achievable by Allstate. The process is progressing well and has confirmed our strategic logic. Slide 15 recaps Allstate strategy in this quarter's results. Auto and Homeowners insurance profitability has improved. National General is profitably growing policies in force. We're accelerating transformative growth to increase auto and homeowners' policies in force. Proactive risk and return management of the investment portfolio continues to generate value. And Protection Plans is expanding with broadened product offerings and distribution. We're confident that this strategy will continue to create value for our shareholders. And with that context, let's open the line for your questions."
},
{
"speaker": "Operator",
"content": "Certainly. And our first question for today comes from the line of Gregory Peters from Raymond James. Your question, please."
},
{
"speaker": "Gregory Peters",
"content": "Good morning, everyone. So for my first question, I'll focus on growth. And Tom, I know you've been talking about transformational growth now for several years. And we're seeing this strong increase in new issued applications. So I'm wondering if you might help us understand how you think that new issued application result is going to drive increased policies in force in the auto stats that we see in some of your supplements."
},
{
"speaker": "Tom Wilson",
"content": "Good morning Greg. Thank you for both being here and paying attention over years, appreciate it. Mario talked about the growth by channel. And we highlighted National General this quarter because it's a $10 billion business on an annual basis. And we feel like the market is really not looking through that one in terms of growth as much. Transformative growth includes what we're doing in National General. But to your point, it really also includes remaking a lot of the business processes inside the Allstate brand. So let me make a couple of comments about that. And give it to Mario to talk about specific things he's doing in various geographies. It's just the most macro view growth driven by two factors, sell more, as you point out and keep more. And so we spent a bunch of time Mario talked about selling more. We feel good about the trajectory there. You can see the benefits of the increased advertising and direct volume Mario talked about. And that also will translate into increased growth in productivity in the Allstate agent channel as we roll it out. So the other question then is, of course, how many do you keep? And retention was up slightly in the quarter versus the prior year quarter. If you kind of look over the last 12 months, it's been reasonably flat in Auto Insurance. I assume you're talking about Auto Insurance, by the way, we can talk about Home as well because I think that's a great opportunity for us. But on Auto Insurance, it's been relatively flat and normally, you would expect as rate increases come down, you would expect retention to increase. It's not clear what that trend will be at this point in time. And the reason I say that is not that I think traditional economics of don't ask me to pay a lot more and more likely to stay breakdown. It's just that the price elasticity curves broke down when we raised prices over the last couple of years. So it's a little hard to tell what the tail on that will be because it's hard to figure out attribution of why did in the face of 33% increase in rates we were able to hold retention pretty well. Some have been -- maybe car people understood the cars worth more, maybe they had a bunch of cash the government gave them. Some of it's competitors were also raising rates. So you can't really do attribution as to why we are where we are. So looking forward, we said it's a little hard to tell exactly what retention will do in the future. I take Senate goes up because we are taking fewer price increases. That's almost -- it's pretty close to one to one in terms of movement retention rate and growth, which is really a good thing, obviously. But we're not waiting around to see what happens there. We're working on improving the customer experience. We have a goal of growing 20 million customer interactions on an annual basis by next year, and we're well along the goal on that. So we're doing a whole bunch of continuous improvement. We've got new tech tools out there, new products, all of which are designed around improving retention and growth. Mario, do you want to talk about specific aspects of growth in terms of states or something?"
},
{
"speaker": "Mario Rizzo",
"content": "Sure. Thanks for the question, Greg. So maybe the place I'd start like Tom said, retention is obviously critically important to growth, and we're pleased with the fact that retention is stabilizing. But we also recognize there's a handful of states that we have taken some pretty significant rate increases more recently, California, New York, New Jersey. Those are going to continue to have an impact on retention going forward. But absent those three states, we kind of like the trends that are emerging. But I want to talk a little bit about new business production and get at your question. So Greg, where I would start would be kind of how did we get here? And the reality is, as we've been implementing the auto profit improvement plan over the past couple of years, that's obviously being executed on a state-by-state, market-by-market basis. But as states have gotten to a rate adequate level, we've begun to lean in and invest more in growth to drive production in those states. And that would include things like unwinding underwriting guidelines to restrict business, increasing advertising spend, both nationally and locally. And as where we sit right now, as I'd say, about two-thirds of our states, the premium volume represented like two-thirds of our states, are what we would consider at profit target levels. And then there's about another 10% or so that are kind of on the path to getting there. So overall, we feel really good about the vast majority of country in terms of geographically where we're comfortable investing. And you see the momentum that's really been building over the course of the year. Last quarter, production was up about 9% in total. This quarter, it was up 17% as we further ramped up growth investments. And we're going to continue to do that. At the same time, you've seen us take less rate, which, as Tom mentioned, helps retention. But we're going to continue to be diligent about staying on top of loss cost trends really broadly across states. And as I mentioned, there are some states that aren't in that growth category right now that we've got to get to target levels of profitability. We're going to continue to focus on taking rates that are necessary there. And when we're successful, those will become additive to the parts of the country where we can invest. So that kind of got us to where we're at in terms of geography and new business and the good news is we're seeing the growth across brands and across channels."
},
{
"speaker": "Gregory Peters",
"content": "Great. I guess in a related question as a follow-up -- my follow-up would be on the expense ratio side. You called out the increased advertising expense in the second quarter. I think it was 3 points of your property liability combined ratio. When we look forward, what kind of expectation do you have about how maybe the adjusted expense ratio is going to move through the balance of this year and sort of what your longer-term objectives are there?"
},
{
"speaker": "Tom Wilson",
"content": "Let me answer that both by first by going up and then coming down a little bit. So Transform Growth had 5 components that Mario walked through. We've -- on each of those, the underlying assumptions between whether that was a good thing to do or not, we've proven out. We haven't -- they all are not working all at the same time right now so that you're seeing the growth we think we can get, which is to increase market share. So we're confident we're going to increase market share in personal property liability. When you get into what's retention next quarter, what happens in new business exporter, we're confident that all of those things will work in the same direction. As it relates to expenses, we think we need to continue. I mean we wanted to affordable simple, connected protection. Affordable means low price. That means we're going to continue to reduce costs. And so we've got a whole bunch of things we're working on now that are -- we've been working on for a couple of years as you point out, that are starting to generate benefits. But we have more to go. Like we don't -- we think there's with the age of digitization and the things we can do in our business, we can still drive cost on. As it relates to advertising, the reason we broke that out separately is that, that does relate to the fact of we don't want people to be to miscommunicate to people that we think taking advertising down and making that lower is a good idea, because we think growth creates value for shareholders as long we're operating at attractive returns. We've got a good set of capabilities there. And I'd be happy to talk about that. If anybody wants to get there, but we're comfortable that we can continue to invest in growth, get good returns, lower expenses at the same time, increased market share, which then will lead to a re-rating of the earnings multiple."
},
{
"speaker": "Gregory Peters",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Jimmy Bhullar from JPMorgan. Your question please."
},
{
"speaker": "Jimmy Bhullar",
"content": "Hi. Good morning. I just had a question on, what you're seeing in terms of competitive trends in the Personal Auto market, both in terms of pricing and advertising. It seems like margins for most of the companies are getting closer to normal. So wondering if that, if you're starting to see some of them, get aggressive on price? I know certainly advertising spending has been going up a lot. But what are you seeing out there?"
},
{
"speaker": "Tom Wilson",
"content": "Let me talk about advertising and Mario, can jump in on pricing. And of course, there's a lot of competitors, but let's focus on the biggest competitors for time being a business is the ones that are mostly in play here. So from a -- as we were just talking about, growth is good for shareholders. It's good, because we're earning good returns. Secondly, we're leveraging capabilities over a broader capital base, which drives more shareholder value creation, and then that should lead to a re-rating other multiple. And then you say, what needs to be true for you to do good advertising and to head into a fight on that one. And first, you got to have a product that's differentiated and appeals to customers. So we have that with our new ASC Auto product. We know it from the close to quote ratios higher with product you've got to have -- you got to be getting attractive returns when we talked about that at length. You got to have a great brand because that increases consideration like if people view the first time people have heard of you your dollar advertisings done is effective, obviously, we a great brand and great consideration. You have to have broad access, and this, ties together with transforming growth. We advertise, you can go to exclusive agent, you can go on our website, you can go to a direct. So you want to make sure that however they want to come to, they had advertising dollars effectively used. Now I would say advertising today, though, is a game of precision, much as Auto Insurance pricing went through this great push on sophistication, those who are good at sophistication win. And you can see that when you look at the combined ratios of people like Allstate Progressive, Geico, we all have really good combined ratios, because we're sophisticated in how we price product. Same thing is true in advertising today. So you have to be good at search. And we don't just listen to ourselves. We had external reviews, and we're really good at search. You have to be good at a bidding strategy. How much you're bidding for Elite? We're good at bidding for Elite. It's not like we're perfect. We got other stuff we need to do. You got figure out how you're using different kind of messaging for different groups. And you can imagine with the refrain of number of media channels, number of messages you can do now, particularly with AI, the number of segments you have, your pricing sophistication, it gets complicated really fast. And we're really good at it. So when we go into this, and we're thinking about us increasing the advertising versus other people, you're like, well, how good are you? And we think we're good at it. If you look at where we are with Arity and our Telematics work, that's to really end run around having more information on who you bid on because we track 15% of the U.S. population they're driving. So we can decide how good a driver you are without even sticking a device on you or an app on your phone or a device in your car. So will competition increase in advertising, probably. Do I -- it will be from those carriers who have the same kind of capabilities we do. So we're fully up to winning that game. I think there will be some other people who hold back or even drop out because they can't -- they don't have the capabilities and expertise to do it. So that's where we are in the advertising, good for shareholders because it's good for growth. And we use the money effectively. Mario, do you want talk about pricing environment?"
},
{
"speaker": "Mario Rizzo",
"content": "Yes. And Jimmy, thanks for the question. I'll answer the question broadly, but I'd put a caveat around it that, obviously, what I'm going to say is going to vary by company and it's going to vary geographically because the business has just operated that way, and there's a lot of competitors in the market. But I would say, by and large, as we discussed this morning and as many of our competitors have reported profitability in auto is improving as loss cost trends have improved. And all of the things being equal, when that happens and margins are better. There's just less rate activity in the system, and that's what we're saying -- companies generally taking less rate than they were over the last couple of years. Again, that will vary by company. Some started later than others and are still catching up. Others are a little further along. But generally, we see less rate getting pushed through. And then certainly, that varies geographically as well. Having said that, I would just take that along with what Tom talked about in terms of advertising and say that when you take the totality of where we're positioned and what we're building with transformative Growth, we like where we're positioned in our ability to be able to increase growth investments and be successful in a competitive marketplace. That's what we're building, and we like our chances."
},
{
"speaker": "Jimmy Bhullar",
"content": "And then just on the benefit sale, we're late in the year, and there hasn't been an announcement, but maybe talk a little bit about how the process is going. And I'm assuming it's probably not going to close this year, but are you still assuming the close within the next few months, even if it drags on to next year?"
},
{
"speaker": "Jess Merten",
"content": "Hi, Jimmy, it's Jess. First, I guess I would start by reminding everyone, the third great businesses. You saw it in the results that I covered. So we're really happy to continue to focus on execution in the operations. It might be helpful if I give you a little bit of a window into the process to help you understand of where we're at and where we're going. So if you think about our process, we started out with a preference for single transaction. But in the same note, we were unwilling to compromise value for that preference, right? So we spent a lot of time with a single transaction buyer that thought they could, in the end, change the terms and/or that we didn't have better options, quite frankly. So we spent a lot of time on a process there, and ultimately, what we decided was to work with other buyers. And that has created a delay in things, it just has. But we're confident that by making that switch, we'll get a better outcome. A better outcome for our shareholders, a better outcome for the businesses. So what I would say right now, and I don't want to get into timing of announcements to close, what I would say is that we're likely to be in a position to announce transactions this year, and you'll get more details about the what and the how, when those announcements come. But that's just a little bit of window into the process and why you still haven't heard anything, if that's helpful."
},
{
"speaker": "Jimmy Bhullar",
"content": "And do you intend to sell a disposal of the entire unit eventually, even if it goes into pieces? Or are there some pieces you might decide to retain?"
},
{
"speaker": "Jess Merte",
"content": "We still intend to make the divestiture of the Health and Benefits segment."
},
{
"speaker": "Jimmy Bhullar",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Bob Huang from Morgan Stanley. Your question please."
},
{
"speaker": "Bob Huang",
"content": "Hi. Good morning. Maybe one on homeowner. I think last year, when it comes to cat losses, severe convective storm was a one in 2018 event, if I remember correctly, which obviously was a headwind to your cat numbers. Just given how things are developing so far, curious how is it tracking this year? Is it going to be more of a worse than one in 2018 event? Just pace on what we have in the first half, curious in terms of like how are the weathers are developing for the Homeowner side."
},
{
"speaker": "Tom Wilson",
"content": "Bob, it's Tom. Thanks for the question on Homeowners. I would look at Homeowners on a longer-term basis than one year. So if you look over the last 11 years, we've made three-quarter of the profit that whole industry has made because we have a pretty sophisticated business model, we've talked about before and be happy to go into, but we're good at homeowners. It's currently turning into a, I guess, what we do domestically, we called the hard market, but a lot of people are bailing on growth in that market because they were either part of the 25% or they were part of the negative amount that led to us every three quarters. So that entire profit pool when we have less than 10% of the total business. So we think that is a great growth opportunity. As it relates to this year, too hard to predict whether. It comes and goes. For the first six months, we made money on an underwriting basis. That makes me feel better than last year, where we didn't make money for the whole year, prior 10 years. We've made money in each of those 10 years. So I feel good about our business model. As it relates to any individual quarter, they're keeping for us is be there for our customers. Like when I got a problem and we're good at getting there fast. We want to be there to take care of their claims. They tell their friends. Our Homeowners as you saw the unit growth is up. It's particularly -- we're doing extremely well in our Allstate agents with bundling customers. So other people are interested in that segment. We're just killing it right now on cross line sales. So we feel good about that. Some of that is the hard market. Some of it's great relationships. Some of it is the product and the pricing we have it all kind of comes together. So we like the business. We think it's got good long-term growth potential. And we -- on a quarterly basis, I wouldn't get too focused on whether it's up or down this second quarter is -- you can decide it's either higher or lower depending on which period of time you wanted to evaluate it against. And so I would just say focus on the long-term results from it."
},
{
"speaker": "Bob Huang",
"content": "Okay. Thanks. My second question, a little bit of a shot in the dark here. For the DOJ lawsuit for National General, there has been precedent where under FIRREA Civil Enforcement Actions, where SEC can potentially get involved under the current litigation environment, do you expect that the National General case should get SEC involved at some point down the road? I'm not sure if that's the question you can answer at this point."
},
{
"speaker": "Tom Wilson",
"content": "Well, we don't give a lot of specifics on active litigation, obviously. And I certainly can't speak for what other people want to do when we have -- I don't know what the SEC will or will not choose to do. What I can give us a little bit of information. This is -- the lawsuit is in reference to a lender-placed insurance program, so that stuff sold through agents. It's focused on auto insurance. Our program was transparent. We borrowers are treated fairly. And we're confident that we will prevail in this and at the lawsuits will have no impact on our ongoing business."
},
{
"speaker": "Bob Huang",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Michael Zaremski from BMO. Your question, please."
},
{
"speaker": "Jack Matten",
"content": "Hi. Good morning. This is Jack on for Mike. Just a follow-up on the advertising spend strategy. I'm curious how your strategy and focus today compares to the last cycle? And more specifically, how much of your ad spend has historically been geared toward direct-to-consumer targeted sales versus supporting your agents? And then how is that evolving today given the success of your transformative growth strategy in your lower expense base?"
},
{
"speaker": "Tom Wilson",
"content": "Jack, I would say that the third component of transformative growth was increase the sophistication and investment in new customer acquisition. We didn't talk about it here much, but we've gotten much more sophisticated versus the last time we did this. But I think other people have too. So I'm not -- like I don't want conclude we're 5 miles ahead of everybody else but we're good. And so we feel much better about our sophistication. The way in which we go through the allocation of investment is think about it as upper and lower funnel, upper funnel being get the brand out there, do some TV advertisements to make sure people are considering you when they're getting insurance. So you'll notice that more advertising on TV. Then there's what we call lower funnel, which is you're on the website, you're cruising around for a new car, and we pop something into your web browsing that says, hey, what about Allstate or we use addressable TV to do it. So there's lots of different ways we try to do, what I would call, lower funnel. And the first one, you do because we are off a little bit for the last couple of years in terms of down in advertising, we've increased our upper funnel some just because we want people to remember there, got a great brand because we've been investing in it forever. It's got great unaided recognition, and we want to keep investing in that. The biggest portion of our increase would be in the lower funnel piece. That gets tightly tied to what Mario described, which is really by state by market, by risk class, and it's highly sophisticated in terms of how we do that. As it relates to both of those upper and lower funnel work for both all of our -- all of the Allstate brand channels, so agents and direct. Our agents also do some of their own lead generation, whether they go to mortgage brokers or other people in their local areas and buy leads. I think there is an area where we need to bring increased sophistication to it because we're just better at doing it globally than you would be if you live it to Boeing or something like that. So there's increased sophistication there. But think of it as a large machine has got a number of different levers we can pull, and we have -- it has got good gauges on it, so we can tell what's coming out on the other end. And so we're constantly turning and dialing those levers and watching the gauges so that we beat our current competition."
},
{
"speaker": "Jack Matten",
"content": "That's helpful. Thank you. And then maybe switching gears to auto loss cost trends. If you look at the average underlying loss you disclosed, it's now running slightly lower compared to 2023. I guess does that mean you're now seeing frequency benefits more than offsetting higher severity. And I'm curious how you view the sustainability of current favorable frequency trends. I know last quarter, you mentioned favorable weather. Just curious how those pieces are moving."
},
{
"speaker": "Tom Wilson",
"content": "Jack, I'll let Mario jump into both frequency and severity and by coverage. I can just say it's nice to have it be about halfway through the call on loss costs and be talking about growth, which is much more optimistic. A year ago that would have been in the first, second and third question. So it's a good question. Mario will go to it, but I'm happy we're talking about growth because we think that's where we're going to create a lot of shareholder value. So Mario over to you."
},
{
"speaker": "Mario Rizzo",
"content": "Sure. Thanks, Jack. I guess the place I'd start is as much as we dig into the components of profitability. They're all important, but we should lose sight of the fact that the way we manage the auto business is to generate mid-90s combined ratios across the entirety of the system. And we use levers like rates and we look at pure premium, whether that's frequency and severity and expenses, they all matter. And certainly, the loss trend helps inform what we need to do with some of the other levers. What I would say, as I mentioned, the negative trend, the negative 0.8% that you see in the supplement as I mentioned in my prepared remarks, there's a little bit of noise in in there terms of year-over-year comparisons because we were moving severity targets around intra-quarter last year. So the adjusted numbers, it's slightly positive, it's about 1%. So not all that different. But I would say it's -- favorable frequency has continued through the first half of the year has been offset by higher severity predominantly in bodily injury, which continues to run above inflation and on the physical damage side, we continue see some good tailwinds with things like used car prices and stabilizing repair costs and so on. But that's kind of the overall loss trend that we're reacting to. In terms of the sustainability of frequency, it's a really difficult question to answer. Things like weather and geography risk segments all come into play. Frequency has been better than it was a year ago. When we look at our telematics data, which gives us a lot of rich information, miles driven per operators up a little bit but trips are shorter. So that could be having an impact on frequency. Weather favorably impacted frequency in the first quarter. And the other thing I'd say is as we've been looking to improve profitability over the last couple of years and not growing, the risk segmentation and the mix of our auto book has shifted around a bit to higher lifetime value, let lower frequency type business, that's having an impact as well. So there's a lot of moving parts in there. One thing I will say is as we go forward and write more new business, that will impact prospective frequency trends, but I'll go back to where I started. We manage the system in its entirety to generate mid-90s combined ratio profitability, and we're going to continue to do that despite however frequency bounces around."
},
{
"speaker": "Jack Matten",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Yaron Kinar from Jefferies. Your question please."
},
{
"speaker": "Yaron Kinar",
"content": "Thank you, good morning. I wanted to go back to growth or continue to focus on growth. I think ever since the Transformative Growth program was announced and launched. Clearly, you've had some issues with COVID and the aftermath of COVID. But now that we're hopefully starting to come out of that transitionary period and all the levers from Transformative Growth are kind of kicking in. Can you maybe help us think through -- I'm not even asking about a one or two-year horizon, but maybe over the cycle, what you think reasonable growth expectations should be on a PIF basis for Allstate. And I say this also in the context of I think we see some of industry leaders in growth, achieving pretty consistent, call it, high -- mid-to-high single-digit growth in PIF. Do you think that you can be at that level?"
},
{
"speaker": "Tom Wilson",
"content": "So we haven't given out a target for PIF growth, but it's the right way to think about it. Because when you're looking at market share, a lot of times, market share is done in the industry by premiums. Also charge, more have fewer customers and presumably could increase your market share on that basis, that's not our goal. Our goal is PIF growth. If you want to assume that, if you said okay, the U.S. economy in terms of number of cars, house and stuff like that, it's going to be a low single-digit increase, I don't know. So 1% there's not going to be a whole bunch of more new cars in houses in the United States. And so obviously, PIF growth has got to be higher than that. And it is higher than that you can see right now in Homeowners because we're winning in that business. When you look at how far up is up, we don't have a limit on that, if you look at National General, which is one of the reasons we called it out, it's got every bit as good a growth as some of those our competitors who get much higher valuations than we do. And it's got really good profitability. So we know how to do it. And the question is how do you translate it into? And what is the timing? We think there's great growth potential here. And that when you put on, just call it, -- if you take 1% for the overall growth in assets in the United States. You put on top of that what would be modest increases in premiums then you should get revenue growth which is above 5%. And so what does that turn into? You can do the math as well as we can. But we think there's great potential here. When you look at other people, we don't think they figured out how to turn lead into gold. They're just really good at what they do. We think we can be every bit, as good in the Allstate brand and growing that business. Particularly now that we've gotten direct, what I would say is improved and unleashed that. And you can see that from Mario's charts on how much new business we're writing there. So we think there's lots of potential, like we're very optimistic, but we don't have -- here's our magic number that we're going to get to. But whatever the number is, it would lead a higher valuation of earnings than we currently have."
},
{
"speaker": "Yaron Kinar",
"content": "Same question. Does the company have reps and warranties insurance associated with the NatGen acquisition that's still in effect?"
},
{
"speaker": "Tom Wilson",
"content": "If you're relating to the DOJ lawsuit, I don't think that will impact what eventually happens. But let me just reiterate, we're really confident in where we are with that claim, we put it that way."
},
{
"speaker": "Yaron Kinar",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of David Motemaden from Evercore ISI. Your question please."
},
{
"speaker": "David Motemaden",
"content": "Hi thanks. Good morning. I was wondering if you could just talk about within the auto underlying loss ratio. If there's any way to size if there was any one time or unsustainable benefit from frequency in there, one of your peers had called out, I think it was a 2.5 point benefit from unsustainable factors the quarter. I wonder if you could give us any insight in terms of, if any, of the improvement was driven by something that is unsustainable within the auto business?"
},
{
"speaker": "Tom Wilson",
"content": "No. Let me give you a little -- I'll give you the summary and then go through Mario you can jump in here front. I don't know how you determine what's sustainable or not sustainable in frequency. Examples, if it -- in the winter, if it snows at 3 p.m., and it's kind of wet and then the temperature drops quickly and it turns the ice by time you get to 5:30 rush hour, a bunch of cars getting accidents. If it snows at 2 a.m., it doesn't matter so much. So I'm not really sure how you -- and that's just one example of the myriad of things that Mario talked about how far are you driving? How often do you drive? How fast you drive? What city driving? Who else drives? Like I don't know how you -- I don't know if they -- I don't know who it was on that remember said that, but I'm not sure how we would be able to with our math and the precision that we were being able to determine what's sustainable or unsustainable. What I would come back to is what Mario said, we price on what it is. So what it is, is what we factor in. Just the frequency goes down in a quarter, we don't suddenly decrease rates. Just like if it goes up in a quarter, we don't suddenly increase rates. We price to get a mid-90s combined ratio in auto insurance, and that's what we'll keep doing."
},
{
"speaker": "David Motemaden",
"content": "Got it. That's helpful. Understood. It is pretty complex to do that. So that's fair. My follow-up question is just on the ad spend? And just I think in the past, you've shown -- I think it was the states that are under a 96 combined. I guess, I'm assuming that clearly went up this quarter. And I guess I'm wondering, are there any states where you're holding back on ad spend? And if so, could you just size how big those are as a percentage of the total book?"
},
{
"speaker": "Tom Wilson",
"content": "I'll let Mario answer the percentage question. I would say in hold back -- I was trying -- think of it as a lever that dialed you turned. Some states were wide open and testing really high levels. Other states were at what we think is appropriate there. So we're constantly managing and testing learning in a live market on how much we bid on stuff. I mean there's just -- it's very sophisticated. So it's not like there's a go or no go level. But there is, to your point, important from a macro standpoint, like how many states you're making money."
},
{
"speaker": "Mario Rizzo",
"content": "Yes. And David, what I'd say -- I'd go back to what I said earlier, as we look at that kind of same mix of states, about two-thirds in terms of premium volume of states are at or below our target combined ratio. And I'd say about another 10% or so are on the path to getting there with rate that we've already approved. I guess there's a handful of states that that we're not leaning in, and that's true beyond just the advertising spend, but it would be around things like underwriting guidelines and so on. As much as we've talked about California, New York, New Jersey. California, we got approval for a 30% rate. We are writing new business across all channels in California. As a matter of fact, we filed an additional 6.9% rate to stay ahead of the loss trend because you don't want to get behind in California. But we are now writing in California, and we're spending some marketing dollars there. The two that on the other side of the country, New York and New Jersey are ones that we're still effectively managing what we write. And we're writing very low volumes of business. Having said that, we've gotten rate approvals in New York. We're in active conversations with the department on a 24% rate that we filed that we hope to get resolution on hopefully reasonably soon. And then we'll revisit that stance. And in New Jersey, we got rate approved at the end of last year. We just implemented another low teens rate in July, and we've got another one coming in December. And as we evaluate where that positions us we'll reassess our risk appetite and how much we want to invest. And I'll go back to saying what I've said multiple times is our objective function is to be able to write in every state. But the reality is we need to see a path to attractive returns and profitability to be able to do that once we get there, then we'll expand our appetite across geographies."
},
{
"speaker": "Tom Wilson",
"content": "I would just add a couple of things. First, I don't think we'll ever be at 100%. But I also that that the high-growth competitors that your competitor, I guess, you're comparing us to, it probably has the same situation. Like not everything goes well in every state in this business. So I can see what people are trying to do. You're trying to triangulate between the gap of a small decrease in auto insurance to what's the increase is going to be and how does that translate into the increase in valuation multiple. Appropriate thing, we're focused on it as well. I would just say that the gap between the current growth and what potential is probably narrower than the gap that between the valuation, like our valuation multiple could be substantially higher even with small moves in the growth rate. You have to decide what you think that's worth and whether you want to pay for it or not. But I think that focusing -- it's not going to be a one-to-one thing, and it's not all going to happen at the same time. But we're confident we can grow like we know how to run this business."
},
{
"speaker": "David Motemaden",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Vikram Gandhi from HSBC. Your question, please. Vikram, you might have your phone on mute. We're still not hearing you. Would you like me to…"
},
{
"speaker": "Tom Wilson",
"content": "Why don't we go to the next question?"
},
{
"speaker": "Operator",
"content": "All right. Our question then comes from the line of Charles Lederer from Citi. Your question please."
},
{
"speaker": "Charles Lederer",
"content": "Hi, can you talk about the new issued app mix on Slide 8, I guess how does your customer appetite differ across channels as you open things back up? And how do you see that impacting your margins given direct tends to have a higher upfront expense ratio as I understand it?"
},
{
"speaker": "Tom Wilson",
"content": "First, I would say we want all customers all locations or most locations, but all risk levels. Mario, do you want to talk about maybe specialist, not general or non-standard."
},
{
"speaker": "Mario Rizzo",
"content": "Yes, Charlie, I'd say from a channel perspective, like in the Allstate brand, we have differentiated pricing between agency and direct. So we have we have the ability to do that to match the cost of doing business in the channel with the price that we charge. In terms of underwriting risk appetite, we write in standard and preferred across the entirety of the risk segment. And if we have the right price in the agent channel, we're right in the agent channel, and we'll also write it indirect. So there's very few exceptions in terms of different underwriting standards across channels. In terms of brands, the one risk segment that I think is new in the sense of we acquired it when we acquired National General is the nonstandard auto business, which historically Allstate really didn't participate in, in a meaningful way. That's a very well-run business. That's the lion's share currently of the nonstandard auto premium, generating really strong growth unit growth just under 12% with really strong profitability. And the one thing I'd say on that segment of business, there tend to be a lot of shoppers in that segment. So you can turn growth on and off a lot more rapidly. You tend to be able to reprice the book pretty quickly because the retention is lower. And I think that's become a real growth lever for us. As you can see in our numbers, we've been able to grow that business grow it profitably because we now have the right capabilities to write in that segment, which we didn't have when we started transformative growth. So but we're -- as Tom mentioned, we're positioned to write across channels, across brand and equally importantly, risk segments through National General in nonstandard Auto. But now, as I've talked about, Custom360 and rolling out middle market standard preferred and homeowner product, we can go upmarket in the independent agent channel as well. But we're positioned to write across the entirety of system."
},
{
"speaker": "Tom Wilson",
"content": "Okay. Thank you all for spending your time with us as we move forward, we'll keep doing what do well, which is to serve our customers. We're going work on accelerating our growth in the profit liability business, making sure we're proactively investing and we didn't have spent a lot of time on that today, but we've had really great results in our investment portfolio. And then expanding protection offerings through great platforms like Protection Plans. Thank you all. We'll see you next quarter."
},
{
"speaker": "Operator",
"content": "Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day."
}
] |
all | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good day, and thank you for standing by. Welcome to Allstate's First Quarter Earnings Investor Call. [Operator Instructions] As a reminder, please be aware that this call is being recorded."
},
{
"speaker": "",
"content": "And now I'd like to introduce your host for today's program, Brent Vandermause, Head of Investor Relations. Please go ahead, sir."
},
{
"speaker": "Brent Vandermause",
"content": "Thank you, Jonathan. Good morning, and welcome to Allstate's First Quarter 2021 Earnings Conference Call. Yesterday, following the close of market, we issued our news release and investor supplement, filed our 10-Q and posted today's presentation, along with our reinsurance update on to our website at allstateinvestors.com. Our management team is here to provide perspective on these results and our strategy. After prepared remarks, we will have a question-and-answer session."
},
{
"speaker": "",
"content": "As noted on the first slide of the presentation, our discussion will contain non-GAAP measures for which there are reconciliations in the news release and investor supplement and forward-looking statements about Allstate's operations. Allstate's results may differ materially from these statements, so please refer to our 10-K for 2023 and other public documents for information on potential risks."
},
{
"speaker": "",
"content": "Before I turn the call over to Tom, I would also like to provide an update on our monthly financial disclosures since early 2022, and implemented rate actions from the prior month have been included in our monthly release and disclosed on our Investor Relations website to provide additional transparency on our proactive response to the rapid rise in loss costs. Going forward, our implemented rate disclosures for auto and homeowners insurance will be disclosed on a quarterly basis instead of monthly within our investor supplement."
},
{
"speaker": "",
"content": "And now I'll turn the call over to Tom."
},
{
"speaker": "Thomas Wilson",
"content": "Good morning. Thank you for investing your time and have interest in explaining why Allstate's such an attractive [indiscernible]. And then Mario and Jesse are going to walk through the operating performance. And then as Brent mentioned, as there we'll have time for Q&A."
},
{
"speaker": "",
"content": "Let's begin on Slide 2. Allstate strategy has 2 components, which is shown on the left there, increased personal property-liability market share and expand protection provided to customers. On the right-hand side, you can see the highlights for the quarter. So we generated net income of $1.2 billion in the first quarter. The profit improvement was broad-based. It reflects successful execution of the auto insurance profit improvement plan, attractive homeowners' insurance margins, and they also benefited from lower catastrophe losses in this quarter."
},
{
"speaker": "",
"content": "Net investment income was up almost 33%, reflecting the 2022 and 2023 repositioning into longer duration, higher fixed income yields and then yields also went up some. And We had good performance-based valuations this quarter as well. Protection Services also had a good quarter, and that was led by Protection Plans and Roadside Services; if you go; down to the bottom, what do we do from here, we have a broad approach to further increase shareholder value."
},
{
"speaker": "",
"content": "First improving auto profitability in underperforming states will increase returns. Secondly, we're focused on increasing policies in force under the Allstate brand while continuing to expand National General. Mario is going to talk about that in a few minutes. Allstate's integrated approach to investing has and will continue to create value for shareholders. Expanding protection services will benefit both our customers and shareholders. And then the sale of the Health and Benefits business to a buyer that can further leverage our success will create more shareholder value. Although I'd point out, it will have a short-term negative impact on return on equity."
},
{
"speaker": "",
"content": "Let's review the broad-based profit improvement on Slide 3. So revenues were $15.3 billion in the first quarter, reflecting a 10.9% increase in Property-Liability earned premium and that, of course, was primarily due to kick rate increases in both auto and homeowners insurance. Over the last 12 months, property-liability written premiums have increased by almost $5 billion on an annual basis. Net investment income in the quarter was $764 million, or $32.9 for the prior year, and that reflects those higher fixed income yields and the duration extension I just mentioned. The strong profitability in the quarter generated adjusted net income of $1.4 billion or $5.13 per diluted share."
},
{
"speaker": "",
"content": "Now let me turn it over to Mario to go through property liability results."
},
{
"speaker": "Mario Rizzo",
"content": "Thanks, Tom. Let's start on Slide 4. Property-Liability earned premium increased 10.9% in the first quarter, driven by higher average premiums. Underwriting income was $89 million, the combined ratio of 93%, which improved by 15.6 points compared to prior year was driven by higher premiums earned, improved underlying loss cost trends, lower catastrophe losses and operating efficiencies. The chart on the right depicts the components of the 93 combined ratio. Lower catastrophe losses of $731 million were 8.8 points favorable to the prior year quarter, reflecting milder winter weather."
},
{
"speaker": "",
"content": "The underlying combined ratio of 86.9% improved by 6.4 points compared to the prior year quarter. The improvement was driven by higher average premium and moderating loss cost increases. Expense reduction programs also benefited results more than offsetting higher advertising spend. Prior year reserve reestimates, excluding catastrophes, had only a small impact on results. Favorable development in personal auto and homeowners insurance largely offset increases in personal umbrella liabilities and commercial auto reserves for the transportation network contracts we began exiting in late 2022."
},
{
"speaker": "",
"content": "Now let's take a closer look at auto insurance profitability on Slide 5. The first quarter recorded auto insurance combined ratio of 96 improved by 8.4 points compared to the prior year quarter, showing that our profit improvement plan is working. The left chart shows quarterly underlying combined ratios. You will remember, we showed this chart last year, which adjusts 2022 and 2023 quarterly reported figures to reflect the updated average severity estimates as of the end of each respective year. As you can see, the underlying combined ratio improved sequentially in each of the last 5 quarters to 95.1% in the first quarter of 2024."
},
{
"speaker": "",
"content": "The chart on the right shows that in the first half of 2023, premium increases in dark blue were being offset by higher underlying losses and expenses. Profits began to improve in the third quarter of 2023 as premiums outpaced loss and expense increases and this continued in this year's first quarter. The slight first quarter drop in underlying loss and expense reflects lower claim frequency that benefited from milder weather and improved operating efficiencies, partially offset by higher severity."
},
{
"speaker": "",
"content": "Relative to the prior year quarter, average underlying loss and expense in the first quarter of 2024 was 6.7% higher as you can see at the top of the table. This reflects higher current year incurred severity estimates, primarily driven by bodily injury coverage, which was partially offset by lower accident frequency and the favorable impact on current year severity of favorable prior year reserve development in the Allstate brand."
},
{
"speaker": "",
"content": "Given the impact that good weather had on frequency in the quarter, favorable frequency may not persist as the year progresses. While auto margins have improved due to our price improvement actions we remain focused on ensuring that rate levels continue to keep pace with underlying cost trends driving improved profitability in those states not yet achieving target margins."
},
{
"speaker": "",
"content": "Slide 6 shows how auto profit improvement supports pursuing policy growth. As shown on the left, Allstate brand implemented rate increases exceeding 16% in both 2022 and 2023. In the first quarter of 2024, we implemented rate increases of 2.4% to keep up with the cost trends and improve margins in states not achieving target margins. The chart on the right depicts the Allstate brand auto proportion of premium in states with an underlying combined ratio of below 96%, shown by the dark blue bars. As more states have achieved target returns, we have started to increase marketing investment, both nationally and in those states. Slide 7 shows that while Allstate brand policies in force decreased compared to prior year, albeit at a slower rate than last quarter, over half that decline was offset by growth at National General."
},
{
"speaker": "",
"content": "On the left, you can see that total protection auto policies in force decreased by 2% and compared to prior year due to a decline of 5.2% in the Allstate brand, reflecting the continued impact of auto insurance profit improvement actions. Underneath this decline is the positive impact of higher Allstate agent productivity and direct channel sales. Customer retention in the Allstate brand also continued to improve, and that improvement has a significant impact on growth trends. Allstate brand auto retention of 86% improved by 0.3 points compared to prior year, as the negative impact of large rate increases in 2022 and 2023 begins to moderate."
},
{
"speaker": "",
"content": "As we discussed last quarter, we received approval for rate increases in the profit challenge states of California, New York and New Jersey, which were affected this quarter. Renewal trends in those states were stable in the first quarter, but the full impact on customer retention had not yet impacted growth. Allstate brand new business also increased 7% versus the prior year, reflecting more advertising and increased Allstate agent productivity and direct sales."
},
{
"speaker": "",
"content": "National General was another positive to growth. Policies in force increased by 12.6% over the prior year due to an increase in nonstandard auto insurance and the continued rollout of a new middle market standard and preferred auto insurance product, also known as Custom360."
},
{
"speaker": "",
"content": "Slide 8 summarizes homeowners insurance profitability, which generated strong returns in the quarter. Homeowners insurance provides a differentiated customer experience and represents an additional growth opportunity across channels. The chart shows the homeowners combined ratio over time, achieving a 10-year average of approximately 92. The first quarter combined ratio of 82.1 translated to $564 million of underwriting income and improved 36.9 points compared to prior year, primarily driven by lower catastrophe losses. The underlying combined ratio of 65.5 also improved by 2.1 points due to higher average premium and lower noncatastrophe claim frequency."
},
{
"speaker": "",
"content": "Allstate Protection homeowners generated double-digit written premium growth compared to prior year, reflecting higher average gross written premium per policy and policies in force growth of 1.4%. Allstate agents continue to bundle auto and homeowners insurance at historically high levels. And National General's Custom360 product offers additional growth opportunities in the independent agent channel. Allstate has created an industry-leading business model, and we remain confident in our ability to generate attractive risk-adjusted returns."
},
{
"speaker": "",
"content": "Moving to Slide 9, let's discuss the property liability growth opportunities. Starting on the first row. Improving customer retention remains key to improving our growth trajectory. Auto retention levels have stabilized and sequentially improved over the last two quarters and homeowners retention improved 0.8 points to the prior year quarter. Our agents and employees continue to guide customers through the renewal process by offering coverage options and ways to save through innovative programs and discounts like Drivewise and Milewise telematics offerings."
},
{
"speaker": "",
"content": "Growth can also be increased by easing new business restrictions. As rate adequacy has been achieved in more states, restrictive underwriting policies have been unwound in states representing more than 75% of Allstate brand auto premium. Increased Allstate brand advertising is also expected to increase growth. The components of transformative growth are being implemented to create sustainable growth. An improved competitive position will result from further expense reductions."
},
{
"speaker": "",
"content": "Expanded customer access comes from increased Allstate agent productivity, enhanced direct distribution and the expansion of Custom360 to more independent agents. A new Allstate brand, affordable, simple and connected auto insurance product is available in 9 states on the direct sales side. Online quote completion time has been reduced by 40% to less than 3 minutes within the new technology ecosystem. This platform will be expanded to the Allstate agent channel this year into more states and homeowners over the next several years. With these growth levers, Allstate is positioned to generate sustainable, profitable growth."
},
{
"speaker": "",
"content": "Now I'll turn it over to Jesse to talk about other operating results."
},
{
"speaker": "Jesse Merten",
"content": "Thank you, Mario. I'm moving to Slide 10, let's discuss the increase in investment income. Before we dig into specifics, let me reiterate that our active portfolio management includes comprehensive monitoring of economic conditions, market opportunities, interest rates and credit spreads by rating, sector and individual names. We seek to optimize return per unit of risk across the enterprise. This approach to portfolio management continued to benefit results in the quarter. Net investment income shown in the chart on the left totaled $764 million in the quarter, which is $189 million above the first quarter of last year."
},
{
"speaker": "",
"content": "Market-based income of $626 million shown in blue was $119 million above the prior year quarter as the fixed income portfolio continues to benefit from repositioning into longer duration and higher yielding assets that have sustainably increased income. Performance-based income of $201 million shown in black was $75 million above the prior year quarter due to higher valuation increases and was above the trend that we have seen in recent quarters but lower than 2022."
},
{
"speaker": "",
"content": "The performance-based portfolio is constructed to enhance long-term returns and volatility on these assets from quarter-to-quarter as expected. Total portfolio return of 0.5% for the quarter and 4.8% for the last 12 months which is shown in the table below the left chart indicates that a balanced approach to risk and return creates shareholder value. The chart on the right shows changes made to the bond portfolio duration in comparison to interest rates over time. Higher income this quarter reflects increases in duration as inter rates rose in 2022 and 2023. The table below the chart shows fixed income portfolio earned yield was 4.1% at quarter end, but 0.7 point increase compared to 3.4% for the prior year quarter."
},
{
"speaker": "",
"content": "Slide 11 breaks down the growth and profit performance of the Protection Service businesses. Revenues in these businesses increased 12.2% to $753 million in the first quarter compared to the prior year quarter. This result is mainly driven by growth in Allstate Protection Plans, which increased 20.5% compared to the prior year quarter, reflecting expanded product breadth and international growth. In the table on the right, you will see adjusted net income of $54 million in the first quarter increased $20 million compared to the prior year quarter. The increase was primarily attributable to 2 businesses. Profitable growth in Allstate Protection plans resulted in adjusted net income of $40 million, representing an increase of $12 million compared to the prior year quarter, higher revenue and improved claims trends benefited the bottom line. Allstate Roadside had adjusted net income of $11 million, driven by increased pricing, improved provider capacity and lower costs."
},
{
"speaker": "",
"content": "Shifting to Slide 12, the Health and Benefits business continued to perform well. For the first quarter of 2024, revenues of $635 million increased by $52 million compared to the prior year quarter, driven by premium growth in individual and group health in addition to higher fees and other revenue in those businesses. Adjusted net income of $56 million in the first quarter was consistent with the prior year quarter as individual health fee income growth was offset by lower employer voluntary benefit income."
},
{
"speaker": "",
"content": "On Slide 13, we'll wrap up our prepared remarks where we started by reiterating Allstate's strategy and opportunities to increase shareholder value; improving auto insurance profitability, pivoting to growing auto and homeowners' policies in force, proactive risk and return management of the investment portfolio, expanding Protection Services and completing the sale of Health and Benefits, which we expect to occur in 2024."
},
{
"speaker": "",
"content": "With that context, let's open up the line for your questions."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] Our first question comes from the line of Jimmy Bhullar from JPMorgan."
},
{
"speaker": "Jamminder Bhullar",
"content": "So my first question was just on your views on PIF growth. And I realize it's going to be challenging in the near term, just given price increases. But with the expense cuts and coming through and once you're done with repricing, do you think that it's reasonable to assume that you'll have positive growth beginning sometime later this year or early next year in the auto business?"
},
{
"speaker": "Thomas Wilson",
"content": "Jimmy, we do believe that it's time to pivot to growth that we has had restrict growth so we could get profitability up in the auto insurance business. We're not done with it yet, but we feel that the trajectory is good and we get a path forward on that. Mario went through the long list of various ways we can do it. First, of course, you just keep more of your existing customers. And then we have a bunch of other ways that we think we can grow new business."
},
{
"speaker": "",
"content": "When that will actually turn by quarter will be dependent on what happens in the marketplace. But it is, we believe, the really great opportunity to increase shareholder value because when you look at our valuation relative to a higher growth company like Progressive, it's -- there's a substantial discount. And we believe that this pivot to growth will drive more shareholder value. Mario, anything you want to add to that?"
},
{
"speaker": "Mario Rizzo",
"content": "No, I think that covers it in. The only thing I'd say is in the Allstate brand, obviously, we continue to see the impacts of the profit improvement plan that we've implemented over the last couple of years. But we're starting to see, as Tom mentioned, some positive signs on retention as well as an uptick in production. And first, we need to see sequential growth before we'll get to annual year-over-year growth. And I think it's important to point out in National General. We continue to see really strong growth in that business, along with really strong profitability that we're encouraged by. And we think there's -- most of that growth in National General is coming in the nonstandard auto insurance business, we think there's an additive opportunity that we're going to continue to go after, as I mentioned, with Custom360. So opportunity across all brands and all channels going forward."
},
{
"speaker": "Jamminder Bhullar",
"content": "And can you talk about progress on the benefit sale? Obviously, from the outside, we haven't seen any movement. But -- and then just how you think about the deployment of the proceeds that come out of that sale?"
},
{
"speaker": "Jesse Merten",
"content": "Jimmy, this is Jesse. So as it relates to the process, I would say things are progressing as expected on the pursuit of the divestiture. You'll remember we announced the intention to pursue the sale about 6 months ago, almost to the day. And as you might expect, there was robust interest from a large group of quality potential buyers on both strategic and financial. So diligence on a large complex business takes some time in so to selecting the right potential buyers to stay involved in the process. At this point, we're pleased with how the process is progressing, and we're confident that we'll be in a position to select a buyer that sees the same potential in the business that we do and is aligned with our strategic rationale for the sale. So we continue to pursue the divestiture as we said. And obviously, we'll let you all know as soon as we have a definitive agreement in place and offer more details at that time."
},
{
"speaker": "Thomas Wilson",
"content": "Jim, let me make a comment about the capital since it came up -- you mentioned that it came up at a number of the analyst write-ups last night. So first, we're very well capitalized. We've made that point consistently over the last couple of years. Obviously, the divestiture of health and benefits would free up additional capital. We're doing it because we believe it's the right way to harvest value, as Jesse pointed out. We think this is a great business that's shown up in the people who have been interested in buying it, but we also think that somebody else could do more with it than we can do with.it."
},
{
"speaker": "",
"content": "When you look at capital utilization, I would say that it's embedded in kind of a like from our strategy to enterprise risk and return to reinsurance to how we price homeowners insurance in a local market. And a couple of things I would say all those decisions are made with math, highly sophisticated math. So sometimes I think that confuses some people when we have more sophisticated math than things like premium surplus ratios."
},
{
"speaker": "",
"content": "But when we do that, we're looking at what the impact is economically and what the impact is on shareholder value. And we look at a really wide range of alternatives. First -- the first best opportunities of organic growth, given the high returns in our auto home protection plan businesses, we get really good returns there. And as I mentioned, we think that will drive increased valuation in the stock without earnings. After that, you said, well, share repurchase, a number of people asked about share repurchases. It's another thing that we look at."
},
{
"speaker": "",
"content": "We've -- as you know, we bought back a lot of stock since we went public we've bought back almost $42 billion worth of stock, which is 83% of shares outstanding. If you look over the last 10 years, it's about half the shares and about $20 billion, you look over 5 years, that's 1/4 of the shares and about $10 billion. So we have no aversion to that. When you say, well, what kind of return do you get on that? Of course, it depends on what price you bought it at and what day you're marking it to market."
},
{
"speaker": "",
"content": "It is low point, it tends to look like cost of capital. Today, it looks like it's in the 10% to 14% range, depending on what period of time we look at. So that's a good return, one that we think benefits shareholders. On the other hand, it's not as good as at which we get from deploying it in those businesses. So deploying getting growth is why we believe that we have a whole bunch of other things we look at. We could increase the equity allocation and investment portfolio."
},
{
"speaker": "",
"content": "As we've told you, we're -- we have a bimodal approach there. About 60% is illiquid. We hang on to over ups and downs and 40%, it's liquid, we're down at the lowest level we've ever been in liquid equity securities. And we did it because we didn't like the risk in return. We're not trying to be a hedge fund, but we thought we had better places to put the money. We could decide we want to dial up there. Sometimes we put opportunity money in new capabilities, Arity."
},
{
"speaker": "",
"content": "If you look at Arity, we've now got 1.5 trillion miles of driving data. We're getting over $1 billion a week. We're expanding that from just pricing people who are our customers to pricing people before they become customers, which makes you be more efficient in marketing and advertising. Sometimes we acquire companies. So if you look at our protection plans business, it's like 10x its size and we bought it for $1.4 billion. We look at National General, we paid $4.1 billion, I think just -- and that's like double its size."
},
{
"speaker": "",
"content": "So we did -- haven't done as well harvesting the value out of our identity protection business yet, but we're confident we got the right pick there that people are at greater risk, recently figure out how to grow it faster and make more money. So we have a whole bunch of opportunities that we look at. So I don't think you should just automatically default to something that falls into an easy analysis if you got the extra money to do share repurchases. No, we'll think about it hard. We'll do the right thing for shareholders, and then we'll make sure we're communicating with people."
},
{
"speaker": "Operator",
"content": "And our next question comes from the line of Andrew Kligerman from TD Cowen."
},
{
"speaker": "Andrew Kligerman",
"content": "Yes, it seems like your PIF growth is right around the corner of pivoting down only 1.4% year-over-year. So I'm wondering on the Allstate brand your expense ratio on advertising was 2.2%. Historically, if I look back at 2017 to '19, it was roughly 2.5%. So is there First question, is there much to go in terms of your ad campaigns? Or do you feel like you're kind of at a level where you need to be?"
},
{
"speaker": "Thomas Wilson",
"content": "I'll let Mario talk about how he's reorganizing the business and really going to market in an integrated fashion to drive growth. As it relates to advertising, we don't like to give those numbers out just because we've got other people out there doing their advertising as well. What I will point out is one of the key components of transformative growth was improving our sophistication of customer acquisition. So no matter what percentage it is we want it to be more effective. But Mario, maybe you should talk about how you're changing your go-to-market."
},
{
"speaker": "Mario Rizzo",
"content": "Yes. Thanks for the question, Andrew. I guess where I start. First, the good news, as we pointed out, in the presentation as more and more states are achieving rate adequacy. And right now, in about 75% of the states we operate in, we've began to unwind underwriting restrictions. And to your point, begin investing in marketing to look to grow."
},
{
"speaker": "",
"content": "The other thing we've done in anticipation of that opportunity, not only being there, but continuing to expand, is we're organizing ourselves in what we call go-to-market teams that are local market focused that are really intended to drive kind of bottoms-up opportunity, identification and capture again, at the local market level so that we can get the highest possible return on things like the marketing investments we're making, the continued expansion, up distribution as well as the growth opportunity that exists across channels in those states."
},
{
"speaker": "",
"content": "So we're early days in that, but we are putting behind our organization structure to be more focused on local market growth. And you remember, we manage this business state by state, market by market. So having local market insight, intelligence and the ability to move rapidly to capture opportunities is really going to be critical. And we think that alongside the expanded investment we're making in growth, will create significant growth opportunity for us going forward."
},
{
"speaker": "Thomas Wilson",
"content": "And we know that it works because we've used it for a long time. So -- and we dismantled some of it about 2 or 3 years ago when we were cutting expenses that didn't want to grow. And now that we're back into growth mode, we're just expanding what we know works."
},
{
"speaker": "Adam Klauber",
"content": "That's very helpful. And then the second question with regard to National General, just trying to get my arms around, how much growth potential there? How much of the book right now is nonstandard versus the Custom360s. The Custom360 relatively very small. And are those the right agents to generate big time growth on the more traditional or more standard products?"
},
{
"speaker": "Thomas Wilson",
"content": "Well, we wouldn't give out that percentage in each, but you're correct. And then it's -- when we bought National General, it was mostly a nonstandard company. And we bought it for the strategic opportunity to leverage our capabilities in, which is called preferred auto and home insurance, and that's turning out to be true. Mario, maybe you want to talk about the success you're having with Custom360."
},
{
"speaker": "Mario Rizzo",
"content": "Yes. So Andrew, I guess the place I'd start is, first of all, we're really happy with the acquisition of National General. As Tom mentioned, we've effectively doubled the size of our independent agent business since we bought it in early 2021. And there's really 3 pieces to the business. There's the nonstandard auto piece, which is the by far the biggest component. And then there's what we call the legacy household business, which is think about our Encompass business that we integrated into it along with the legacy National General Standard Auto, Preferred and home business. And then there's Custom360."
},
{
"speaker": "",
"content": "And Custom360 is the new product offering. We're in about 17 states currently with the intent to expand pretty much into every state by the end of this year or into 2025. And we think that really represents an additive growth opportunity. The product offering itself is built on the Allstate product chassis. So think about the sophisticated rating plans that we have in standard and preferred auto in Allstate, the host and home product that we have in Allstate."
},
{
"speaker": "",
"content": "So those are the products that we're launching in the independent agent channel. And really, to your point, there's a different distribution, a different segment of the independent agent distribution system that we're looking to engage with to really grow that product portfolio. We're early stages. As I said, we're in 17 states. We're really encouraged by the early growth that we're seeing in the states that we've rolled out and more importantly, the agency engagement we're seeing on the IA side. We're going to continue to look to expand on that and leverage that going forward, but we're really optimistic around Custom360 and the opportunity beyond nonstandard auto and the IA channel."
},
{
"speaker": "Operator",
"content": "And our next question comes from the line of Gregory Peters from Raymond James."
},
{
"speaker": "Charles Peters",
"content": "So for the first question, I'd like to just have you comment on both frequency and severity, frequency trends through the first quarter and sort of how you're thinking about severity for 2024, both inside the Allstate brand and also at NatGen."
},
{
"speaker": "Mario Rizzo",
"content": "Thanks, Greg. This is Mario. I'm going to make some comments off the slide -- off of Slide 5 that we showed you in the presentation, which really shows the -- starts with the average underlying loss and expense trend that we saw in the quarter. That number is about 6.7%. If you take out the expense component, it drops by over 1 point. So I'd say the loss trend we're seeing in the protection business in the mid-5s, and that's made up of both frequency and severity. As we indicated, frequency relative to last year, just given the milder weather was favorable. And then the other component of it is severity. So it's, I'd say, favorable frequency more than offset by higher severity. But severity is continuing to moderate in terms of the rate of increase that we're seeing."
},
{
"speaker": "",
"content": "Maybe a little bit of color underneath severity broadly because really, there's 2 different emerging stories both in physical damage and in injury. And physical damage, we continue to see the benefit of things like lower used car prices. Total loss severity continues to drop. But it continues to cost more to fixed cars, and that's made up of continually increasing parts prices and labor costs. So we've seen increasing severity and physical damage repairable -- for repairable vehicles, but not at the same rate we have been seeing before. That has moderated."
},
{
"speaker": "",
"content": "The real ongoing severity pressure is in beyond the injury side, which continues to run at higher than historical levels. That's driven by a lot of the things we've been talking about, medical treatments, medical consumption, inflation. It's also being driven by the fact that more of our customers continue to get sued and attorney representation levels continue to increase and that's putting pressure on severity. It's also resulting in higher cost for consumers ultimately. The cost to settle injury claims going up at the level that it is translating into higher insurance prices for consumers."
},
{
"speaker": "",
"content": "I'd point out a state like Florida, where last year, they passed meaningful tort reform, and we're starting to see some positive impacts of that tort reform, which I think will bode well for consumers going forward."
},
{
"speaker": "",
"content": "Georgia just -- the Georgia legislature just passed some tort reform, which, again, can be a positive for consumers going forward. And obviously, we're a strong proponent of that kind of reform broadening across more states going forward. But Greg, to your question, positive frequency in the quarter, hard to quantify with any degree of precision what the weather was worth, but it was favorable, offset with severity levels that are running lower than they have been running, but still at positive levels, which is why we're going to stay on top of pricing to make sure that our rates fully reflect loss trends and keep pace with loss trends in the states that we've reopened for growth and continue to pursue rates in states where we haven't achieved target profitability yet. And that would be true both in the Allstate brand and National General."
},
{
"speaker": "Charles Peters",
"content": "I guess in conjunction with that answer, you brought up rate. And I know you mentioned that you're not going to provide us updates on pricing going forward because you're rate adequate. I know -- if you go back to previous presentations, you've called out 3 states. And even after you reported fourth quarter, you still were I think New Jersey and New York were kind of still in the question mark period. Has there been some updates there in those 2 states that you want to give us that leads you to believe that they are rate adequate now too as well?"
},
{
"speaker": "Thomas Wilson",
"content": "I'll let Mario go into the 3 states, but I just want to clarify. We decided not to give it to you every month because -- we don't -- we think you get to drill, you know what we're doing, and we don't need to do it. We didn't say we're very adequate so don't worry about it. We're always focused on it. We just didn't think we needed to like burden people sending out every month."
},
{
"speaker": "Mario Rizzo",
"content": "Yes, Greg, it's Mario. I'll just give you a little more color on those 3 states. Remember, last quarter, we told you we had just got an approval in the fourth quarter for auto rate increases in all 3 of those states. In California -- and we implemented those rate increases this past quarter. In California, we feel comfortable of where the rate level is with the increase, and we've reopened California for new business. really no change in New York and New Jersey in terms of our underwriting risk appetite, even with the rate approvals that we got late last year."
},
{
"speaker": "",
"content": "We still don't feel like we're at the appropriate rate level to want to grow in those two states. The only update I'd give you on one of the states is, New Jersey recently approved a 13.9% auto rate increase, which was one of the filings we had pending. That will be effective in the second half of this year. We're still going to need more rate beyond that before we would look to reopen that market. And in New York, we're having ongoing conversations around a pending rate that's with the department, but really nothing new to report at this point. And in those two states, in particular, we have not lifted any of the underwriting restrictions that we have in place."
},
{
"speaker": "Operator",
"content": "And our next question comes from the line of Bob Jian Huang from Morgan Stanley."
},
{
"speaker": "Jian Huang",
"content": "Maybe just going back to the PIF growth and rates -- for Slide 6, if we look at the states that are above 96% combined ratio, I know that you talked about New York, New Jersey, California, but are there any other reasonably large states where you continue to need rates? And in those states, are you -- like comparing to your peers, is your loss ratio significantly above everyone else? Or in other words, if you were to raise rates in those states, do the customers have anywhere else to go?"
},
{
"speaker": "Thomas Wilson",
"content": "Well, that's a complicated question. Let's see if I can address it. So in all states, when you have severities going up the way Mario described it. You're going to be increasing rates at levels above what is the general inflation rate. So we expect to continue to have to do that. If our customers quick and sued every time they get an access, then maybe it will back off some. But -- so we're always moving rate up. You're really get into where is your competitive position."
},
{
"speaker": "",
"content": "And I think it's difficult right now to determine where one's competitive position is in any individual state given how rapidly rates are moving and how they're moving through books of business, given how -- and so that said, we're confident that with transformative growth by reducing our expenses will end up in a lower cost, more competitive position than when we started this 4 years ago whatever place. It's just this blip in here where everyone is raising prices a lot, including us, as Mario pointed out, in auto alone, it was 16% in each of the last 2 years."
},
{
"speaker": "",
"content": "Homeowners is not -- it's slightly lower, but also has the same trends to it. So -- we feel confident that the product offering we have, the technology we have, the agents we have, the broad set of distribution that will enable us to grow. Price is clearly an important part of that. And we're focused on making sure we're competitive, but we're not going to not take rate so that we can grow. One of our big competitors, State Farm's picked up almost a couple of points of market share over the last couple of years because they chose to run fairly large underwriting losses that won't be us."
},
{
"speaker": "Jian Huang",
"content": "Okay. That's very helpful. But just curious, are there any other relatively large states outside of New York, New Jersey, California, where you still need rate at this point in time?"
},
{
"speaker": "Mario Rizzo",
"content": "No. Like if you go back to Page 6 that you mentioned that the top bar on the right, the 26%, the vast majority of that is those 3 states: California, New York and New Jersey. And then the -- both the light blue and the dark blue, when you kind of add those together, and we talked about unwinding underwriting restrictions in about 3/4 of the states. Again, we base those decisions on rate adequacy versus kind of a backward-looking combined ratio."
},
{
"speaker": "",
"content": "And we feel good about where we're positioned the growth opportunity, and as we said a couple of times, we're going to stay on top of the loss trend in those states. But the states that are in that top section are the ones that we're going to continue to push incremental rate through because we're not at target margins yet."
},
{
"speaker": "Operator",
"content": "And our next question comes from the line of Elyse Greenspan from Wells Fargo."
},
{
"speaker": "Elyse Greenspan",
"content": "My first question is on the auto. I guess it's more on the underlying loss ratio. I thought in the past, right, the first quarter would seasonally be a better quarter for just an auto book in general, but understanding rate increases that can earn in can kind of mask that as we go through the year. And then I'm also not sure if there was maybe some favorable non-cat weather in the Q1 numbers. So just can you give us a sense of the cadence would you expect on the underlying loss ratio within auto to improve as we go through the year given the rate to earn in? Or is there some seasonality or other factors that we need to consider?"
},
{
"speaker": "Thomas Wilson",
"content": "Let me start, and Mario, you can jump in. First, you're correct in that first quarter is usually a better quarter in combined ratio in auto insurance than like the summer months when everybody is driving. To be able to do attribution of this current quarter versus other quarters and weather and how much -- what the sustainable [indiscernible] is really difficult to get it with any sort of precision. It's not that we don't try and we look at it when we come up with numbers, but they're not numbers that I would say would be for public consumption."
},
{
"speaker": "",
"content": "What I would say is we feel really good about the trend in auto insurance profitability. As you point out, we got a lot more rates still coming through. We've gotten good control over our expenses. We're working hard on claims to try to deal with a high inflationary environment. Make, sure we keep costs down and not just accept that they have to go up at high single digits. So we feel really good about the trend, at least I don't know that I feel like one quarter makes a trend in that, I would say, this first quarter x percent was due to just some [indiscernible]. Mario, anything you would add to that?"
},
{
"speaker": "Mario Rizzo",
"content": "Yes. I think, Elyse, the components you mentioned are the right ones. And while I can't -- I'm not going to give you the guidance on continually improving loss ratio going forward. What we do know are a handful of things. Number one, we took over 16 points of rate last year and another 2.4 points in the first quarter. That's going to continue to earn through the book, and you're going to continue to see average earned premium growth going forward. That's just based on the actions we've taken so far."
},
{
"speaker": "",
"content": "I talked a little bit about the loss trend earlier and where that was running -- we'll see how that plays out over the duration of the year. The only other piece I'd give you is the frequency component of that, there clearly is a weather benefit we got difficult to quantify. So the frequency benefit may or may not persist going forward. That would be the only thing in addition to just the Q1 seasonality that exists. But we feel good about where the earned premium trend is going and then we're obviously going to watch both components of the loss trend, and we're going to continue to push hard on expenses to drive cost out of the system, which will also help from a margin perspective."
},
{
"speaker": "Elyse Greenspan",
"content": "And then my second question, going back to earlier comments on the Health and Benefits transaction, is your plan still to expect to announce and close the transaction this year? And then I think based on your comments to a prior question, you implied right, that there was conversations with parties. It sounds like you're going down the route of one counterparty instead of perhaps maybe multiple. But can you just confirm, I guess, that that's the thought as well just to find one counterparty to buy the entirety of the business?"
},
{
"speaker": "Jesse Merten",
"content": "It's a normal process, Elyse. We're not going to go through [indiscernible] it. We still think we'll sell it this year. A lot of people are interested in the business, and we're confident we made the right choice."
},
{
"speaker": "Operator",
"content": "And our next question comes from the line of Yaron Kinar from Jefferies."
},
{
"speaker": "Yaron Kinar",
"content": "Most of my questions have been asked, but I did want to dig a little deeper into NatGen, if I could, in the PIF growth there. So I understand you have the Custom360 that should drive further growth. At the same time, we also see maybe some competitive pressures rising in nonstandard auto, which may actually result in a little bit of a decrease in that segment's growth? Maybe you can help us think through the two combined."
},
{
"speaker": "Thomas Wilson",
"content": "I'll let Mario jump in, I know you're probably referring to Klauber's numbers. I'll let Mario jump in on state. But let me just mentioned something, I think kind of we talk about, but I'm not sure if it gets as much focus as I think it should, which is homeowners. The homeowners business is a really attractive business for us. We're really good at it. We have an integrated business model that you can see Mario showed the slide where we've earned a 92 combined ratio over a 10-year period. The industry dynamics today. A lot of that business is sold through independent agents, about half of it."
},
{
"speaker": "",
"content": "And industry dynamics are right for us to leverage that position. There's a great interest in independent agents and having what they call markets or we would call availability. And when you look at why that is, this is -- the first customer risks are increasing, right, whether that's inflation in home values, whether it's demographic trends, people moving in the way of where there's severe weather or just increased severe weather. So there's increased need for risks. And then at the same time, the industry has lost money."
},
{
"speaker": "",
"content": "So the industry lost money over the last 3 years, last 5 years, over the last 10 years, it made money but we made about 3/4 of that money. So the industry made about $10 billion over a 10-year period, and we made about 75% of that. So we're really good at it. And so we think that one of the ways to grow there is in the independent agent channel is by leveraging our homeowners. So we obviously can grow in homeowners in the Allstate agent channel. You see that our bundling stuff, whether you look at any of the industry reports, we're really good at bundling there."
},
{
"speaker": "",
"content": "And you see the PIF growth there even when auto growth is going down, which wasn't always the case. They used to trend more together, but we've got so much better at bundling. So that's -- I don't want to leave homeowners on the cutting-room floor, as it relates to growth, both in the National General channel and the Allstate channel. Mario, do you want to talk about that."
},
{
"speaker": "Mario Rizzo",
"content": "Yes. Thanks for the question, Yaron. Look, where I start is the National General nonstandard auto business is a really well-run business for us. And when we acquired NatGen several years ago, it allowed us to get into a business that Allstate was not in at that time in a particularly meaningful way. And we've been able to grow that pretty aggressively and grow it profitably. Over the last several years. Some of the ways we've been able to expand is we've expanded geographically, so we're in a lot more states with nonstandard auto now than when we bought the business."
},
{
"speaker": "",
"content": "We've also expanded from a channel perspective, we allow Allstate agents to sell nonstandard auto through National General for business that's outside of Allstate's risk appetite. We sell it direct to consumer. So we've been able to expand the business, both geographically as well as across channels."
},
{
"speaker": "",
"content": "And the business has been subject to the same inflationary pressures that the standard and preferred auto business has been subject to. But we've stayed on top of rate need. We've taken a lot of rate over the last couple of years, I believe, over 15 points in the last 12 months. So we've stayed on top of the rate need. It's a business that you can effectively reprice most of the book almost every policy period, just given the deflection rates. And we've been able to, over the last couple of years, take advantage of the competitive dislocation in nonstandard auto as a number of carriers have backed off from that business."
},
{
"speaker": "",
"content": "We've taken advantage of that opportunity and taking advantage of by leveraging our capabilities in that space. And as much as the competition might be heating up there, we feel really good about our capabilities, and we're going to continue to look to grow that business as well as the standard preferred and homeowners that Tom talked about with Custom360."
},
{
"speaker": "Operator",
"content": "And our next question comes from the line of David Motemaden from Evercore ISI."
},
{
"speaker": "David Motemaden",
"content": "I had a question just on the brand auto PIF. So the brand auto PIF was down about 1.5% compared to the fourth quarter. And I guess I'm wondering how. And now is for the entire book, the entire brand auto book. I guess I'm wondering how that PIF growth trended versus the fourth quarter in the 64% of the book that is at target margins that you showed on Slide 6, are you guys growing PIF in that part of the book?"
},
{
"speaker": "Thomas Wilson",
"content": "We wouldn't break those numbers out for competitive reasons. When it's big enough, so David, you could do math on it. So you could say, okay, here's when the churn is going to come. We would say it. But obviously, there are some markets, we're growing in other markets, we're not growing in. Some of those are markets. Some of those are states. When we get to the point where you can do the math to show when -- I know you -- I totally get where you're going because you want to figure out when the turn is. But we don't like to show what states were growing in at higher rates than others because then they get our competitors interested in going to those states. And we'd rather grow without having them be aware of where we're growing."
},
{
"speaker": "David Motemaden",
"content": "No, understood. It was worth a shot anyway. Just another question, just on the agent productivity. You gave some interesting stats last quarter that agent productivity was up 6% excluding California, New York, New Jersey. I'm just wondering how the productivity looked this quarter. Did that improve significantly? Or just how to think about that as a potential growth driver?"
},
{
"speaker": "Thomas Wilson",
"content": "Let me go up to transformative growth and get Mario to talk about the specifics of your question. So as part of transformative growth, we said we want to improve customer value. And that meant getting our agents to really focus on there were those things that customers really want them to do for them, which includes helping them buy insurance. It doesn't necessarily include having them there when they have to pay a bill for retention."
},
{
"speaker": "",
"content": "They will pay for that, but they won't pay as much as they will for when they get to new business. So we shifted our compensation program to move to lower our cost for customers and better align it with what customers want to pay for. As a result of that, we both lowered distribution expense and we've had some agents who had the word -- had built business models on higher retention [indiscernible]. So our overall agent capacity in the Allstate brand has gone down. That said, to your point, productivity has gone up, and so our overall volume has been even better when you adjust for those 3 states that are not to be named. So Mario, do you want to go there?"
},
{
"speaker": "Mario Rizzo",
"content": "Yes. Thanks for the question. So I think the short answer to your question is yes. We -- when you look at overall Allstate brand new business production is up about 6.5%. It was up both in the Allstate exclusive agent channel as well as direct. And then if you kind of carve out California, New York and New Jersey. Because you have to remember, the California rate wasn't effective until February. So we really didn't start opening things back up until the really the latter part of the quarter."
},
{
"speaker": "",
"content": "We're really pleased with how our agents are responding to the changes we've made that Tom talked about continue to invest in their businesses, continuing to drive higher levels of average productivity. And despite the fact that we have fewer agents and have restricted -- or have been restricting grown in 3 pretty significant states."
},
{
"speaker": "",
"content": "Overall productivity is increasing and absolute production is up. So we're really happy with the productivity levels of our agents. And as we look to accelerate growth going forward, they're going to be a core part of how we grow prospectively in addition to things we've been talking about with independent agents and the direct channel."
},
{
"speaker": "Brent Vandermause",
"content": "We'll take one more question."
},
{
"speaker": "Operator",
"content": "Certainly. And our final question for today comes from the line of Mike Zaremski from BMO."
},
{
"speaker": "Michael Zaremski",
"content": "I guess just I know there's been a lot of talk about growth. And the strategy has been clear you guys have successfully kind of transformed your expense ratio lower, which should help grow direct-to-consumer channel specifically. And I know Allstate has a ton of marketing expertise. But I'm just kind of curious, the direct-to-consumer -- customer, my understanding is a bit different than the average current Allstate customer. So is there -- are there any different strategies or maybe you kind of -- or just go slow to learn as you kind of grow into DC? Or anything you'd like to -- you think we should be thinking about there?"
},
{
"speaker": "Thomas Wilson",
"content": "Yes. The first -- the direct customer does have different needs. So they necessarily want to pay for someone to help them buy insurance, which is why we price our direct insurance under the Allstate brand, cheaper than Allstate-branded insurance bought through an agent. Because we're trying to do exactly what our customers want. They also have different ways they want to interact with us. And so we've -- with our new Transformer growth and new tech stack, it's really everything from what's prepopulated into the thing to the offers it presents to the questions you required to."
},
{
"speaker": "",
"content": "As Mario talked about, we're down 40% in the time. We've been able to add other products to that flow and so increase things like roadside services and sell more products, which lowers our acquisition costs. So it is different. We're good at it, we could be better at it. And so we're working at getting better at it. About 2 years ago, we really reformed the business, put some new leadership in place and then are updating everything from the technology I talked about to also who you market to."
},
{
"speaker": "",
"content": "So you mentioned they're direct, but some of the customers directly, that's where you go to. Like if you go to people who are shopping all time, then you will get higher risk drivers because they shop all the time as opposed to lower risk drivers don't shop as much. So it costs more to get the lower risk drivers on board. So we're working through how do we expand that. We believe that the direct channel has tremendous upside with us to serve those customers who want it that way not just on auto insurance, but things like home insurance and whether it's protection plans or what we're doing in. We get some stuff going on in the commercial space with direct."
},
{
"speaker": "",
"content": "So we think it's just another way the customer would interact. Often -- not a lot of homeowners is sold over direct. We'll see how successful we are. I believe we can. I mean, people buy houses direct. So like if your buyouts or probably buy a home insurance from us. And so there's a great upside. You will notice that when you look over the last couple of years, One of the first places we dialed down new business was in the direct channel. So it was down like 50% or 60%, I think in '23 or something."
},
{
"speaker": "",
"content": "Because we wanted to make sure we maintained our agent force levels of compensation because they have businesses right and this is the revenue that comes into their business. We said, okay, well, this is a temporary window it's easier for us to concentrate that reduction in new business in the direct channel than it is to spread it amongst a bunch of agents who are now also trying to get through a new comp plan. That turned out to be a good choice. It gave us the opportunity to build new capabilities. And now we're hitting the gas side expanding direct. So you should expect to see our direct volume is go up higher as a percentage of new business than it has better in the past. Thank you all for joining us and investing your time in Allstate. We'll talk to you next quarter."
},
{
"speaker": "Operator",
"content": "This concludes the investor call. You can now disconnect. Good day."
}
] |
alle | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Good morning and welcome to the Allegion Fourth Quarter 2024 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Josh Pokrzywinski, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Josh Pokrzywinski",
"content": "Thank you, Drew. Good morning, everyone. Thank you for joining us for Allegion's fourth quarter 2024 earnings call. With me today are John Stone, President and Chief Executive Officer; and Mike Wagnes, Senior Vice President and Chief Financial Officer of Allegion. Our earnings release, which was issued earlier this morning and the presentation, which we will refer to in today's call, are available on our website at investor.allegion.com. This call will be recorded and archived on our website. Please go to Slide 2. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the Safe Harbor Provisions of Federal Securities Law. Please see our most recent SEC filings for a description of some of the factors that may cause actual results to differ materially from our projections. The company assumes no obligation to update these forward-looking statements. Today's presentation and commentary include non-GAAP financial measures. Please refer to the reconciliation in the financial tables of our press release for further details. Please go to Slide 3 and I'll turn the call over to John."
},
{
"speaker": "John Stone",
"content": "Thanks, Josh. Good morning, everyone. Thanks for joining us. Q4 marked the end to another solid year of growth and strong execution by the entire Allegion team. We've demonstrated the resilience of our business model, expanded our industry leading margins, and accelerated capital deployment to invest in our business and return cash to shareholders. I'm pleased with the topline growth in the fourth quarter and 2024 as a whole, especially in the Americas, where we've delivered mid-single-digit growth for the past three quarters as comparisons have normalized. Over the past year, we have primed the portfolio and the organization to grow faster, especially as our business continues to benefit from the stability of our institutional base. We accelerated capital deployment in 2024, returning cash to shareholders and growing our business with accretive tuck-in acquisitions. Our strong cash generation, balance sheet, and pipeline of opportunities continue to position us well for future capital deployment to create long-term value for our shareholders. We're encouraged by trends in our Americas non-residential business exiting 2024 and we'll share some additional market perspectives when we discuss 2025 outlook later in the call. Please go to Slide 4. Let's take a look at capital allocation for the full year. Allegion marked 2024 with meaningful product launches that demonstrate our deep customer understanding and the strength of our R&D effort and market leading brands. Throughout the year, you heard us speak to a few of these, the Schlage XE360 series, our next-generation commercial electronic lock family that supports the latest credential technologies across multifamily and commercial markets. Schlage's new Smart Lock integration with Airbnb, which was yet another industry first for our company, and the Schlage Indication Solutions, a best-in-class lock portfolio that allows users to more easily see the locked or unlocked status of a door, specifically designed with K-12 school security in mind. Lastly, the Von Duprin 70 series, a new product line that's leveraging more than a century of expertise in developing high-performance exit devices to meet the safe entry and egress needs of customers today. We're very proud of these and many others that you may have also heard about. SimonsVoss in Germany launched AX2Go, supporting mobile, smartphone-based credentials across both iOS and Android phones. And notably in Q4, Allegion became the first security solutions provider to support mobile credentials on Wear OS by Google smartwatches. Look for more announcements like these in 2025 as Allegion continues to build on our legacy and invest for organic growth. Allegion executed M&A amounting to $137 million in 2024, this included five bolt-on acquisitions spanning our core markets. In Allegion International, we added Boss Doors and Dorcas to our portfolio, expanding how we go to market and expanding our electromechanical product portfolio. In the Americas, we added Krieger Specialty Products, Unicel Architectural, and SOSS Door Hardware, which increased the breadth of highly profitable specialty offerings in our non-residential portfolio. All of these are leveraging Allegion's strengths like spec writing capability and expertise, our manufacturing distribution scale, and strong customer relationships. We're very pleased with the accretive returns they bring to Allegion. We continue to see opportunity to grow inorganically in 2025 and have entered the year with a very active pipeline. This was recently marked by our acquisition of the Next Door Company in the United States and the announcement of our intent to acquire Lemaar in Australia. We'll share more on both of these bolt-on acquisitions in our Q1 call. Allegion continues to be a dividend paying stock and earlier this month, we announced our 11th consecutive increase to our dividend. As we've shared before, you can expect our dividends to grow commensurate with earnings over the long-term. Lastly, we made share repurchases in the year amounting to approximately $220 million. We remain committed to balanced, consistent capital allocation with a clear priority of investing for growth. We have an active pipeline that complements our core mechanical and electronics portfolio and leverages our channel strengths. I look forward to updating you as we progress through the year. Mike will now walk you through the fourth quarter financial results."
},
{
"speaker": "Mike Wagnes",
"content": "Thanks, John, and good morning, everyone. Thank you for joining today's call. Please go to Slide number 5. As John shared, our Q4 results reflect solid performance from the Allegion team, delivering another quarter of margin expansion with mid-single-digit topline growth. Revenue for the fourth quarter was $945.6 million, an increase of 5.4% compared to 2023. Organic revenue increased 3.5% in the quarter as a result of favorable price and volume. We saw strength within our Americas segment with international organic revenue down slightly in the quarter. Q4 adjusted operating margin increased by 10 basis points, driven primarily by volume leverage and favorable mix. Price and productivity, net of inflation, and investment was a slight headwind in Q4, but strong for the full year. I am pleased with the 70 basis points of operating margin expansion for the full year of 2024. Adjusted earnings per share of $1.86 increased $0.18 or 10.7% versus the prior year. Operational performance, favorable tax, and accretive capital deployment more than offset a slight headwind from interest and other. Finally, full year 2024 available cash flow was $582.9 million, which was a 12.9% increase versus last year. We continue to effectively manage working capital and generate strong cash flow. I'll provide more details on our balance sheet and cash flow a little later in the presentation. Please go to Slide number 6. This slide provides an overview of our quarterly revenue. I will review our enterprise results here before turning to our respective regions. Organic revenue grew 3.5% in the quarter, which included volume growth of 2.9% and price realization of 0.6%. Price realization stepped down about a point in the fourth quarter versus Q3, largely due to timing of rebate accruals in the Americas business compared to prior year. For the full year, the enterprise had solid price realization of 2.4%. And as we think about 2025, we expect continued price realization. Acquisitions drove two points of growth in the quarter and currency was a slight headwind, bringing total reported growth to 5.4%. Please go to Slide number 7. Our Americas segment delivered strong operating results in Q4. Revenue of $750 million was up 6.4% on a reported basis and up 4.6% on an organic basis. Organic growth included both favorable price and volume in the quarter. Reported revenue includes 1.9% growth from acquisitions and a slight currency headwind. Our residential business was up high-single-digits in the quarter. The quarter was stronger than expected as some of our residential customers pulled in purchases ahead of inflation and tariff uncertainty. We believe underlying residential markets likely grew more in line with the previous couple of quarters. As a result, Q4 revenue was benefited by approximately mid-single-digit millions of dollars. Our non-residential business increased mid-single-digits organically in the quarter as institutional end-markets remained stable. We did not have pull ahead within our non-residential customers. Electronics revenue was up low-single-digits compared to Q4 last year. As we discussed on prior calls, electronic comparisons in recent years have reflected the timing of supply chain disruptions in prior years. Americas adjusted operating income of $205.1 million increased 8.9% versus the prior year period. Adjusted operating margin was up 70 basis points as a result of favorable volume leverage and accretive acquisitions. Price and productivity, net of inflation, and investments was a slight headwind in Q4, but strong for the full year. Please go to Slide number 8. Our International segment had a tough fourth quarter, driven by a challenging macroeconomic environment, particularly in Germany, which is our largest market internationally. Revenue of $195.6 million was up 1.5% on a reported basis and down 0.7% organically. Acquisitions were a tailwind this quarter, positively impacted reported revenue by 2.4%. Currency was a slight headwind in the quarter versus prior year. China was also a headwind to international organic growth. We took additional steps in the quarter to exit our already small operations there. In total, we had approximately $5 million of revenue in full year 2024, which represents a slight headwind to 2025 organic growth. International adjusted operating income of $30.9 million decreased 4.3% versus the prior year period. Adjusted operating margin for the quarter decreased 100 basis points, while price and productivity exceeded inflation and investments, margin declines were due to lower volumes. Please go to Slide 9 and I will provide an overview of our cash flow and balance sheet. 2024 available cash flow came in at approximately $583 million, up $66.5 million versus the prior year. This increase is driven by higher earnings and improvements in working capital, partially offset by higher capital expenditures. Working capital as a percent of revenue improved as we continue to focus on working capital efficiency to convert earnings to cash. We saw improvements in both inventory turns and DSO this year, which drove the improvement. Finally, our balance sheet remains strong. Our net debt to adjusted EBITDA is at a healthy ratio of 1.6 times. Our business continues to generate strong cash flow and our balance sheet supports continued capital deployment. I will now hand the call back over to John."
},
{
"speaker": "John Stone",
"content": "Thanks, Mike. Please go to Slide 10. Last quarter, we provided some initial market commentary for 2025. Today, I'd like to focus specifically on our institutional markets to provide more perspective on what's one of the main drivers of our business. Allegion holds an enviable position in the industry here with strength in our sales footprint, our specification capabilities, and our relationships with channel partners. We win business by solving complex problems for end users and working closely with architects with whom we've had decades long relationships. As we start off 2025, we continue to see indications of stable growth in our key market segments. A key source of funding, as indicated by new municipal bond issuance remains healthy, following a very strong 2024 and you can expect these bonds will be spent over the next several years. Dodge Institutional Indicators also support volume growth as square footage starts have been in positive territory. The institutional markets are still growing, partially offset by known pockets of softness like commercial office and multifamily. Please go to Slide 11 and let's walk through our outlook for 2025. We expect total Allegion revenue growth to be 1% to 3% and organic revenue growth to be 1.5% to 3.5%. Total growth includes approximately one point of acquisitions, which is largely carryover from 2024 and approximately 1.5 points of headwind from foreign currency, primarily in Allegion International. In the Americas, we expect organic revenue growth to be low to mid-single-digits with growth coming from both our non-residential and residential businesses. For Allegion International, we anticipate that organic revenue will remain relatively flat. As Mike mentioned earlier, macroeconomic conditions in our International markets, particularly in Germany, continue to be weak. We're estimating an adjusted earnings per share outlook in the range of $7.65 to $7.85. This represents growth of approximately 1.5% to 4% over the prior year period, inclusive of a significant headwind from tax rate, which is estimated to be 17.5% in 2025 at the midpoint. You can find more details in the appendix. Lastly, our outlook on available cash flow is 85% to 90% of adjusted net income. We are committed to balanced, consistent and disciplined approach to capital deployment and this outlook assumes $86.7 million in average diluted shares outstanding, inclusive of anticipated share repurchases in 2025. Allegion's M&A pipeline is active and we anticipate allocating additional capital to acquisitions this year. However, this outlook does not account for any further acquisitions beyond the recent announcements we've shared on Next Door Company at Lemaar. One more item of interest that I'd like to cover given the evolving headlines in recent weeks is tariffs. Our guidance includes the currently enacted tariffs on imports from China and at the enterprise level, we import less than 5% of our cost of goods sold from China. We're taking a combination of pricing actions and sharing those costs with our suppliers to minimize the impact. Our guidance does not include potential tariffs that may be enacted on Mexico. We source approximately 20% to 25% of cost of goods sold from Mexico, primarily related to our residential business in the Americas. Should tariffs go into effect, we anticipate taking pricing actions to cover the higher costs and expect to offset the dollar impact at the operating income and earnings per share level. Please go to Slide 12. In summary, Allegion delivered a record year in 2024, a year marked by consistent execution, solid margin expansion and balanced capital deployment. These results are a testament to our team of highly engaged experts, who together with our distribution and channel partners, solve complex problems for our end-user customers and work tirelessly to make the world safer. We expect 2025 will be another opportunity to showcase the strength of this team. And with the consistency and discipline we have in investing for our future, Allegion is primed for more growth. With that we'll be happy to take your questions."
},
{
"speaker": "Josh Pokrzywinski",
"content": "Drew, we can open up the line for questions. Drew, we can move to Q&A."
},
{
"speaker": "Operator",
"content": "We will now begin the question-and-answer session. [Operator Instructions] Our first question today will come from Jeff Sprague of Vertical Research. Please go ahead."
},
{
"speaker": "Jeffrey Sprague",
"content": "Thank you. Good morning, everyone. And I guess the old adage patience is a virtue still holds. I wonder if we could just address first is kind of the price-cost productivity investment equation. I think it's the first time that's flipped negative maybe since you've reported it. Can you give us a little color on maybe just kind of headline price-cost or maybe what was going on in investment spending in the quarter to drive that change?"
},
{
"speaker": "Operator",
"content": "The speaker line may be muted. You are live."
},
{
"speaker": "Jeffrey Sprague",
"content": "Can you hear me? I'm not muted."
},
{
"speaker": "Operator",
"content": "I hear the questioner. I'm asking if the speaker line is muted from Allegion. Is your line muted? Okay. Ladies and gentlemen, it appears we are having difficulty with the speaker line. Please stand by one moment."
},
{
"speaker": "Josh Pokrzywinski",
"content": "Hello. This is Allegion. Are we audible?"
},
{
"speaker": "Operator",
"content": "Okay. Hi. This is the operator. Go ahead and would you like me to have the questioner repeat the question? I can hear your line now."
},
{
"speaker": "John Stone",
"content": "You got the question. Mike Wagnes is going to go ahead and answer it. Thanks for the patience everyone and thanks for the question, Jeff."
},
{
"speaker": "Mike Wagnes",
"content": "Yes. Hey, Jeff, can you hear me?"
},
{
"speaker": "Jeffrey Sprague",
"content": "I got you loud and clear, Mike. Thanks."
},
{
"speaker": "Mike Wagnes",
"content": "Perfect. Sorry about that. So if you think about pricing in the quarter, it did step down like we shared in the prepared remarks, but that was a function of timing of our rebate accruals. It wasn't core pricing driven. Core pricing was still decent. If you remember in 2023, our volume was more first-half loaded, right? And so as we got through the end of '23, we took down those rebated reserves. In '24, it was actually a positive development, our volume accelerated in the back half of the year and especially Q4, you saw the volume. So we had to make some adjustments to those accruals. I think the key takeaway for me is pricing was still decent in the Americas, of course, led by non-residential, which was strong. And as we think about 2025, continue to expect to see pricing and productivity in excess of inflation and investment on a dollar basis. So that equation that you're comfortable for the full year, we expect that dynamic to continue next year."
},
{
"speaker": "Jeffrey Sprague",
"content": "Great. Thanks for that. And John then thanks for the color on the tariffs, obviously on everyone's mind. I guess one other element is just the sourcing of steel or other metals, steel, and aluminum. Anything you could add there on where you're sourcing for your US plants and if there's any particular risk that you've identified there?"
},
{
"speaker": "John Stone",
"content": "Yes, that's a good question, Jeff, on these steel and aluminum derivative tariffs. Initial look through that, the impact is very small. It doesn't even have two commas in it. We've still got more analysis to do on that, but I'd say our non-residential business is largely sourced and produced in the United States. So we don't anticipate a big impact from those additional tariffs on steel and aluminum."
},
{
"speaker": "Jeffrey Sprague",
"content": "Okay, great. Thanks. I'll leave it there. Much appreciated."
},
{
"speaker": "John Stone",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Your next question today will come from Julian Mitchell of Barclays. Please go ahead."
},
{
"speaker": "Julian Mitchell",
"content": "Hi. Good morning. Maybe just a first question around the adjusted sort of operating margin that's embedded in the guide. So you had pretty good margin expansion most of last year. It sort of dried up a bit in the fourth quarter, partly because of that price dynamic that you've discussed. For the full year '25, are we sort of assuming it's a few tens of basis points of margin expansion that's in the guide? And is there any kind of acceleration in there year-on-year in the back half versus the first half? Thank you."
},
{
"speaker": "Mike Wagnes",
"content": "Yes, thanks for the question, Julian. If you look at the guide, right, we give EPS all the below the line items. And then as you pick revenue, you can back into the margin expansion. We do expect to have margin expansion in 2025. And as you think about the framework that we gave previously, the last two years, '23, '24 extremely strong, 230 basis points of margin expansion. If you think about 2025, that third year in that framework, I'd expect to be at the lower end of that framework we previously gave of the 50 basis points to 100 basis points. And when you back into the implied guide, you can kind of calculate that. With respect to timing, I would just share 2025 will look similar to 2024 from a normal seasonality as we progress throughout the year."
},
{
"speaker": "Julian Mitchell",
"content": "That's helpful. Thank you. And then just within the Americas organic sales guidance for 2025. Is it sort of embedding residential up kind of low-single-digits, non-residential organic sales up mid-single-digits? And then Electronics is that getting back on track for kind of decent growth in '25? I think it was down low-single in '24."
},
{
"speaker": "Mike Wagnes",
"content": "Yes, we would expect non-residential to be the stronger of the two, as you would think from our prepared remarks. We don't give exact figures resi versus non-resi, but you could think the non-residential being the stronger of the two. And then for Electronics, I think, we're back to a normal comparison. So you can expect to see Electronics growth outpace the mechanical like we've shown in the past. So you could see Electronics growth certainly be better than the overall Americas growth."
},
{
"speaker": "Julian Mitchell",
"content": "Great. Thank you."
},
{
"speaker": "Mike Wagnes",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Your next question today will come from Joe O'Dea of Wells Fargo. Please go ahead."
},
{
"speaker": "Joe O'Dea",
"content": "Hi. Good morning. Thanks for taking my questions. On the margin commentary and what's implied in roughly 50 bps of year-over-year margin expansion. Can you just touch on that kind of across the organization? Should we think about both segments seeing year-over-year margin expansion, maybe Americas leading that and then a little bit of corporate leverage on top of that?"
},
{
"speaker": "Mike Wagnes",
"content": "Yes, sure. Thanks for the question, Joe. Obviously, if you think about Allegion, the enterprise can't get there without the Americas. So we expect the Americas to have a stronger margin expansion. If you think about international though, we do expect to expand margins there this year. And then from a corporate, every year, we have just like a normal increase of a few percent for regular inflation. So you could take the actuals for the current 2024, so the past '24 and just increase it by a few percent for inflation."
},
{
"speaker": "Joe O'Dea",
"content": "Got it. And then just in terms of the international growth guidance in '25, can you touch on the China component to that and what is embedded within that in terms of any headwind as it relates to the exit there and timing around being done with those actions?"
},
{
"speaker": "Mike Wagnes",
"content": "I'll just share like we had in the prepared remarks, the revenue was only $5 million in '24. So as you think about a headwind for '25, it kind of sizes up that it's small."
},
{
"speaker": "Joe O'Dea",
"content": "Got it. Thanks very much."
},
{
"speaker": "Operator",
"content": "Your next question today will come from Tim Wojs of Baird. Please go ahead."
},
{
"speaker": "Timothy Wojs",
"content": "Hey, guys, good morning."
},
{
"speaker": "John Stone",
"content": "Hey, Tim."
},
{
"speaker": "Timothy Wojs",
"content": "Hey, maybe just on the non-res business. It sounded like you, in your prepared remarks were a little bit more confident or saw some things in the quarter that you thought developed positively. So maybe just talk a little bit about some of the quoting activity that you're seeing. And I guess if you could kind of thread that into how do you get to kind of the upper-end of the Americas guide for 2025 on the revenue side?"
},
{
"speaker": "John Stone",
"content": "Yes, thanks for the question, Tim. I'd say the non-res side of the business in the Americas did accelerate in 2024 a bit better than we had originally contemplated. Volumes picked up a little bit like Mike talked about and that's carried on into 2025. That momentum has carried on. I think our spec activity supports that view. Other indicators like we showed on Dodge Starch on the institutional side. The earliest of the early indicators, Dodge Momentum has been reading a little bit favorable. So just the project work that we're seeing on the commercial side, the sell-through that our channel partners are sharing with us, the volume outlook just feels a bit better than it has in recent months. So it's a good end to 2024 and a good start to 2025 on the commercial side of the business."
},
{
"speaker": "Timothy Wojs",
"content": "Okay. And I guess what would you need to see, would it just be like this needs to continue kind of through the year to get to the upper end? I'm just trying to kind of gauge what you kind of think about and kind of guardrails in terms of what gets you the kind of the lower or the higher end of that revenue guide in Americas."
},
{
"speaker": "Mike Wagnes",
"content": "Yes, Tim, we give an outlook there. It's a range. Clearly, we're only a month into the year, right. So let's see how this year progresses before we think about changing to upper end. I'd share with you on the residential side, obviously, we think that will not be as strong as the non-residential side. So obviously, if that is better than we anticipate, that could help. But overall, that core institutional part of the business has remained stable for quite some time on the non-res side and we expect that to continue."
},
{
"speaker": "Timothy Wojs",
"content": "Okay. That's helpful. And then it sounds like you have a pretty healthy pipeline in terms of M&A deals. And I guess if you just kind of look through the filings, I mean, it does seem like the M&A that you've done kind of in 2024 is accretive to margins. Is that a similar makeup to, I guess, what's in the pipeline or is there a little bit more variance within the margin profile of potential deals?"
},
{
"speaker": "John Stone",
"content": "I think I appreciate the question, Tim. I think we can't speculate on deals we haven't done yet, but I would say the M&A environment is good, it's healthy. I think we have a lot of interesting targets, very high quality targets in the pipeline today. Working hard on those. Will every single one be accretive to industry leading margin business like Allegion? Maybe not, but I think don't lose sight of we will be disciplined on our acquisitions, but I do see if I was ended 2024 happy with our progress on M&A, I could see myself ending '25 very happy on M&A."
},
{
"speaker": "Timothy Wojs",
"content": "Okay. Sounds great. Thanks a lot for the time."
},
{
"speaker": "John Stone",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "And our next question today will come from Brett Linzey of Mizuho. Please go ahead."
},
{
"speaker": "Brett Linzey",
"content": "Hi. Good morning. Thank you. Hey, I wanted to come back to the organic sales outlook, the 1.5% to 3.5% and really the non-res side of that. How are you thinking about commercial versus institutional? Do you see growth in both of those areas? And then is there anything to think about in terms of the phasing of that growth first-half versus second-half? Is it fairly level loaded year-over-year or is there some front-end or back-end weighting?"
},
{
"speaker": "Mike Wagnes",
"content": "Yes. I'll address the phasing and then John can talk to the vertical markets. With respect to the phasing, I kind of look to '24 as a more normal year. And so, I wouldn't say that this is a back-end loaded year vis-a-vis what we just put on the board for 2024."
},
{
"speaker": "John Stone",
"content": "Yes. I think on the non-res side, as we showed, a bit of a focus on the institutional verticals, education, and healthcare, supported by very strong issuance of muni bonds in 2024. That segment is still growing. That is where Allegion's business is a bit more heavily weighted. So that's quite favorable for us. In the commercial verticals, still a mixed bag, I would say. Data Centers, as everyone knows, is growing very rapidly. Allegion has a very good and very rapidly growing business there, supported by rapidly growing specification activity. On multifamily, obviously, rather soft on the new construction side on commercial office, major metro areas. Again, this is mature bad news. Still a bit soft, but we're encouraged when we hear return to office mandates and things like this. So there are reasons to start to think about flirting with the bottom on those segments and we'll just have to see, as Mike said, we'll have to see as the year progresses, how those other verticals start to shape up."
},
{
"speaker": "Brett Linzey",
"content": "Okay. Great. And then just a follow-up on the tariffs, and this is specific to Mexico. You talked about some of the pricing mitigation actions. I'm just curious what would the mechanics of price look like? Would these be normal list prices or would they be surcharges? Any color on the nature of that?"
},
{
"speaker": "John Stone",
"content": "Yes. So I think we would have to evaluate once something gets implemented, Brett. I mean it's difficult to speculate on the unknown and just give you some hypotheticals. So, I would just summarize it with, we would see ourselves implementing pricing actions. There could be a mix of pricing actions to be able to offset the dollar impact on the operating income and earnings per share line. I think that's the best we can give you at this point because again, we're -- it's just hypothetical at this point."
},
{
"speaker": "Brett Linzey",
"content": "Appreciate the detail."
},
{
"speaker": "John Stone",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "We have just one final question in queue and that question will come from Chris Snyder of Morgan Stanley. Please go ahead."
},
{
"speaker": "Christopher Snyder",
"content": "Thank you. I wanted to ask about the Q4 tariff pull forward. I think you said mid-single-digit millions for Americas resi, if I heard that right, so maybe like 2% to 3% kind of tailwind in the quarter if my math is right. I guess the question, one, how do you size that? How can you kind of pinpoint that number? And then the second is like is the expectation that this tariff pre-buy continues into Q1? Are you seeing that here kind of halfway through the quarter? Thank you."
},
{
"speaker": "Mike Wagnes",
"content": "Thanks for the question, Chris. If you think about our residential business, we grew at the high-single-digits and that was frankly more than you would expect based on underlying market demand. So our best estimate is, hey, there's about mid-single-digit millions. So if you back that out, you're looking at maybe a low-to-mid type growth for resi, it's not precise. It's an estimate that we have, knowing that our channel partners in the residential business tend to be pretty large companies who place larger size orders because it's more concentrated than on the non-res side. I think for me, the more important thing is we didn't see this in non-residential, where John talked about how we ended strong. With respect to Q1, I would expect that mid-single-digit millions to be a headwind to resi. But if you think about total Americas, that's not very big. So when you model it, just know that that's coming from Q1 into the fourth quarter of '24, but I wouldn't expect further pull out."
},
{
"speaker": "Christopher Snyder",
"content": "Thank you. I appreciate that. And then I also appreciate all the color and the communication around the Institutional business. I guess anything -- maybe that you could flag around the government exposure within institutional? I know education and healthcare are the largest verticals, but obviously, just a lot of uncertainty out there on government buildings with headlines of layoffs, et cetera. Thank you."
},
{
"speaker": "Mike Wagnes",
"content": "Yes. It's a timely question and a fair one. I would say the majority of the project work that we see out there is coming from local funding sources, right, municipal bonds, local property taxes, that's what funds K-12 schools as an example, rather than federal monies out of Washington. So fair to ask the question, I would just say the majority of our end-user customers are a little bit insulated from that because it's more local funding sources, property taxes, muni bonds, things like that."
},
{
"speaker": "Christopher Snyder",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "At this time, we will conclude the question-and-answer session. I'd like to turn the conference back over to John Stone, President and CEO, for any closing remarks."
},
{
"speaker": "John Stone",
"content": "So thanks everyone again for joining the call. I am very proud of the year that the Allegion team and our distribution channel partners put on the board for 2024 and very excited to see us navigate our way through what should be a very favorable 2025."
},
{
"speaker": "Mike Wagnes",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "The conference has now concluded. We thank you for attending today's presentation and you may now disconnect."
}
] |
alle | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Good morning and welcome to the Allegion Third Quarter 2024 Earnings Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Josh Pokrzywinski, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Josh Pokrzywinski",
"content": "Thank you, Jason. Good morning, everyone. Thank you for joining us for Allegion's Third Quarter 2024 Earnings Call. With me today are John Stone, President and Chief Executive Officer; and Mike Wagnes, Senior Vice President and Chief Financial Officer of Allegion. Our earnings release, which was issued earlier this morning and the presentation we will refer to in today's call are available on our website at investor.allegion.com. This call will be recorded and archived on our website. Please go to slide two. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the Safe Harbor provisions of Federal Securities Law. Please see our most recent SEC filings for a description of some of the factors that may cause actual results to differ materially from our projections. The company assumes no obligation to update these forward-looking statements. Today's presentation and commentary include non-GAAP financial measures. Please refer to the reconciliation in the financial tables of our press release for further details. Please go to slide three, and I'll turn the call over to John."
},
{
"speaker": "John Stone",
"content": "Thanks, Josh. Good morning, everyone. Thanks for joining us. We can sum up this quarter with stable markets and strong execution. Q3 marks another quarter of strong execution by the entire Allegion team, resulting in revenue growth and margin expansion, demonstrating the resilience of our business model. I'm especially pleased with the top-line growth in the quarter, and overall, demand remains stable and is supported by our broad in-market exposure and specification expertise. Institutional markets have continued to lead, while commercial verticals have been more mixed. We have accelerated capital deployment in 2024, returning cash to shareholders, and growing our business with accretive acquisitions. Our strong cash generation, balance sheet, and pipeline of opportunities continue to position us well for future capital deployment, creating long-term value for our shareholders. As we push to year end, I feel we're performing at a high level. We're raising our full-year guidance for EPS, and we're affirming our overall revenue with some small updates at the segment level. Additionally, we're affirming our available cash flow outlook. Later in the call, we'll discuss these full-year updates, as well as provide some initial thoughts on how we see the market shaping up for next year. Please go to slide four. Let's take a look at capital allocation. First, we continue to invest in the core to drive organic growth. In June, we introduced a new product line of Exit Devices, the Von Duprin 70 Series. Our 70 Series combines the quality and trust Von Duprin is known for as the creator of this product category, with the performance and value ideal for many modern applications, ranging from warehouse, industrial, office, multifamily, retail, and hospitality spaces. This new product line is backed by our expert safety and security consulting, specification writing, technical support, and training, and it highlights what we do well with our flagship brands like Von Duprin. We innovate for new markets while still expanding the core, a capability that's difficult to match but is a strength of Allegion. With the Von Duprin 70 Series, we're leveraging more than a century of experience in developing high-performance exit devices to meet the safe entry and egress needs of customers today. Allegion continues to be a dividend-paying stock. In the third quarter, this amounted to approximately $42 million in cash return to shareholders. Turning now to M&A, and as announced last week, we recently closed the acquisition of SOSS Door Hardware. SOSS manufactures premium door hardware primarily sold across North American non-residential markets. Best known for their line of invisible hinges, SOSS complements our core mechanical portfolio with fire-rated heavy-duty solutions for industrial, commercial, and institutional spaces. And like our other well-known brands, SOSS is an industry pioneer with more than a century of experience that makes it a category leader today. SOSS is a small bolt-on with Allegion-like margins. We expect SOSS to deliver solid returns accretive to EPS in 2025 in a space we know well as a pure-play leader in security and access. Lastly, in the quarter, we made share repurchases amounting to approximately $40 million. To sum up this slide, Allegion will continue to take advantage of the strong cash generation our business drives for the benefit of our shareholders. Mike will now walk you through the third quarter financial results."
},
{
"speaker": "Mike Wagnes",
"content": "Thanks, John, and good morning, everyone. Thank you for joining today's call. Please go to slide number five. As John shared, our Q3 results reflect solid performance from the entire Allegion team. We continue to execute at a high level, delivering another quarter of strong margin expansion with mid-single-digit top-line growth driven by price, volume, and acquisitions. Revenue for the third quarter was $967.1 million, an increase of 5.4%, compared to 2023. Organic revenue increased 3.3% in the quarter as a result of favorable price and volume. We saw strength within our America segment with international organic revenue relatively flat in the quarter. Q3 adjusted operating margin and adjusted EBITDA margin, both increased by 100 basis points, driven by price and productivity in excess of inflation and investment, as well as favorable volume leverage. I am pleased with the operational execution and margin expansion in 2024. Adjusted earnings per share of $2.16 increased $0.22, or 11.3%, versus the prior year. Strong operational performance, accretive capital deployment, and favorable interest in other more than offset headwinds from higher tax. Finally, year-to-date 2024 available cash flow was $388 million, which was a 21.1% increase versus last year. I am pleased with our cash flow and working capital management, and we'll provide more details a little later in the presentation. Please go to slide number six. This slide provides an overview of our quarterly revenue. I will review our enterprise results here before turning to our respective segments. Organic revenue grew 3.3% in the quarter, which included price realization of 1.8% and volume growth of 1.5%. Acquisitions drove approximately 2 points of growth in the quarter. Additionally, currency was a slight tailwind, bringing total reported growth to 5.4%. Q3 revenues were sequentially consistent with Q2 and reflects a more normal seasonality compared to an unusual 2023, as we indicated previously. Please go to slide number seven. Our America segment delivered strong operating results in Q3. Revenues of $782.4 million was up 5.6% on a reported basis and up 4.1% on an organic basis. Organic growth included both favorable price and volume in the quarter. Reported revenue included 1.6% growth from the June acquisitions of Krieger and Unicel. Our non-residential business increased mid-single digits organically in the quarter, as institutional end markets remained stable. Our residential business was up low single digits, similar to what we saw in Q2. Electronics revenue was down high single digits compared to Q3 last year, which included significant catch-up in volumes as supply chains recovered from disruptions that we experienced in 2021 and 2022. It's worth noting Q3 electronic revenue dollars were flat sequentially to Q2 levels, generally following the seasonality of the rest of the business. We continue to believe electronics are a long-term growth driver for Allegion. America's adjusted operating income of $231.1 million, increased 9.7% versus the prior year period due to solid top-line growth and strong operational execution. Adjusted operating margin and adjusted EBITDA margin for the quarter were up 110 basis points and 120 basis points, respectively, as we continue to drive margin expansion through price and productivity in excess of inflation and investments. Let's go to slide number eight. Our international segment had a solid third quarter. Revenue of $184.7 million was up 4.4% on a reported basis and up 0.2% organically. Acquisitions were a tailwind this quarter. Positively impacted reported revenue by 2.9%, driven by the Dorcas and Boss businesses. Currency was also a tailwind, contributing 1.3 points of growth. International adjusted operating income of $25.2 million, increased 6.3% versus the prior year period. Adjusted operating margin and adjusted EBITDA margin for the quarter increased 20 basis points and 10 basis points, respectively. Margin expansion was driven by price and productivity exceeding inflation and investments offsetting the volume decline. Please go to slide number nine, and I will provide an overview of our cash flow and balance sheet. Year-to-date available cash flow came in at $388 million, up $67.6 million versus the prior year. This increase is driven by higher earnings and improvements in working capital, partially offset by higher capital expenditures. Next, working capital as a percent of revenue improved, as we continue to focus on working capital efficiency to convert earnings to cash. Finally, our balance sheet remains strong, and our net-debt to adjusted EBITDA is at a healthy ratio of 1.7 times. It's worth noting our gross debt and cash balances at September 30, 2024, include the proceeds from our $400 million senior note issuance in Q2, which were used to repay a $400 million senior note on October 1. This results in a slightly higher gross leverage at the end of the third quarter, but has no impact on net leverage. Our business continues to generate strong cash flow, and our balance sheet supports continued capital deployment. I will now hand the call back over to John."
},
{
"speaker": "John Stone",
"content": "Thanks, Mike. Please go to slide 10. Allegion remains on track for record results in 2024. We are affirming our total reported revenue growth outlook of 2.5% to 3.5%. We're also affirming our total organic revenue growth outlook of 1.5% to 2.5%. Although, we now expect international organic revenue growth to be slightly higher and America's organic growth to be slightly lower than what we previously shared with you. The international team has executed well. As markets have been slow the past two years, there's now seen some stability in the mechanical portfolio. In the Americas, we're lapping record multifamily markets, which have slowed with higher interest rates this year. On balance, we'd still describe our markets as stable, particularly in the institutional verticals. We'll share more color on our markets on the next slide as we look forward to next year. Based on our strong operational performance in the third quarter, capital deployment, and a revised tax rate, we are increasing our adjusted earnings per share outlook to a range of $7.35 to $7.45. Lastly, we're affirming our outlook on available cash flow to be in the range of $540 million to $570 million. Please go to slide 11. As you know, we'll provide Allegion's formal 2025 financial outlook during our February earnings call, but today we'd like to share a preliminary view on our key markets for next year. Overall, demand has been stable throughout 2024. Last quarter, we highlighted what makes our business model resilient, from our front-end spec engine that pulls product through the channel to our broad in-market coverage and large install base. And of course, strong execution by one of the safest, most engaged workforces in the industry, complemented by what is, without a doubt, the best distribution channel that the industry has. As we approach 2025, we see many of the same dynamics in place and do expect to grow organically. Starting with the Americas, macro indicators remain rather mixed. Institutional markets are stable and showing signs of modest growth. Commercial markets have been muted, and while we're encouraged by improvement in some indicators, the long-cycle nature of our business results in a lag versus planning and start data. Based on past starts, multifamily is one market likely to be slower as we enter 2025. We do expect America's residential markets to grow next year. As a reminder, we're mostly exposed to residential aftermarket and view existing home sales as an important driver of activity for us. For international, macro indicators remain soft. However, we have been in this environment for most of the last two years. As such, more moderate comparisons and continued strong execution should support growth in 2025. Finally, Allegion has a healthy balance sheet and strong cash generation that give us flexibility as we enter the new-year. We do expect capital deployment to drive additional earnings per share growth, focused on returns for our shareholders. Please go to slide 12. In summary, Q3 marks another quarter of strong results for Allegion. Our team continues to perform at a high level, driving revenue growth and margin expansion, demonstrating the resilience of our business model. We've seen stable markets this year and have accelerated capital deployment, and heading into the last few months of 2024, we're focused on meeting customer needs and delivering on our commitments to shareholders. With that, let's turn to Q&A."
},
{
"speaker": "Operator",
"content": "We now begin the question-and-answer session. [Operator Instructions]. The first question is from Joe Ritchie from Goldman Sachs. Please go ahead."
},
{
"speaker": "Vivek Srivastava",
"content": "Hi. Thanks for the question. This is Vivek Srivastava on for Joe. My first question is just on the America's non-residential business. The mid-single-digit growth this quarter is pretty impressive in light of all project delay. I mean, we've been hearing intra-quarters, so maybe could you help us understand, how is your visibility over the next 12 months based on specification activity in this vertical? And then, can you also provide any color on residential spec activity?"
},
{
"speaker": "John Stone",
"content": "Yeah. So, let's talk non-res first and thanks for the question. I'd say, consistent with the slide and prepared remarks, we do continue to see organic growth. We do continue to see non-res overall as stable with some mix there in some of the commercial verticals like we indicated. Multifamily, we do expect it to be soft for a while, but on the institutional side, looking at leading indicators like Dodge Starch and Dodge Momentum would be indicative of the kind of activity that we're seeing in the market. If you look at municipal bond issuance this year, it's been very strong, up almost 30% year-to-date, which is an indicator of, again, spending in education, where safety and security are always on the list. And our advocacy and our activity promoting safe schools position us well to support customers there. So, I think, just consistent with what we shared with you on that last slide, we see overall stable markets for the foreseeable future led by the institutional verticals with some of the commercial verticals a bit more mixed. On the residential side, I think you asked about spec activity. We don't spec residential. We do participate primarily in the aftermarket on residential. We do see as the interest rate environment, as if that continues to improve, we do see signs that both on the new build side as well as the aftermarket side, there are signs that are indicating growth."
},
{
"speaker": "Vivek Srivastava",
"content": "Very helpful. And just a follow-up on just productivity, the equation pricing net of productivity and investment continues to remain positive through the year. Curious, where are you in your productivity journey versus pre-COVID levels? And what are the opportunities you see on key KPIs like, plant utilization levels as we enter 2025?"
},
{
"speaker": "Mike Wagnes",
"content": "Yeah. So, really pleased with our productivity. If you recall the last couple of years, '21 and the beginning of '22, we really ran into challenges in our supply chain that resulted in us being inefficient. If you fast forward to, you know, the '23 and '24, much more efficient where we can drive productivity. And when you look at the equation and how we like to look at it, it's the price and the productivity that cover the inflation and fund the investments. And so, we've gotten margin expansion this year. Really pleased with the expansion, as I mentioned earlier. And just know, when you think of Allegion, Allegion is going to be driving the price and productivity to cover that inflation and fund investments on a go forward."
},
{
"speaker": "Operator",
"content": "Question from Julian Mitchell with Barclays. Please go ahead."
},
{
"speaker": "Julian Mitchell",
"content": "Hi, good morning. Maybe a first question just on the residential side of things. You know, I think about the sort of market outlook for next year. You talk about recovering starts on slide 11. And I think, it's about maybe just remind us it's sort of close to maybe 40% or so green field. So, just wanted to check that exposure. And when you look back historically at the business, what's the sort of typical lag from interest rates moving lower to seeing some help in your top line, whether residential green field or repair and remodel? Any sort of context around how your thoughts on that market have changed in recent months?"
},
{
"speaker": "Mike Wagnes",
"content": "Yeah, thanks for the question, Julian. If you think of our resi business, certainly a little more is the aftermarket. So, you can think of it as roughly a third of our business is aftermarket. Retail being -- I'm sorry, two-thirds aftermarket. I apologize. Two-thirds aftermarket, a third new built. And retail being the biggest piece, think of like a Home Depot, a Lowe's, a customer like that, Amazon. And then with respect to building construction of new home, that could take six months to a year. It's not like an institutional building, so it is quicker responding to interest rates. And on the aftermarket side, I mean, that's consumer spending money. So, it is less determinate or less long, I would say, from a timing of recovery, when you think about versus the new build side."
},
{
"speaker": "Julian Mitchell",
"content": "That's very helpful. Thank you. And then as we're thinking about electronics, that market, you talk about growth in both electronics, America's-plus international next year. This year, I think still digesting sort of tough comps and the sudden easing of supply chain conditions. Remind us perhaps, what's the medium term electronics growth assumption as you see it globally? And as we think about 2025, you've had such volatility in recent years. Is it sort of trend growth realistic or we're still dealing with complications around comps and that type of thing for next year?"
},
{
"speaker": "John Stone",
"content": "Yeah, Julian, appreciate the question. And you're exactly right. 2023 marked a lot of still wonky comps, particularly on electronics. And we're still dealing with, as you can tell, with the longest of the long tail of issues, particularly on a couple of high volume electronics locks. We do see, I would say, more, a more normal comp environment in '25. And for the foreseeable future, we do still see electronics adoption growing, we do still see electronics replacement cycle just kind of starting. So I think those two combined, we would be very consistent in our, our feeling that this is a high single to low double digit growth driver for Allegion over the cycle. And I think that's still our view as we look forward."
},
{
"speaker": "Julian Mitchell",
"content": "Great. And you have a chance of being in that range next year because of normal comps?"
},
{
"speaker": "John Stone",
"content": "I'd probably, hesitate to give like too much of a breakdown of too much detail. We really intended just to give you a high level look into the market and the more specific detail would come in our February call for 2025 outlook."
},
{
"speaker": "Julian Mitchell",
"content": "Understood. Thanks very much."
},
{
"speaker": "John Stone",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question is from Joe O'Dea with Wells Fargo. Please go ahead."
},
{
"speaker": "Joe O'Dea",
"content": "Hi, good morning. Thanks for taking my questions. Just wanted to start on some of the 2025 comments. And when you talk about a stable environment, moving forward, I think, you know, also saying in a stable environment, you would expect organic growth. But just want to make sure that in terms of moving pieces year-over-year, some of the more notable would be resi potentially getting a little better multifamily, potentially with some headwinds, just anything else in terms of as you look at a pipeline and think about developments next year versus this year and how the market sort of changes?"
},
{
"speaker": "John Stone",
"content": "Hey, Joe, this is John. Appreciate the question. And I think, yeah, the overall macro look, we would just say is stable. We do see signs of America's residential improving. That's -- I think that's fair to say, the degree of which we need to come back to you in February and give you more detail there. On the non-res side, our view would still be and I think again, there's some Dodge indices you can reference that show that in the non-res side, the institutional verticals will still continue to lead the way. There is still, as we mentioned, a lot of municipal bond issuances this year, which does provide funding in the K-12 vertical where we're quite strong. You know, our business is a little bit heavily tilted to the institutional verticals as well. So you sum all that up. And there is mix in there, like you say, and it's fair to see multifamily has been kind of soft and probably stays kind of soft for a little while, data centers, as you know, have been exceptionally strong. We participate very well there. And so yeah, add it all up. Stable markets. Yep. And I think we do still see organic growth."
},
{
"speaker": "Joe O'Dea",
"content": "Perfect. I appreciate the color there. And then just in terms of the price cost environment, and as you're looking out in terms of pricing, and maybe fatigue from customers on inflation, and how you're thinking about the pricing opportunity environment, and just in terms of timing for us and sort of when you would be going to market, such that, any anticipated price next year would be out there?"
},
{
"speaker": "Mike Wagnes",
"content": "Yeah, Joe, we're still in an inflationary environment. And in an environment where there's inflation, look for Allegion to drive pricing to cover the inflationary pressures. As to timing, we would always announce that to the channel before an earnings call. We have some history that you're pretty familiar with that you can get an idea of what the industry does. But just understand that, hey, we are in an inflationary environment. And as such, look for us to ensure that we manage the profitability by driving the pricing to cover the inflationary pressures."
},
{
"speaker": "Joe O'Dea",
"content": "Understood. Thanks a lot."
},
{
"speaker": "Mike Wagnes",
"content": "Thanks, Joe."
},
{
"speaker": "Operator",
"content": "The next question is from Brett Linzey with Mizuho. Please go ahead."
},
{
"speaker": "Unidentified Analyst",
"content": "Hey, guys. Good morning. This is [indiscernible] on for Brett Linzey. So just another on the on the spec side, what are you guys seeing? Just with the build out in international spec rating? And just how is that trending? Thanks."
},
{
"speaker": "John Stone",
"content": "Yeah, it's a good question. I appreciate that. I would say that has historically not been a strength for Allegion, but it is things that we have been investing in in capability. If you recall from our release earlier in the year, the acquisition of Boss Door Controls, that was also a step in the direction of more capability and more channel alignment with spec driven business there in the UK. We've been building out human resources, human capability, human capital there for that capability and international. And I'd say, it's early innings yet, but it is going to be an important part of the business as we go forward for international."
},
{
"speaker": "Unidentified Analyst",
"content": "Well, thanks. And then just I know you're calling it the muni bond issue and since being strong, feeding into education. But have you seen any change demand there just related to the sun setting of investor funding?"
},
{
"speaker": "John Stone",
"content": "Yeah, so Esther was probably more directed at other products than ours. And so wasn't much of a tailwind and I don't see much-much change for our business there. Suffice it to say, as schools get funding, they have a lot of things they need to direct those funds too, safety and security are paramount in those budget exercises. And I'd say, we've released new products, we continue to write specs that keep schools up to code, we continue to consult, we're very strong advocates for safe schools. And some of the products that we showed you we highlighted as investing for organic growth on our quarterly calls are directed right there. And they've hit a sweet spot in the market. We're happy with them. We think they add value to faculty and teachers. And I think that is a vertical, critically important to our mission, but also has the tailwinds of pretty strong muni bond issuance here in this calendar year."
},
{
"speaker": "Unidentified Analyst",
"content": "Perfect. Thanks, everybody."
},
{
"speaker": "John Stone",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "[Operator Instructions]. The next question is from Robert Schultz with Baird. Please go ahead."
},
{
"speaker": "Robert Schultz",
"content": "Hey, guys, thanks for taking the question. Maybe first off here, your commentary on spec activity seems to be slightly more positive than your largest competitor. But within institutional, they called out seeing some more weakness in the healthcare verticals. Are you seeing any weakness there? And how would you describe any possible share gains over the past nine months?"
},
{
"speaker": "John Stone",
"content": "That's appreciate the question. And I think, first off, we don't give really specific detail on spec activity. It's just it's just not, yeah, not details. We don't disclose. But I would just at a high level say, our spec activity is in line with the overall macro commentary we've given you. In terms of our largest competitor, look, they're a great company. They have great products. They keep us on our toes. They're tough to compete with. I think consistent with past quarters, any share gain that's happened out there has probably been at the expense of short line suppliers in the market, who might have found some opportunity when we had supply chain problems. But overall, we feel good about the institutional verticals as a whole and continue to see institutional leading the way in the near term."
},
{
"speaker": "Robert Schultz",
"content": "Got it. Thanks. And then maybe on M&A, with thoughts, does that help any specific vertical? And then maybe more broadly on M&A, I think you guys, correct me if I'm wrong here, but have done about five deals year-to-date. How do you think about the pipeline in the '25 and the cadence there? Do you see that playing out at a similar level to 2024? Or any incremental thoughts there would be appreciated."
},
{
"speaker": "John Stone",
"content": "Yeah, I appreciate that. And yeah, we're very excited about the SOSS acquisition. It's a great team. It's a great product line. It's perfectly complementary to a business unit that we already have. So really nice add to the business that will help our customers. And this is products that primarily serve the non-residential markets here in the Americas, with some smaller amount of the sales in Asia Pacific. I would say overall, we feel really excited about the pipeline that we're looking at. I would still feel consistent with past quarter commentary. The M&A environment is definitely better than it was for strategics in '22, '23. And again, excited about the pipeline. We have some good momentum going this year, as you mentioned. And I would say, as we look forward, the objective won't be to pile up cash on the balance sheet. We will deploy it in the best interest of our shareholders. So as that means accretive acquisitions, you can look for us to continue to be disciplined like we have been. And when that means repurchase, we will do that at the right time too."
},
{
"speaker": "Robert Schultz",
"content": "Awesome. Appreciate the color. Thanks, guys."
},
{
"speaker": "John Stone",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "This concludes our question-and-answer session. I would like to turn the conference back over to John Stone, President and CEO, for any closing remarks."
},
{
"speaker": "John Stone",
"content": "Thanks very much. Thanks everyone for attending the call today. Again, Allegion stable markets, strong execution by a great team, united by a mission of making the world safer and more accessible. And now, we look forward to connecting with you again in Q4."
},
{
"speaker": "Operator",
"content": "The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Goodbye."
}
] |
alle | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Allegion Second Quarter 2024 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Josh Pokrzywinski, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Josh Pokrzywinski",
"content": "Thank you Jason. Good morning everyone. Thank you for joining us for Allegion's Second Quarter 2024 Earnings Call. With me today are John Stone, President and Chief Executive Officer; and Mike Wagnes, Senior Vice President and Chief Financial Officer of Allegion. Our earnings release, which was issued earlier this morning and the presentation we will refer to in today's call are available on our website at investor.allegion.com. This call will be recorded and archived on our website. Please go to Slide 2. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the Safe Harbor provisions of Federal Securities Law. Please see our most recent SEC filings for a description of some of the factors that may cause actual results to differ materially from our projections. The company assumes no obligation to update these forward-looking statements. Today's presentation and commentary include non-GAAP financial measures. Please refer to the reconciliation in the financial tables of our press release for further details. Please go to Slide 3, and I'll turn the call over to John."
},
{
"speaker": "John Stone",
"content": "Thanks, Josh. Good morning everybody. Thanks for joining today. I can sum up this call and this quarter with four words; Stable markets, strong execution. And that strong execution was by the entire Allegion team and our distribution channel partners. That's the team that drove these record Q2 results. I'll briefly walk through some of the highlights for our quarter and updated full year outlook, and then we'll share more on each of these later in the presentation. Allegion Q2 revenue growth and margin expansion demonstrates the resilience of our business model. We see stability in demand given our broad end-market exposure and specification expertise. Our team continues to see strength in areas like institutional markets and data centers, further helped by our own investments in electronics and new product development. And as expected, we saw a return to volume growth and a seasonal bump in the quarter sequentially over Q1. We’re accelerating capital deployment, returning cash to shareholders and investing in accretive acquisitions. We've announced four acquisitions already this year with Krieger Specialty Products and Unicel Architectural in Q2. Overall heading into the second half, we're executing at a high level. We are raising our full year guidance for reported revenue and adjusted earnings per share, and we are affirming our available cash flow outlook. I am very proud of how the Allegion team is living our values, while driving results for our customers and our shareholders. Please go to Slide 4. Allegion continues to pursue balanced, consistent capital allocation for the benefit of shareholders and to take advantage of the strong cash generation this business drives. We are investing for organic growth. In April, we introduced three new lines of Schlage indication solutions, a best-in-class lock portfolio with trims that allow users to more easily see the status of a door. Developed specifically with K-12 schools and higher education security needs in mind, our new locks have some of the largest indication windows on the market and differentiated 180-degree views. They offer unparalleled functionality and durability for Grade 1 fire-rated applications, in addition to tamper resistance and color-blind friendly backgrounds. Combined, these features allow for quick confirmation that doors are secured, providing teachers and administrators peace of mind and time, their most valuable resource when it matters most when every second counts. Allegion continues to be a dividend-paying stock. For the quarter, this amounted to approximately $42 million in cash returned to shareholders. We closed two bolt-on acquisitions in our Americas region in Q2, Krieger Specialty Products and Unicel Architectural. Krieger is a leading specialty door manufacturer with expertise in highly engineered, acoustical, high-security, thermal and radio frequency applications. Krieger products complement our hollow metal portfolio and are used in a wide range of facilities, including government agencies, data centers, concert halls and health care. Unicel is a leading manufacturer of advanced glass wall systems that support privacy, safety, energy efficiency and sustainability across institutional markets. This business is a natural extension of our core door and window systems portfolio of TGP, AD Systems and Stanley Access Technologies. Both Krieger and Unicel expand our portfolio with fast growing niche products for key verticals that will benefit from the strength of our spec writing capability and nationwide sales footprint. On a combined basis these businesses are accretive to overall Allegion growth rates and carry Allegion-like EBITDA margins in the low 20s. Total purchase price represents a valuation of approximately 10 times 2024 EBITDA. We are very pleased with the recent acquisitions we've made, strong management teams that have come on board and a great cultural fit with the employees that they bring to Allegion. We are excited to the future. Lastly in the quarter, we made additional share repurchases amounting to approximately $40 million. I am happy with the balanced and shareholder-friendly capital allocation that you see here on the slide, and Allegion continues to invest in the core, grow the business and return cash to shareholders. Mike will now walk you through the second quarter financial results, and I will be back to provide an update on our outlook and some final thoughts."
},
{
"speaker": "Mike Wagnes",
"content": "Thanks, John, and good morning, everyone. Thank you for joining today's call. Please go to Slide Number Five. As John shared, our Q2 results reflect solid performance from the entire Allegion team. We continue to execute at a high level, delivering another quarter of strong margin expansion with mid-single-digit top-line growth, driven by both price and volume. Revenue for the second quarter was $965.6 million, an increase of 5.8% compared to 2023. Organic revenue increased 5.2% in the quarter as a result of favorable price and volume. We saw strength across both our Americas and International regions. Q2 adjusted operating margin and adjusted EBITDA margin increased by 150 and 170 basis points, respectively driven by price and productivity in excess of inflation and investments, as well as favorable volume leverage. I'm very pleased with the operational execution and margin expansion in 2024. Adjusted earnings per share of $1.96 increased $0.20 or approximately 11.4% versus the prior year. Strong operational performance, accretive capital deployment and favorable interest and other more than offset the headwinds from higher tax. Finally year-to-date 2024 available cash flow was $176 million, which was a 7.4% decrease versus last year. I’ll provide more details on our cash flow and balance sheet a little later in the presentation. Please go to Slide Number Six. This slide provides an overview of our quarterly revenue. I will review our enterprise results here, before turning to the respective regions. Organic revenue grew 5.2% in the quarter, comprised of price realization of 2.7% and volume growth of 2.5%. As I mentioned last quarter, we are seeing the business return to expected seasonality in 2024 versus what we experienced last year. As John discussed earlier, we're accelerating capital deployment and have made investments in inorganic growth in both our Americas and International segments. As a result, acquisitions drove almost a point of growth in the quarter. Currency was a slight headwind, bringing total reported growth to 5.8%. Please go to Slide Number 7. Our Americas segment delivered strong operating results in Q2. Revenue of $770.7 million was up 6% on a reported basis and up 5.7% organically as a result of favorable price and volume in the quarter. Reported revenue includes 0.4% growth from the acquisitions of Krieger and Unicel. Our non-residential business, inclusive of Access Technologies increased mid-single digits in the quarter as end-markets remained stable. Our residential business was up low-single digits in the quarter, showing an improvement versus the declines in Q1. Demand for electronics in our Americas region remained strong. While electronics revenue was down low-single digits in the quarter against a tough comparable, our business has grown well above 30% over the last two years for both the quarter and year-to-date. Americas' adjusted operating income of $226.2 million increased 9.9% versus the prior year period due to solid top-line growth and strong operational execution. Adjusted operating margin and adjusted EBITDA margin for the quarter were up 110 and 130 basis points respectively, as we continue to drive margin expansion through price and productivity in excess of inflation and investments. Overall, our Americas team delivered another strong quarter. Please go to Slide Number 8. Our International segment had a solid second quarter. Revenues of $194.9 million was up 5.2% on a reported basis and up 3.1% organically. Price realization and strength in our electronics business drove the growth in the quarter. Acquisitions were a tailwind this quarter, positively impacting reported revenues by 3.2% driven by the Dorcas and Boss acquisitions announced earlier this year. Currency, however was a headwind of 1.1%. International adjusted operating income of $23.6 million increased 12.9% versus the prior year period. Adjusted operating margin and adjusted EBITDA margin for the quarter both increased 80 basis points. Volume and favorable mix are driving the margin expansion, as well as margin accretion from our acquisitions. Please go to Slide Number Nine. Year-to-date available cash flow came in at $176 million down $14.1 million versus the prior year. We did see year-over-year growth in the second quarter this year. However, the first half of 2023 was particularly strong as it benefited from supply chain lead-time reductions. Next, working capital as a percent of revenue increased primarily driven by higher receivables, as a result of the timing of revenue and collections within the quarter versus the prior year. Finally, our net debt to adjusted EBITDA remains at a healthy ratio of 1.9 times, consistent with where we finished 2023. It is worth noting that our gross debt and cash balances include the proceeds from our $400 million senior note issuance in the second quarter, which will be used to repay a $400 million senior note maturity in the back half of 2024. This resulted in a slightly higher gross debt to adjusted EBITDA at the end of the second quarter, but has no impact on net debt to adjusted EBITDA. Our business continues to generate strong cash flow and our balance sheet supports continued capital deployment. I will now hand the call back over to John."
},
{
"speaker": "John Stone",
"content": "Thanks, Mike. Please go to Slide 10. Allegion is on track for record full-year revenue, adjusted operating income and adjusted earnings per share in 2024. We are increasing our full year outlook on reported revenue and adjusted EPS, tightening our organic revenue range and affirming available cash flow. We now expect the Americas segment to be up 2.5% to 3.5% for total growth and 2% to 3% organically, led by our non-residential business. For International, we expect revenue to be up 3% to 4% in total including a 0.5% to 1.5% organically based on a solid start to the year, particularly in electronics and software. All in for the company, we’re raising total growth to a range of 2.5% to 3.5%. Organically, we are tightening the range by 0.5 point on both ends to 1.5% to 2.5%. Based on our strong operational performance in the second quarter and capital deployment, we are increasing our adjusted earnings per share outlook by $0.15 to a range of $7.15 to $7.30. Lastly, we affirm our outlook on available cash flow to be in the range of $540 million to $570 million. Please go to Slide 11. Now two years into my role at Allegion, I want to take a moment to reflect. I feel very lucky and very humbled to stepped into such a great team and business. We overcame supply chain and inflationary disruptions, and are now putting up record revenues and margins. We have two new factories ramping up productions smoothly and safely. We have successfully integrated the largest acquisition in Allegion's history and have grown our business further with five additional bolt-on acquisitions. And earlier this year, we earned the Gallup Exceptional Workplace Award, an achievement that I’d say is probably my proudest moment with Allegion so far. It is helpful to step outside the market discussion at the moment, whether it is supply chain and inflation as it was two years ago or Fed policy and macro data today. With Allegion, you will find a resilient business model, reflecting a strong value proposition, as well as opportunities to further drive growth and reward shareholders. It starts with the front-end and a spec engine that is always running and solving complex problems for our end-user customers, regardless of which non-res segment they're a part of. Plugging in bolt-ons like Krieger and Unicel into this spec engine creates additional value, as we bring heightened channel access to their strong niche products and help them grow. Our industry leading margins are the hallmark of a strong culture of execution at Allegion. We have a long standing track record of success on price and productivity that has created durable returns through the cycle. Allegion's broad portfolio and end-market exposure and mix of aftermarket and new construction further adds to the resiliency of our business. Our consistent balanced framework on capital allocation has allowed us to deploy approximately $280 million of cash flow year-to-date through accretive M&A and return of capital directly to shareholders. In summary, stable demand and strong execution by the entire Allegion team and our channel partners, drove record Q2 revenue and earnings per share results. We expanded margins and are accelerating capital deployment for the benefit of our shareholders, which supports our higher outlook for 2024. With that, let's turn to Q&A."
},
{
"speaker": "Operator",
"content": "We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Tim Wojs from Baird. Please go ahead."
},
{
"speaker": "Tim Wojs",
"content": "Hi everybody. Good morning. Nice job. Maybe just first question, just John, if you could maybe give us a little bit of color on what you are seeing on the spec side of the business within Americas. Just color on what you are seeing around like quoting and releases and maybe anything specific on end-markets. And then any sort of variances that you guys might be seeing from new construction and kind of re-modeling activity."
},
{
"speaker": "John Stone",
"content": "Yes. Thanks Tim. Appreciate the question. And I think channel checks recently, have been out in the field with our sales teams and our end-users and distributors, would indicate pretty much what we said at the outset that we are in, what we would just call, a stable demand environment, really driven by the institutional segments and the stability there. I think the specification activity is always on, just the way we said it in the prepared remarks. And our spec writers have the capability to flex to whichever vertical, whichever job that they need to. So whether it is an office building, whether it's a school, a university, a hospital, a data center, our spec writers can do it all. And so just think of that as a flywheel that doesn't stop. I'd say, on the -- just the demand side, certainly there is pockets of strength, pockets of weakness, like we've been saying for the last few quarters. That ebbs-and-flows, depending on where you are or which vertical you are looking at. But in general, I think, we would just stick with a stable demand environment, and we feel like our strength and our execution will differentiate us and we will outperform the market."
},
{
"speaker": "Tim Wojs",
"content": "Okay. Okay. That's helpful. And then just on M&A, I would say, historically the pace of M&A has been kind of uneven at Allegion. It is kind of come in clusters in the past. And you've closed four acquisitions year-to-date and I'm just wondering if that represents a change in the underlying pace of activity from your perspective, where we should expect a lot more kind of tuck-in activity or if that is just kind of a function of timing again. And really, what I'm asking is, should investors start to think about a much more regular cadence of M&A going forward for Allegion on an annualized basis?"
},
{
"speaker": "John Stone",
"content": "Yes, it's a great question, Tim and I appreciate that. And I’d just reinforce, we are really pleased with the acquisitions we've tucked in this year. Every one accretive to EPS right out of the chute. We talked a little bit gave a little bit of an indication on the kind of valuation that we were looking at here in the Americas recently. And I would say, way back to as I first stepped in the seat, we talked about orienting Allegion more towards growth. We do want to be acquisitive. We don't want to become a serial acquirer that just wantonly buys anything. We want to be very strategic. We want to play to our strengths. We want to have acquisitions that complement our portfolio and bring benefits to our customers. We want to have returns that are accretive to our shareholders. And so each acquisition, each deal is going to take on a life of its own and so the timing is going to be what it is. But I’d say, in terms of activity, our view would be -- my view would be the environment for strategics like Allegion is better than it was a year or two ago. We don't see that changing in the near-term, and we do see a good pipeline of opportunity. So I think you can look forward to seeing more quarters like you've seen these last couple from Allegion."
},
{
"speaker": "Tim Wojs",
"content": "Okay, great. Thanks for the time and good look on rest of the year."
},
{
"speaker": "John Stone",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Joe Ritchie from Goldman Sachs. Please go ahead."
},
{
"speaker": "Joe Ritchie",
"content": "Hi, guys. Good morning."
},
{
"speaker": "John Stone",
"content": "Hi, Joe."
},
{
"speaker": "Joe Ritchie",
"content": "Hi. Maybe we can touch on Americas margins to start off. It is about the best margin we've seen in some time. And I'm just wondering on the sustainability of that margin going forward, what are the key levers? Especially impressive, given that you have margin-dilutive mix coming through in the Access Tech business. And so any color that you can provide on the go forward would be helpful."
},
{
"speaker": "Mike Wagnes",
"content": "Thanks for the question, Joe. We've been talking about this for some time. Our business, the way we manage it we drive pricing to cover inflation. We are going to drive productivity to fund our investments. And in aggregate, that price productivity investments and inflations dynamic is a net positive for us. We've shown that over many quarters now. We expect that to continue. From a pricing perspective in the Americas, that non-res business, it is very sticky. So we feel comfortable about the resiliency of the margin profile. And that productivity DNA that we have, we expect that to continue. So I would expect us to maintain these margins that you see. There was that temporary decline in 2021 and 2022, where we had supply chain challenges, that's kind of behind us now and we are in a good place. And I think from here, think of Allegion that you've known us over the last decade, where we are going to be driving that price and productivity to maintain and expand margins."
},
{
"speaker": "Joe Ritchie",
"content": "Yes. That's helpful. And John maybe just along that point, we have seen some commodities deflate to start the year. I'm just curious like what are you seeing in your core commodities? And how do you see the cost side of the equation evolving as we progress through the year?"
},
{
"speaker": "John Stone",
"content": "Yes. It is a good question, Joe. And I think we had some rather extreme volatility in '21, '22. That volatility, for sure has dampened. And I'd say lately, it is kind of been not much of an event. You see little blips up and down, but generally within a range that's not concerning to us either way deflation or inflation on the raw mat side. And as Mike mentioned, I think we've got a whole host of pretty exciting productivity projects in the pipeline for our factories. And then again, two new factories ramping up that are going to drive more productivity in a couple of parts of the business that need it. So I would say, raw mat has been stable enough recently. We don't see anything dramatic on the horizon."
},
{
"speaker": "Joe Ritchie",
"content": "Okay, great. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Joe O'Dea from Wells Fargo. Please go ahead."
},
{
"speaker": "Joe O’Dea",
"content": "Hi, good morning thanks for taking my questions."
},
{
"speaker": "John Stone",
"content": "Hi, Joe."
},
{
"speaker": "Joe O’Dea",
"content": "Can you start on the International side, I think this is the first quarter of volume growth in a couple of years. And so just in terms of expanding on what you are seeing there and confidence that things could have turned and expectations for volumes as we move into the back half of the year."
},
{
"speaker": "John Stone",
"content": "Yes. So it is a great question, Joe. I'm glad you asked us. We've been dying for the chance to brag on International, because we think they've been performing extremely well. I would call your attention to over the past couple of years, there has been some intentional pruning in International just to exit a couple of underperforming businesses. So let us not forget that. The acquisitions made recently have been contributing favorably to growth in International as well. The demand for electronics and our software solutions has remained strong in the high single-digit range in International. Those businesses continue to outperform. And then I would say, even Portable Security, after many, many quarters of very tough end markets, turned positive on volume here in Q2. So really happy for them. They've done a great job managing margins over the past year, 1.5 years in really tough volume environments, and that turned positive as well. Overall, I’d say, there is been just a ton of self-help work going on, on the mechanical side of our International business in addition to continued strong demand and strong performance by our electronics and software teams."
},
{
"speaker": "Joe O’Dea",
"content": "And then also I wanted to get your views on institutional in Americas. I think maybe some kind of contrasting data points out there when we look at the Dodge Momentum, institutional looks soft. I think recently we had the AIA come out with new forecasts for 2025, it is actually got institutional up 4%. So pretty good. So I guess when you look at spec activity, when you peel back anything you understand about Dodge Momentum, just overall in terms of direction on institutional, and if you see sort of tailwinds, headwinds there based on spec activity."
},
{
"speaker": "John Stone",
"content": "Yes, it is a good question. And certainly, we watch the same leading indicators that you referenced. They have been pretty volatile. Some of them have been flashing negative for a long, long time now. I’d say, in general, our view would be institutional segment has less volatility than maybe parts of the commercial segments. It is a bit more stable. And I think something else to look at that maybe wouldn't make it into an ABI or a Dodge Dart is municipal bond issuance, which is up about 30% year-to-date versus prior year period, which goes to funds, school budgets and things like that. Just something else to think about in terms of what's driving the activity, whether it is new construction or expansion or repair and maintenance, aftermarket type activity that's going on. I would say, the headline from the beginning of the prepared remarks is still the best takeaway, Joe. We see stable demand, but we feel like we're executing at a very high level."
},
{
"speaker": "Joe O'Dea",
"content": "That’s great. I appreciate it. Thanks."
},
{
"speaker": "Operator",
"content": "The next question comes from Julian Mitchell from Barclays. Please go ahead."
},
{
"speaker": "Julian Mitchell",
"content": "Hi, good morning. Maybe just a first question around the operations kind of guidance on the EPS tailwind. So you raised that, I think, at the high end and the low end, the organic growth guide is unchanged. So maybe just help us understand kind of what moved around in that? Was there just some conservatism and a cushion that you don't need anymore? Given we're at the halfway point of the year, did something move around in terms of, say, expectations on cost inflation? Any help on that, please, why that kind of operating guide has moved up for the year?"
},
{
"speaker": "Mike Wagnes",
"content": "Yes. Thanks for the question, Julian. If you look at our first half, we're doing quite well on the margin front. And we've been talking about it, and I mentioned it earlier to the earlier question. Just driving that price and productivity, the actions we can control to push margins. And we feel we've made good progress. So although organically we tightened the guide, we feel that the margin performance has really performed well. And so we did raise a [$0.05] (ph) as you see in our operational performance."
},
{
"speaker": "Julian Mitchell",
"content": "That's great. And then maybe just my follow-up question would be around if we think about the residential outlook surprising, I think, to see a positive result there in the second quarter. Maybe just update us how you're feeling about that market. The sort of consumer discretionary side seems very weak more broadly, understanding though that locks is not that discretionary. So maybe just some color on resi-expectations for the year ahead. Thank you."
},
{
"speaker": "John Stone",
"content": "Julian, this is John. That's a super insightful question. And I think a couple of different things going on in res. You are right. secondary home sales are at really low levels, really depressed levels. Housing completions has kind of maintained a decent pace. So we are hearing some better growth sentiment from large national builders. Interest rates, though mortgage rates are still quite high depressing some activities. So you sum all that up, we feel really good about how our resi business has executed the first half of the year. That being said, still a bit of a cautionary outlook, a bit of a flattish outlook is what we are contemplating. And then any relief in the interest rate environment would definitely be a positive for us. And I think that seems to be what the broader market is waiting for."
},
{
"speaker": "Julian Mitchell",
"content": "Sounds great. Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from Brett Linzey from Mizuho. Please go ahead."
},
{
"speaker": "Brett Linzey",
"content": "Hi, good morning. Congrats on a great quarter."
},
{
"speaker": "John Stone",
"content": "Thanks, Brett."
},
{
"speaker": "Brett Linzey",
"content": "Hi. Just a question on the electronic locks performance, better than I expected. The two-year stack did accelerate versus Q1. Would you attribute that to the improvement in the mix of the end-markets so multifamily, commercial softer; institutional, a little better? Or are you just seeing broader adoption across some of the different verticals?"
},
{
"speaker": "John Stone",
"content": "Yes, Brett, it's a really good question. And I appreciate you looking at the comps and the two-year stack. It is relevant to [top-back] (ph) given the tail of those supply chain disruptions that we've dealt with through first half of 2023, et cetera. Demand is still strong, and it is broad-based, I’d say, is the other conclusion. We see electronic locks being adopted in education, being adopted in health care, commercial office, multifamily, et cetera. It is broad-based adoption. The demand is still strong. And I think one of the key underlying growth drivers is still the leverage of the smartphone wallet, mobile credentials, digital credentials, digital identities that are now just increasing both the security of the access point, as well as the convenience, which is right up the middle of our seamless access and safer world strategy. You hear things from large university customers of ours that -- inbound students just flat-out refuse to carry a key or a plastic card these days and smartphone is a natural extension of their persona. So I see still tailwinds there in terms of electronics demand and adoption. And the work that we are doing in our hardware, the work we are doing in our software, as well as credential technology, really feel like Allegion is in a leading position here in the space and can continue to drive growth and good results."
},
{
"speaker": "Brett Linzey",
"content": "That's great. And then just a follow-up on the sales performance between new versus aftermarket. I understand you lose track of it at some point through the channels. But just curious if you had any granular color on how new construction versus aftermarket performed that you could glean through, whether it is lock categories or some other metrics."
},
{
"speaker": "John Stone",
"content": "Yes. It's a good question, Brett. And I think the most accurate way we can describe that as still think of us as roughly a 50-50 mix, and that -- those two 50s are not pinpoint precision numbers. You are right, selling through distribution and in some cases, two step distribution, you do lose sight of exactly where that goes. And I’d say, it probably also depends on where you are in the Americas. If you're in a place where there's net migration, like a Texas or Florida, a new construction is probably more than 50% right now. If you are in some more mature markets, regions, Midwest or Northeast or whichever maybe, it is more heavily weighted towards aftermarket. That's why I'd say, on balance and in aggregate, it is still appropriate to think of us as about a 50-50 mix. The other thing I’d say is that once you spec yourself in to a large institution, university campus, school district, et cetera that makes that aftermarket business really sticky. And so break, fix, repair maintenance, new wing or whatever expansion like-for-like, replacement is quite prevalent. And that's another important tailwind on the electronics side because we are seeing some early adopters of electronic locks now upgrading to a recent model after installing locks just six, seven years ago. So a faster replacement cycle is also showing up these days."
},
{
"speaker": "Brett Linzey",
"content": "Appreciate the insight."
},
{
"speaker": "John Stone",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "The next question comes from David MacGregor from Longbow Research. Please go ahead."
},
{
"speaker": "David MacGregor",
"content": "Yes, good morning. Thanks for taking my questions. Pretty solid quarter. So congratulations there."
},
{
"speaker": "John Stone",
"content": "Thank you very much."
},
{
"speaker": "David MacGregor",
"content": "Yes, I guess we are going to be talking about tariffs a little more here over the next few months. So I was wondering if you could just remind us what was the tariff burden to earnings last time around? And what's changed since in terms of reshoring suppliers? And maybe what percentage of your North American COGS would now be sourced outside of North America?"
},
{
"speaker": "John Stone",
"content": "Yes. Tough to break all that down. We'll see if Mike has anything to add, David. But this is John, I'll start. I'd say, for any global company like Allegion, tariffs in general are not helpful, right? That's not helpful to a company like Allegion. I would say -- I'd call you back to the near-shoring that Allegion invested in with our new factory in Querétaro, Mexico. The ramp-up is going well. Our people are safe. They are focused on quality. The numbers are coming through just like we thought. Great culture, great team down there. And that's for a lot of our residential products, are manufactured between Querétaro and our manufacturing campus in the Baja area that we have. I'd say, that investment did significantly derisk our supply chain, made our supply chain more resilient in terms of some product supply that used to be single-sourced and outsourced in China. And so we've acquired the IP, and we can produce that product wherever we want to now. We have that flexibility since we own the design. As well as shortening the supply lines, obviously, sourcing it close to home. I’d say, now is not really the time to speculate about any future tariff regimes. We need to just wait and see how the policies evolve. But in terms of supply chain resiliency, I think the investments we've made over the past 18 months or so have been very well-placed and are delivering the kind of results that we'd like to see. Mike, anything you'd add?"
},
{
"speaker": "Mike Wagnes",
"content": "Yes. If you remember, David we tend to manufacture in the region that we sell, right? So if you think of our Americas business, most of our non-residential business is really manufactured here in the United States. We do have some operations in Mexico as John mentioned, but we don't have a large supply chain where we are manufacturing our product in Asia and shipping it over here. If it is sold in the US, we tend to make it here as well."
},
{
"speaker": "David MacGregor",
"content": "Got it. Thanks for that detail. And just as a follow-up, I guess obviously not inventory in the specified business, but just wondering what you're seeing in terms of channel inventory in the commercial and the retail space?"
},
{
"speaker": "John Stone",
"content": "Yes, it is a good question, David. And I think we operate and our distribution channel operates in a made to order environment. And so in general, our channel does not hold a lot of inventory, unless that's specific to their business model where they -- a particular distributor will want to hold some, whatever unique or rarely ordered SKUs, just to be that provider of choice in their market. So lead times over the course of 2023 progressed back down to the two-week to four-week range for most of our products that our channel is used to. Ordering patterns have adjusted pretty well I think. And so I guess what I’d feel like is, similar like you saw with Allegion's seasonality Q1 to Q2, I think just kind of back to a more normal environment on the inventory side. And that's how we feel internally as well. I think our own inventory turns are up modestly this year. We feel good about that, good working capital discipline there. So my sense is our channel would feel the same."
},
{
"speaker": "David MacGregor",
"content": "Got it. Thanks very much. Good luck."
},
{
"speaker": "John Stone",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] There are no more questions in the queue. This concludes our question-and-answer session. I would like to turn the conference back over to John Stone, President and CEO, for any closing remarks."
},
{
"speaker": "John Stone",
"content": "Thanks very much everyone for joining. Appreciate your time. I think in summary, stable demand, strong execution by the entire Allegion team. And it is worth to call out, what I’d feel, is probably the best field sales and marketing team and distribution channel organization in the industry. Very proud of how they've executed in Q2. Very proud of our Q2 revenue and EPS results. And we definitely feel like Allegion's best days are still ahead. Thanks everyone."
},
{
"speaker": "Operator",
"content": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
alle | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Good morning, and welcome to the Allegion First Quarter 2024 Earnings Call [Operator Instructions] Please note, this event is being recorded."
},
{
"speaker": "",
"content": "I would now like to turn the conference over to Josh Pokrzywinski, Vice President of Investor Relations. Please go ahead."
},
{
"speaker": "Joshua Pokrzywinski",
"content": "Thank you, Drew. Good morning, everyone. Thank you for joining us for Allegion's First Quarter 2024 Earnings Call. With me today are John Stone, President and Chief Executive Officer; and Mike Wagnes, Senior Vice President and Chief Financial officer of Allegion. Our earnings release, which was issued earlier this morning, and the presentation, which we will refer to in today's call, are available on our website at investor.allegion.com. This call will be recorded and archived on our website."
},
{
"speaker": "",
"content": "Please go to Slide 2. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Please see our most recent SEC filings for a description of some of the factors that may cause actual results to differ materially from our projections. The company assumes no obligation to update these forward-looking statements."
},
{
"speaker": "",
"content": "Today's presentation and commentary include non-GAAP financial measures. Please refer to the reconciliation in the financial tables of our press release for further details."
},
{
"speaker": "",
"content": "Please go to Slide 3, and I'll turn the call over to John."
},
{
"speaker": "John Stone",
"content": "Thanks, Josh. Good morning, everyone. Thanks for joining us. Allegion is off to a solid start in 2024, and I'm very proud of our entire team. I'll walk through some of the top Q1 highlights briefly, and will share more on each of these through the course of the presentation. Institutional markets remain healthy as we expected, our team continues to leverage our capabilities in spec writing, made-to-order manufacturing and strong distribution partnerships to best serve our end user customers."
},
{
"speaker": "",
"content": "We're executing at a high level, expanding margins in the quarter and delivering balanced capital allocation. As previously announced, we acquired Boss Door Controls and Dorcas in Q1 and returned cash to our shareholders through dividends and share repurchases."
},
{
"speaker": "",
"content": "Driven by our vision of enabling seamless access in a safer world, Allegion's Q1 performance has set a solid foundation for the year. We're performing well, and we're affirming the 2024 outlook we provided to you in February."
},
{
"speaker": "",
"content": "Please go to Slide 4. Allegion continues to deliver on balanced and consistent capital allocation and our Q1 performance showcases this. We continue to invest for organic growth, building on the legacy of our flagship brands delivering new value and access through industry-first innovations and nurturing strategic relationships to be the partner of choice."
},
{
"speaker": "",
"content": "In March, Schlage announced a new smart lock integration with Airbnb to help improve and simplify host and guest experiences alike. Our integration means most Airbnb hosts with listings in the U.S. and Canada can now provide the seamless access experience to guests with the industry-leading Schlage Encode smart lock family directly within the Airbnb app. Host can streamline the check-in and checkout process with automatically generated guest access codes, removing the need to manually create unique codes for each visitor."
},
{
"speaker": "",
"content": "Access codes are shared with guests at the time of booking, and those codes are only active during their trip, automatically deactivating after checkout. Hosts can make any needed adjustments to their guest check-in and checkout times in the Airbnb app, which will automatically update the smart lock, keeping them in control of the access experience, while guests can rest easy with the peace of mind brought by having Schlage on the door. The smart lock integration within the Airbnb app is currently only compatible with Schlage, making this another industry first for our company."
},
{
"speaker": "",
"content": "Allegion also continues to be a dividend-paying stock. And as a reminder, in February, we announced our tenth consecutive annual dividend increase. For the quarter, this amounted to approximately $42 million in cash returned to shareholders."
},
{
"speaker": "",
"content": "Additionally, in Q1, we closed 2 bolt-on acquisitions. During our last earnings call, we discussed the February acquisition of Boss Door Controls in the U.K., which brings a strong architectural channel and a flexible supply chain while positioning us to increase our spec-driven business in Allegion International."
},
{
"speaker": "",
"content": "In March, we acquired Dorcas, a leading manufacturer of electromechanical access control solutions based in Spain. Dorcas' solutions are distributed and sold internationally with a strong presence across European markets, including in the education and health care verticals. Their electric strikes and locks are integral elements of access control systems and bringing this business into Allegion International is another strategic investment in the quality of our portfolio there. Lastly, in the first quarter, we made additional share repurchases amounting to approximately $40 million."
},
{
"speaker": "",
"content": "Overall, I'm happy with the balanced capital allocation you see here on this slide. We continue to invest in the core, continue growing the business and continue returning cash to shareholders. Mike will now walk you through first quarter financial results, and I'll be back to provide some final thoughts."
},
{
"speaker": "Michael Wagnes",
"content": "Thanks, John, and good morning, everyone. Thank you for joining today's call. Please go to Slide #5. As John shared, our team's Q1 performance reflects a solid start to 2024. Revenue for the first quarter was $893.9 million, a decrease of 3.2% compared to 2023. Organic revenue declined 3.6% on a challenging prior year comparable, which was up 15%. Q1 2023 experienced abnormally strong seasonality as the business recovered from previous supply chain interruptions."
},
{
"speaker": "",
"content": "Adjusted operating margin and adjusted EBITDA margin increased by 40 and 50 basis points, respectively, in the first quarter, driven by price and productivity in excess of inflation and investment. The team executed well to deliver margin expansion despite the volume declines."
},
{
"speaker": "",
"content": "Adjusted earnings per share of $1.55 decreased $0.03 or approximately 1.9% versus the prior year. Volume declines and tax headwinds more than offset margin expansion and interest and other favorability."
},
{
"speaker": "",
"content": "Finally, Q1 2024 available cash flow was $23.9 million, which was a 48.8% decrease versus last year and represents a return to historical norms. I will provide more details on our cash flow and balance sheet a little later in the presentation."
},
{
"speaker": "",
"content": "Please go to Slide #6. This slide provides an overview of our quarterly revenue. I will review our enterprise results here before turning to our respective regions. Organic revenue declined in the quarter by 3.6% as a result of the tough comparable I just mentioned. We saw the business returning to more normal seasonality in Q1 2024 versus what we experienced last year. Currency and acquisitions drove additional favorability in the quarter, bringing the total reported decline to 3.2%."
},
{
"speaker": "",
"content": "Please go to Slide #7. Our Americas segment delivered strong operating results in Q1. Revenue of $709.3 million was down 4.3% on both the reported and organic basis as favorable pricing more than offset lower volumes. On a 2-year basis, our Americas business grew approximately 17% organically. Our nonresidential business, inclusive of Access Technologies, declined mid-single digits against the prior year comp that grew nearly 30%."
},
{
"speaker": "",
"content": "Residential markets remained soft with our business down low single digits in the quarter as higher interest rates continue to impact new and existing home sales. Demand for electronics in our Americas business remained strong. While revenue was down low single digits in the quarter against a tough comp, our electronics business has grown nearly 30% over the last 2 years."
},
{
"speaker": "",
"content": "Americas adjusted operating income of $197.3 million decreased 0.4% versus the prior year period due to lower volumes. However, adjusted operating margin and adjusted EBITDA margins for the quarter were up 120 and 140 basis points, respectively. Overall, our Americas team continues to execute well and operate efficiently, driving margin expansion through price and productivity in excess of inflation and investments despite lower volumes."
},
{
"speaker": "",
"content": "Please go to Slide #8. Our International segment continues to see a challenging macroeconomic environment. Revenue of $184.6 million was up 1.4% on a reported basis but down 0.8% organically. Price realization was more than offset by lower volumes associated with soft end market demand. Currency and acquisitions were a tailwind this quarter, positively impacted reported revenue by 0.8% and 1.4%, respectively. International adjusted operating income of $19.3 million decreased 2% versus the prior year period."
},
{
"speaker": "",
"content": "Adjusted operating margin and adjusted EBITDA margin for the quarter decreased 40 and 50 basis points, respectively. Price and productive tailwinds, covering inflationary pressures, but modest volume declines resulted in lower year-on-year margin rates."
},
{
"speaker": "",
"content": "Please go to Slide #9. As I mentioned earlier, year-to-date available cash flow came in at $23.9 million, down $22.8 million versus the prior year. Q1 2023 cash flow was particularly strong as it benefited from supply chain lead time reductions, while the current year is more in line with historical norms."
},
{
"speaker": "",
"content": "Next, working capital as a percent of revenue increased primarily driven by higher receivables as a result of timing of revenue and collections within the quarter versus the prior year. Finally, our net debt to adjusted EBITDA remains at a healthy ratio of 1.9x, consistent with where we finished 2023. Our business is generating strong cash flow and our balance sheet supports continued capital deployment."
},
{
"speaker": "",
"content": "I will now hand the call back over to John."
},
{
"speaker": "John Stone",
"content": "Thanks, Mike. Please go to Slide 10. As we did last quarter, I want to spend a moment to highlight some of the key factors that we believe distinguish Allegion's business model and how we win in the marketplace. We continue to see favorable long-term demand drivers, particularly in our core institutional markets. Projects in these markets are largely funded outside of traditional bank financing and may be more commonly funded by municipal bond issuance. Bond issuance has continued its steady long-term growth with cycles around election year referendums. Issuance continues to support our view for stable institutional market demand as we progress through 2024."
},
{
"speaker": "",
"content": "Moving to the right side. We feel strongly we have a winning formula that comes from bringing the depth of Allegion expertise into these attractive markets. Our team has notched multiple health care wins in 2024, our traditional mechanical hardware and sliding door solutions have a strong value proposition in this vertical and the service capability we acquired with Access Technologies frequently puts us over the top. This shows the value we unlock through M&A as we continue to deploy capital and broaden our portfolio as a pure play in security and access."
},
{
"speaker": "",
"content": "Please go to Slide 11. In summary, Allegion's first quarter was marked by strong execution. Our team expanded margins and delivered balanced capital allocation, and we're affirming our full year 2024 outlook. It's noteworthy to share that Allegion was named a 2024 Gallup Exceptional Workplace Award winner earlier this month. This highly competitive award recognizes Allegion as 1 of the most engaged workplaces and it's a testament to the dedication of all 12,000-plus Allegiant employees."
},
{
"speaker": "",
"content": "Our team truly believes in Allegion's responsibility to keep our employees safe, operate sustainably, live up to high ethical standards and serve our local communities. By living our values and increasing employee engagement, we accelerate Allegion's success and advance our vision of enabling seamless access in a safer world for you. I'm proud of the progress we're making and grateful to be a part of this high-performing team."
},
{
"speaker": "",
"content": "Okay. Let's turn to Q&A."
},
{
"speaker": "Operator",
"content": "[Operator Instructions] The first question comes from Julian Mitchell with Barclays."
},
{
"speaker": "Matthew Pan",
"content": "This is Matthew Pan from Julian Mitchell's team at Barclays. Just the first one, kind of thinking about seasonality, Q2 is typically about 25% of the year's earnings. Any reason that might be different this year?"
},
{
"speaker": "Michael Wagnes",
"content": "Thanks for the question, Matt. When you think about our year, I would say return to normal seasonality is a theme that we said last year was abnormal. As far as individual quarters, we really don't like giving individual quarterly guidance, as you know."
},
{
"speaker": "",
"content": "I would just say, as you think about our business, don't think of last year as normal. Think of maybe some of the history that we had in the past where the summer months have more revenue. Like many companies that deal with the construction industry, we have more revenue in the summer months, the middle 2 quarters, with the revenues on the book ends 1 and 4 being a little less."
},
{
"speaker": "",
"content": "So our business tends to have a little more revenue in the back half of the year than the first half. But in general, think of '24 as a return to more normal seasonality versus what you saw in '23."
},
{
"speaker": "Matthew Pan",
"content": "Got it. And then just 1 follow-up. Lennox talked about some project delays in commercial construction and Otis was pretty downbeat on new orders. Does Allegion see any sort of project delays or any worse market outlook in the Americas nonresi piece versus, say, 6 months ago?"
},
{
"speaker": "John Stone",
"content": "Yes. So this is John. I appreciate the question. I think we would just go back to some of the prepared remarks, where we see Allegion's business is rather heavily weighted towards institutional, which, as we indicated, has more public financing type avenues to market. And the institutional segment is stable."
},
{
"speaker": "",
"content": "And I think in the commercial space, if our commercial business is kind of split between office, multifamily and then kind of everything else, which would include retail, which would include warehouses, manufacturing, data centers, there are certainly pockets of strength and pockets of weakness."
},
{
"speaker": "",
"content": "I think the broad portfolio and the broad end market exposure we have, that's what comes together and gives you the guide that we're contemplating for 2024, the outlook that we're contemplating. And so institutional, stable. Bond issuance actually had a pretty strong Q1, if you look at that year-over-year, which gives us a good feel that our outlook is pretty solid."
},
{
"speaker": "",
"content": "In terms of specifics, like did this project get delayed as you go through channel checks and as we get out and visit distributors and customers and things, yes, you do hear about that. You don't hear much in the way of cancellation. You do hear maybe a multifamily project is on hold for a little bit. You do hear some of that. But I'd say our business is more heavily weighted towards institutional and that segment is quite stable right now."
},
{
"speaker": "Operator",
"content": "The next question comes from Joe O'Dea with Wells Fargo."
},
{
"speaker": "Joseph O'Dea",
"content": "So I wanted to ask on Americas electronics. The downward single digit in the quarter on a tough comp, plus 30% to your stack still showing strong demand there. I guess just in terms of as you think about the year and what the comps look like in the remainder of the year, is this an area where you expect to see growth? Any context on kind of magnitude of year-over-year change for electronics demand in Americas on a full year basis?"
},
{
"speaker": "Michael Wagnes",
"content": "Joe, if you think about -- thanks for the question. If you think about individual product lines, we don't guide a product line or electronics. What I would share with you, long-term growth driver. You can see this business on a long-term basis, delivering CAGRs of high single-digit to low double-digit growth for electronics."
},
{
"speaker": "",
"content": "Clearly, last year, we had some catch-up associated with previous supply chain challenges. And so it was very robust growth that you saw, frankly, over the last 2 years. When you think of our electronics business, think of it as a long-term growth driver that's going to provide tailwinds for us to deliver above-market growth."
},
{
"speaker": "Joseph O'Dea",
"content": "Got it. And then also just related to the end markets and I guess, what we've seen recently in kind of ABI and Dodge Momentum, some of the softening there. Not really sure that, that kind of aligns with maybe the way you're characterizing things in particular, saw some softness related to Dodge Momentum in institutional markets. And really just interested on your perspective and what we're seeing in some of those leading indicators versus what you're seeing in spec writing and activity on the ground."
},
{
"speaker": "",
"content": "And especially as it relates to backlog of projects and the degree that, that could be weighing on some of the lead indicators where there's just a large backlog of projects. And so the stuff that's coming in might be a little bit slower just because of long lead times. So anyway, observations on kind of lead indicators."
},
{
"speaker": "John Stone",
"content": "Yes. This is John. I'll add some comments, I guess, to your comments, Joe. I think the lead indicators are what they are. I'd say we always got to be cautious not to read too much positive or too much negative into those. They're good signals, and we watch them just like you do. I think over the last like 18 to 20 months, institutional has been favorable when compared with some of the other commercial verticals. That does seem to play out in the end market as we get out and visit customers and distributors."
},
{
"speaker": "",
"content": "I think the lead time that you brought up with construction labor shortages, projects taking longer, that probably is extending some jobs out, some projects out longer than maybe historically it has been. In terms of quantifying that in an impact and the Dodge Momentum or any of these indices, we're not the right people to do that. What I would say is, again, we see stable institutional markets as -- and again, that's where our business is heavily weighted."
},
{
"speaker": "",
"content": "And the commercial segment of our business, you see a mixed set of verticals, just like we mentioned on the previous question. Our resi business, as we mentioned, is flat to slightly down. And in our outlook, we don't contemplate any dramatic changes or any dramatic tailwinds from those end markets, but feel good about the outlook we've provided. And I think initial start to the year affirms that for us."
},
{
"speaker": "Operator",
"content": "The next question comes from Brett Linzey with Mizuho."
},
{
"speaker": "Peter Costa",
"content": "This is Peter Costa on for Brett. I just have a strategic question around the election and tariffs. Obviously, we don't know what the outcome looks like, but just understanding that Allegion has a manufacturing footprint outside the U.S. Can you just talk about how nimble your supply chain is and just your ability to flex around different regions should we enter a more aggressive tariff regime?"
},
{
"speaker": "John Stone",
"content": "Well, let me -- this is John. I would just open with tariffs of any kind or not helpful to a company like Allegion in terms of our supply chain. I'd say we learned a lot of lessons as did everybody else over the course of 2022 and 2023. And in terms of supply chain resiliency, we feel a lot better about our position than we would have a couple of years ago."
},
{
"speaker": "",
"content": "Not going to get into specifics of where we buy this part or that part or where we make this or that. But I would say, managing the portfolio of several million SKUs like we do, made-to-order environment in terms of supply chain and manufacturing, I'm quite confident in Allegion's capabilities regardless of tariff regimes or administrations."
},
{
"speaker": "Operator",
"content": "This concludes our question-and-answer session. I would like to turn the conference back over to John Stone, President and CEO, for any closing remarks."
},
{
"speaker": "John Stone",
"content": "Well, thanks very much. And just to reiterate, we feel we're off to a solid start in 2024. We look forward to connecting with you again next quarter. Be safe, be healthy, everyone."
},
{
"speaker": "Operator",
"content": "The conference has now concluded. Thank you for attending today's presentation. You may now disconnect."
}
] |
amat | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Welcome to the Applied Materials Fourth Quarter Fiscal 2024 Earnings Conference Call. During the prepared remarks, all participants will be in a listen-only mode. Afterwards, there will be a question-and-answer session. I would now like to turn the call over to Liz Morali, Vice President of Investor Relations. Liz, you may begin."
},
{
"speaker": "Liz Morali",
"content": "Thank you. Good afternoon, and thank you for joining us for today's call. With me today are Gary Dickerson, President and CEO; and Brice Hill, CFO. Before we continue, let me remind you that today's discussion contains forward-looking statements within the meaning of the federal securities laws, including predictions, estimates, projections, or other statements about future events. Actual results may differ materially from those mentioned in these forward-looking statements, as a result of risks and uncertainties. Information concerning these risks and uncertainties is discussed in our most recent Form 10-Q and 8-K filings with the SEC. We do not intend to update any forward-looking statements. During today's call, we will also reference non-GAAP financial measures. Reconciliations of GAAP to non-GAAP results can be found in today's earnings press release and in our quarterly earnings materials, which are available on our Investor Relations website at ir.appliedmaterials.com. I will now turn the call over to Gary."
},
{
"speaker": "Gary Dickerson",
"content": "Thanks, Liz. With record revenue and earnings in our fourth quarter, Applied Materials delivered a strong finish to fiscal 2024 and our fifth consecutive year of growth. I would like to recognize the hard work and commitment of our global team for delivering these outstanding results. As this is our year-end call, I'll begin by highlighting our key accomplishments over the past 12 months. A year ago, in our November 2023 call, I said the company's priorities for 2024 were driving R&D programs to further differentiate our unique and connected portfolio to extend our leadership at key inflections that enable future industry growth, making operational and supply chain improvements to better serve customers, and drive productivity across the enterprise, and, ensuring that we scale the company in ways that are sustainable and environmentally responsible. Over the past year, we made significant progress in all these areas. We strengthened our position at major inflections in logic, DRAM and advanced packaging. We delivered double-digit growth in our parts and services business. We made improvements to our operations and supply chain that supported strong cash flow and margin performance. And, our key strategic initiatives are on track including the build out of our EPIC collaborative R&D platform and the deployment of our Net Zero Playbook. In my prepared remarks today, I'll talk about three key topics. First, how large-scale, secular trends are driving growth and innovation in semiconductors, and why energy-efficient computing is emerging as a unifying driving force for the industry. Second, how the major device architecture inflections that make up the semiconductor industry's roadmap are increasingly enabled by innovations in Materials Science and Materials Engineering, where Applied has clear leadership. And third, as the industry roadmap becomes increasingly complex, how we are creating incremental growth opportunities for the company to offer new solutions with our unique and connected portfolio, our high-velocity collaborative R&D platform, and our advanced service products. In the coming years, we are going to experience the biggest technology changes of our lifetimes with major advances in automation and robotics, electric and autonomous transportation, clean energy, and artificial intelligence. All of these tectonic shifts are made possible by semiconductors, and this provides a catalyst for the semiconductor industry to create and capture more value than ever before. The biggest tectonic shift is AI, which has virtually endless applications and therefore the potential to transform almost every area of the economy. Deploying AI at large scale will require AI-computing to be significantly more energy-efficient than it is today. To realize the full potential of AI, the leading AI companies are talking about the need to drive a 10,000 times improvement in computing-performance-per-watt over the next 15 years. To deliver energy-efficiency improvements of this magnitude, evolutionary innovation will be insufficient. Instead, we see a new technology roadmap emerging made up of multiple device architecture inflections in logic, memory and advanced packaging. This creates three significant opportunities for Applied to deliver more value to customers and extend our differentiation in the market. First, we have built a broad, unique and connected portfolio of highly enabling technologies that we can supply to customers as co-optimized and integrated solutions. By combining adjacent process steps such as material deposition, etch, and material modification into an integrated system, we are providing chipmakers innovative and comprehensive solutions to enable their energy-efficient architecture inflections. Integrated solutions account for around 30% of our Semiconductor Systems revenue, and we expect them to become an even larger part of our portfolio in the future. Second, we are driving earlier and broader collaborations with our customers and partners to bring next-generation technology to market faster. Our global EPIC platform, that we will build out over the next several years, is specifically designed to accelerate cycles of learning, increase mutual success rates, and improve investment efficiencies. In the U.S., construction of the EPIC Center in Silicon Valley is well underway and on-track to come online in 2026, and we will share more details about our EPIC Advanced Packaging strategy at a technical summit we are hosting for R&D leaders next week in Singapore. And our third key opportunity is in services, where we are focused on helping customers manage increasing complexity in their business as the industry scales. We are deploying our advanced service products to help them accelerate their R&D, speed up transfer of new chip technologies from lab to fab, and then optimize device performance, yield, output, and cost in high-volume manufacturing. This is supporting double-digit growth in our parts and service business, with a high percentage of these revenues coming from subscriptions in the form of long-term agreements. These subscriptions have a high renewal rate, and the average tenure of the agreements is growing. This year, we signed our first five-year service agreements with multiple customers. Overall, AGS delivered a record quarter, a record year, and their 21st consecutive quarter of year-on-year growth. Across the business, we are translating opportunities into results as major device architecture inflections grow our available market and we gain share through the technology transitions. In 2024, the leading-edge logic companies started moving the first gate-all-around nodes from their R&D pilot lines into high-volume production. We generated more than $2.5 billion of revenue from these advanced nodes in the fiscal year and expect those revenues to approximately double in 2025. Overall, the transition from a FinFET-based node to a node with gate-all-around transistors and backside power distribution grows Applied's available market from around $12 billion to approximately $14 billion for every 100,000 wafer starts per month of capacity. We also expect to capture more than 50% of the process equipment spending for the gate-all-around nodes, up from the mid-to-high 40% range for FinFET generation fabs. In DRAM, our revenues also grew significantly in fiscal 2024, up more than 60% year-on year. Compute memory is a critical technology for AI datacenters, and DRAM makers are accelerating their capacity plans especially in high-bandwidth memory, where high-performance DRAM dies are stacked and connected to a logic die with advanced packaging. The dies used in high-bandwidth memory are much larger than standard DRAM, which means that more than 3 times the wafer capacity is needed to produce the same volume of chips. On top of this, the packaging steps needed for die-stacking further increase our available market. In fiscal 2024, our HBM packaging revenues grew to more than $700 million. DRAM is a great example of how our inflection-focused innovation strategy is succeeding. By focusing on the most-enabling steps for next-generation technologies, Applied has increased our share of the DRAM market by around 10 points over the past decade. Future DRAM inflections will further expand our available market as next-generation 4F-squared and 3D DRAM architectures are even more materials engineering intensive. Advanced packaging is another major device architecture inflection that provides significant improvements in the performance, energy consumption, and cost of next-generation chips. We have been investing in new technology to enable advanced packaging for more than a decade, establishing strong leadership positions in micro-bump and through-silicon via. In fiscal 2024, our overall advanced packaging product portfolio generated close to $1.7 billion of revenue, up 3 times in the last four years. We believe this business will double in size in coming years, as heterogeneous integration is more widely adopted and we introduce new solutions that grow our addressable market. Gate-all-around transistors, backside power distribution, 4F-squared and 3D-DRAM, advanced packaging and next-generation power semiconductors are all examples of device architecture inflections that are enabled by materials engineering. As a result, materials engineering, which spans all the technologies needed to deposit materials, remove or shape materials, and modify the properties of materials at an atomic level, is growing as a percentage of overall equipment spending at advanced nodes. Before I hand over to Brice, let me summarize. In fiscal 2024, Applied grew revenue and earnings for the fifth consecutive year, we strengthened our position at the key technology inflections that customers will ramp in volume production over the next several years, we delivered double-digit growth in parts and services, and we drove operational performance improvements across Applied and our supply chain. As we look ahead to 2025 and beyond, we see AI and energy-efficient computing remaining the key driver of innovation in the semiconductor industry, and the industry's roadmap becoming increasingly dependent on materials engineering which grows Applied's addressable market and provides a tailwind for us to outperform through the investment cycle. I strongly believe that Applied Materials has the right capabilities, strategy, and partnerships, at the right time, and this puts us in a great position for the future. We are delivering differentiated solutions to our customers to help them win the key device architecture inflection races, we are strengthening R&D collaboration with customers and partners to drive innovation and commercialization velocity and optimize mutual success rates, and we are growing our service business by helping customers manage increasing complexity as the industry scales. Now, I'll hand over to Brice."
},
{
"speaker": "Brice Hill",
"content": "Thanks, Gary, and thanks to everyone joining today's call. We had a strong fiscal 2024, delivering record revenue and earnings per share, generating healthy operating cash flow, and distributing over $5 billion to shareholders via dividends and share repurchases. I would like to thank the entire Applied Materials team for their hard work and execution, which enabled us to achieve these excellent results. For the full fiscal year, net sales were $27.2 billion, up 2.5% on a year-over-year basis with growth in all three business segments. Non-GAAP gross margin was 47.6%, up 80 basis points year-over-year and our highest annual gross margin rate since fiscal 2000, as we optimized our operations and made progress on value-based pricing. On a year-over-year basis, non-GAAP operating profit grew 2.7% and non-GAAP operating margin was up 10 basis points. Non-GAAP earnings per share grew 7.5% year-over-year to $8.65. For fiscal Q4, net sales were $7.05 billion, up nearly 5% on a year-over-year basis, driven by solid growth in Semiconductor Systems and Services. China declined to 30% of revenue, in line with our previously communicated expectation and our historical average. Non-GAAP gross margin was 47.5%, up slightly on both a year-over-year and quarter-over-quarter basis, driven by a favorable mix and operational improvements offsetting headwinds related to the lower China revenue. Non-GAAP operating expenses were $1.28 billion, or 18.2% of revenue, and roughly in line with our expectations as we prioritized funding long-term strategic programs. Non-GAAP earnings per share was a record $2.32, up 9% year-over-year, and benefiting from higher gross margin, higher interest income, a lower effective tax rate and share repurchases. Turning to the segments, Semiconductor Systems sales were $5.18 billion for Q4, up 6% year-over-year, driven by leading-edge foundry-logic demand. Non-GAAP operating margin was 35.4%, down 50 basis points year-over-year given the normalizing China mix. DRAM sales declined 10% year-over-year, given the elevated purchases from China in Q4 of fiscal 2023. NAND sales were flat year-over-year. Foundry-logic sales increased 12% year-over-year, fueled by robust growth at the leading-edge, including increasing investments for gate-all-around nodes, as customers invested to enable critical technology inflections. Sales for the ICAPS nodes, which serve customers across the IoT, communications, automotive, power and sensor markets, were down year-over-year, given high demand in the year-ago period. Moving to Applied Global Services, AGS delivered record revenue of $1.64 billion in Q4, up 11% on a year-over-year basis and driven by robust growth in services, partially offset by a decline in 200-millimeter equipment sales. Non-GAAP operating margin of 30% was up 2.7 percentage points year-over-year, and non-GAAP operating income was a record $492 million. Year-over-year, we saw increases across many operational metrics, including a 7% increase in the installed base and a 10% increase in tools under service agreements. Our average contract length increased to 2.9 years, and we maintained a renewal rate of greater than 90%. Lastly, our Display business generated revenue of $211 million, in line with our expectations, as the industry experienced lower investment levels amidst ongoing weakness in end market demand. Over time, we expect there to be an increase in capital investments to support the adoption of OLED technology in IT devices like notebooks, PCs, and tablets. We are well-positioned to enable customers for the coming OLED IT inflection with our technology. Moving to the balance sheet and cash flows, we ended the quarter with cash and cash equivalents of $8 billion and debt of $6.3 billion. Cash from operations in the quarter was $2.6 billion, capital expenditures were $407 million and free cash flow was $2.2 billion. In total, we generated $8.7 billion in operating cash flow and $7.5 billion in free cash flow in fiscal 2024. We distributed $1.8 billion to shareholders in the quarter, including $329 million in dividends and $1.4 billion in share repurchases. For the full year, we distributed $5 billion to shareholders, of which $3.8 billion was through share repurchases, up 75% from $2.2 billion in fiscal 2023. As of the end of the quarter, approximately $8.9 billion remains available under our share repurchase authorization. As we contemplate fiscal Q1, we are seeing strong demand in leading-edge logic and the ICAPS nodes, and sequential growth in memory. With that in mind, let me share our outlook for fiscal Q1. We expect total revenue of $7.15 billion, plus or minus $400 million, and non-GAAP EPS of $2.29, plus or minus $0.18, both representing an increase of approximately 7% on a year-over-year basis. We expect Semiconductor Systems revenue of approximately $5.3 billion, which is up 8% year-over-year, AGS revenue of approximately $1.65 billion, which is up 12% year-over-year, and Display revenue of approximately $175 million. We expect non-GAAP gross margin of approximately 48.4%, driven by a favorable mix, and cost and pricing improvements, and non-GAAP operating expenses of approximately $1.33 billion. We are modeling a tax rate of approximately 14%. And our outlook is consistent with trade rules currently in effect. In closing, we had a strong fiscal 2024, with momentum across the majority of our markets, fueling record revenue and earnings per share. Our portfolio positions us to uniquely capitalize on the secular megatrends shaping the technology landscape from datacenter and AI to edge computing, the Internet of Things and display. Underpinning this is our strong investment-grade balance sheet, solid cash generation and healthy shareholder distributions. Operator, we are now ready to begin the Q&A session please."
},
{
"speaker": "Operator",
"content": "Thank you. We will now open the line for questions. [Operator Instructions] And our first question comes from the line of Stacy Rasgon from Bernstein Research. Your question, please."
},
{
"speaker": "Stacy Rasgon",
"content": "Hi guys, thanks for taking my questions. My first one, I wanted to ask what you're seeing or expecting for China mix as we go through next year. And I guess to that end, I was a little surprised you suggested, you saw ICAPS strength going into Q1. Do you think -- I guess maybe you can talk to us about how that ICAPS strength in the near term splits out between China and rest of the world, and how you see China mix either sustaining at 30% or moving off that number as we go through next year?"
},
{
"speaker": "Brice Hill",
"content": "Great. Thanks for the question Stacy, and hello. Yeah, the China mix, a couple of signals there. So, 30% in Q4 as we reported, and that's normalized and come down after we serve that China DRAM demand that we had in earlier quarters. Our outlook in Q1 is -- also contains approximately 30% for the China mix. When we think about ICAPS across the world, it is still very healthy. So, we said it's lower than our prior Q4. So, Q4 of '24 was a little bit lower than Q4 of '23, but the ICAPS market is still very healthy and it's healthy globally. It's healthy in China and it's healthy across the world from a total level perspective. Having said that, we expect the ICAPS markets to grow over time. We've talked about mid- to high-single-digits at the device level. We expect customers to continue to add capacity. There are signs to watch for. There are slower end markets in ICAPS, automotive, industrial, analog, image sensors are all markets that have been slower. So, we've kind of been looking to see if the investment rate would go a little bit lower, but as far as our Q4 and our Q1, it remains strong."
},
{
"speaker": "Stacy Rasgon",
"content": "Got it. Thanks. And for my follow-up then, if China mix isn't going up, gross margins are, so it doesn't sound like the gross margin increase is due to an increase in China mix. So, can you talk about the drivers of that gross margin increase into Q1? And I guess maybe talk to sustainability as we go through next year? Do you think you get back closer to the target ranges for gross margins as we go through the end of the year?"
},
{
"speaker": "Brice Hill",
"content": "Yeah. Thanks for the question on that. So, our gross margin, the way we want to shape that from your modeling perspective and where the business is, we think our underlying rate has improved to about 48.0% at this point. So, it has improved and that's -- we've made improvements top to bottom in the business, logistics, our inventory management, scrap management, cost overall and our implementation of value pricing. So, a lot of elements working on the gross margin equation. In Q1, in particular, it's -- we're guiding 48.4%, so above that 48.0% sort of baseline, and that's based on really strong product mix that we have in Q1. So, we think 48% is the right level for you to think about longer term and we'll of course continue to work on improving that."
},
{
"speaker": "Gary Dickerson",
"content": "Yeah, Stacy, this is Gary. One of the things also that we're very focused on is winning the inflections. There's a lot of really great inflections that provide a tailwind for Applied and we're bringing enabling technology to our customers in a number of different markets. So, one thing that is also a tailwind for us is pricing improvement as we're shipping more valuable products. So, that's part of what you're seeing in that increased gross margin. And I think that we have a great opportunity to continue to drive that going forward."
},
{
"speaker": "Stacy Rasgon",
"content": "Got it. Thank you, guys."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of CJ Muse from Cantor. Your question, please."
},
{
"speaker": "CJ Muse",
"content": "Yeah, good afternoon. Thank you for taking the question. I know you guys don't want to talk about WFE, but I was hoping you could speak to it directionally. How are you thinking about 2024, 2025 more importantly, growth? And maybe perhaps more importantly, in terms of the change in the administration, how you're thinking about the potential risk in terms of adding restrictions or perhaps going the other direction? Would love to hear your first thoughts there."
},
{
"speaker": "Gary Dickerson",
"content": "Okay. Thanks for the question, Stacy -- sorry, CJ, and thanks for staying up for us. So, on the WFE, directionally for '24, so we just closed our fifth year of growth. So, we'll see what the print is across the whole industry, but we would expect it to have shown growth. And then, for '25, if you zoom out, we're talking about $1 trillion semiconductor industry by 2030. I think that's consistent across most of the industry having that view. And we certainly have that view given the added wafer starts and added capacity across the industry basically every single year. So, it's hard to guarantee '25, but I'll just call out that our Q4 was growth year-over-year, our Q1 is growth year-over-year, and we just completed those five years, and we're starting to see that leading-edge component of logic accelerate as the gate-all-around nodes are being invested in across the world. Last, as far as the change in administration, it's early, we really can't speculate on what might change there. So, we'll have to wait for more input on that one. Thank you."
},
{
"speaker": "CJ Muse",
"content": "Very helpful. As a follow-up on gross margins, the 48% now as a floor is fairly pretty good accomplishment. So, would love to hear kind of how you got there and I guess how to think about growth beyond that over time."
},
{
"speaker": "Brice Hill",
"content": "Yeah, I don't think I can be as aggressive to call a floor, but I won't call it peak either. So, 48.4% for Q1, that's mix positive for Q1, but we do expect to continue to make improvements on that 48.0% baseline. So, we continue to have significant cost projects in our pipeline and as we introduce new equipment and improve the value of the equipment that's existing, we'll improve our value pricing. So, we expect to continue to make progress."
},
{
"speaker": "CJ Muse",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Vivek Arya from Bank of America. Your question, please."
},
{
"speaker": "Vivek Arya",
"content": "Thanks for taking my question. On the leading edge, the three big kind of foundries and the IDM among them, one of them is doing extremely well. The other two are not as much. So, when you say that leading edge is very strong, is it -- is the expectation that the one player that is doing very well continues to stay very strong and the others, even if they fall behind, are still sufficient to kind of give the overall industry a strong growth outlook for next year? So, I'm just I guess, the direct question is how much have you handicapped this kind of dichotomy in the market where one pair is doing extremely well and the other two are not doing as well?"
},
{
"speaker": "Brice Hill",
"content": "Thanks for the question, Vivek. Yeah, the way that we think about forecasting demand long term for the business really starts with the end markets. So, our view, if you think about datacenter, PC, smartphones, all the things that -- artificial intelligence that drive the leading edge, we think the eventual footprint of capacity will need to match those end-market requirements and it will be sort of independent of which foundries are serving what amount of each -- of that demand. And so, at a high level, we haven't really changed our expectations from the amount of leading-edge capacity that needs to be installed. And so, I would say, as customers change their schedules and their micro factory forecast, our forecast really hasn't changed."
},
{
"speaker": "Gary Dickerson",
"content": "Vivek, this is Gary. What I would add is that, I've been spending a lot of time with all of these different companies. The really big focus for everybody is improvement in energy efficient computing. AI is driving a significant amount of growth, those die sizes are very large. And so, when we look forward not just in '25, but we look over longer term, we see significant growth in leading-edge foundry logic. And the good thing for Applied is that those improvements in energy efficient computing are really enabled through architecture changes like gate-all-around or backside power distribution, where in every one of these architecture inflections, you're improving the power efficiency 20% to 30%. So, it's really, really important. One of the customers I was talking to said that every percent of energy efficiency improvement matters. And as we've talked about, we're really well positioned to gain share as our customers are going through those inflections with new gate-all-around nodes and backside power. So, that puts -- that gives us a really great tailwind going forward. And as Brice said, we really look at this from an overall market standpoint and we're pretty optimistic relative to the growth in leading-edge foundry logic."
},
{
"speaker": "Liz Morali",
"content": "Thanks, Vivek. We'll take our next question."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Atif Malik from Citigroup. Your question, please."
},
{
"speaker": "Atif Malik",
"content": "Hi, thank you for taking my question. I have a question for Brice. Brice, I believe on the last earnings call, you talked about China being 20% of your sales on a normalized basis next year. Is that still your view? And some of your peers have talked about decline anywhere ranging from mid-teens to down 30% for their China sales. And I know you're not talking about WFE next year, but is that kind of the right decline for China sales for you guys as well between 15% and 30%?"
},
{
"speaker": "Brice Hill",
"content": "Hi, Atif. We have some shaking heads in the room here. We don't recognize -- if I heard you right, we don't recognize the 20%, but I think the last quarter was 32%. Our quarter -- this quarter reported Q4 is 30% for our China as a share of total revenue. And our outlook quarter, Q1, is approximately 30% also. So, we think that's a normalized rate. It was elevated for a few quarters even up into the mid-40%s, and that was because we were shipping that DRAM demand to some specific China customers when it was allowed. Since then, it's come back down to the 30% range. And as we've highlighted in our outlook, that's consistent with our Q1, and we think that's -- when we look over the past several years, we think 30% is approximately normal for the company and that does include all of our businesses. That includes the Semi Systems, that includes our Services business and our Display business, which has significant sales in China."
},
{
"speaker": "Atif Malik",
"content": "Thank you for the clarification."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Toshiya Hari from Goldman Sachs. Your question, please."
},
{
"speaker": "Toshiya Hari",
"content": "Hi, good afternoon. Thank you so much for taking the question. Gary and Brice, I think you both mentioned the concept of value-based pricing a couple of times in your script and how that's driving gross margin. I know this isn't necessarily a new initiative at Applied, but if you can kind of expand on what you're doing exactly with your customers? Is it primarily tied to your IMS offering or is it broader than that? And which inning are you in as it pertains to you guys essentially trying to capture value? Thank you."
},
{
"speaker": "Brice Hill",
"content": "Yeah. Thanks, Toshiya. I would say third inning. And the reason I say that is because we are -- since we had the COVID events, we had supply chain and we had changes in our cost, we also had to reconcile with that. We've always had value pricing in the company. We've always thought about the value of the tools, but that was a bit of a shock in terms of what the cost levels were coming through the supply chain. So, we really had to stimulate our evaluation of the value being provided for each application and especially those integrated applications that are unique to the company. And so, we're in the process of strengthening our training process and our analytical process and our communications with the customers. And since the tools that we're providing and the systems we're providing, we do think create more value for the customers, we're making progress in that."
},
{
"speaker": "Gary Dickerson",
"content": "Yeah, Toshiya, if I look across all of the different businesses within Applied, I've never been more optimistic regarding the technology pipeline and product pipeline that we have and our positions around these key inflections that are important for energy efficient computing. So, as you mentioned, the integrated platforms, that's about 30% of our revenue, and those are absolutely crucial for these technology inflections. But I would say that if I look at foundry-logic or DRAM, where we've gained 10 points of share over the last 10 years, or advanced packaging or even in ICAPS, we have new products in the pipeline that will expand our available market and are incredibly valuable for some of these segments. I think we have a really robust pipeline of capabilities and that will help us from a value pricing standpoint. So, as Brice said, I think we have a lot of room to continue to grow."
},
{
"speaker": "Toshiya Hari",
"content": "Great. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Timothy Arcuri from UBS. Your question, please."
},
{
"speaker": "Timothy Arcuri",
"content": "Thanks a lot. Brice, you gave a number just now. You said that advanced node revenue is going to double. You said it was $2.5 billion I think this year. And you said it's going to double next year. Not all that's going to be incremental though because some is going to cannibalize I would think N3, N4, N5. So, do you have a sense of how much of that would be incremental? I mean, I'm sure that some of it is, but do you have a sense of how much of it would be?"
},
{
"speaker": "Brice Hill",
"content": "Thanks, Tim. So, yeah, this approximate doubling has to do with our shipments to the gate-all-around nodes across the industry. And what we said is in the fiscal '24, we shipped approximately $2.5 billion of equipment to gate-all-around nodes and we expect that to approximately double next year. And if I think about it, we've also described the increment for gate-all-around for us as approximately $1 billion raising what was a $6 billion investment for 100,000 wafer starts of capacity, wafer starts per month, to $7 billion. So, the increment would be about one-sixth if you're thinking about it from that perspective. And then, I think most of our shipments at this point are on the leading-edge logic are towards gate-all-around nodes. So, most of that is replacing revenue that was at prior nodes in the past."
},
{
"speaker": "Timothy Arcuri",
"content": "Very, very helpful. Thank you, Brice. And then, Gary, I know you talk about $1 trillion in semiconductor revenue, [that's this much value] (ph), longer-term number, but my question is how much WFE spending do you think has to be spent to support that much revenue? And really it kind of gets to what the longer-term WFE intensity is, which used to be 13.5% before COVID and it got to like 17% in 2023, but it's been coming down since then as China has come down. So, how do you think about like for $1 trillion worth of semiconductor revenue, how much WFE do you think the industry has to spend to support that? I don't know, Brice, if you want to answer that or Gary."
},
{
"speaker": "Brice Hill",
"content": "Yeah, I can jump in on that because we have seen elevated intensity this -- the WFE investment, the equipment investment over semiconductor revenues. We've seen that intensity increase largely on that significant ramp in China over the past couple of years as China ramped up capacity. So, we do expect it to decrease a little bit over time as we look forward in the forecast, but we're comfortable at this point that it should stay in the mid-teens, somewhere in the mid-teens as a metric."
},
{
"speaker": "Gary Dickerson",
"content": "Yeah. Tim, the other thing I would add is that we're very deeply engaged with all of our customers, I would say, more so than ever. This concept of high velocity co-innovation where we're co-innovating with our customers a decade out over multiple technology nodes has never been stronger with all of our innovative technologies, our device integration teams, really deep partnerships with customers. And what we see going forward besides overall capital intensity is increasing intensity in materials engineering and the technologies from Applied Materials. So, I think, again, we have very, very deep visibility across all of these different market segments, and that will put us in a good position."
},
{
"speaker": "Timothy Arcuri",
"content": "Thank you, both."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Krish Sankar from TD Cowen. Your question, please."
},
{
"speaker": "Krish Sankar",
"content": "Yeah. Hi. Thanks for taking my question. Gary or Brice, I just wanted to follow-up again on the value-based pricing argument. Is part of it driven by some of these technologies like gate-all-around where it's really difficult to do some of the vertical epi steps and therefore there's a lot more value added to it? The reason I'm asking is, once you get past gate-all-around, go to backside power delivery or even 6F-squared DRAM, does that intensity come down? In other words, gate-all-around is so difficult to do, the next steps might not be as critical? I'm just kind of curious how to think about this value pricing and whether it was a gate-all-around specific thing."
},
{
"speaker": "Gary Dickerson",
"content": "Hi, Krish. This is Gary. Thanks for the question. So, I would say that the entire industry is focused on energy-efficient computing. And we've heard some of the system companies talking about 100x improvements in five years or 10,000 times improvements in 15 years. It's really hard to accomplish those types of improvements. And the value why do these companies go to the most advanced nodes, they go there even though those wafers are more expensive because -- one CEO was telling me even 1% improvement in energy-efficient computing is worth a lot. So, when you think about all of these different nodes -- yes, gate-all-around is difficult, backside power is difficult, 4F-squared and 3D DRAM are difficult. All of these areas are very, very challenging and we have unique capability with our integrated platforms. We have one platform with multiple technologies that enables 50% improvement in resistance and obviously that's really critical for energy-efficient computing. So, I don't think this is a one-shot thing with the first generation of gate-all-around. All of these things I think are critical for customers and Applied is extremely well positioned."
},
{
"speaker": "Krish Sankar",
"content": "Thanks, Gary. Very helpful."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Harlan Sur from JPMorgan. Your question, please."
},
{
"speaker": "Harlan Sur",
"content": "Good afternoon. Thanks for taking my question. On the team's services business, strong performance, so 21 consecutive quarters of year-over-year growth and that trend clearly looks to sustain going into an improving semiconductor demand environment next year. Additionally, you guys have driven a much more annuity-like recurring and attractive revenue profile, however, operating margins are still about a 100 basis points below the 31% level that you drove for five, six consecutive quarters in fiscal '21 and '22 timeframe, and that was at a lower revenue base. And then maybe, about 200 basis points, 300 basis points below your prior long-term targets for low-30% operating profitability on revenue targets that were also lower. So, what's been responsible for the lower operating margin expansion? Is there still line of sight to getting into the low-30% range on continued AGS growth, or is there something sort of structurally that has changed?"
},
{
"speaker": "Brice Hill",
"content": "Yeah. Harlan, thanks for the question. There is something structurally that's changed. We have begun allocating more of our corporate expenses and our central expenses that are supporting each of our segments during this year, and that was accountable for a portion of the reduction in operating profit there. So, I think you see us improving our operating profit for that business over the last eight quarters generally. And I think the expectation is we'll continue to be able to make improvements even with those allocations -- that allocation increase that we made."
},
{
"speaker": "Gary Dickerson",
"content": "Yeah, Harlan, also there's tremendous pull as customers are going through these inflections in all of these different markets to accelerate time to market for those innovations and then transferring technology, first time right, faster technology transfer and then ramp into high-volume manufacturing, those are big opportunities. We're also driving tremendous innovation in our services and I've been meeting with a lot of the different customers here over the next quarter. There is real traction for many of these service innovations. So, that will continue to drive the value we create for customers and drive our margins higher in the future."
},
{
"speaker": "Harlan Sur",
"content": "No. I appreciate that. And maybe just a quick follow-up. So, as you guys focus on more value capture, especially with your integrated solutions, Gary, you spent a lot of time talking about sort of new technology enablement with these integrated systems. Do your customers also get the additional benefit in terms of better operational and manufacturability dynamics? I mean, I can imagine with an integrated system, you eliminate a lot of the wafer transport, transfer activities, which ultimately increases process module throughput, increases cycle time. You also potentially get smaller tool footprint, right? Is this an accurate assessment in any way to kind of quantify some of these operational benefits with your integrated systems?"
},
{
"speaker": "Gary Dickerson",
"content": "Yeah. Thanks for the question. So, we're always focused on improvements in energy-efficient computing and all of these different architectures, but there is also a huge focus in cost innovation. And cost innovation when we're combining these different technologies together, is one aspect. But the other thing is really helping our customers optimize these new device architectures. So, when we're in these technology discussions with a number of different companies, there are cases where we can simplify processes that really enable them to drive lower costs. Another example is with our pattern-shaping technology that we've talked about where our customers can reduce the number of EUV steps. So, there are a number of those kinds of opportunities. And then getting back to services, again, I was with one of our biggest customers here recently and we were talking about service innovation that can drive their overall operating costs lower. So, this is also a really big focus and I think an opportunity both for our systems business and our service business."
},
{
"speaker": "Harlan Sur",
"content": "Thank you, Gary."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Joe Quatrochi from Wells Fargo. Your question, please."
},
{
"speaker": "Joe Quatrochi",
"content": "Hey, thanks for taking the question. You mentioned in the prepared remarks that you were seeing DRAM customers accelerate capacity plans especially for HBM. I think most people expect HBM to continue to be strong spending, but are you seeing customers look to add capacity for conventional DRAM? I just want to make sure I understand that comment right. And then, how do we think about just the growth that you talked about sequentially from memory into the January quarter?"
},
{
"speaker": "Brice Hill",
"content": "Hi, Joe. We do see customers adding capacity in DRAM in total, more wafer start capacity. I actually haven't calculated how much of that was driven by HBM. What we would say is, about 10% of DRAM wafers right now are allocated towards HBM production, high-bandwidth memory. And the high-bandwidth memory demand is growing at about a 30% rate. So, we do see more capacity allocated each quarter to high-bandwidth memory, and we do see the growth rate there very high. My sense is that doesn't equate to exactly what's being added in the overall capacity footprint, but anyway, we do see capacity increases in the DRAM customers and we do see that market continue to be fairly strong."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Srini Pajjuri from Raymond James. Your question, please."
},
{
"speaker": "Srini Pajjuri",
"content": "Thank you. I have a follow-up to the previous question, Brice. If I look at your DRAM, obviously, very strong in fiscal 2024. I think you said 60%-plus growth and you kind of quantified the HBM at $700 million roughly. I think that's roughly about 20 points of growth. So, as I look out to the next, I guess, fiscal year, I'm just trying to understand how to think about overall DRAM growth, because HBM will obviously grow. And I believe there was some China in last 12 months, that's probably declining or already declined. So, all-in, do you expect, I guess, DRAM to grow next year or do you think it's going to be a challenge? Thank you."
},
{
"speaker": "Brice Hill",
"content": "Yeah. So, a couple of comments there. Long term, we've talked about the $1 trillion market and our view that -- $1 trillion semiconductor market and our view that capacity will be continued to be added across the ecosystem on the wafer side to support that. I think we've articulated in the past that for WFE, we expect about two-thirds to be foundry logic and one-third to be memory. We haven't gotten specific about what the share is for DRAM, but right now, today, in our Q4 and our Q1 guide, we're seeing a strong DRAM market, and that's a continuation, and we talked about the pull of high-bandwidth memory from the artificial intelligence usage models. So, I think it's fair that we expect capacity to be added over time, and we're not making a call on '25, but those are the dynamics."
},
{
"speaker": "Srini Pajjuri",
"content": "Got it. And then maybe another quick one on NAND. I know you guys have been fairly cautious on WFE spending when it comes to NAND, but there is definitely some optimism about tech transitions and in particular, molyb transitions. So, just want to hear your thoughts about how you're thinking about NAND for next year in terms of tech transitions and the opportunity for you guys."
},
{
"speaker": "Brice Hill",
"content": "Yeah. From a macro perspective, similar to the comments on DRAM, we do see a little bit of growth in NAND in our Q1 outlook. And the dynamic is slightly different at the macro level for NAND and DRAM. On the DRAM side, we do see added capacity, more wafer starts across the ecosystem. On the NAND, we haven't seen that because, I think the bit rate density, so the actual shrink rate of the NAND technologies has been so impressive and so high that it's actually delivered the amount of bits that are in the demand profile. And so, there hasn't been new wafer starts needed on the NAND side. So, most of that has been an upgrade market. So, that dynamic is slightly different. But in any case, we see a little bit of an uptick in the NAND in our outlook for Q1."
},
{
"speaker": "Srini Pajjuri",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Brian Chin from Stifel. Your question, please."
},
{
"speaker": "Brian Chin",
"content": "Hi there. Appreciate the time this afternoon. It sounds like you still view 30% as a normalized level of China sales, but of course, it did go higher than normalized into the 40%s in recent quarters. So, I was curious, is it reasonable that China could go below 30% in '25 if areas like leading-edge foundry or DRAM improve and ICAPS remains more stable plus or minus?"
},
{
"speaker": "Brice Hill",
"content": "Thanks for the question, Brian. I think that most of the variability for us will be based on the health of the ICAPS market in China. That's the vast majority of our business right now. We have served most of the DRAM and NAND business that we can serve and we [can't] (ph) serve leading-edge in China. So, most of -- the vast majority of the business is ICAPS and it will just depend on how that ICAPS market evolves. Earlier, I shared that there's a couple of signals that say the rate of investment might be slower. Those are higher inventory positions and slow end markets that are automotive, industrial, image sensors and analog are markets that are slower, but having said that, our Q4 and Q1 outlook is still strong for ICAPS across the world. And so, we'll just have to see how that matures. We do expect customers to continue to add capacity over the medium term."
},
{
"speaker": "Brian Chin",
"content": "All right. Thank you. Maybe if I could just ask a little bit of a longer-term question here. ASML earlier today was upbeat on its outlook for AI-driven DRAM spending overall. They also talked about lithography intensity increasing for DRAM toward decade end. This seems to differ, I guess, a little bit from your prior messaging around the potential timing and introduction of technologies like vertical transistor DRAM and even 3D DRAM. Can you maybe compare and contrast where the differences here might arise?"
},
{
"speaker": "Brice Hill",
"content": "I'll say one thing and then Gary will help here. I think my view is it's complementary, very complementary. So, as there's more business and more demand on the litho side of the equation, that of course, requires more equipment to do the actual materials. So, Gary has a comment."
},
{
"speaker": "Gary Dickerson",
"content": "Yeah. We're deeply engaged with all of the memory companies on their DRAM roadmaps. So, relative to the vertical channel transistor, also known as 4F-squared, I think that's where everybody is focused in the near term. We believe that inflection will be more materials engineering intensive. And again, we're really deeply engaged on the key technologies that will enable that architecture inflection. And I would say that everyone is also focused on 3D DRAM and that one is further out in time and that is significantly more materials engineering intensive. So, again, I can't really comment on what other people are seeing, but I would say that we're deeply engaged with all of those different companies on those architectures. We're working with their integration teams, their device teams, and we have high confidence that materials engineering intensity will increase with those inflections."
},
{
"speaker": "Brian Chin",
"content": "All right. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Joseph Moore from Morgan Stanley. Your question, please."
},
{
"speaker": "Joseph Moore",
"content": "Great. Thank you. I wanted to follow-up the strength in ICAPS. You sort of said there's weakness in automotive, industrial, analog and image sensors, that's a lot of the trailing edge category. So, I'm wondering [what's that believe] (ph) that's doing well? And does that sort of imply that it's geopolitically-related spending? Is there -- just what aspect of it is that's still strong?"
},
{
"speaker": "Brice Hill",
"content": "Yeah. Thanks, Joe. I think power -- some of the power-related components and I think some of the microcontrollers are stronger than those markets. Those are two that I recall from the discussions. So, I think what we see across ICAPS is it's continued to be fairly strong. It wasn't quite as high in our Q4 '24 as in our Q4 '23, but still a very strong market. So, we'll just have to watch how this evolves. Our perspective is that customers will continue to add capacity as the underlying market continues to grow towards this $1 trillion 2030 semiconductor market. But utilizations right now are a little bit lower than the ideal utilization level. So, we do think there could be some slowing of investment as we go through this year."
},
{
"speaker": "Liz Morali",
"content": "Thanks, Joe. We have time for one last question."
},
{
"speaker": "Operator",
"content": "Certainly. And our final question for today then comes from the line of Vijay Rakesh from Mizuho. Your question, please."
},
{
"speaker": "Vijay Rakesh",
"content": "Yeah. Hi. Just a quick question on the China side. Gary and Brice, when you look at the China revenues, do you expect it to kind of hold at these levels going through calendar 2025?"
},
{
"speaker": "Brice Hill",
"content": "Thanks, Vijay. In our Q1 guide, we are highlighting that it is also approximately 30%. So -- and looking historically, that's been the number that we've seen historically. And I'll just say that the market for us, I highlighted a few minutes ago, we're not serving much DRAM or NAND and no leading edge at this point. It's mostly the ICAPS business. And so, the fact that it's been restricted to the ICAPS business at this point, it will really change over time with the strength of that particular end market. We do expect that to grow over time. We'll have to see how '25 shakes out as the market matures. Thanks for the question."
},
{
"speaker": "Operator",
"content": "Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Brice for any further remarks."
},
{
"speaker": "Brice Hill",
"content": "Thank you, operator. I'm pleased with the strong performance we delivered in Q4 and for our fiscal year. We're in a strong position with an industry-leading portfolio of products and services and poised to uniquely benefit from the secular megatrends driving technology demand. Thank you for joining today's call. And Liz, please close the call."
},
{
"speaker": "Liz Morali",
"content": "Thank you, Brice, and thanks to everyone for joining the call today. A replay of today's call will be available on the Investor Relations website by 5 pm Pacific Time today. Thank you for your continued interest in Applied Materials."
},
{
"speaker": "Operator",
"content": "Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day."
}
] |
amat | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Welcome to the Applied Materials Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, you will be invited to participate in a question-and-answer session. I would now like to turn the conference over to Michael Sullivan, Corporate Vice President. Please go ahead, sir."
},
{
"speaker": "Michael Sullivan",
"content": "Good afternoon, everyone, and thank you for joining Applied's third quarter of fiscal 2024 earnings call. Joining me are Gary Dickerson, our President and CEO, and Brice Hill, our Chief Financial Officer. Before we begin, I'd like to remind you that today's call contains forward-looking statements which are subject to risks and uncertainties that could cause our actual results to differ. Information concerning the risks and uncertainties is contained in Applied's most recent Form 10-Q filing with the SEC. Today's call also includes non-GAAP financial measures. Reconciliations to GAAP measures are found in today's earnings press release and in our quarterly earnings materials, which are available on our website at ir.appliedmaterials.com. And with that introduction, I'd like to turn the call over to Gary Dickerson."
},
{
"speaker": "Gary Dickerson",
"content": "Thanks, Mike. With record revenues in our third quarter, and earnings towards the high-end of our guided range, Applied Materials continues to deliver strong results in 2024. Secular trends are growing our available market, and our unique and connected portfolio of capabilities, products and services, positions us to outperform the industry over the longer term. At our recent investor event at SEMICON West, leaders from our semiconductor business shared their perspective on the powerful, multi-decade technology trends driving the industry forward, and explained the role Applied is playing to enable the next generations of semiconductor technology. In today's call, I will summarize some of the key themes we talked about at that event including: how advancing energy-efficient computing performance is critical to deploying AI at scale, why the energy-efficient computing roadmap is increasingly enabled by materials engineering and Applied Materials, and how we are working in new ways to accelerate this complex roadmap and create new growth opportunities for Applied. Semiconductors provide the foundation for tectonic shifts in technology that will reshape the global economy over the next several decades, including AI, IoT, robotics, electric and autonomous vehicles, and clean energy. These multi-trillion-dollar global inflections are increasing demand for chips and driving the need for significant advances in semiconductor technology. The biggest tectonic shift of all is AI, and the race for AI leadership will, in large part, be determined by which companies in the semiconductor industry are first to deliver substantial improvements in energy-efficient compute performance. In our discussions with leading AI companies, they are telling us that reducing power-per-operation is now more important than increasing operations-per-second. They are also talking about the need to drive a 10,000 times improvement in performance-per-watt over the next 15 years. Evolutionary innovation is insufficient to deliver improvements of this magnitude, and we are seeing the emergence of a new industry playbook made up of major device architecture inflections in logic, memory and advanced packaging. These device architecture inflections are increasingly enabled by materials science and materials engineering where Applied is the clear market and technology leader. For AI, the advanced chips in the datacenter, used for training AI models, are built upon four critical categories of semiconductor technology: leading-edge logic, high-performance DRAM, high-bandwidth memory enabled by die-stacking technology and advanced packaging to connect the logic and memory chips together in a single integrated package. In leading-edge logic, key device inflections, in both transistor and interconnect, are currently moving from chipmakers' R&D pilot lines to high-volume production. The transition from FinFET to gate-all-around transistors grows Applied's available market for the transistor module from around $6 billion to approximately $7 billion for every 100,000 wafer-starts-per-month of capacity. We also expect to gain share through the gate-all-around transition and we're on track to capture more than 50% of the process equipment spending for the transistor fabrication steps. For the interconnect module, our available market is also about $6 billion for every 100,000 wafer- starts-per-month. We forecast this will also grow by about $1 billion with the implementation of Backside Power Delivery, and we expect to win more than 50% of the applications we address in interconnect when Backside Power ramps in volume manufacturing. In DRAM, we have also established clear leadership in process equipment, and are in a great position for future growth. Over the past decade, we have grown our market share in DRAM by around 10 points. As DRAM plays a critical role in energy-efficient computing performance, there is a huge focus on advancing the roadmap. The next major DRAM inflection, from 6F-squared to 4F-squared, or vertical transistor architectures, is materials-enabled, and we expect our market opportunity to grow by approximately 10% to around $6.5 billion for each 100,000 wafer-starts-per-month of capacity. We also expect to increase our share based on our position to enable the 4F-squared inflection. In addition, we believe the subsequent transition to 3D DRAM will grow our addressable market by an incremental 15%, further compounding Applied's opportunity. In the die-stacking technologies that enable high-bandwidth memory, we also have strong leadership positions, both in micro-bump and through-silicon via. We have seen demand for high-bandwidth memory accelerating in 2024 and expect to generate more than $600 million of HBM packaging revenue this year, which is approximately six times 2023. Overall, including HBM, we expect revenue from our advanced packaging product portfolio to grow to approximately $1.7 billion in 2024. We believe this business can double in size over the next several years, as heterogenous integration is more widely adopted and we introduce new solutions that grow our addressable market. Advanced logic, high-performance DRAM, high-bandwidth memory, and advanced packaging are all great examples of how future device architecture inflections are increasingly enabled by materials engineering. As a result, we expect materials engineering, as a percentage of total wafer fab equipment, to grow in both logic and memory through the coming node transitions. At the same time, thanks to our inflection-focused approach to R&D, and the strong positions we've established at these future device architecture inflections, we expect to capture more of the expanded opportunities we serve. The value of bringing next-generation semiconductor technology to market faster has never been greater. At Applied, our strategy and investments are focused on accelerating the industry's roadmap to support the highest growth-rate global inflections spanning: AI datacenters, edge-AI and IoT, robotics, electric vehicles and clean energy. This strategy is enabled by three pillars: First, we have built a broad, unique and connected portfolio of highly enabling technologies. As well as providing traditional, best-in-class unit processes, we can co-optimize, combine, and integrate our technologies to deliver more comprehensive solutions that address higher-value challenges for our customers. These integrated 'fab-in-a-fab' solutions have grown from approximately 20% of our semiconductor products revenue in 2019 to around 30% today. We expect demand for our integrated products to continue growing, both at the leading-edge and from our ICAPS customers who are serving specialty markets. Second, we are changing the way we work inside and outside the company. Over the past five years, we have built new capabilities and dedicated teams focused on module integration, device design and simulation, data analytics and AI, advanced packaging, and ICAPS. At the same time, we are driving earlier, deeper and more extensive collaboration with our customers and partners to win the device architecture inflection races, accelerate mutual success rates, and increase investment efficiencies. To further support these collaborative partnerships, we will build out our global EPIC platform over the next several years, which is specifically designed for high-velocity innovation and commercialization of next-generation technologies. And third, we are helping customers transfer new technology into high-volume manufacturing faster and then optimize performance, yield, output, and cost in their factory operations. This is supporting double-digit growth in services, with a high percentage of our service revenue coming from subscriptions in the form of long-term agreements. Overall, AGS delivered another record quarter, which is their 20th consecutive quarter of year-on-year growth. Before I hand over to Brice, I will quickly summarize. Applied Materials is delivering record results in 2024, and we are in a great position to benefit from secular growth trends over the longer-term. Semiconductors are the foundation for tectonic shifts in technology which will reshape the global economy over the next several decades. This is driving increasing demand for chips as well at the need for significant advances in semiconductor innovation. The race for AI leadership depends on delivering significant improvements in energy-efficient compute performance in the range of 10,000 times over the next 15 years. The need for more energy-efficient compute is driving major device architecture inflections within the semiconductor roadmap that are enabled by materials engineering and Applied Materials' innovations. This expands our served market and is accretive to our share, and the increasingly complex industry roadmap creates new collaboration and growth opportunities for Applied, enabled by our broad, unique and connected portfolio of capabilities, products and services. Finally, as you may be aware, Mike Sullivan will be retiring at the end of this calendar year and handing the reigns to Liz Morali, who recently joined Applied as our new Head of Investor Relations. I would like to say a huge thank you to Mike for his many contributions to the success of our company and congratulate him on an outstanding career. Now, over to Brice."
},
{
"speaker": "Brice Hill",
"content": "Thank you, Gary. And I'd like to thank our teams for their strong execution this quarter which enabled us to deliver record revenue, improved operational performance, and healthy gross margin. Today, I'll summarize the market environment, discuss our Q3 performance, and share our Q4 outlook. As Gary mentioned, Mike Sullivan plans to retire from Applied at the end of this calendar year. Liz Morali has joined Applied as our new Vice President of Investor Relations. Mike and Liz are working on a smooth handoff of the IR function beginning with our November earnings call. I hope you'll join Gary and me in congratulating Mike on his extraordinary career and leadership, and welcoming Liz to Applied Materials. Beginning with the business environment, our revenue in Q3 as well as our outlook for Q4 reflect the industry's focus on the major inflections Gary highlighted earlier. We are seeing particularly strong pull related to AI and data center computing. Specifically, our DRAM system shipments remained strong even as DRAM sales in China decline as anticipated. Adoption of high-bandwidth memory and other forms of advanced packaging continues to grow. And in foundry-logic, leading-edge investment is growing each quarter and becoming a larger percentage of our mix while ICAPS demand remains strong overall. Turning to our Q3 performance, we delivered record revenue of $6.78 billion, which was up 5% year-over- year, with growth in all three segments. Operationally, we saw improvements in a number of key metrics such as manufacturing cycle times, linearity and on-time delivery. These improvements give me confidence that we are preparing the company to more efficiently support the growth we are forecasting in the years ahead. The strong operational performance helped us deliver non-GAAP gross margin of 47.4%, which was up 100 basis points year-over-year. Non-GAAP operating expenses of $1.26 billion were up 8% year-over-year, and over 70% of the increase was driven by R&D programs aimed at the technology inflections Gary described. Non-GAAP EPS of $2.12 was up 12% year-over-year and $0.01 below our highest EPS quarter ever. Turning to cash flows and profit distributions in Q3, we generated nearly $2.4 billion in operating cash flow and over $2 billion in free cash flow. We distributed nearly $1.2 billion to shareholders including the first $0.40 per-share dividend and $861 million in stock buybacks. Turning to the segments, Semiconductor Systems sales were $4.92 billion in Q3, up 5% year-over-year. Segment non-GAAP operating margin was 35%, up 130 basis points year-over-year. From a device perspective, our DRAM sales grew nearly 50% year-over-year to $1.16 billion. Our DRAM sales in China declined sequentially as we anticipated, and this contributed to our company revenue in China declining by 11 percentage points sequentially to 32%, which is in line with our longer-term average inclusive of Semi Systems, AGS and Display. Our NAND memory sales grew 10% year-over-year to $203 million. Our foundry-logic sales were down 4% year-over-year to $3.56 billion. Leading-edge foundry-logic demand was lower year-over-year but continued to strengthen on a sequential basis. We continue to expect to generate more than $2.5 billion in system revenue from gate-all-around nodes this calendar year, with the potential to more than double next year. Our ICAPS business remained strong overall, with pockets of weakness in the auto and industrial end markets. Longer term, we expect the ICAPS market to remain around half the foundry-logic market as major inflections in IoT, autonomous and electric vehicles, and the global energy transformation are expected to drive mid- to high-single-digit, through-cycle growth in ICAPS semiconductors well into the future. We are investing in new products to compete in more areas of the ICAPS semiconductor and packaging ecosystem. We are also working with our customers to enable new power and sensor device architecture inflections using our co-optimized and integrated materials systems. Next, Applied Global Services delivered record revenue of $1.58 billion in Q3, which was up 8% year-over- year. AGS recurring parts, services and software revenue grew more than twice as fast as overall segment revenue during the quarter. AGS non-GAAP operating margin of 29.6% was up 230 basis points year-over-year, and non-GAAP operating profit was a record $467 million. From a business perspective, customer factory utilization continued to strengthen during the quarter across memory, foundry-logic and advanced packaging. Our leading indicators of future AGS growth remain positive. Our installed base of systems and chambers increased 7% year-over-year, and our average revenue-per-unit increased even more. Our average subscription agreement length increased to 2.8 years, and the renewal rate was above 90%. We continue to expect AGS to grow at a low double-digit rate over the long term. As a reminder, the consistency of our profitable growth in services gives us confidence in our ability to continue to increase our dividend per share. In fact, over the past 10 years, we have increased the dividend per share at a compound annual growth rate of approximately 15%. Moving to Display, Q3 revenue of $251 million was up 7% year-over-year, and segment non-GAAP operating margin was 6.4%. While LCD equipment spending remains low, we are becoming more confident that the OLED technology found in smartphones will be adopted in notebook PCs and tablets whose larger screen sizes will require a significant increase in capital investments. Applied has built a leadership position in deposition and e-Beam metrology technologies for the display industry and we are well positioned to enable our customers to convert the notebook PC and tablet markets to OLED technology over the coming years. Now, I'll share our guidance for Q4. We expect company revenue of $6.93 billion, plus or minus $400 million, and non-GAAP EPS of $2.18, plus or minus $0.18, both up 3% year-over-year at the midpoint. Within this outlook, we expect Semi Systems revenue of around $5.1 billion, which is up 4% year-over-year, AGS revenue of about $1.61 billion, which is up 9% year-over-year, and Display revenue of around $200 million. We expect non-GAAP gross margin to be approximately 47.4%, and non-GAAP operating expenses to be around $1.275 billion. Finally, we are modeling a tax rate of 12.5%. Thank you, and now Mike, let's begin the Q&A."
},
{
"speaker": "Michael Sullivan",
"content": "Thanks, Brice. To help us reach as many people as we can, please ask just one question on today's call. If you have another question, please re-queue and we'll do our best to come back to you later in the session. Operator, let's please begin."
},
{
"speaker": "Operator",
"content": "Certainly. [Operator Instructions] Our first question comes from the line of CJ Muse from Cantor Fitzgerald. Your question, please."
},
{
"speaker": "CJ Muse",
"content": "Yeah, good afternoon. Thank you for taking the question. I guess, for my question, I was hoping you could speak to how your outlook for WFE in the second half of the year and for all of 2025 has evolved over the last three months. Obviously, tremendous strength, anything AI related, but elsewhere kind of seasonal at best. So I guess, first part of the question is, can you share with us how you're thinking about your silicon business in the second half of calendar '24 versus the first half? And then, the early signs that you see today and how that informs kind of your view both positive and negative into 2025? Thanks so much."
},
{
"speaker": "Brice Hill",
"content": "Okay, CJ, thanks for joining the call. I think what we're seeing in the business today when we look at Q3 and our Q4 outlook, very strong energy around the AI inflections that Gary talked about. So, leading-edge is accelerating. We highlighted that in the prepared remarks. We're -- our forecast for $2.5 billion of gate-all-around related equipment in this fiscal year, we haven't changed that forecast. That stays the same. And when we think about DRAM and HBM memory, those kind of all go along with this energy we're seeing around the AI inflections and investments in that area. At the same time, our ICAPS business in both Q3 and Q4 remains very strong. We think that's robust. We can dig into that a little bit more during the call. But if anything, over the last 30 days, you ask us how we're feeling about the outlook, I would say the ICAPS business continues. It seems like every quarter, we sort of raise our expectations with respect to ICAPS. So, a lot of energy around leading-edge. ICAPS remaining strong. A very strong year for DRAM and HBM. Those are kind of key themes. For '25, we're not giving specific guidance, but we just say, we're pretty enthusiastic about gate-all-around and the technologies we've talked about on the leading-edge."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Stacy Rasgon from Bernstein Research. Your question, please."
},
{
"speaker": "Stacy Rasgon",
"content": "Hi, guys. Thanks for taking my question. I wanted to dig into the China revenues a little bit. So, 32% of revenue this quarter. It sounds like a lot of that was DRAM. I guess, was it all DRAM? And then, in the guidance for next quarter and I guess your expectations going forward from there, do you expect the China mix to be staying around these levels in the low 30% or does it go higher or lower? Is there anything else going on with China that we need to be aware of?"
},
{
"speaker": "Brice Hill",
"content": "Great. Thanks for joining, Stacy. So, yeah, on the 32%, I'll shift your perspective on that just a little bit. So, the 32% is almost no DRAM to China. So, you've got it right. Our business mix to China declined to 32%. And if I think back in time, just to remind everybody, if we go just over a year back, it was like 17% mix to China. We were having supply chain issues. So, it was very low at that point. In the last three quarters, we bounced up to the mid-40%s while we served the DRAM that we could ship and that's the prior three quarters. And we feel this quarter 32% is probably normal for us or in the normal range for us, that's across our entire business for shipments to China. And what it really represents is ICAPS. And the ICAPS market in total has been very robust. We think it will be a record year in our fiscal year for ICAPS. And China also, we would call it robust. There's -- we're adding customers. Utilizations are improving. It's a wide variety of products and factories. So, we think that market is robust both in Q3 and in Q4. So that gives you a sense of what's happening for us. And then, next quarter, we'll have a small amount of DRAM, but nothing like we've had the prior three quarters."
},
{
"speaker": "Stacy Rasgon",
"content": "So, is it fair to say that you still see the mix in the low-30%s next quarter to China?"
},
{
"speaker": "Brice Hill",
"content": "Yeah, we expect that mix approximately normal, which we call 30% for the next quarter, yes."
},
{
"speaker": "Stacy Rasgon",
"content": "Got it. That's helpful. Thank you, guys."
},
{
"speaker": "Brice Hill",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Srini Pajjuri from Raymond James. Your question, please."
},
{
"speaker": "Srini Pajjuri",
"content": "Thank you. Brice, just to follow-up to the previous question on China DRAM, obviously, you said it's near zero levels. Can you talk to your visibility as to when -- if you're seeing any hope on the horizon? Do you expect DRAM to come back at some point in China? And then, also ICAPS, you said the demand is pretty strong in China. Can you talk to what kind of trends you're seeing outside of China for ICAPS? Thank you."
},
{
"speaker": "Brice Hill",
"content": "Yes. Thanks, Srini. Thanks for joining. So, yeah, the China DRAM in Q3 and Q4 will be at nominal levels. We have speculated you may see new investments in DRAM there. I don't have any comments to make on that specifically for the roadmap, but I would say that DRAM globally is very strong, should be a very, very strong year for DRAM. Of course, that includes some of that China volume, but we think that goes along with the mix to HBM and utilizations in DRAM have improved and there's a lot of energy around the high-bandwidth memory for the leading-edge systems. And then, on the ICAPS side, no surprise here for probably anybody. We expect the edge technologies that we describe as ICAPS to grow mid- to high-single-digits over time. And that's driven by the inflections that we talk about, which is clean energy, renewable power, electrification, those sorts of -- AI edge sensors, all those sorts of usages. So mid- to high-single-digits is our view long term. And when we look at China for both Q3 and Q4 and the entire ICAPS business, I said before, it's probably going to be a record for us in our fiscal year. And it's not just China, we've had regions, other regions grow during this quarter."
},
{
"speaker": "Srini Pajjuri",
"content": "Got it. Thanks, Brice."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Vivek Arya from Bank of America Securities. Your question, please."
},
{
"speaker": "Vivek Arya",
"content": "Thanks for taking my question. I'm curious if we should bake in the impact of any CapEx cuts that were announced recently at Intel. What does that imply for just the overall WFE market for the remainder of the year and into next year? From your comments, it doesn't seem like it's having a big impact. Is the assumption that whatever CapEx has been cut there is being increased somewhere else, or just what are the puts and takes? Because it is a fairly sizable CapEx cut, which we are saying is more WFE in terms of the mix."
},
{
"speaker": "Brice Hill",
"content": "Yes. Thanks for joining, Vivek. Our outlook, we're not changing our outlook. We're still saying $2.5 billion on the leading-edge for gate-all-around in this fiscal year. And when we think about next year, we've just had -- we've had every quarter accelerating this year in the leading-edge and we think that's being driven by a lot of the excitement around AI and AI datacenter. So, we get as you -- I think you know, we get regular updates from our customers and our outlook that we've just given for Q4 is up to date with all of our customers. So, I think we tend to think of the market as a macro level. Customers update us all the time, but no real change to our view for leading-edge looking forward."
},
{
"speaker": "Vivek Arya",
"content": "Thank you, Brice."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Chris Caso from Wolfe Research. Your question, please."
},
{
"speaker": "Chris Caso",
"content": "Yes, thank you. Good evening. Question is on foundry-logic, and perhaps you could give some color on the growth you're expecting into '25 driven by some of the new process nodes such as gate-all-around as compared to capacity, because we know foundry capacity has -- additions have taken a pause here. Are you seeing any signs of that starting to improve either as you go through the second half of '24 into '25?"
},
{
"speaker": "Brice Hill",
"content": "Yes. Thanks, Chris, and thanks for joining. When we think about leading-logic, actually I'll make a comment for utilizations. We've seen utilizations improve in every single end market this quarter and our expectation is for that to continue next quarter. So, DRAM, NAND, ICAPS and leading-edge. And no change to our expectation on absolute leading-edge investment, gate-all-around technologies, not changing our number for this fiscal year. And we do think it's a harbinger for acceleration next year as we look forward. We're not giving a guide for '25, but we think there's a lot of energy around the AI markets and we see that in HBM, we see that in DRAM, we see that in leading-edge acceleration. So, we'll hope that those trends continue."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Krish Sankar from TD Cowen. Your question, please."
},
{
"speaker": "Krish Sankar",
"content": "Yeah, hi. Thanks for taking my question. Gary or Brice, I'm kind of curious about -- I know you don't want to comment on next year, but qualitatively, you see there's optimism on DRAM and NAND WFE is growing, but if you strip out HBM, you're beginning to see big demand in memory pricing, moderate for DDR and NAND compared to the first half of this year. So, I'm curious how to think about DRAM and NAND WFE next year relative to this year, and what end markets actually drive up spending next year?"
},
{
"speaker": "Brice Hill",
"content": "Okay, Chris. You're right, we won't give a guide for '25 specifically, but we do think that DRAM -- even outside of HBM, we do think that DRAM will put new capacity in place, so we expect investment in DRAM. There has been additions in wafer start capacity in DRAM, and there's more allocation of the DRAM capacity to HBM as you sort of highlight. So, the investment level there is higher than NAND. Looking forward to NAND, NAND still remains fairly low, but we did see, as I highlighted, utilizations improving. I would call them probably normal range for both DRAM and NAND. We see prices improve. We saw inventory positions improve at the vendors. So, we think it's a more positive environment looking forward than prior quarters for actually both memory technologies."
},
{
"speaker": "Krish Sankar",
"content": "Thanks, Brice."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Joseph Moore from Morgan Stanley. Your question, please."
},
{
"speaker": "Joseph Moore",
"content": "Great. Thank you. It looks like you had some good solid growth from the services business again. Are you benefiting there from the utilization increases in memory that you just talked about? Are you seeing offsetting utilization declines on the ICAPS services side? And then, any indication of customers worry about export controls, stockpiling on spares, anything like that? Just any puts and takes around that service growth? Thank you."
},
{
"speaker": "Brice Hill",
"content": "Hi, Joe. Yes, thank you. Services business, very exciting for us. We grew 8% year-over-year in Q3, 9% is our expectation for Q4. And just a reminder for everybody, we expect low double-digit growth going forward. We're expanding our services book with customers, kind of getting into information, AI-related services that help them ramp et cetera. We actually did expect a little more growth in Q3. We had thought we would grow double-digits this year. We're just short of that, and it's because utilization, while it grew, it grew a little bit less than we -- or a little bit slower than we thought. So, there's good news here. Utilizations are improving across the whole system, 8% year-over-year growth for us, and we expect that to pick up, as I highlighted, as we go into Q3 and looking forward. And just one other comment just for the rest of the investors. The other thing with this business since it's mostly recurring revenue for us about 85%, that gives us a very stable operating profit and growing. And so, we think about our dividend as being enabled by the profits from the services business and that gives us confidence we'll be able to raise our dividend looking forward."
},
{
"speaker": "Gary Dickerson",
"content": "Hi, Joe. Just maybe a little bit more color. If you look at what really all of our customers are focused on, there is a race for these new device architectures and the complexity is going up a significant. And in the prepared remarks, I talked about, about 30% of our tools are these integrated platforms that have a high degree of complexity. So, as these customers are racing to bring these new devices, complex devices to market, and also we're shipping more and more of these integrated platforms with multiple technologies, that also gives us a really good tailwind."
},
{
"speaker": "Joseph Moore",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Joe Quatrochi from Wells Fargo. Your question, please."
},
{
"speaker": "Joe Quatrochi",
"content": "Yeah, thanks for taking the question. Wanted to ask about the advanced packaging. I think based on the revenue expectations you have for HBM and advanced packaging, it implied basically that the non-memory advanced packaging relatively unchanged year-over-year. Is that the right way to think about it? And if so, why wouldn't that grow this year?"
},
{
"speaker": "Brice Hill",
"content": "I think so, Joe. In our forecast, we highlighted that advanced packaging was $1.1 billion last year, should grow to $1.7 billion this year, and we highlighted that $600 million of the growth would come from HBM-related equipment. So, I think you're thinking about it right. It was probably stable this year with HBM, high-bandwidth memory, driving the growth in that area. And again, we would point back to the energy around high performance systems and sort of the race Gary talks about to develop systems optimized for the AI workload. So, there's a lot of energy there at this point. And then just the last thing is we have highlighted that, that total packaging business sort of, to your point, $1.7 billion, we think it has the opportunity to double over several years looking forward given the energy around advanced packaging technologies. So, we'll keep investing there."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Toshiya Hari from Goldman Sachs. Your question, please."
},
{
"speaker": "Toshiya Hari",
"content": "Hi. Thank you so much for taking the question. I was hoping you could speak to gross margins and how you're thinking about profitability going forward, the puts and takes price, Brice. And Gary, you talked about complexity growing and how things like IMS contributing toward 30% of your business and that number growing over time. I would think your ability to price would improve going forward. What am I missing in terms of again the puts and takes as it pertains to gross margins? Thank you."
},
{
"speaker": "Brice Hill",
"content": "Okay. Thank you, Toshiya. I'll start on that. So, 47.4% gross margin for us in the quarter. We're actually very pleased with our performance in cost and pricing this quarter. And I'll just highlight as our mix to China, which are generally smaller customers declined during the quarter to 32%, that gave us some headwinds on the gross margin side. We were able to get some pricing performance and also some cost improvements and improvements in managing our inventory that helped us offset that mix decline and deliver 47.4% in the quarter. Since the China mix is 32%, we call that normal. I'll say now that 47.4% should be approximately our baseline level. And then, we look forward, we've talked about a goal of getting to 48% or higher next year, that's still our goal. We think we can make improvements going forward. There's a couple of headwinds if services or display grow faster than the core business that can be a headwind. But that's still our goal and we think we'll make -- continue to make cost and pricing improvements. And then, Gary on the..."
},
{
"speaker": "Gary Dickerson",
"content": "Yeah, Toshiya, again, our focus is really to enable our customers to accelerate their innovations for these new architectures especially around AI datacenter. That datacenter will pass smartphones and PCs relative to wafer starts. Everybody is focused on energy-efficient computing. So, these inflections are incredibly important for the entire ecosystem. Whoever gets there first wins big and everybody else is left behind. So, we're driving tremendous innovations in foundry-logic, leading-edge, high-bandwidth memory, DRAM, there's new architecture inflections, I talked about 4F-squared, advanced packaging. So, our positions in all of those inflections are very strong. We're on track to capture more than 50% of the inflection spending as those new devices ramp. And our goal is to move the needle for our customers and for Applied, and that includes how we drive value for them and how we drive our margins higher."
},
{
"speaker": "Toshiya Hari",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Harlan Sur from JPMorgan. Your question, please."
},
{
"speaker": "Harlan Sur",
"content": "Yeah, good afternoon. Thanks for taking my question. So, as we look at those companies that are pushing the absolute limits on advanced manufacturing technologies like 2-nanometer and 3-nanometer, and they're maxing out their [radical field] (ph) limits, they're also pushing advanced packaging technologies. Their design -- these are the guys that are designing the AI and accelerated compute GPUs, accelerators, for example. So, what we're hearing is that most of today's designs on these next-generation chips are targeting [indiscernible] second half of '25 and beyond. They're specifically focused around these new 3D SoIC architectures. So, using hybrid bonding, chip-stacking approach, 3-nanometer on 3-nanometer die, 2-nanometer die on 3-nanometer die. The manufacturability challenges here are pretty significant, right? But similar to your front-end integrated solutions, I mean, the team has been working on an integrated hybrid bonding system with some of your partners. What's the timeline for introducing these integrated solutions? And will you be trying to intercept these next-generation of 3D SoIC solutions coming to market, let's say, in the 2026 timeframe?"
},
{
"speaker": "Gary Dickerson",
"content": "Hi, Harlan. Thanks for the question. So, heterogeneous integration is one of the biggest areas of focus for Applied and for the entire industry. At our AI event, along with AMD at SEMICON, there was a discussion around driving 100x improvement in energy-efficient computing. So again, this is the big race that everybody is focused on, and certainly packaging is a key part of that. So, we're in deep engagements, really multiple technology nodes, five, 10 years out into the future, and there's going to be tremendous innovations. If you look even at new DRAM technologies like 4F-squared or high-bandwidth memory, you're going to see adoption of hybrid bonding technologies that are going to be really important for those parts of this ecosystem. And you mentioned what's happening from a logic standpoint. So, I think the great thing for Applied is we have this broad portfolio in packaging. We have, as you mentioned, the hybrid bonding, digital lithography. We have other new technologies in the pipeline that even expand our portfolio further. We have an advanced full flow packaging lab in Singapore, where we're driving co-innovation with our customers to accelerate those architecture inflections. So, I think this is going to be one of the most exciting segments of the market going forward. We're at about $1.7 billion today. We've talked about doubling the packaging revenue over the next few years. And I think it's going to keep going from there. Again, this is a really key part of the industry drive for energy-efficient computing."
},
{
"speaker": "Harlan Sur",
"content": "Thank you, Gary."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Charles Shi from Needham & Company. Your question, please."
},
{
"speaker": "Charles Shi",
"content": "Hi, good afternoon. I want to follow-up on the China question. Looks like your China revenue has well past the peak around almost the $3 billion per quarter level. Now it's down to like in the low $2 billion. And based on the commentary, it sounds like you are still expecting roughly 40%-ish of the China revenue growth year-on-year. But I mean, should the current dollar revenue level sustain into this year? I'm just hoping if you can give us any color because that would imply the China revenue probably is going down year-on-year, roughly 15%, 20% next year. I know you're not guiding, but that will be the conclusion I draw up on all the commentary you provided. Plus, I do want to get a little bit more insights. If I compare the China revenue performance of Applied Materials with some of your process control peers like KLA, they were expecting China to be flat into the second half, but you're obviously seeing a half of the half decline. Since you have the PDC business and I was hoping you definitely will have some insights into what drives the dispersion there. Thank you."
},
{
"speaker": "Brice Hill",
"content": "Okay, Charles. Thanks for joining. I think I would separate between ICAPS, the edge technology markets and the DRAM market for China. We had three quarters with elevated shipments that we described where we caught up on what was allowed from a DRAM perspective. If you separate that out, we're currently not expecting that to repeat at least nothing near that magnitude for next year. So that leaves us with the ICAPS market. And what we expect in the ICAPS market, our Q3 and Q4 and all of this year has been very strong in ICAPS. When we look at China in particular, utilizations are improving. We're adding customers. We've got a large number of factory projects that are building out. So, if you strip out your estimate for those extraordinary DRAM shipments the last three quarters, our expectation over time is that the ICAPS market will grow. We say mid- to high-single-digits. We will make a call for next year, but we would expect growth over time."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Brian Chin from Stifel. Your question, please."
},
{
"speaker": "Brian Chin",
"content": "Hi, there. Good afternoon. Thanks for letting us ask a question. So, if I look at the past three years, past three 10-Ks, TSMC was your largest customer. But they weren't 10% in either the April or January quarters. Taiwan, as a geography, was a little higher this quarter. Did TSMC cross the 10% threshold in fiscal 3Q? And then, even bigger picture, this overall pattern would seem to suggest a pretty favorable year-over-year compare moving into 2025 when you think about the type of spending gate-all-around and expansions being discussed. And so just kind of wanted to get maybe your view on that."
},
{
"speaker": "Brice Hill",
"content": "Yes. TSMC was a 10% customer in Q3 and we think obviously they're a large part of that leading-edge investment when we think about the gate-all-around technologies and lot of the energy being driven there as we look forward. One of the other callers talked about the need for innovation and Gary talked about the need for innovation on leading-edge. There's a lot of energy around that. We see acceleration each quarter on -- of this year on leading-edge and really haven't changed our outlook as we've moved through the year."
},
{
"speaker": "Brian Chin",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Blayne Curtis from Jefferies. Your question, please."
},
{
"speaker": "Blayne Curtis",
"content": "Hey, thanks for letting me ask a question. I was maybe a little confused on some of the history with ICAPS and the strength. I thought you were talking about last quarter that segment kind of being down slightly. I think you just said mid- to high-single-digits. So, maybe I have my reference point wrong, but also maybe it'd be helpful if you could just talk about the growth you saw in July, 15% sequentially for foundry-logic. Can you just relate that to leading-edge in ICAPS? I think the reception is leading-edge is very strong, but it sounds like your comments on ICAPS are suggesting that ICAPS is also strong. But then I'm trying to put that all with like the comment that it's going to be 50% of the mix, which I think that -- I thought that business is running a lot higher. So, if you kind of just help the full history and then how July played out would be helpful."
},
{
"speaker": "Brice Hill",
"content": "Yes. Thanks, Blayne. So, in the quarter, we did see strength in both end markets, leading-logic and ICAPS. Leading-logic is accelerating every quarter this year and we said ICAPS is very strong and continues to be strong throughout the year. This will probably be a record year for us in ICAPS for our fiscal year anyway. And so, leading-logic is accelerating based on the gate-all-around investments and the AI trends that we're talking about. And then, ICAPS, the mid- to high-single-digits was a longer-term forecast. We've had utilizations improving. And when we think about that market, we don't give a guide for next year, but we think there will be continued growth in the mid- to high-single-digits as all those different end markets like AI sensors, electrification, autonomous vehicles, renewable energy, all those end markets continue to build out and grow faster than GDP. That's our expectation."
},
{
"speaker": "Blayne Curtis",
"content": "Thanks for that."
},
{
"speaker": "Operator",
"content": "Thank you. And our next question comes from the line of Jed Dorsheimer from William Blair. Your question, please. [Operator Instructions]"
},
{
"speaker": "Jed Dorsheimer",
"content": "Hey, thanks for taking my question. Just a two-part one on the ICAPS, Gary. So first, in that business, I was just over in some of your -- some of the fabs or your customers over in Malaysia last week and it seems like capacity expansion outside of China has started again after some of the EV pressures have shifted to opportunities in power density in datacenters. So, I'm just wondering if you could comment on that. And then secondly, just as it relates to services for ICAPS, is that the same as on leading-edge or are there nuances in terms of the amount and timing there? Thanks."
},
{
"speaker": "Gary Dickerson",
"content": "Hi, Jed. Yeah. So, ICAPS, we're very bullish on ICAPS longer term. Brice talked about kind of mid-, high-single-digit growth rates in ICAPS over time, growth driven by all of those different segments, IoT, industrial automation, robotics, really edge computing also for AI, we think that's going to be a really strong business over -- I think many of the people on the call know that over five years ago, it's actually April 12, 2019, we formed our ICAPS group. And since we formed that group, just to focus on that market for IoT, communication, auto power and sensors, we've had share gains in that market. We've introduced more than 20 major new ICAPS products. And this group is just completely focused on innovation in those device segments. And there are races that are happening there. Your comment on what's happening on the different device segments, if you look at power electronics, there will be some major architecture inflections that will happen there that are important for electric vehicles and renewable energy. And we have an ICAPS architecture innovation group working -- co-innovating with our customers on those new ICAPS architectures. That's part of the strategy that we've built over the last five years. We have new products that are in the pipeline that will serve large ICAPS' new segments and new products for cost competitive applications. So again, it's been a big focus for us over a number of years. We've built tremendous capabilities. From a service standpoint, ICAPS is also a good market for us, and that's part of that overall growth opportunity for us, not only on systems where we've gained a significant amount of share. I'm very positive on how we're positioned. The actions that we've taken, I think really position us going forward in ICAPS. Brice, I don't know if you want to add anything else."
},
{
"speaker": "Brice Hill",
"content": "No, I would just say that two of our regions grew during this Q3. So, if the question is, is there investment in other areas of the world? Absolutely. And we expect that to continue. Thanks for the question, Jed."
},
{
"speaker": "Michael Sullivan",
"content": "And operator, we have time for two more questions, please."
},
{
"speaker": "Operator",
"content": "Certainly. And our next question comes from the line of Mehdi Hosseini from Susquehanna. Your question, please."
},
{
"speaker": "Mehdi Hosseini",
"content": "Yes. Thanks for taking my question. Just a very quick follow-up for Brice. If you could give us an update with the progression towards that 48%, 49% gross margin target, I assume that's for fiscal year '25? And how the funding for the EPIC R&D center, which I think is a $4 billion project is going to impact those targets? Thank you."
},
{
"speaker": "Brice Hill",
"content": "Okay. Thanks, Mehdi. So, the update -- the gross margin at 47.4%, we expect to make -- we talked about very gradual improvements as we work towards that 48%, and that would still be my expectation. You see actually the movement between last quarter and this quarter was modest. We fought those headwinds that we had from a mix perspective. On the EPIC, we did get the notice that we're not getting the grants, but EPIC, that's an important platform for us. It stands for Equipment, Process Innovation and Commercialization. It's going to allow us to accelerate co-innovation with all of our customers. We are continuing with that investment. It will elevate our CapEx as we look forward. And we are benefiting from the investment tax credit that's related to those types of projects. So, we still do have some help from the government from that perspective. And just a couple other modeling notes since we're on CapEx. So, as we look forward, the CapEx will -- for the EPIC center and in general will be at a higher run rate than we've had in the past. If you look forward in your modeling, just wanted to highlight that Q1 will be our normal step-up for pay-related increases and that you can look at the history to see what that step-up should look like if you're modeling that. And then the last piece would be our tax rate. Tax rate next year expectation will be 14% versus the 12.5% this year as more of our mix will be -- more of our worldwide mix will be US related. So that will change the tax mix. So thanks for the opportunity to get those in there."
},
{
"speaker": "Gary Dickerson",
"content": "Yeah, Mehdi, this is Gary. Maybe just a little bit more color on EPIC. As we've talked about, the whole industry is in a race to be first to market to deliver innovations for energy efficient computing. So, we -- in discussions with our partners, our customers and partners, we really believe that EPIC can enable us to innovate the way we innovate, really innovate in parallel, so accelerating both for our customers and partners and for Applied, our ability to bring those energy-efficient innovations to market. So, the concept we're getting tremendous traction and pull with our customers and partners. And we also think of EPIC as a global platform. So, where we make investments is going to be based on incentives, talents, proximity to innovation ecosystem. So, we are moving forward for sure with this EPIC concept. Very good traction with customers. And again, over the last several years, we've built out this innovation engine inside Applied Materials. We have architecture innovation teams that are working on ICAPS. They're working on foundry-logic and DRAM and packaging. We have this unique and connected portfolio of materials innovations that are crucial for all of those major inflections. So, EPIC is a way for us to innovate the way we innovate to move all of that in parallel to accelerate all of these major inflections that are crucial for AI, datacenter and all those major tectonic shifts in technology that we talked about earlier. But again, where we invest is going to be based on incentives, talent and proximity to local innovation ecosystem."
},
{
"speaker": "Michael Sullivan",
"content": "Great. Thanks, Mehdi, for your question. I think we're approaching the end of the hour. So, Brice, I'm going to go ahead and ask if you have any closing thoughts for us."
},
{
"speaker": "Brice Hill",
"content": "Okay. Thanks, Mike. From my perspective, I'm pleased that the investments we've been making in the technology roadmap inflections and also in our operational capabilities are showing up in our financial results this quarter on both the revenue and gross margin lines. I believe we put the company in a great position to grow along with megatrends like datacenter AI as a whole host of new technologies come to market across leading-edge, foundry-logic, DRAM, advanced packaging and ICAPS specialty chips. We have the fuel we need to keep driving the materials engineering roadmap with our customers, while also distributing profits to our shareholders through dividends and buybacks. Gary will be at the Goldman Sachs Conference in San Francisco on September 11, and I hope to see many of you at the Citi Conference in New York on September 4. Mike, thank you, and please close the call."
},
{
"speaker": "Michael Sullivan",
"content": "Okay. Thanks, Brice. And we'd like to thank everybody for joining us today. A replay of today's call is going to be available on the IR page of our website by 5 o'clock Pacific Time. Thank you for your continued interest in Applied Materials."
},
{
"speaker": "Operator",
"content": "Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day."
}
] |
amat | 2,024 | 2 | [
{
"speaker": "Operator",
"content": "Welcome to the Applied Materials Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards you will be invited to participate in a question-and-answer session. I would now like to turn the conference over to Michael Sullivan, Corporate Vice President. Please go ahead, sir."
},
{
"speaker": "Michael Sullivan",
"content": "Good afternoon everyone, and thank you for joining Applied's second quarter of fiscal 2024 earnings call. Joining me are Gary Dickerson, our President and CEO, and Brice Hill, our Chief Financial Officer. Before we begin, I'd like to remind you that today's call contains forward-looking statements which are subject to risks and uncertainties that could cause our actual results to differ. Information concerning the risks and uncertainties is contained in Applied's most recent Form 10-Q filing with the SEC. Today's call also includes non-GAAP financial measures. Reconciliations to GAAP measures are found in today's earnings press release and in our quarterly earnings materials, which are available on our website at ir.appliedmaterials.com. Before we begin, I have a calendar announcement. On Tuesday morning, July 9th, from 7:30 to 9 a.m., Applied will host a technology breakfast event at Semicon West in San Francisco. Joining us will be Dr. Prabu Raja, President of Applied's Semiconductor Products Group, along with Mark Fuselier, who is Senior Vice President of Technology and Product Engineering at AMD. After Mark shares AMD's AI computing technology vision, Applied's experts will share our advanced materials engineering roadmap for making future AI chips. We'll outline device architecture inflections in logic, including transistors, frontside wiring and backside power, along with DRAM, high-bandwidth memory, and other forms of advanced packaging. We hope you'll join us. And with that introduction, I'd like to turn the call over to Gary Dickerson."
},
{
"speaker": "Gary Dickerson",
"content": "Thank you, Mike. With second quarter revenue and earnings towards the high-end of our guided range, Applied Materials continues to deliver strong performance in 2024, and we are in a great position to benefit from secular growth trends over the longer-term. Semiconductors are the foundation of huge technology trends reshaping the global economy. These trends are driving demand for more chip manufacturing capacity, as well as better chips with higher performance and improved energy-efficiency. Key inflections that underpin the semiconductor roadmap are enabled by Applied Materials and will support our ongoing outperformance as next-generation chip technologies move into high-volume production. In addition, the complexity of implementing the industry's roadmap and bringing new semiconductor technologies to market is driving earlier, deeper and broader collaboration with customers, as well as supporting double-digit growth for our service business. In my prepared remarks today, I'll provide some examples of how Applied's innovations are helping to enable multi-trillion-dollar technology inflections, including AI. I'll explain how this translates to our performance in the near-term, and our future growth potential. I'll also describe how we are working with our customers and partners to accelerate major semiconductor inflections all the way from research and development to high-volume manufacturing, and by doing this, how we are capturing more value in our service business. I'll start with a big picture perspective. Tectonic shifts in technology, including AI, IoT and automation, electric and autonomous vehicles and clean energy, will transform virtually every area of the economy over the next several decades, and they all have one thing in common. They are built upon semiconductors. As these new technologies are deployed, they are driving growth and innovation across the semiconductor ecosystem. In terms of impact and scale, I believe AI will be the biggest technology inflection of our lifetimes. And at the heart of AI are some of the world's most sophisticated chips. In simple terms, the advanced chips that power AI datacenters are enabled by four key semiconductor technologies: leading-edge logic; compute memory or high-performance DRAM; DRAM stacking technology, referred to as high-bandwidth memory, or HBM; and advanced packaging to connect the logic and memory chips together and create a 'system in a package'. Applied has process technology leadership in all four of these areas, and we have made significant investments in next-generation solutions to make possible the key device architecture inflections that are essential for our customers' future roadmaps. In advanced logic, Applied has long-standing leadership in the materials engineering processes for both transistors and interconnects. The first nodes that use gate-all-around transistors are now transitioning to high-volume manufacturing. These new transistor process flows are considerably more complex, and the shift from FinFET to gate-all-around grows Applied's available market for the transistor module from around $6 billion to approximately $7 billion for every 100,000 wafer starts per month of capacity. With the gate-all-around transition, we are also gaining share and we are on track to capture over 50% of the process equipment spending for transistor steps. We also have very strong market share in interconnect, or the wiring used to transmit data at high speed and low power. Our available market for the wiring steps is approximately $6 billion for each 100,000 wafer starts per month, and we expect it to grow by $1 billion when Backside Power Delivery is introduced into volume manufacturing. Overall, we expect to generate more than $2.5 billion of revenue from gate-all-around nodes this year and potentially more than double that in 2025. In DRAM, one of the key approaches that memory makers are using to improve performance and power consumption is to implement logic technologies in the peripheral circuitry. Our deep capabilities in logic, combined with our strong position in DRAM patterning and our unique, co-optimized hard mask solutions for capacitor scaling, makes us the clear leader in process equipment for DRAM today and best positioned for future growth. In the critical die-stacking technologies used in high-bandwidth memory, we also have strong leadership positions, including in micro-bump and through-silicon via. Last quarter, we said that we expected our HBM packaging revenue to be 4 times larger in 2024 than in 2023. As we have recently seen customers accelerate their capacity plans for HBM, we now believe that our revenue could be 6 times higher this year, growing to more than $600 million. Across all device types, we now expect revenue from our advanced packaging product portfolio to grow to approximately $1.7 billion this year. Looking further ahead, we see opportunities for this business to double again, as heterogenous integration is more widely adopted, beyond the AI datacenter, and we introduce new products that expand our served market. AI datacenter is just one example that illustrates how the major inflections that underpin the next generation of semiconductors are enabled by Applied Materials. Materials science and materials engineering are increasingly important to the industry's roadmap. Applied has invested early to develop a broad, unique, and connected portfolio of materials engineering solutions that are critical to enable major semiconductor inflections from AI high-performance computing to ICAPS edge computing. We are translating those investments into consistent outperformance. Recent TechInsights data confirms that in 2023 Applied grew faster than the wafer fab equipment market for the fifth year in a row. We accomplished this despite headwinds created by trade rules that we estimate restricted us from more than 10% of the China market during that period. While we have gained share overall, we are growing share within our served market even faster. This is important, because as logic devices become more three dimensional, future generations of DRAM come to market and advanced packaging becomes more prevalent, we expect materials engineering to become an even larger portion of overall wafer fab equipment. Another key component of Applied's strategy is to address the increasing complexity faced by the industry. First, we are driving earlier, deeper and broader collaboration with customers and partners. We are changing the industry's innovation model with the goal to accelerate mutual success rates and increase investment efficiencies. Our global EPIC platform, that we will build out over the next several years, is specifically designed to support high-velocity innovation and commercialization of next-generation technologies. Second, we are able to provide more complete and connected solutions that accelerate major device inflections. The portion of our revenue generated by integrated solutions has grown from approximately 20% in 2019 to 30% today. We expect demand for these fab-in-a-fab-type solutions to continue growing, both at the leading-edge and from our ICAPS customers who are serving specialty IoT, communications, auto, power and sensor applications. And third, we are helping customers transfer new technology into high-volume manufacturing faster and then optimize performance, yield, output and cost in their factory operations. This is supporting double-digit growth of our service business. AGS delivered a new record for revenue this quarter, $1.5 billion, with a significant portion of this coming from subscriptions in the form of long-term service agreements. Before I hand over to Brice, I will quickly summarize. Applied Materials continues to deliver strong performance in 2024 and we are in a great position to benefit from secular growth trends over the longer-term. Tectonic shifts in technology, including AI, IoT, EVs and clean energy, that are reshaping the global economy are built on semiconductors, driving demand for more chips and new chips with higher-performance and better energy-efficiency. Key device architecture inflections that underpin the semiconductor roadmap are enabled by Applied Materials. We expect this to support our ongoing outperformance as next-generation chip technologies, including gate-all-around logic nodes, high performance DRAM and HBM and Advanced Packaging, move into high-volume production. And finally, the increasingly complex industry roadmap is driving earlier, deeper and broader collaboration between Applied Materials and our customers and partners, accelerating demand for our most advanced co-optimized and integrated solutions and supporting double-digit growth in our service business. Now, I'll hand over to Brice."
},
{
"speaker": "Brice Hill",
"content": "Thank you, Gary. And I'd like to thank our teams for their focus and execution, which resulted in another strong quarter for revenue and gross margin. Today, I'll discuss our overall business environment and share insights into our ICAPS business which serves the IoT, communications, auto, power and sensor markets. I'll describe our capital allocation strategy and operating model, demonstrating how we are driving profitable growth and attractive shareholder returns. I'll also summarize our Q2 results and provide our guidance for Q3. In calendar Q1, the global market for semiconductors grew 15% year-over-year and we are optimistic that the data center trends Gary outlined will help drive solid growth for the semiconductor industry. During the quarter, cloud service providers announced strong capital spending plans which is good news for our customers. In the market briefing we issued earlier this month, we forecast that the data center market will eventually become the number one driver of leading-edge foundry-logic wafer starts, surpassing PCs and then smartphones in the coming years. Within our business, we had a strong quarter in fiscal Q2 across DRAM, advanced packaging, ICAPS and services. In February, we projected that factory utilization would increase across all device types, and it did. Gary discussed how the data center AI megatrend is driving strong demand for our technologies used in leading-edge logic, DRAM, high-bandwidth memory and other forms of advanced packaging. Our ICAPS business is driven by three additional megatrends, notably IoT and edge computing, electric and autonomous vehicles and renewable energy. Across our ICAPS business, one of the largest demand drivers this year is edge computing, especially at the 28-nanometer node needed by smartphone companies and makers of IoT devices for industrial and home automation applications. A second large demand driver is power chips for electric vehicles where industry leaders are now establishing supply chains to support their long-term growth plans. A third driver is the power chips used to capture renewable solar and wind energy which are needed to achieve Net Zero goals in the decades ahead. We believe our ICAPS business will remain a large portion of our overall foundry-logic business for several reasons. One, the megatrends we described will continue to increase unit demand for ICAPS chips. Two, we are innovating at the device level which creates better chips, stimulates new system sales, and extends Applied's position as the highest-value partner for our customers. And finally, we are introducing ICAPS products in additional market segments which will help us broaden our reach and gain share. Next, I'll summarize our capital allocation strategy and the results it enables. Our efficient business model generates healthy free cash flow. Our first priority is investing in R&D and capital infrastructure to enable profitable growth. And our second priority is growing our dividend per share and using our buyback program to distribute excess free cash flow to shareholders. Specifically, over the past 10 fiscal years, we have reinvested more than $20 billion in R&D and over $5 billion in capital additions and distributed more than 90% of free cash flow to shareholders. Our capital allocation strategy supports our operating model, which I'll summarize. First, we invest over $3 billion in R&D each year collaborating closely with our customers to invent new semiconductor technologies that are critical to their competitive positions in the global megatrends we've described. Second, we design high-volume manufacturing systems that enable our customers to deploy these new chip and advanced packaging technologies at global scale. Third, we manage a global factory and supply chain network to manufacture these systems. Fourth, we service our systems which have decades of useful life helping customers maximize their return on investment by accelerating ramps and optimizing output, yield and cost. Fifth, we reinvest a high percentage of the profits from this activity back into R&D to develop more new technologies and solutions. And finally, we distribute excess cash to shareholders. An important point is that every tool we manufacture and ship grows our installed base and our service opportunity, which leads to consistent and stable growth for Applied Global Services. In fact, AGS has delivered 19 consecutive quarters of year-over-year growth spanning two memory downcycles. Over 80% of AGS revenue comes from recurring services and parts sales, about two-thirds of which is delivered under long-term service agreements that have a 90% renewal rate. Connecting this to our capital allocation strategy, AGS has continued to produce more than enough operating profit to fully fund our growing dividend. In March 2023, we announced a 23% increase in our dividend per share, and in March of this year, we announced a 25% increase. In summary, over the past ten fiscal years, our operating model has increased company revenue at a compound rate of over 13%, non-GAAP EPS at nearly 30%, free cash flow at 33%, and dividends per share at nearly 12%. Also over this period, we reduced net shares outstanding by over 30%. Now I'll summarize our Q2 results. On a year-over-year basis, net sales grew slightly to nearly $6.65 billion, non-GAAP gross margin grew 70 basis points to 47.5%, non-GAAP OpEx grew 5% to $1.23 billion, and non-GAAP EPS grew 4.5% to $2.09. Turning to segment results, Semiconductor Systems revenue remained strong at $4.9 billion and included record ion implant sales. Segment non-GAAP operating margin was 34.9%. Applied Global Services revenue increased 7% year-over-year to $1.53 billion, and segment non-GAAP operating margin was 28.5%. Our tools under subscription agreement increased by 8% year-over-year and our installed base of chambers surpassed 200,000 for the first time. Moving to Display, Q2 revenue was $179 million, and segment non-GAAP operating margin was 2.8%. We are becoming more confident that the OLED technology found in smartphones will be adopted in notebook, PCs and tablets, whose larger screen sizes would spur an increase in capital investments. Turning to cash flows, in Q2, we generated nearly $1.4 billion in operating cash flow and nearly $1.14 billion in free cash flow. We distributed nearly $1.1 billion to shareholders, including $266 million in dividends and $820 million in buybacks. We repurchased 4.1 million shares at an average price of $197.77. Now, I'll share our guidance for Q3. We expect revenue of $6.65 billion, plus or minus $400 million, and non-GAAP EPS of $2.01, plus or minus $0.18. Within this outlook, we expect Semi Systems revenue of around $4.8 billion, AGS revenue of about $1.57 billion, and Display revenue of around $245 million. We expect non-GAAP gross margin to be approximately 47%, and non-GAAP operating expenses to be around $1.26 billion. Finally, we are modeling a tax rate of 12.3%. Thank you, and now Mike, let's begin the Q&A."
},
{
"speaker": "Michael Sullivan",
"content": "Thanks, Brice. To help us reach as many people as we can, please ask just one question on today's call. If you have another question, please re-queue, and we'll do our best to come back to you later in the session. Operator, let's please begin."
},
{
"speaker": "Operator",
"content": "Certainly. And our first question comes from the line of CJ Muse from Cantor Fitzgerald. Your question, please."
},
{
"speaker": "CJ Muse",
"content": "Yeah, thank you for taking the question. I guess we'd love for you to talk about your visibility today and how your ongoing conversations are going with your large customers as it pertains both to your outlook for kind of second half versus first half on a calendar basis, as well as building that potential backlog into calendar '25. Thank you."
},
{
"speaker": "Gary Dickerson",
"content": "Okay, great. Hi, CJ. Thanks for the question. So, when we look at our business, and think about the largest customers as we look at Q3 and our guidance for Q3, we know that the DRAM shipments that we've had for China that we called out that were fairly high in Q1 and Q2 are falling off in the second half. And what we've been expecting is that ICAPS strength and leading-logic strength would backfill that drop-off in DRAM. And that's exactly what we see happening in Q3. And that's consistent on the leading-logic side with the advent of gate-all-around process technology and equipment beginning to ship earnest -- in earnest for the HVM ramp that will be upcoming, and I think that's a good indication of what we're expecting in the second half. We talked about whether leading-logic and ICAPS would be able to fill in for the drop-off in China DRAM, and that's exactly what we see in Q3. And then, when we look ahead to '25, we'll point to the same fundamental ramp for leading-logic. That will be gate-all-around. Gary highlighted in his remarks that we expected $2.5 billion of business related to gate-all-around shipments in '24. And we expect to be able to grow that significantly in '25 as that process technology ramps towards HVM, high-volume manufacturing."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Stacy Rasgon from Bernstein Research. Your question, please?"
},
{
"speaker": "Stacy Rasgon",
"content": "Hi, guys. Thanks for taking my question. Brice, I wanted to -- and Gary, I wanted to follow up on that sort of qualitative 2025 outlook. So, I guess, I heard you right, you said $2.5 billion gate-all-around this year, doubling next year or more. So, $2.5 billion of incremental year-over-year growth from gate-all-around, it sounds like you said the advanced packaging had the opportunity to double again over time, so that should be growing. HBM, theoretically, should be growing. ICAPS, I know has been a little weaker than it was. It feels like it's bottomed just given what we're seeing, that ought to grow. And I mean NAND flash is -- for you guys is pretty close to zero right now as well, so [indiscernible]. I mean, how do I think about like -- you've talked about over-delivering versus the market. Like let's say the WFE market was flat next year, given those drivers, how would I think about how you guys could grow relative to a market like that given those drivers?"
},
{
"speaker": "Brice Hill",
"content": "Yeah, thanks, Stacy, for the question. So, the way -- our perspective, we start with the longer-term view. And as Gary described, we're investing in the key inflections for the fastest-growing markets. And so, our perspective, if you stand back and think over many quarters or the next several years is that the leading-logic technologies like gate-all-around and backside power, the advanced packaging, HBM memory, our services business, we think all of those will grow faster than the average market and will help us gain share. And so, it's harder to call any particular quarter or a short time period in the near future, but that would be our perspective. And I think from a ICAPS perspective, you called out gate-all-around and ICAPS and DRAM and NAND, I think, thinking about all of them. We've talked about our DRAM share having improved over 10 percentage points over the last 10 years. And we expect that technology has great tailwinds. We talked about how HBM and utilization in DRAM is improving. So that's a positive. And if we think about ICAPS, the market, we have three quarters here that you can see, two -- our first two that are closed and our Q3 guidance, and ICAPS is very strong in those quarters and grows in Q3 to fill in some of that China DRAM business that drops off. And then finally, gate-all-around, the $2.5 billion that Gary highlighted, that's not just the incremental, that's our shipments for the entire business that are associated with gate-all-around that are shipping this year, and we do expect that to grow next year."
},
{
"speaker": "Gary Dickerson",
"content": "Stacy, this is Gary. Really, the big focus for us is enabling and winning major device architecture inflections. So, when you break out all of these different device segments, certainly, foundry-logic leading-edge, the opportunity there for us to grow is significant because we have a very high share of those big inflections. The gate-all-around, backside power delivery, wiring is a real strength for us. As Brice mentioned, in DRAM, we gained 10 points of overall DRAM share over the last 10 years. And if I look forward at the architecture inflections in DRAM, we're even better positioned. Those will be much more materials-intensive, materials engineering-enabled, and that's going to be a really good position for us. We also talked about packaging. We've increased our view of packaging in '24 to $1.7 billion. But as I mentioned and Brice reiterated, we have an opportunity to double advanced packaging business. In HBM, that's -- we've increased that growth from 4x to 6x this year. And the last one is our services business, 19th consecutive quarters year-over-year, where we've seen growth. And with these highly complex architecture inflections, it gives us a really great opportunity to add more value with our services business. Also as people are moving into new locations where they don't have an experienced workforce, we've talked about double-digit growth in services right now. That's a $6 billion run rate, but that's adding significant growth as we go forward. So, there's just a few other thoughts."
},
{
"speaker": "Stacy Rasgon",
"content": "But you said $2.5 billion this year from gate-all-around and more than double that in -- did I hear that wrong? Does that suggest $5 billion in gate-all-around in 2025?"
},
{
"speaker": "Brice Hill",
"content": "Yeah, that's what..."
},
{
"speaker": "Stacy Rasgon",
"content": "Or did I misunderstand what you said?"
},
{
"speaker": "Gary Dickerson",
"content": "No, I think that math is correct."
},
{
"speaker": "Brice Hill",
"content": "Yeah, that's right, Stacy. So, that's not just the increment. That's the entire equipment sales that we'll have for that technology. So, $2.5 billion for this year and opportunity to double that next year."
},
{
"speaker": "Stacy Rasgon",
"content": "Got it. Thank you, guys."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Mark Lipacis from Evercore ISI. Your question, please?"
},
{
"speaker": "Mark Lipacis",
"content": "Hi. Thanks for taking my question. Maybe a question for Gary. Gary, when you talk about like investing more in materials engineering, it seems like you're kind of climbing up the value chain to the place where your -- it used to be your customers' domain. And a lot of times when you see companies moving up the value chain and adding more value, ultimately, you see that reflected in improving margins. So, appreciate that you engage in partnerships and that's the spirit. But like if you're adding more value, it seems like that ultimately, at the end of the day, should come back to you in the higher profitability. And I'm wondering if you could just talk philosophically about that. Like how -- is that something you would expect to see happen, or does that manifest in other ways? Thank you."
},
{
"speaker": "Gary Dickerson",
"content": "Yeah. Thanks for the question, Mark. So, if you look at the industry overall, all of our customers are racing to be first to market to deliver those major device architecture inflections that determine their competitive position. So, gate-all-around, backside power, those new DRAM architectures and packaging is becoming more and more important to power performance and costs. So that is really what shapes the competitive landscape in the industry. And it's very, very clear, we're working with our customers for technology generations out into the future. So, we have very high visibility in -- this broad and connected portfolio that we have gives us an opportunity to engage with customers in those early and very deep relationships on those architecture inflections. And as we look forward, we do see materials engineering as a percentage of spend and the relative contribution increasing. And Applied has clear leadership, especially with this broad, connected portfolio. We built integration capability inside Applied that is really tremendous and really co-innovating with our customers as they're driving those architecture inflections. So, I do believe, for sure, that we will be creating more value in those relationships with our customers, and that certainly is valuable for them. And our focus is to capture more value as we're delivering more value with them. So, your basic question, I agree with your thoughts."
},
{
"speaker": "Mark Lipacis",
"content": "Thanks. Very helpful."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Vivek Arya from Bank of America Securities. Your question, please?"
},
{
"speaker": "Vivek Arya",
"content": "Thanks for taking my question. Gary, maybe back to the gate-all-around. So, you're raising the forecast there by $1 billion. I think on, I think, HBM, you're raising it by another $100 million or so. Is that all going to show up in July and October? So, does it mean that conceptually, the second half of the year is over $1 billion higher than what you thought before? And then, on gate-all-around, what is driving such a significant growth versus what you thought before? $1 billion increase over $1.5 billion base is a very strong number. So, I'm just curious, what are the kind of the qualitative factors? And then just also quantitatively, does it mean that second half is $1 billion higher -- $1.1 billion higher than what you thought before?"
},
{
"speaker": "Brice Hill",
"content": "Hi, Vivek, it's Brice. I'll just do a clarification here. This quarter -- we decided last quarter when we talked about the incremental revenue for gate-all-around that it was a little bit confusing. So, we changed. And this quarter, we're talking about all of our revenue that's associated with the gate-all-around transistor and wiring. And so, that's not just the increment. So, the $2.5 billion that we're talking about this quarter is not supposed to be interpreted as an increase relative to the $1 billion we talked about last quarter. We're just changing the basis. Now, we're just quoting all of the business that's associated with the gate-all-around product. So, hopefully, that helps. So, as far as answering the question about what's driving the increase, I don't think our perspective has changed very much. It's $2.5 billion for this year. It can grow significantly next year as the technology ramps. And then, what I would say is you do see some of that in our Q3 guide. So, as you know, we took down -- or we're dropping off the incremental China DRAM shipments that we had. And in the second half, we're filling that in with ICAPS strength and growing leading-logic shipments that are driven by gate-all-around."
},
{
"speaker": "Vivek Arya",
"content": "Brice, just a clarification..."
},
{
"speaker": "Gary Dickerson",
"content": "Vivek, I'd add, relative to kind of what drives the incremental spending, these technologies where you're improving device performance, the drive current, leakage, power consumption, all of those things, are incredibly difficult. And so, the customers -- and it's really all about this materials magic that we're able to provide with that broad portfolio of different types of technologies. So, step counts are increasing at every one of those different technology nodes as they are driving those roadmaps for performance, power to meet the -- especially for high-performance computing, AI computing demand type of applications. So again, those are very, very, very difficult technologies. Whether it's 100 billion transistors in a GPU or 100 kilometers of wiring in an applications processor, those are really amazing, amazing technology accomplishments with materials. That's what drives that incremental spending."
},
{
"speaker": "Vivek Arya",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Chris Caso from Wolfe Research. Your question, please?"
},
{
"speaker": "Chris Caso",
"content": "Yes, thank you. Good evening. The question is on advanced packaging, and you were pretty specific with what you're expecting this year. You spoke about the opportunity to double that again. You didn't provide a timeframe on that. So, if you could help us with some of the timeframe on when you expect to double that? And just in terms of what's driving that -- we know there's advanced packaging in logic and HBM, what's the mix of that in terms of what's driving the expectations higher?"
},
{
"speaker": "Gary Dickerson",
"content": "Hi, Chris. This is Gary. So, this whole focus around advanced packaging, heterogeneous integration is really a major drive across the entire industry. When you look at AI servers or any of these different kinds of applications, you see tremendous innovation in the high-bandwidth memory. You see tremendous innovation in how you're connecting together all of those high-performance logic chips and memory chips. And we really see the growth there being very, very significant, because it's so important to the industry's roadmap as kind of classic Moore's Law has slowed down significantly. This is another major driver of how the industry will innovate going forward. And with Applied, we have the broadest portfolio of technologies, PVD, CVD, CMP, plating, etch, we've added hybrid bonding, digital lithography, eBeam test. We have a very broad portfolio. And as we see those roadmaps -- and this is why I come back to architecture inflections are really what drives your incremental business going forward. So, we can see the roadmaps for our foundry-logic customers, for memory customers, all of them are investing very heavily in these types of technologies. And some of these areas also that are new innovations from Applied will help us drive that business 2 times higher, and I think that the compound annual growth rate keeps going up from there. The other advantage that we have besides this broad portfolio in the deep, multi-generation connection that we have with all of our customers is our full-flow packaging lab in Singapore. We're working with leading customers on those next-generation innovations, Chris. So, we have pretty good line of sight to what those inflections look like, the architecture inflections will look like in a very strong position to grow our share as those inflections come to market. We're not giving a specific timeframe on the doubling. It will happen over a number of years, but very, very optimistic about our opportunities in packaging."
},
{
"speaker": "Chris Caso",
"content": "Thanks."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Srini Pajjuri from Raymond James. Your question, please?"
},
{
"speaker": "Srini Pajjuri",
"content": "Thank you. Brice, I have a question on China. I think last quarter, you said you expect China to normalize to about 30% or so by the end of this year. So, my question is, is that still the expectation? And then, it looks like ICAPS is still holding up pretty well. So, is the decline primarily DRAM going forward? And I'm just curious as to given what we are hearing about what we're seeing in the end markets of ICAPS, I mean it looks like the broader analog is still relatively weak and auto is kind of mixed. I'm just curious as to what's driving the strength in ICAPS. Thank you."
},
{
"speaker": "Brice Hill",
"content": "Okay. Thanks, Srini. Yes, first of all, our mix, as we move to the second half of the year, will normalize with respect to China as a percent of our total revenue. So, it will be closer to 30% as expected. And it's the dynamic that you highlighted. We had some catch-up DRAM shipments to particular customers in China for the last three quarters. Those will fall off as we go through Q3 and Q4, and that really will bring our percentage of China revenue back down to -- closer to what's average over the last few years, which we'll call about 30%. And then, with respect to the mix of business, so as that DRAM business falls off, our ICAPS business and our leading-edge logic business does increase to fill that in. And so that's consistent with continued strength in ICAPS, which the rest of the market for us in China would be ICAPS-related. And I think you described it well. The end markets are mixed. So, industrial and auto have been weaker. Smartphone, PC-related products have been slow, but gaining some strength recently. And then, as we've talked about image sensors, power chips, microcontrollers, a lot of those markets have been stronger. So, it's been mixed end markets, but the customers are investing for forward-looking demand and to get capacity in place for forward-looking demand. And when we see utilization in those markets, we've seen it improve. So, I think when people ask us for guidance, hopefully, the best thing we can tell you is Q1 and Q2 were very strong in ICAPS and Q3 will be another strong quarter in the ICAPS market. Thanks for the question."
},
{
"speaker": "Srini Pajjuri",
"content": "Thanks, Brice."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Atif Malik from Citi. Your question, please?"
},
{
"speaker": "Atif Malik",
"content": "Thank you for taking my question. I have a question on gate-all-around as well. Very strong outlook, $2.5 billion, doubling to next year. Is the customer funnel for this demand pretty broad across the four foundries? And also, if you can rank order for us in the $2.5 billion, FPE, ALD patterning, like what's driving the most demand? Thank you."
},
{
"speaker": "Brice Hill",
"content": "I think, I'll take the first part. I think that demand is across our customer base. So, it's not one single customer, but we won't share any details about the relative balance between customers. And then, from a device mix perspective, Gary -- or I'm sorry, equipment mix, I don't know if there's anything you would highlight there."
},
{
"speaker": "Gary Dickerson",
"content": "Yeah. I think again, one of the advantages that we have is this broad portfolio of technologies along with integrated tools and also our integration engineering where we're working with customers who are really co-innovating on these different technology inflections. So, if you look at gate-all-around, we have Epi, PVD, ALD, selective removal, etch, thermal processing, implant, CMP and eBeam. So, it's a very broad portfolio. And I'm not going to break out all of those different pieces. But what I would say is our ability to connect that portfolio together is really a tremendous strength in our ability to co-optimize as you're thinking about -- and we've done this back in FinFET also, where we were able to co-optimize and innovate in how you're building those structures so that you can improve power and performance. And we're doing the same thing with gate-all-around."
},
{
"speaker": "Operator",
"content": "Does that answer your question?"
},
{
"speaker": "Atif Malik",
"content": "Yes. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Toshiya Hari from Goldman Sachs. Your question, please?"
},
{
"speaker": "Toshiya Hari",
"content": "Hi. Good afternoon. Thank you so much for taking the question. I had two quick ones, one on HBM and the other one on NAND. So, in HBM, your customers would tell us that they're sold out, certainly for '24. For the most part, they're sold out for '25 as well. So, my guess is you've got pretty good visibility into next year. Gary, you talked about overall advanced packaging doubling over the medium to long term. But when you zoom into HBM, could that business for you multiply again in '25 on a year-over-year basis? And then, on the NAND side, the business continues to be pretty depressed. Your customers, their profitability is improving, cash flow is improving or becoming less bad. Are you starting to see purchase orders from your customers come back? Or what do they need to see for them to spend on WFE again? Thank you."
},
{
"speaker": "Brice Hill",
"content": "Okay. Toshiya, it's Brice. I'll start, and then Gary may add something on the HBM. So, on the sold out comment, what we do -- we have seen utilizations improve across the DRAM wafer starts. We've seen the allocation to HBM from a wafer start perspective increase from 5% to probably something closer to 20%. That said, it's not 100% utilized. So, you could speculate what the -- if there's some restraints, it could be in the packaging side, and we have seen orders for HBM going up. So, we'll have to let you think about that and talk to those vendors from that perspective. On the NAND side, our perspective on NAND is that Moore's Law is still very much alive in NAND. The bit density is increasing with each generation of NAND fairly aggressively. And it's meeting the demand function for increased bits. And what that really means is that the business we see in NAND is for technology upgrades, more technology upgrades not really new wafer starts. So, that's what we expect to see as we move forward. And overall, we expect NAND to grow at the speed of semiconductors. It's -- obviously, storage has a very important part, and several of the vendors called out how important storage is even for AI and that it will grow. So, I think for us, it's been slow, but we expect it to grow over time and memory in total to be about a third of our sales for WFE. And then, Gary, back to you whether anything specific on HBM..."
},
{
"speaker": "Gary Dickerson",
"content": "Yeah. Really -- hi, Toshiya. Nothing really too much more beyond what Brice was talking about. And we have seen demand for HBM strengthening. We went from about 4x increase to 6x increase from the last time that we talked to you guys. And I would say that we still are seeing incremental demand going forward. So that pull is still there from customers. We're not giving any point estimate for next year, but we do continue to see stronger demand in that segment."
},
{
"speaker": "Toshiya Hari",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Krish Sankar from TD Cowen. Your question, please?"
},
{
"speaker": "Krish Sankar",
"content": "Yeah. Hi, thanks for taking my question. Gary, I had a question on backside power delivery. It seems that the industry has two approaches to it. One is the backside wiring with direct contact with the transistors, and another one is the [nano-TFE] (ph) approach. I'm kind of curious, you've spoken about the 100 -- incremental $1 billion SAM for 100,000 wafer starts per month. How does it split between those two approaches? And also, can you quantify what kind of revenues you expect this year and next year for Applied in backside power delivery? Thank you."
},
{
"speaker": "Gary Dickerson",
"content": "Hi. Krish. Yeah, I don't want to talk too much about the specific architectures that customers are using. That's confidential for all of those different customers. I would say that going forward, that direct connect to the backside is the path that everybody is focused on. So, I think over time, that will grow a fairly significant amount -- well, both of those approaches will grow a fairly significant amount. And we're deeply engaged with customers on that inflection. We're leading in wiring overall. We have a very, very high share of wiring. And so, wiring going to the backside, we've said that, that gives us an opportunity of 50% of that spend when that inflection happens. So, we're supporting both of those different types of approaches for the backside, but I don't want to get too specific in terms of which one do we see bigger. Over time, I think that it could move to the direct connect. But that timing, I don't want to give specifically because that's going to be each one of different customers' roadmaps. Relative to timing for revenue, it's pretty small for us right now in 2024. It will grow in '25, but the ramp -- significant ramp for backside power is still out beyond '25 in revenue."
},
{
"speaker": "Krish Sankar",
"content": "Thanks, Gary. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Timothy Arcuri from UBS Securities. Your question, please?"
},
{
"speaker": "Timothy Arcuri",
"content": "Thanks a lot. Brice, I have two-part question on China DRAM. And the first part is, you talked about it coming down [$500 million] (ph). Is that stepping all the way down in fiscal Q3? So, what's the assumed step-down in China DRAM for fiscal Q3? And then, more broadly, of the $1.6 billion worth of DRAM business, I'm wondering if you can kind of help us figure out how much of that is China. If I look at Korea and I look at how much that is, it looks like about $1 billion of the $1.6 billion DRAM revenue is China. Can you confirm whether that's in the right ballpark? Thanks."
},
{
"speaker": "Brice Hill",
"content": "Hi, Tim, thanks for the question. The only quantification that I gave in prior quarters was that our DRAM as a whole was up more than $500 million in the quarters where we had that incremental. So, I think I'll just leave it at that and say it's more than $500 million in each of the last three quarters. And as we look into the second half, it doesn't drop completely to zero in Q3, but it drops significantly and then it's pretty close to zero in Q4. And our mix to China revenue for the company, as I highlighted to an earlier question, will be about -- in the range of 30%, which is normal for us. So, I think that's as close as I can get on that. Thanks for the question."
},
{
"speaker": "Timothy Arcuri",
"content": "Sure, Brice. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Joe Quatrochi from Wells Fargo. Your question, please?"
},
{
"speaker": "Joe Quatrochi",
"content": "Yes, thanks for taking the question. I wanted to kind of try to understand just the trends that you're seeing in ICAPS. Can you help us just understand the difference in the growth that you're seeing from China versus non-China? Because it sounds like as we look at China revenue normalizing, the DRAM falling off, obviously, the rest of that is mostly just ICAPS. So, can you help us just kind of understand the trends between China and non-China?"
},
{
"speaker": "Brice Hill",
"content": "Hi, Joe, thanks for the question. Yeah, for China, what I would say is the last three quarters have been very strong. So, if we're speculating about a slowdown or a digestion period, one of the reasons I didn't reemphasize that is we're kind of going by what we're seeing. So, we had two strong quarters, Q1, Q2. Our Q3 guide again has strength in ICAPS and a strong fourth quarter for China. When we think about the world right now, I think we have three regions growing and the rest of the regions not growing. So that corresponds with the end markets sort of being mixed at this point. Our view of China overall, the team showed a pie chart of the different device elements of WFE last year. ICAPS was about 40% of WFE by that pie chart on May 2 that was put out. China is our largest market in ICAPS, and we monitor that carefully. We've got about -- we've got a large number of customers. We're tracking about 30 different -- more than 30 factory projects that are in ramp process. In other words, they have capacity, they're adding capacity, they're ramping. We're tracking utilizations. Utilizations are improving. We understand yields are improving. So, we think that the China market will be very large and important market for us going forward. We said we don't see a cliff for that market, and I think we'd stick by all those remarks at this point."
},
{
"speaker": "Joe Quatrochi",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Harlan Sur from JPMorgan. Your question, please?"
},
{
"speaker": "Harlan Sur",
"content": "Good afternoon. Thanks for taking my question. As we transition from a more mature specialty ICAPS-driven growth profile to a leading edge, sort of advanced foundry-logic memory spending profile this year and going forward, this typically tends to be a strong tailwind for your process control and diagnostics portfolio, which leans very heavily on your most advanced tools and solutions, right? Because [picture] (ph) sizes get smaller, so better resolution required, but also new and more [defecting yield] (ph) challenges, right? So, it's probably a driver of your leading-edge CFE-driven eBeam portfolio this year. Are you guys still seeing that portfolio grow like 4x this year? And how does the pipeline look for next year? And maybe mid to longer term, like given the significant manufacturability challenges, does the Applied team see process control and diagnostics intensity rising faster than overall WFE intensity over the next few years?"
},
{
"speaker": "Gary Dickerson",
"content": "Thanks, Harlan. This is Gary. So, I would say that for sure, the connection that we have with our eBeam technology and these major architecture inflections is a real advantage for us, because, again, it's a race on who gets there first relative to those major architecture inflections and learning rate, how fast you learn is one of the determining factors. So, having this unique capability is a real advantage for Applied. I mean, obviously, it's a good growth driver for us from a revenue perspective, but that synergy with the rest of our broad portfolio, our connected portfolio, is a real advantage. On coalfield emission, which is really one of the key technologies in the electron optics, it gives us the highest resolution at up to 10 times higher imaging speeds. So, it really is highly differentiated. And we are still on track this year to grow our CFE systems revenue around 4x in '24, and that would represent about 50% of our total eBeam system sales. And then, when I look forward, again, I see PDC as a really great growth driver for Applied. We've had the strongest pipeline of new products than we've ever had. And the synergy with the rest of our process equipment business, all of that materials magic, materials innovation is increasing. So again, very, very optimistic about the shape of that business."
},
{
"speaker": "Harlan Sur",
"content": "Thank you, Gary."
},
{
"speaker": "Michael Sullivan",
"content": "Yeah, thanks, Harlan. And operator, we have time for just one more quick question please."
},
{
"speaker": "Operator",
"content": "Certainly. One moment for our final question. And our final question for today comes from the line of Mehdi Hosseini from Susquehanna. Your question, please?"
},
{
"speaker": "Mehdi Hosseini",
"content": "Yes, thanks for letting me ask the question. Gary, you were talking about this inflection point technology leading-edge logic, HBM, DRAM and advanced packaging, but would it be fair to say that what is not in your backlog is the additional wafer capacity, especially for gate-all-around and memory, and that would be something that would be coming in, the [POS] (ph) be placed later this year for shipment in 2025?"
},
{
"speaker": "Brice Hill",
"content": "Yeah. Hi, Mehdi, it's Brice. I guess I'll take that one. We do expect -- I can't tell if it's a greenfield question or not, but we do expect increased wafer starts across definitely ICAPS, definitely leading logic, a smaller amount in DRAM. And probably the place where we don't really expect increased wafer starts is in NAND, but that will still be upgrades. So, most of the memory technologies are upgrades. But it will be a combination of new technologies and new plant and equipment across the board."
},
{
"speaker": "Mehdi Hosseini",
"content": "Thank you."
},
{
"speaker": "Michael Sullivan",
"content": "Okay. Thanks, Mehdi, for your question. And now, Brice, would you like to give us your closing thoughts?"
},
{
"speaker": "Brice Hill",
"content": "Thanks, Mike. I think we've done a good job anticipating the roadmap inflections in datacenter AI. We can see the pull for our solutions in gate-all-around chips, from transistors to frontside wiring and backside wiring and in advanced packaging. Same goes for DRAM, where we're number one in materials engineering and especially strong in HBM stacking. In future calls, we'll have a lot more to say about our positions in edge, AI and IoT plus automotive and clean energy, which are very big and long-term drivers of our ICAPS business. The momentum in our systems business fuels our service business, which is driving very stable subscription-like growth and helping us increase the dividend at an accelerated rate. Gary will be at the Bernstein Conference in New York on May 30, and I hope to see many of you at the BofA conference in San Francisco on June 6. Thank you, Mike. Let's close the call."
},
{
"speaker": "Michael Sullivan",
"content": "Okay. Thanks, Brice. And we'd like to thank everybody for joining us today. A replay of today's call is going to be available on the IR page of our website by 5 p.m. Pacific Time today. And we'd like to thank you for your continued interest in Applied Materials."
},
{
"speaker": "Operator",
"content": "Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day."
}
] |
amat | 2,024 | 1 | [
{
"speaker": "Operator",
"content": "Welcome to the Applied Materials Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards you will be invited to participate in a question-and-answer session. I would now like to turn the conference over to Michael Sullivan, Corporate Vice President. Please go ahead, sir."
},
{
"speaker": "Michael Sullivan",
"content": "Good afternoon, everyone, and thank you for joining Applied’s First Quarter of Fiscal 2024 Earnings Call. Joining me are Gary Dickerson, our President and CEO; and Brice Hill, our Chief Financial Officer. Before we begin, I’d like to remind you that today’s call contains forward-looking statements, which are subject to risks and uncertainties that could cause our actual results to differ. Information concerning the risks and uncertainties is contained in Applied’s most recent Form 10-K filing with the SEC. Today’s call also includes non-GAAP financial measures. Reconciliations to GAAP measures are found in today’s earnings press release and in our quarterly earnings materials, which are available on our website at ir.appliedmaterials.com. Before we begin, I have a calendar announcement. On Monday evening, February 26, Applied will host a panel at the SPIE Advanced Lithography and Patterning Conference in San Jose. Joining us will be leading experts from NVIDIA, Intel, imec and Siemens EDA. We’ll also have demo stations with several new products and technologies, we’ll be introducing at the event. There won’t be a webcast, so we hope you’ll join us in San Jose. And with that introduction, I’d like to turn the call over to Gary Dickerson."
},
{
"speaker": "Gary Dickerson",
"content": "Thank you, Mike. Applied Materials made a strong start to fiscal 2024 with first quarter revenue in the high end of our guidance and earnings that exceeded our guided range. Our inflection-focused innovation strategy is delivering results. We have outperformed our markets for five consecutive years and believe we are in a great position as customers transition major new chip innovations to high-volume production over the next several years. The breadth of our technology capabilities, combined with our deep customer relationships, allows us to see inflections early and accelerate key technology innovations that are critical to scaling AI, IoT, electric vehicles and renewable energy. We have reshaped and expanded our portfolio of solutions that enable next-generation transistors, new interconnect schemes, including backside power delivery, high-performance DRAM including high bandwidth memory, and specialty applications in the ICAPS market. In my prepared remarks today, I’ll provide some examples of how these inflections grow Applied’s available market and are highly accretive to our share. I’ll also talk about our long-term strategy to accelerate innovation and commercialization velocity through tighter collaboration with our customers and partners. But to begin, let me share our latest perspective on the market environment. In our discussions with customers, we’re hearing that overall market dynamics are improving. There is a reacceleration of capital investment by cloud companies, fab utilization is increasing across all device types and memory inventory levels are normalizing. In terms of Applied’s business in 2024, we see leading-edge foundry-logic being stronger year-over-year, even though some important projects are delayed. We’re forecasting ICAPS demand to be slightly lower than 2023 with weakness in some end markets being offset by strong regional investments. We expect our NAND revenues to be up year-on-year, but NAND to remain less than 10% of total wafer fab equipment spending. And we see continued strength in our DRAM business, driven by customers ramping production of high-bandwidth memory. High-bandwidth memory where high-performance DRAM dies are stacked and connected to logic die with advanced packaging is a key enabler for the AI data center. The dies used in high-bandwidth memory are more than two times larger than standard DRAM, which means that more than twice the capacity is needed to produce the same volume of chips. On top of this, the packaging steps needed for die stacking further increase our total available market. High-bandwidth memory, or HBM, made up only about 5% of DRAM output in 2023, but is expected to grow at a 50% compound annual growth rate over the coming years. DRAM is a great example of how our inflection-focused innovation approach is working, by focusing on the critically enabling process and packaging steps for next-generation technologies, Applied has significantly increased our share of the DRAM market. In 2023, we estimate that our DRAM share was more than 10 points higher than it was a decade earlier. And our DRAM revenues were larger than our two closest process equipment peers combined. We’re also best positioned for future growth, thanks to our leadership in logic technologies that have been implemented for DRAM peripheral circuitry applications to enable significantly increased IO speeds. Our strong position in DRAM patterning, our unique co-optimized hard mask solutions, which are critical for capacitor scaling and advanced packaging, where we have strong leadership positions in Micro-bump and Through-Silicon Vias that will enable multiple generations of high-bandwidth memory. In fiscal 2024, we expect our HBM packaging revenues to be four times larger than last year, growing to almost $0.5 billion. And across all device types, we expect revenue from our advanced packaging product portfolio to grow to approximately $1.5 billion. Looking further ahead, we see opportunities for this business to double again, as heterogeneous integration is more widely adopted, and we introduced new products that expand our served market. Another key inflection that will transition to high-volume production beginning this year is gate-all-around transistors in leading-edge foundry-logic. These complex 3D structures can provide a more than 30% improvement in a chip’s energy efficiency. This is especially enabling for high-performance AI data center applications. The shift from FinFET to gate-all-around grows Applied’s available market by $1 billion for every 100,000 wafer starts per month of capacity. And we’re on track to gain share and capture over 50% of the spending for the process equipment used in this new transistor module. Major advances in leading-edge foundry-logic and DRAM are also driving the need for more and better metrology and inspection to be integrated into the manufacturing flow. We have developed industry-leading cold field emission eBeam technology that enables highly sensitive 2D and 3D imaging at up to ten times higher speeds. We expect our CFE systems revenue to grow by a factor of 4 in 2024 and represent 50% of our total eBeam system sales. The incredible innovation we see in the industry today is not limited to the leading edge. In recent years, ICAPS customers have invested about 10% of their revenues or about $30 billion annually in research and development to accelerate the roadmap for IoT, communications, automotive, power and sensor technologies. ICAPS technology depends less on shrinking device features and customer investments are heavily weighted towards new structures, new materials and new integration approaches, playing to the core strengths of Applied. ICAPS is another area where we saw market inflections early. And five years ago, we formed a dedicated team to focus on the needs of these customers. Since then, we’ve released more than 20 new ICAPS products that target the highest value device innovations in these markets and we have a robust development pipeline of unit process and integrated solutions. While major end market inflections, such as AI and IoT, electric vehicles and renewable energy are already driving semiconductor growth and innovation, it’s important to recognize they are still in the early stages of adoption. For example, high-performance GPUs for AI data centers only represent 6% of leading-edge foundry-logic wafer starts today. The full potential of technologies like AI cannot be unlocked without next-generation chips with better performance, power and cost. The technology roadmap for semiconductors is rich with possibilities and opportunities, but also incredibly complex. No company is better placed to address this complexity than Applied Materials. With the industry’s broadest and deepest portfolio of capabilities and products, we have a unique ability to combine, co-optimize and integrate our technologies to develop highly differentiated solutions for our customers. To bring these advances to market faster, we’re also innovating the way we innovate, by driving earlier and deeper collaboration with our customers and partners. We are expanding our global innovation network that will connect into the EPIC center we’re building in Silicon Valley. During the quarter, we announced an expansion of our long-term partnership with Leti, which is focused on accelerating ICAPS innovation, and we launched a new collaboration with MIT, which is centered around next-generation power electronics. As industry complexity rises, we’re also delivering more value to customers with our advanced services that enable our customers to accelerate R&D, transfer new technology into volume manufacturing faster and then optimize yield, output and cost in their factories. AGS has delivered 18 consecutive quarters of year-on-year growth. Revenue for the first quarter was up 8% versus the same period last year, and the business is now at a $6 billion annual run rate. AGS has the opportunity for double-digit growth this year, and we believe we can sustain this growth rate into the future. A significant portion of AGS revenue is generated from subscriptions. We have almost 17,000 tools under service agreements, up 8% year-on-year, and these agreements have a very high renewal rate over 90%. Before I pass the call over to Brice, I will quickly summarize. Applied Materials outperformed our markets in 2023 for the fifth consecutive year and we delivered strong results in the first quarter of 2024. The positions we’ve established at key industry inflections, will support continued outperformance, as customers ramp next-generation chip technologies into high-volume production. We are strengthening R&D collaboration with customers and partners to drive innovation and commercialization velocity, improvements in mutual success rate and R&D investment efficiencies. And we see growing demand for our advanced services that are helping customers manage increasing complexity in their business as the industry scales. Now I’ll hand over to Brice."
},
{
"speaker": "Brice Hill",
"content": "Thank you, Gary. And I’d like to thank our teams for delivering strong revenue and margins this quarter and making further improvements in our operating performance. On today’s call, I’ll discuss our value creation strategy and the results it is producing, then I’ll summarize our growth thesis and why we believe we will outperform our markets in the years ahead, finally, I’ll summarize our Q1 results and provide our guidance for Q2. I’ll begin by discussing how our assets and strategy create value for shareholders. Applied has the broadest and deepest process equipment portfolio and expertise in the industry. We are highly invested in collaborating with our customers, allocating $3 billion in annual R&D to invent new solutions to the most critical Semiconductor manufacturing challenges. Increasingly, the only way to solve these challenges is by co-optimizing and integrating our chamber technologies in new ways. In addition, identifying new materials and processes early and collaborating closely with customers, leads to faster results, a higher probability of success, greater efficiency and stronger financial returns. The benefits of our value creation strategy are being demonstrated in our financial results. We generated record equipment sales, $20.7 billion in calendar 2023, including legacy equipment reported in AGS. And we extended our strong position in DRAM with record calendar year sales of over $4.3 billion. In fact, over the past ten years, the company has gained over 10 points of DRAM share in multiple points of overall share. This has contributed to Applied delivering a fifth straight year of overall WFE share gains and one of the best share outcomes of the past 20 years. Over the same ten fiscal years, we’ve grown company revenue at a compound rate of over 13%, non-GAAP EPS at nearly 30%, free cash flow at 33% and dividends per share at nearly 12%. Also, over this period, we increased return on invested capital from 8% to 35% and reduced net shares outstanding by over 30%. Next, I will summarize our growth thesis. As we look out over the planning horizon, we expect semiconductors to grow significantly faster than GDP. Second, we expect the equipment market to grow as fast or faster than semiconductors over time, driven by increasing technical complexity. Third, we expect Applied’s equipment business to outgrow the market. And fourth, we expect our services business to grow as fast or faster than our equipment business. I’ll take a moment to support the third pillar of our thesis that Applied’s equipment business will outgrow the market. The reason is that our technologies enable the key semiconductor advances needed to drive growth in AI, IoT and renewable energy. Looking ahead to the semiconductor process inflections that will play out over the next several years, the company is extremely well positioned. In data center AI, we are number one in process equipment for advanced logic and compute memory, both standard DRAM and high-bandwidth memory. We also have line of sight to share a 50% or more in gate-all-around transistors, backside power delivery and advanced packaging. We are equally strong in edge AI and IoT with the number one position in ICAPS silicon, which is used to sense and convert analog information and transmit it to the cloud. We are also innovating rapidly in ICAPS technology for the global energy transformation, including through new agreements with partners like Leti and MIT, which Gary described. In summary, we feel confident that our unique assets and collaboration strategy position Applied to continue to outpace our markets and deliver strong shareholder returns as these major inflections play out over the next several years. Now I’ll summarize our Q1 results. On a year-over-year basis, net sales declined slightly to $6.7 billion. Non-GAAP gross margin grew 110 basis points to 47.9%, non-GAAP OpEx grew 5.6% to $1.23 billion, and non-GAAP EPS grew nearly 5% to $2.13. Turning to our segment results, Semiconductor Systems revenue was strong at $4.91 billion and included record DRAM and edge system sales. Segment non-GAAP operating margin was 35.7%. While our operating expenses are primarily focused on R&D programs for emerging technology inflections, we are also investing to expand and diversify our manufacturing logistics and supply chain to efficiently serve future growth. Applied Global Services delivered record revenue and its 18th consecutive quarter of year-over-year growth. AGS revenue increased approximately 8% year-over-year to nearly $1.8 billion and segment non-GAAP operating margin was 28.3%. Our installed base surpassed 49,000 tools, during the quarter and grew to nearly 200,000 chambers. Around two thirds of AGS recurring services and parts revenue was delivered as subscription agreements. Finally, AGS continued to produce more than enough operating profit to fund Applied’s growing dividend. Moving to Display, Q1 revenue was $244 million, and segment non-GAAP operating profit was 10.2%. We continue to look forward to our opportunity in the upcoming OLED IT growth inflection. Turning to cash flows in Q1, we generated $2.3 billion in operating cash flow and $2.1 billion in free cash flow. We distributed $966 million to shareholders, including $266 million in dividends and $700 million in buybacks. We repurchased nearly five million shares, at an average price of $152.60. Please note that our Q1 results include the following. First, as we discussed in our recent 10-K report, we increased the estimated useful lives of our plant and equipment and this increased non-GAAP EPS by $0.03. Also effective Q1, we refined the way we allocate stock-based compensation, moving the majority of the expenses from corporate unallocated to the operating segments, which gives managers greater visibility over costs. While the change has no impact on company operating profit or EPS, it reduced the segment operating profit and corporate unallocated costs proportionately. To help you with your segment models, our quarterly earnings presentation includes a table showing what operating profits would have been in fiscal 2022 and in each quarter of fiscal 2023 on a like basis. Finally, the reduction in depreciation and share-based compensation, in cost of sales, increased gross margin by approximately 40 basis points. Now I will share our guidance for Q2. We expect revenue to be $6.5 billion, plus or minus $400 million, and we expect non-GAAP EPS of $1.97, plus or minus $0.18. Within this outlook, we expect Semi Systems revenue of around $4.8 billion, AGS revenue of about $1.5 billion and Display revenue of around $150 million. We expect non-GAAP gross margin to be approximately 47.3% and non-GAAP operating expenses to be around $1.235 billion. We are modeling a tax rate of 12.5%. Thank you. And now, Mike, let’s begin the Q&A."
},
{
"speaker": "Michael Sullivan",
"content": "Thanks, Brice. Our goal is to help as many of our analysts as possible. With that in mind, please ask just one question on today’s call. If you have another question, please re-queue and we’ll do our best to come back to you later in the session. Operator, let’s please begin."
},
{
"speaker": "Operator",
"content": "Certainly. [Operator Instructions] Our first question comes from the line of Stacy Rasgon from Bernstein Research. Your question please."
},
{
"speaker": "Stacy Rasgon",
"content": "Hi guys, thanks for taking my questions. I wanted to ask about DRAM in China. So DRAM was very strong. It was supposed to be strong, but it was quite a bit stronger than, I think, we had thought it was going to be. I guess, can you tell us how much of that was China versus non-China? And going forward, last quarter, you had talked about the expectations for the China piece of that that had been pulled forward due to the sanctions to roll off as we went through the rest of the year. What are your thoughts on that China trajectory, as we go into April quarter and into the second half?"
},
{
"speaker": "Brice Hill",
"content": "Hi Stacy, thanks for your question. So in the current – in the quarter we just closed, we did see high shipments of China DRAM. And it was approximately the same in terms of the higher quantity as we saw in Q4. And just to be clear, we will expect another quarter in Q2, in our outlook quarter that it should remain elevated. I think for the Q4, we had said it was approximately $500 million increase on the DRAM side, that’s probably a good estimate for all of those quarters. And then the second part of the question, as we look through the rest of the year, we’ll expect that to normalize. Our China mix should normalize from the levels it’s at right now to something that’s more typical with our average."
},
{
"speaker": "Stacy Rasgon",
"content": "Which is what? Is that – what’s the typical?"
},
{
"speaker": "Brice Hill",
"content": "Well, I would say from a long term – from a many year perspective, we averaged approximately 30%. So if we’re at 45% right now will decline across the year to somewhere around that level."
},
{
"speaker": "Stacy Rasgon",
"content": "Got it. That’s helpful guys, thank you."
},
{
"speaker": "Brice Hill",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Vivek Arya from Bank of America. Your question please?"
},
{
"speaker": "Vivek Arya",
"content": "Thank you for taking my question. I was hoping if you could give us your view on how you see the WFE environment in 2024. I think many of your competitors have suggested kind of a low to mid-single-digit growth. But within that, the move towards more leading edge and DRAM and less on the trailing edge, but just given how strongly Applied grew in some of your trailing-edge and ICAPS, how does that position you in this new WFE environment? Because I think, Gary, you said that you only see only limited decline on the ICAPS side. But when I look at the CapEx of many of the auto industrial or analog companies in the U.S., they are cutting it quite sharply. So that’s why I was curious why you think that it’s only going to decline? So just broadly comment on WFE and the different piece parts and then maybe China versus non-China kind of cutting of that. Thank you."
},
{
"speaker": "Brice Hill",
"content": "Okay. Thanks, Vivek. No real change, I think, in our outlook for 2024, in terms of shaping how those end markets are evolving. So, we do think DRAM will continue to be a strong market. We think NAND will improve from its low levels a little bit. We think leading logic will be larger as gate-all-around and new investments start to ramp towards the back half of the year. And we do think there will be some digestion in ICAPS in China, both. Just to be crystal clear, we had enormous growth for two years in ICAPS and the China-related ICAPS business. And so we won’t see that enormous growth this year. It may be a little bit smaller. We think there’s some digestion with that capacity. But we expect that market to grow over time along with the underlying rates for the company. So that’s – those – the shape of those end markets hasn’t changed in our outlook."
},
{
"speaker": "Vivek Arya",
"content": "So is that consistent with the low-to-mid single-digit WFE, that others are suggesting? Or do you have a different view?"
},
{
"speaker": "Brice Hill",
"content": "Well, all we can do is tell you what we see from Applied’s perspective. When we commented on 2023, we said it was a strong year for Applied. And to the way you asked your question, we had strong ICAPS. We had strong DRAM; we were strong in growth in packaging. And so as we look toward 2024, those are the puts and takes. We’re not going to give a precise number for 2024."
},
{
"speaker": "Vivek Arya",
"content": "Thank you, Brice."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] And our next question comes from the line of CJ Muse from Cantor Fitzgerald. Your question please."
},
{
"speaker": "CJ Muse",
"content": "Yes, good afternoon. Thanks for taking the question. I guess given the strong outperformance that you showed in 2023, where your silicon business actually grew where I think most people are thinking WFE down in the high single digits. Curious how you’re thinking about 2024? You’ve talked about, clearly, you’re benefiting from share gains across leading-edge foundry-logic and DRAM. But also a vision for ICAPS slowing. So do you think it’s another year of outperformance? Or is it a year of digestion, if you could kind of walk through that? And just as a kind of a bonus question, with SPY [ph] just a little over a week away, would you care to give a preview of what we’ll hear, including a focus on Sculpta? Thanks so much."
},
{
"speaker": "Brice Hill",
"content": "Okay. So I’ll tackle the first part, and then I know Gary wants to tackle the second part of the question. So on outperforming in 2024, CJ, we do expect, because of our exposure to the fast-growing markets and some of the inflections growing quickly in 2024. We do expect to outperform. We’re not making a call on the size of the market. It’s like you said, there’s a couple of markets that are growing, the ICAPS market and the China piece, we think won’t grow. And so we’re not making a call on which is the stronger trend. And I don’t know if we know. So we’ll see how the year plays out from that perspective. And Gary, on the show."
},
{
"speaker": "Gary Dickerson",
"content": "Hi CJ. On – just let me start on the outperformance. I think the most important thing to think about is, how we’re positioned for major inflections. So if you think about foundry-logic leading edge, gate all around, backside power distribution, those are incremental billion-dollar opportunities for Applied, where we have an opportunity for more than 50% share, which is very accretive to our overall market share. So we’re really well positioned there. ICAPS, we formed that group five years ago, as I said earlier, 20 major new products have been introduced. We have a strong pipeline of future ICAPS products. And so again, they’re – and we have opportunities to grow in segments like edge and PDC, where we have a lot of momentum. So, I like our position in ICAPS. DRAM, we’ve gained more than 10 points of share over the last 10 years. And as I mentioned in the prepared remarks, extremely well positioned for the major inflections in DRAM. In packaging, we have the strongest and broadest portfolio. And this is around $1.5 billion of revenue for us in 2024 and an opportunity to double over the next few years. So all of those areas, I think, really set us up for continued outperformance. And then on your question about SPIE, one of the things we’ll be talking about there is Sculpta, just reminding people, that’s a breakthrough pattern shaping technology that provides a simpler, faster and more cost-effective alternative to EUV double patterning. So, we’re engaged with all of the leading foundry-logic customers and expanding Sculpta steps for advanced patterning, including High-NA EUV, and we’re also working with customers on new Sculpta applications. And we expect this business to grow to close to $200 million in 2024, in ramp to around $0.5 billion in annual revenue, in the next few years. Also at SPIE, for those of you that will attend, you’ll hear about new edge and CVD technology for patterning that will be very large growth drivers for the company and enable us to continue to outperform. And just for reference, in patterning, we’ve increased our served market from around $1.5 billion, 10 years ago, to $8 billion now and our share from around 10% to 30%. So when Brice said, I was excited, I am absolutely excited these are some really, really great technologies with very strong customer pull and delivering meaningful growth for the company."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] And our next question comes from the line of Chris Caso from Wolfe Research. Your question please."
},
{
"speaker": "Chris Caso",
"content": "Yes, thank you, good afternoon. I guess the question is kind of looking at the order rates and more importantly, what your customers are telling you as you’re looking into calendar 2025. As you know, some others in the industry with long lead times have started to see some of those green shoots coming into 2025. I know that we’re balancing here between some of your customers burning off capacity and going through technology transitions. What’s the thought as we start to look into 2025, at these early days?"
},
{
"speaker": "Brice Hill",
"content": "Hi Chris, thanks for the question. When we look at the market currently, we’re seeing improvements in inventories, and we’re seeing improvements in utilization. So it’s starting to pick up. That’s pretty much across – that is across the entire market on the utilization side. And then what we’re hearing from customers is optimism, generally speaking, for 2025. We would echo comments we’ve heard from others that the semiconductor end market for devices is expected to be growing. And it’s an investment cycle on the leading edge. We’re expecting the memory markets to continue to improve. So 2025, we are optimistic about the direction for 2025."
},
{
"speaker": "Chris Caso",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] And our next question comes from the line of Krish Sankar from TD Cowen. Your question please."
},
{
"speaker": "Krish Sankar",
"content": "Yes, hi, thanks for taking my question. Garry, I had a question for you. You have a broad-based product portfolio. You outperformed WFE last two years. I’m kind of curious for some of these new applications, whether it’s HBM, gate-all-around or even backside power delivery, are customers looking at a one-stop shop? Or more going with best-of-breed solutions? And in other words, let’s say, for gate-all-around, is your strength in Epi helping your edge or ALD products?"
},
{
"speaker": "Gary Dickerson",
"content": "Yes. Chris, one thing I would say that for all of these inflections, it’s a tremendous advantage for us to have that broad portfolio. Again, when you think about – one of the examples I’ve used many times is, your processor chip and your smartphone with 15 billion transistors and 60 miles of wiring, which is kind of mind-boggling, when you think about how do we do that? How do we create something like that. There are over 1,500 steps in building that type of chip. And when you’re developing these new technologies, like gate-all-around, like backside power or new DRAM technologies or any of these packaging technologies, the ability to combine and co-optimize these steps is an enormous advantage, enormous that 60 miles of wiring, we have one platform that combines seven technologies under vacuum, to enable that those 60 miles long, very thin wires to move the data at super high speeds, very low resistance and very low power. So it’s completely unique. And that’s about one-third of our portfolio are those integrated solutions. We also have clear leadership in eBeam technology. I talked about our cold field emission electron optics. And that enables us to see those structures, when you’re building gate-all-around, and you want to look at the width of those nanosheets, again, we have unique technology that enables us to learn faster and then we can co-optimize all of those technologies. So as we’re driving our innovation with customers, we’re deeper, we’re earlier, we can see four generations out, relative to those technologies. So super, super deep connectivity. That’s why also I think EPIC is going to be a game changer in how we innovate, the way we innovate. We talked about the relationship with Larry [ph] for innovation and edge computing and ICAPs, all of those things, then we have our advanced packaging lab in Singapore that is also a full flow lab, where customers are working on innovation and new architectures. So Chris, I think that gives us a tremendous advantage. We can see what’s needed earlier. And then the ability to co-optimize all of that gives us a tremendous advantage."
},
{
"speaker": "Krish Sankar",
"content": "Thanks, Gary."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] And our next question comes from the line of Atif Malik from Citi. Your question please."
},
{
"speaker": "Atif Malik",
"content": "Hi, thank you for taking my question. I have a question for Brice. Brice, you talked about China mix normalizing from 45% to 30%. Can you talk about the impact of the mix on the gross margin from the 47.3% you’re guiding through for the rest of the year?"
},
{
"speaker": "Brice Hill",
"content": "Thanks, Atif. Appreciate the question. So yes, our gross margin reported in Q1 was 47.9%. We think that we’ve modeled what it would be without the higher China mix, and our view is the underlying gross margin is approximately 46.7% at this point. So as we go through the course of the year, we expect that gross margin to come down from 47.9%, to a more normal amount. At the same time, where we are underneath that, the 46.7% will continue to improve slowly, if that makes sense. So, if you normalize Q1 immediately, you’d be at 46.7%. We expect that to improve through the course of the year. And then we’re not changing our goals. Our goal is 48% to 48.5% for 2025. That’s still where we’re targeting as we work on pricing improvements and continue to work on our cost road map."
},
{
"speaker": "Gary Dickerson",
"content": "Yes. Atif, I would just add that we have made progress pretty much across all customers on pricing improvements. I think we’ve talked before about cost headwinds that we encountered in the supply chain. We’re making improvements there, and as Brice said, we’re committed to hit those goals."
},
{
"speaker": "Unidentified Analyst",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Srini Pajjuri from Raymond James. Your question please."
},
{
"speaker": "Srini Pajjuri",
"content": "Thank you. Hi guys. Gary, I have a question on your HBM comment. I think you said HBM accounted for about 5% of industry output. If you can clarify if that’s wafer output or if that bids, but my question is, as we look out to the next few years I think you’re forecasting about 50% growth for this business. So, it’s a little tricky to understand for us as to how much of DRAM WFE is going to HBM right now? And how do you see that evolving? I mean if the market grows 50%, should we expect I guess the equipment spending also to grow 50%? Or do you think it’s going to grow faster than that?"
},
{
"speaker": "Brice Hill",
"content": "Hi Srini, since I’ve seen a lot of the modeling, I’ll just share a couple of those data points. So on the first question, its wafer starts when we think about the 5%, its wafer starts. I think it is difficult to estimate the equipment purchases at this point because you probably understand that the DRAM business itself has been underloaded as most of the markets have. So I think what many of the customers are doing is shifting some of their capacity to HBM, to get this output. Gary highlighted in his prepared remarks that the dye sizes for the are larger than the non-HBM. So it certainly will help drive up utilization, which will eventually increase equipment orders going forward. And we do think the DRAM business, if you look at the past few years, the level of WFE for DRAM, we do think that – it’s been fairly strong, and it will continue to be strong is our expectation. And then the last piece, of course, is customers are having to expand the HBM related apps of their DRAM process. Gary highlighted what that is for us, and that’s growing a lot faster than what you see on the general Equipment side. So my understanding of the DRAM is about 700 steps in a DRAM process and about 15 additional steps, possibly 20 to do the HBM level of that. So for sure, you’ll see customers growing the HBM packaging techniques and capabilities alongside the regular capacity. And then we’ll expect to see utilization increase as time goes on."
},
{
"speaker": "Srini Pajjuri",
"content": "Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Toshiya Hari from Goldman Sachs. Your question please."
},
{
"speaker": "Toshiya Hari",
"content": "Hi. Thank you so much for taking the question. I had a two-part question. The first one is on the conventional DRAM part of your business. And the second part is on the NAND business. So the bullishness in terms of HBM, we understand. I’m hoping to better understand what your customers are doing, what they’re telling you, Gary, in terms of their plans on the conventional DRAM side are things still very muted? And are they disciplined from a supply perspective? Or are you seeing a pickup in your conventional DRAM business, as well to the extent you have visibility there? And then I guess a similar question on the NAND side. It’s been a soft market for everyone. I guess there’s hope that at least node transitions or layer count increases will resume this year. Are you starting to see early signs of a pickup? Or are things pretty soft there? Thank you."
},
{
"speaker": "Brice Hill",
"content": "Yes. Toshiya, its Brice. I’ll just make a couple of comments and maybe Gary will add to that. So, on the DRAM side, and this is true for DRAM and NAND, but I’ll start with DRAM. We do see utilization improving, and we also see improvements in prices, and we also see improvements in inventory positions. So we do think that’s consistent with the rising optimism on the DRAM side. The utilizations have been low enough that there’s a ways to go before they have to start thinking about adding capacity. So our view on the market is it’s mostly from a WFE perspective, the nodal upgrades and the HBM that we talked about. And it would be similar for NAND. We’re seeing improvements in inventory, seeing improvements in pricing. Utilization is starting to pick up. And our perspective would be the same as technology advances will be what drives the spending. And we do have signals that, as we suggested that the spending will pick up."
},
{
"speaker": "Gary Dickerson",
"content": "Yes. Toshiya, relative to Applied in DRAM as I talked about earlier, we’ve gained more than 10 points of overall DRAM WFE share, over the last 10 years. And then if you look at the technologies for DRAM going forward, periphery moving to higher speed IO, enabled by our leadership logic products, capacitor scaling, we’re achieving patterning share gains. And I’ve talked about very strong position in advanced packaging, including high bandwidth memory; we’re really well positioned there to continue our outperformance in DRAM. And as Brice said or I said earlier also, we think that business is going to remain very healthy for us. NAND for Applied, we see the revenue up a fair percentage in 2024 versus 2023, but the total amount is still far below 2022. So that’s a little bit more color."
},
{
"speaker": "Toshiya Hari",
"content": "Thank you so much."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Harlan Sur from JPMorgan. Your question please."
},
{
"speaker": "Harlan Sur",
"content": "Hi. Good afternoon. Thanks for taking y question. One of your peers alluded to this on their last earnings call and talked about a push-out on advanced foundry-logic programs, due to potentially persistent delays in chip sack funding. I mean I think the industry thought that after Congress and the President signed off on the CHIPS Bill, I think it was like 18 months ago that grant funding would be appropriated at least in 2023, but here we are in February 2024 and still no grant disbursements. Obviously, all fab programs will launch at some point, right, but maybe some near-term movements on timing due to the absence of this grant funding. Is that what’s driving some of the leading-edge foundry-logic program delays that you guys talked about in your opening remarks?"
},
{
"speaker": "Brice Hill",
"content": "Okay, Harlan, I’ll make a comment there. I do think those schedule changes that have been in the news, we’re up-to-date on those. So our outlook is consistent with any of those discussions and schedule changes that you’re talking about. On the CHIPS Act, we’ve recently seen news reports about the government beginning to accelerate that process. We’re in the process ourselves of preparing our application on the R&D side and expecting that to open soon. So I think the answer to your question is, yes, it is affecting schedules, but we don’t expect it will change the ultimate destination of those projects."
},
{
"speaker": "Harlan Sur",
"content": "Great. Thank you."
},
{
"speaker": "Brice Hill",
"content": "Yes."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Joe Quatrochi from Wells Fargo. Your question please."
},
{
"speaker": "Joe Quatrochi",
"content": "Yes. Thanks for taking the question. I was wondering if you could help us quantify how much your ICAPS business grew in calendar 2023. And then as we think about the foundry-logic business for 2024, do you think the recovery in leading-edge can offset the decline in ICAPS?"
},
{
"speaker": "Brice Hill",
"content": "Okay, Joe thanks. So I think what we’ve highlighted publicly on ICAPS is that grew approximately 40% in 2022, and it grew faster than that in 2023. And so we wouldn’t change that and be more specific. But to your point, it’s been the strongest market for us. It’s now the largest market for Applied. Gary highlighted that there’s innovations across that market. It’s very important to us from an investment perspective. And so you’ll see us continue to focus on serving that market and the growth. And then the second part was the linearity across the quarters. We’re not giving guidance across the quarters. But since we did highlight that we expect some digestion in ICAPS, and we highlighted we expect leading edge to accelerate. We’ll leave it to you to kind of think about what – which is the stronger force and how the next few quarters go forward. But that is the right shape of those two end markets."
},
{
"speaker": "Gary Dickerson",
"content": "Yes, Joe, just let me add. I think our perspective hasn’t changed at all, relative to how we see the market. So we still see semiconductors at $1 trillion by 2030. And if you look at – there’s some powerful drivers in the digital transformation of every industry. AI, certainly, there’s a lot of focus there. And AI server has 8 times more foundry-logic content and eight times more DRAM compute memory content. So as Brice said earlier, and I think as you’ve heard from others, I think there’s a pretty positive perspective on 2025. And I think longer term we have a very positive perspective relative to semiconductor growth, equipment growing as faster, faster and Applied outgrowing the equipment market continuing to outgrow, as we have for the last five years. So I think quarter-to-quarter or half-to-half, frankly, we don’t focus as much on that, as we do this secular growth that we see in this industry and the great opportunities Applied has, as I’ve talked about, relative to the major inflections. So anyway, that’s the way we think about it."
},
{
"speaker": "Joe Quatrochi",
"content": "Got it. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Timothy Arcuri from UBS. Your question please."
},
{
"speaker": "Timothy Arcuri",
"content": "Thanks. I had a clarification and a question. So the clarification, Brice, is the 2023 WFE baseline, would you agree with something like $86 billion to $87 billion? So if you can clarify what your baseline is when you say that you gain share? And then my question is on China WFE. So if I use your numbers, it implies WFE from China is roughly $30 billion in 2023, maybe a little bit less. I know the customers are not stockpiling tools per se, but we know that SMIC and some of the other public companies, they have revenue to support what they spend. But that seems like only about half of that amount. So I guess the question is, would you disagree with the idea that maybe half of what’s coming from China is companies just kind of getting off the ground and trying to displace what’s being imported from the U.S. or Europe. And I guess, Gary, the real crux of the question is that the China stuff is not really a free lunch. It’s sort of duplicative with spending happening elsewhere. So how do you handicap that when you plan your business going forward? Thanks."
},
{
"speaker": "Brice Hill",
"content": "Okay, Tim. Thank you. So, on the 2023 WFE, we’ve been careful not to engage in the discussion about that. We just shared what our view of Applied’s performance in our view of that market. And for us, 2023 was a strong year. We talked about ICAPS strength. We talked about DRAM strength, Packaging strength, et cetera. And so we’ll just have to wait and see what the third parties say about the size of the market. For us, we saw a strong market. On the China WFE we agree. We don’t see stockpiling. There are a number of new customers. So I don’t know if it’s exactly the partition that you described, in terms of leading and public companies versus not. But, we do think there are a large number of projects that are under investment, where we see over the next four years, added wafer start capacity, planned wafer start capacity that market will be a strong market for us across the planning horizon. And so I think it is a mix. You’ve got real demand there. When we look at the macro, we compare the amount of capacity put in place to local China consumption, and we think they’re still behind the amount of local China consumption. So we think the investments are rational. And actually, the utilizations look okay. They’re lower than rest of the world generally speaking, but they’re improving, and we expect yields to be improving also over time. And then I know, Gary, you’re asking Gary, about the free lunch. We think you’re right from the perspective of no capacity, we’re planning for all of the tools that we sell, whether it’s to China or whether it’s to a government incentivized project. None of these things, we think, increase the amount of equipment installed sort of abnormally such that it’s not going to be used and not going to serve an end market. So we don’t believe that China demand is an end line free launch. We don’t believe the government incentives are a free lunch from that perspective, it’s just affecting a location of needed equipment. Thank you."
},
{
"speaker": "Timothy Arcuri",
"content": "Thanks a lot."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Joseph Moore from Morgan Stanley. Your question please."
},
{
"speaker": "Joseph Moore",
"content": "Yes, I wonder if you could give us some clarity on the $500 million of HBM related revenue that you’re forecasting – and actually – that’s a relatively small portion of your overall DRAM run rate, at least. And I guess I would have thought it would be even bigger. Can you talk about that? And then there’s more than just HBM, when it comes to Advanced Packaging for AI DRAM people are doing stacks for other types of memory? Are you – is that HBM kind of encompassing all of the Advanced Packaging? Or is there other opportunity above and beyond that?"
},
{
"speaker": "Brice Hill",
"content": "Okay. Thanks, Joe. So on the DRAM, I think going back to that Q4, the first quarter, we saw elevated DRAM from the China demand. That was the approximation we used for the impact of that. So you’re right, it doesn’t – it’s not going to exactly describe every single quarter, but I think that was a good estimate of the incremental that we’re seeing. So we’ll end up with three straight quarters of incremental DRAM shipping to customers in China for those allowed technologies. And Gary, on the..."
},
{
"speaker": "Gary Dickerson",
"content": "Yes, Joe. On the HBM, again, the HBM packaging is what we talked about increasing to almost $0.5 billion in 2024. And our overall Packaging – overall Advanced Packaging is around $1.5 billion. So that’s kind of how to think about it. About $0.5 billion in HBM Packaging and the total Advanced Packaging for us is around $1.5 billion."
},
{
"speaker": "Joseph Moore",
"content": "Okay. That’s helpful. Thank you."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Brian Chin from Stifel. Your question please."
},
{
"speaker": "Brian Chin",
"content": "Hi there. Good afternoon. Thanks for letting [ph] us ask a question here. Just curious, in route to Applied doing better than the industry over the full year. In terms of the handshake that occurs maybe around midyear, but between some digestion and ICAPS and some pickup in advanced foundry-logic – but the current timing around this suggest maybe a bigger dip in revenue in the July quarter?"
},
{
"speaker": "Brice Hill",
"content": "Hi, Brian, it’s Brice. So yes, we’re not going to guide future quarters beyond the outlook quarter. So we’ve given you the shape that we think the end markets will take. And to your point, it’s hard to tell which force will be stronger, whether leading – growing leading edge or a little digestion on the ICAPS side. So we’re not going to call that until we get to those quarters."
},
{
"speaker": "Brian Chin",
"content": "Okay. Fair enough. Thanks."
},
{
"speaker": "Operator",
"content": "Thank you. One moment for our next question. And our next question comes from the line of Charles Shi from Needham & Company. Your question please."
},
{
"speaker": "Charles Shi",
"content": "Hi. Thanks for taking my question. I have a long-term question for leading-edge foundry-logic. So you guys talked a lot about the Material engineering potentially driving outperformance. If I look at the back in the last 10 years, I mean, I think the back half of the last decade, I mean, between 2015 and 2019 because the manufacturers kind of slow to jump on to EUV, there was a lot more adoption of multi-pattern. – actually led to like outperformance of the depth [ph] and edge equipment suppliers like Applied Materials, but the last five years because of the EUV adoption seems to be that trend has reversed a little bit. But looking out for the next five years, I know there are recent discussions about maybe high end EUV may not actually get adopted before 2030. Does that – does Applied think that may lead to more of the multi-patterning EUV again and that could actually drive up the material engineering intensity again? And any thoughts would be helpful. Thank you."
},
{
"speaker": "Gary Dickerson",
"content": "Yes. Thanks for the question. So one thing I would point to, one of our largest customers, they talked about what’s driving their road map going forward. They talked about something called design technology co-optimization. So what they said basically was that much of the area scaling they were driving going forward is coming from new structures and new materials. So an example is backside power you can get 30% area savings through that type of a structure with no change in feature size. So I think what – certainly, what we see and we’re working with customers for technology nodes out, past the end of the decade, we see the relative contribution of materials innovations spending going higher, the percentage of that going higher. Gate-all-around, backside power, there’s CFAT technology. There’s many different innovations, Packaging technologies. All of those areas, we have over 50% share opportunity in those inflections that are very accretive. And again, we do see a relative contribution from – of spending for those innovations to go higher over time. I’ll give you one more data point. So gate-all-around. Gate-all-around is a new innovation and the transistor to process the data faster. We see Gate-all-around ramping to more than $1.5 billion for Applied revenue in 2024 and almost double that amount in calendar 2025. So again, those are – they’re very powerful new architecture inflections, where Applied is extremely well positioned."
},
{
"speaker": "Charles Shi",
"content": "Thank you."
},
{
"speaker": "Michael Sullivan",
"content": "Okay. Thanks, Charles. And operator, we’re getting close to the end of the session. So if we have time for one more quick question, please."
},
{
"speaker": "Operator",
"content": "Certainly one moment for our final question for today then. And our final question for today comes from the line of Thomas O’Malley from Barclays. Your question please."
},
{
"speaker": "Thomas O’Malley",
"content": "Hey guys, thanks for sneaking me in. I had another question on kind of the handoff in the first half, for the second half. Clearly, you’re kind of talking about the ICAPS business, getting a little softer in the back half, but leading edge is really picking up slightly offsetting. In terms of where you’re seeing the strength in the leading edge, is that greenfield new fab build-outs or is that existing capacity additions? Any kind of help on where that strength is coming from in the second half would be helpful. Thank you."
},
{
"speaker": "Brice Hill",
"content": "Sure, Tom. It’s Brice. Typically, it’s greenfield. So I think that when companies start the first part of a process, you’re typically putting in greenfield and you’ll shift some of your reused equipment later if you’re able to do that. So that would be my expectation. Thank you."
},
{
"speaker": "Thomas O’Malley",
"content": "Thank you."
},
{
"speaker": "Michael Sullivan",
"content": "Okay. Thanks, Tom. And appreciate that question. Brice, how would you like to give us your closing thoughts for today?"
},
{
"speaker": "Brice Hill",
"content": "Sure, Mike. What stands out to me from a summary perspective, is that we’ve anticipated the major market trends and we work closely with our customers to invest in the most important technology inflections. I think will be a major beneficiary, as AI and IoT spending grows over the next several years. Our number one positions in gate-all-around, backside power and advanced packaging are higher than our corporate average, which gives me confidence that we’ll continue to gain share. Beyond our strong portfolio, we’re also making operational progress, which makes me confident we can meet strong demand and make progress in gross margins. Finally, our services growth is accelerating to double digits and generating more than enough profit to fund our growing dividend. Also, I hope to see many of you at the Morgan Stanley conference on March 4. Mike, thank you. Let’s close the call."
},
{
"speaker": "Michael Sullivan",
"content": "Okay. Thanks, Brice. And we’d like to thank everybody for joining us today. A replay of today’s call is going to be available on the IR page of our website by 5 o’clock Pacific Time, and we’d really like to thank you for your continued interest in Applied Materials."
},
{
"speaker": "Operator",
"content": "Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day."
}
] |
amcr | 2,024 | 4 | [
{
"speaker": "Operator",
"content": "Hello, and welcome to the Amcor Fiscal Year '24 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Tracey Whitehead, Head of Investor Relations. Please go ahead."
},
{
"speaker": "Tracey Whitehead",
"content": "Thank you, operator, and thank you, everyone, for joining Amcor's fiscal 2024 fourth quarter and full year earnings call. Joining today is Peter Konieczny, Interim Chief Executive Officer; and Michael Casamento, Chief Financial Officer. Before I hand over, let me note a few items. On our website, amcor.com, under the Investors section, you'll find today's press release and presentation, which we'll discuss on this call. Please be aware that we will also discuss non-GAAP financial measures, and related reconciliations can be found in that press release and the presentation. Remarks will also include forward-looking statements that are based on management's current views and assumptions. The second slide in today's presentation lists several factors that could cause future results to differ than current estimates. Reference can be made to Amcor's SEC filings including our statements on Form 10-K and 10-Q for further details. Please note that during the question-and-answer session, we request that you limit yourself to a single question and then rejoin the queue if you have any additional follow-ups. With that, over to you, PK."
},
{
"speaker": "Peter Konieczny",
"content": "Thank you, Tracey, and thank you to all who have joined us for today's call. I want to open the call with a big thank you to our Amcor colleagues around the world, all of whom demonstrated tremendous focus in fiscal '24. Their hard work and dedication enabled us to improve our financial performance through the year and to finish the year strong. And I want to publicly recognize their efforts. In terms of Q4, we start as always with safety on slide three. Safety is our number one priority and our efforts to provide a safe and healthy work environment for our teams resulted in another year of improved performance, which reinforces our industry leadership when it comes to safety. 73% of our sites have remained injury-free for 12 months or longer and overall, Amcor experienced a 12% reduction in injuries, compared to fiscal '23. Our commitment to our people and to their safety remains our most important value, and we continue to aspire to achieve our ultimate goal of zero injuries. Turning to slide four. Amcor's near-term priorities remain consistent with those I shared on our Q3 earnings call, and I'm happy to report we are successfully delivering against these, and -- against these priorities. As I just mentioned, providing a safe and healthy work environment for our global workforce will always be number one. Second, is to stay close to our key stakeholders, including employees and customers, which helped us finish the fiscal '24 year strongly. Our teams continued to execute well in the fourth quarter, maintaining cost discipline as volume trends continued to improve sequentially with a return to volume growth in Q4. As a result, we delivered another quarter of solid margin expansion and earnings per share growth above the expectations we set out in April. Third, is to build on the progress we have worked hard to deliver across the business and ensure we maintain momentum in fiscal '25. We expect our earnings and volume performance to continue to improve, and this is reflected in our fiscal '25 guidance. And fourth, I and our senior leaders continue to focus on providing stability for the business and helping our teams deliver for all our stakeholders. We're executing well and winning with our customers as we continue to reinforce the Amcor strategy, agenda, and priorities have not changed. Moving to our key messages for today on slide five. First, Amcor reported strong financial results for the fourth quarter, driven by solid performance in the underlying business and a return to volume growth, resulting in both segments delivering adjusted EBIT growth on a comparable basis. Second, volumes, EPS growth, and free cash flow were ahead of expectations we set out in April. Overall volumes increased 1% in the quarter compared to last year, which exceeded the low single-digit decline we were anticipating. Earnings per share also outperformed expectations, up 9%, which was above our guidance for mid-single-digit growth. Third, we expect to build further momentum and deliver annual EPS growth through continued strong performance from the underlying business. At the midpoint of our fiscal '25 EPS guidance range of growth of 3% to 8%, we expect total annual value generated to once again be consistent with the 10% to 15% outlined on our shareholder value-creation model, assuming a dividend yield aligned with historical average. It is important to point out that we expect the underlying business to continue to deliver strong growth in line with the high-single-digit earnings growth experienced in Q4, considering our guidance includes an EPS headwind of approximately 4 percentage points related to normalization of incentives. Michael will step through the components embedded in our guidance range in more detail broadly. Our final key message is that our capital allocation priorities and strategies for long-term growth have not changed. We continue to invest in organic growth across the business, including in higher-value priority categories in emerging markets. Strategic M&A also remains an important source of incremental growth and value creation. We believe, the strength of our market positions, our opportunities to invest for growth, our execution capabilities, and our commitment to a compelling and growing dividend, and to maintaining an investment-grade credit rating sums up to a convincing investment case for Amcor. Moving to Slide 6, for a summary of our financial results. We finished fiscal '24 on a strong note. As customer demand continued to improve off second quarter lows, and our teams did an excellent job leveraging our differentiated value proposition to support our customers and drive volumes higher. At the same time, our unwavering focus on proactive cost management through the year resulted in a -- in four consecutive quarters of strong margin expansion. Overall volumes returned to growth earlier than we anticipated and were up 1% in Q4, our second consecutive quarter of strong sequential volume improvement. As expected, volumes across healthcare categories and in the North America beverage business remained soft through the fourth quarter. Combined, these two businesses, which represent approximately 25% of sales in Q4, unfavorably impacted overall volumes by approximately 2%. Across the balance of the business, overall volumes were approximately 3% higher than the June quarter last year. This reflects broad-based improvements in customer demand across many end markets and what we believe is the end of destocking in all categories other than healthcare. Price mix had an unfavorable impact on sales of approximately 3%, primarily driven by continued destocking in high-margin healthcare categories. Cost reduction and productivity initiatives remained a focus and we delivered another quarter of significant cost savings totaling more than $110 million, including an additional $20 million of benefits from structural cost initiatives in Q4. This builds on the outstanding efforts by all our teams across the businesses through the first three quarters, bringing the total cost savings for the year to more than $40 million, including structural savings of $35 million. The result of improving volume trends and our focus on cost and productivity actions was another quarter of strong earnings leverage as momentum in Amcor's underlying business continued. Fourth quarter adjusted earnings per share of $0.211 grew by 9% on a comparable constant currency basis, above our April guidance for mid-single-digit growth and adjusted EBIT was up 4% compared with last year. Overall, for fiscal '24, we delivered adjusted EPS toward the top-end of our guidance range we provided last August and our ongoing focus on cash conversion was rewarded with adjusted free cash flow of $952 million, up more than $100 million of last year and just above the top-end of our guidance range. We also continued to return significant cash to shareholders through a compelling and growing dividend in addition to share repurchase, which combined totaled approximately $750 million for fiscal '24. I'll turn it over to Michael now to provide some further color on the financials and our outlook. Michael?"
},
{
"speaker": "Michael Casamento",
"content": "Thanks, PK, and hello, everyone. Beginning with the Flexibles segment on slide seven, and focusing on our fiscal Q4 performance. Q4 volumes increased by 3%, which represented a significant sequential improvement of 5 percentage points compared with the March quarter. Net sales, however, were down 1% on a comparable constant currency basis, whilst volume growth was offset by unfavorable price mix of approximately 4%, primarily related to lower healthcare sales, which we anticipated. Destocking in healthcare categories continued in North America and Europe and this resulted in a headwind of approximately 2% on overall segment volumes. Across the balance of our Flexibles portfolio, Amcor experienced very solid growth with volumes increasing by approximately 5% in the quarter. The improved customer demand we saw in the third quarter continued as customers increased their focus on growing volumes and returned to more normalized order patterns now that destocking has ended. This led to broad-based growth across most geographies with volumes increasing in several categories, including meat, cheese, home and personal care, and unconverted film and foil. Across North America and Europe, fourth quarter demand improved across many end markets, resulting in a return to overall volume growth in the low-to mid-single-digit range in both regions despite continued softness in healthcare. In North America, volumes were higher in meat, cheese, and snacks categories. And in Europe, the business delivered particularly strong volume growth in meat, home and personal care, and unconverted film and foil. Emerging market volumes were up mid-single digits in Q4. Most countries experienced solid growth with volumes in China increasing for the fourth consecutive quarter and strength continuing in India, Thailand, Brazil, and Mexico, to name a few. Adjusted EBIT for the quarter of $403 million was 5% higher than last year on a comparable constant currency basis. Higher volumes combined with strong cost performance through the quarter, including from restructuring initiatives, led to another quarter of margin expansion with EBIT margins up 110 basis points to 15%. Turning to Rigid Packaging on Slide 8. Volumes and earnings trajectory for Rigid continued to improve in the fourth quarter with the business delivering consecutive quarters of earnings growth in the second half. As anticipated, overall volume performance for the business improved sequentially as the 5% volume decline in Q4 was 3 percentage points better than the March quarter. As expected, the Q4 decline was driven by lower volumes in the North America beverage business. Across the balance of the Rigid packaging portfolio, volumes were in line with the fourth quarter last year and favorable price mix benefits of approximately 3% resulted in a 2% decline in net sales on a comparable constant currency basis. In North America, beverage volumes were down 8%, reflecting lower consumer demand in Amcor's key end markets and unfavorable customer mix. Volumes improved by 3 percentage points on a sequential basis as destocking ended and warmer weather resulted in modest improvement in consumer consumption versus the March quarter. In Latin America, volumes increased in the low single-digit range compared with last year, driven by continued growth in Brazil and in Colombia. And from an earnings perspective, the business delivered another quarter of earnings growth and margin expansion through an ongoing focus on cost reduction and productivity measures and the realization of benefits from restructuring initiatives. Adjusted EBIT increased by 2% in Q4 with EBIT margin increasing by 70 basis points to 8.8%. Moving to cash and the balance sheet on Slide 9. Adjusted free cash flow for fiscal '24 was just above the top end of our guidance range at $952 million, up more than $100 million or 12% compared with last year. Cash generation was strong through the fourth quarter and we delivered good cash conversion by remaining laser-focused on improving working capital performance with inventories reducing for the sixth consecutive quarter. The timing of spend on CapEx projects was also a modest tailwind in the year, which we expect to unwind in fiscal '25. Leverage of 3.1 times was down 0.3 of a turn from the March quarter and was in line with our expectations for year-end. This brings me to the outlook on Slide 10. For fiscal '25, we expect to continue building on the volume and earnings momentum we achieved through the second half of fiscal '24. Adjusted earnings are expected to be in the range of $0.72 to $0.76 per share on a reported basis, representing comparable constant currency growth of 3% to 8%. As PK noted earlier, we expect the growth in the underlying business will remain strong in fiscal '25. However, it's important to note that our guidance includes an EPS headwind of approximately 4% related to more normalized levels of incentive compensation based on our expectations for improved annual financial results. Excluding this incentive normalization, our guidance range implies expected growth from the underlying business in the high-single to low-double-digit range. Our guidance range assumes an expected volume increase in the low-to-mid single-digit range for the year with trading performance in July aligned with this expectation. Interest expense is expected to be between $290 million and $305 million and the effective tax rate is estimated to be in the range of 19% to 20%. When combining interest and tax in absolute terms, the expectation is for a modest headwind to earnings when compared with fiscal '24. In terms of phasing, we anticipate this will be broadly aligned with historical average of approximately 45% of earnings being delivered in the first half of the year and 55% in the second half, with the fourth quarter typically the strongest of the year. And finally, we expect to continue to generate strong adjusted free cash flow in the range of $900 million to $1 billion, even as we fund an increase in capital expenditure of approximately $40 million to $60 million from a lower base in '24, which I mentioned earlier. And we expect to exit the year with leverage back within our 2.5 times to 3 times management range. We are pleased with the finish to fiscal '24 and look forward to delivering strong financial results in '25 and beyond. So, with that, I'll hand it back to you, PK."
},
{
"speaker": "Peter Konieczny",
"content": "Thank you, Michael. In closing, on Slide 11, we finished '24 on a strong note and we are encouraged by the broad-based improvement in volumes we're seeing across most geographies and end markets. Earnings both -- earnings growth in both segments in the second half of fiscal '24, combined with a return to volume growth in the fourth quarter and the trends experienced in the first several weeks of fiscal '25, give us confidence that momentum will continue to build in the underlying business. We expect overall volumes to continue to grow in fiscal '25 and we will maintain a sharp focus on cost control and productivity initiatives to drive solid earnings growth. And importantly, assuming a dividend yield aligned with historical average, at the midpoint of our EPS guidance range, we are well positioned to deliver annualized value generated in fiscal '25 to be in line with the 10% to 15% outlined in our shareholder value-creation model. We will continue to capitalize on opportunities to grow the business by staying close to our customers, providing the support and the differentiated more sustainable packaging solutions they need, to protect, preserve, and promote their products as they drive their own volume growth. We continue to invest in organic growth, including in higher-value priority categories and emerging markets. Strategic M&A is an important source for incremental growth and value-creation and we are committed to a compelling dividend which grows annually. We're confident in our execution capabilities and in the opportunities we have, to continue delivering profitable growth from the underlying business and to create strong free cash flow in fiscal '25 and beyond. Operator, we are now ready to turn the line over to questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Your first question comes from the line of Ghansham Panjabi with Baird. Your line is open."
},
{
"speaker": "Ghansham Panjabi",
"content": "Thank you. Hello, everybody. Look, can you just give us a sense as to what you're seeing as it relates to true market conditions? I mean, obviously, you're cycling over easier comparisons from a year ago, just given inventory destocking, etc., but what is your characterization of the actual end-market in context of what we read about with consumer affordability issues and so on? And I guess I'm asking because last year, your volumes were down 5% in fiscal year '24 and your guidance is, I think it was low-to mid-single-digit volumes. So, just trying to get a sense as to what you're actually seeing in the market."
},
{
"speaker": "Peter Konieczny",
"content": "Yes. Thanks, Ghansham. Let me take that question here and then see if Michael wants to build if needed or required. Look, first of all, we've been very pleased with the performance of the volumes with a sequential improvement from Q3 to Q4, which was even better than what we expected. And we went back to volume growth, which was again better than the low-single-digit decline that we had indicated after Q3. And we've been pleased with that being pretty much broad-based across the different regions and categories. So, it was a broad momentum that was building here and we're very pleased to see that too. Then, if I double-click on where the 1% comes from, and I try to depict that into the different drivers. The first thing that I would say is, it's not necessarily consumer demand. Consumer demand continues to be muted. We would consider that to be low-single-digit down still. And also when we go into '25 with our expectations, we wouldn't assume that that necessarily improves. And what we're seeing is that our customers are starting to do better, our customers. When we talked about this also in the last earnings call, and where we pointed out that our customers are looking for a better balance between volumes and price. And you also see that when you go through some of the announcements that have come out lately. So, that's better and we are demonstrating an ability to win with those customers. And that is through what we have to offer. And I would just call that on a headline, the value proposition that we can bring to the customer. So, that's encouraging. And that's really the driver of the improvement to a large extent. Of course, we are seeing some benefits from cycling out of the destocking that we had last year. In the fourth quarter, to give you a feel, that would have been not really much, maybe a couple of percentage points. But also remember that we're still seeing destocking in the healthcare business that pretty much goes against us. And those would be the major drivers. And they are very consistent with sort of what we're seeing when we look to '25. I hope that sort of answers the question."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Keith Chau of MST Financial Services. Your line is open."
},
{
"speaker": "Keith Chau",
"content": "Hi there, Peter and Michael. I just want to maybe actually reflect back on that question. So, what you're saying is that the consumer is still weak at the moment. So, the growth is not consumer demand, still low-single-digit down. Your volumes in FY ‘25, it feels like part of that is the unwinded destocking, which is a couple of percent that you're expecting kind of low-to mid-single-digit. So, there is maybe some slight improvement in your underlying volume. So, I'm just trying to work out what the difference is between those two factors. Like who do you think is losing and taking share? I'm just trying to square up the numbers from the first question. Thank you."
},
{
"speaker": "Peter Konieczny",
"content": "Yes, Keith. So, first of all, I would say it's not really a share story here. It comes down to, again, the things that I've mentioned before, the consumer demand we would hope to improve going forward, but we're careful in terms of our expectations for the next year. We're not banking much on that to happen. If it comes, that would be great and that would be providing further tailwinds for us. And again, what you're seeing is, on a comparative basis to prior periods, you would see the stocking sort of cycling off. That gets us a better volume performance in terms of what we report. And a little more color on that, in the first half of '25, we would be comping a pretty broad range destocking versus prior period. However, we said that pretty much came to an end after the first half last year. So, that won't be there in the second-half anymore. And in the first-half, we will still continue to see destocking in the healthcare category, which is pretty much a quarter longer than what we guided towards in Q3 -- in the earnings call after Q3. But that will abate in the back half of the year. And then we continue to believe that our customers, and to a large extent we have good exposure to big global customers, that they will continue to drive their volume performance, which is very consistent with what you're hearing. And we have -- we're partnering up with them. Like we have built a good relationship with them over the past. We always have been very close to the big customers. And as their volumes are coming back, we take advantage of that. So, you pull all that together, that sort of results to -- into the volume guidance of low-single-digit to mid-single-digit next year."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Adam Samuelson with Goldman Sachs. Your line is open."
},
{
"speaker": "Adam Samuelson",
"content": "Yes. Thank you. Good evening, everyone. I guess maybe continuing along that line of discussion, maybe I'd like to dig in a little more on the healthcare end market, which is still your most challenged. And if I was doing the algebra right, it seems like you're implying that was down near high-single-digit volumes in the fiscal fourth quarter. Sounds like destocking continuing for at least one more quarter. You talked about the confidence that you have of that ending by the end of this calendar year, and maybe a little bit more clarity on what the assumptions are for the healthcare business for volumes in fiscal '25, has obviously had important implications on mix as we move through the year. Thank you."
},
{
"speaker": "Peter Konieczny",
"content": "Yes, good question, Adam. I mean, first of all, I'd say that healthcare is as far as I'm concerned, a real gem in our portfolio. Let's start right there. And if we're challenged with the healthcare category, it would really just be on the back of the normalization that the category is seeing after a major dislocation that the category has gone through in the more recent past. And that dislocation is now coming to an end with the category essentially rightsizing their inventories. That's what we're seeing. So, we don't have any concerns overall in the stability and the attractiveness of this category to start right there. But what we're going through until the end of the calendar on the back of what we know right now is really just continued destocking. I can confirm that the high-level estimates that you're doing on volumes is correct in terms of high-single-digits being down in the more recent past. I think that the destocking that we've seen in Q4 is probably slightly better than what we've seen in Q3. And again, on the back of everything that we know, the destocking will come to an end by the end of the calendar. And that would be based on various conversations that we have with our customers and what they're confirming currently is happening in their business. Now, in the back half then when the destocking has come to an end, we're expecting a better volume performance with the business as you would imagine. And we would definitely have no concerns to believe that healthcare can return to growth rates that are in line with the historical averages of sort of mid-single-digits growth. The final point that I'd like to make maybe on healthcare is as I'm thinking through it, how to best answer your question. The destocking that we're seeing in healthcare is actually, when you look at the numbers, quite similar to some other categories that we've seen beforehand. It's just that healthcare started later, pretty much in Q2 last year, and has started mostly with medical on the medical side, which we've cycled through right now. And then with the phase delay, we've seen some impacts on the pharma side, which we're now crunching through. And that will come to an end by the end of the calendar, as I said before."
},
{
"speaker": "Michael Casamento",
"content": "And maybe Adam, just to pick up on the mix point. Yes, you're quite right. Obviously, the mix is unfavorable in Q4. And with the destocking continuing, if we think about our guidance assumptions for the FY ‘25, we would expect that negative mix to continue in the first half. But then as we head into the second half, it will obviously improve as we're through the destocking. So, on a full year basis, we probably expect the mix to be more neutral."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Daniel Kang with CLSA. Your line is open."
},
{
"speaker": "Daniel Kang",
"content": "Good morning, everyone. Just a quick question on capital management. I noticed that the Board has chosen to refrain from share buyback at this point. Can you talk us through the decision there? Is it a reflection of wanting to see leverage ratios lower or is it a reflection of more confidence in the M&A pipeline?"
},
{
"speaker": "Michael Casamento",
"content": "Yes. Thanks, Dan. It's Michael here. I can take that one for you. Look, we've still got a little bit more to go of a buyback that was approved earlier on. So, we didn't do that in Q4. And that's really a function of, we have a good M&A pipeline and there's opportunities there as always. So, we elected to not do the buyback. From a capital allocation standpoint, I mean, the buyback is just one element of that. Clearly the strong cash flow, we direct the CapEx first to grow the business organically. We continue to pay a dividend and you saw us increase the dividend again and then with the free cash flow left over, clearly we'd like to invest that first and foremost in M&A because that's where we get the greatest return. And if that's not available, then the buyback is really the next alternative. So, the buyback is -- and obviously, it's a function of the cash flow performance as well. So, for now, we haven't called out a buyback for '25. We've still got to finish a little bit left over there to do. But we've got a good pipeline of M&A activity. We're expecting the cash flow in the business to be solid through the year as we've guided to $900 million to $1 billion. So, we'll see how things play out as we work our way through the year and if there's capacity to do the buyback, we'll do it."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Anthony Pettinari with Citi. Your line is open."
},
{
"speaker": "Anthony Pettinari",
"content": "Good evening. We've come off two, three years of pretty sharp cost inflation that you had to absorb and pass on to your customers. Just wondering, as you look at the '25 guidance, what kind of cost inflation, raw material inflation, resin assumptions are baked in to the full year guidance? And how might it be different or not different than what you've kind of experienced over the last couple of years?"
},
{
"speaker": "Michael Casamento",
"content": "Yes, you're quite right. I mean, we've been in a highly inflationary environment. Clearly, inflation is abating, though it's still at a later level, but clearly abating. I think from where we sit today, the main area of inflation now is really in the labor of things. And that's probably in that kind of mid-single-digit range, and we'd expect that again in FY ‘25. But our cost inflation in the quarter-four was about $35 million or $190 million for this year versus $340 million in the prior year. So, you can see that it is abating. And I think the main area really now is just on the labor side as we look forward. From a raw material standpoint, look, it's a pretty benign environment at the moment. I think in Q4, probably overall, and we buy a broad basket of raw materials and across multiple geographies across the globe. If I think about Q4, probably in general it was up kind of low-single-digit, I would say, and -- but it was a bit mixed by raw material types, so resin is up a little, aluminum up probably more mid-to-high, but then films and liquids were down. So, on balance, not a material impact to the business, and from an EBIT standpoint, we really, for the year, were pretty neutral on the raw material side. As we look into '25, really, as we look into the first quarter, again, we're seeing a pretty benign environment. If I think about North America and Europe, raw materials typically look pretty flat in the first quarter. Perhaps Asia is the one area where we might see some slight increases in raw materials, but, again, generally, I'd say the basket of goods is pretty benign across the globe. So, that's what we've factored into our guidance assumptions, and, of course, we've given you a range of growth in the guidance assumptions, kind of 3% to 8%. Obviously, raw materials is a factor within that. I mean, we pass through raw materials contractually, but there can be a lag. So, that's just one element that could get us to the bottom or upper end of that range."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of George Staphos with Bank of America. Your line is open."
},
{
"speaker": "George Staphos",
"content": "Hi, everyone. Thanks for taking my question. Hope you can hear me. Can you comment on the outlook for beverage in North America and when you expect the volumes to turn more positive? Thank you so much."
},
{
"speaker": "Peter Konieczny",
"content": "Yes, George, it's PK here. I'll take that question. Look, beverage in North America is a little more discretionary than many of the other categories that we serve. Think about the acetonics categories as such. We're seeing in the current environment, if you just look at scanner data, sort of low-single-digit to mid-single-digit decline in that category. And that's what we're facing in the market right now. On top of that, I would say that our performance is also somewhat impacted by our exposure to customers that are in their totality underperforming the market. Sort of some low-single-digit, if you want, and that sort of rolls up to our own volume performance. On your question, how do we expect that to continue? I think as we're looking at '25, it will to a large extent come down to the question of how consumer demand is developing in that category going forward. I think we've got to be realistic here. We've got to say that we're not overly ambitious in terms of expecting the volumes to turn around in the near future. We would hope that that's the case. But as we're looking into the next year, I think we're being realistic about that. And it has mostly to do with the discretionary sort of nature of the category that we're exposed to. So, that's how I would answer the question. I hope that helps."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of James Wilson with Jarden Australia. Your line is open."
},
{
"speaker": "James Wilson",
"content": "Morning, guys. Just heading into FY ‘25, can you give us a bit of a sense of the quantum of the $400 million of cost-out that you've managed to do over FY ‘24 that will have to come back into the business as volumes pick up?"
},
{
"speaker": "Michael Casamento",
"content": "Yes, sure, James. It's Michael here. I can take that one. As you said, we've been pretty focused on cost in' 24 and I'm pleased with where we ended up. We've generated savings in excess of $440 million, which includes $35 million of benefits from the structural program that we've put in place as well. And if you think about where that's coming from, there's two elements to it, obviously. The operating performance of the business, we've been laser-focused on managing our shift patterns, taking whole shifts out where we can, and flexing the operational costs of the business to the lower volumes. Procurement has been a big driver in this environment, obviously. We've been working hard through our global reach and scale on that front. And discretionary spend has been managed quite tightly. Obviously, we've had a strong year in '24 and we'll be lapping some of that. But as we look into '25, the structural benefits of $35 million, there'll be a further $15 million in '25. So, that completes that program where we were going to invest $170 million in cash and get the $50 million out. So, we're well down the path of that and confident in that space. And then on the balance, I mean, we continue to get procurement benefits. We'll continue to manage the operations. But clearly, as the volumes increase, which is what we saw in Q4, we'll have to flex the labor back up to manage those higher volumes that we're anticipating. That said, it won't be linear. So, we'll be able -- we're more efficient today. We'll continue to see benefits from the cost takeout that we've had just in the efficiency as we deal with those increasing volumes working through the next year. So, hopefully, that helps."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Brook Campbell-Crawford with Barrenjoey. Your line is open."
},
{
"speaker": "Brook Campbell-Crawford",
"content": "Yes. Good evening. Thanks for taking my question. Just a quick one for you, Michael, please. Just around the D&A charge in the fourth quarter was quite a bit lower than we were thinking. It was down about 8% year-over-year or 6% quarter-on-quarter. Do you mind just commenting on what sort of drove that reduction in D&A in the quarter? And should we really just be analyzing that fourth quarter D&A charge when thinking about FY ‘25? Or is there other adjustments we need to think about? Thanks."
},
{
"speaker": "Michael Casamento",
"content": "Yes. Thanks, Brook. I can help you there. Look, in the quarter -- well, for the year, as I said, D&A was down kind of $7 million or thereabouts, not material. I mean, it's really a factor of a couple of things. Obviously, we reduced cap expense. So, you've got a little less there. And also, with the restructuring we've been doing, we've closed seven plants, four restructures as well. So, clearly, some assets have come out of the business from that front. And there's been some other minor adjustments here and there. So, as I look forward, I'd still expect depreciation to be in that kind of $400 million to $420 million range on an annual basis, which is, again, as we build cap expense in '25, as I mentioned in my speaking notes, we are expecting to increase CapEx again in '25 as we work our way through high volume. So, that will normalize some of that depreciation."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Richard Johnson with Jefferies. Your line is open."
},
{
"speaker": "Richard Johnson",
"content": "Thanks very much. PK, I've been thinking a little bit about the business kind of beyond the volume normalization process and in the nearer term, the benefits, your profitability is getting from the structural -- the restructuring program that you've put in place. Is it possible to get a sense from you when you look across your portfolio, which of course is very broad from both a category but a geographic perspective, are there areas that you think that could do with a bit of refreshing on the one hand or on the other hand, maybe structurally challenged in long term might actually be a drag on the growth that you think the business could ultimately produce? Thanks."
},
{
"speaker": "Peter Konieczny",
"content": "Yes. Hi, Richard. I wonder how I can best sort of answer that question you're asking about refreshing certain areas of the portfolio and seeing potential drags on the performance of the business going forward. I got to -- first of all, I got to remind everyone here, the position that I'm in and it's hard for me right now as an interim to sort of formulate the views on the long-term strategy of the Company, which that sort of touches on when you go to the portfolio. But in essence, having said that, I believe that the business should continue to focus on categories that are more attractive than others. And that would be a starting point, that we feel strongly about focusing the business on certain areas that are potentially value-driven, therefore higher margins and offering better growth than others. In Flexibles, the problem is always -- or the challenge is, you can be everything to everybody and that has never really played out. I'm a big fan of focusing the business on those areas that are more attractive to us. Now, the ones that I would call out here as just as examples is the protein category that we've talked about in the past, which breaks out into meat and into dairy, cheese to be a little more specific. We do like coffee or particularly premium coffee. We do like healthcare. While I did say that we're going through the short-term normalization of the business, we like pet food and so on and so forth. So, that's a good starting point. When you sort of go through the portfolio, you may find other categories that are less attractive and that is something that we sort of need to strategically think through. In terms of geographies, I like the exposure of the business between developed and emerging markets. And there, we would want to continue the journey that we've been on. You've seen us make acquisitions also in the past. If I just look at the healthcare business that we acquired in China, the Flexibles business in India, we made an acquisition in Eastern Europe, which is positive, just to mention a few examples. So, I think that's what we're doing. This is the way how we're thinking about it and we need to continue to think about it. And I hope that provides a bit of color to the question."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of John Purtell with Macquarie. Your line is open."
},
{
"speaker": "John Purtell",
"content": "Good day, Peter and Michael. I hope you're both well. Look, just a question regarding the flow of volumes through the quarter. Where did the exit rate end at? And if you're able to make any comment on developed markets and emerging markets within that?"
},
{
"speaker": "Peter Konieczny",
"content": "Yes, I'm happy to take that question. Look, I'll start out by saying I'm not a big believer in commenting on monthly volume performances because you have big swings in there and you can't really read too much into it. And I think that a quarter is better of an indicator for actual performance. And I would like to stay on that level. So, 1% overall growth in the fourth quarter is a good indication for the momentum that we carry forward into fiscal '25. Now, to the second part of the question, developed markets versus emerging markets, we have in the past quarter seen growth in the emerging markets like you would expect. The developed markets were a little more muted. And what's been encouraging in the fourth quarter is that the developed markets also returned back to growth. And I say that, particularly encouraged by the fact that they also have the large exposure to healthcare, where we have seen continued destocking. So, that's quite encouraging for us. So, again, developed markets performing better. Despite the healthcare destocking, emerging markets continue to grow. And that's the momentum that we carry forward. Hope that helps."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Cameron McDonald with E&P. Your line is open."
},
{
"speaker": "Cameron McDonald",
"content": "Good morning, guys. Just going back to sort of the structural questions that were asked before, we're seeing some changes in preference shift around substrate towards aluminum cans particularly. Is that providing any sort of headwind to the beverages segment that you've got and then -- and/or any of the regulatory changes in the European market that could also be providing a bit of a challenge going forward? If you can comment on those, please."
},
{
"speaker": "Peter Konieczny",
"content": "Yes, happy to do that. I mean, these are two big questions or one big question, maybe another one that I can take first. That's a little easier to answer. Let me go to the beverage question first. Substrates in the beverage side of the business, they do coexist, particularly between aluminum and PET and they both have their place. PET typically is, you see that on the go consumption resealable. And that's where PET sort of finds its home. So, in the different categories on beverage, you find PET or cans coexist or aluminum coexist. There is one category where they both sort of compete with each other. And that would be in the subsegment of CSD on the beverage side. Now, over long periods of time, we have seen pretty much constant share between the two substrates in that category. In the more recent past, given the more discretionary environment that we're looking at, consumers are shifting to the better value option. And those tend to be aluminum cans, which are sold in multi-packs through the big box stores and the channel. And because when you take a look at the price points, they seem to be more attractive. So, in the more recent times, we've seen a bit of a share shift to cans on that end. And then we'll have to see how that plays out as the environment normalizes. But it's not been a big trend for us that significantly impacts the volumes because it's really just this one subcategory. So, that said, to the second part of the question, regulatory developments, which is a different animal, but likewise really important for our business. What we've seen in Europe, particularly the packaging and packaging waste regulations come through, and we are obviously taking a close look at that. This is a regulatory development that we, to be honest with you, welcome, because at the end of the day, all these initiatives try to do one thing and try to accomplish one thing, which is, trying to keep plastic waste out of the environment. And that's much aligned with our targets here as a Company and comes back to our efforts in terms of the sustainability -- or on the sustainability side. The developments there, they help us essentially move the industry faster to an end-point that we're more than happy to support and that we feel we're very well-placed to support. We have made great progress on developing more sustainable products, which are designed to be recyclable. And the regulation that we've seen essentially moves the whole industry to the concept of circularity that we want to support and that we want to get in place. So, we're supportive of the regulatory developments there in Europe, but also elsewhere, and we welcome it."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Keith Chau with MST Financial Services. Your line is open."
},
{
"speaker": "Keith Chau",
"content": "Hi there. Thanks for taking my follow-up. One for Michael, just the restructuring costs seem to have subsided a touch in the fourth quarter. I think there are some restructuring costs to go in FY ‘25, below the line. Just wondering if you can give us a sense, Michael, on what the drag on that will be on cash flow? Thank you."
},
{
"speaker": "Michael Casamento",
"content": "That's okay. Look, we're -- the program was going to be around $170 million in cash-out. We've spent net today around $110 million. So, we've got FY ‘25, we'll pretty much finish the program. So, it's another $60 million-odd to go, which you'd expect to see in the adjusted cash flow."
},
{
"speaker": "Keith Chau",
"content": "Okay. Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Nathan Reilly with UBS. Your line is open."
},
{
"speaker": "Nathan Reilly",
"content": "Pete, I'm just curious, how much spare capacity do you have in the existing manufacturing footprint to respond to demand growth, really just in terms of managing your shift flexibility?"
},
{
"speaker": "Peter Konieczny",
"content": "That's a great question, Nathan. You've got to -- you got to distinguish between sort of manned capacity and sort of machine capacity that we have in place. That's the way how sort of we think about it. And on the manned capacity side, we're challenging ourselves in the business really hard to sort of balance that with the actual demand profile as you would expect, right? So, from a manned capacity side, that we were pretty much balanced and that's what we flex, right? When we say we flex, that's what we're flexing. Now if you -- and when you look at the volume development over the more recent past and you know that we've gone through a pretty tough patch here. Obviously, volumes overall have come down and therefore, the machine capacity offers up some headroom for additional volumes, which is encouraging for the future when the volumes come back. But where we do have a challenge as a business then is to flex up again and operationalize essentially the additional machine capacity that we require. Now, there is always -- and that's going to be my last comment on that question, there is always a challenge because the reality is you never have the capacity where you need it. And so, that's -- that never plays out in a perfect world and particularly where we're well-positioned with a compelling value proposition, we are full in terms of our capacity, very oftentimes also from a machine capacity standpoint, but that's something that we need to manage on a tactical day-to-day business."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, that's all-the-time we have for the question-and-answer session. I will now turn the call back to management for closing remarks."
},
{
"speaker": "Peter Konieczny",
"content": "Well, look, thanks everybody for the interest in the Company and for joining the call. I think the most important thing for me is to really just go back and to -- go back to the key messages for the call. We really had a strong quarter and we've had good questions, but overall, the Company is I think in a good spot with the momentum that we have developed in the fourth quarter to go into '25. We are pretty good about where we stand and where we sit and pretty good about the guidance that we have out there and we're looking at a good year to come. So, thanks very much for the interest in the call and talk to you soon."
},
{
"speaker": "Operator",
"content": "This concludes today's conference call. We thank you for joining. You may now disconnect."
}
] |
amcr | 2,024 | 3 | [
{
"speaker": "Operator",
"content": "Thank you for standing by. My name is Jay and I will be your conference operator today. At this time, I would like to welcome everyone to the Amcor Third Quarter 2024 Results Call. [Operator Instructions] I would now like to turn the conference over to Tracey Whitehead, Head of Investor Relations. You may begin."
},
{
"speaker": "Tracey Whitehead",
"content": "Thank you, operator and thank you everyone for joining Amcor’s fiscal 2023 third quarter earnings call. Joining today is Peter Konieczny, Interim Chief Executive Officer; and Michael Casamento, Chief Financial Officer. Before I hand over, a few items to note. On our website, amcor.com, under the Investors section, you’ll find today’s press release and presentation, which we will discuss on this call. Please be aware that we’ll also discuss non-GAAP financial measures and related reconciliations can be found in that press release and the presentation. Remarks will also include forward-looking statements that are based on management’s current views and assumptions. The second slide in today’s presentation lists several factors that could cause future results to be different than current estimates. Reference can also be made Amcor’s SEC filings, including our statements on Form 10-K and 10-Q for further details. [Operator Instructions] With that, over to you, P.K."
},
{
"speaker": "Peter Konieczny",
"content": "Thank you, Tracey and thank you to all who have joined us for today’s call. Prior to discussing our third quarter performance, I want to spend a few moments recognizing my predecessor, Ron Delia, and his many accomplishments at Amcor. In the last few years alone, Ron led us through the transformational acquisition and integration of Bemis, the largest acquisition in the company’s history, successfully and safely guided the business through a pandemic and made the difficult and correct decision to divest our business in Russia. And most recently, Ron directed our teams in navigating that particularly challenging economic period. I now will speak for the Board, our global management team and our employees around the world and thanking Ron for his leadership, guidance and dedication during his 18 years with Amcor and 9 years as CEO. I’ve worked closely with Ron, our board and the other members of our executive team over many years to help shape and execute our strategy, and I am honored to take the leadership reigns in an interim capacity at this time. Today, Amcor is the established industry leader in our key markets and geographies, has world class talent and clearly differentiated commercial innovation capabilities, all providing us with multiple opportunities to capture high value growth. Importantly, the business is also well positioned to continue benefiting from the proactive steps taken by our leaders across the company to align the cost base with recent challenging market conditions. The results of those decisive actions were again evident in our third quarter financial performance as we showed strong earnings leverage across the business. Third quarter year-over-year volume performance also improved on a sequential basis, and we expect this trend to continue driving stronger earnings growth as we close fiscal year ‘24. My role right now is to ensure we stay focused and on track and that we capitalize on the strong position we are in to maintain momentum and further accelerate earnings growth. It is a team effort and will drive success. And I am surrounded and supported by credible leaders and talented team players throughout our organization. As seen on Slide 3, my near-term priorities are simple. First, ensure Amcor continues to provide a safe and healthy work environment for our global workforce. Second, stay close to our key stakeholders, including our employees and customers and finish our 2024 fiscal year strongly. After an improved third quarter performance, we are well positioned to do so and we’ve raised our full year guidance today. Third, build on the momentum we have worked hard to deliver across the business and as we work through our planning cycle for fiscal ‘25 set clear priorities to ensure our momentum continues. And fourth, provide stability for the business and keep our teams focused on delivering for all our stakeholders by reinforcing that. Our strategy has not changed, our agenda has not changed, and our priorities have not changed. Moving to Amcor’s Q3 performance, starting with safety on Slide 4. Our commitment to health and safety of our teams remains our number one priority, and we continue to focus on providing a safe and healthy work environment. 72% of our sites have been injury-free for the past 12 months or longer, and we experienced a 19% reduction in injuries compared to the first 9 months of fiscal ‘23. Safety is deeply embedded in Amcor’s culture and is a critical cornerstone of our success. Turning to our key messages for today on Slide 5. First, outperformance in the underlying business resulted in adjusted earnings per share for the third quarter that exceeded the expectations we set out in February. Our Flexibles and Rigid Packaging segment each delivered adjusted EBIT growth, leading to Amcor returning to year-over-year earnings growth a quarter sooner than we anticipated. Improved working capital performance through the year also resulted in a year-to-date increase in adjusted free cash flow. Second, as I mentioned earlier, our third quarter volume trajectory improved significantly on a sequential basis as destocking abated across most end markets, and we experienced higher customer demand in several of our businesses. While this is clearly an encouraging and positive trend, our teams remain highly focused on continuing to control costs and this helped us deliver a third consecutive quarter of improved earnings leverage and a return to earnings growth. Third, our March quarter financial performance and expected further momentum in our fourth quarter gives us the confidence to increase our full year adjusted EPS guidance range to $0.685 to $0.71 per share and reaffirm our guidance for adjusted free cash flow between $850 million and $950 million for the fiscal year. We believe we have turned the corner after a challenging calendar 2023, and we expect our sequential volume and earnings growth trajectories will continue to improve, which is supported by the demand trends experienced across the business in the first weeks of April. Finally, we remain confident in our capital allocation framework and strategy for long-term growth. We believe the strength of our market positions, our opportunities for investment and our execution capabilities, along with our commitment to a compelling and growing dividend, make a convincing investment case for Amcor. Moving to Slide 6 for a summary of our financial results. The first 9 months of fiscal ‘24 continued to reflect significant benefits from our proactive cost actions. Three consecutive quarters of strong operating leverage helped offset the unfavorable impact of 7% lower sales – lower year-to-date sales, leading to a decline in adjusted EBIT of 3%. We believe we’ve reached an inflection point in the trajectory of earnings and volumes with our Q3 results, and we are pleased with our financial results in the March quarter. Better-than-anticipated demand trends and continued strong cost performance resulted in EBIT and earnings per share ahead of our expectations entering the quarter. The underlying business saw a return to profit growth in the third quarter with adjusted EBIT of 3% compared with last year. Volume trends improved as the broad-based destocking experienced in the December quarter abated and customer demand strengthened. Our teams also continue to focus on cost reduction and productivity initiatives and delivered another quarter of outstanding results with approximately $130 million in total cost savings, including approximately $15 million of benefit from structural cost initiatives. These benefits, combined with improving volume trends, resulted in another quarter of improved earnings leverage. Interest and tax expects were modestly higher than the prior year, in line with our expectations and adjusted earnings per share of $0.178, grew by 1%. Q3 net sales were down 6% on a comparable constant currency basis, which primarily reflects overall volumes 4% lower than the prior year. This is predominantly related to expected ongoing weakness, including further destocking in healthcare categories and in the North American beverage business, which collectively represent approximately 3% of Amcor’s total sales. Across the remaining 70% of our business, overall net volumes were relatively flat with last year, a significant improvement compared with the December quarter and the business delivered volume growth across several categories and geographies. Outside of healthcare, we believe destocking is now largely behind us. Price mix for Q3 had an unfavorable impact on sales of approximately 3%, which is a result of greater volume declines in high-margin healthcare categories, which we anticipated and called out last quarter. We continue to return significant cash to shareholders through a compelling and growing dividend and share repurchases, which totaled approximately $570 million through the first 9 months of the year. I’ll turn it over to Michael now to provide some further color on the financials and our outlook."
},
{
"speaker": "Michael Casamento",
"content": "Thanks, PK, and hello, everyone. Beginning with the Flexibles segment on Slide 7 and focusing on our Q3 performance. Net sales for Q3 were down 6%, reflecting an unfavorable pricing impact of 4% and a 2% decline in overall volumes, which was a significant improvement of 8 percentage points compared with the December quarter. As we anticipated and called out last quarter, volumes for healthcare products remained weak and destocking continued, particularly in North America and Europe. In total, healthcare volumes were down double digits, and this had an unfavorable impact of approximately 3% on overall segment volumes and was the primary driver of the 4% unfavorable mix in the quarter. Across the balance of our flexibles portfolio, net volumes grew approximately 1% in the quarter, with growth in several end markets, including meat, pet food, cheese and unconverted film foil, and we also saw growth across a number of emerging markets. Across North America and Europe, third quarter net sales decline a high-single-digit rates and favorably impacted by a mid-single-digit lower volumes and unfavorable price/mix related decline in healthcare categories. Excluding healthcare across these two regions, we saw mid-single volume growth in cheese and a strong sequential improvement in meat and pet care volumes, which were flat and up low-single digits for the quarter, respectively. Across the Asian region, net sales were modestly higher than the prior year. China grew volumes for the third consecutive quarter. And volume growth in Thailand, India and the Philippines also helped offset lower volumes in South East Asian healthcare business. In Latin America, the business delivered good volume growth in Brazil, Mexico and Peru. Q3 adjusted EBIT of $358 million, was 5% higher than last year on a comparable constant currency basis. Strong cost performance through the quarter, including from restructuring initiatives, combined with broadly improving demand trends, led to another quarter of strong earnings leverage, and EBIT margins increased by 170 basis points to 13.8%. Turning to Rigid Packaging on Slide 8. Q3 net sales were 8% lower on a comparable constant currency basis, mainly reflecting lower volumes. While overall volumes were down 8% for the quarter, this represents a meaningful improvement over the December quarter. In North America, overall beverage volumes continue to be impacted by soft consumer and customer demand in Amcor’s key end markets, along with some lingering destocking. Total beverage volumes were down 11%, improving sequentially from the 19% decline we experienced in December quarter, which was impacted by significantly more destocking. Latin America volumes were in line with last year with growth in Brazil and Colombia, offset by weaker demand in Argentina. We are pleased to see the Rigid Packaging business return to earnings growth, with adjusted third quarter EBIT up modestly over last year. Strong earnings leverage resulting from a continued focus on cost reduction and productivity measures and the realization of benefits from restructuring initiatives more than offset lower volumes, leading to an 80 basis point increase in EBIT margins to 8.7% for the quarter. Moving to cash and the balance sheet on Slide 9. Adjusted free cash flow for the first 9 months was approximately $100 million ahead of last year, mainly driven by improved working capital performance and successfully reducing inventory levels for the fifth consecutive quarter. Leverage at 3.4x is broadly in line with the first half and within the range of expected outcomes for the third quarter. As a reminder, the business is cycling through temporary increases in working capital, and trailing 12-month EBITDA remains at lower than historic levels, reflecting the divestiture of our Russian business in December 2022. Looking ahead, we continue to expect leverage will decrease to approximately 3x at the end of our fiscal year, supported by seasonally stronger earnings and cash flow in our fiscal fourth quarter. This brings me to our outlook on Slide 10. As P.K. noted earlier, we are raising our full year guidance for adjusted EPS to $0.685 to $0.71 per share to reflect our performance in the underlying business in the third quarter and our expectation that volumes will continue to improve through the balance of the year. We also remain focused on controlling costs and expect to deliver further savings in Q4, including from our structural initiatives. For fiscal 2024, we continue to expect the underlying business to contribute organic earnings growth in the plus/minus low single-digit range with share repurchases adding a benefit of approximately 2% and favorable currency translation contributing a benefit of up to 2%. This is offset by negative impact of approximately 3% related to the sale of our Russian business in December 2022. The impact of which was all in the first half. We also expect a negative impact of up to 6% from higher interest and tax expense, which takes into account our updated estimate for the full year net interest expense of between $310 million to $320 million. We are confident, we will build on our third quarter performance, and adjusted earnings per share for the fourth quarter is expected to grow over last year by mid-single digits on a comparable constant currency basis. And overall volumes in the fourth quarter are expected to be down in the low single-digit range, primarily due to ongoing destocking in healthcare categories and continued weak consumer and customer demand in North America beverage. We expect the volume improvement we experienced in the third quarter to continue as we progress through the fourth quarter, which will position us well as we enter fiscal 2025. We have also reaffirmed our guidance range for adjusted free cash flow of $850 million to $950 million for the year. So with that, I’ll hand back to P.K."
},
{
"speaker": "Peter Konieczny",
"content": "Thank you, Michael. In closing, on Slide 11, our Q3 financial results guidance for the balance of the fiscal year and our expectation that we will continue to build earnings momentum in fiscal ‘25 will highlight that Amcor is a very well-positioned business. Amcor’s industry leadership across the globe is well established. Our differentiated innovation capabilities are assisting the world’s best known brands and smaller companies in achieving their objectives to protect, preserve and promote their products while enabling them to meet the sustainability commitments they have made to the stakeholders. And Amcor’s talented employees around the world are capitalizing on growth opportunities in priority categories, emerging markets and through sustainable offerings while also continuing to closely focus on cost controls. We’re confident we will continue to see positive momentum given the actions we have taken and continue to take across our operations to invest in growth, reduce cost and improve productivity. As I mentioned at the beginning of the call, my role right now is to ensure we stay focused and on track and that we capitalize on the strong position we are in to maintain momentum and further accelerate earnings growth. The continued safety of our goal will always be at the top of Amcor’s agenda. But a very close second for me right now is to keep our teams focused on delivering for all our stakeholders by reinforcing that our strategy, our agenda and our priorities have not changed. Our Q3 volume trajectory and financial performance underscores our confidence in stronger earnings growth momentum as the challenges we faced in calendar ‘23 are put further behind us. We have raised our full year EPS guidance, and we anticipate delivering mid-single-digit earnings growth in Q4. Our performance in the first few weeks of April supports this expectation. And our commitments to our longer-term growth and value creation strategy gives us line of sight to a return to growth in line with our shareholder value creation model. Operator, we’re now ready to turn the line over to questions."
},
{
"speaker": "Operator",
"content": "Thank you. [Operator Instructions] Your first question comes from the line of Ghansham Panjabi of Baird. Your line is open."
},
{
"speaker": "Ghansham Panjabi",
"content": "Hi, guys. How are you? I guess first off, it just sounds like volume surprised you to the upside during your third quarter. Do you think that’s just a function of 2Q coming in lower than forecast just given aggressive year-end inventory destocking by your customers? What do you think this is more of a sustainable improvement that you’re going to build upon as you look out to your fiscal year ‘25? Thanks."
},
{
"speaker": "Peter Konieczny",
"content": "Yes, thanks. It’s a great question. I mean there is a couple of things to take away here from the discussion of the quarter. The first one really is that the volumes improved. The second one is that we had great cost performance. And the third one really is that we believe the momentum carries over into the Q4. But let me get back to the volume question. So significant improvement sequentially on volumes from the second to the third quarter, to remind ourselves, second quarter, we were down 10%. Third quarter, we were coming in 4% down versus prior year. And when you look at the 4% that we were down, it pretty much equally split between two drivers. That’s the market impacts. And by that, I mean consumer demand and our exposure to categories and customers. And then the second one is destocking. So that made up the 4% decline. And when you – and another way to look at that is the 4% decline was pretty much all driven by destocking in healthcare and North American beverage. That also means that the balance of the portfolio ended up being pretty flat. And we’re pretty much pleased with this outcome because when you think about it, healthcare and North American beverage is about 30% of our business, that means the balance of the portfolio, 70% came in flat. Now when I take a step back and we look at the third quarter volume performance, now there’s a few things that we take away. The first one is, we saw a bit of unwind of a very strong destocking in the December month. And when we discussed the second quarter, we talked about a pretty strong January. And there was a bit of a question mark around how much of that performance was driven by unwind of the December month. And as we sort of left Q3 behind us, we can confirm that the volumes in January and also February, to a certain extent, benefited from a bit of an unwind in an unusually low December month. So that was the first one. But the second thing that we’ve seen is that our customers perform better. And we talked about that also in the last quarter. The background here is that customers are – particularly large customers are talking more and more and responding more and more towards turning the dial a bit towards a better balance between volumes and margins. So we’ve seen that come through. And then the third one is pretty much what we expected to a certain extent that the destocking would abate. And that pretty much happened with the exception of healthcare and some lingering destocking in North American beverage. So look, that’s pretty much the discussion of the third quarter. But as I have the floor on volumes, let me just make two more comments and breaking it down into the segments here because I think the color is important. In Flexibles, we came from being 10% down in the second quarter to being 2% down in the third quarter. And again, the customer performance sort of drove improved market impact performance and then the destocking significantly abated. And when you look at the Flexibles segment, it was all made up by the healthcare impact in terms of the decline, the balance of the portfolio is flat to even slightly up. And then just one more comment on Rigid and then I’ll stop. Rigid went from 12% down in the second quarter to 8% down in the third quarter, so also an improvement. We continue to see a soft market, but the destocking as significantly rated in Rigids also. So across the board, really, really good improvement. And when you think back to what I discussed, there’s components in where the – that we believe to be sustainable, no question. And that relates to one further abatement of the destocking and second, to good customer performance that we continue – that we believe we will continue to see people."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Daniel Kang of CLSA. Your line is open."
},
{
"speaker": "Daniel Kang",
"content": "Good morning, Peter. Good morning, Michael. Just a question on healthcare. You mentioned healthcare continued to fall double digits in 3Q, which from memory sounds quite similar to the December quarter. Can you comment on whether there was any sequential improvement in 3Q? And just from the visibility of customer stock levels and given the low comps that you should be working with going forward, is it reasonable to expect that first half fiscal year ‘25 to show some improvement in healthcare bond?"
},
{
"speaker": "Peter Konieczny",
"content": "Let me help you with healthcare a bit. So the main driver of the healthcare performance really has been the destocking and the destocking sort of abating from Q2 to Q3. I would say, overall, the demand situation has not really changed much in healthcare. So you would see overall healthcare is marginally better between the second and the third quarter. We do expect further improvement in healthcare though because the destocking will further sort of reduce in the fourth quarter. As a matter of fact, when we guide to low single-digit volume decline in the fourth quarter, we would believe that most of that is driven by healthcare – all of that is driven by healthcare. And we don’t really know exactly when the destocking will come to an end. It will certainly sort of stretch into the fourth quarter. Maybe we’ll see a bit of an – we see a bit of an impact also in the first quarter of fiscal ‘25. But that would be as far as I would go with everything that I know at this point in time. Maybe one more thing that I would want to add to is that, again, we’re talking about low single digits decline in volumes in the fourth quarter. But with a further improving trajectory, we’re expecting to exit the fourth quarter flat on volumes."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Adam Samuelson of Goldman Sachs. Your line is open."
},
{
"speaker": "Adam Samuelson",
"content": "Yes. Thank you. Good afternoon, everyone. I was hoping to maybe talk a little bit about the operating leverage in the business or lack thereof on the deleverage side just given the profit performance, especially in Flexibles relative to the volume and mix declines you still saw in the period. And hoping to maybe just aggregate a little bit the amount of fixed cost reductions actually realized in the period versus the variable cost kind of efficiencies and productivity gains in the quarter and how kind of durable you think those variable costs and productivity improvements proved to be if volumes start to normalize or how much cost would have to leak into the system to serve incremental volumes from here?"
},
{
"speaker": "Michael Casamento",
"content": "Thanks for the question, Adam. I’ll take that. It’s Michael here. Yes, look, on the cost side, we’re really pleased with the cost performance of the business in Q3. We took another kind of $130 million out of cost, which included some benefit from the restructuring program that we’ve got in place. So we now are now starting to see that come through. So that was about $15 million, as expected. And if you just take a step back and think about the cost work we’ve been doing, what are we actually doing? There’s two things that we’re focused on. Firstly, the operational side of the business, the cost productivity and cost flexing in a lower volume environment. And then the second is that structural program that we’ve talked about in response to trying to offset some of the divested Russia earnings. So in the quarter, we saw benefits from both, and we saw that in both the Flexibles and Rigid segment as well. So that was pleasing. And look, on the operational side, what have we been doing, we’ve been really both proactive and aggressive in flexing the cost base. And that’s into account the lower demand environment. So we’ve been certainly eliminating shifts to take labor out where we can, reducing the overtime to take that labor cost out, taking extended shuts when we’re aligning with some of our customers, so we’re going to take extended shuts over long weekends and other things to get the plants fully closed and get the cost out that way. We’re driving procurement. Obviously, in a lower volume environment, that’s also an opportunity for us to drive procurement savings and we’ve been really focused on that, and the team has done really good work there. And we’ve been tightly controlling our discretionary spend. So that’s kind of on the operating side. And then on the structural side, that’s more about plant closures. So we’ve announced seven plant closures and two restructures. And more recently, we’ve actually completed the closure around three or four of those. So we’ve now started to see that benefit flow through as we anticipated. And that program was going to deliver about a $50 million EBIT benefit over the program, $35 million, predominantly in the second half of FY ‘24 and then another $15 million into FY ‘25. And we’re pleased to report that we are now seeing those benefits come through. And in Q3, that contributed $15 million. The majority of that was in Flexibles, but also a few million in Rigid. So again, good cost control in both of those areas. And it’s difficult to determine how much of that is going to stick with the business long-term. But I guess what we would say is that we’ve taken a pretty significant head count out of the business. If you think about the structural cost out, I mean, those structural costs that have come out and they’re permanent. So the $50 million over time that comes through will be permanent. I mean on the procurement benefits, they’ll be sustained. The productivity we’d anticipate over the last several quarters, we’ve improved productivity, improved efficiency, being able to do more with less. So again, we’d expect that to continue. But as the volumes come back, we will have to put labor back into the business, rebuild shifts, but it’s not going to be linear. So we expect that we will continue to see margin improvement. And this will just contribute to Amcor’s ongoing margin enhancement. We typically, over a long period of time, have added 20 to 30 basis points in margin a year. And this program – we’d expect to continue that through the cost measures that we’ve taken here, and you saw that in the quarter. I mean we delivered a 120 basis point increase on the back of volumes improving, but cost take out really strong and the performance there across the business was great. So we feel pretty good about where we’re at. There’s still more cost to come out. You’ll see further benefits from the structural programs in Q4 as well as some ongoing efficiency benefits from the actions we’ve already taken."
},
{
"speaker": "Peter Konieczny",
"content": "And I would add that we’re particularly pleased with the work that’s been done in the Rigid segment here because we acknowledged that the business returned active profit growth in the third quarter on the back of a pretty soft environment still. So that speaks to a good leverage in that business."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of John Purtell of Macquarie. Your line is open."
},
{
"speaker": "John Purtell",
"content": "Good afternoon, Peter and Michael. I’ll just ask my one. The sequential volume pickup in Flexibles, just from the commentary and the release, so that appeared to mainly come from emerging markets rather than developed markets. So was there much sequential volume improvement in North America and Europe, for example?"
},
{
"speaker": "Peter Konieczny",
"content": "Yes, that’s also a great question. So in terms of our country sort of performance or the different regions, you’re right, we saw low single-digit growth in emerging markets in the third quarter, which was obviously pleasing and positive. And on the developed markets, we saw a bigger sequential improvement while we’re still negative in terms of our volume performance versus prior year. Now you got to keep in mind that the bigger markets were the ones that were more heavily hit with inventory builds and now with a normalization, therefore, the destocking. And that would also make sense, particularly with our exposure to healthcare in those markets."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Richard Johnson of Jefferies. Your line is open."
},
{
"speaker": "Richard Johnson",
"content": "Thanks, very much. PK, I think I’m right in saying you pretty much worked in every part of the business, except Rigid. I’d be really interested just to get a sense of how you feel about the strategic positioning of the group overall at the moment, but also particularly focusing on Rigid Plastics, which is perhaps in a slightly different position. And with the backdrop of in the beverage market anyway, other substrates appearing to be recovering a lot quicker than plastics."
},
{
"speaker": "Peter Konieczny",
"content": "Yes, Richard, thanks for the question. I mean there is we’re in a particular situation right now with the business. We’ve had a couple of tough quarters behind us with volume weakness. And we’ve worked really hard to position the business as well as possible to take advantage of the volumes improving again. And we believe that’s exactly the situation we’re in right now. So we said in discussing – after discussing the second quarter, we said we feel like the second quarter for the business was below point. And particularly now as we’re having the third quarter an hour back, I think we can confirm that. That’s where we stand. And we believe that we will see a better volume performance in Q4. So that’s the starting point. In that environment, we felt we want to get, first of all, back to the earnings capacity of the businesses that we have without asking strategic questions about the businesses. And we believe, particularly to Rigid Plastics, you’re right. I’ve been around in Amcor a bit, Rigid Plastics, I’ve not managed myself. But when we look at Rigid Plastics, we think it’s a good business strategically. And I’ll give you a couple of views here from my side. First of all, it’s a scale business. It’s business for Amcor. There’s no question about it. And secondly, when you look at the portfolio of the business, it’s actually a number of different businesses under one roof. We – often, we focus very strong in discussing North American beverage, but it’s more than that. We have a specialty containers business. So where we started to diversify, we have a Latin American business and we have a closures business with our [indiscernible] business. So it’s a portfolio of businesses. We have really good industry positions. And across Rigids where we participate, we like the customer relationships that we have with good solid customer relationships. And on top of that, also in the overall context of plastic, we have a strong sustainability profile, particularly in that business, which is really important. And finally, I’ll come back to what I said at the beginning. We’ve done a lot of strengthening in the business and the restructuring, for example, with the footprint optimization that we’ve gone through when we’ve generated a leverage that has enabled us to return the business back to profit growth. So I think where we stand right now is we want to see the volumes come back and then we want to see what the business can deliver. There’s no question that we want the business to deliver more and that’s where I would leave it for now. By the way, I think – I don’t know if you said it’s the Rigid Plastics business or the Rigid Packaging business. Actually, we call the Rigid Packaging business, and it’s just a little clarification. Thank you."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of James Wilson of Jarden Australia. Your line is open."
},
{
"speaker": "James Wilson",
"content": "Hey, guys. Good morning. Would you be able to just talk us through the net interest guidance that you guys have put out, particularly what’s driving the lower net interest given that leverage looks unchanged in your guidance? I understand that you’ve had some working capital improvements, but are there anything else that’s driving that?"
},
{
"speaker": "Michael Casamento",
"content": "Yes. No, thanks for the question. You saw us we reduced slightly the guidance. Our guidance prior to this quarter was $315 million to $330 million, and we reduced that down to $310 million to $320 million. And look, that’s really just on the back of the timing of the cash flows and the working capital improvements. We saw a little better timing of cash coming into the business, which, as we look at the forecast for the fourth quarter, we can see that and see that there’s a little bit of upside there on the interest cost. So we adjusted the guidance range accordingly. But outside of that, there’s not a lot of to it. No real change in the rate profile or the mix of debt."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of George Staphos of Bank of America. Your line is open."
},
{
"speaker": "George Staphos",
"content": "Good afternoon. Thanks for taking my question. PK, could you give us a bit more color in terms of some of the trends you’re seeing in Flexibles, in cheese and protein and some of the other key markets. And relatedly, are you seeing your customers perhaps pushing back some of their sustainability targets one of the larger branded companies and what are the implications for you in terms of growth as well? Thank you."
},
{
"speaker": "Peter Konieczny",
"content": "Sure. So in Flexibles, again, a pretty significant improvement in volumes between Q2 and Q3. I did make a comment earlier in terms of the two main drivers here: market impact. We are pretty much – were flat in the third quarter and the destocking sort of went to low single digits, and it pretty much is the healthcare impact of destocking that drove the volume decline versus prior year and the balance of the portfolio is pretty much flat to slightly growing. Now in terms of the category performance against that, you would remember that we’re driving a couple of priority categories here in the business where we believe we have really differentiated products and a good position in the market and where we like the market dynamics. And those would be healthcare need. You have heard us talk to that protein, protein breaks out and cheese and meat. Hot-fill beverage, obviously, would be one pet food premium coffee. And those are really the five focused categories that we drive. And we have seen, particularly in pet care, meat and cheese, we’ve seen growth in the quarter, which we are pleased with. Now I will say these are green shoots and don’t walk away from the call believing that this is like significant growth numbers. These would be low single digits. So we got to stay bolted here. But we like what we see, and we’d love to see a little more. Maybe a little more color here on cheese, as you particularly asked North America and Europe, we would be up also on the basis of less destocking. Meat, also less destocking and some regional wins that we have seen. Sorry, I just want to take the other part of the question, which was just check my notes here on the sustainability side and targets being pushed out and the effect on our business. Look, we follow the discussions closely. Actually, we are part of the conversations. And of course, we noticed that some industry participants have started to think about resetting their targets for their sustainability initiatives. At the end of the day, we are talking about essentially putting circularity in place, a circular economy for plastic, which will be the critical initiative to keep plastic waste out of the environment. That requires a lot of things that have to come together, and we are going to have to work together. Nobody can do that alone. And I think the understanding in the industry right now is after having worked very closely on the topic that it may make a little – take a little more time to get to the targets that we have set years ago. I mean I don’t know if you particularly think about Unilever, who has come out with pushing the targets backwards. But they were the first ones to come out and make a commitment, and that was sort of in 2017, if I have that correctly in my mind. And over the years, they have learned a lot, and the industry has learned a lot. So, I think it’s a matter of additional realism to just simply [Technical Difficulty] what they are saying. Now, in terms of Amcor, we have made a pledge in 2018, we are the first packaging company out there to pledge that will make 100% of our packaging recyclable and reusable or compostable by 2025, and we are pretty much around the corner. We do not have the need to push our targets out at this point in time. We are making really good progress because we have, at this point in time, roughly 90% of our packaging portfolio in recycle-ready structures or we have those alternatives available, and we are ready to sell them to customers when they want them. So, everybody needs to do their piece. We are holding on to our targets right now. We don’t think that it means anything to us that others are pushing their targets out. We are very committed to our sustainability targets. Like the industry is, particularly our big customers are particularly Unilever is. So, we continue to drive that with full force."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Brook Campbell of Barrenjoey. Your line is open."
},
{
"speaker": "Brook Campbell",
"content": "Yes. Good evening. Thanks for taking my question. Just with respect to trajectory in the business, this financial year has been better than expected. In the third quarter, you saw some EPS good versus back in Feb, the expectation was for the third quarter to be down a bit at EPS. And despite this, you have kept your fourth quarter EPS growth at mid-single digits, which is unchanged. So, my question really is, why wouldn’t the better performance for the first three quarters continue into the fourth quarter? Any reasons what’s holding you back from upgrading that fourth quarter expectation would be great? Thanks."
},
{
"speaker": "Michael Casamento",
"content": "Yes. Thanks. Brook, it’s Michael here. I can take that one for you. So yes, look, we finished Q3 with EPS growth, which was really pleasing. And that was on the back of a couple of things, slightly better volumes really coming out of that December period as P.K. touched on earlier. When we look our way through January, clearly, we saw an improved performance and some of that was relating to some of the unwind out in December. We weren’t 100% sure on how that might translate for the rest of the quarter. And what we saw in February was some more unwind clearly from December, which helped improve the performance in the March quarter and led to us being able to deliver EPS growth, which was really pleasing. So, you have seen us increase the full year guidance. We have taken the full year guidance to $0.685, $0.71, so an increase there. That’s really on the back of that improved performance in Q3. In Q4, we are still expecting sequential improvement, both in volumes and profit. And clearly, the driver of that, we are going to see that sequential improvement in the volume really held back by the continued destocking in healthcare. That’s really the key point that’s holding the volumes back in Q4 as P.K. touched on. That in itself has some unfavorable mix, which we have talked to in the past. So, that will continue into Q4, although start to abate and certainly down favorable mix from healthcare will unwind as volumes start to normalize into the future there. But Q4 is still expecting good cost out, good leverage through the P&L from that cost initiative as well as the structural piece, adding through there. And we are also expecting the earnings trajectory to improve to that mid-single digit. We get benefits from the Q4, the absorption in Q4, which is seasonally our biggest quarter as well. So, we feel pretty good about where the outlook is for Q4. We have confidence in delivering within that range. What we have seen in the early parts of April confirmed the volume outlook, so we feel confident there. And we just felt that we didn’t need to get ahead of ourselves at this point in time. Clearly, we have given you a range. We have given the marketing range. So, that’s a reasonable range in Q4. And if the volumes come in a little better than what we are expecting, then, clearly, that’s one way that the outcome for the full year could get towards the upper end of the range, along with cost and let’s see where raw materials impact as well. So, overall, I would say we feel pretty good about where we have landed in Q3 and what’s ahead of us in Q4 to deliver a good year."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Keith Chau of MST. Your line is open."
},
{
"speaker": "Keith Chau",
"content": "Good afternoon Peter and Michael. Peter, a question just around the PPWR that was voted into European Parliament earlier in this month, can you give us a sense of what Amcor is planning with respect to any changes to the regulation around plastics in the European Union? I know there is some impacts that are expected to the, I guess a headwind for the plastics industry in Europe by 2030. But just we came to hear your views on whether you think there is a headwind for the Amcor flexibles business? And if there are any mitigation strategies that are being put in place or whether Amcor is planning ahead to mitigate those headwinds? Thank you."
},
{
"speaker": "Peter Konieczny",
"content": "Yes. It’s also a great question and obviously falls into our sustainability strategy. Look, I will start out by saying that we are very supportive of regulatory and legislative developments that sort of drive the whole industry to this circular economy for plastic. And as such, the PPWR is actually welcomed from – by Amcor and from Amcor because I think we are making – we are creating an environment that allows us and the whole industry to make more progress into that direction. Again, everybody has a role to play. We are sitting in the value chain at pretty much the start. Our job is to come up with structures for plastic packaging that are recycle-ready that can be recycled. And I said a little earlier that we are making really good progress in hitting our targets by the end of 2025. So, when customers want to have these structures, we are ready to provide them to the extent we are not doing that already today, right. So, these – many of these cycle ready structures are commercial. And by creating a regulatory environment, everybody gets level set. And we can work with certainty in certain directions in order to support the business and help the very efficient and high-performance packaging substrate, find its place also in the context of sustainability. I mean there is a place for plastic here. And we got to remind ourselves why we have so much plastic packaging. It’s because it’s a very efficient and high-performing substrate. The challenge is end of life. The circular economy addresses that and regulation that gets us into that direction is welcomed."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Cameron McDonald of E&P. Your line is open."
},
{
"speaker": "Cameron McDonald",
"content": "Good morning. Question for Michael, if I can, just going back to the interest rate guidance. Can you remind us of what your hedging profile actually looks like? There was – obviously, last year, you had some significant interest rate exposure. And my understanding is that, that was mainly due to hedging and the exposure to floating rates. So, as interest rate expectations have been rather volatile in the last month or so, how do we think about your hedging profile in that and the exposure to that changing interest rate environment into FY ‘25, please?"
},
{
"speaker": "Michael Casamento",
"content": "Yes, sure. I think – look, the first point we could start, the debt profile today is about 70% fixed, 30% floating. With that, we have no maturities coming off now until the middle of 2025. So, from that respect, we have got a bit of flexibility in how we can manage the debt book and the interest exposure. As you look forward, we haven’t provided any guidance for FY ‘25. But clearly, we have given you some guidance for ‘24. If you look at our debt profile and then you look at some of the forward curves over the next 12 months or so, we are not expecting a material movement in our interest expense just based on the debt profile we have and the maturities that we have got coming. So, we have got some flexibility to work through how we manage that debt book and that currency exposure as well. So, when you put all that together, we don’t see any material change or impact on the interest expense as we look forward into ‘25. But we will provide you further guidance on that in August when we provide the full year guidance for FY ‘25 at that time."
},
{
"speaker": "Operator",
"content": "Your next question comes from the line of Anthony Longo of JPMorgan. Your line is open."
},
{
"speaker": "Anthony Longo",
"content": "Hey. Good afternoon Peter and Michael. Just a quick one on destocking you spoken about that a fair bit already. But how are you ultimately thinking about the restocking cycle in light of as some of the early positive customer discussions that you have had to-date? And ultimately, what does that inform the top line growth expectations from here? I appreciate there is no guidance, but just how you are thinking about that and philosophies around your customers’ inventory management from here as well?"
},
{
"speaker": "Peter Konieczny",
"content": "Look, I will start and then maybe Michael wants to build on it. The way that we look at this is the destocking that we are seeing currently is really a correction of the industry of holding too much inventory after a pretty volatile environment, which was driven by partly supply chain shocks that we have seen in the industry sort of de-risking and protecting their top line by building inventory and then there are other reasons. But anyway, what we are seeing right now is that the industry is normalizing across the categories. We see healthcare a little bit delayed because that’s a very conservative industry, and they probably built more because of the dynamics over the last couple of years. And now they have – they are starting to be confident, again, in the environment so that they can also reduce their inventory levels again to a normal level. Now, the new normal is probably different from what it was before holding cost of inventories because of interest rates drive that down further. The industry is looking at new efficiency levels in terms of running inventories, and that’s what we are going through right now. Going forward, we will see changes in inventory, but those will be tactical or they will go along with the seasonality of the business. So, I would not think about it as there was a trend to restocking. The industry is coming down to a new normal and everything that we see from there is going to be tactical or following the seasonality of the different businesses. So, that’s how I think about it. And therefore, once we have this extraordinary impact behind us, and we will see with our category and customer exposure and then also – hopefully going forward, also a renewed and stronger consumer interest and demand, we will see top line growth."
},
{
"speaker": "Tracey Whitehead",
"content": "Operator, we have time for one more question, please."
},
{
"speaker": "Operator",
"content": "Thank you. Your last question comes from the line of Andrew Scott of Morgan Stanley. Your line is open."
},
{
"speaker": "Andrew Scott",
"content": "Thank you. Michael, just a question for you, $40-odd million of below the line items there, I see the restructuring charges up relative to last quarter. Can you talk to us just two things, cash versus non-cash there? And when do we get line of sight to maybe seeing an end of these below the line items?"
},
{
"speaker": "Michael Casamento",
"content": "Look, Andrew, the main items in the quarter are really around the restructuring program, which we have had in there for the last 12 months or so. That program is pretty much two-thirds of the way through. We have now started to see the benefits come through from that program. You might remember, we committed to invest around $170 million in cash. We have spent on that program to-date about $110 million. So, we have still got $50 million to $60 million to go. But we are starting to see the benefits come through from that, so we are pretty pleased about the progress. And really by the end of the calendar year, we would expect to be most of the way through that program. So, that’s the way we see it from there. And as I said, we are pleased that we are now getting the benefits of $15 million in the quarter came through and we will expect to build on that in quarter four and then into ‘25. So, pretty pleased with where the program is at and it’s on track."
},
{
"speaker": "Operator",
"content": "Ladies and gentlemen, this concludes our question-and-answer session. I will now turn the call back to management for closing remarks."
},
{
"speaker": "Peter Konieczny",
"content": "Yes. Thank you, operator. Look, thank you everybody for the interest in the company. The only thing that I want to say here before we close the call is we are pretty pleased with the way how the Q3 turned out for us. I hope we were able to demonstrate that we – this was based on a broad-based volume improvement that we have seen in the business, combined with really some good cost performance in the third quarter. That also has impacted our margin performance. And more importantly, we believe that we have some underlying momentum here in order to – that will carry into Q4. So, we are very pleased with the situation we are in. We are going to take advantage of the momentum. And with that, we are going to close the call, and we are going to talk to each other again at the end of the fiscal year. Thank you very much."
},
{
"speaker": "Operator",
"content": "This concludes today’s conference call. You may now disconnect."
}
] |
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